- Quarterly Report (10-Q)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934

for the Quarterly Period Ended March 31, 2009,

Transition report pursuant to Section 13 or 15(d) Of the Exchange Act

for the Transition Period from to

No. 000-25425

(Commission File Number)

MERCER INSURANCE GROUP, INC.

(Exact name of Registrant as specified in its charter)


PENNSYLVANIA		23-2934601

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

10 North Highway 31, P.O. Box 278, Pennington, NJ		08534

(Address of principal executive offices)		(Zip Code)

(609) 737-0426

(Registrant’s telephone number, including area code)

(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 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

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

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


Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

Indicate by check mark if the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

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


		Number of Shares Outstanding as of May 1, 2009

COMMON STOCK (No Par Value)		6,443,560

(Title of Class)		(Outstanding Shares)

TABLE OF CONTENTS


	Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements		5

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk		33

Item 4. Controls and Procedures		36

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		37

Item 1A. Risk Factors		37

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		37

Item 3. Defaults Upon Senior Securities		37

Item 4. Submission of Matters to a Vote of Security Holders		38

Item 5. Other Information		38

Item 6. Exhibits		38

SIGNATURES		39

Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Forward-looking Statements

Mercer Insurance Group, Inc. (the “Group”) may from time to time make written or oral “forward-looking statements,” including statements contained in the Group’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits hereto and thereto), in its reports to shareholders and in other communications by the Group, which are made in good faith by the Group pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements with respect to the Group’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Group’s control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Group’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:

future economic conditions in the regional and national markets in which the Group competes which are less favorable than current or expected conditions;

the effects of weather-related and other catastrophic events;

the concentration of insured accounts in California, New Jersey and Pennsylvania;

the effect of legislative, judicial, economic, demographic and regulatory events in the seven states in which we do the majority of our business as of March 31, 2009;

the continuation of an A.M. Best rating in the Excellent category;

the ability to enter new markets successfully and capitalize on growth opportunities either through acquisitions or the expansion of our producer network;

the ability to obtain regulatory approval for an acquisition, to close the transaction, and to successfully integrate an acquisition and its operations;

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

the impact of acts of terrorism and acts of war;

the effects of terrorist related insurance legislation and laws;

inflation;

the cost, availability and collectibility of reinsurance;

estimates and adequacy of loss reserves and trends in losses and loss adjustment expenses;

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

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

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

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

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

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

adverse litigation or arbitration results;

the ability to carry out our business plans;

disruption in world financial markets, which could adversely affect demand for the Company’s products, and credit risk associated with agents, customers, and reinsurers, as well as adversely affecting the Company’s investment portfolio value and investment income. Disrupted markets could present difficulty if the Company needed to raise additional capital in the future,or

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

The Group cautions that the foregoing list of important factors is not exclusive. Readers are also cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this report. The Group does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Group.

Part I — FINANCIAL INFORMATION

Item 1. Financial Statements

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets
March 31, 2009 and December 31, 2008
(Dollars in thousands, except share amounts)


	2009			2008
	(Unaudited)
Assets
Investments, at fair value:
Fixed-income securities, available for sale, at fair value (cost $342,730 and $331,075, respectively)	$	349,798			334,087
Equity securities, at fair value (cost $8,083 and $9,232, respectively)		7,943			10,203

Total investments		357,741			344,290

Cash and cash equivalents		26,206			37,043
Premiums receivable		33,126			34,165
Reinsurance receivables		82,917			86,443
Prepaid reinsurance premiums		5,934			7,096
Deferred policy acquisition costs		18,761			20,193
Accrued investment income		3,666			3,901
Property and equipment, net		18,365			16,144
Deferred income taxes		10,319			9,814
Goodwill		5,416			5,416
Other assets		3,770			4,481

Total assets	$	566,221			568,986

Liabilities and Equity
Liabilities:
Losses and loss adjustment expenses	$	304,062			304,000
Unearned premiums		75,521			80,408
Accounts payable and accrued expenses		9,737			13,283
Other reinsurance balances		12,596			11,509
Trust preferred securities		15,580			15,576
Advances under line of credit		3,000			3,000
Other liabilities		3,882			3,940

Total liabilities		424,378			431,716


Stockholders’ Equity:
Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding		—			—
Common stock, no par value, authorized 15,000,000 shares, issued 7,074,333 shares, outstanding 6,816,533 and 6,801,095 shares		—			—
Additional paid-in capital		71,542			71,369
Accumulated other comprehensive income		4,439			2,494
Retained Earnings		76,565			74,138
Unearned ESOP shares		(2,351	)		(2,505	)
Treasury stock, 630,773 and 621,773 shares		(8,352	)		(8,226	)

Total stockholders’ equity		141,843			137,270

Total liabilities and stockholders’ equity	$	566,221			568,986

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended March 31, 2009 and 2008


	2009			2008
	(Dollars in thousands, except per
	share data)
	(Unaudited)
Revenues:
Net premiums earned	$	35,582			39,077
Investment income, net of expenses		3,603			3,361
Net realized investment losses		(481	)		(820	)
Other revenue		488			455


Total revenues		39,192			42,073


Expenses:
Losses and loss adjustment expenses		22,199			24,770
Amortization of deferred policy acquisition costs (related party amounts of $253 and $274, respectively)		9,905			10,362
Other expenses		2,891			3,195
Interest expense		352			296


Total expenses		35,347			38,623

Income before income taxes		3,845			3,450

Income taxes		954			858


Net income	$	2,891			2,592


Earnings per common share:
Basic	$	0.47			0.42
Diluted	$	0.46			0.41

Weighted average shares:
Basic		6,180,227			6,219,748
Diluted		6,233,044			6,378,247

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Three months ended March 31, 2009
(Unaudited, dollars in thousands)


							Accumulated
					Additional		other					Unearned
	Preferred		Common		paid-in		comprehensive		Retained			ESOP			Treasury
	stock		stock		capital		income		earnings			shares			stock			Total
Balance, December 31, 2008	$	—		—		71,369		2,494		74,138			(2,505	)		(8,226	)		137,270
Net income										2,891									2,891
Unrealized gains on securities:
Unrealized holding gains arising during period, net of related income tax expense of $810								1,573											1,573
Less reclassification adjustment for losses included in net income, net of related income tax benefit of $191								371											371
Defined benefit pension plan, net of related income tax of $1								1											1

Other comprehensive income																			1,945

Comprehensive income																			4,836

Stock compensation plan amortization						117													117
ESOP shares committed						56							154						210
Purchase of treasury stock																(126	)		(126	)
Dividends to stockholders										(464	)								(464	)

Balance,March 31, 2009	$	—		—		71,542		4,439		76,565			(2,351	)		(8,352	)		141,843

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2009 and 2008


	2009			2008
	(Dollars in thousands)
	(Unaudited)
Cash flows from operating activities:
Net income	$	2,891			2,592
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of fixed assets		770			530
Net amortization of premium		342			356
Amortization of stock compensation		117			129
ESOP share commitment		210			273
Net realized investment losses		481			820
Deferred income tax		(1,507	)		187
Change in assets and liabilities:
Premiums receivable		1,039			2,390
Reinsurance receivables		3,526			(3,669	)
Prepaid reinsurance premiums		1,162			1,659
Deferred policy acquisition costs		1,432			944
Other assets		217			(481	)
Losses and loss adjustment expenses		62			13,097
Unearned premiums		(4,887	)		(6,197	)
Other reinsurance balances		1,087			(2,520	)
Other		(3,599	)		(5,731	)

Net cash provided by operating activities		3,343			4,379


Cash flows from investing activities:
Purchase of fixed income securities, available for sale		(28,185	)		(21,790	)
Purchase of equity securities		—			(931	)
Sale and maturity of fixed income securities, available for sale		15,869			15,940
Sale of equity securities		1,717			497
Purchase of property and equipment, net		(2,991	)		(1,249	)

Net cash used in investing activities		(13,590	)		(7,533	)


Cash flows from financing activities:
Purchase of treasury stock		(126	)		—
Dividends to stockholders		(464	)		(312	)

Net cash used in financing activities		(590	)		(312	)


Net decrease in cash and cash equivalents		(10,837	)		(3,466	)
Cash and cash equivalents at beginning of period		37,043			21,580

Cash and cash equivalents at end of period	$	26,206			18,114


Cash paid during the period for:
Interest	$	348			293
Income taxes	$	—			250

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) Basis of Presentation

The financial information for the interim periods included herein is unaudited; however, such information reflects all adjustments which are, in the opinion of management, necessary to a fair presentation of the financial position, results of operations, and cash flows for the interim periods. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year.

Mercer Insurance Group, Inc. (MIG) and subsidiaries (collectively, the Group) includes Mercer Insurance Company (MIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and its subsidiary Mercer Insurance Company of New Jersey, Inc. (MICNJ), Franklin Holding Company, Inc. (FHC) and its subsidiary Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS), Financial Pacific Insurance Group, Inc. (FPIG) and its subsidiary Financial Pacific Insurance Company (FPIC). FPIG also holds an interest in three statutory business trusts that were formed for the purpose of issuing Floating Rate Capital Securities.

The Group, through its property and casualty insurance subsidiaries, provides a wide array of property and casualty insurance products designed to meet the insurance needs of individuals in New Jersey and Pennsylvania, and small and medium-sized businesses throughout Arizona, California, Nevada, New Jersey, New York, Oregon and Pennsylvania.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2008 included in the Group’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Share-Based Compensation

The Group makes grants of qualified (ISO’s) and non-qualified stock options (NQO’s), and non-vested shares (restricted stock) under its stock incentive plan. Stock options are granted at prices that are not less than market price at the date of grant, and are exercisable over a period of ten years for ISO’s and ten years and one month for NQO’s. Restricted stock grants vest over a period of three or five years.

The Group applies the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment”, using the modified-prospective-transition method. The after-tax compensation expense recorded in the consolidated statements of earnings for stock options (net of forfeitures) for the three months ended March 31, 2009 and 2008 was $46,000 and $54,000, respectively. The after-tax compensation expense recorded in the consolidated statements of earnings for restricted stock (net of forfeitures) for the three months ended March 31, 2009 and 2008 was $45,000 and $47,000, respectively. As of March 31, 2009, the Group has $0.4 million of unrecognized total compensation cost related to non-vested stock options and restricted stock. That cost will be recognized over the remaining weighted-average vesting period of one year, based on the estimated grant date fair value.

