- Annual Report (10-K)

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		for the fiscal year ended December 31, 2009
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		transition period from to .

Commission file number 000-25425

Mercer Insurance Group, Inc.

(Exact name of registrant as specified in its charter)


Pennsylvania		23-2934601
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

10 North Highway 31

P.O. Box 278

Pennington, NJ 08534

(Address of principal executive offices)

Registrant’s telephone number, including area code:

(609) 737-0426

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock (no par value)

Title of Each Class:

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

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months 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 website every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes o No o

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

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

The aggregate market value of the voting and non-voting common stock held by non-affiliates (computed by reference to the price at which the common stock was last sold) as of the last business day of the Registrant’s most recently completed second fiscal quarter was: $102,436,895.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of March 1, 2010. Common Stock, no par value: 6,442,257.

Documents Incorporated by Reference

Portions of the definitive Proxy Statement for the 2010 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.

FORM 10-K

For the Year Ended December 31, 2009

Table of Contents

PART I	3

ITEM 1. Business.	3

ITEM 1A. Risk Factors.	36

ITEM 1B. Unresolved Staff Comments.	41

ITEM 2. Properties.	41

ITEM 3. Legal Proceedings.	41

ITEM 4. Submission of Matters to a Vote of Security Holders.	41

PART II	42

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.	42

ITEM 6. Selected Financial Data.	44

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.	45

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.	70

ITEM 8. Financial Statements and Supplementary Data.	74

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.	111

ITEM 9A. Controls and Procedures.	111

ITEM 9B. Other Information.	113

PART III	113

ITEM 10. Directors, Executive Officers and Corporate Governance.	113

ITEM 11. Executive Compensation.	113

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.	113

ITEM 13. Certain Relationships and Related Transactions, and Director Independence.	113

ITEM 14. Principal Accounting Fees and Services.	113

PART IV	114

ITEM 15. Exhibits, Financial Statement Schedules.	114

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PART I

ITEM 1. BUSINESS

THE HOLDING COMPANY

Mercer Insurance Group, Inc. (the “Holding Company”, the “Company”, or “MIG”) is a holding company which resulted from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of organization on December 15, 2003 (the “Conversion”). Prior to the Conversion, and since 1844, Mercer Mutual Insurance Company was engaged in the business of selling property and casualty insurance. Mercer Mutual Insurance Company, a Pennsylvania domiciled company, changed its name to Mercer Insurance Company immediately after the Conversion, and became a subsidiary of the Holding Company.

Mercer Insurance Group, Inc. and subsidiaries (collectively, the “Group”) includes Mercer Insurance Company (MIC), its subsidiaries Mercer Insurance Company of New Jersey, Inc., Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS), Financial Pacific Insurance Group, Inc. (FPIG) and its subsidiaries, Financial Pacific Insurance Company (FPIC) and Financial Pacific Insurance Agency (FPIA), which is currently inactive. FPIG also holds an interest in three statutory business trusts that were formed for the purpose of issuing Floating Rate Capital Securities.

OVERVIEW OF THE BUSINESS

MIG, 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, Oregon and Pennsylvania. A limited amount of business is written in New York to support accounts in adjacent states.

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

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 9 years. An “A” rating is the third highest rating of A.M. Best’s 16 possible rating categories. At its last review, A.M. Best affirmed the “A” rating with a negative outlook.

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).

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, surety 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. The Group markets its products

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through a network of approximately 560 independent agents, of which approximately 290 are located in New Jersey and Pennsylvania, 220 in California, and the balance in Arizona, Nevada and Oregon.

OUR INSURANCE COMPANIES

Mercer Insurance Company

MIC is a stock Pennsylvania insurance company originally incorporated under a special act of the legislature of the State of New Jersey in 1844 as a mutual insurance company. On October 16, 1997, it filed Articles of Domestication with Pennsylvania which changed its state of domicile from New Jersey to Pennsylvania, and then subsequently changed its name to Mercer Insurance Company after the Conversion in 2003. MIC owns all of the issued and outstanding capital stock of both MICNJ and FIC.

MIC is a property and casualty insurer of primarily small and medium-sized businesses and property owners located in New Jersey and Pennsylvania. It markets commercial multi-peril and homeowners policies, as well as other liability, workers’ compensation, fire, allied, inland marine and commercial automobile insurance. MIC does not market private passenger automobile insurance in New Jersey. MIC is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business — Regulation.”

Mercer Insurance Company of New Jersey, Inc.

MICNJ is a stock property and casualty insurance company that was incorporated in 1981. It writes the same lines of business as MIC, with its book of business entirely located in New Jersey. MICNJ is subject to examination and comprehensive regulation by the New Jersey Department of Banking and Insurance. See “Business — Regulation.”

Franklin Insurance Company

FIC is a stock property and casualty insurance company that was incorporated in 1997. MIC acquired 49% of FIC in 2001, with the remaining 51% acquired as part of the Conversion transaction in 2003. FIC currently offers private passenger automobile and homeowners insurance to individuals located in Pennsylvania. FIC is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business - Regulation.”

Financial Pacific Insurance Company

FPIC is a stock property and casualty company that was incorporated in California in 1986 and commenced business in 1987. The Group acquired all of the outstanding stock of FPIG, the holding company for FPIC, on October 1, 2005. FPIC is based in Rocklin, California, and writes primarily commercial package policies for small to medium-sized businesses in targeted classes. It has developed specialized underwriting and claims handling expertise in a number of classes of business, including apartments, restaurants, artisan contractors and ready-mix operators. FPIC’s business is heavily weighted toward the liability lines of business (commercial multi-peril liability, commercial auto) but also includes commercial multi-peril property, commercial auto physical damage and surety for small and medium-sized businesses. FPIC is licensed in nineteen western states, and actively writes insurance (other than its direct-marketed surety business) in four (Arizona, California, Nevada and Oregon). FPIC is subject to examination and comprehensive regulation by the California Department of Insurance. See “Business – Regulation.”

OUR BUSINESS STRATEGIES

The acquisition of FPIG has moved the Group closer to its goals of a higher proportion of commercial lines premiums as well as product and geographic diversity. As a west coast-based commercial writer, the addition of FPIG resulted in an expansion of our geographic scope and a meaningful line of business diversification. We will continue our efforts to pursue geographic and product line diversification in order to diminish the importance of any one line of business, class of business or territory.

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Increase our commercial writings

In recent years, and including the FPIG acquisition, the Group has taken steps to increase commercial premium volume, and we will continue our focus on this goal, despite the decline in writings in this sector caused by the weak economy. Growth in commercial lines reduces our personal lines exposure as a percentage of our overall exposure, which reduces the relative adverse impact that weather-related property losses can have on us. Increased commercial lines business also benefits us because we have greater flexibility in establishing rates for these lines.

In order to attract and retain commercial insurance business, we have developed insurance products and underwriting guidelines specifically tailored to meet the needs of particular types of businesses. These programs are continually refined and, if successful, expanded based on input from our producers and our marketing personnel. We are continually looking for new types of business where we can apply this focus.

We have specialized pricing approaches and/or products designed for religious institutions, contracting, apartment, restaurant, condominium and “main street” accounts as well as various other types of risks. The products, rates and eligibilities vary based on our opinion of the local market opportunities for products in a given area.

We believe that there is an opportunity to increase our volume of commercial business by working with our existing producers of commercial lines business and forming and developing relationships with new producers that focus on commercial business. We believe an increasing share of this market is desirable and attainable given our existing relationships with our producers and our insureds.

For selected commercial lines products, we have developed technology that will allow our agents to rate and bind transactions via an internet-based rating system. Based on the success of this technology, our goal is to expand the process to other products. We launched this process in late 2008 in California and launched a similar process for New Jersey and Pennsylvania agents in January, 2009. During 2009, we added on-line rating capability for more lines of business in each of these states. We are also continually working to improve the systems and processes to make it easier for our agents to write and service business they place with us. We believe we will increase our commercial lines writings by expanding the use of internet-based processing in the future.

We began writing our business owners policy in the California territory in the fourth quarter of 2008. This product targets small to medium sized businesses which we believe are somewhat less price sensitive than larger accounts. This product will also help to balance FPIC’s business between property and casualty exposures. Additionally, a new contracting product which specializes in covering artisan contractors was introduced in Arizona and California in 2009, and is being developed for Nevada and Oregon for introduction in 2010. Artisan contractors primarily provide repair and maintenance services, and this segment tends to experience less severe market fluctuations compared to the real estate construction industry.

Both the California business owners and western states artisan products are transacted using an internet-based rating process where agents will be able to rate and bind these products, subject to pre-programmed underwriting criteria.

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Diversify our business geographically

As of December 31, 2009, 2008 and 2007 our direct written premiums were distributed as follows:

	Years Ended December 31,						% of Total
	2009		2008		2007		2009			2008			2007
	(In thousands)
California	$	78,935		89,629		100,202		51.6	%		54.3	%		54.7	%
New Jersey		45,293		47,000		48,750		29.6	%		28.4	%		26.7	%
Pennsylvania		14,277		13,332		13,259		9.3	%		8.1	%		7.2	%
Nevada		8,397		8,494		11,670		5.5	%		5.1	%		6.4	%
Arizona		4,247		4,711		6,134		2.8	%		2.8	%		3.4	%
Oregon		1,707		1,995		2,758		1.1	%		1.2	%		1.5	%
Other States		189		216		134		0.1	%		0.1	%		0.1	%
Total	$	153,045		165,377		182,907		100.0	%		100.0	%		100.0	%

We hold twenty two state licenses, and we are currently focused on doing business in primarily six of these states. In addition, we write business in New York, where our activity is currently limited to supporting accounts located in adjacent states. These state licenses provide additional opportunity for future growth when market opportunities dictate utilization of those licenses. If market opportunities indicate desirable growth is available through the acquisition of additional state licenses, we will pursue licenses in new states.

Attract and retain high-quality producers with diverse customer bases

We believe our insurance companies have a strong reputation with producers and insureds for personal attention and prompt, efficient service. This reputation has allowed us to foster our relationships with many high volume producers. Several of these producers focus primarily on commercial business and are located in areas we have targeted as growth opportunities within our territories. We intend to focus our marketing efforts on maintaining and improving our relationships with these producers, as well as on attracting new high-quality producers in areas with a substantial potential for growth. We also intend to continue to develop and tailor our commercial programs to enable our products to meet the needs of the customers served by our producers.

Reduce our ratio of expenses to net premiums earned

We are committed to improving our profitability by reducing expenses through the use of enhanced technology, by increasing our net premium revenue through the strategic deployment of our capital and by prudently deploying our workforce to build efficiencies in our processes.

Reduce our reliance on reinsurance

We strive to minimize our reliance on reinsurance by maintaining a focus on appropriate levels of retention of the business written by our insurance companies on individual property and casualty risks. Our capital is best utilized by retaining as much profitable business as practical. We continually evaluate our reinsurance program to reduce the cost and achieve the optimal balance between cost and protection.

We determine the appropriate level of reinsurance based on a number of factors, which include:

• the amount of capital the Group is prepared to dedicate to support its underwriting activities;

• our evaluation of our ability to absorb multiple losses; and

• the terms and limits that we can obtain from our reinsurers.

A decrease in the use of reinsurance would result in a decrease in ceded premiums and a corresponding increase in net premium revenue, but would also potentially increase our losses from claims that would previously have been reinsured. See “Business – Reinsurance” for a description of our reinsurance program.

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COMMERCIAL LINES PRODUCTS

The following table sets forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our commercial lines products on a consolidated basis for the periods indicated.


	Year Ended December 31,
	2009			2008			2007
	(Dollars in thousands)
Direct Premiums Written:
Commercial multi-peril	$	93,490		$	103,864		$	116,622
Commercial automobile		26,311			25,779			28,232
Other liability		2,223			2,408			4,251
Workers’ compensation		5,455			5,833			4,959
Surety		3,337			4,711			4,987
Fire, allied, inland marine		698			685			979
Total	$	131,514		$	143,280		$	160,030
Net Premiums Earned:
Commercial multi-peril	$	85,394		$	95,481		$	90,088
Commercial automobile		24,873			25,913			22,551
Other liability		1,722			1,247			2,387
Workers’ compensation		5,632			5,828			5,501
Surety		3,028			3,651			4,428
Fire, allied, inland marine		222			305			472
Total	$	120,871		$	132,425		$	125,427
Net Loss Ratios:
Commercial multi-peril		62.2	%		61.8	%		55.6	%
Commercial automobile		51.4			60.6			61.2
Other liability		(19.3	)		34.7			315.3
Workers’ compensation		71.3			48.0			51.4
Surety		93.3			73.9			41.5
Fire, allied, inland marine		65.7			176.7			46.9
Total		60.0	%		61.3	%		60.8	%
Expense Ratio:
Commercial multi-peril		37.0	%		35.5	%		34.2	%
Commercial automobile		35.6			34.2			38.5
Other liability		32.0			56.8			36.1
Workers’ compensation		30.1			28.4			19.8
Surety		36.6			44.2			34.4
Fire, allied, inland marine		68.3			65.8			46.7
Total		36.4	%		35.5	%		34.4	%
Combined Ratios(1):
Commercial multi-peril		99.2	%		97.3	%		89.8	%
Commercial automobile		87.0			94.8			99.7
Other liability		12.7			91.5			351.4
Workers’ compensation		101.4			76.4			71.2
Surety		129.9			118.1			75.9
Fire, allied, inland marine		134.0			242.5			93.6
Total		96.4	%		96.8	%		95.2	%

____________________________

(1)	A combined ratio over 100% means that an insurer’s underwriting operations are not profitable.

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Commercial Multi-Peril

We write a number of multi-peril policies providing property and liability coverage. Various risk classes are written on this policy.

We offer a business owners policy in Pennsylvania and New Jersey that provides property and liability coverages to small businesses. We introduced this product in our California territory in the fourth quarter of 2008. This product is marketed to several distinct groups: (i) apartment building owners; (ii) condominium associations; (iii) business owners who lease their buildings to tenants; (iv) mercantile business owners, such as florists, delicatessens, and beauty parlors; and (v) offices with owner and tenant occupancies. In March 2009, we introduced a specialized product designed for smaller service and repair contractors in California. All of our business owners and small artisan contracting products can be rated by our agents using an internet-based platform. We also introduced in 2009 a garage program in Pennsylvania and New Jersey.

We offer in New Jersey and Pennsylvania a specialized multi-peril policy specifically designed for religious institutions. This enhanced product offers directors and officers coverage, religious counseling coverage and equipment breakdown coverage (through a reinsurance arrangement). Coverage for child care centers and schools is also available. We offer versions of this product to individual religious institutions as well as to denomination groups who seek coverage for participating member institutions. This product is also available in New York on a limited basis.

A custom underwritten commercial multi-peril package policy is written in the western states for select contracting classes, as well as small to medium-sized businesses within specified niche markets. This product is focused on commercial accounts primarily in non-urban areas that do not easily fit within a generic business owner policy. The target markets for this product include apartments, artisan and construction contractors, farm labor operations, service contractors, and mercantile (including restaurants) as well as various other risk types. We introduced a new specialized product for artisan contractors in Arizona and California in 2009, and plan to launch that product in Oregon and Nevada in early 2010.

Commercial Automobile

This product is designed to cover primarily trucks used in business, as well as company-owned private passenger type vehicles. Other specialty classes such as church vans, funeral director vehicles and farm labor buses can also be covered. The policy is marketed as a companion offering to our business owners, commercial multi-peril, religious institution, commercial property, general liability policies or artisan contracting policies.

We also write heavy and extra heavy trucks through our refuse hauler, aggregate hauler and ready-mix programs offered principally in the western states and in Pennsylvania.

In 2009, we updated our California rates to be more competitive for risks with up to four power units. In early 2010 we introduced an internet-based rating system to enable our agents to quote smaller risks on-line.

Other Liability

We write liability coverage for insureds who do not have property exposure or whose property exposure is insured elsewhere. The majority of these policies are written for contractors such as carpenters, painters or electricians, who often self-insure small property exposures. Coverage for both premises and products liability exposures are regularly provided. Coverage is available for other exposures such as vacant land and habitational risks.

Commercial umbrella coverage and following form excess coverage is available for insureds that insure their primary general liability exposures with us through a business owners, commercial multi-peril, religious institution or commercial general liability policy. This coverage typically has limits of $1 million to $10 million, but higher limits are available if needed. To improve processing efficiencies and maintain underwriting standards, we prefer to offer this coverage as an endorsement to the underlying liability policy rather than as a separate stand-alone policy, but both versions are available.

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Workers’ Compensation

We typically write workers’ compensation policies in conjunction with an otherwise eligible business owners, commercial multi-peril, religious institution, commercial property or general liability policy. As of December 31, 2009, most of our workers’ compensation insureds have other policies with us. Workers’ compensation is written principally in New Jersey and Pennsylvania, with availability in New York on a limited basis.

Surety

The Group, through FPIC, writes a mix of contract and subdivision bonds as well as miscellaneous license and permit bonds in our western states. Our bonds are distributed through both our independent agents as well as a direct marketing effort that includes on-line sales via our web-site Bondnow.com.

Fire, Allied Lines and Inland Marine

Fire and allied lines insurance generally covers fire, lightning and extended perils. Inland marine coverage insures merchandise or cargo in transit and business and personal property. We offer these coverages for property exposures in cases where we are not insuring the companion liability exposures. Generally, the rates charged on these policies are higher than those for the same property exposures written on a multi-peril or business owners policy.

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PERSONAL LINES PRODUCTS

The following table sets forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our personal lines products on a consolidated basis for the periods indicated. [Missing Graphic Reference]

	Year Ended December 31,
	2009			2008			2007
	(Dollars in thousands)
Direct Premiums Written:
Homeowners	$	14,125		$	14,339		$	14,675
Personal automobile		4,954			5,343			5,822
Fire, allied, inland marine		2,062			2,015			1,967
Other liability		361			371			380
Workers’ compensation		29			29			33
Total	$	21,531		$	22,097		$	22,877
Net Premiums Earned:
Homeowners	$	12,216		$	12,503		$	13,005
Personal automobile		4,896			5,320			5,797
Fire, allied, inland marine		2,040			1,927			2,049
Other liability		363			375			369
Workers’ compensation		27			27			28
Total	$	19,542		$	20,152		$	21,248
Net Loss Ratios:
Homeowners		74.9	%		78.3	%		73.8	%
Personal automobile		79.5			70.8			69.2
Fire, allied, inland marine		17.9			8.5			44.1
Other liability		21.0			69.7			101.5
Workers’ compensation		243.5			28.3			16.8
Total		69.4	%		69.5	%		70.1	%
Expense Ratio:
Homeowners		37.9	%		39.9	%		27.7	%
Personal automobile		28.6			29.9			34.1
Fire, allied, inland marine		40.0			45.8			22.9
Other liability		23.8			30.9			18.1
Workers’ compensation		27.2			24.6			10.6
Total		35.5	%		37.6	%		28.8	%
Combined Ratios(1):
Homeowners		112.8	%		118.2	%		101.5	%
Personal automobile		108.1			100.7			103.3
Fire, allied, inland marine		57.9			54.3			67.0
Other liability		44.8			100.6			119.6
Workers’ compensation		270.7			52.9			27.4
Total		104.9	%		107.1	%		98.9	%

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(1)	A combined ratio over 100% means that an insurer’s underwriting operations are not profitable.

Homeowners

Our homeowners policy is a multi-peril policy providing property and liability coverages and optional inland marine coverage. The homeowners policy is sold to provide coverage for an insured’s residence. We market both a standard and a preferred homeowner product. The preferred product is offered at a discount to our standard rates to our customers who have a lower risk of loss. This product is sold only in New Jersey and Pennsylvania. During 2009 we introduced a new on-line system for Homeowners policies. It enables agents to quote, bind and service Homeowners policies in New Jersey and Pennsylvania.

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Personal Automobile

We write comprehensive personal automobile coverage including liability, property damage and all state required insurance minimums for individuals domiciled in Pennsylvania only. This product is multi-tiered with an emphasis placed on individuals with lower than average risk profiles. During 2008, we introduced a new online rating system for agents to make it easier for them to quote, sell, bind and service business.

Combination Dwelling Policy

Our combination dwelling product is a flexible, multi-line package of insurance coverages. It is targeted to be written on an owner or tenant occupied dwelling of no more than two families. The dwelling policy combines property and liability insurances but also may be written on a monoline basis. The property portion is considered a fire, allied lines and inland marine policy, and the liability portion is considered an other liability policy. This product is available in both New Jersey and Pennsylvania. We plan to introduce on-line rating and service capabilities for CDP in 2010.

Other Liability

We write personal lines excess liability, or “umbrella,” policies covering personal liabilities in excess of amounts covered under our homeowners policies. These policies are available generally with limits of $1 million to $5 million. We do not market excess liability policies to individuals unless we also write an underlying primary liability policy.

Workers’ Compensation

A small portion of our workers’ compensation premiums are considered personal lines insurance because our New Jersey homeowners policy is required to include workers’ compensation coverage for domestic employees.

MARKETING

We market our insurance products exclusively through independent producers, with the exception of a relatively small amount of business within our surety book of business marketed online and by direct mail. All of these producers represent multiple carriers and are established businesses in the communities in which they operate. They generally market and write the full range of our insurance companies’ products. We consider our relationships with our producers to be positive. For the years ending December 31, 2009, 2008 and 2007, there were no agents in the Group that individually produced greater than 5% of the Group’s direct written premiums.

We emphasize personal contact between our producers and the policyholders. We believe that our producers’ fast and efficient service and name recognition, as well as our policyholders’ loyalty to and satisfaction with producer relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention.

Our insurance companies depend upon their producer force to produce new business, to provide customer service, and to be selective underwriters in their screening of risks for our insurance companies to consider underwriting. The network of independent producers also serves as an important source of information about the needs of the communities served by our insurance companies. We use this information to develop new products and new product features.

Producers are compensated through a fixed base commission often with an opportunity for profit sharing depending on the producer’s aggregate premiums earned and loss experience. Profit sharing opportunities are for a producer’s entire book of business with the Group and not specifically for any individual policy. The Group does not have any marketing services agreements, placement services agreements, or similar arrangements. By contract, our producers represent one or more of the Group’s carriers. They are monitored and supported by our marketing representatives, who are employees of the Group. These marketing representatives also have principal responsibility for recruiting and training new producers.

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Our insurance companies manage their producers through periodic business reviews (with underwriter and marketing participation) and establishment of benchmarks and goals for premium volume and profitability. Our insurance companies in recent years have terminated a number of underperforming producers.

Our marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service, resulting in a positive experience for producers and policyholders. We believe that these positive experiences are then conveyed by producers and policyholders to many potential customers.

UNDERWRITING

Our insurance companies write their personal and commercial lines by evaluating each risk with consistently applied standards. We maintain information on all aspects of our business that is regularly reviewed to determine product line profitability. We also employ a staff of underwriters, who specialize in either personal or commercial lines, and have experience as underwriters in their specialized areas. Specific information is monitored with regard to individual insureds to assist us in making decisions about policy renewals or modifications. New property risks are frequently inspected to insure they are as desirable as suggested by the application process.