For the three months ended March 31, 2009, the Group made no grants of restricted stock and stock options. In addition, there were no forfeitures of restricted stock and no options exercised during the first three months of 2009. During the first quarter of 2009, ISO’s on 10,000 shares of stock expired unexercised and were consequently forfeited.

New Accounting Pronouncements

In February 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) FAS 157-2, Effective Date of FASB Statement No. 157 (“FSP FAS 157-2”), which delayed the application of FASB Statement No. 157 Fair Value Measurement until January 1, 2009 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis. The adoption of FSP FAS 157-2 did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162) to identify the sources of accounting principles and provide a framework for selecting the principles to be used in the preparation of financial statements in accordance with generally accepted accounting principles in the United States. The hierarchy of authoritative accounting guidance is not expected to change current practice but is expected to facilitate the FASB’s plan to designate as authoritative its forthcoming codification of accounting standards. This Statement was effective November 15, 2008. The adoption of SFAS 162 did not have a material impact on the Group’s results of operations or financial condition.

In June 2008, the FASB issued FASB Staff Position (FSP) No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities (FSP 03-6-1). FSP 03-6-1 addresses the treatment of unvested share-based payment awards containing nonforfeitable rights to dividends or dividend equivalents in the calculation of earnings per share and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. The adoption of FSP 03-6-1 did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FSP FAS 107-1 and APB 28-1”) which provide guidance relating to required disclosures concerning the fair value of financial instruments when a publicly traded company issues financial information for interim reporting periods. The requirements are effective for interim reporting periods ending after June 15, 2009. The Company did not early adopt FSP FAS 107-1 and APB 28-1, and is evaluating the impact they will have on the Company’s financial condition and results of operations.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2 and FAS 124-2”), which change the amount determined to be an other-than-temporary impairment when there are non-credit losses on a debt security which management does not intend to sell and for which it is more-likely-than-not that the entity will not have to sell the security prior to recovery of the non-credit impairment. In these situations, the portion of the total impairment that is related to the credit loss would be recognized as a charge against earnings, and the remaining portion would be included in other comprehensive income. These pronouncements are effective for interim and annual reporting periods ending after June 15, 2009. The Company did not early adopt FSP FAS 115-2 and FAS 124-2, and is evaluating the impact they will have on the Company’s financial condition and results of operations.

In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”), which addresses the factors that determine whether there has been a significant decrease in the volume and level of activity for an asset or liability when compared to the normal market activity. This pronouncement provides that if it has been determined that the volume and level of activity has significantly decreased and that transactions are not orderly, further analysis is required and significant adjustments to the quoted prices or transactions might be needed. FSP FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. The Company did not early adopt FSP 157-4 and is evaluating the impact it will have on the Company’s financial condition and results of operations.

(2) Segment Information

The Group markets its products through independent insurance agents, which sell commercial lines of insurance primarily to small to medium-sized businesses and personal lines of insurance to individuals.

The Group manages its business in three segments: commercial lines insurance (including surety), personal lines insurance, and investments. The commercial lines insurance and personal lines insurance segments are managed based on underwriting results determined in accordance with U.S. generally accepted accounting principles, and the investment segment is managed based on after-tax investment returns.

Underwriting results for commercial lines and personal lines take into account premiums earned, incurred losses and loss adjustment expenses, and underwriting expenses. The investments segment is evaluated by consideration of net investment income (investment income less investment expenses) and realized gains and losses.

In determining the results of each segment, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes.

Financial data by segment is as follows:


	Three Months Ended March 31,
	2009			2008
	(In thousands)
Revenues:
Net premiums earned:
Commercial lines	$	30,704		$	34,031
Personal lines		4,878			5,046

Total net premiums earned		35,582			39,077
Net investment income		3,603			3,361
Net realized investment losses		(481	)		(820	)
Other revenue		488			455

Total revenues	$	39,192		$	42,073

Income before income taxes:
Underwriting income (loss):
Commercial lines	$	1,320		$	772
Personal lines		(733	)		(22	)

Total underwriting income		587			750
Net investment income		3,603			3,361
Net realized investment losses		(481	)		(820	)
Other		136			159

Income before income taxes	$	3,845		$	3,450

(3) Reinsurance

Premiums earned are net of amounts ceded of $4.5 million and $5.7 million for the three months ended March 31, 2009 and 2008, respectively. Losses and loss adjustment expenses are net of amounts ceded of $0.7 million and $5.9 million for the three months ended March 31, 2009 and 2008, respectively.

Effective January 1, 2009, the Group renewed its reinsurance coverages with a number of changes. The retention on any individual property or casualty risk was increased to $1.0 million from $850,000. Umbrella liability written by FPIC is now reinsured on a 75% quota share basis up to $1.0 million and on a 100% quota share basis in excess of $1.0 million. Prior to 2009, umbrella liability written by FPIC was reinsured on a 100% quota share basis with the exception of business owner policies, which were reinsured 75% up to $1.0 million and then on a 100% quota share basis in excess of $1.0 million. The 2009 changes to the umbrella liability reinsurance program conform FPIC’s retention on umbrella liability with all of the other insurance companies in the Group.

In conjunction with the renewal of the reinsurance program for both 2009 and 2008, the prior year reinsurance treaties were terminated on a run-off basis, which requires that for policies in force as of December 31, 2008 and 2007, respectively, these reinsurance agreements continue to cover losses occurring on these policies in the future. Therefore, the Group will continue to remit premiums to and collect reinsurance recoverable from the reinsurers on these prior year treaties as the underlying business runs off.

(4) Comprehensive Income

The Group’s comprehensive income for the three month period ended March 31, 2009 and 2008 is as follows:


	Three Months Ended March 31,
	2009		2008
	(In thousands)
Net income	$	2,891	$	2,592
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period, net of related income tax expense of $810 and $239, respectively		1,573		464
Less reclassification adjustment for losses included in net income, net of related income tax benefit of $191 and $42, respectively		371		82
Defined benefit pension plan, net of related income tax of $1		1		—

		1,945		546

Comprehensive income	$	4,836	$	3,138

(5) Share-based Compensation

The Group adopted the Mercer Insurance Group, Inc. 2004 Stock Incentive Plan (the Plan) on June 16, 2004. Awards under the Plan may be made in the form of incentive stock options, nonqualified stock options, restricted stock or any combination to employees and non-employee Directors. At adoption, the Plan initially limited to 250,000 the number of shares that may be awarded as restricted stock, and to 500,000 the number of shares for which incentive stock options may be granted. The total number of shares initially authorized in the Plan was 876,555 shares, with an annual increase equal to 1% of the shares outstanding at the end of each year. As of March 31, 2009, the Plan’s authorization has been increased under this feature to 1,206,091 shares. The Plan provides that stock options and restricted stock awards may include vesting restrictions and performance criteria at the discretion of the Compensation Committee of the Board of Directors. The term of options may not exceed ten years for incentive stock options, and ten years and one month for nonqualified stock options, and the option price may not be less than fair market value on the date of grant. The grants made under the plan employ graded vesting over vesting periods of 3 or 5 years for restricted stock, incentive stock options, and nonqualified stock option grants, and include only service conditions. Upon exercise, it is anticipated that newly issued shares will be issued to the option holder.

Information regarding stock option activity in the Group’s Plan is presented below:


				Weighted Average
	Number of			Exercise Price
	Shares			per Share
Outstanding at December 31, 2008		600,700		$	13.24
Granted — 2009		—			—
Exercised — 2009		—			—
Forfeited — 2009		(10,000	)		12.21

Outstanding at March 31, 2009		590,700		$	13.26


Exercisable at:
March 31, 2009		535,867		$	12.87
Weighted-average remaining contractual life				5.3 years
Compensation remaining to be recognized for unvested stock options at March 31, 2009 (millions)				$	0.2
Weighted-average remaining amortization period				1.1 years
Aggregate Intrinsic Value of outstanding options, March 31, 2009 (millions)				$	1.1
Aggregate Intrinsic Value of exercisable options, March 31, 2009 (millions)				$	1.0

In determining the expense to be recorded for stock options in the consolidated statements of earnings, the fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model. The significant assumptions utilized in applying the Black-Scholes-Merton option pricing model are the risk-free interest rate, expected term, dividend yield, and expected volatility. The risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used as the assumption in the model. The expected term of an option award is based on expected experience of the awards. The dividend yield is determined by dividing the per-share dividend by the grant date stock price. The expected volatility is based on the volatility of the Group’s stock price over a historical period.

Information regarding unvested restricted stock activity in the Group’s Plan is below:


			Weighted Average
	Number of		Fair Value
	Shares		per Share
Unvested restricted stock at December 31, 2008		22,792	$	15.26
Granted — 2009		—		—
Vested — 2009		—		—
Forfeited — 2009		—		—

Unvested restricted stock at March 31, 2009		22,792	$	15.26

Compensation remaining to be recognized for unvested restricted stock at March 31, 2009 (millions)			$	0.2
Weighted-average remaining amortization period			0.6 years

(6) Earnings per Share

The computation of basic and diluted earnings per share is as follows:


	Three Months Ended March 31,
	2009		2008
	(Dollars in thousands,
	except per share data)
Numerator for basic and diluted earnings per share:
Net income	$	2,891	$	2,592

Denominator for basic earnings per share — weighted-average shares outstanding		6,180,227		6,219,748
Effect of stock incentive plans		52,817		158,499

Denominator for diluted earnings per share		6,233,044		6,378,247

Basic earnings per share	$	0.47	$	0.42

Diluted earnings per share	$	0.46	$	0.41

The denominator for diluted earnings per share does not include the effect of outstanding stock options that have an anti-dilutive effect. Options on 40,000 shares were considered to be anti-dilutive for the three month period ended March 31, 2009 and 2008 and were excluded from the earnings per share calculation.

(7) Fair Value of Assets and Liabilities

In accordance with SFAS 157, the Group’s assets and financial liabilities measured at fair value are categorized into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

•

Level 1 — Valuations based on unadjusted quoted market prices in active markets for identical assets that the Group has the ability to access. Since the valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these securities does not entail a significant amount or degree of judgment.

•

Level 2 — Valuations based on quoted prices for similar assets in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, prepayment speeds, default rates, loss severities, etc.) or can be corroborated by observable market data.