We have recently introduced, for selected products, an automated process for acceptance and rejection of small accounts through an internet-based rating system. Based on the success of this process, we intend to expand it to other products in the future. Though there will be less direct underwriter involvement, we are confident that underwriting standards will continue to be maintained as risks will continue to be subject to our standardized underwriting verification processes, including physical inspections.

We rely on information provided by our independent producers. Subject to certain guidelines, producers also pre-screen policy applicants. The producers have the authority to sell and bind insurance coverages in accordance with pre-established guidelines in some, but not all cases, provided their historic underwriting performance warrants such authority. Producers’ results are continuously monitored, and continued poor loss ratios often result in agency termination.

CLAIMS

Claims on insurance policies are received directly from the insured or through our independent producers. Claims are then assigned to either an in-house adjuster or an independent adjuster, depending upon the size and complexity of the claim. The adjuster investigates and settles the claim. Our trend is to manage an increasing proportion of our claims internally without the use of independent adjusters where scale permits. The Group also has a contingency plan for adjusting and processing claims resulting from a natural catastrophe.

Claims settlement authority levels are established for each claims adjuster based upon his or her level of experience. Multi-line teams exist to handle all claims. The claims department is responsible for reviewing all claims, obtaining necessary documentation, estimating the loss reserves and resolving the claims.

We attempt to minimize claims and related legal costs by encouraging the use of alternative dispute resolution procedures. Litigated claims are assigned to outside counsel for many types of claims, however most litigated claims files handled in our western state operations are managed by in-house attorneys who have specialized training relating to construction liability issues and other casualty risks. We believe this arrangement reduces dramatically the cost of managing these types of claims, as the use of in-house attorneys dramatically reduces the cost of defense work.

TECHNOLOGY

The Group seeks to transact much of its business using technology wherever possible and, in recent years, has made significant investments in information technology platforms, integrated systems and internet-based applications.

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The focus of our ongoing information technology effort is:

•

to streamline how our producers’ transact business with us;

•

to continue to evolve our internal processes to allow for more efficient operations;

•

to enable our producers to efficiently provide their clients with a high level of service;

•

to enhance agency online inquiry capabilities; and

•

to provide agencies with on-line reporting.

We believe that our technology initiative may increase revenues by making it easier for our insurance companies and producers to exchange information and do business. Increased ease of use is also an opportunity for us to lower expenses, eliminating the need to operate more than one system once the transition is complete. This will further reduce technology expense and simplify information technology management.

We take reasonable steps to protect information we are entrusted with in the ordinary course of business. As a core part of our disaster recovery planning, we have implemented a secure and reliable off-site disk-to-disk backup and restore capability.

In 2009, we virtualized our database and applications servers. This will reduce future cost relating to expansion of our server farm and increase our flexibility for providing computing power where needed.

INTERCOMPANY AGREEMENTS

Our insurance companies are parties to a Reinsurance Pooling Agreement (the “Pool”). Under this agreement, all premiums, losses and underwriting expenses of our insurance companies are combined and subsequently shared based on each individual company’s statutory surplus from the most recently filed statutory annual statement. The Pool has no impact on our consolidated results.

The Group’s insurance subsidiaries are parties to a Services Allocation Agreement. Pursuant to this agreement, any and all employees of the Group are employees of BICUS, a wholly owned subsidiary of MIC. BICUS has agreed to perform all necessary functions and services required by the subsidiaries of the Group in conducting their respective operations. In turn, the subsidiaries of the Group have agreed to reimburse BICUS for its costs and expenses incurred in rendering such functions and services in an amount determined by the parties. The Services Allocation Agreement has no impact on our consolidated results.

The Company and its subsidiaries are parties to a consolidated Tax Allocation Agreement that allocates to each company a pro rata share of the consolidated income tax expense based upon its contribution of taxable income to the consolidated group. The Tax Allocation Agreement has no impact on our consolidated results.

LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES

Our insurance companies are required by applicable insurance laws and regulations to maintain reserves for the payment of losses and loss adjustment expenses (LAE). These reserves are established for both reported claims and for claims incurred but not reported (IBNR), arising from the policies that have been issued related to the premiums that have been earned. The provision must be made for the ultimate cost of those claims that have occurred through the date of the balance sheet without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial projections of what our insurance companies expect to be the cost of the ultimate settlement and administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and changing judicial theories of liability.

In light of such uncertainties, the Group also relies on policy language, developed by the Group and by others, to exclude or limit coverage where coverage is not intended. If such language is held by a court to be

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invalid or unenforceable, it could materially adversely affect the Group’s results of operations and financial position. The possibility of expansion of an insurer’s liability, either through new concepts of liability or through a court’s refusal to accept restrictive policy language, contributes to the inherent uncertainty of reserving for claims.

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 large proportion of our gross and net loss reserves, particularly for long tail liability classes, are reserves for IBNR losses. Approximately 79% and 76% of our aggregate loss reserves at December 31, 2009 and 2008, respectively, were bulk and IBNR reserves.

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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 techniques, such as the Bornhuetter-Ferguson 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. Please see the discussion under “Liabilities for Loss and Loss Adjustment Expenses of the Critical Accounting Policies” section of ITEM 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further information relating to methods used to estimate reserves.

Because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material adverse effect on the Group’s results of operations and financial condition. We do not believe our insurance companies are subject to any material potential asbestos or environmental liability claims.

The charts below display the Company’s case and IBNR reserves by line of business as of December 31, 2009 and 2008:

As of December 31, 2009
	Case Loss Reserves		Case LAE Reserves		Total Case Reserves		IBNR Reserves (including LAE)			Reinsurance Recoverable on Unpaid Losses and Loss Expenses			Net Reserves
	(In thousands)
Homeowners	$	3,658		-		3,658		2,919			330			6,247
Workers’ compensation		4,519		-		4,519		4,292			428			8,383
Commercial multi-peril		36,466		6,584		43,050		202,311			65,609			179,752
Other liability		2,544		-		2,544		2,593			166			4,971
Other lines		81		-		81		172			106			147
Commercial auto liability		8,179		220		8,399		23,508			10,357			21,550
Commercial auto physical damage		276		11		287		2,220			785			1,722
Products liability		15		-		15		120			-			135
Personal auto liability		1,004		-		1,004		836			-			1,840
Personal auto physical damage		262		-		262		(239	)		(20	)		43
Surety		1,824		216		2,040		6,757			2,563			6,234
Total Loss & LAE Reserves	$	58,828		7,031		65,859		245,489			80,324			231,024


As of December 31, 2008
	Case Loss Reserves		Case LAE Reserves		Total Case Reserves		IBNR Reserves (including LAE)			Reinsurance Recoverable on Unpaid Losses and Loss Expenses			Net Reserves
	(In thousands)
Homeowners	$	4,894		-		4,894		2,491			673			6,712
Workers’ compensation		3,864		-		3,864		4,321			602			7,583
Commercial multi-peril		32,501		5,737		38,238		186,205			61,450			162,993
Other liability		4,185		-		4,185		4,793			86			8,892
Other lines		60		-		60		269			104			225
Commercial auto liability		14,990		391		15,381		24,227			17,959			21,649
Commercial auto physical damage		355		17		372		2,293			860			1,805
Products liability		30		-		30		18			197			(149	)
Personal auto liability		800		-		800		695			33			1,462
Personal auto physical damage		279		-		279		(21	)		(20	)		278
Surety		3,536		464		4,000		6,606			4,094			6,512
Total Loss & LAE Reserves	$	65,494		6,609		72,103		231,897			86,038			217,962

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The following table shows the development of our consolidated reserves for unpaid losses and LAE from 1999 through 2009 as determined under U.S. generally accepted accounting principles (GAAP). The top line of each table shows the liabilities, net of reinsurance, at the balance sheet date, including losses incurred but not yet reported. The upper portion of each table shows the cumulative amounts subsequently paid as of successive years with respect to the liability. The lower portion of each table shows the re-estimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimates change as additional information becomes known about the frequency and severity of claims for individual years. A redundancy exists when the re-estimated liability at each December 31 is less than the prior liability estimate. A deficiency exists when the re-estimated liability at each December 31 is greater than the prior liability estimate. The “cumulative redundancy (deficiency)” depicted in the tables, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years.

Amounts shown in the 2005 column of the table include both 2005 and prior to 2005 accident year development for FPIC, which was acquired on October 1, 2005, and accounted for as a purchase business combination.

	Year Ended December 31,
	1999		2000		2001		2002			2003			2004
	(In thousands)

Liability for unpaid losses and LAE net of reinsurance recoverable	$	23,643	$	24,091	$	25,634	$	27,198		$	32,225		$	32,965
Cumulative amount of liability paid through:
One year later		5,842		5,726		7,376		8,840			12,772			14,580
Two years later		8,627		9,428		11,850		15,442			20,624			23,011
Three years later		11,237		12,142		15,610		19,947			26,610			29,177
Four years later		12,726		14,139		18,493		23,126			29,309			33,369
Five years later		13,613		15,750		20,123		24,156			30,939			35,811
Six years later		14,865		16,628		20,726		24,910			32,493
Seven years later		15,702		17,210		21,187		25,997
Eight years later		16,254		17,493		21,344
Nine years later		16,388		17,586
Ten years later		16,449
Liability estimated as of:
One year later		19,689		20,810		23,490		26,601			31,339			32,427
Two years later		18,506		19,539		22,084		26,924			32,392			35,323
Three years later		17,484		17,745		22,522		26,681			32,763			37,330
Four years later		16,167		18,050		22,047		26,507			33,228			38,333
Five years later		16,200		17,751		21,817		26,458			34,312			38,930
Six years later		16,604		17,934		22,014		26,952			34,770
Seven years later		16,791		18,153		22,169		27,177
Eight years later		16,919		18,210		22,243
Nine years later		16,987		18,348
Ten years later		17,153
Cumulative total redundancy (deficiency), net	$	6,490	$	5,743	$	3,391	$	21		$	(2,545	)	$	(5,965	)
Gross liability - end of year		29,471		28,766		31,059		31,348			37,261			36,028
Reinsurance recoverable - end of year		5,828		4,676		5,425		4,150			5,036			3,063
Net liability - end of year	$	23,643	$	24,090	$	25,634	$	27,198		$	32,225		$	32,965
Gross re-estimated liability - latest		21,865		22,538		27,054		31,839			40,637			45,259
Re-estimated reinsurance recoverable - latest		4,712		4,190		4,811		4,662			5,867			6,329
Net re-estimated liability - latest	$	17,153	$	18,348	$	22,243	$	27,177		$	34,770		$	38,930
Cumulative total redundancy (deficiency), gross	$	7,606	$	6,228	$	4,005	$	(491	)	$	(3,376	)	$	(9,231	)

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	Year Ended December 31,
	2005			2006			2007			2008			2009
	(In thousands)

Liability for unpaid losses and LAE net of reinsurance recoverable	$	132,935		$	164,522		$	192,017		$	217,962		$	231,024
Cumulative amount of liability paid through:
One year later		32,826			41,102			44,752			47,752			-
Two years later		62,178			73,491			78,980
Three years later		87,618			100,541
Four years later		109,711
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Liability estimated as of:
One year later		141,357			172,693			198,148			218,058			-
Two years later		151,741			182,603			201,704
Three years later		164,537			188,847
Four years later		171,054
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Cumulative total redundancy (deficiency), net	$	(38,119	)	$	(24,325	)	$	(9,687	)	$	(96	)	$	-
Gross liability - end of year		211,679			250,455			274,399			304,000			311,348
Reinsurance recoverable - end of year		78,744			85,933			82,382			86,038			80,324
Net liability - end of year	$	132,935		$	164,522		$	192,017		$	217,962		$	231,024
Gross re-estimated liability - latest		256,323			273,110			279,580			297,994
Re-estimated reinsurance recoverable - latest		85,269			84,263			77,876			79,936
Net re-estimated liability - latest	$	171,054		$	188,847		$	201,704		$	218,058
Cumulative total redundancy (deficiency), gross	$	(44,644	)	$	(22,655	)	$	(5,181	)	$	6,006

Changes in Reinsurance

In each of the years ended December 31, 2009, 2008 and 2007, reinsurance retentions were increased. An increase in retention means that the Company retains responsibility for losses and loss adjustment expenses to a higher initial threshold before which reinsurance attaches and becomes responsible for the amount of a claim exceeding the threshold, subject to the terms of the reinsurance agreement. The impact of such an increase in retention is generally to cause the net liability for losses and loss adjustment expenses to increase, since fewer losses are ceded to reinsurers, although the direct liability for losses and loss adjustment expenses will be unchanged by a change in retention. This increase in retention will result in a decline over time in the amount of the difference between the Net Liability and Gross Liability totals in the ten-year chart above.

For further information about the Company’s reinsurance program and retentions, please see the “Reinsurance” heading in this ITEM 1. “Business” section.

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Prior Year Development

As a result of changes in estimates for losses on insured events occurring in prior years, the liability for losses and loss adjustment expenses increased by $0.1 million, $6.1 million and $8.1 million in 2009, 2008 and 2007, respectively.

The following table presents, by line of business, the change in the liability for unpaid losses and loss adjustment expenses incurred in the years ended December 31, 2009, 2008 and 2007, for insured events of prior years.

Prior year favorable (unfavorable) development, by line of business, reported in:
	Year Ended December 31,
	2009			2008			2007
	(In Thousands)

Commercial multi-peril	$	(5,331	)	$	(9,220	)	$	(5,911	)
Commercial automobile		4,221			3,041			2,504
Other liability		1,310			869			(4,388	)
Workers' compensation		9			413			787
Homeowners		559			(1,093	)		(1,220	)
Personal automobile		(214	)		(98	)		(101	)
Other lines		(650	)		(43	)		158

Net unfavorable prior year development	$	(96	)	$	(6,131	)	$	(8,171	)

We evaluate our estimated ultimate liability by line of business on a quarterly basis. The establishment of loss and loss adjustment expense reserves is an inherently uncertain process, and reserve uncertainty stems from a variety of sources. Court decisions, regulatory changes and economic conditions, among other factors, can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Similarly, actual experience, including the number of claims and the severity of claims, to the extent it varies from data previously used or projected, will be used to update the projected ultimate liability for losses, by accident year and line of business. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such changes are made. A discussion of factors contributing to an (increase) decrease in the liability for unpaid losses and loss adjustment expenses (as shown in the chart immediately above) for the Group’s major lines, representing 92% of net loss and loss adjustment reserves at December 31, 2009, follows:

Commercial multi-peril

With $179.8 million, $163.0 million, and $140.0 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008 and 2007, respectively, commercial multi-peril is the line of business that carries the largest net loss and loss adjustment expense reserves, representing 78%, 75%, and 73%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008, and 2007.

The commercial multi-peril line of business experienced adverse prior year development of $5.3 million in 2009, $9.2 million in 2008, and $5.9 million in 2007. The majority of this development relates to the west coast contractor liability book of business. Contractor liability claims, particularly construction defect claims, are long-tailed in nature and develop over a period of up to twelve years.

The adverse development in 2009, 2008 and 2007 was driven by higher than expected reported construction defect claim activity, particularly on the 1998 through 2002 accident years. The adverse development in 2009, 2008 and 2007 includes $0.3 million, ($0.4) million, and $0.7 million, respectively, in reserve increases (decreases) related to accident years 1997 and prior which are pre- Montrose claims (see discussion of Montrose under the heading of Description of Ultimate Loss Estimation Methods in the Critical Accounting Policies section of ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations).

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The adverse development in 2009, 2008 and 2007 also includes ($0.8) million, $1.9 million, and $0.5 million, respectively, in post-commutation reserve (decreases) increases for losses formerly subject to reinsurance treaties.

In 2009, there was $2.0 million in favorable development on accident year 2008 due to lower than expected loss emergence, primarily on west coast commercial multi-peril property which was offset in part by $1.7 million in higher than expected reserve development on the 2007 accident year, primarily on east coast commercial multi-peril liability. In 2008 there was $3.5 million in favorable development on west coast commercial multi-peril liability accident years 2003 through 2005, due to lower than expected loss emergence. In 2007 there was no development on the 2003 through 2005 accident years. The favorable development in 2008 was driven by a decrease in claim frequency for accident years 2003 through 2005 which reflects the impact of both rate increases and changes in underwriting.

The variances from previous expectations in the loss activity described above were taken into account in evaluating the ultimate liability for losses and loss adjustment expenses.

Commercial automobile

With $23.3 million, $23.5 million, and $18.3 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008, and 2007, respectively, commercial automobile is the Group’s second largest reserved line of business, representing 10%, 11%, and 10%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008, and 2007.

The commercial automobile line of business experienced favorable prior year development of $4.2 million in 2009, $3.0 million in 2008, and $2.5 million in 2007.

The favorable development on the commercial automobile line of business reflects a reduction in claims frequency for the recent accident years and a lower than expected emergence of losses, particularly on the Group’s heavy truck programs like Ready Mix and Aggregate Haulers. Additionally, in 2009, the favorable development on the 2007 accident year was impacted by better than expected case reserve development.

The variances from previous expectations in the loss activity described above were taken into account in evaluating the ultimate liability for losses and loss adjustment expenses.

Workers compensation

With $8.4 million, $7.6 million, and $7.6 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008, and 2007, respectively, workers compensation represents 4%, 3%, and 4%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008 and 2007. A portion of this business is assumed from the National Involuntary Pool managed by the National Council on Compensation Insurance (NCCI).

Workers compensation reserves developed favorably in 2009 by $0.0 million, in 2008 by $0.4 million, and in 2007 by $0.8 million, respectively.

Workers compensation losses are impacted heavily by medical cost increases which have been significant recently.

The variances from previous expectations in the loss activity described above were taken into account in evaluating the ultimate liability for losses and loss adjustment expenses.

All Other lines

The remaining lines of business collectively contributed approximately $1.0 million in favorable development and adverse development of $0.4 million and $5.6 million for the years ended December 31, 2009, 2008, and 2007, respectively. These lines did not individually reflect any significant trends related to prior year development, in 2009 or 2008. The adverse development in 2007 was mainly on the Other Liability line of business and related to an unexpected increase in litigation activity. At December 31, 2009, Other Liability recorded reserves, net of reinsurance, totaled $5.0 million or 2% of net loss and loss

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adjustment reserves (as compared to $12.4 million or 6% of net loss and loss adjustment reserves at December 31, 2008).

Reconciliation Table for Loss and Loss Adjustment Expenses

The following table provides a reconciliation of beginning and ending consolidated loss and LAE reserve balances of the Group for the years ended December 31, 2009, 2008 and 2007, prepared in accordance with U.S. generally accepted accounting principles.

Reconciliation of Reserve for Losses and Loss Adjustment Expenses

	2009			2008			2007
	(In thousands)
Reserves for losses and loss adjustment expenses at the beginning of period	$	304,000		$	274,399		$	250,455
Less: Reinsurance recoverable on unpaid losses and loss expenses		(86,038	)		(82,382	)		(85,933	)
Net reserves for losses and loss adjustment expenses at beginning of period		217,962			192,017			164,522
Add: Provision for losses and loss adjustment expenses for claims occurring in:
Current year		86,046			89,088			83,015
Prior years		96			6,131			8,171
Total incurred		86,142			95,219			91,186
Less: Loss and loss adjustment expense payments for claims occurring in:
Current year		25,328			24,521			22,589
Prior years		47,752			44,753			41,102
Total paid		73,080			69,274			63,691
Net balance, December 31		231,024			217,962			192,017
Plus reinsurance recoverable on unpaid losses and loss expenses at end of period		80,324			86,038			82,382
Reserves for losses and loss adjustment expenses at end of period	$	311,348		$	304,000		$	274,399

Potential Impact on Reserves due to Changes in Key Assumptions

The following table presents, by line of business, the (increase) decrease in the liability for unpaid losses and loss adjustment expenses attributable to insured events of prior years incurred in the year ended December 31, 2009.

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Prior Year development in 2009:

				Loss events of indicated prior years
	Total			2008			2007			2006			2005 and Prior
	(In Thousands)

Commercial multi-peril	$	(5,331	)	$	1,972		$	(1,721	)	$	(187	)	$	(5,395	)
Commercial automobile		4,221			1,155			3,015			183			(132	)
Other liability		1,310			1,001			332			(194	)		171
Workers' compensation		9			(533	)		675			225			(358	)
Homeowners		559			379			117			(73	)		136
Personal automobile		(214	)		56			(192	)		36			(114	)
Other lines		(650	)		(573	)		460			283			(820	)

Net 2009 (unfavorable) favorable
prior year development	$	(96	)	$	3,457		$	2,686		$	273		$	(6,512	)

The Group has concluded that in its judgment the range of reasonable estimates of loss and loss expense reserves, on a net basis, is likely to range from $195.4 million to $241.6 million as of December 31, 2009. Similarly, the Group concluded that in its judgment the range of reasonable estimates of loss and loss expense reserves, on a net basis, ranged from $169.2 million to $227.9 million as of December 31, 2008. The Group’s net loss and loss adjustment expense reserves are carried at $231.0 million as of December 31, 2009, and $218.0 million as of December 31, 2008, toward the upper ends of the ranges for the respective years. We have not performed stochastic modeling of the reserves; however, management believes that it is probable that the final outcome will fall within the range specified above.

The table below summarizes the impact on net loss and loss adjustment expense reserves and stockholders’ equity of variances from the selected carried reserves to either extreme of the management-selected range of estimates of loss and loss adjustment expense reserves, net of reinsurance, based on reasonably likely changes in the variables considered in establishing loss and loss adjustment expense reserves. The range of reasonably likely changes was established based on a review of changes in accident year development by line of business and applied to loss reserves as a whole. The asymmetry of the range of estimates reflects the general shape of the probability distribution for liability loss reserves (i.e., it is typical to have smaller redundancies more often than larger deficiencies) and the fact that the consequences of deficiencies are more severe. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:

Range of Loss and Loss Adjustment Reserves Net of Reinsurance	Adjusted Loss and Loss Adjustment Reserves Net of Reinsurance as of December 31, 2009	Percentage Change in Stockholders Equity as of December 31, 2009 (1)	Adjusted Loss and Loss Adjustment Reserves Net of Reinsurance as of December 31, 2008	Percentage Change in Stockholders Equity as of December 31, 2008 (1)
(Dollars in thousands)

Reserve range low end	$195,447	14.7%	$169,228	23.4%
Selected reserves	$231,024	-	$217,962	-
Reserve range high end	$241,616	(4.4)	$227,942	(4.8)

(1) Net of tax

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The following paragraphs discuss considerations taken into account for the Group’s major lines of business in selecting reserves for losses and loss adjustment expenses (note that in the discussions below reserves relating to FPIC are discussed in the context of their actual accident years, notwithstanding that they are shown in the ten-year development chart above as attributable under purchase accounting to 2005, the year of FPIC’s acquisition by the Group).

Commercial multi-peril

The Group’s selection of an estimate towards the upper end of the range is related primarily to its commercial multiple peril liability book, and is due to a number of factors, including the fact that historically generally accepted actuarial projection techniques have proved somewhat inadequate in estimating loss reserves for CMP liability (more specifically, in the Group’s case, contractors’ liability). Trends in legal, economic, and social factors have caused development patterns for CMP liability to become more protracted; that is, claims, especially construction defect claims, are being reported much longer after the occurrence of the event giving rise to the claim. This effect causes the use of historical development patterns to understate loss reserves for more recent accident year periods. It also makes the investigation and defense of the claim more difficult and costly. We have therefore applied alternative techniques in our analysis (and segregated contractors’ policies from all other policies in the analysis) and have judgmentally selected our best estimate of the loss reserves to reflect our expectation that such trends will continue.

Commercial automobile

The loss and loss adjustment expense reserves for commercial automobile liability have experienced favorable trends in the last few years. Prior to 1998, the development of reported losses was effectively complete (claims were reported and case reserves were at or near ultimate values) by about four years after the beginning of an accident year. For accident years 1998 through 2001, the development pattern extended as long as seven years. Since accident year 2003, however, the development pattern has shortened to about five years. At the same time, claims frequencies have decreased. Reliance on historical emergence patterns have produced redundancies in the loss and loss adjustment expense reserves in recent accident years.

Workers Compensation

The development in workers compensation reserves is almost entirely due to our experience on assumed business from the national involuntary pool, which has been volatile. We continuously review the trends in this experience and use our best judgment in estimating assumed reserves.

Sensitivity of key assumptions in reserve selection

Our process of establishing loss reserves for long-tailed classes of business takes into account a variety of key assumptions, including, but not limited to, the following:

•	the selection of loss development patterns;

•	the selection of Tail Factors;

•	the selection of Expected Ultimate Loss Ratios; and

•	for CMP liability, the Company’s biggest line of business, for the older policy years (1996 and prior), the number of remaining unreported claims and expected average cost of those claims.

The relative significance of any individual assumption depends upon several considerations, such as the line of business and the accident year. If the actual experience emerges differently than the assumptions used in the process of establishing reserves, then it is possible that there will be changes in the reserve estimates (prior year development) that may be material to the results of operations in future periods. Set forth below is a discussion of the potential impact of using certain key assumptions that differ from those used in our latest reserve analysis. It is important to note that the following discussion considers each assumption individually without any consideration of the correlation (or the lack thereof) between lines of business and accident years or between assumptions, and therefore does not constitute an actuarial range. While the following discussion represents possible volatility due to variations in key assumptions identified by management, there is no assurance that future emergence of our loss experience will be consistent with either our current or alternative sets of assumptions. By the very nature of the insurance business, it is normal for loss development patterns to have a certain amount of variability.

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As an illustration of the potential volatility, consider the impact of the use of the different assumptions described below in setting reserves for the Commercial multiple peril liability line, the Group’s biggest line of business and the one for which reserves have been the most volatile. CMP comprises about 78% of the Group’s net reserves of which 90% of the reserves for CMP relate to the west coast CMP liability net reserves.

•

For west coast CMP liability, if we chose certain alternate sets of assumptions for loss development, assumptions which would still be considered reasonable, the net (of ceded reinsurance) reserve estimates at December 31, 2009, could decrease by $15.2 million, pre-tax, implying a redundancy (i.e., reserves should be lower), or increase by $4.0 million, pre-tax, implying a deficiency (i.e., reserves should be higher).

•

In selecting management’s best estimates of the loss reserves for accident years 1998 and subsequent, we use methods that rely on expected ultimate loss ratios (the ratios of expected net ultimate losses and loss expenses to net earned premiums). Those ratios vary by accident year and class of business. For west coast CMP liability, if we increased or decreased those expected ultimate loss ratios by 5 percentage points, then the net loss reserves at December 31, 2009, would increase or decrease by $23.7 million, pre-tax, respectively.

•

For accident years 1997 and prior, the years most affected by the California Montrose decision, we project the reserves for incurred but not reported claims judgmentally. We have assumed that the twelve-year statute of limitations is valid and enforceable (as it has been in the past) and that therefore there will be no additional claims reported after December 31, 2009, for accident years 1997 and prior (related to policy years 1996 and prior), that will require the payment of losses. However, there are claims still pending from these older years and it is possible that claims previously closed without payment may reopen. Using alternative assumptions, the estimates of the net reserves at December 31, 2009, could increase or decrease by less than $0.5 million, pre-tax, respectively.

In light of the many uncertainties involved in the estimation of reserves, we monitor the reserves monthly, quarterly, and semi-annually, and perform a comprehensive review of our reserve estimates at least twice a year. These reviews could result in the identification of information and trends that would require us to increase or decrease some reserves for prior periods and could materially affect our results of operations, equity, business, financial strength and ratings. In 2009, we experienced adverse development of $0.1 million, comprised of adverse development of $5.3 million for commercial multiple peril, offset by a redundancy of $4.2 million for commercial automobile liability and relatively small amounts of redundancies and deficiencies for other lines of business.

Statutory and GAAP Loss and Loss Expense Reserves

There are no material differences between the Group’s loss and loss expense reserves under Statutory Accounting Principles and its loss reserves under U.S. Generally Accepted Accounting Principles at December 31, 2009, and 2008.

See additional discussion of loss and loss adjustment expense reserves in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Policies” under the sections titled “Liabilities for Loss and Loss Adjustment Expenses”, “Methods Used to Estimate Loss and Loss Adjustment Expense Reserves” and “Description of Ultimate Loss Estimation Methods”.

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REINSURANCE

The table below summarizes for 2009, 2008 and 2007, the premiums and losses and loss adjustment expenses assumed and ceded under the Group’s reinsurance programs in place for those years:

	2009			2008			2007
Premiums written:
Direct	$	153,045		$	165,377		$	182,907
Assumed		801			1,058			1,383
Ceded		(16,016	)		(19,083	)		(24,623	)
Net premiums written	$	137,830		$	147,352		$	159,667

Premiums earned:
Direct	$	156,735		$	172,817		$	176,395
Assumed		918			1,233			1,801
Ceded		(17,240	)		(21,473	)		(31,521	)
Net premiums earned	$	140,413		$	152,577		$	146,675

Losses and loss expenses incurred
Direct	$	96,590		$	110,150		$	107,141
Assumed		31			1,043			1,185
Ceded		(10,479	)		(15,974	)		(17,140	)
Net losses and loss expenses incurred	$	86,142		$	95,219		$	91,186

Reinsurance Ceded

In accordance with insurance industry practice, our insurance companies reinsure a portion of their exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by our companies are reinsured with other insurance companies principally to:

•

reduce net liability on individual risks;

•

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

•

stabilize underwriting results;

•

decrease leverage; and

•

increase our insurance companies’ underwriting capacity.

Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each policy or portion of a policy is reinsured individually. Under treaty reinsurance, an agreed-upon portion of a class of business is automatically reinsured. Reinsurance also can be classified as quota share reinsurance, pro-rata reinsurance or excess of loss reinsurance. Under quota share reinsurance and pro-rata reinsurance, the ceding company cedes a percentage of its insurance liability to the reinsurer in exchange for a like percentage of premiums less a ceding commission. The ceding company in turn recovers from the reinsurer the reinsurer’s share of all losses and loss adjustment expenses incurred on those risks. Under excess reinsurance, an insurer limits its liability to all or a particular portion of the amount in excess of a predetermined deductible or retention. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the ceding company to the extent of the coverage ceded.

The amount and scope of reinsurance coverage we purchase each year is determined based on a number of factors. These factors include the evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance. Reinsurance arrangements are placed with non-affiliated reinsurers, and are generally renegotiated annually.

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The decrease in ceded premium in 2009 and 2008 relates primarily to the increases in underlying retentions in 2009, 2008, and 2007, and the related decrease in ceding rates.

The largest exposure retained in 2009, 2008, and 2007 on any one individual property risk was $1,000,000, $850,000 and $750,000, respectively. Individual property risks in excess of these amounts are covered on an excess of loss basis pursuant to various reinsurance treaties. All property lines of business, including commercial automobile physical damage, are reinsured under the same treaties.

Except for umbrella liability, individual casualty risks that are in excess of $1,000,000, $850,000 and $750,000, respectively, in 2009, 2008, and 2007 are covered on an excess of loss basis up to $1.0 million per occurrence. Casualty losses in excess of $1.0 million arising from workers’ compensation claims are reinsured up to $10.0 million per occurrence per insured. Umbrella liability losses are reinsured on a 75% quota share basis up to $1.0 million and a 100% quota share basis in excess of $1.0 million.

For the surety line of business, written exclusively by FPIC, the Group maintains an excess of loss contract under which it retains the first $500,000 and 10% of the next $4.0 million resulting in a maximum retention of $900,000 per principal.

Catastrophic reinsurance protects the ceding insurer from significant aggregate loss exposure. Catastrophic events include windstorms, hail, tornadoes, hurricanes, earthquakes, riots, blizzards, terrorist activities and freezing temperatures. We purchase layers of excess treaty reinsurance for catastrophic property losses. We reinsure 100% of losses per occurrence in excess of $5.0 million up to a maximum of $55.0 million, for 2009, 2008 and 2007.

The Group also carries coverage on commercial lines of business for acts of terrorism of $10.0 million excess of $3.0 million in 2009, 2008 and 2007. This coverage does not apply to nuclear, chemical or biological events.

Prior to 2007, FPIC had a separate reinsurance program from the other insurance companies in the Group, which was largely a continuation of the program it had in place immediately prior to its acquisition by the Group. Commercial multi-peril property and auto physical damage coverage was reinsured, through a $1,650,000 excess of $350,000 excess of loss contract. Excess of $2.0 million, FPIC had a semi-automatic facultative agreement, which provided $8.0 million of coverage. On casualty business FPIC maintained two reinsurance layers, $250,000 excess of $250,000, and $500,000 excess of $500,000, respectively, for commercial multiple peril liability and commercial automobile liability with a syndicate of reinsurers. The maximum exposure on any one casualty risk was $250,000. Excess of $1.0 million, there was a semi-automatic facultative agreement, which provided $5.0 million of coverage.

Effective January 1, 2008, the Group renewed its reinsurance coverages with the following changes. The retention on any individual property or casualty risk was increased to $850,000 from $750,000. Pollution coverage written by FPIC was fully retained with a standard sub-limit of $150,000 (and up to $300,000 on an exception basis). Prior to 2008, FPIC reinsured 100% of its pollution coverage, which in 2007 represented $1.8 million of ceded written premium. The Group also purchased an additional $1.0 million of surety coverage (subject to a 10% retention) which resulted in an increased reinsurance coverage to $4.5 million from $3.5 million per principal and a maximum retention of $900,000 per principal as compared to the previous $800,000. The Group continued its primary treaties (i.e., treaties covering risk limits less than $1.0 million on casualty lines, less than $7.5 million on property lines and less than $10 million on workers’ compensation) with General Reinsurance Corporation, rated A++ (Superior) by A.M. Best, their highest rating.

Effective January 1, 2009, the Group renewed its reinsurance coverages with the following 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. Additionally, in 2009 FPIC’s umbrella reinsurance coverage was increased to $10.0 million from $5.0 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.

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In conjunction with the renewal of the reinsurance program for 2009, 2008 and 2007, the prior year reinsurance treaties were terminated on a run-off basis, requiring that for policies in force as of December 31, 2008, 2007 and 2006, respectively, these reinsurance agreements continue to cover losses occurring on these policies in the future. Therefore, the Group will remit premiums to and collect reinsurance recoverables from the reinsurers on these prior year treaties as the underlying business runs off.

During the fourth quarter of 2008, the Group commuted all reinsurance agreements with St Paul Fire and Marine Insurance Company. These reinsurance agreements included participation in the property quota share and casualty excess of loss treaties. As a result of the commutation the Group received a cash payment of $2.5 million, and recorded a pre-tax net gain on commutation of $0.9 million.

Prior to 2007, some of the Group’s reinsurance treaties (primarily FPIC treaties) have included provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Group shares on a limited basis in the profitability through contingent ceding commissions. Exposure to the loss experience is contractually defined at minimum and maximum levels, and the terms of such contracts are fixed at inception. Since estimating the emergence of claims to the applicable reinsurance layers is subject to significant uncertainty, the net amounts that will ultimately be realized may vary significantly from the estimated amounts presented in the Group’s results of operations.

The Group’s significant reinsurance treaties as of December 31, 2009 are summarized below:

Property Excess of Loss

The Property Excess of Loss program consists of two layers with coverage of $6,500,000 above an $1,000,000 retention. The first layer is $4.0 million excess of $1.0 million with a per occurrence limit of $8.0 million. The second layer is $2.5 million excess of $5.0 million with a per occurrence limit of $2.5 million. The first layer has no annual aggregate limit or reinstatement premium. The second layer has a $5.0 million annual aggregate limit and a reinstatement premium based on the reinsurance premium multiplied by the percentage of reinstated limit. The Group purchases facultative coverage in excess of these limits. Effective January 1, 2010, a third layer of $2.5 million in coverage was added resulting in a total coverage of $9.0 million above an $1.0 million retention.

Property Catastrophe Excess of Loss

The Property Catastrophe Excess of Loss program consists of three layers with coverage of $50.0 million above a $5.0 million retention. The first layer is $5.0 million excess of $5.0 million with a per occurrence limit of $5.0 million. The second layer is $10.0 million excess of $10.0 million with a per occurrence limit of $10.0 million. The third layer is $35.0 million excess of $20.0 million with a per occurrence limit of $35.0 million. There is an annual aggregate limit of $10.0 million on the first layer, $20.0 million on the second layer and $70.0 million on the third layer. There is a reinstatement premium on each layer based on the reinsurance premium multiplied by the percentage of reinstated limit. There will be no change to this program’s structure for 2010.

Casualty Excess of Loss

The Casualty Excess of Loss program consists of three layers with coverage of $9.0 million above an $1.0 million retention. The first layer is $1.0 million excess of $1.0 million with a per occurrence limit of $1.0 million. The second layer is $3.0 million excess of $2.0 million with a per occurrence limit of $3.0 million. The third layer is only for the workers’ compensation line of business and is $5.0 million excess of $5.0 million with a per occurrence limit of $5.0 million. The first, second and third layers have a $5.0 million, $6.0 million and $10.0 million annual aggregate limit, respectively. The first and second layers have no reinstatement premium and the third layer has a reinstatement premium based on the reinsurance premium multiplied by the percentage of reinstated limit. Effective January 1, 2010, this program was renewed with no material changes.

Umbrella Liability Quota Share

The Umbrella Liability Quota Share program consists of two treaties, one for MIC, MICNJ, and FIC, and one for FPIC. Both treaties reinsure losses on a 75% quota share basis up to $1.0 million and on a 100%

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quota share basis in excess of $1.0 million and provide for up to $10.0 million in limit. The Group purchases facultative coverage in excess of these limits. Effective January 1, 2010, this program was renewed with no material changes.

Surety Excess of Loss

The Surety Excess of Loss program consists of four layers with coverage of $4.0 million above a $500,000 retention. The first layer is $1.5 million excess of $500,000 with a 10% retention and a per occurrence limit of $1,350,000. The second layer is $1.5 million excess of $2.0 million with a 10% retention and a per occurrence limit of $1,350,000. The third layer is $500,000 excess of $3.5 million with a 10% retention and a per occurrence limit of $450,000. The fourth layer is $500,000 excess of $4.0 million with a 10% retention and a per occurrence limit of $450,000. The first and second layers have a $2.7 million annual aggregate limit and a 25% and 50%, respectively, reinstatement premium. The third and fourth layers each have a $450,000 annual aggregate and no reinstatement premium. The Group’s maximum retention is $900,000 per principal. This reinsurance structure was renewed for 2010 with the addition of a $500,000 annual aggregate deductible on the first layer.

Terrorism

The Terrorism program consists of three treaties. The first treaty is $10.0 million above a $3.0 million retention for commercial lines of business. This coverage does not apply to nuclear, chemical or biological events. The annual aggregate limit is $10.0 million. The second treaty is the Property Terrorism Excess treaty with coverage of $6,500,000 above a $1,000,000 retention. This coverage does not apply to nuclear, chemical or biological events. The annual aggregate limit is $6,500,000. The third treaty is the Workers’ Compensation Terrorism treaty with coverage of $4,000,000 above a $1,000,000 retention. This coverage does not apply to nuclear, chemical or biological events. The annual aggregate limit is $4,000,000. Effective January 1, 2010, this program was renewed with no material changes.

Reinsurance Assumed

We generally do not assume risks from other insurance companies. However, we are required by statute to participate in certain residual market pools. This participation requires us to assume business for workers’ compensation and for property exposures that are not insured in the voluntary marketplace. We participate in these residual markets pro rata on a market share basis, and as of December 31, 2009, our participation is not material. For the years ended December 31, 2009, 2008 and 2007, our insurance companies assumed $0.8 million, $1.1 million and $1.4 million of written premiums, respectively.

Reinsurer Credit Risk

The insolvency or inability of any reinsurer to meet its obligations to us could have a material adverse effect on our results of operations or financial condition. As of December 31, 2009, the Group’s five largest reinsurers based on percentage of ceded premiums are set forth in the following table:

Name		Percentage
		of Ceded	A.M. Best
		Premiums	Rating
1.	Berkley Insurance Company	33%	A+
2.	General Reinsurance Corporation	30%	A++
3.	Munich Reinsurance America, Inc.	15%	A+
4.	Hartford Steam Boiler Inspection and Insurance Company	7%	A+
5.	Montpelier Reinsurance	3%	A-

The following table sets forth the five largest amounts of loss and loss expenses recoverable from reinsurers on unpaid claims as of December 31, 2009.

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Name		Loss and
		Loss Expenses
		Recoverable on		A.M. Best
		Unpaid Claims		Rating
		(In thousands)
1.	Berkley Insurance Company	$	34,556	A+
2.	Partner Reinsurance Company of the U.S.		13,953	A+
3.	General Reinsurance Corporation		11,844	A++
4.	QBE Reinsurance Corporation		7,170	A
5.	Continental Casualty Company		5,126	A

The A++, A+, A and A- ratings are the top four of A.M. Best’s 16 ratings. According to A.M. Best, companies with a rating of “A++” or “A+” are rated “Superior”, with “…a superior ability to meet their ongoing obligations to policyholders.” Companies with a rating of “A” or “A-” are rated “Excellent”, with “…an excellent ability to meet their ongoing obligations to policyholders.”

INVESTMENTS

On a consolidated basis, all of our investments in fixed income and equity securities are classified as available for sale and are carried at fair value.

An important component of our consolidated operating results has been the return on invested assets. Our investment objectives are to: (i) maximize current yield, (ii) maintain safety of capital through a balance of high quality, diversified investments that minimize risk, (iii) maintain adequate liquidity for our insurance operations, (iv) meet regulatory requirements, and (v) increase surplus through appreciation. However, in order to enhance the yield on our fixed income securities, our investments generally have a moderately longer duration than the duration of our insurance liabilities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the subsection entitled “Quantitative and Qualitative Information about Market Risk.”

Our investment policy requires that investments be made in a portfolio consisting of bonds, equity securities, and short-term money market instruments. Our equity investments are concentrated in companies with larger capitalizations. The investment policy does not permit investment in unincorporated businesses, private placements or direct mortgages, foreign denominated securities, financial guarantees or commodities. The Board of Directors of the Group has developed this investment policy and reviews it periodically.

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The following table sets forth consolidated information concerning our investments.

	At December 31, 2009				At December 31, 2008				At December 31, 2007
	Cost (2)		Fair Value		Cost (2)		Fair Value		Cost (2)		Fair Value
	(In thousands)

Fixed income securities (1):
United States government and
government agencies (3)	$	68,864	$	72,021	$	84,747	$	87,975	$	83,016	$	83,715
Obligations of states and
political subdivisions		136,706		143,293		143,042		145,125		142,873		144,026
Industrial and miscellaneous		124,135		130,223		77,859		77,499		65,109		65,208
Mortgage-backed securities		18,930		19,927		25,427		23,488		30,980		31,289
Total fixed income securities		348,635		365,464		331,075		334,087		321,978		324,238
Equity securities		7,516		9,484		9,232		10,203		12,500		17,930
Short-term investments		-		-		-		-		-		-
Total	$	356,151	$	374,948	$	340,307	$	344,290	$	334,478	$	342,168

_________

(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 writedowns and amortization of premium and accretion of discount.

(3)	Includes approximately $55,092, $66,576 and $56,142 (cost) and $57,874, $68,696 and $56,637 (estimated fair value) of mortgage-backed securities backed by the U.S. government and government agencies as of December 31, 2009, 2008 and 2007, respectively.

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

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

Fixed income securities
Financial	$	29,612	$	31,537	$	36,520	$	36,065
Retail specialty		42,211		43,897		27,561		27,810
Energy		30,685		32,317		9,680		9,444
Pharmaceutical		9,367		9,744		2,249		2,320
Information Technology		12,260		12,728		1,849		1,860
Total	$	124,135	$	130,223	$	77,859	$	77,499


Equity securities
Financial	$	1,293	$	1,505	$	2,329	$	2,343
Retail specialty		3,488		4,216		4,117		4,565
Energy		407		636		746		1,135
Pharmaceutical		1,333		1,764		794		974
Information Technology		995		1,363		1,246		1,186
Total	$	7,516	$	9,484	$	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.

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The table below contains consolidated information concerning the investment ratings of our fixed maturity investments at December 31, 2009:

Type/Ratings of Investment (1)(2)	Amortized Cost		Fair Value		Percentages(3)
	(Dollars in thousands)
U.S. government and agencies	$	68,864	$	72,021		19.7	%
AAA		83,007		86,982		23.8	%
AA		93,244		97,719		26.7	%
A		93,812		98,360		26.9	%
BBB		8,155		8,368		2.3	%
BB and lower		1,553		2,014		0.6	%
Total	$	348,635	$	365,464		100.0	%

_________________

(1)	The ratings set forth in this table are based on the ratings assigned by Standard & Poor’s Corporation (S&P). If S&P’s ratings were unavailable, the equivalent ratings supplied by Moody’s Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where available.

(2)	The ratings shown above include, where applicable, credit enhancement by monoline bond insurers (see Item 7A for discussion of credit enhancement)

(3)	Represents the fair value of the classification as a percentage of the total fair value of the portfolio.

The table below sets forth the maturity profile of our consolidated fixed maturity investments as of December 31, 2009 (note that mortgage-backed securities in the below table include securities backed by the U.S. government and agencies):

	Amortized
Maturity	Cost (1)		Fair Value		Percentages (2)
			(Dollars in thousands)
1 year or less	$	22,071	$	22,579		6.2	%
More than 1 year through 5 years		93,520		98,530		27.0	%
More than 5 years through 10 years		145,745		152,851		41.8	%
More than 10 years		13,277		13,703		3.7	%
Mortgage-backed securities		74,022		77,801		21.3	%
Total	$	348,635	$	365,464		100.0	%

__________________

(1)	Fixed maturities are carried at fair value in our consolidated financial statements.