•

Level 3 — Valuations that are derived from techniques in which one or more of the significant inputs are unobservable, including broker quotes which are non-binding.

The Group uses quoted values and other data provided by a nationally recognized independent pricing service (pricing service) as inputs into its process for determining fair values of its investments. The pricing service covers over 99% of all asset classes, fixed-income and equity securities, domestic and foreign.

The pricing service obtains market quotations and actual transaction prices for securities that have quoted prices in active markets. Fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis. For these securities, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.

Relevant market information, relevant credit information, perceived market movements and sector news is used to evaluate each asset class. The market inputs utilized in the pricing evaluation include but are not limited to: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and industry and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities additional inputs may be necessary.

The pricing service utilized by the Group has indicated that they will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If the pricing service discontinues pricing an investment, the Group would be required to produce an estimate of fair value using some of the same methodologies as the pricing service, but would have to make assumptions for market based inputs that are unavailable due to market conditions.

The Group reviews its securities measured at fair value and the classification of such investments based on industry practice. A review process is performed on prices received from the pricing service. In addition, a review is performed of the pricing service’s processes, practices and inputs, which include any number of financial models, quotes, trades and other market indicators. Pricing of the portfolio is reviewed on a monthly basis and securities with changes in prices exceeding defined tolerances are verified to other sources (e.g. broker, Bloomberg, etc.). Any price challenges resulting from this review are based upon significant supporting documentation which is provided to the pricing service for its review. The Group does not adjust quotes or prices obtained from the pricing service without first going through this process of challenging the price with the pricing service.

The fair value estimates of most fixed maturity investments are based on observable market information rather than market quotes. Accordingly, the estimates of fair value for such fixed maturities, other than U.S. Treasury securities, provided by the pricing service are included in the amount disclosed in Level 2 of the hierarchy. The estimated fair values of U.S. Treasury securities are included in the amount disclosed in Level 1 as the estimates are based on unadjusted market prices. The Group determined that Level 2 securities would include corporate bonds, mortgage backed securities, municipal bonds, asset backed securities, certain U.S. government agencies, non-U.S. government securities, certain short-term securities and investments in mutual funds.

Securities are generally assigned to Level 3 in cases where non-binding broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. The Group’s Level 3 securities were valued primarily through the use of non-binding broker quotes.

Equities that trade on a major exchange are assigned to Level 1. Equities not traded on a major exchange are assigned to Levels 2 or 3 based on the criteria and hierarchy described above. Short-term investments such as open ended mutual funds where the fund maintains a constant net asset value of one dollar, money market funds, cash and cash sweep accounts and treasury bills are classified as Level 1. Level 2 short-term investments include commercial paper and certificates of deposit, for which all inputs are observable.

Included in Level 2, Other Liabilities are interest rate swap agreements which the Group is a party to in order to hedge the floating interest rate on its Trust Preferred Securities, thereby changing the variable rate exposure to a fixed rate exposure for interest on these obligations. The estimated fair value of the interest rate swaps is obtained from the third-party financial institution counterparties.

The table below presents the balances of financial assets and liabilities measured at fair value on a recurring basis.


	March 31, 2009
			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
(in thousands)	Total		(Level 1)		(Level 2)		(Level 3)

Fixed-income securities, available for sale	$	349,798	$	4,399	$	343,934	$	1,465
Equity securities		7,943		7,652		245		46

Total assets	$	357,741	$	12,051	$	344,179	$	1,511


Other liabilities	$	1,797	$	—	$	1,797	$	—

Total liabilities	$	1,797	$	—	$	1,797	$	—

The changes in Level 3 financial assets and liabilities measured at fair value on a recurring basis are summarized as follows:


	For the Three Months Ended
	March 31, 2009
	Fixed-income
	securities,
	available			Equity
(in thousands)	for sale			securities

Balance, beginning of period	$	1,767		$	46
Total net losses included in net income		(285	)		—
Total net losses included in other comprehensive income		(15	)		—
Purchases, sales, issuances and settlements, net		(2	)		—

Balance, end of period	$	1,465		$	46

(8) Derivative Instruments and Hedging Activities

The Group entered into three interest rate swap agreements to hedge against interest rate risk on its floating rate Trust preferred securities. Our interest rate swaps are contracts to convert, for a period of time, the floating rate of the Trust preferred securities into a fixed rate without exchanging the instruments themselves. As of March 31, 2009 and December 31, 2008, the Group was party to interest-rate swap agreements with an aggregate notional principal amount of $15,500.

The Group accounts for its interest rate swaps in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities . On January 1, 2009, the Group adopted SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (SFAS 161), which changes the disclosure requirements for derivative instruments and hedging activities. The adoption of SFAS 161 did not have a material impact on the Group’s results of operations or financial condition.

The Group has designated the interest rate swaps as non-hedge instruments. Accordingly, the Group recognizes the fair value of the interest rate swaps as assets or liabilities on the consolidated balance sheets with the changes in fair value recognized in the consolidated statement of earnings. The estimated fair value of the interest rate swaps is based on the valuation received from the financial institution counterparty.

By using hedging financial instruments to hedge exposures to changes in interest rates, the Group exposes itself to market and credit risk. Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates. Credit risk is the failure of the counterparty to perform under the terms of the contract. When the fair value of a contract is positive, the counterparty owes the Group, which creates credit risk for the Group. When the fair value of a contract is negative, the Group owes the counterparty and, therefore, it does not possess credit risk. The Group minimizes the credit risk in hedging instruments by entering into transactions with high-quality counterparties whose credit rating is higher than Aa.

A summary of the fair values of interest rate swaps outstanding as of March 31, 2009 and December 31, 2008 follows:


	March 31,				December 31,
	2009				2008
	Balance				Balance
	Sheet	Fair Value			Sheet	Fair Value
	Location	asset (liability)			Location	asset (liability)
Interest rate swaps:

Union Bank of California (Trust I)	Other liabilities	$	(534	)	Other liabilities	$	(546	)
Union Bank of California (Trust II)	Other liabilities		(353	)	Other liabilities		(366	)
Union Bank of California (Trust III)	Other liabilities		(911	)	Other liabilities		(967	)


Total derivatives		$	(1,798	)		$	(1,879	)

A summary of the effect of derivative instruments on the consolidated statements of earnings for the three months ended March 31, 2009 and 2008 follows:

March 31,

2009

2008

Amount of Gain

Amount of (Loss)

Location of Gain Recognized in

Recognized in

Location of (Loss) Recognized in

Recognized in

Income

Interest rate swaps:

Union Bank of California (Trust I)

Realized investment losses

(223

)

Union Bank of California (Trust II)

Realized investment losses

(121

)

Union Bank of California (Trust III)

Realized investment losses

(352

)

Total derivatives

(696

)

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

The following presents management’s discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. You should read this discussion in conjunction with the consolidated financial statements and notes thereto included in this report. This discussion contains forward-looking information that involves risks and uncertainties. Actual results could differ significantly from these forward-looking statements. See “Forward-Looking Statements”.

Overview

Mercer Insurance Group, Inc. (MIG or the Holding Company) is a holding company owning, directly and indirectly, all of the outstanding shares of our four insurance companies and our non-insurance subsidiaries (collectively, the Group). Mercer Insurance Company, our oldest insurance company, has been engaged in the sale of property and casualty insurance since 1844. Our insurance companies underwrite property and casualty insurance principally in Arizona, California, New Jersey, New York, Nevada, Oregon, and Pennsylvania and are as follows:

•

Mercer Insurance Company (MIC), a Pennsylvania property and casualty stock insurance company offering insurance coverages to businesses and individuals in New Jersey, New York and Pennsylvania;

•

Mercer Insurance Company of New Jersey, Inc. (MICNJ), a New Jersey property and casualty stock insurance company offering insurance coverages to businesses and individuals located in New Jersey and businesses located in New York;

•

Franklin Insurance Company (FIC), a Pennsylvania property and casualty stock insurance company offering private passenger automobile and homeowners insurance to individuals located in Pennsylvania; and

•

Financial Pacific Insurance Company (FPIC), a California property and casualty stock insurance company offering insurance and surety products to small and medium sized commercial businesses in Arizona, California, Nevada and Oregon, and direct mail surety products to commercial businesses in various other states.

The Group’s operating subsidiaries are licensed collectively in twenty-two states, but are currently focused on doing business in seven states: Arizona, California, Nevada, New Jersey, New York, Pennsylvania and Oregon. MIC and MICNJ write property and casualty insurance in New York which only supports existing accounts written in other states. FPIC holds an additional fifteen state licenses outside of the Group’s current focus area. Currently, only direct mail surety is being written in some of these states.

The Group is subject to regulation by the insurance regulators of each state in which it is licensed to transact business. The primary regulators are the Pennsylvania Insurance Department, the California Department of Insurance, and the New Jersey Department of Banking and Insurance, because these are the regulators for the states of domicile of the Group’s insurance subsidiaries, as follows: MIC (Pennsylvania-domiciled), FPIC (California-domiciled), MICNJ (New Jersey-domiciled), and FIC (Pennsylvania-domiciled).

The insurance affiliates within the Group participate in a reinsurance pooling arrangement (the “Pool”) whereby each insurance affiliate’s underwriting results are combined and then distributed proportionately to each participant. Each insurer’s share in the Pool is based on their respective statutory surplus from the most recently filed statutory annual statement as of the beginning of each year.

All insurance companies in the Group have been assigned a group rating of “A” (Excellent) by A.M. Best. The Group has been assigned that rating for the past 8 years. An “A” rating is the third highest rating of A.M. Best’s 16 possible rating categories.

We manage our business and report our operating results in three operating segments: commercial lines insurance, personal lines insurance and the investment function. Assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. Our commercial lines insurance business consists primarily of multi-peril, general liability, commercial auto, and related insurance coverages. Our personal lines insurance business consists primarily of homeowners (in New Jersey and Pennsylvania) and private passenger automobile (in Pennsylvania only) insurance coverages.