(2)	Represents the fair value of the classification as a percentage of the total fair value of the portfolio.

As of December 31, 2009, the average maturity of our fixed income investment portfolio (excluding mortgage-backed securities) was 4.3 years and the average duration was 5.7 years. Our fixed maturity investments include U.S. government bonds, securities issued by government agencies, obligations of state and local governments and governmental authorities, corporate bonds and mortgage-backed securities, most of which are exposed to changes in prevailing interest rates. We carry these investments as available for sale. This allows us to manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by our management and board of directors and consultation with our portfolio advisor.

We continue to maintain a conservative, diversified investment portfolio, with fixed maturity investments representing 98% of invested assets. As of December 31, 2009, the fixed income portfolio consists of 99% investment grade securities, with 1% non-investment grade rated securities, which includes three corporate securities held with a combined market value of $1.3 million, three asset-backed securities held with a combined market value of $0.6 million, one mortgage-backed security with a market value of $0.1 million, and one small tax-exempt municipal bond. The fixed income portfolio has an average rating of Aa3/AA and an average tax equivalent book yield of 5.14%.

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Our consolidated average cash and invested assets, net investment income and return on average cash and invested assets for the years ended December 31, 2009, 2008 and 2007 were as follows:

	Year Ended December 31,
	2009			2008			2007(1)
	(Dollars in thousands)
Average cash and invested assets	$	395,216		$	366,852		$	332,580
Net investment income (1)		14,198			13,936			13,053
Return on average cash and invested assets		3.6	%		3.8	%		3.9	%

(1)	Net investment income for 2007 includes $720,000 non-recurring investment income from the retaliatory tax refund.

A.M. BEST RATING

A.M. Best rates insurance companies based on factors of concern to policyholders. All companies in the Group participate in the intercompany pooling agreement (see “Intercompany Agreements” above) and have been assigned a group rating of “A” (Excellent) by A.M. Best. The Group has been assigned that rating for the past 9 years. An “A” rating is the third highest of A.M. Best’s 16 possible rating categories.

On its annual review in 2009 of Mercer’s rating, A.M. Best affirmed the Group’s “A” rating, but with a negative outlook.

According to the A.M. Best guidelines, A.M. Best assigns “A” ratings to companies that have, on balance, excellent balance sheet strength, operating performance and business profiles. Companies rated “A” are considered by A.M. Best to have “an excellent ability to meet their ongoing obligations to policyholders.” In evaluating a company’s financial and operating performance, A.M. Best reviews:

• the company’s profitability, leverage and liquidity;

• its book of business;

• the adequacy and soundness of its reinsurance;

• the quality and estimated market value of its assets;

• the adequacy of its reserves and surplus;

• its capital structure;

• the experience and competence of its management; and

• its marketing presence.

COMPETITION

The property and casualty insurance market is very highly competitive. Our insurance companies compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Some of these competitors have substantially greater financial, technical and operating resources than our insurance companies. Within our producer’s offices we compete to be a preferred market for desirable business, as well as competing with other carriers to attract and retain the best producers. Our ability to compete successfully in our principal markets is dependent upon a number of factors, many of which are outside our control. These factors include market and competitive conditions. Many of our lines of insurance are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other distribution methods, rather than through independent producers paid on a commission basis (as our insurance companies do). In addition to price, competition in our lines of insurance is based on quality of the products, quality and speed of service, financial strength, ratings, distribution systems and technical expertise.

Pricing in the property and casualty insurance industry historically has been and remains cyclical. During a soft market cycle, price competition becomes prevalent, which makes it difficult to write and retain properly priced personal and commercial lines business. In response to the current soft market, the marketplace is populated with some competitors who are significantly reducing their prices and/or offering coverage terms that are generous in relation to the insurance premiums being charged. We believe that in some instances the prices and terms being offered, if matched by us, would not provide us with an adequate rate of return, if any.

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Our policy is to maintain disciplined underwriting during soft markets, declining business which is inadequately priced for its level of risk. The market is highly competitive, with competition being seen in virtually all classes of commercial and personal accounts. This affects our new business opportunities and creates more challenges for renewals, which can adversely impact premium revenue levels for the Group. We continue to focus on long-term profitability rather than short-term revenue. We also continue to work with our agents to target classes of business and accounts compatible with our underwriting appetite, which includes certain types of religious institutions risks, contracting risks, small business risks and property risks.

Many of our competitors offer internet-based quoting and/or policy issuance systems to their producers. In response to this improvement in marketplace technology, we have developed technology that will allow our agents to rate and bind transactions via an internet-based rating system for some products and lines of business. We launched this process in late 2008 in California and launched a similar process for New Jersey and Pennsylvania agents in January 2009. During 2009, we expanded the number of lines of business that may be produced on-line. We intend on continuing to expand the use of internet-based processing in the future.

A new form of competition may enter the marketplace as reinsurers attempt to diversify their insurance risk by writing business in the primary marketplace. The Group also faces competition, primarily in the commercial insurance market, from entities that may desire to self-insure their own risks.

REGULATION

General

Insurance companies are subject to supervision and regulation in the states in which they do business. State insurance authorities have broad administrative powers to administer statutes and regulations with respect to all aspects of our insurance business including:

•

approval of policy forms and premium rates;

•

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

•

classifying assets as admissible for purposes of determining statutory surplus;

•

licensing of insurers and their producers;

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advertising and marketing practices;

•

restrictions on the nature, quality and concentration of investments;

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assessments by guaranty associations;

•

restrictions on the ability of our insurance company subsidiaries to pay dividends to us;

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restrictions on transactions between our insurance company subsidiaries and their affiliates;

•

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

•

requiring deposits for the benefit of policyholders;

•

requiring certain methods of accounting;

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•

periodic examinations of our operations and finances;

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claims practices;

•

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

•

requiring reserves for unearned premiums, losses and other purposes.

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

Financial Examinations

Financial examinations are conducted by the Pennsylvania Insurance Department, the California Department of Insurance, and the New Jersey Department of Banking and Insurance every three to five years. The Pennsylvania Insurance Department’s last completed examination of MIC and FIC was as of December 31, 2004. The New Jersey Department of Banking and Insurance’s last completed examination of MICNJ was as of December 31, 2004. The last examination of FPIC by the California Department of Insurance was as of December 31, 2003. These examinations did not result in any adjustments to the financial position of any of our insurance companies. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on the operations of our insurance companies.

In 2008, the Pennsylvania Insurance Department began an examination of MIC and FIC which is a coordinated examination with both the New Jersey Department of Banking and Insurance and the California Department of Insurance for MICNJ and FPIC, respectively. That examination was ongoing as of December 31, 2009.

NAIC Risk-Based Capital Requirements

In 1990, the NAIC began an accreditation program to ensure that states have adequate procedures in place for effective insurance regulation, especially with respect to financial solvency. The accreditation program requires that a state meet specific minimum standards in over five regulatory areas to be considered for accreditation. The accreditation program is an ongoing process and once accredited, a state must enact any new or modified standards approved by the NAIC within two years following adoption. As of December 31, 2009, Pennsylvania, New Jersey, and California, the states in which our insurance company subsidiaries are domiciled, were accredited.

Pennsylvania, New Jersey and California impose the NAIC’s risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital (“RBC”). This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations, (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business risks and such other relevant risks as are set forth in the RBC instructions. A company’s “total adjusted capital” is the sum of statutory capital and surplus and such other items as the risk-based capital instructions may provide. The formula is designed to allow state insurance regulators to identify weakly capitalized companies.

The requirements provide for four different levels of regulatory attention. The “company action level” is triggered if a company’s total adjusted capital is less than 2.0 times its authorized control level but greater than or equal to 1.5 times its authorized control level. At the company action level, the company must submit a comprehensive plan to the regulatory authority that discusses proposed corrective actions to improve the capital position. The “regulatory action level” is triggered if a company’s total adjusted capital is less than 1.5 times but greater than or equal to 1.0 times its authorized control level. At the regulatory action level, the

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regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The “authorized control level” is triggered if a company’s total adjusted capital is less than 1.0 times but greater than or equal to 0.7 times its authorized control level; at this level the regulatory authority may take action it deems necessary, including placing the company under regulatory control. The “mandatory control level” is triggered if a company’s total adjusted capital is less than 0.7 times its authorized control level; at this level the regulatory authority is mandated to place the company under its control. The capital levels of our insurance companies have never triggered any of these regulatory capital levels. We cannot assure, however, that the capital requirements applicable to the business of our insurance companies will not increase in the future.

Market Conduct Regulation

State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations, which the Group is subject to from time to time. No material issues have been raised in the market conduct exams performed on the Group’s insurance subsidiaries.

Property and Casualty Regulation

Our property and casualty operations are subject to rate and policy form approval. All of the rates and policy forms that we use that require regulatory approval have been filed with and approved by the appropriate insurance regulator. Our operations are also subject to laws and regulations covering a range of trade and claim settlement practices. To our knowledge, we are currently in compliance with these laws and regulations. State insurance regulatory authorities have broad discretion in approving an insurer’s proposed rates. The extent to which a state restricts underwriting and pricing of a line of business may adversely affect an insurer’s ability to operate that business profitably in that state on a consistent basis.

State insurance laws and regulations require us to participate in mandatory property-liability “shared market,” “pooling” or similar arrangements that provide certain types of insurance coverage to individuals or others who otherwise are unable to purchase coverage voluntarily provided by private insurers. Shared market mechanisms include assigned risk plans; fair access to insurance requirements or “FAIR” plans; and reinsurance facilities, such as the New Jersey Unsatisfied Claim and Judgment Fund. In addition, some states require insurers to participate in reinsurance pools for claims that exceed specified amounts. Our participation in these mandatory shared market or pooling mechanisms generally is related to the amounts of our direct writings for the type of coverage written by the specific arrangement in the applicable state. For the three years ended December 31, 2009, 2008 and 2007, we received earned premiums from these arrangements in the amounts of $918,000, $1,233,000, and $1,801,000, respectively, and incurred losses and loss adjustment expenses from these arrangements in the amounts of $31,000, $1,043,000, and $1,185,000, respectively. Because we do not have a significant amount of direct writings in the coverages written under these arrangements, we do not anticipate that these arrangements will have a material effect on us in the future. However, we cannot predict the financial impact of our participation in any shared market or pooling mechanisms that may be implemented in the future by the states in which we do business.

Guaranty Fund Laws

All states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. The states in which our insurance companies do business have such laws. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. For the years ended December 31, 2009, 2008 and 2007, we incurred approximately $225,000, $98,000, and ($180,000), respectively, in assessments pursuant to state insurance guaranty association laws. We establish reserves relating to insurance companies that are subject to insolvency proceedings when we are notified of assessments by the guaranty associations. We cannot predict the amount and timing of any future assessments on our insurance companies under these laws.

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Terrorism Risk Insurance Act

The Terrorism Risk Insurance Act of 2002 (TRIA) established a program that provides a backstop for insurance-related losses resulting from any act of terrorism as defined. Under this law, coverage provided by an insurer for losses caused by certified acts of terrorism is partially reimbursed by the United States under a formula under which the government pays 85% (beginning in 2007) of covered terrorism losses, exceeding a prescribed deductible. Therefore, the act limits an insurer’s exposure to certified terrorist acts (as defined by the act) to the deductible formula. The deductible is based upon a percentage of direct earned premiums for commercial property and casualty policies. Coverage under the act must be offered to all property, casualty and surety insureds. On December 26, 2007, the President of the United States signed into law the Terrorism Risk Insurance Program Reauthorization Act of 2007 which extends TRIA through December 31, 2014. The law extends the temporary federal program that provides for a transparent system of shared public and private compensation for insured losses resulting from acts of terrorism.

We are currently charging a premium for terrorism coverage on our businessowners, commercial automobile, commercial workers’ compensation, tenant-occupied dwelling, special contractors, special multi-peril, monoline commercial fire, monoline general liability and religious institution policies. Insureds that are charged a terrorism premium have the option (except workers' compensation) of deleting terrorism coverage to reduce their premium costs; however many do not do so. Insureds under commercial workers’ compensation policies do not have the option to delete the terrorism coverage. Most other policies include terrorism coverage at no additional cost. Where allowed, we exclude coverage for losses that are from events not certified as terrorism events, with no buyback option available to the policyholder.

We are unable to predict the extent to which this legislation may affect the demand for our products or the risks that will be available for us to consider underwriting. We do not know the extent to which insureds will elect to purchase this coverage when available.

New and Proposed Legislation and Regulations

The property and casualty insurance industry continues to receive a considerable amount of publicity related to pricing, coverage terms, the lack of availability of insurance, and the issue of paying profit-sharing commissions to agents. Regulations and legislation are being proposed to limit damage awards, to control plaintiffs’ counsel fees, to bring the industry under regulation by the federal government and to control premiums, policy terminations and other policy terms. We are unable to predict whether, in what form, or in what jurisdictions, any regulatory proposals might be adopted or their effect, if any, on our insurance companies.

Dividends

Our insurance companies are restricted by the insurance laws of their respective states of domicile regarding the amount of dividends or other distributions they may pay without notice to or the prior approval of the state regulatory authority.

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 realized capital gains) for the preceding calendar year or (b) 10% of statutory surplus as of the preceding December 31. As of December 31, 2009, the amount available for payment of dividends from MIC in 2010, without the prior approval, is approximately $7.6 million.

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, 2009, the amount available for payment of dividends from FPIC in 2010, without the prior approval, is approximately $7.2 million.

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Holding Company Laws

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

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

EMPLOYEES

All of our employees are employed directly by BICUS, a wholly owned subsidiary of MIC. Our insurance companies do not have any employees. BICUS provides management services to all of our insurance companies. As of December 31, 2009, the total number of full-time equivalent employees of BICUS was 202. None of these employees are covered by a collective bargaining agreement, and BICUS believes that its employee relations are positive.

AVAILABLE INFORMATION

The Company maintains a website at www.mercerins.com . Our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available free of charge on our website as soon as practicable after electronic filing of such material with, or furnishing it to, the Securities and Exchange Commission.

ITEM 1A. RISK FACTORS

Risks Relating to Our Business and Industry

General Economic Conditions

A disruption in world financial markets could adversely affect demand for the Group’s products, and credit risk associated with agents, customers, and reinsurers, as well as adversely affecting the Group’s investment portfolio value and investment income. Disrupted markets could also adversely affect the Group’s ability to raise additional capital if it needed to do so in the future.

A prolonged downturn in the construction segment of the economy would have a continued negative effect on the Group’s premium volume through fewer construction risks to insure and reduced premiums for those contractors that remain in business.

During 2008 and 2009, there were significant disruptions to the financial and equity markets. This 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 affected the valuations of both the fixed income and equity securities held by the Group. If the financial and equity markets suffer further adverse performance, the Group’s business and stockholders’ equity could be adversely affected.

Catastrophic Events

As a property and casualty insurer, we are subject to claims from catastrophes that may have a significant negative impact on operating and financial results. We have experienced catastrophe losses, and can be expected to experience catastrophe losses in the future. Catastrophe losses can be caused by various events, including coastal storms, snow storms, ice storms, freezing, hurricanes, earthquakes, tornadoes, wind, hail, fires, and other natural or man-made disasters. We also face exposure to losses resulting from acts of war, acts of terrorism and political instability. The frequency, number and severity of these losses are unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event.

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We attempt to manage catastrophe risk by reinsuring a portion of our exposure. However, reinsurance may prove inadequate if:

• A major catastrophic loss exceeds the reinsurance limit;

• A number of small catastrophic losses occur which individually fall below the reinsurance retention level.

In addition, because accounting regulations do not permit insurers to reserve for catastrophic events until they occur, claims from catastrophic events could cause substantial volatility in our financial results for any fiscal quarter or year and could have a material adverse affect on our financial condition or results of operations. Our ability to write new business also could be adversely affected.

Climate change

Longer-term natural catastrophe trends may be changing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain and snow. Climate change, to the extent it produces rising temperatures and changes in weather patterns, could impact the frequency or severity of weather events such as hurricanes.

To the extent climate change does increase the frequency and severity of such weather events, our insurance companies may face increased claims, including with respect to properties located in coastal areas. To the extent climate change leads to increased claims, our financial condition and results of operations could be materially, adversely affected.

Loss Reserves

We maintain reserves to cover amounts we estimate will be needed to pay for insured losses and for the expenses necessary to settle claims. Estimating loss and loss expense reserves is a difficult and complex process involving many variables and subjective judgments. Estimates are based on management assessment of the known facts and circumstances, prediction of future events, claims severity and frequency and other subjective factors. We regularly review our reserving techniques and our overall amount of reserves. We review historical data and consider the impact of various factors such as:

•	trends in claim frequency and severity;

•	our loss history and the industry’s loss history;

•	information regarding each claim for losses;

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

•	changes in political attitudes; and

•	trends in general economic conditions, including inflation.

Our estimated loss reserves could be incorrect and potentially inadequate. If we determine that our loss reserves are inadequate, we will have to increase them. This adjustment would reduce income during the period in which the adjustment is made, which could have a material adverse impact on our financial condition and results of operation. There is no precise way to determine the ultimate liability for losses and loss settlements prior to final settlement of the claim.

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Terrorism

The threat of terrorism, both within the United States and abroad, and military and other actions and heightened security measures in response to these types of threats, may cause significant volatility and declines in the equity markets in the United States, Europe and elsewhere, as well as loss of life, property damage, additional disruptions to commerce and reduced economic activity. Actual terrorist attacks could cause losses from insurance claims related to the property and casualty insurance operations of the Group as well as a decrease in our stockholders’ equity, net income and/or revenue. The Terrorism Risk Insurance Reauthorization and Extension Act of 2007 requires that some coverage for terrorist loss be offered by primary property insurers and provides Federal assistance for recovery of claims. In addition, some of the assets in our investment portfolio may be adversely affected by declines in the equity markets and economic activity caused by the continued threat of terrorism, ongoing military and other actions and heightened security measures.

We cannot predict at this time whether and the extent to which industry sectors in which we maintain investments may suffer losses as a result of terrorism-related decreases in commercial and economic activity, or how any such decrease might impact the ability of companies within the affected industry sectors to pay interest or principal on their securities, or how the value of any underlying collateral might be affected.

We can offer no assurances that the threats of future terrorist-like events in the United States and abroad or military actions by the United States will not have a material adverse effect on our business, financial condition or results of operations.

Reinsurance

Our ability to manage our exposure to underwriting risks depends on the availability and cost of reinsurance coverage. Reinsurance is the practice of transferring part of an insurance company's liability and premium under an insurance policy to another insurance company. We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. The availability and cost of reinsurance are subject to current market conditions and may vary significantly over time.

Significant variation in reinsurance availability and cost could result in us being unable to maintain our desired reinsurance coverage or to obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring coverage or obtain new coverage, it will be difficult for us to manage our underwriting risks and operate our business profitably.

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

If our reinsurers do not pay our claims in a timely manner, we may incur losses. We are subject to loss and credit risk with respect to the reinsurers with whom we deal because buying reinsurance does not relieve us of our liability to policyholders. If our reinsurers are not capable of fulfilling their financial obligations to us, our insurance losses would increase.

Investments

Our investment portfolio contains a significant amount of fixed-income securities, including at different times bonds, mortgage-backed securities (MBSs) and other securities. The market values of all of our investments fluctuate depending on economic conditions and other factors. The market values of our fixed-income securities are particularly sensitive to changes in interest rates.

We may not be able to prevent or minimize the negative impact of interest rate changes. Additionally, we may, from time to time, for business, regulatory or other reasons, elect or be required to sell certain of our invested assets at a time when their market values are less than their original cost, resulting in realized capital losses, which would reduce net income.

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Regulation

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

Our insurance companies are regulated by government agencies in the states in which we do business, as well as by the federal government. Most insurance regulations are designed to protect the interests of policyholders rather than shareholders and other investors. These regulations are generally administered by a department of insurance in each state in which we do business.

State insurance departments conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to financial condition, holding company issues and other matters. These regulatory requirements may adversely affect or inhibit our ability to achieve some or all of our business objectives.

In addition, regulatory authorities have relatively broad discretion to deny or revoke licenses for various reasons, including the violation of regulations. In some instances, we follow practices based on our interpretations of regulations or practices that we believe may be generally followed by the industry. These practices may turn out to be different from the interpretations of regulatory authorities. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or otherwise penalize us. This could adversely affect our ability to operate our business. Further, changes in the level of regulation of the insurance industry or changes in laws or regulations themselves or interpretations by regulatory authorities could adversely affect our ability to operate our business.

We are also subject to various accounting and financial requirements established by the NAIC. If we fail to comply with these laws, regulations and requirements, it could result in consequences ranging from a regulatory examination to a regulatory takeover of one or more of our insurance companies. This would make our business less profitable. In addition, state regulators and the NAIC continually re-examine existing laws and regulations, with an emphasis on insurance company solvency issues and fair treatment of policyholders. Insurance laws and regulations could change or additional restrictions could be imposed that are more burdensome and make our business less profitable.

We are subject to the application of U.S generally accepted accounting principles (GAAP), which are periodically revised and/or expanded. As such, we are periodically required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the Financial Accounting Standards Board. It is possible that future changes required to be adopted could change the current accounting treatment that we apply and such changes could result in a material adverse impact on our results of operations and financial condition.

Geographic

Due to the geographic concentration of our business (principally, Arizona, California, Nevada, New Jersey, Oregon and Pennsylvania, and a limited amount in New York) catastrophe and natural peril losses may have a greater adverse effect on us than they would on a more geographically diverse property and casualty insurer.

We could be significantly affected by legislative, judicial, economic, regulatory, demographic and other events and conditions in these states. In addition, we have significant exposure to property losses caused by severe weather that affects any of these states. Those losses could adversely affect our results.

Additionally, a significant portion of our direct premium writings are written in the construction contractor markets, primarily in California. A significant downturn in the United States or California construction industry could adversely affect our direct written premiums.

Competition

The property and casualty insurance market in which we operate is very highly competitive. Competition in the property and casualty insurance business is based on many factors. These factors include

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the perceived financial strength of the insurer, premiums charged, policy terms and conditions, services provided, reputation, financial ratings assigned by independent rating agencies and the experience of the insurer in the line of insurance to be written. We compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Many of these competitors have substantially greater financial, technical and operating resources than we have.

We pay producers on a commission basis to produce business. Some of our competitors may offer higher commissions or insurance at lower premium rates through the use of salaried personnel or other distribution methods that do not rely on independent producers. Increased competition could adversely affect our ability to attract and retain business and thereby reduce our profits from operations.

We believe that our current marketplace is experiencing significant pressure to reduce prices and/or increase coverage that is generous in relation to the premium being charged. This pricing pressure could result in fewer new business opportunities for us and possibly fewer renewals retained, which could lead to reduced direct written premium levels.

Many of our competitors offer internet-based quoting and/or policy issuance systems to their agents.

Our ability to compete with marketplace technology advances could adversely affect our ability to write business and service accounts with the agency force, and could adversely impact its results of operations and financial condition.

A new form of competition may enter the marketplace as reinsurers attempt to diversify their insurance risk by writing business in the primary marketplace. We also face competition, primarily in the commercial insurance market, from entities that may desire to self-insure their own risks. The Group’s ability to compete with reinsurers and self-insurers could adversely impact our results of operations and financial condition.

Rating

A reduction in our A.M. Best rating could affect our ability to write new business or renew our existing business. Ratings assigned by the A.M. Best Company, Inc. are an important factor influencing the competitive position of insurance companies. A.M. Best ratings represent an independent opinion of financial strength and ability to meet obligations to policyholders and are not directed toward the protection of investors. If our financial position deteriorates, we may not maintain our favorable financial strength rating from A.M. Best. A downgrade of our rating could severely limit or prevent us from writing desirable business or from renewing our existing business.

Key Producers

Our results of operations may be adversely affected by any loss of business from key producers. Our products are marketed by independent producers. Other insurance companies compete with us for the services and allegiance of these producers. These producers may choose to direct business to our competitors, or may direct less desirable risks to us which could have a material adverse effect on us.

Dividends

Our subsidiaries may declare and pay dividends to MIG (the holding company) only if they are permitted to do so under the insurance regulations of their respective state of domicile. If our insurance subsidiaries are unable to pay adequate dividends to us through their respective holding companies, our ability to pay shareholder dividends would be affected. All of the states in which our subsidiaries are domiciled regulate the payment of dividends. States, including New Jersey, Pennsylvania, and California require that we give notice to the relevant state insurance commissioner prior to its subsidiaries making any dividends and distributions to the parent. During the notice period, the state insurance commissioner may disallow all or part of the proposed dividend upon determination that: (i) the insurer's surplus is not reasonable in relation to its liabilities and adequate to its financial needs and those of the policyholders, or (ii) in the case of New Jersey, the insurer is otherwise in a hazardous financial condition. In addition, insurance regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval upon determination that, because of the financial condition of the insurance subsidiary or otherwise, payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors.

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Future cash dividends will depend upon our results of operations, financial condition, cash requirements and other factors, including the ability of our subsidiaries to make distributions to us, which ability is restricted in the manner previously discussed in this section. Also, there can be no assurance that we will continue to pay dividends even if the necessary financial conditions are met and if sufficient cash is available for distribution.

Technology

Our business is increasingly dependent on computer and internet-enabled technology. Our ability to anticipate or manage problems with technology associated with scalability, security, functionality or reliability could adversely affect its ability to write business and service accounts, and could adversely impact our results of operations and financial condition.

Acquisitions

We last made an acquisition in 2005 and intend to grow our business in part through acquisitions as part of our long term business strategy. These types of transactions involve significant challenges and risks that the acquisition will not advance our business strategy, that we won’t realize a satisfactory return on the investment we make, or that we may experience difficulty in the integration of new employees, business systems, and technology or diversion of management’s attention from our other businesses. These factors could adversely affect our operating results and financial condition.

Key Personnel

We could be adversely affected by the loss of our key personnel. The success of our business is dependent, to a large extent, on the efforts of certain key management personnel, and the loss of key personnel could prevent us from executing our business strategy and could significantly and negatively affect our financial condition and results of operations. As we continue to grow, we will need to recruit and retain additional qualified management personnel, and our ability to do so will depend upon a number of factors, such as our results of operations and prospects and the level of competition then prevailing in the market for qualified personnel. Recruiting key personnel can be a difficult challenge.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our main office and corporate headquarters is located at 10 North Highway 31, Pennington, New Jersey in a facility of approximately 25,000 square feet owned by MIC. We also own a tract of land adjacent to our main office property.

MIC also owns a 32,000 square foot office facility in Lock Haven, Pennsylvania. MIC sub-leases a portion of this facility.

FPIC owns a 41,000 square foot building it constructed in 2009 at a cost of $5.1 miilion, which serves as its headquarters and operations facility. FPIC also owns a townhouse, used for corporate purposes, in Rocklin, California carried at $0.4 million at December 31, 2009.

ITEM 3. LEGAL PROCEEDINGS

Our insurance companies are parties to litigation in the normal course of business. Based upon information presently available to us, we do not consider any present litigation to be material. Nonetheless, given the often large or indeterminate amounts sought in litigation, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time to time, have a material adverse effect on our financial position, consolidated results of operations, or cash flows.

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

None.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

The Group’s common stock trades on the NASDAQ National Market under the symbol “MIGP”. As of February 19, 2010, the Group had 275 certificated accounts holding approximately .7 million shares, with the balance of the outstanding shares held in street name.

The payment of shareholder dividends is subject to the discretion of the MIG’s Board of Directors which considers, among other factors, the Group’s operating results, overall financial condition, capital requirements and general business conditions. 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 during 2009 and 2008 totaled $1.9 million and $1.7 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. We currently expect that the present quarterly dividend of $0.075 per common share will continue through 2010.

The Group's ability to receive dividends, loans or advances from its insurance subsidiaries is subject to the approval and/or review of the insurance regulators in the respective domiciliary states of the insurance subsidiaries. Such approval and review is made under the respective domiciliary states’ insurance holding company act, which generally requires that any transaction between currently related companies be fair and equitable to the insurance company and its policyholders. The Group does not believe that such restrictions reasonably limit the ability of the insurance subsidiaries to pay dividends to the Group now or in the foreseeable future.

Information regarding restrictions and limitations on the payment of cash dividends can be found in Item 1, “Business - Regulation” in the “Dividends” section.

The range of closing prices of the Group’s stock, traded on the NASDAQ National Market, during 2009 was between $12.00 and $19.26 per share. The range of closing prices during each of the quarters in 2009 and 2008 is shown below:

	4th Quarter				3rd Quarter				2nd Quarter				1st Quarter
	2009		2008		2009		2008		2009		2008		2009		2008
Share price range:
High	$	19.10	$	17.01	$	19.26	$	17.68	$	17.66	$	17.85	$	15.25	$	17.94
Low	$	17.12	$	10.91	$	16.64	$	16.40	$	14.20	$	16.35	$	12.00	$	17.16

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. Based on this authorization, there remains outstanding authorization to purchase 205,176 shares of the Group’s common stock outstanding.

The Group purchased 1,303 shares from employees in connection with the vesting of restricted stock in 2009, with 385 of those shares repurchased in the fourth quarter of 2009. No other repurchases were made in the fourth quarter. These repurchases were made to satisfy tax withholding obligations with respect to those employees and the vesting of their restricted stock. These tax-withholding shares were purchased at the current market value of the Group’s common stock on the date of purchase, and were not purchased as part of the publicly announced program.

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Performance Graph

Set forth below is a line graph comparing the cumulative total shareholder return on the Group’s Common Stock to the cumulative total return of the Nasdaq Stock Market (symbol: IXIC) and the Nasdaq Insurance Index (symbol:IXIS) for the period commencing December 31, 2004 and ended December 31, 2009.

	December 31, 2004	December 31, 2005	December 31, 2006	December 31, 2007	December 31, 2008	December 31, 2009
Mercer Insurance Group, Inc.	100	112	152	136	98	143
Nasdaq Companies Index	100	101	111	122	72	104
Nasdaq Insurance Index	100	109	122	122	107	109

The graph assumes $100 was invested on December 31, 2004, in the Group’s Common Stock and each of the indices, and that dividends were reinvested. The comparisons in the graph are not intended to forecast or be indicative of possible future performance of our common stock.

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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected consolidated financial data for MIG at and for each of the years in the five year period ended December 31, 2009. You should read this data in conjunction with the Group’s consolidated financial statements and accompanying notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this report.

	Years Ended December 31,
	2009			2008			2007			2006			2005
	(Shares and dollars in thousands, except per share amounts)
Revenue Data:
Direct premiums written	$	153,045		$	165,377		$	182,907		$	185,745		$	92,240
Net premiums written		137,830			147,352			159,667			145,791			75,266
Statement of Earnings Data:
Net premiums earned		140,413			152,577			146,675			137,673			74,760
Investment income, net of expenses		14,198			13,936			13,053			10,070			4,467
Net realized investment gains / (losses)		621			(7,072	)		24			151			1,267
Total revenue		157,312			161,462			161,681			149,929			81,266
Net income (7)		13,821			8,234			14,235			10,635			7,020
Comprehensive income (1)(7)		23,547			5,832			16,316			10,599			4,685
Balance Sheet Data (End of Period):
Total assets		595,354			568,986			546,435			506,967			446,698
Total investments and cash		414,875			381,333			363,748			315,286			269,076
Stockholders' equity		160,208			137,270			133,406			115,839			103,399
Ratios:
GAAP combined ratio (2)(7)		97.6	%		98.1	%		95.8	%		97.0	%		94.9	%
Statutory combined ratio (3)(7)		97.5	%		98.5	%		94.4	%		95.2	%		94.1	%
Statutory premiums to-surplus ratio (4)		0.95	x		1.17	x		1.26	x		1.23	x		1.15	x
Yield on average investments, before tax (5)		3.6	%		3.8	%		3.9	%		3.4	%		2.2	%
Return on average equity		9.3	%		6.1	%		11.4	%		9.7	%		6.9	%
Per-share data:
Net income:
Basic (7)		2.23			1.32			2.32			1.77			1.18
Diluted (7)		2.18			1.30			2.25			1.71			1.14
Dividends to stockholders		0.30			0.28			0.20			0.15			-
Stockholders' equity		25.63			22.21			21.48			19.06			17.34
Weighted average shares: (6)
Basic		6,212			6,217			6,144			6,023			5,943
Diluted		6,345			6,344			6,325			6,222			6,160

________________

(1)	Includes Net Income and the change in Unrealized Gains and Losses of the investment portfolio as well as a defined benefit pension adjustment.

(2)	The sum of losses, loss adjustment expenses, underwriting expenses and dividends to policyholders divided by net premiums earned. A combined ratio of less than 100% means a company is making an underwriting profit.

(3)	The sum of the ratio of underwriting expenses divided by net premiums written, and the ratio of losses, loss adjustment expenses, and dividends to policyholders divided by net premiums earned.

(4)	The ratio of net premiums written divided by ending statutory surplus.

(5)	The ratio of investment income, net of expenses divided by average cash and investments.

(6)	Unallocated ESOP shares at December 31 of each year are not reflected in weighted average shares.

(7)	The 2007 results include a non-recurring refund of state premium retaliatory taxes, plus interest, in the after-tax amounts of $2.8 million, or $0.44 per diluted share. See footnote 15 to the consolidated financial statements.

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ITEM 7. 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, and the “Description of Business” contained in Item 1 of this report. This discussion contains forward-looking information that involves risks and uncertainties. Actual results could differ significantly from these forward-looking statements.

OVERVIEW

MIG, 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, Oregon and Pennsylvania. The Group also writes a limited amount of business in New York which supports accounts in adjacent states.

The Group manages its business in three segments: commercial lines insurance, 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. In determining the results of each segment, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes.

The Group’s net income is primarily determined by five elements:

net premium earned;

underwriting cost, including agent commissions;

investment income;

general and administrative expenses;

amounts paid or reserved to settle insured claims.

Variations in premium earned are subject to a number of factors, including:

limitations on rates arising from competitive market place conditions or regulation;

general economic conditions and economic conditions in sectors in which the group offers insurance products, such as the construction industry;

limitation on available business arising from a need to maintain the pricing and quality of underwritten risks;

the Group’s ability to maintain it’s A (“Excellent”) rating by A.M. Best;

the ability of the Group to maintain a reputation for efficiency and fairness in claims administration;

the availability, cost and terms of reinsurance.

Variations on investment income are subject to a number of factors, including:

general interest rate levels;

specific adverse events affecting the issuers of debt obligations held by the Group;

changes in prices of debt and equity securities generally and those held by the Group specifically.

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Loss and loss adjustment expenses are affected by a number of factors, including:

the quality of the risks underwritten by the Group;

the nature and severity of catastrophic losses;

weather-related patterns in areas where we insured property risks;

the availability, cost and terms of reinsurance and the financial condition of our reinsurers;

underlying settlement costs, including medical and legal costs.

The Group seeks to manage each of the foregoing to the extent within its control. Many of the foregoing factors are partially, or entirely, outside the control of the Group.

CRITICAL ACCOUNTING POLICIES

General

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

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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. More than 79% and 76% of our aggregate gross loss reserves at December 31, 2009 and 2008, respectively, were bulk and IBNR reserves.

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.

Methods Used to Estimate Loss & Loss Adjustment Expense Reserves

We apply the following general methods in projecting loss and loss adjustment expense reserves for the Group:

1.	Paid loss development;

2.	Paid Bornhuetter-Ferguson loss development;

3.	Reported loss development;

4.	Reported Bornhuetter-Ferguson loss development; and

5.	Separate developments of claims frequency and severity.

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In addition, we apply several diagnostic ratio tests of the reserves for long-tailed liability lines of business, including but not limited to:

1.	Retrospective tests of the ratios of IBNR reserves to earned premiums and to estimated ultimate incurred losses;

2.	Retrospective tests of the ratios of the loss reserves to earned premiums and to estimated ultimate incurred losses;

3.	Ratios of cumulative and incremental incurred and paid losses to earned premiums and to estimated ultimate incurred losses;

4.	Ratios of cumulative and incremental paid losses to cumulative incurred losses and ratios of incremental paid losses to prior case loss and LAE reserves;

5.	Ratios of cumulative average incurred loss per claim and cumulative average incurred loss per reported claim; and

6.	Ratios of cumulative average paid loss per claim closed with payment and average case reserve per pending claim.

Description of Ultimate Loss Estimation Methods

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

The paid loss development method is mechanically identical to the reported loss development method described above with the exception that paid losses replace incurred losses. The paid method does not rely on case reserves or their adequacy in making projections.

The validity of the results from using a loss development approach can be affected by many conditions, such as internal claim department processing changes, a shift between single and multiple claim payments, legal changes, or variations in a company’s mix of business from year to year. Also, since the percentage of losses paid for immature years is often low, development factors are volatile. A small variation in the number of claims paid can have a leveraging effect that can lead to significant changes in estimated ultimates. Therefore, ultimate values for immature accident years are often based on alternative estimation techniques.

The Bornhuetter-Ferguson expected loss projection method based on reported loss data relies on the assumption that remaining unreported losses are a function of the total expected losses rather than a function of currently reported losses. The expected losses used in this analysis are selected judgmentally based upon the historical relationship between premiums and losses for more mature accident years, adjusted to reflect changes in average rates and expected changes in claims frequency and severity. The expected losses are multiplied by the unreported percentage to produce expected unreported losses. The unreported percentage is calculated as one minus the reciprocal of the selected cumulative reported loss development factors. Finally, the expected unreported losses are added to the current reported losses to produce ultimate losses.

The calculations underlying the Bornhuetter-Ferguson expected loss projection method based on paid loss data are similar to the reported Bornhuetter-Ferguson calculations with the exception that paid losses and unpaid percentages replace reported losses and unreported percentages.

The Bornhuetter-Ferguson method is most useful as an alternative to other models for immature accident years. For these immature years, the amounts reported or paid may be small and unstable and therefore not

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predictive of future development. Therefore, future development is assumed to follow an expected pattern that is supported by more stable historical data or by emerging trends. This method is also useful when changing reporting patterns or payment patterns distort the historical development of losses.

For the property lines of business (special property, personal auto physical damage, and commercial auto physical damage) the results of the reserve calculations were similar and we generally rely on an averaging of the methods utilized.

For the homeowners and commercial multi-peril lines of business (excluding California CMP business for policy years 1996 and prior) we generally rely on the incurred loss development and incurred Bornhuetter-Ferguson methods in estimating loss reserves. These two methods yield more consistent results although the two paid methods yielded reserves that were similar in total to the incurred methods.

In July of 1995, the California Supreme Court rendered its Opinion in Admiral Insurance Company vs. Montrose Chemical Corporation (the Montrose Decision). In that decision, the California Supreme Court ruled that in the case of a continuous and progressively deteriorating loss, such as pollution liability (or construction defect liability), an insurance company has a definitive duty to defend the policyholder until all uncertainty related to the severity and cause of the loss is extinguished.

After the Montrose Decision, FPIC (a subsidiary of the Group since October 1, 2005) experienced a significant increase in construction defect liability cases impacting our West Coast commercial multi-peril liability lines of business, to which it would not have been subject under the old interpretation of the law. In response, FPIC (prior to its acquisition by the Group) implemented a series of underwriting measures to limit the prospective exposure to Montrose and construction defect liability claims. These changes to coverage and risk selection resulted in an improvement in the post- Montrose underwriting results.

FPIC evaluates commercial multi-peril liability reserves by segregating pre- and post- Montrose activity as well as segregating contractor versus non-contractor experience. An inception to date ground-up incurred loss database was created as the basis for this new analysis. The pre- Montrose activity is evaluated on a report year basis, which eliminates the accident year development distortions caused by the effects of the Montrose Decision. For policy years 1997 and later, the reserves are analyzed using the more traditional accident year analysis.

For the casualty lines (commercial multi-peril liability, other liability, personal auto liability, commercial auto liability, workers’ compensation) the paid loss development method yielded less than reliable results for the immature years, and we did not use the method in selecting ultimate losses and reserves. For these lines we primarily relied on the incurred Bornhuetter-Ferguson method for the most recent accident years and both of the incurred loss development methods for the remaining years.

The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and mold, and other uncertain or environmental exposures. We have not experienced significant losses from these types of claims.

We compute our estimated ultimate liability using these principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves and have a material adverse effect on the Group’s results of operations and financial condition. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such adjustments are made.

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 December 31, 2009.

For further information relating to the determination of loss and loss adjustment expense reserves, please see the discussion under “Loss and Loss Adjustment Expense Reserves” contained in ITEM 1. “Business” of this Form 10-K.

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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 and due to credit concerns 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” and caused by credit concerns, 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 years ended December 31, 2009, 2008 and 2007, we recorded a pre-tax charge to earnings of $0.8 million, $6.2 million and $0.1 million, respectively, for write-downs of other than temporarily impaired securities (OTTI).

In 2009, the Group recorded a pre-tax charge to earnings of $0.8 million for write-downs of other-than-temporarily impaired securities, of which $0.4 million related to fixed income securities, and $0.4 million related to equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.3 million) which experienced increased delinquency and default rates, as well as two asset-backed securities whose underlying collateral deteriorated. The equity security impairments related to thirteen common stock securities and two preferred stock securities, which demonstrated weakening fundamentals in their businesses.

During the second half of 2008 (and early 2009), there were significant disruptions to the financial and equity markets. This 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 in addition to a dramatic widening in credit spreads. Such impacts affected the valuations of both the fixed income and equity securities held by the Group, and resulted in pre-tax charge to earnings in 2008 of $6.2 million for write-downs of other-than-temporarily impaired securities. Of the $6.2 million in 2008 impairments $3.9 million related to 11 fixed-income securities, and $2.3 million related to 33 equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.5 million) which experienced increased delinquency and default rates, four asset-backed securities ($0.8 million) whose underlying collateral deteriorated, and six corporate bonds ($2.6 million) whose issuers were a experiencing deteriorating financial condition. The $2.3 million in 2008 equity security impairments related to twenty-nine common stock securities and four preferred stock securities, which demonstrated weakening fundamentals in their businesses.

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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. If the estimation of net realizable value indicates that the acquisition costs are unrecoverable, further analyses are completed to determine if a reserve is required to provide for losses that may exceed the related unearned premiums.

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 related 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.

Many of the reinsurance treaties participated in by the Group prior to 2007, and primarily FPIC treaties, have included provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Group shares on a limited basis in the profitability of our reinsurance treaties through contingent ceding commissions. The Group’s exposure in the loss experience is contractually defined at minimum and maximum levels. The terms of such contracts are fixed at inception. Since estimating the emergence of claims to the applicable reinsurance layers is subject to significant uncertainty, the net amounts that will ultimately be realized may vary significantly from the estimated amounts presented in the Group’s results of operations.

Income Taxes

We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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.

Contingencies

Besides claims related to its insurance products, the Group is subject to proceedings, lawsuits and claims in the normal course of business. The Group assesses the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. There can be no assurance that actual outcomes will be consistent with those assessments.

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RESULTS OF OPERATIONS

Revenue and income by segment is as follows for the years ended December 31, 2009, 2008 and 2007.

	December 31
	2009			2008			2007
	(In thousands)
Revenues:
Net premiums earned:
Commercial lines	$	120,871		$	132,425		$	125,427
Personal lines		19,542			20,152			21,248
Total net premiums earned		140,413			152,577			146,675
Net investment income		14,198			13,936			13,053
Realized investment gains / (losses)		621			(7,072	)		24
Other		2,080			2,021			1,929
Total revenues		157,312			161,462			161,681
Income before income taxes:
Underwriting income (loss):
Commercial lines		4,332			4,246			5,964
Personal lines		(956	)		(1,423	)		234
Total underwriting income		3,376			2,823			6,198
Net investment income		14,198			13,936			13,053
Realized investment gains / (losses)		621			(7,072	)		24
Other		657			703			714
Income before income taxes	$	18,852		$	10,390		$	19,989

Our results of operations are 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, we increased our retention to $1,000,000 (from a maximum retention of $850,000 and $750,000 in 2008 and 2007, respectively) on the casualty, property and workers’ compensation lines of business. As we increase the net retention of the business we write, net premiums written and earned will increase and ceded losses will decrease. The impact of increased retentions under our reinsurance program in 2009, 2008 and 2007 was offset in part by a decline in direct written premiums due to the contraction of the economy in our markets and the competitive marketplace, particularly as it relates to new construction contractors we insure. As older reinsurance treaties run off, the impact described above of the new reinsurance program will become more evident in net premiums written, net premiums earned and net losses incurred.

We write 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 we do business.

The key elements of our business model are the sales 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 influencing the success of the business model. These factors are affected by the factors impacting the insurance industry in general and factors unique to us as described in the following discussion.

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YEAR ENDED DECEMBER 31, 2009 COMPARED TO YEAR ENDED DECEMBER 31, 2008

The components of income for 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.

2009 vs. 2008 Income	2009			2008			Change			% Change
	(Dollars in thousands)
Commercial lines underwriting income	$	4,332		$	4,246		$	86			2.0	%
Personal lines underwriting loss		(956	)		(1,423	)		467			32.8	%
Total underwriting income		3,376			2,823			553			19.6	%
Net investment income		14,198			13,936			262			1.9	%
Net realized investment gains/(losses)		621			(7,072	)		7,693			N/M
Other		2,080			2,021			59			2.9	%
Interest expense		(1,423	)		(1,318	)		(105	)		8.0	%
Income before income taxes		18,852			10,390			8,462			81.4	%
Income taxes		5,031			2,156			2,875			133.3	%
Net Income	$	13,821		$	8,234		$	5,587			67.9	%

Loss/ LAE ratio (GAAP)		61.3	%		62.4	%		(1.1	) %
Underwriting expense ratio (GAAP)		36.3	%		35.7	%		0.6	%
Combined ratio (GAAP)		97.6	%		98.1	%		(0.5	) %

Loss/ LAE ratio (Statutory)		61.8	%		62.4	%		(0.6	) %
Underwriting expense ratio (Statutory)		35.7	%		36.1	%		(0.4	) %
Combined ratio (Statutory)		97.5	%		98.5	%		(1.0	) %

(N/M means “not meaningful”)

Underwriting income in 2009 was $3.4 million, as compared to $2.8 million in 2008. Our GAAP combined ratio for 2009 was 97.6%, as compared to a combined ratio for the prior year of 98.1%. The statutory combined ratio for 2009 and 2008 was 97.5% and 98.5%, respectively. See the discussion below relating to commercial and personal lines performance.