Our income is principally derived from written premiums received from insureds in the commercial lines (businesses insured) and personal lines (individuals insured) segments, less the costs of underwriting the insurance policies, the costs of settling and paying claims reported on the policies, and from investment income reduced by investment expenses and gains or losses on holdings in our investment portfolio. Written premiums are the total amount of premiums billed to the policyholder less the amount of premiums returned, generally as a result of cancellations, during a policy period. Written premiums become premiums earned as the policy ages. In the absence of premium rate changes, if an insurance company writes the same number and mix of policies each year, written premiums and premiums earned will be equal, and the unearned premium reserve will remain constant. During periods of growth, the unearned premium reserve will increase, causing premiums earned to be less than written premiums. Conversely, during periods of decline, the unearned premium reserve will decrease, causing premiums earned to be greater than written premiums.

Variability in our income is caused by a variety of circumstances, some within the control of our companies and some not within our control. Premium volume is affected by, among other things, the availability and regular flow to our insurance companies of quality, properly-priced risks being produced by our agents, the ability to retain on renewal existing good-performing accounts, competition from other insurance companies, regulatory rate approvals, our reputation, and other limitations created by the marketplace or regulators. Our underwriting costs are affected by, among other things, the amount of commission and profit-sharing commission we pay our agents to produce the underwriting risks for which we receive premiums, the cost of issuing insurance policies and maintaining our customer and agent relationships, marketing costs, taxes we pay to the states in which we operate on the amount of premium we collect, and other assessments and charges imposed on our companies by the regulators in the states in which we do business. Our claim and claim settlement costs are affected by, among other things, the quality of our accounts, severe or extreme weather in our operating region, the nature of the claim, the regulatory and legal environment in our territories, inflation in underlying medical and property repair costs, and the availability and cost of reinsurance. Our investment income and realized gains and losses are determined by, among other things, market forces, the rates of interest and dividends paid on our investment portfolio holdings, the credit or investment quality of the issuers and the success of their underlying businesses, the market perception of the issuers, and other factors such as ratings by rating agencies and analysts.

Critical Accounting Policies

General. The Group’s financial statements are prepared in conformity with U.S. generally accepted accounting principles (GAAP). We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments.

Liabilities for Loss and Loss Adjustment Expenses. Unpaid losses and loss adjustment expenses, also referred to as loss reserves, are the largest liability of our property and casualty subsidiaries. Our loss reserves include case reserve estimates for claims that have been reported and bulk reserve estimates for (a) the expected aggregate differences between the case reserve estimates and the ultimate cost of reported claims and (b) claims that have been incurred but not reported as of the balance sheet date, less estimates of the anticipated salvage and subrogation recoveries. Each of these categories also includes estimates of the loss adjustment expenses associated with processing and settling all reported and unreported claims. Estimates are based upon past loss experience modified for current and expected trends as well as prevailing economic, legal and social conditions.

The amount of loss and loss adjustment expense reserves for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved, specific knowledge of the circumstances surrounding each claim, and the insurance policy provisions relating to the type of loss. The amounts of loss reserves for unreported losses and loss adjustment expenses are determined using historical information by line of business, adjusted to current conditions. Inflation is ordinarily provided for implicitly in the reserving function through analysis of costs, trends, and reviews of historical reserving results over multiple years. Our loss reserves are not discounted to present value.

Reserves are closely monitored and recomputed periodically using the most recent information on reported claims and a variety of projection techniques. Specifically, on at least a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves, and paid losses with respect to the current and prior accident years. We use historical paid and incurred losses and accident year data to derive expected ultimate loss and loss adjustment expense ratios (to earned premiums) by line of business. We then apply these expected loss and loss adjustment expense ratios to earned premiums to derive a reserve level for each line of business. In connection with the determination of the reserves, we also consider other specific factors such as recent weather-related losses, trends in historical paid losses, economic conditions, and legal and judicial trends with respect to theories of liability. Any changes in estimates are reflected in operating results in the period in which the estimates are changed.

We perform a comprehensive annual review of loss reserves for each of the lines of business we write in connection with the determination of the year end carried reserves. The review process takes into consideration the variety of trends and other factors that impact the ultimate settlement of claims in each particular class of business. A similar review is performed prior to the determination of the June 30 carried reserves. Prior to the determination of the March 31 and September 30 carried reserves, we review the emergence of paid and reported losses relative to expectations and make necessary adjustments to our carried reserves. There are also a number of analyses of claims experience and reserves undertaken by management on a monthly basis.

When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are adjusted by our claims staff as more information becomes available. It is our policy to periodically review and revise case reserves and to settle each claim as expeditiously as possible.

We maintain bulk and IBNR reserves (usually referred to as “IBNR reserves”) to provide for claims already incurred that have not yet been reported (and which often may not yet be known to the insured) and for future developments on reported claims. The IBNR reserve is determined by estimating our insurance companies’ ultimate net liability for both reported and incurred but not reported claims and then subtracting both the case reserves and payments made to date for reported claims; as such, the “IBNR reserves” represent the difference between the estimated ultimate cost of all claims that have occurred or will occur and the reported losses and loss adjustment expenses. Reported losses include cumulative paid losses and loss adjustment expenses plus aggregate case reserves. A relatively large proportion of our gross and net loss reserves, particularly for long tail liability classes, are reserves for IBNR losses.

Some of our business relates to coverage for short-tail risks and, for these risks, the development of losses is comparatively rapid and historical paid losses and case reserves, adjusted for known variables, have been a reliable guide for purposes of reserving. “Tail” refers to the time period between the occurrence of a loss and the settlement of the claim. The longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary. Some of our business relates to long-tail risks, where claims are slower to emerge (often involving many years before the claim is reported) and the ultimate cost is more difficult to predict. For these lines of business, more sophisticated actuarial methods, such as the Bornhuetter-Ferguson loss development method, are employed to project an ultimate loss expectation, and then the related loss history must be regularly evaluated and loss expectations updated, with a likelihood of variability from the initial estimate of ultimate losses. A substantial portion of the business written by FPIC is this type of longer-tailed casualty business.

Reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at March 31, 2009.

The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product liability, mold, and other uncertain exposures. We have not experienced significant losses from these types of claims. Our subsidiary, FPIC, insures contractors for liability for construction defect risks, among other risks.

The table below summarizes loss and loss adjustment reserves by major line of business:


	March 31,		December 31,
	2009		2008
	(In thousands)
Commercial lines:
Commercial multi-peril	$	227,010	$	224,444
Commercial automobile		39,598		42,230
Surety		10,658		10,606
Other liability		8,601		8,018
Workers’ compensation		8,166		8,150
Fire, allied, inland marine		153		163

		294,186		293,611

Personal lines:
Homeowners		7,064		7,215
Personal automobile		1,823		1,795
Other liability		529		1,008
Fire, allied, inland marine		458		335
Workers’ compensation		2		36

		9,876		10,389

Total	$	304,062	$	304,000

Investments. Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in stockholders’ equity as a component of accumulated other comprehensive income and, accordingly, have no effect on net income. A decline in fair value of an investment below its cost that is deemed other than temporary is charged to earnings as a realized loss. We monitor our investment portfolio and review investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. These evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. Adverse investment market conditions, poor operating performance, or other adversity encountered by companies whose stock or fixed maturity securities we own could result in impairment charges in the future. Our policy on impairment of value of investments is as follows: if a security has a market value below cost it is considered impaired. For any such security a review of the financial condition and prospects of the company will be performed by the Investment Committee to determine if the decline in market value is other than temporary. If it is determined that the decline in market value is “other than temporary”, the carrying value of the security will be written down to “realizable value” and the amount of the write down accounted for as a realized loss. “Realizable value” is defined for this purpose as the market price of the security. Write down to a value other than the market price requires objective evidence in support of that value.

In evaluating the potential impairment of fixed income securities, the Investment Committee will evaluate relevant factors, including but not limited to the following: the issuer’s current financial condition and ability to make future scheduled principal and interest payments, relevant rating history, analysis and guidance provided by rating agencies and analysts, the degree to which an issuer is current or in arrears in making principal and interest payments, and changes in price relative to the market.

In evaluating the potential impairment of equity securities, the Investment Committee will evaluate certain factors, including but not limited to the following: the relationship of market price per share versus carrying value per share at the date of acquisition and the date of evaluation, the price-to-earnings ratio at the date of acquisition and the date of evaluation, any rating agency announcements, the issuer’s financial condition and near-term prospects, including any specific events that may influence the issuer’s operations, the independent auditor’s report on the issuer’s financial statements; and any buy/sell/hold recommendations or price projections by outside investment advisors.

In the three months ended March 31, 2009 and 2008, we recorded a pre-tax charge to earnings of $535,000 and $100,000, respectively, for write-downs of other than temporarily impaired securities (OTTI).

Since the middle of 2008, there have been continuing disruptions in the financial and equity markets. This has resulted from, in part, failures of financial institutions on an unprecedented scale, and caused a significant reduction in liquidity and trading flows in the credit markets. Such impacts have affected the valuations of both the fixed income and equity securities we hold. The loss of confidence and the so-called, “credit freeze” in the capital markets recently have also led to significant changes in banking institutions which further impact market valuations.

In the first quarter of 2009, the Company recorded $535,000 in OTTI write-downs. Six securities were written down, including a mortgage backed security ($286,000), an asset backed security ($46,000), two equity positions ($64,000), and two capital trust preferred stock securities ($139,000). All were treated as other than temporarily impaired as a result of deteriorating underlying collateral issues, including increased delinquency and default rates and slower payments, as well as declining business conditions and rating agency downgrades.

Policy Acquisition Costs. We defer policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses that vary with and are primarily related to the production of business. These costs are amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, loss and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected loss and loss adjustment expenses, may require acceleration of the amortization of deferred policy acquisition costs.

Reinsurance. Amounts recoverable from property and casualty reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts.

Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid loss and loss adjustment expenses are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve us of our legal liability to our policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid loss and loss adjustment expenses affect the estimates for the ceded portion of these liabilities. We continually monitor the financial condition of our reinsurers.

Income Taxes. We use the asset and liability method of accounting for income taxes. Deferred income taxes are provided and arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.

Results of Operations

The key goal of the Group’s business model is the sale of properly priced and underwritten personal and commercial property and casualty insurance through independent agents and the investment of the premiums in a manner designed to assure that claims and expenses can be paid while providing a return on the capital employed. Loss trends and investment performance are critical factors in the success of the business model.

Our results of operations are also influenced by factors affecting the property and casualty insurance industry in general. The operating results of the United States property and casualty insurance industry are subject to significant variations due to competition, weather, catastrophic events, regulation, the availability and cost of satisfactory reinsurance, general economic conditions, judicial trends, fluctuations in interest rates and other changes in the investment environment.

The availability of reinsurance at reasonable pricing is an important part of our business. Effective, January 1, 2009, the Group increased its retention to $1 million (from a maximum retention of $850,000 in 2008) on the casualty, property and workers’ compensation lines of business. As the Group increases the net retention of the business it writes, net premiums written and earned will increase and ceded losses will decrease.

The Group writes homeowners insurance only in New Jersey and Pennsylvania, and personal automobile insurance only in Pennsylvania. Personal lines insurance is not written in any other states in which the Group does business.

Three months ended March 31, 2009 compared to three months ended March 31, 2008

The components of income for the first three months of 2009 and 2008, and the change and percentage change from year to year, are shown in the charts below. The accompanying narrative refers to the statistical information displayed in the chart immediately above the narrative.


Three months ended March 31,
2009 vs. 2008 Income	2009			2008			Change			% Change
	(Dollars in thousands)

Commercial lines underwriting income	$	1,320		$	772		$	548			71.0	%
Personal lines underwriting loss		(733	)		(22	)		(711	)		N/M
Total underwriting income		587			750			(163	)		(21.7	)%
Net investment income		3,603			3,361			242			7.2	%
Net realized investment losses		(481	)		(820	)		339			N/M
Other		488			455			33			7.3	%
Interest expense		(352	)		(296	)		(56	)		18.9	%
Income before income taxes		3,845			3,450			395			11.4	%
Income taxes		954			858			96			11.2	%
Net Income		2,891			2,592			299			11.5	%

Loss/ LAE ratio (GAAP)		62.4	%		63.4	%		(1.0	)%
Underwriting expense ratio (GAAP)		36.0	%		34.7	%		1.3	%
Combined ratio (GAAP)		98.4	%		98.1	%		0.3	%

Loss/ LAE ratio (Statutory)		62.4	%		63.4	%		(1.0	)%
Underwriting expense ratio (Statutory)		36.1	%		35.6	%		0.5	%
Combined ratio (Statutory)		98.5	%		99.0	%		(0.5	)%

(N/M means “not meaningful”)

Net income for the quarter ended March 31, 2009 increased by $299,000 or 11.5% over the net income for the quarter ended March 31, 2008, going from $2.59 million to $2.89 million.

Our GAAP combined ratio for the first three months of 2009 was 98.4%, as compared to a combined ratio for the prior year of 98.1%. The statutory combined ratio for the three months ended March 31, 2009 and 2008 was 98.5% and 99.0%, respectively. See the discussion below relating to commercial and personal lines performance.

Net investment income increased $242,000 or 7.2% to $3.6 million for the first three months of 2009 as compared to $3.4 million for the first three months of 2008. This increase was driven by an increase in net cash and invested assets resulting from operating cash flow, including the benefits of the 2009 and 2008 reinsurance agreement changes, which result in less premium being ceded to reinsurers.

Net realized investment losses amounted to $481,000 for the first three months of 2009, which is primarily driven by other than temporary impairment write-downs on investment securities, as well as a realized gain on the mark-to-market valuation on the interest rate swaps for the trust preferred securities (which convert the interest rate on our trust preferred obligations from floating to fixed) and a realized loss on the sales of investments. Net realized investment losses amounted to $820,000 for the first three months of 2008, driven primarily by changes in the fair value of the interest rate swaps for the floating rate trust preferred securities. Other revenue of $0.5 million and $0.5 million for the first three months of 2009 and 2008, respectively, represents primarily service charges recorded on insurance premium payment plans. Interest expense of $352,000 and $296,000 for the first three months of 2009 and 2008, respectively, represents interest charges on the trust preferred obligations of FPIG.

Charts and discussion relating to each of our segments (commercial lines underwriting, personal lines underwriting, and the investment segment) follow with further discussion below.


Three Months Ended March 31,
2009 vs. 2008 Revenue	2009			2008			Change			% Change
	(In thousands)
Direct premiums written	$	34,993		$	38,297		$	(3,304	)		(8.6)	%
Net premiums written		31,856			34,539			(2,683	)		(7.8)	%
Net premiums earned		35,582			39,077			(3,495	)		(8.9)	%
Net investment income		3,603			3,361			242			7.2	%
Net realized investment losses		(481	)		(820	)		339			N/M
Other revenue		488			455			33			7.3	%
Total revenue	$	39,192		$	42,073		$	(2,881	)		(6.8)	%

(N/M means “not meaningful”)

Total revenues declined to $39.2 million from $42.1 million in the three months ended March 31, 2009, as compared to the prior year. Net premiums earned totaled $35.6 million for the first three months of 2009 as compared to $39.1 million for the first three months of 2008, representing a 8.9% or $3.5 million decrease. Net premiums written decreased $2.7 million or 7.8% to $31.9 million for the first three months of 2009 as compared to $34.5 million for the first three months of 2008. The decline in net premiums written is attributable to the 8.6% decline in direct premiums written, offset by the positive impact on net premiums written of the change in reinsurance structure (in 2009 working-layer retention increased to $1,000,000 from $850,000, and in 2008 working-layer retention increased to $850,000 from $750,000, on casualty and property lines). Direct premiums written and earned were negatively impacted in large part by the weak economy, particularly as it relates to the new construction industry in California, an important operating territory for the Company.

In the first three months of 2009, direct premiums written declined $3.3 million or 8.6% to $35.0 million, as compared to $38.3 million in the first three months of 2008. The decline in direct premiums written is attributable to a more difficult economic environment, particularly in our California operating territory, as well as competitive market conditions and continuing competition on large accounts.

The decline in year-to-date direct premiums written reflects a continuing competitive marketplace and declining levels of economic activity in our operating territories. The current market is very competitive, with pricing and coverage competition being seen in virtually all classes of commercial accounts, package policies, commercial automobile policies and in the Pennsylvania personal auto market and Pennsylvania and New Jersey homeowners markets, all of which makes it more challenging to retain our accounts on renewal, or to renew a policy at the expiring premium. Competition also continues on large accounts, particularly in the East Coast habitational and California construction contracting programs, as competitors aggressively compete for these higher premium accounts. Pricing in the property and casualty insurance industry historically has been and remains cyclical. During a soft market cycle, such as the current market condition, price competition is prevalent, which makes it challenging to write and retain properly priced personal and commercial lines business. We continue to work with our agents to target classes of business and accounts compatible with our underwriting appetite, which includes certain types of religious institution risks, contracting risks, small business risks and property risks. Despite the pricing pressures of the marketplace, management maintains a strong focus on its policy of disciplined underwriting and pricing standards, declining business which it determines is inadequately priced for its level of risk. In spite of these competitive market conditions, our Group’s policy retention on renewal has been favorable across most product lines.

In the fourth quarter of 2008, a new Business Owners Policy (“BOP”) for California risks was introduced. This product targets small to medium sized businesses, which have been shown to be somewhat less price sensitive than larger accounts. This product also helps to balance FPIC’s business between property and casualty exposures. Additionally, a new contracting product which specializes in covering artisan contractors was introduced in the first quarter. Artisan contractors primarily provide repair and maintenance services, and this segment tends to experience less severe market fluctuations in difficult economic times compared to the real estate construction industry.

Net investment income totaled $3.6 million for the first three months of 2009, as compared to $3.4 million for the first three months of 2008, representing a 7.2% increase. Net realized investment losses amounted to $481,000 for the first three months of 2009 as compared to net realized investment losses of $820,000 for the first three months of 2008. The net realized investment loss in 2009 is primarily driven by other than temporary impairments on investment securities, a small realized gain on the mark-to-market valuation on the interest rate swaps for the trust preferred securities, and a small realized loss on sales of investments. The net realized investment loss in 2008 is primarily driven by a realized loss on the mark-to-market valuation on the interest rate swaps for the trust preferred securities. See the discussion of other than temporary impairments on investment securities in the “Critical Accounting Policies” section.

Growth in Net Investment Income is discussed below.


Three Months Ended March 31,
2009 vs. 2008 Investment Income and Realized Losses	2009			2008			Change			% Change
	(In thousands)
Fixed income securities	$	3,937		$	3,609		$	328			9.1	%
Dividends		80			85			(5	)		(5.9)	%
Cash, cash equivalents & other		47			170			(123	)		(72.4)	%
Gross investment income		4,064			3,864			200			5.2	%
Investment expenses		(461	)		(503	)		42			8.3	%
Net investment income	$	3,603		$	3,361		$	242			7.2	%

Realized losses — fixed income securities	$	(319	)	$	—		$	(319	)		N/M
Realized losses — equity securities		(243	)		(124	)		(119	)		N/M
Mark-to-market valuation for interest rate swaps		81			(696	)		777			N/M
Net realized losses	$	(481	)	$	(820	)	$	339			N/M

(N/M means “not meaningful”)

In the first three months of 2009 net investment income increased $242,000, or 7.2%, to $3.6 million, as compared to $3.4 million in the first three months of 2008. The increase in net investment income in 2009 is the result of an increase in average net cash and invested assets. The increase in invested assets is driven primarily by operating cash flow, including the benefits of the 2009 and 2008 reinsurance agreement changes, which result in less premium being ceded to reinsurers.

In the first three months of 2009 investment income on fixed income securities increased $328,000, or 9.1%, to $3.9 million, as compared to $3.6 million in the first three months of 2008. This was driven largely by an increase in the average investments held in fixed income securities. Our tax equivalent yield (yield adjusted for tax-benefit received on tax-exempt securities) on fixed income securities increased to 5.49% in the first three months of 2009, as compared to 5.19% in the first three months of 2008.

Dividend income remained relatively consistent at $80,000 in the first three months of 2009, as compared to $85,000 in the first three months of 2008. Interest income on cash and cash equivalents declined $123,000 in the first three months of 2009 to $47,000, as compared to $170,000 in the first three months of 2008, as we put cash balances to work in the bond portfolio as the credit crisis lost some of its intensity in the quarter. Investment expenses declined slightly in the first three months of 2009.