Net investment income increased $0.3 million or 1.9% to $14.2 million in 2009 as compared to $13.9 million in 2008. This increase was driven by an increase in cash and invested assets. The increase in cash and invested assets was driven by operating cash flow.

Net realized investment gains amounted to $0.6 million in 2009, as compared to a realized loss of $7.1 million in 2008. The Group had gains on the sales of securities of $0.9 million and $0.6 million, and write-downs of other than temporary impairments of $0.8 million and $6.2 million, in 2009 and 2008, respectively. The Group also recorded a gain on the mark-to-market of interest rate swaps in 2009 of $0.5 million, and a loss in 2008 of $1.5 million. These interest rate swaps were entered into to convert the floating interest rate to a fixed rate on the Group’s trust preferred securities obligations, and the mark-to-market gains or losses are recorded as realized gains. See also the discussion of other than temporary impairments on investment securities in the “Critical Accounting Policies” section.

Other revenue of $2.1 million and $2.0 million in 2009 and 2008, respectively, represents primarily service charges recorded on insurance premium payment plans.

Interest expense of $1.4 million and $1.3 million in 2009 and 2008, respectively, represents interest expense on the trust preferred securities obligations of FPIG.

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

2009 vs. 2008 Revenue	2009		2008			Change			% Change
	(In thousands)
Direct premiums written	$	153,045	$	165,377		$	(12,332	)		(7.5	)%
Net premiums written		137,830		147,352			(9,522	)		(6.5	)%
Net premiums earned		140,413		152,577			(12,164	)		(8.0	)%
Net investment income		14,198		13,936			262			1.9	%
Net realized investment gains/(losses)		621		(7,072	)		7,693			N/M
Other revenue		2,080		2,021			59			2.9	%
Total revenue	$	157,312	$	161,462		$	(4,150	)		(2.6	)%

(N/M means “not meaningful”)

Total revenues declined to $157.3 million in 2009 from $161.5 million in 2008 due to lower net premiums written, offset by a net realized gain in 2009 as compared to a net realized loss in 2008. Net premiums written decreased $9.5 million, or 6.5%, to $137.8 million in 2009, as compared to $147.3 million in 2008. Net premiums earned totaled $140.4 million in 2009, as compared to $152.6 million in 2008, representing a 8.0%, or $12.2 million, decrease.

Direct premiums written decreased 7.5%, or $12.3 million, to $153.0 million as a result of the weak economy, particularly in California, and competition in our all of our market places. The decline in net premiums written and net premiums earned is attributable to the decline in direct written premium, offset by the positive impact on net premiums written of changes in the Group’s reinsurance structure (in 2009 retention increased to $1,000,000 from $850,000 in 2008, and to $850,000 in 2008 from $750,000 in 2007 on the property, casualty and workers’ compensation lines). Direct premiums written and earned were also negatively impacted by the increased negative audit premium recorded during 2009, which is earned immediately upon booking (see the discussion below for discussion of audit premium. See the “Reinsurance ceded” discussion in Item 1. Business for further discussion of the Group’s reinsurance arrangements).

The decline in year-to-date direct premiums written reflects reduced levels of economic activity in our operating territories, predominantly California. In addition, the current market continues to be very competitive, with pricing and coverage competition present in 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 presents a challenge in retaining our accounts on renewal, or renewing a policy at the expiring premium. Competition also continues on large accounts, including East Coast habitational and California construction contracting programs, as competitors 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.

Audit premium is derived principally from the contractor book of business written by FPIC. The premium on these policies is estimated at policy inception based on a prediction of the volume of the insured’s business operations during the policy period. In addition to endorsing the policy throughout the policy period based on known information, at policy expiration FPIC may conduct an audit of the insured’s business operations in order to adjust the policy premium from an estimate to actual. Contractor liability policy premium tends to vary with local construction activity as well as changes in the nature of the contractor’s operations. The decline in construction related activity and failing businesses in the construction industry caused by the weak California economy has impacted both the volume of premium for the contractor in-force book of business (as well as reducing related exposures) and the related audit premium on expiring policies. Audits, primarily of construction related policies, generated return premium of $3.7 million in 2009, representing a decline of $1.1 million as compared to $2.6 million of return audit premium generated in 2008.

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Despite the competitive market conditions and weakened economy, the Group’s policy retention on renewal has been favorable across most product lines and the Group has been able to grow its policy count, aided through the introduction of new products. In the fourth quarter of 2008, a new Business Owners Policy for California risks was introduced. This product targets small to medium sized businesses, which have been shown to be somewhat less price sensitive and demonstrate higher renewal retention than larger accounts. In 2009, a new contracting product which specializes in covering artisan contractors was introduced in Arizona and California. Artisan contractors primarily provide repair and maintenance services, and this segment tends to experience less severe market fluctuations compared to the construction industry.

Net Investment Income is discussed below.

2009 vs. 2008 Investment Income and Realized Gains	2009			2008			Change			% Change
	(In thousands)
Fixed income securities	$	15,949		$	14,871		$	1,078			7.2	%
Dividends		283			351			(68	)		(19.4	) %
Cash, cash equivalents & other		159			473			(314	)		(66.4	) %
Gross investment income		16,391			15,695			696			4.4	%
Investment expenses		2,193			1,759			434			24.7	%
Net investment income	$	14,198		$	13,936		$	262			1.9	%

Net realized (losses)/gains - fixed income securities	$	(293	)	$	(3,832	)	$	3,539			N/M
Net realized gains/(losses) - equity securities		395			(1,740	)		2,135			N/M
Mark-to-market valuation gain/(loss) for interest rate swaps		519			(1,500	)		2,019			N/M
Net realized gains/(losses)	$	621		$	(7,072	)	$	7,693			N/M

(N/M means “not meaningful”)

In 2009 net investment income increased $0.3 million, or 1.9%, to $14.2 million, as compared to $13.9 million in 2008. This increase was driven by an increase in cash and invested assets driven 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 2009 investment income on fixed income securities increased $1.1 million, or 7.2%, to $15.9 million, as compared to $14.8 million in 2008. This was driven by an increase in the average investments held in fixed income securities, and a focus on expanding our corporate and industrial sector fixed income holdings. Our tax equivalent yield (yield adjusted for tax-benefit received on tax-exempt securities) on fixed income securities increased slightly to 5.14% in 2009, as compared to 5.06% in 2008.

Dividend income declined 19.4% to $283,000 in 2009, as compared to $351,000 in 2008, due to a reduction in the size of our equities portfolio since 2008. Interest income on cash and cash equivalents declined $314,000, or 66.4%, to $159,000 in 2009, as compared to $473,000 in 2008, primarily as a result of extremely low short term yields in 2009. Investment expenses increased $434,000 to $2.2 million in 2009, from $1.8 million in 2008.

Net realized investment gains amounted to $0.6 million in 2009, as compared to a realized loss of $7.1 million in 2008. The Group had gains on the sales of securities of $0.9 million and $0.6 million, and write-downs of other than temporary impairments of $0.8 million and $6.2 million, in 2009 and 2008, respectively. The Group also recorded a gain on the mark-to-market of interest rate swaps in 2009 of $0.5 million, and a loss in 2008 of $1.5 million. We have three ongoing interest rate swap agreements to hedge against interest rate risk on our floating rate trust preferred securities obligations. The estimated fair value of the interest rates swaps is obtained from the third-party financial institution counterparty. We mark the investments to market using these valuations and record the change in the economic value of the interest rate swaps as a realized gain or loss in the consolidated statement of earnings. See also the discussion of other than temporary impairments on investment securities in the “Critical Accounting Policies” section.

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Fixed income investments represent 97.5% of invested assets. As of December 31, 2009, the fixed income portfolio consists of 99% investment grade securities, with 1% non-investment grade rated securities, which includes three corporate securities held with a combined market value of $1.3 million, three asset-backed securities held with a combined market value of $0.6 million, one mortgage-backed security with a market value of $0.1 million, and one small tax-exempt municipal bond. The fixed income portfolio has an average rating of Aa3/AA and an average tax equivalent book yield of 5.14%.

Among our portfolio holdings, the only direct subprime exposure consists of asset-backed securities (ABS) within the home equity subsector . The ABS home equity subsector totaled $0.5 million on December 31, 2009, representing 3.21% of the ABS holdings and 0.14% of total fixed income portfolio holdings. The subprime related exposure consists of three individual securities, of which two are insured by monolines against default of principal and interest. However, since FGIC is no longer rated and AMBAC has been downgraded to Caa2/CC, the two insured securities are now rated according to the higher of the underlying collateral or the monoline rating. One bond is rated Ba3/BB while the other is rated Caa2/CCC. With regard to the remaining security without monoline insurance, it is rated A3/B by Moody’s and S&P, respectively.

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 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	$	4,571	$	52	$	-	$	-	$	4,571	$	52
Obligations of states and
political subdivisions		1,889		61		1,478		95		3,367		156
Corporate securities		18,561		256		460		36		19,021		292
Mortgage-backed securities		768		8		256		3		1,024		11
Total fixed maturities		25,789		377		2,194		134		27,983		511
Total equity securities		349		25		388		8		737		33
Total securities in a
temporary unrealized loss
position	$	26,138	$	402	$	2,582	$	142	$	28,720	$	544

Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2009 the Group has 3 fixed maturity securities with unrealized losses for more than twelve months. Of the 3 securities with unrealized losses for more than twelve months, all of them have fair values of no less than 92% of book value. The Group does not believe these declines are other than temporary due to the credit quality of the holdings. We currently have no intention or expectation that we will have to sell these securities before recovery.

There are 4 common stock securities that are in an unrealized loss position at December 31, 2009. All of these securities have been in an unrealized loss position for less than 6 months. There is one preferred stock security that has been in an unrealized loss position for more than twelve months. The Group does not believe these declines are other than temporary as a result of reviewing the circumstances of each such security in an unrealized loss position. The Group currently has the ability and intent to hold these securities until recovery.

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The following table summarizes the period of time that equity securities sold at a loss during 2009 had been in a continuous unrealized loss position:

	Fair
	Value on		Realized
Period of Time in an Unrealized Loss Position	Sale Date		Loss
	(In thousands)
0-6 months	$	789	$	187
7-12 months		-		-
More than 12 months		-		-
Total	$	789	$	187

The equity securities sold at a loss had been expected to appreciate in value, but were sold due to a desire to reduce exposure to certain issuers and industries or in light of difficult economic conditions.

Results of our Commercial Lines segment were as follows:

2009 vs. 2008 Commercial Lines (CL)	2009			2008			Change			% Change
	(Dollars in thousands)
CL Direct premiums written	$	131,514		$	143,280		$	(11,766	)		(8.2	) %
CL Net premiums written	$	118,410		$	127,418		$	(9,008	)		(7.1	) %
CL Net premiums earned	$	120,871		$	132,425		$	(11,554	)		(8.7	) %

CL Loss/ LAE expense ratio (GAAP)		60.0	%		61.3	%		(1.3	) %
CL Expense ratio (GAAP)		36.4	%		35.5	%		0.9	%
CL Combined ratio (GAAP)		96.4	%		96.8	%		(0.4	) %

In 2009 our commercial lines direct premiums written decreased by $11.8 million, or 8.2%, to $131.5 million, as compared to direct premium written in 2008 of $143.3 million. The decline in direct premiums written is attributed to several factors, including a decline in construction related activity due to a weak economy, increased negative audit premium on our contractors book, increased competition on large accounts, and increased competition in the California contractor market and the east coast habitational market. Our California contractors book reflects the significant decrease in new construction 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 is up year-over-year, despite the decline in direct premiums written. See additional discussion above in the “2009 vs. 2008 Revenue” discussion.

In 2009 our commercial lines net premiums earned decreased by $11.6 million, or 8.7%, to $120.8 million, as compared to net premiums earned in 2008 of $132.4 million. The decrease in net premiums earned was caused by the 8.2% decline in direct premiums written, offset by the positive impact on net premiums written of the change in our reinsurance structure as described above. Contributing to the decline in net premiums earned was the increase in the negative audit premium discussed above, which is earned immediately upon booking.

In the commercial lines segment for 2009 we had underwriting income of $4.3 million, a slight increase from the underwriting income of $4.2 million in 2008, a GAAP combined ratio of 96.4%, a GAAP loss and loss adjustment expense ratio of 60.0% and a GAAP underwriting expense ratio of 36.4%, compared to a GAAP combined ratio of 96.8%, a GAAP loss and loss adjustment expense ratio of 61.3% and a GAAP underwriting expense ratio of 35.5% in 2008. Our commercial lines loss ratio for 2009 reflects a lower level of adverse prior year loss reserve development.

One of our strategies in this market is to introduce new products leveraging our core skills. In the fourth quarter of 2008, a new Business Owners Policy for California risks was introduced. This product targets small to medium sized businesses, which have been shown to be somewhat less price sensitive and demonstrating higher renewal retention than larger accounts. This product also helps to balance FPIC’s

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business between property and casualty exposures. In 2009, a new contracting product which specializes in covering artisan contractors was introduced in Arizona and California, and is being developed for Nevada and Oregon with a targeted introduction in early 2010. Artisan contractors primarily provide repair and maintenance services, and this segment tends to experience less severe market fluctuations compared to the construction industry. During 2009, a new Garage Program was introduced in New Jersey and Pennsylvania, which targets repair shops, auto body shops, and gas stations.

Results of our Personal Lines segment were as follows:

2009 vs. 2008 Personal Lines (PL)	2009			2008			Change			% Change
	(Dollars in thousands)
PL Direct premiums written	$	21,531		$	22,097		$	(566	)		(2.6	) %
PL Net premiums written	$	19,420		$	19,934		$	(514	)		(2.6	) %
PL Net premiums earned	$	19,542		$	20,152		$	(610	)		(3.0	) %

PL Loss/ LAE expense ratio (GAAP)		69.4	%		69.5	%		(0.1	) %
PL Expense ratio (GAAP)		35.5	%		37.6	%		(2.1	) %
PL Combined ratio (GAAP)		104.9	%		107.1	%		(2.2	) %

Personal lines direct premiums written declined to $21.5 million in 2009 as compared to $22.1 million in 2008, representing a decline of $0.6 million or 2.6%. Our personal lines have also been impacted by increased competition, as in the case of our commercial lines.

In the personal lines segment for 2009 we had an underwriting loss of $1.0 million, a GAAP combined ratio of 104.9%, a GAAP loss and loss adjustment expense ratio of 69.4% and a GAAP underwriting expense ratio of 35.5%, compared to an underwriting loss of $1.4 million, a GAAP combined ratio of 107.1%, a GAAP loss and loss adjustment expense ratio of 69.5% and a GAAP underwriting expense ratio of 37.6% in 2008.

During 2009 we introduced a new on-line system for Homeowners policies. It enables agents to quote, bind and service Homeowners policies in New Jersey and Pennsylvania.

Underwriting Expenses and the Expense Ratio is discussed below.

2009 vs. 2008 Expenses and Expense Ratio	2009			2008			Change			% Change
	(Dollars in thousands)
Amortization of Deferred Acquisition Costs	$	38,805		$	41,684		$	(2,879	)		(6.9	) %
As a % of net premiums earned		27.6	%		27.3	%		0.3	%
Other underwriting expenses		12,090			12,851			(761	)		(5.9	) %
Total expenses excluding losses/ LAE	$	50,895		$	54,535		$	(3,640	)		(6.7	) %
Underwriting expense ratio		36.3	%		35.7	%		0.6	%

Underwriting expenses decreased by $3.6 million, or 6.7%, to $50.9 million in 2009, as compared to $54.5 million in 2008. The decrease in underwriting expenses primarily reflects a decrease in the amortization of deferred acquisition costs in 2009. The amortization of deferred acquisition costs decreased in 2009 as compared to 2008 due in part to the decrease in net earned premiums. In addition, in the fourth quarter of 2008 the Group undertook a significant expense reduction program, resulting in significant cost reductions which are reflected in lower other underwriting expenses in 2009 and, subject to the deferred acquisition cost methodology, to some extent in 2009 amortization of deferred acquisition costs. Underwriting expenses also reflect lower share-based compensation expense and lower contingent commission expense.

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2009 vs. 2008 Income Taxes	2009			2008			Change			% Change
	(Dollars in thousands)
Income before income taxes	$	18,852		$	10,390		$	8,462			81.4	%
Income taxes		5,031			2,156			2,875			133.3	%
Net income	$	13,821		$	8,234		$	5,587			67.9	%
Effective tax rate		26.7	%		20.8	%		(5.9	) %

Federal income tax expense was $5.0 million and $2.2 million for 2009 and 2008, respectively. The effective tax rate was 26.7% and 20.8% for 2009 and 2008, respectively. The 2009 effective tax rate was higher than that of 2008 because the 2009 pre-tax income was not impacted by the significant level of other than temporary investment impairments reflected in the 2008 pre-tax income, and by the fact that tax-advantaged income was slightly lower in 2009.

YEAR ENDED DECEMBER 31, 2008 COMPARED TO YEAR ENDED DECEMBER 31, 2007

The components of income for 2008 and 2007, 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.

2008 vs. 2007 Income	2008			2007			Change			% Change
	(Dollars in thousands)
Commercial lines underwriting income	$	4,246		$	5,964		$	(1,718	)		(28.8	) %
Personal lines underwriting (loss) income		(1,423	)		234			(1,657	)		N/M
Total underwriting income		2,823			6,198			(3,375	)		(54.5	) %
Net investment income		13,936			13,053			883			6.8	%
Net realized investment (losses) /gains		(7,072	)		24			(7,096	)		N/M
Other		2,021			1,929			92			4.8	%
Interest expense		(1,318	)		(1,215	)		(103	)		8.5	%
Income before income taxes		10,390			19,989			(9,599	)		(48.0	) %
Income taxes		2,156			5,754			(3,598	)		(62.5	) %
Net Income	$	8,234		$	14,235		$	(6,001	)		(42.2	) %

Loss/ LAE ratio (GAAP)		62.4	%		62.2	%		0.2	%
Underwriting expense ratio (GAAP)		35.7	%		33.6	%		2.1	%
Combined ratio (GAAP)		98.1	%		95.8	%		2.3	%

Loss/ LAE ratio (Statutory)		62.4	%		62.2	%		0.2	%
Underwriting expense ratio (Statutory)		36.1	%		32.2	%		3.9	%
Combined ratio (Statutory)		98.5	%		94.4	%		4.1	%

________________

(N/M means “not meaningful”)

As previously disclosed in our SEC filings, we paid an aggregate of $3.5 million, including accrued interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, we filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division of taxation.

We received $4.3 million in 2007 as a reimbursement of protested payments of retaliatory tax, including accrued interest thereon, previously made by us for the periods 1999-2004. The refund was recorded, after reduction for Federal income tax, in the amount of $2.8 million in the 2007 consolidated statement of earnings. The allocation of the refund to 2007 pre-tax earnings included an increase to net investment income

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of $720,000 for the interest received on the refund, and $3.6 million as a reduction to other expense to recognize the recovery of amounts previously charged to other expense. This is a non-recurring item which significantly affected the earnings for the year ended December 31, 2007, and related performance metrics such as the combined ratio.

Our GAAP combined ratio for 2008 was 98.1%, as compared to a combined ratio for the prior year of 95.8%. On a pro-forma basis, after removing the effect of the non-recurring retaliatory tax refund described above, the GAAP combined ratio for 2007 was 98.3%. The statutory combined ratio for 2008 and 2007 was 98.5% and 94.4%, respectively. See the discussion below relating to commercial and personal lines performance.

Net investment income increased $0.9 million or 6.8% to $13.9 million in 2008 as compared to $13.1 million in 2007. This increase was driven by an increase in average cash and invested assets. Net investment income for 2007 included $720,000 of interest income as a result of the non-recurring impact of the retaliatory tax refund. Average cash and invested assets totaled $367 million for 2008 as compared to $333 million for 2007, representing an increase of $34 million, driven by operating cash flow.

Net realized investment losses amounted to $7.1 million in 2008, which is primarily driven by other than temporary impairment write-downs on investment securities, a realized loss on the mark-to-market valuation on the interest rate swaps for the trust preferred securities, offset in part by realized gains on the sales of investments. Net realized investment gains amounted to $24,000 in 2007, which is primarily realized gains on the sales of investments, offset in part by other than temporary impairments on investment securities and 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. Other revenue of $2.0 million and $1.9 million in 2008 and 2007, respectively, represents primarily service charges recorded on insurance premium payment plans. Interest expense of $1.3 million and $1.2 million in 2008 and 2007, 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.

2008 vs. 2007 Revenue	2008			2007		Change			% Change
	(In thousands)
Direct premiums written	$	165,377		$	182,907	$	(17,530	)		(9.6	)%
Net premiums written		147,352			159,667		(12,315	)		(7.7	)%
Net premiums earned		152,577			146,675		5,902			4.0	%
Net investment income		13,936			13,053		883			6.8	%
Net realized investment (losses) / gains		(7,072	)		24		(7,096	)		N/M
Other revenue		2,021			1,929		92			4.8	%
Total revenue	$	161,462		$	161,681	$	(219	)		(0.1	)%

(N/M means “not meaningful”)

Total revenues remained consistent at $161.5 million and $161.7 million in 2008 and 2007, respectively. Revenues were flat year-on-year due to the significant realized loss on OTTI write-downs in 2008, which offset the growth in net premiums earned and net investment income. Net premiums earned totaled $152.6 million in 2008 as compared to $146.7 million in 2007, representing a 4.0% or $5.9 million increase. Net premiums written decreased $12.3 million or 7.7% to $147.4 million in 2008 as compared to $159.7 million in 2007. Net premiums earned increased 4.0% despite the 7.7% decline in net premiums written. The decline in net premiums written is attributable to the 9.6% decline in direct premiums written, offset by the positive impact on net premiums written of the change in reinsurance structure (in 2007 retention increased to $750,000 from $250,000 and $350,000 in 2006 on FPIC’s casualty and property lines, respectively, and from $500,000 on MIC’s, MICNJ’s and FIC’s 2006 property, casualty and workers’ compensation lines, and in 2008 to $850,000 from $750,000). Direct premiums written and earned were negatively impacted by the reduction in audit premium recorded during 2008, which is earned immediately upon booking (see the discussion below for discussion of audit premium and changes in reinsurance arrangements).