Net realized losses in the first three months of 2009 were $481,000, as compared to net realized losses of $820,000 in the first three months of 2008. In 2009, the net realized losses included write-downs of securities determined to be other than temporarily impaired of $535,000, net losses on securities sales of $27,000, and a gain on the mark-to-market valuation on the interest rate swaps of $81,000. In 2008, net realized losses of $820,000 included losses on securities sales of $24,000, a loss on the mark-to-market valuation on the interest rate swaps of $696,000, and a write-down of securities determined to be other than temporarily impaired of $100,000. Securities determined to be other-than-temporarily impaired were written down to their fair value at the time of the write-down. See the discussion of other than temporary impairments on investment securities in the Critical Accounting Policies section. We have three ongoing interest rate swap agreements to hedge against interest rate risk on our floating rate trust preferred securities. The estimated fair value of the interest rates swaps is obtained from the third-party financial institution counterparties. We mark the swap agreements to market using these valuations and records the change in the economic value of the interest rate swaps as a realized gain or loss in the consolidated statement of earnings.

The following table sets forth consolidated information concerning our investments.


	At March 31, 2009				At December 31, 2008
	Cost (2)		Fair Value		Cost (2)		Fair Value
	(In thousands)

Fixed income securities (1):
United States government and government agencies (3)	$	79,961	$	83,620	$	84,747	$	87,975
Obligations of states and political subdivisions		141,660		146,563		143,042		145,125
Industrial and miscellaneous		97,896		97,153		77,859		77,499
Mortgage-backed securities		23,213		22,462		25,427		23,488

Total fixed income securities		342,730		349,798		331,075		334,087
Equity securities		8,083		7,943		9,232		10,203

Total	$	350,813	$	357,741	$	340,307	$	344,290


(1)		In our consolidated financial statements, investments are carried at fair value.

(2)		Original cost of equity and fixed income securities adjusted for other than temporary impairment write downs and amortization of premium and accretion of discount.

(3)		Includes approximately $62,777 and $66,576 (cost) and $65,652 and $68,696 (estimated fair value) of mortgage-backed securities backed by the U.S. government and government agencies as of March 31, 2009 and December 31, 2008, respectively.

The following table shows our Industrial and miscellaneous fixed income securities and equity holdings by industry sector:


	March 31, 2009				December 31, 2008
	Cost (1)		Fair Value		Cost (1)		Fair Value
	(In thousands)
Industrial and miscellaneous:

Fixed income securities
Retail specialty	$	34,087	$	34,598	$	27,561	$	27,810
Financial		32,903		31,341		36,520		36,065
Energy		20,432		20,567		9,680		9,444
Information Technology		5,756		5,755		1,849		1,860
Pharmaceutical		4,718		4,892		2,249		2,320

Total	$	97,896	$	97,153	$	77,859	$	77,499


Equity securities
Retail specialty	$	3,500	$	3,228	$	4,117	$	4,565
Financial		1,861		1,561		2,329		2,343
Information Technology		1,182		1,250		1,246		1,186
Pharmaceutical		794		875		794		974
Energy		746		1,029		746		1,135

Total	$	8,083	$	7,943	$	9,232	$	10,203


(1)		Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount, as well as any impairment write-downs.

Fixed maturity investments represent 97.8% of invested assets, and as of March 31, 2009, the fixed income portfolio consists of 99.3% investment grade securities, with the remaining 0.7% non-investment grade rated securities. The 0.7% includes four corporate securities held with a combined market value of $2.1 million, and one asset-backed security held with a market value of $0.2 million. The fixed income portfolio has an average rating of Aa2/AA, an average effective maturity of 5.1 years, an average duration of 3.6 years with an average tax equivalent book yield of 5.49%.

Among its portfolio holdings, the Group’s only subprime exposure consists of asset-backed securities (ABS) within the home equity subsector. The ABS home equity subsector totaled $0.57 million (book value) on March 31, 2009, representing 3.89% of the ABS holdings, 0.67% of the total structured product holdings, and 0.16% of total fixed income portfolio holdings. The subprime related exposure consists of three individual securities, of which two are insured by a monoline against default of principal and interest. However, since FGIC and AMBAC have been downgraded from their past AAA status, the two insured securities are now rated according to the higher of the underlying collateral or the monoline rating. One bond is rated Baa1/A while the other is rated Baa3/BB. With regard to the remaining security without monoline insurance, it is rated A3/AA by Moody’s and S&P, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the subsection entitled “Quantitative and Qualitative Information about Market Risk.”

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of March 31, 2009 are as follows:


	Less than 12 Months				12 Months or Longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(In Thousands)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	498	$	2	$	286	$	2	$	784	$	4
Obligations of states and political subdivisions		9,902		145		2,181		481		12,083		626
Corporate securities		23,859		1,326		7,947		1,280		31,806		2,606
Mortgage-backed securities		4,594		74		7,104		1,011		11,698		1,085

Total fixed maturities		38,853		1,547		17,518		2,774		56,371		4,321
Total equity securities		3,838		844		364		32		4,202		876

Total securities in a temporary unrealized loss position	$	42,691	$	2,391	$	17,882	$	2,806	$	60,573	$	5,197

Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment and anomalies in pricing in the current difficult credit markets. At March 31, 2009 we had 20 fixed maturity securities with unrealized losses for more than twelve months. Of the 20 securities with unrealized losses for more than twelve months, 15 of them have fair values of no less than 86% of book value. The other five securities have a fair value greater than 65% of cost. We do not believe these declines are other than temporary due to the credit quality of the holdings. We currently have the ability and intent to hold these securities until recovery.

There are 33 common stock securities that are in an unrealized loss position at March 31, 2009. All of these securities have been in an unrealized loss position for less than 7 months. There are 3 preferred stock securities that are in an unrealized loss position at March 31, 2009. Two preferred stock securities have been in an unrealized loss position for less than 6 months. One preferred stock security has been in an unrealized loss position for more than twelve months. We do not believe these declines are other than temporary as a result of reviewing the circumstances of each such security in an unrealized loss position. We currently have the ability and intent to hold these securities until recovery. However, future write-downs may become necessary in light of unprecedented market and liquidity disruptions that have continued into 2009.

Results of our Commercial Lines segment were as follows:


Three Months Ended March 31,
2009 vs. 2008 Commercial Lines (CL)	2009			2008			Change			% Change
	(Dollars in thousands)
CL Direct premiums written	$	30,237		$	33,333		$	(3,096	)		(9.3)	%
CL Net premiums written	$	27,590		$	30,126		$	(2,536	)		(8.4)	%
CL Net premiums earned	$	30,704		$	34,031		$	(3,327	)		(9.8)	%

CL Loss/ LAE expense ratio (GAAP)		59.9	%		63.4	%		(3.5)	%
CL Expense ratio (GAAP)		35.8	%		34.3	%		1.5	%
CL Combined ratio (GAAP)		95.7	%		97.7	%		(2.0)	%

In the first three months of 2009 our commercial lines direct premiums written decreased by $3.1 million or 9.3% to $30.2 million as compared to direct premium written in the first three months of 2008 of $33.3 million. The decline in direct premiums written is attributable to several factors, including a decline in construction related activity in California, continuing competition on large accounts, and continued competition in the California contractor market and the East Coast habitational market. Our California contractors book reflects the decreased economic activity in the California construction market. Since the insurance premiums for these contractors generally reflect their level of economic activity, the average premium per policy has fallen as the insured’s business has contracted, resulting in lower insurance exposures for these contractors. The retention levels in this book remain attractive, and policy count continues to be up year-over-year, despite the decline in direct premiums written. This means that we have more customers in this market than in the previous year, but that on average we collect less premium from each in the current year. It also means that insurance exposures per contractor on average are down, since their businesses are less busy than before. See additional discussion above in the “2009 vs. 2008 Revenue” discussion.

In the first three months of 2009 our commercial lines net premiums earned decreased by 9.8% to $30.7 million as compared to net premiums earned in the first three months of 2008 of $34.0 million.

In the commercial lines segment for the first three months of 2009, we had underwriting income of $1.3 million, a GAAP combined ratio of 95.7%, a GAAP loss and loss adjustment expense ratio of 59.9% and a GAAP underwriting expense ratio of 35.8%, compared to underwriting income of $772,000, a GAAP combined ratio of 97.7%, a GAAP loss and loss adjustment expense ratio of 63.4% and a GAAP underwriting expense ratio of 34.3% in the first three months of 2008. Our commercial lines loss ratio for 2009 reflects a more favorable result than the similar period in 2008 for casualty and property lines of business in our West Coast commercial lines business.

Results of our Personal Lines segment were as follows:


Three Months Ended March 31,
2009 vs. 2008 Personal Lines (PL)	2009			2008			Change			% Change
	(Dollars in thousands)
PL Direct premiums written	$	4,755		$	4,964		$	(209	)		(4.2)	%
PL Net premiums written	$	4,266		$	4,413		$	(147	)		(3.3)	%
PL Net premiums earned	$	4,878		$	5,046		$	(168	)		(3.3)	%

PL Loss/ LAE expense ratio (GAAP)		78.3	%		63.2	%		15.1	%
PL Expense ratio (GAAP)		36.7	%		37.3	%		(0.6)	%
PL Combined ratio (GAAP)		115.0	%		100.5	%		14.5	%

Personal lines direct premiums written declined to $4.8 million in the first three months of 2009, as compared to $5.0 million in the first three months of 2008, representing a decline of $209,000 or 4.2%. Our personal lines have also been impacted by increased competition, similar to our commercial lines.

In the personal lines segment for the first three months of 2009, we had an underwriting loss of $733,000, a GAAP combined ratio of 115.0%, a GAAP loss and loss adjustment expense ratio of 78.3% and a GAAP underwriting expense ratio of 36.7%, compared to an underwriting loss of $22,000, a GAAP combined ratio of 100.5%, a GAAP loss and loss adjustment expense ratio of 63.2% and a GAAP underwriting expense ratio of 37.3% in the first three months of 2008. Our personal lines loss ratio for the first three months of 2009 reflects an elevated level of losses from severe winter weather as well as an unusual number of large fire losses.

Underwriting Expenses and the Expense Ratio is discussed below.


Three Months Ended March 31,
2009 vs. 2008 Expenses and Expense Ratio	2009			2008			Change			% Change
	(Dollars in thousands)
Amortization of Deferred Acquisition Costs	$	9,905		$	10,362		$	(457	)		(4.4)	%
As a % of net premiums earned		27.8	%		26.5	%		1.3	%
Other underwriting expenses		2,891			3,195			(304	)		(9.5)	%
Underwriting expenses	$	12,796		$	13,557		$	(761	)		(5.6)	%
Underwriting expense ratio		36.0	%		34.7	%		1.3	%

Underwriting and other expenses decreased by $761,000, or 5.6%, to $12.8 million in the first three months of 2009, as compared to $13.6 million in the first three months of 2008. The decrease in underwriting expenses primarily reflects the decrease in net premiums earned, as well as the Company’s ongoing expense reduction efforts. Underwriting expenses also reflects lower share-based compensation expense under SFAS 123R and lower net contingent commission expense. Lastly, underwriting expenses are impacted by the previously discussed changes in the 2009 and 2008 reinsurance program whereby less ceded premium is being recorded and accordingly less ceding commission is received, which increases underwriting expenses and net acquisition costs.

Our Federal income tax was as follows:


Three Months Ended March 31,
2009 vs. 2008 Income Taxes	2009			2008			Change			% Change
	(Dollars in thousands)

Income before income taxes	$	3,845		$	3,450		$	395			11.4	%
Income taxes		954			858			96			11.2	%
Net income	$	2,891		$	2,592		$	299			11.5	%
Effective tax rate		24.8	%		24.9	%		(0.1)	%

Federal income tax expense was $954,000 and $858,000 for the first three months of 2009 and 2008, respectively. The effective tax rate was 24.8% and 24.9% for the first three months of 2009 and 2008, respectively.

LIQUIDITY AND CAPITAL RESOURCES

Our insurance companies generate sufficient funds from their operations and maintain adequate liquidity in their investment portfolios to fund operations, including the payment of claims. The primary source of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments.

Our insurance companies maintain investment and reinsurance programs that are intended to provide sufficient funds to meet their obligations without forced sales of investments. This requires them to ladder the maturity of their portfolios and thereby maintain a portion of their investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.

The principal source of liquidity for the Holding Company (which has modest expenses and does not currently, or for the foreseeable future, need a significant regular source of cash flow to cover these expenses other than its debt service on its indebtedness to MIC, its quarterly dividend to shareholders, and the funding necessary for any stock repurchases pursuant to the currently authorized stock repurchase program) is dividend payments and other fees received from the insurance subsidiaries, and payments it receives on the 10-year note it received from the ESOP (see below) when the ESOP purchased shares at the time of the conversion from a mutual to a stock form of organization (the “Conversion”). The Holding Company also has access to an existing credit line under which it can draw up to $7.5 million dollars.

On April 16, 2008, the Holding Company was authorized by the Board of Directors to repurchase, at management’s discretion, up to 5% of its outstanding stock. Any such purchases will be funded by the Holding Company’s existing resources, dividends from subsidiaries, or the credit line, or any combination of these resources. As of March 31, 2009, the Holding Company had purchased, pursuant to the authority granted by the Board on April 16, 2008, a total of 123,300 shares of outstanding stock at an average cost of $15.89 per share, and is holding the stock as treasury stock.

The Group’s insurance companies are required by law to maintain a certain minimum surplus on a statutory basis, and are subject to risk-based capital requirements and to regulations under which payment of a dividend from statutory surplus may be restricted and may require prior approval of regulatory authorities.

Additionally, there is a covenant in the Group’s line of credit agreement that requires the Group to maintain at least 50% of its insurance company subsidiaries’ capacity to pay dividends without state regulation pre-approval.

As part of the funding of the acquisition of FPIG, MIC entered into a loan agreement with MIG, by which it advanced on September 30, 2005, a loan of $10 million with a 20-year note and a fixed interest rate of 4.75%, repayable in 20 equal annual installments. MIG has no special limitations on its ability to take periodic dividends from its insurance subsidiaries except for normal dividend restrictions administered by the respective domiciliary state regulators as described above. The Group believes that the resources available to MIG will be adequate for it to meet its obligation under the note to MIC, the line of credit and its other expenses.

MIG began paying quarterly dividends of $0.05 per common share in the second quarter of 2006. On April 16, 2008, MIG’s Board of Directors increased the quarterly dividend from $0.05 per share of common stock to $0.075 per share of common stock, effective with the payment of the June 27, 2008 dividend. The amount of dividends paid for the first three months of 2009 and 2008 totaled $0.5 million and $0.3 million, respectively. The shareholder dividend was funded from the Group’s insurance companies, for which approval was sought and received (where necessary) from each of the insurance companies’ primary regulators.

The Group maintains an Employee Stock Ownership Plan (ESOP), which purchased 626,111 shares from the Group at the time of the Conversion in return for a note bearing interest at 4% on the principal amount of $6,261,110. MIC makes annual contributions to the ESOP sufficient for it to make its required annual payment under the terms of the loan to the Holding Company. It is anticipated that approximately 10% of the original ESOP shares will be allocated annually to employee participants of the ESOP. An expense charge is booked ratably during each year for the shares committed to be allocated to participants that year, determined with reference to the fair market value of the Group’s stock at the time the commitment to allocate the shares is accrued and recognized. The issuance of the shares to the ESOP was fully recognized in the additional paid-in capital account at Conversion, with a contra account entitled Unearned ESOP Shares established in the stockholders’ equity section of the balance sheet for the unallocated shares at an amount equal to their original per-share purchase price. Shareholder dividends received on unallocated ESOP shares are used to pay-down principal and interest owed on the loan to the Holding Company.

All dividends from MIC to MIG require prior notice to the Pennsylvania Insurance Department. All “extraordinary” dividends require advance approval. A dividend is deemed “extraordinary” if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (a) statutory net income (excluding unrealized capital gains) for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2008, the amount available for payment of dividends from MIC in 2009, without the prior approval, is approximately $5.7 million. In 2005, MIC applied for, and received, approval to pay an extraordinary dividend of $10 million, which was used in connection with the acquisition of FPIG.

All dividends from FPIC to FPIG (wholly owned by MIG) require prior notice to the California Department of Insurance. All “extraordinary” dividends require advance approval. A dividend is deemed “extraordinary” if, when aggregated with all other dividends paid within the preceding 12 months, the dividend exceeds the greater of (a) statutory net income for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2008, the amount available for payment of dividends from FPIC in 2009, without the prior approval, is approximately $6.4 million.

The Group adopted a stock-based incentive plan at its 2004 annual meeting of shareholders. Pursuant to that plan, Mercer Insurance Group may issue a total of 876,555 shares, which amount will increase automatically each year by 1% of the number of shares outstanding at the end of the preceding year. At March 31, 2009, the number of shares authorized under the plan has been increased under this provision to 1,206,091 shares. For the three months ended March 31, 2009, the Group made no grants of restricted stock and stock options. In addition, there were no forfeitures of restricted stock and no options exercised during the first three months of 2009. During the first quarter of 2009, ISO’s on 10,000 shares of stock expired unexercised and were consequently forfeited.

Total assets decreased 0.5%, or $2.8 million, to $566.2 million, at March 31, 2009, as compared to $569.0 million at December 31, 2008. The Group’s cash and invested assets had a net increase of $2.6 million or 0.7%, primarily due to net cash provided by operating activities. Premiums receivable decreased $1.0 million or 3.0%, primarily due to timing differences in the recording and collecting of premium, and the decrease in premiums written. Reinsurance receivables decreased $3.5 million or 4.1%, primarily due to a decrease in ceded loss and loss adjustment expense reserves. Prepaid reinsurance premiums decreased $1.2 million or 16.4%, primarily due to a change in certain of the Group’s reinsurance contracts, whereby fewer unearned premium reserves are ceded. Property and equipment increased $2.2 million, or 13.8%, due primarily to construction of a new building in Rocklin, Califonia, as well as capitalization of internally developed software costs. Additionally, the deferred income tax asset increased $0.5 million or 5.1%, due to changes in a variety of temporary differences items.

Total liabilities decreased 1.7% or $7.3 million, to $424.4 million at March 31, 2009 as compared to $431.7 million at December 31, 2008, primarily as a result of the decrease in unearned premium reserves of $4.9 million or 6.1%, and a decline in accounts payable and accrued expenses of $3.5 million or 26.7%, offset by an increase in other reinsurance balances of $1.1 million or 9.4%. Unearned premiums declined primarily due to the decline in written premiums. Accounts payable and accrued expenses declined primarily due to payments for agents profit sharing, state premium taxes, Group salary bonuses and retirement funding and other payments normally made in the first quarter of each year. Other reinsurance balances increased primarily due to additional ceded contingent commissions received in the first quarter of 2009.

Total stockholders’ equity increased $4.5 million or 3.3%, to $141.8 million, at March 31, 2009, from $137.3 million at December 31, 2008, primarily due to net income of $2.9 million, stock compensation plan amortization of $0.1 million, ESOP shares committed to be allocated to participants of $0.2 million and changes in unrealized holding gains and losses on securities of $1.9 million, offset by stockholder dividends of $0.5 million and the purchase of treasury stock of $0.1 million.

IMPACT OF INFLATION

Inflation increases an insured’s need for property and casualty insurance coverage. Inflation also increases the cost of claims incurred by property and casualty insurers as property repairs, replacements and medical expenses increase. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We establish property and casualty insurance premiums levels before the amount of losses and loss expenses, or the extent to which inflation may affect these expenses, are known. Therefore, our insurance companies attempt to anticipate the potential impact of inflation when establishing rates, and if inflation is not adequately factored into rates, the rate increases will lag behind increases in loss costs resulting from inflation. Because inflation has remained relatively low in recent years, financial results have not been significantly affected by inflation.

Inflation also often results in increases in the general level of interest rates, and, consequently, generally results in increased levels of investment income derived from our investments portfolio, although increases in investment income will generally lag behind increases in loss costs caused by inflation.

OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The Group was not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at March 31, 2009 which would give rise to previously undisclosed market, credit or financing risk.

The Group has no significant contractual obligations at March 31, 2009, other than its insurance obligations under its policies of insurance, trust preferred securities interest and principal, a line of credit obligation, its obligations in connection with the construction of a new building in Rocklin, California, and operating lease obligations. Projected cash disbursements pertaining to these obligations have not materially changed since December 31, 2008, and the Group expects to have the resources to pay these obligations as they come due.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

General.

Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to three principal types of market risk through our investment activities: interest rate risk, credit risk and equity risk. Our primary market risk exposure is to changes in interest rates. We have not entered, and do not plan to enter, into any derivative financial instruments for hedging, trading or speculative purposes, other than the interest rate swap agreements that hedge the floating rate trust preferred securities which were assumed as part of the FPIG acquisition.