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Net investment income totaled $13.9 million in 2008, as compared to $13.1 million in 2007, representing a 6.8% or $0.9 million increase. Net investment income for 2007 was impacted by the $720,000 non-recurring impact of the retaliatory tax refund. Net realized investment losses amounted to $7.1 million in 2008 as compared to net realized investment gains of $24,000 in 2007. The net realized investment loss in 2008 is primarily driven by other than temporary impairments on investment securities, a realized loss on the mark-to-market valuation on the interest rate swaps for the trust preferred securities, offset in part by realized gains on the sales of investments. The net realized investment gain in 2007 is primarily driven by realized gains on the sales of investments, offset in part by other than temporary impairments on investment securities and 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.

In 2008, direct premiums written declined $17.5 million or 9.6% to $165.4 million as compared to $182.9 million in 2007. The decline in direct premiums written is attributable to a more difficult economic environment and competitive market conditions. A decline in construction related activity and related audit premium in California, increased competition on large accounts, as well as the return of a number of competitors to the California contractor market and the East Coast habitational market contributed to this decline.

The decline in audit premium, as compared to the prior year, relates to a general decline in construction related activity and failing businesses in the construction industry, specifically in California, driven by a slowdown of the residential housing market. Approximately 50% of FPIC’s business (and approximately one-third of our business in total) is related to contractor liability.

Commercial multiple peril policies constitute a majority of the business written in FPIC’s contractor book of business. The premium on these policies is estimated at policy inception based on a prediction of the volume of the insured’s business operations during the policy period. In addition to endorsing the policy throughout the policy period based on known information, at policy expiration FPIC conducts an audit of the insured’s business operations in order to adjust the policy premium from an estimate to actual. Contractor liability policy premium tends to vary with local construction activity as well as changes in the nature of the contractor’s operations. The decline in construction related activity and failing businesses in the construction industry has impacted both the volume of premium for the contractor in-force book of business (and related exposures) and the related audit premium on expiring policies. Audits, primarily of construction related policies, generated return premium of $2.6 million in 2008, representing a decline of $5.7 million as compared to $3.1 million of additional premium that was generated in 2007.

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 highly 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 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 2009 in Arizona and California, and is being developed for introduction in Nevada and Oregon in 2010. Artisan contractors primarily provide repair and maintenance services, and this segment

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tends to experience less severe market fluctuations compared to the real estate construction industry.

Effective January 1, 2008, the Group increased its reinsurance retention to $850,000 (from a maximum retention of $750,000 in 2007) on the casualty, property and workers’ compensation lines of business. Pollution coverage written by FPIC is now fully retained with a standard sub-limit of $150,000 (and up to $300,000 on an exception basis). Prior to 2008, FPIC reinsured 100% of its pollution coverage, which in the twelve months ended December 31, 2007 represented $1.8 million of ceded written premium. We also purchased an additional $1.0 million of surety coverage (subject to a 10% retention), which resulted in an increased reinsurance coverage to $4.5 million from $3.5 million per principal and a maximum retention of $900,000 per principal as compared to the previous $800,000. The net effect of these changes in reinsurance arrangements increased net premiums written for 2008.

Growth in Net Investment Income is discussed below.

2008 vs. 2007 Investment Income and Realized Gains	2008			2007			Change			% Change
	(In thousands)
Fixed income securities	$	14,871		$	13,356		$	1,515			11.3	%
Dividends		351			319			32			10.0	%
Cash, cash equivalents & other		473			1,442			(969	)		(67.2	) %
Gross investment income		15,695			15,117			578			3.8	%
Investment expenses		1,759			2,064			(305	)		(14.8	) %
Net investment income	$	13,936		$	13,053		$	883			6.8	%

Net realized losses - fixed income securities	$	(3,832	)	$	-		$	(3,832	)		N/M
Net realized (losses) / gains - equity securities		(1,740	)		798			(2,538	)		N/M
Mark-to-market valuation for interest rate swaps		(1,500	)		(774	)		(726	)		N/M
Net realized (losses) / gains	$	(7,072	)	$	24		$	(7,096	)		N/M

______________

(N/M means “not meaningful”)

In 2008 net investment income increased $0.9 million, or 6.8%, to $13.9 million, as compared to $13.1 million in 2007. Net investment income in 2007 benefited from the $720,000 non-recurring impact of the retaliatory tax refund. The increase in net investment income in 2008 is the result of an increase in average cash and invested assets. Average cash and invested assets totaled $367 million for 2008 as compared to $333 million for 2007, representing an increase of $33 million. The increase in invested assets is driven primarily by operating cash flow, including the benefits of the 2008 and 2007 reinsurance agreement changes, which result in less premium being ceded to reinsurers.

In 2008 investment income on fixed income securities increased $1.5 million, or 11.3%, to $14.9 million, as compared to $13.4 million in 2007. This was driven by an increase in the average investments held in fixed income securities, offset by a decline in the yield on investments. Our tax equivalent yield (yield adjusted for tax-benefit received on tax-exempt securities) on fixed income securities declined to 5.06% in 2008, as compared to 5.22% in 2007.

Dividend income remained consistent at $351,000 in 2008 as compared to $319,000 in 2007. Interest income on cash and cash equivalents declined $1.0 million or 67.2% to $0.5 million in 2008, as compared to $1.4 million in 2007, primarily as a result of the $720,000 of non-recurring interest received on the retaliatory tax refund in 2007. Investment expenses declined $0.3 million or 14.8% to $1.8 million in 2008, from $2.1 million in 2007.

Net realized losses in 2008 were $7.1 million, as compared to net realized gains of $24,000 in 2007. In 2008 net realized losses of $7.1 million included write-downs of securities determined to be other than-temporarily impaired of $6.2 million, net gains on securities sales of $0.6 million, and a loss on the mark-to-market valuation on the interest rate swaps of $1.5 million. In 2007 net realized gains of $24,000 included net gains on securities sales of $0.9 million, a loss on the mark-to-market valuation on the interest rate swaps of $0.8 million, and write-downs of securities determined to be other than-temporarily impaired of $0.1 million. Securities determined to be other-than-temporarily impaired were written down to 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 investments 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.

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Fixed maturity investments represent 99.6% of invested assets, and as of December 31, 2008, the fixed income portfolio consists of 99.6% investment grade securities, with the remaining 0.4% non-investment grade rated securities. The 0.4% includes three corporate securities held with a combined market value of $1.2 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 5.0 years, an average duration of 3.5 years with an average tax equivalent book yield of 5.06%.

Among our portfolio holdings, the only subprime exposure consists of asset-backed securities (ABS) within the home equity subsector. The ABS home equity subsector totaled $0.6 million (book value) on December 31, 2008, representing 4.1% of the ABS holdings, 0.7% of the total structured product holdings, and 0.2% of total fixed income portfolio holdings. The subprime related exposure consists of three individual securities, of which two are insured by a monoline insurer against default of principal and interest. However, since FGIC and AMBAC have been downgraded from their previous 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 Aa2/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 December 31, 2008 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	$	2,460	$	4	$	951	$	10	$	3,411	$	14
Obligations of states and
political subdivisions		25,847		564		2,108		559		27,955		1,123
Corporate securities		39,226		1,528		2,535		236		41,761		1,764
Mortgage-backed securities		19,277		1,241		2,761		820		22,038		2,061
Total fixed maturities		86,810		3,337		8,355		1,625		95,165		4,962
Total equity securities		2,232		363		69		31		2,301		394
Total securities in a
temporary unrealized loss
position	$	89,042	$	3,700	$	8,424	$	1,656	$	97,466	$	5,356

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 market. At December 31, 2008 we had 11 fixed maturity securities with unrealized losses for more than twelve months. Of the 11 securities with unrealized losses for more than twelve months, all of them have fair values of no less than 72% of book value. We do not believe these declines are other than temporary due to the credit quality of the holdings.

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In the years ended December 31, 2008, 2007 and 2006, we recorded a pre-tax charge to earnings of $6.2 million, $0.1 million and $0.1 million, respectively, for write-downs of other than temporarily impaired securities. See the discussion of recent downgrades and other than temporary impairments on investment securities in the “Critical Accounting Policies” section.

There are 12 common stock securities that are in an unrealized loss position at December 31, 2008. All of these securities have been in an unrealized loss position for less than 6 months. There are 4 preferred stock securities that are in an unrealized loss position at December 31, 2008. Three preferred stock securities have been in an unrealized loss position for less than 8 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.

The following table summarizes the period of time that equity securities sold at a loss during 2008 had been in a continuous unrealized loss position:

	Fair
	Value on		Realized
Period of Time in an Unrealized Loss Position	Sale Date		Loss
	(In thousands)
0-6 months	$	1,544	$	986
7-12 months		118		54
More than 12 months		-		-
Total	$	1,662	$	1,040

The equity securities sold at a loss had been expected to appreciate in value, but due to unforeseen circumstances were sold so that sale proceeds could be reinvested. Securities were sold due to a desire to reduce exposure to certain issuers and industries or in light of unforeseen economic conditions.

Results of our Commercial Lines segment were as follows:

2008 vs. 2007 Commercial Lines (CL)	2008			2007			Change			% Change
	(Dollars in thousands)
CL Direct premiums written	$	143,280		$	160,030		$	(16,750	)		(10.5	) %
CL Net premiums written	$	127,418		$	139,359		$	(11,941	)		(8.6	) %
CL Net premiums earned	$	132,425		$	125,427		$	6,998			5.6	%

CL Loss/ LAE expense ratio (GAAP)		61.3	%		60.8	%		0.5	%
CL Expense ratio (GAAP)		35.5	%		34.4	%		1.1	%
CL Combined ratio (GAAP)		96.8	%		95.2	%		1.6	%

In 2008 our commercial lines direct premiums written decreased by $16.8 million or 10.5% to $143.3 million as compared to direct premium written in 2007 of $160.0 million. The decline in direct premiums written is attributed to several factors, including a decline in construction related activity and related audit premium in California, increased competition on large accounts, and the return of a number of competitors to 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 is up year-over-year, despite the decline in direct premiums written. See additional discussion above in the “2008 vs. 2007 Revenue” discussion.

In 2008 our commercial lines net premiums earned increased by $7.0 million or 5.6% to $132.4 million as compared to net premiums earned in 2007 of $125.4 million. Net premiums earned increased 5.6% despite a 8.6% decline in net premiums written, with the decline in net premiums written caused primarily by the 10.5% decline in direct premiums written, offset by the positive impact on net premiums written of the change in our reinsurance structure as described above. Offsetting these factors was the reduction in audit premium recorded in 2008, which is earned immediately upon booking.

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In the commercial lines segment for 2008 we had underwriting income of $4.2 million, a GAAP combined ratio of 96.8%, a GAAP loss and loss adjustment expense ratio of 61.3% and a GAAP underwriting expense ratio of 35.5%, compared to underwriting income of $6.0 million, a GAAP combined ratio of 95.2%, a GAAP loss and loss adjustment expense ratio of 60.8% and a GAAP underwriting expense ratio of 34.4% in 2007. Our commercial lines loss ratio for 2008 reflects a higher frequency and claim severity than the similar period in 2007 for casualty and property lines of business in our West Coast commercial lines business. The performance of the commercial lines in 2007 was impacted favorably by the non-recurring retaliatory tax refund.

Results of our Personal Lines segment were as follows:

2008 vs. 2007 Personal Lines (PL)	2008			2007			Change			% Change
	(Dollars in thousands)
PL Direct premiums written	$	22,097		$	22,877		$	(780	)		(3.4	) %
PL Net premiums written	$	19,934		$	20,308		$	(374	)		(1.8	) %
PL Net premiums earned	$	20,152		$	21,248		$	(1,096	)		(5.2	) %

PL Loss/ LAE expense ratio (GAAP)		69.5	%		70.1	%		(0.6	) %
PL Expense ratio (GAAP)		37.6	%		28.8	%		8.8	%
PL Combined ratio (GAAP)		107.1	%		98.9	%		8.2	%

Personal lines direct premiums written declined to $22.1 million in 2008 as compared to $22.9 million in 2007, representing a decline of $0.8 million or 3.4%. Our personal lines have also been impacted by increased competition, similar to our commercial lines.

In the personal lines segment for 2008 we had an underwriting loss of $1.4 million, a GAAP combined ratio of 107.1%, a GAAP loss and loss adjustment expense ratio of 69.5% and a GAAP underwriting expense ratio of 37.6%, compared to underwriting income of $0.2 million, a GAAP combined ratio of 98.9%, a GAAP loss and loss adjustment expense ratio of 70.1% and a GAAP underwriting expense ratio of 28.8% in 2007. Our personal lines loss ratio for 2007 reflected increased severity, due to large losses related to a variety of causes including an increase in water and freeze related claims. In addition, the 2007 expense ratio benefited from the retaliatory tax refund previously noted.

Underwriting Expenses and the Expense Ratio is discussed below.

2008 vs. 2007 Expenses and Expense Ratio	2008			2007			Change			% Change
	(Dollars in thousands)
Amortization of Deferred Acquisition Costs	$	41,684		$	38,763		$	2,921			7.5	%
As a % of net premiums earned		27.3	%		26.4	%		0.9	%
Other underwriting expenses		12,851			10,528			2,323			22.1	%
Total expenses excluding losses/ LAE	$	54,535		$	49,291		$	5,244			10.6	%
Underwriting expense ratio		35.7	%		33.6	%		2.1	%

Underwriting expenses increased by $5.2 million, or 10.6%, to $54.5 million in 2008, as compared to $49.3 million in 2007. The increase in underwriting expenses primarily reflects an increase in the amortization of deferred acquisition costs in 2008 and the inclusion in 2007 of the non-recurring retaliatory tax refund, which reduced other underwriting expenses by $3.6 million in 2007. The amortization of deferred acquisition costs increased in 2008 as compared to 2007 due to the increase in net earned premiums. Underwriting expenses also reflect lower share-based compensation expense and lower net contingent commission expense. Lastly, underwriting expenses are impacted by the previously discussed changes in the 2008 and 2007 reinsurance program whereby less ceded premium is being recorded and accordingly less ceding commission is received, which increases underwriting expenses and net acquisition costs.

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2008 vs. 2007 Income Taxes	2008			2007			Change			% Change
	(Dollars in thousands)
Income before income taxes	$	10,390		$	19,989		$	(9,599	)		(48.0	)%
Income taxes		2,156			5,754			(3,598	)		(62.5	)%
Net income	$	8,234		$	14,235		$	(6,001	)		(42.2	)%
Effective tax rate		20.8	%		28.8	%		8.0	%

Federal income tax expense was $2.2 million and $5.8 million for 2008 and 2007, respectively. The effective tax rate was 20.8% and 28.8% for 2008 and 2007, respectively. The 2007 effective tax rate was impacted by an unusually high amount of taxable income in the period caused by the retaliatory tax refund, which increased the effective tax rate. The 2008 effective tax rate was impacted by the higher level of other than temporary investment impairments, which caused tax-advantaged income (municipal bond interest) to represent a higher proportion of income, reducing the effective tax rate.

LIQUIDITY AND CAPITAL RESOURCES

Our insurance companies generate sufficient funds from their operations and maintain a high degree of liquidity in their investment portfolios. 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, of which $3.0 million was drawn upon at December 31, 2009 .

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 December 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. In addition, 1,303 and 1,659 shares of stock were repurchased from employees in 2009 and 2008, respectively, in order to pay the required tax withholdings on the vesting of restricted stock under the stock incentive plan.

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. See discussion of restrictions on dividends and distributions in the section “Business – Regulation”.

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 companies’ capacity to pay dividends without pre-approval by state regulatory authorities.

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

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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 during 2009 and 2008 totaled $1.9 million and $1.7 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.

The Group adopted a stock-based incentive plan at its 2004 annual meeting of shareholders. Pursuant to that plan, the 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 December 31, 2009, the shares authorized under the plan have been increased under this provision to 1,206,091 shares. During 2009, the Group made no grants of restricted stock, incentive stock options and non-qualified stock options. There were 10,000 stock options which expired unexercised in 2009.

Total assets increased 5%, or $26.4 million, to $595.4 million, at December 31, 2009, as compared to $569.0 million at December 31, 2008. The Group’s cash and invested assets increased $33.5 million or 9%, primarily due to net cash provided by operating activities. Premiums receivable increased $2.2 million or 7%, primarily due to timing differences in the recording and collecting of premium. Reinsurance receivables decreased $6.8 million or 8%, reflecting the decrease in ceded loss and loss adjustment expense reserves. Prepaid reinsurance premiums decreased $1.2 million or 17%, principally due to changes in certain of the Group’s reinsurance contracts, whereby fewer unearned premium reserves are ceded. Property and equipment increased $5.4 million, or 33%, due primarily to construction of a new building in Rocklin, California, as well as capitalization of internally developed software costs. Additionally, the deferred income tax asset decreased $4.9 million or 50%, due to the change in deferred taxes on the unrealized gains on securities as well as changes in a variety of temporary differences items.

Total liabilities increased 1% or $3.4 million, to $435.1 million at December 31, 2009 as compared to $431.7 million at December 31, 2008, primarily as a result of the increases in loss and loss adjustment expense reserves of $7.3 million or 2%, and other reinsurance balances of $0.9 million or 8%, offset by declines in unearned premiums of $3.8 million or 5%, and accounts payable and accrued expenses of $1.1 million or 9%. The unearned premiums decline primarily reflected the reduction in written premiums. Accounts payable and accrued expenses declined primarily due to cost saving measures reducing operating expenses. Other reinsurance balances increased primarily as a result of increased contingent ceding commissions payable on reinsurance contracts.

Total stockholders’ equity increased $22.9 million or 17%, to $160.2 million, at December 31, 2009, from $137.3 million at December 31, 2008, primarily due to net income of $13.8 million, changes in unrealized holding gains and losses on securities of $9.8 million, stock compensation plan amortization of $0.3 million, and ESOP shares committed to be allocated to participants of $1.0 million, offset by stockholder dividends of $1.9 million and changes in valuation for the defined benefit pension plan of $0.1 million.

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IMPACT OF INFLATION

Inflation increases consumers’ needs for property and casualty insurance coverage. Inflation also increases 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. 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.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the Financial Accounting Standards Board (“FASB”) issued guidance on how in a business combination an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. In addition, it provides revised guidance on the recognition and measurement of goodwill acquired in the business combination, and provides guidance specific to the recognition, classification, and measurement of assets and liabilities related to insurance and reinsurance contracts acquired in a business combination. The guidance applies to business combinations for acquisitions occurring on or after January 1, 2009, and accordingly does not impact the Group’s previous transactions involving purchase accounting.

In February 2008, the FASB provided guidance which delayed the application 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 delayed application did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

In March 2008, the FASB issued guidance changing the disclosure requirements for derivative instruments and hedging activities and specifically requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of, and gains and losses on, derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. The guidance is effective for financial statements issued for fiscal years beginning after November 15, 2008. The guidance did not have a material effect on the Group’s disclosures.

In April 2009, the FASB issued 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 disclosures required by the guidance have been included in the notes to the consolidated financial statements.

In April 2009, the FASB issued guidance which changes 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 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 guidance also required the Group to analyze securities held as of the adoption date which were the subject of previous other-than-temporary impairment charges in order to determine a cumulative effect adjustment to the opening balance of retained earnings and other comprehensive income at adoption. The Group reviewed the securities held prior to adoption which were the subject of previous other-than-temporary impairment charges, and concluded that no material amount of non-credit impairment had been previously recognized. Adoption did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

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In April 2009, the FASB issued guidance 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 guidance 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. The guidance is effective for interim and annual reporting periods ending after June 15, 2009. Adoption did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

In May 2009, the FASB issued guidance which establishes the standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. This Statement also requires the disclosure of the date through which subsequent events have been evaluated. The Company adopted this standard and performed a review of subsequent events through the date of issuance of these financial statements, March 16, 2010, in evaluating the need for disclosure. The guidance did not have a material impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued guidance that establishes the FASB Accounting Standards Codification as the source of authoritative GAAP for nongovernmental entities. The Codification will supersede all existing non-SEC accounting and reporting standards. The Codification is effective for financial statements issued for interim and annual periods ending after September 15, 2009. As the Codification will not change existing GAAP, the guidance will not have an impact on our financial condition or results of operations but will change the way the Company refers to GAAP accounting standards.

In August 2009, the FASB issued guidance related to fair value measurements and disclosures for liabilities, which amends earlier guidance related to fair value measurements and disclosures. The new guidance provides clarification in circumstances where a quoted price in an active market for an identical liability is not available, and a reporting entity is required to measure fair value using one or more valuation techniques. In addition, the new guidance also addresses practical difficulties where fair value measurements based on the price that would be paid to transfer a liability to a new obligor and contractual or legal requirements that prevent such transfers from taking place. The Company adopted the new standard which became effective for the annual reporting period ended December 31, 2009. The adoption of the new standard did not have a material impact on the Company’s consolidated financial statements.

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 December 31, 2009 that would give rise to previously undisclosed market, credit or financing risk.

The Group and its subsidiaries have no significant contractual obligations at December 31, 2009, other than their insurance obligations under their policies of insurance, trust preferred securities, a line of credit obligation, and operating lease obligations. Projected cash disbursements pertaining to these obligations at December 31, 2009, are as follows:

	Jan. 1, 2010		Jan. 1, 2011		Jan. 1, 2013		After
	to Dec. 31,		to Dec. 31,		to Dec. 31,		Dec. 31,
	2010		2012		2014		2014		Total
	(In thousands)

Gross property and casualty insurance reserves	$	69,389		83,584		48,324		110,051	$	311,348
Trust preferred securities, net principal outstanding		—		—		—		15,592		15,592
Interest expense relating to trust preferred securities		1,390		2,783		2,780		25,552		32,505
Line of credit		3,000		—		—		—		3,000
Operating leases		61		106		46		—		213
Total contractual obligations	$	73,840		86,473		51,150		151,195	$	362,658

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The timing of the amounts for gross property and casualty insurance reserves are an estimate based on historical experience and expectations of future payment patterns. However, the timing of these payments may vary significantly from the amounts stated above.

ITEM 7A. 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, although in the current difficult fixed income market we also are very concerned about credit risk. 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 on the balance sheet.

The average duration of our fixed maturity investments, excluding mortgage-backed securities that are subject to prepayment, was approximately 4.3 years as of December 31, 2009. As a result, the market value of our investments may fluctuate in response to changes in interest rates. In addition, we may experience investment losses to the extent our liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments.

Fluctuations in near-term interest rates could have an impact on the results of operations and cash flows. Certain of these fixed income securities have call features. In a declining interest rate environment, these securities may be called by their issuer and replaced with securities bearing lower interest rates. In a rising interest rate environment, we may sell these securities (rather than holding to maturity) and receive less than we paid for them.

As a general matter, we do not attempt to match the durations of our assets with the durations of our liabilities. Instead, we ladder the maturities of our investments. Our goal is to maximize the total return on all of our investments. An important strategy that we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-term investments to pay claims.

The table below shows the interest rate sensitivity of our fixed income financial instruments measured in terms of market value (which is equal to the carrying value for all our securities).