Interest Rate Risk.

Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our significant holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the market valuation of these securities. Our available-for-sale portfolio of fixed-income securities is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of these securities would result in losses reflected in the balance sheet.

Credit Risk.

The quality of our interest-bearing investments is generally good. Our fixed maturity securities at March 31, 2009, have an average rating of AA or better.

Municipal Bond Holding Exposure.

The overall credit quality, based on weighted average Standard & Poor’s (S&P) ratings or equivalent when the S&P rating is not available, of the total $146.6 million municipal fixed income portfolio is:

	•		“AA+” including insurance enhancement

	•		“AA” excluding insurance enhancement

	•		99% of the underlying ratings are “A-” or better

	•		88% of the underlying ratings are “AA-” or better

The municipal fixed income portfolio with insurance enhancement represents $104.9 million, or 72% of the total municipal fixed income portfolio.

•

The average credit quality with insurance enhancement is “AA”

•

The average credit quality of the underlying, excluding insurance enhancement, is “AA”

•

Each municipal fixed income investment is evaluated based on its underlying credit fundamentals, irrespective of credit enhancement provided by bond insurers

The municipal fixed income portfolio without insurance enhancement represents $41.6 million, or 28% of the total municipal fixed income portfolio.

•

The average credit quality of those securities without enhancement is “AA+”

The following represents the Group’s municipal fixed income portfolio as of March 31, 2009:


				% of Total
	Average Credit	Market		Muni			Unrealized
	Rating	Value		Portfolio			Gain
	(dollars in thousands)

Uninsured Securities	AA+	$	41,618,449		28	%	$	1,095,225
Securities with Insurance Enhancement	AA		104,944,434		72	%		3,807,666


Total		$	146,562,883		100	%	$	4,902,891


	Market
Credit Enhancement	Value		% of Total
(dollars in thousands)

AMBAC	$	11,097,819		8	%
FGIC		1,002,910		1	%
FSA		30,345,010		21	%
None		32,931,500		22	%
Other Enhancement		6,050,245		5	%
Nat’l Pub Finance		27,427,782		19	%
National Re FGIC		28,455,498		19	%
Escrowed to Maturity		9,252,119		6	%

Grand Total	$	146,562,883		100	%

The following represents the Group’s ratings on the municipal fixed income portfolio as of March 31, 2009:


																Total Municipal					Total Municipal
											Underlying Rating					Fixed Income					Fixed Income
						Insurance					of Insurance					Portfolio					Portfolio
	Uninsured					Enhanced					Enhanced					(with Insurance					(without Insurance
	Securities					Securities					Securities					Enhancement)					Enhancement)
	(1)					(2)					(3)					(1) + (2)					(1) + (3)
	(dollars in thousands)
S&P or	Market		% of			Market		% of			Market		% of			Market		% of			Market		% of
equivalent ratings	Value		Total			Value		Total			Value		Total			Value		Total			Value		Total
AAA	$	25,074,110		60	%	$	39,035,042		37	%	$	12,068,280		11	%	$	64,109,152		44	%	$	37,142,390		25	%
AA+		3,313,759		8	%		20,584,735		20	%		27,018,136		26	%		23,898,494		16	%		30,331,895		21	%
AA		10,992,560		26	%		25,996,635		25	%		32,736,094		31	%		36,989,195		25	%		43,728,654		30	%
AA-		1,059,530		3	%		17,236,600		16	%		16,834,585		16	%		18,296,130		12	%		17,894,115		12	%
A+							1,088,512		1	%		6,364,609		6	%		1,088,512		1	%		6,364,609		4	%
A		1,178,490		3	%							5,897,882		6	%		1,178,490		1	%		7,076,372		5	%
A-												3,021,938		3	%							3,021,938		2	%
BBB-							1,002,910		1	%		1,002,910		1	%		1,002,910		1	%		1,002,910		1	%

Total	$	41,618,449		100	%	$	104,944,434		100	%	$	104,944,434		100	%	$	146,562,883		100	%	$	146,562,883		100	%

Average Rating	AA+					AA					AA					AA+					AA

Insured municipals generally carry two ratings: a standalone rating based on individual fundamentals and an insured rating based on the claims paying ability of the issuer’s monoline insurer (if the issue is insured). The monoline insurers’ downgrades triggered ratings downgrades in the Group’s insured municipal portfolio during the second quarter of 2008. When the monoline insurers are downgraded, the ratings on insured municipal bonds are downgraded to the municipality or revenue bonds’ underlying credit rating or the insured rating, whichever is higher.

As of March 31, 2009, all of the Group’s municipal bonds carry an underlying rating of at least an A- or better by S&P or Moody’s, except $1 million par of Puerto Rico Commonwealth bonds due in 2013. These bonds are rated Baa3/BBB-. The bonds were originally rated A3/A due to the insurance provided by the monoline insurer, FGIC. When FGIC was downgraded, the Puerto Rico municipal bonds were downgraded to their underlying or standalone rating of Baa3/BBB-, as FGIC’s rating is lower at CC by S&P and no longer rated by Moody’s.

Structured Product Exposure.

The Group’s structured product exposure includes commercial mortgage backed securities (CMBS), residential mortgage backed securities (MBS) and asset backed securities (ABS). The total book value, as of March 31, 2009, was $86 million and represented 24% of the total invested assets.

CMBS positions totaled $9.3 million (book value), representing 10% of the total structured product holdings. All CMBS securities are rated Aaa/AAA by either Moody’s, S&P, or Fitch.

MBS positions totaled $62.1 million (book value), representing 53% of the total structured product holdings. The MBS securities consist of both pass-through and collateralized mortgage obligation (CMO) structures. The pass-throughs are all agency sponsored securities and have a Aaa/AAA rating. Among the CMO’s, a majority are agency sponsored and as a result, also have a Aaa/AAA rating. The non-agency backed securities represent 4% of the CMO holdings and 1% of total MBS holdings; three of the four of non-agency CMO’s have a Aaa/AAA rating by Moody’s or S&P and one security is rated A by S&P and unrated by Moody’s.

ABS holdings totaled $14.8 million (book value), representing 17% of the total structured product holdings. The ABS securities consist of a diversified blend of subsectors including, automobile loan and credit card receivables, equipment financing, home equity, rate reduction bonds, among other ABS. Outside of three holdings of home equity (sub-prime) and one split rated (Aa3/AAA) automobile trust, all other ABS securities are rated Aaa/AAA by Moody’s and S&P.

The ABS home equity subsector (collateral of sub-prime home equity loans) totaled $0.57 million (book value) on March 31, 2009, representing 3.89% of the ABS holdings, 0.67% of the total structured product holdings, and 0.16% of total fixed income portfolio holdings. The subprime related exposure consists of three individual securities, of which two are insured by a monoline against default of principal and interest. However, since FGIC and AMBAC have been downgraded from their past AAA-rated status, the two insured securities are now rated according to the higher of either the underlying collateral or the monoline rating. One bond is rated Baa1/A while the other is rated Baa3/BB. With regard to the remaining security without monoline insurance, it is rated A3/AA by Moody’s and S&P, respectively.

There are two sectors where the Group has indirect exposure to subprime securities. These are the U.S. agency and investment grade corporate sectors. As of March 31, 2009, the Group held $12.7 million (book value) of agency debentures, consisting predominately of Fannie Mae, Federal Home Loan Bank, Freddie Mac, and Federal Farm Credit Bank securities.

The second sector of the market in which the Group has indirect exposure to subprime securities is the investment grade corporate market. As of March 31, 2009, the Group’s portfolio held $94.6 million (book value) of corporate bonds. Among the corporate credit exposure, $25.1 million or 27% of the holdings, were in the financial industry. The banking, brokerage, finance, insurance and REIT sectors of the investment grade corporate market continue to face stresses and challenges. Although some issuers, particularly banks, will continue to need to strengthen their reserves and write-off bad debts which will impact their earnings, it is expected that these issuers will continue to pay principal and interest when due.

Equity Risk.

Equity price risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity prices primarily results from our holdings of common stocks, mutual funds and other equities. Our portfolio of equity securities is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of these securities would result in losses reflected in the balance sheet.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including the President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of March 31, 2009. Based on that evaluation, the President and Chief Executive Officer and the Senior Vice President and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of March 31, 2009. There were no changes in our internal control over financial reporting during the three months ended March 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part II — OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

No material changes from risk factors previously disclosed in the registrant’s Form 10-K for the year ended December 31, 2008.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds


					Total Number of Shares Purchased as		Maximum Number of Shares That
	Total Number of		Average Price		Part of Publicly Announced Plans or		May Yet Be Purchased Under The
Period	Shares Purchased		Paid per Share		Programs (Note 1)		Plans or Programs (Note 1)

January 1-31, 2009		9,000	$	14.05		9,000		205,176

February 1-28, 2009		0		N/A		0		205,176

March 1-31, 2009		0		N/A		0		205,176

Total		9,000	$	14.05		9,000		205,176

Note 1 — On April 16, 2008, the Group’s Board of Directors authorized the repurchase of up to 5% of outstanding common shares of the Group. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan.

Item 3. Defaults Upon Senior Securities

None

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits

Exhibits


Exhibit No.		Title
	3.1	Articles of Incorporation of Mercer Insurance Group, Inc. (incorporated by reference herein to the Group’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

	3.2	Bylaws of Mercer Insurance Group, Inc. (incorporated by reference herein to the Group’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)

	31.1	Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	31.2	Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	32.1	Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	32.2	Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

SIGNATURES

In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	MERCER INSURANCE GROUP, INC. (Registrant)
Dated: May 11, 2009	By:	/s/ Andrew R. Speaker
		Andrew R. Speaker,
		President and Chief Executive Officer

Dated: May 11, 2009	By:	/s/ David B. Merclean
		David B. Merclean,
		Senior Vice President and Chief Financial Officer

EXHIBIT INDEX


Exhibit No.		Title

	3.1	Articles of Incorporation of Mercer Insurance Group, Inc. (incorporated by reference herein to the Group’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

	3.2	Bylaws of Mercer Insurance Group, Inc. (incorporated by reference herein to the Group’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)

	31.1	Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	31.2	Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	32.1	Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	32.2	Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)