	As of December 31, 2009 Market Value
	-100 Basis		No Rate		+100 Basis
	Point Change		Change		Point Change
	(In thousands)

Bonds and preferred stocks	$	382,498	$	366,599	$	350,224
Cash and cash equivalents		39,927		39,927		39,927
Total	$	422,425	$	406,526	$	390,151

Credit Risk

As of December 31, 2009, the fixed income portfolio consists of 99% investment grade securities, with 1% non-investment grade rated securities, which includes three corporate securities held with a combined market value of $1.3 million, three asset-backed securities held with a combined market value of $0.6 million, one mortgage-backed security with a market value of $0.1 million, and one small tax-exempt municipal bond. The fixed income portfolio has an average rating of Aa3/AA and an average tax equivalent book yield of 5.14%.

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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 $143 million municipal fixed income portfolio is:

•

“AA+” including insurance enhancement

•

“AA” excluding insurance enhancement

•

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

•

90% of the underlying ratings are “AA-” or better

The municipal fixed income portfolio with insurance enhancement represents $94 million, or 66% 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 $49 million, or 34% 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 December 31, 2009:

	Average Credit	Market	% of Total Muni	Unrealized
	Rating	Value	Portfolio	Gain/Loss

Uninsured Securities	AA+	$49,086,825	35%	$2,275,187

Securities with Insurance Enhancement	AA	$94,206,172	65%	$4,312,393

Total		$ 143,292,997	100%	$6,587,580

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

	(1)					(2)					(3)					(1) + (2)					(1) + (3)
	Municipal					Municipal					Municipal					Municipal					Municipal
	Non-insured					Insured Bonds					Insured Bonds					Total Bonds					Total Bonds
	Bonds					(with insured					(with underlying					(with insured					(with underlying
						rating)					credit rating)					rating)					credit rating)

Rating	Market Value		%			Market Value		%			Market Value		%			Market Value		%			Market Value		%


AAA	$	32,634,368		66.5	%	$	34,076,842		36.2	%	$	9,654,567		10.2	%	$	66,711,210		46.6	%	$	42,288,935		29.5	%
AA+		2,403,200		4.9	%		22,101,339		23.5	%		28,492,347		30.2	%		24,504,539		17.1	%		30,895,547		21.6	%
AA		11,232,731		22.9	%		22,654,289		24.0	%		28,425,402		30.2	%		33,887,020		23.6	%		39,658,133		27.7	%
AA-		1,338,200		2.7	%		11,508,481		12.2	%		14,306,514		15.2	%		12,846,681		9.09	%		15,644,714		10.9	%
A+							1,722,541		1.8	%		3,410,927		3.6	%		1,722,541		1.2	%		3,410,927		2.4	%
A		1,478,326		3.0	%		1,071,140		1.1	%		5,829,345		6.2	%		2,549,466		1.8	%		7,307,671		5.1	%
A-												3,015,530		3.2	%		-		0.0	%		3,015,530		2.1	%
BBB-							1,071,540		1.1	%		1,071,540		1.1	%		1,071,540		0.7	%		1,071,540		0.7	%

	$	49,086,825				$	94,206,172				$	94,206,172				$	143,292,997				$	143,292,997

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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). When a monoline insurer is downgraded, the underlying rating on insured municipal bonds will reflect either the municipality or revenue bonds’ underlying credit rating itself or the insured rating, whichever is higher. Since the monoline insurers have experienced sharp downgrades, the monoline enhancement provides no credit quality improvement to the aggregate portfolio versus the average weighted sum of the underlying credit ratings.

As of December 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 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 rated at their underlying or standalone rating of Baa3/BBB-, as FGIC was downgraded to Caa3/CC. Both agencies have subsequently withdrawn ratings of FGIC.

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 December 31, 2009, was $74.2 million and represented 21.3% of the total invested fixed income assets.

At year end, the single CMBS position held was equal to $0.3 million (book value), representing 0.3% of the total structured product holdings. This CMBS security is rated Aaa/AAA by Moody’s and S&P, and is fully guaranteed by the Federal government.

MBS positions totaled $55.2 million (book value), representing 75% 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 2.9% of the CMO holdings and 0.6% of total MBS holdings; two of the three of non-agency CMO’s have a Aaa/AAA rating by Moody’s or S&P and one security is rated CCC by S&P and unrated by Moody’s.

ABS holdings totaled $18.6 million (book value), representing 25% 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 totaled $0.5 million (book value) on December 31, 2009, representing 3.21% of the ABS holdings, 0.67% of the total structured product holdings, and 0.14% of total fixed income portfolio holdings. The subprime related exposure consists of three individual securities, of which two are insured by monolines against default of principal and interest. However, since FGIC is no longer rated and AMBAC has been downgraded to Caa2/CC, the two insured securities are now rated according to the higher of the underlying collateral or the monoline rating. One bond is rated Ba3/BB while the other is rated Caa2/CCC. With regard to the remaining security without monoline insurance, it is rated A3/B 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 December 31, 2009, the Group held $7.9 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 December 31, 2009, the Group’s portfolio held $124.1 million (book value) of corporate bonds inclusive of FDIC-insured debt issued under the TLGP program. Among the corporate credit exposure, $21 million or 17.5% of the holdings, were non-insured financial issues. While the outlook of the banking, brokerage, finance, insurance and REIT sectors of the investment grade corporate market has improved, challenges and uncertainty remain. Although some issuers, particularly banks, will continue to closely monitor and potentially increase loss reserve levels, it is expected that these issuers will continue to pay principal and interest in accordance with original terms.

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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. Portfolio characteristics are analyzed regularly and market risk is actively managed through a variety of techniques. In accordance with accounting principles generally accepted in the United States of America, when an equity security becomes other than temporarily impaired, we record this impairment as a charge against earnings. For the year ended December 31, 2009, we recorded a pre-tax charge to earnings of $0.4 million for write-downs of other than temporarily impaired equity securities. See discussion of other than temporary impairments on investment securities under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies.

Group and industry concentrations are monitored by the Board of Directors. At December 31, 2009, our equity portfolio made up 2.5% of the Group’s total investment portfolio. At December 31, 2009, investments in the Retail Specialty sector represented 44%, the pharmaceutical sector 19%, the financial sector 16%, while investments in energy companies and information technology companies represented 7%, and 14%, respectively, of the equity portfolio at December 31, 2009. The table below summarizes the Group’s equity price risk and shows the effect of a hypothetical 20% increase and a 20% decrease in market prices as of December 31, 2009. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios.

			Estimated Fair		Hypothetical
Estimated Fair			Value After		Percentage Increase
Value of Equity			Hypothetical		(Decrease) in
Securities at		Hypothetical	Change in		Stockholders'
12/31/09		Price Change	Prices		Equity (1)
(Dollars in thousands)
$	9,484	20% increase	$	11,381		0.8	%
$	9,484	20% decrease	$	7,587		(0.8	%)

_________

(1)	Net of tax

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc.

We have audited the accompanying consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Mercer Insurance Group, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 16, 2010, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2010

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2009 and 2008

(Dollars in thousands, except share amounts)

	2009			2008
Assets
Investments, at fair value:
Fixed-income securities, available for sale, at fair value (cost $348,635 and $331,075, respectively)	$	365,464			334,087
Equity securities, at fair value (cost $7,516 and $9,232, respectively)		9,484			10,203
Total investments		374,948			344,290

Cash and cash equivalents		39,927			37,043
Premiums receivable		36,405			34,165
Reinsurance receivables		79,599			86,443
Prepaid reinsurance premiums		5,871			7,096
Deferred policy acquisition costs		18,876			20,193
Accrued investment income		4,287			3,901
Property and equipment, net		21,516			16,144
Deferred income taxes		4,941			9,814
Goodwill		5,416			5,416
Other assets		3,568			4,481
Total assets	$	595,354			568,986
Liabilities and Equity
Liabilities:
Losses and loss adjustment expenses	$	311,348			304,000
Unearned premiums		76,601			80,408
Accounts payable and accrued expenses		12,150			13,283
Other reinsurance balances		12,386			11,509
Trust preferred securities		15,592			15,576
Advances under line of credit		3,000			3,000
Other liabilities		4,069			3,940
Total liabilities		435,146			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 6,883,498 and 6,801,095 shares		-			-
Additional paid-in capital		72,139			71,369
Accumulated other comprehensive income		12,220			2,494
Retained Earnings		86,101			74,138
Unearned ESOP shares		(1,878	)		(2,505	)
Treasury stock, 632,076 and 621,773 shares		(8,374	)		(8,226	)
Total stockholders’ equity		160,208			137,270
Total liabilities and stockholders’ equity	$	595,354			568,986

See accompanying notes to consolidated financial statements.

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

Years ended December 31, 2009, 2008 and 2007

(Dollars in thousands, except per share data)

	2009			2008			2007
Revenue:
Net premiums earned	$	140,413			152,577			146,675
Investment income, net of expenses		14,198			13,936			13,053
Net realized investment (losses) gains:
Other-than-temporary impairments (none recognized		(807	)		(6,204	)		(138	)
in Other Comprehensive Income)
Other net realized investment gains (losses)		1,428			(868	)		162
Total net realized investment gains (losses)		621			(7,072	)		24
Other revenue		2,080			2,021			1,929

Total revenue		157,312			161,462			161,681

Expenses:
Losses and loss adjustment expenses		86,142			95,219			91,186
Amortization of deferred policy acquisition costs (related party amounts of $1,063, $1,141 and $1,212, respectively)		38,805			41,684			38,763
Other expenses		12,090			12,851			10,528
Interest expense		1,423			1,318			1,215

Total expenses		138,460			151,072			141,692

Income before income taxes		18,852			10,390			19,989

Income taxes		5,031			2,156			5,754

Net income	$	13,821			8,234			14,235

Net income per common share:
Basic	$	2.23			1.32			2.32
Diluted	$	2.18			1.30			2.25

See accompanying notes to consolidated financial statements.

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

Years ended December 31, 2009, 2008 and 2007

(Dollars in thousands)

	Preferred stock		Common stock		Additional paid-in capital		Accumulated other comprehensive income			Retained earnings			Unearned ESOP shares			Treasury stock			Total
Balance, December 31, 2006	$	-		-		68,473		2,815			54,629			(3,757	)		(6,321	)		115,839
Net income											14,235									14,235
Unrealized gains on securities:
Unrealized holding gains arising during period, net of related income tax expense of $1,436								2,787												2,787
Less reclassification adjustment for gains included in net income, net of related income tax expense of $271								(527	)											(527	)
Defined benefit pension plan, net of related income tax benefit of $92								(179	)											(179	)
Other comprehensive loss																				2,081
Comprehensive income																				16,316
Stock compensation plan amortization						1,043														1,043
Tax benefit from stock compensation plan						153														153
ESOP shares committed						549								626						1,175
Treasury stock purchased																	(45	)		(45	)
Issuance of common stock						176														176
Dividends to shareholders											(1,251	)								(1,251	)
Balance, December 31, 2007	$	-		-		70,394		4,896			67,613			(3,131	)		(6,366	)		133,406
Net income											8,234									8,234
Unrealized losses on securities:
Unrealized holding losses arising during period, net of related income tax benefit of $3,156								(6,126	)											(6,126	)
Less reclassification adjustment for losses included in net income, net of related income tax benefit of $1,895								3,678												3,678
Defined benefit pension plan, net of related income tax expense of $24								46												46
Other comprehensive income																				(2,402	)
Comprehensive income																				5,832
Stock compensation plan amortization						547														547
Tax benefit from stock compensation plan						40														40
ESOP shares committed						388								626						1,014
Treasury stock purchased																	(1,860	)		(1,860	)
Dividends to shareholders											(1,709	)								(1,709	)
Balance, December 31, 2008	$	-		-		71,369		2,494			74,138			(2,505	)		(8,226	)		137,270
Net income											13,821									13,821
Unrealized gains on securities:
Unrealized holding gains arising during period, net of related income tax expense of $5,072								9,846												9,846
Less reclassification adjustment for gains included in net income, net of related income tax expense of $35								(68	)											(68	)
Defined benefit pension plan, net of related income tax benefit of $27								(52	)											(52	)
Other comprehensive income																				9,726
Comprehensive income																				23,547
Stock compensation plan amortization						345														345
Tax benefit from stock compensation plan						33														33
ESOP shares committed						392								627						1,019
Treasury stock purchased																	(148	)		(148	)
Dividends to shareholders											(1,858	)								(1,858	)
Balance, December 31, 2009	$	-		-		72,139		12,220			86,101			(1,878	)		(8,374	)		160,208

See accompanying notes to consolidated financial statements.

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2009, 2008 and 2007

(Dollars in thousands)

	2009			2008			2007
Cash flows from operating activities:
Net income	$	13,821			8,234			14,235
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of fixed assets		3,168			2,232			2,135
Net amortization of premium		1,538			1,505			1,272
Amortization of restricted stock compensation		345			547			1,043
ESOP share commitment		1,019			1,014			1,175
Net realized investment losses (gains)		(621	)		7,072			(24	)
Deferred income tax		(137	)		(907	)		(967	)
Change in assets and liabilities:
Premiums receivable		(2,240	)		2,174			1,691
Reinsurance receivables		6,844			(2,599	)		4,143
Prepaid reinsurance premiums		1,225			2,390			6,897
Deferred policy acquisition costs		1,317			335			(3,820	)
Other assets		445			(2,723	)		884
Losses and loss adjustment expenses		7,348			29,601			23,944
Unearned premiums		(3,807	)		(7,616	)		6,094
Other reinsurance balances		877			(3,225	)		(9,854	)
Other		(1,066	)		550			1,445
Net cash provided by operating activities		30,076			38,584			50,293

Cash flows from investing activities:
Purchase of fixed income securities, available for sale		(81,850	)		(57,552	)		(84,640	)
Purchase of equity securities		(1,793	)		(3,569	)		(4,188	)
Sale of short-term investments, net		-			-			7,692
Sale and maturity of fixed income securities, available for sale		62,260			43,119			35,602
Sale of equity securities		4,715			3,726			3,425
Purchase of property and equipment, net		(8,551	)		(5,316	)		(3,255	)
Net cash used in investing activities		(25,219	)		(19,592	)		(45,364	)

Cash flows from financing activities:
Purchase of treasury stock		(148	)		(1,860	)		(45	)
Tax benefit from stock compensation plans		33			40			153
Proceeds from issuance of common stock		-			-			176
Dividends to shareholders		(1,858	)		(1,709	)		(1,251	)
Net cash used in financing activities		(1,973	)		(3,529	)		(967	)

Net increase in cash and cash equivalents		2,884			15,463			3,962
Cash and cash equivalents at beginning of year		37,043			21,580			17,618
Cash and cash equivalents at end of year	$	39,927			37,043			21,580

Cash paid during the year for:
Interest	$	1,406			1,290			1,163
Income taxes	$	4,420			3,900			5,900

See accompanying notes to consolidated financial statements.

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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands, except per share amounts)

(1) Summary of Significant Accounting Policies

(a) Description of Business

Mercer Insurance Group, Inc. (MIG) and subsidiaries (collectively, the Group) includes Mercer Insurance Company (MIC), its subsidiaries Mercer Insurance Company of New Jersey, Inc. (MICNJ), Franklin Insurance Company (FIC), and BICUS Services Corporation (BICUS), and Financial Pacific Insurance Group, Inc. (FPIG) and its subsidiaries Financial Pacific Insurance Company (FPIC) and Financial Pacific Insurance Agency (FPIA), which is currently inactive. FPIG also holds an interest in three statutory business trusts that were formed for the purpose of issuing Floating Rate Capital Securities ( see note 18).

The companies in the Group are operated under common management. The Group’s operating subsidiaries are licensed collectively in twenty two states, but are currently focused on doing business in six states; Arizona, California, Nevada, New Jersey, Oregon and Pennsylvania. MIC and MICNJ write a limited amount of business in New York to support accounts in adjacent 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’s business activities are separated into three operating segments, which are commercial lines of insurance, personal lines of insurance and the investment function. The commercial lines of business consist primarily of multi-peril and commercial auto coverage. These two commercial lines represented 60 % , 62% and 64%, and 19%, 17% and 17%, respectively, of the Group’s net premiums written in 2009, 2008 and 2007. The personal lines business consists primarily of homeowners insurance in Pennsylvania and New Jersey and private passenger automobile insurance in Pennsylvania. These two personal lines represented 9%, 8% and 8%, and 4%, 4% and 4%, respectively, of the Group’s net premiums written in 2009, 2008 and 2007.

(b) Consolidation Policy and Basis of Presentation

The consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP), which differ in some respects from those followed in reports to insurance regulatory authorities. The insurance subsidiaries 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 as of the beginning of each year. The effects of the Pool as well as all other significant intercompany accounts and transactions have been eliminated in consolidation.

The preparation of the accompanying financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates include liabilities for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance, goodwill impairment, deferred income tax assets and investment valuation and assessment of other than temporary impairment of investments. Actual results could differ from those estimates.

(d) Concentration of Risk

The Group’s business is subject to concentration risk with respect to geographic concentration. Although the Group’s operating subsidiaries are licensed collectively in twenty two states, direct premiums written for three states, California, New Jersey and Pennsylvania, constituted 52%, 30% and 9% of the 2009 direct premium written, 54%, 28% and 8% of the 2008 direct premium written, and 55%, 27%, and 7% of the 2007 direct premium written, respectively. Consequently, changes in the California, New Jersey or Pennsylvania legal, regulatory or economic environment could adversely affect the Group.

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For the year ending December 31, 2009, 2008 and 2007, there were no agents in the Group that individually produced greater than 5% of the Group’s direct written premiums.

(e) Investments

Due to periodic shifts in the portfolio arising from income tax planning strategies and asset-liability matching, as well as the need to be flexible in responding to changes in the securities markets and economic factors, management considers the entire portfolio of fixed-income securities as available for sale. Fixed-income securities available for sale are stated at fair value. Equity securities are carried at fair value. 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.

Interest on fixed-income securities is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method. Premiums and discounts on mortgage-backed securities are amortized/accreted using anticipated prepayments with changes in anticipated prepayments, which are evaluated semi-annually, accounted for prospectively. The model used to determine anticipated prepayment assumptions for mortgage-backed securities uses separate home sale, refinancing, curtailment, and full pay-off components, derived from a variety of industry sources as determined by the Group’s third party fixed income securities manager.

Realized investment gains and losses are determined on the specific identification basis. An invested asset is considered impaired when its fair value declines below cost. The Group recognizes as a realized investment loss any impairment of a fixed maturity investment which is determined to be other-than-temporarily impaired because the present value of future cash flows expected to be collected from the security is less than the amortized cost of the security (i.e. a credit loss exists) or where the Group intends to sell or more-likely-than-not will be required to sell the security prior to recovering the security’s amortized cost basis. Impaired equity securities are other-than-temporarily impaired when it becomes apparent that the Group will not recover its cost over a reasonable period of time, in which case the impairment is recorded as a realized investment loss. Factors considered in determining whether a credit loss exists and over what period of time the security is expected to recover include the length of time and the extent to which fair value has been below cost, adverse conditions specifically related to the security, the industry or the geographic area, the financial condition and near-term prospects of the issuer, analysis and guidance provided by rating agencies and analysts, and changes in fair value subsequent to the balance sheet date. Where a realized investment loss is recognized for an impairment, the cost basis of the security is written down to fair value. Where a fixed income security is impaired and the impairment is not attributable to credit issues, this impairment loss, or portion of a larger impairment loss, is included within other comprehensive income. Subsequent recoveries in the fair value of other-than-temporarily impaired securities are recognized at disposition.

(f) Cash and Cash Equivalents

Cash and cash equivalents are carried at cost which approximates fair value. The Group considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.

Cash and cash equivalents as of December 31, 2009 and 2008 include restricted cash of $57 and $264, respectively, consisting of funds held for surety bonds.

(g) Fair Values of Financial Instruments

The Group has used the following methods and assumptions in estimating its fair values:

Investments – The fair values for fixed-income securities available for sale are based on readily observable market data for similar securities or valuations based on models where significant inputs are observable. If not available, fair values are based on values obtained from investment brokers. Fair values for marketable equity securities are based on quoted market prices.

Cash and cash equivalents – The carrying amounts reported in the consolidated balance sheet

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approximate their fair values.

Premium and reinsurance receivables – The carrying amounts reported in the consolidated balance sheet for these instruments approximate their fair values.

Trust preferred securities and line of credit obligations – The carrying amounts reported in the consolidated balance sheets for these instruments approximate their fair values.

Interest rate swaps - The estimated fair value of the interest rate swaps is based on valuations received from the financial institution counterparties.

(h) Reinsurance

The Group cedes insurance to unrelated insurers to limit its maximum loss exposure through risk diversification. Ceded reinsurance receivables and unearned premiums are reported as assets; loss and loss adjustment expense reserves are reported gross of ceded reinsurance credits, unless the reinsurance contract includes a right of offset. Premiums receivable is recorded gross of ceded premiums payable. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information.

(i) Deferred Policy Acquisition Costs

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

(j) Property and Equipment

Property and equipment are carried at cost less accumulated depreciation calculated on the straight-line basis. Property is depreciated over useful lives generally ranging from five to forty years. Equipment is depreciated over three to ten years.

The Group applies the provisions of Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” to account for internally developed computer software costs. In accordance with SOP 98-1, the Group has capitalized $2,067, $4,530 and $2,499 in software development costs, respectively, in 2009, 2008 and 2007. These costs are amortized over their useful lives, ranging from three to five years, from the dates the systems technology becomes operational. At December 31, 2009 and 2008, the unamortized cost of capitalized software was $7,615 and $7,556, respectively.

The carrying value of property and equipment is reviewed for recoverability including an evaluation of the estimated useful lives of such assets. Impairment is recognized only if the carrying amount of the property and equipment is not deemed recoverable. A change in the estimated useful lives of such assets is treated as a change in estimate and is accounted for prospectively.

Upon disposal of assets, the cost and related accumulated depreciation is removed from the accounts and the resulting gain or loss is included in income.

(k) Premium Revenue

Premiums include direct writings plus reinsurance assumed less reinsurance ceded to other insurers and are recognized as revenue over the period that coverage is provided using the daily pro-rata method. Audit premiums and premium adjustments are recorded when they are considered probable and adequate information exists to estimate the premium. Unearned premiums represent that portion of direct premiums

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written that are applicable to the unexpired terms of policies in force and is reported as a liability. Prepaid reinsurance premiums represent the unexpired portion of premiums ceded to reinsurers and is reported as an asset. Premiums receivable are reported net of an allowance for estimated uncollectible premium amounts. Revenue related to service fees is earned over the installment period. Agency commission and related fees are recognized based on the policy issue date.

(l) Losses and Loss Adjustment Expenses

The liability for losses includes the amount of claims which have been reported to the Group and are unpaid at the statement date as well as provision for claims incurred but not reported, after deducting anticipated salvage and subrogation. The liability for loss adjustment expenses is determined as a percentage of the liability for losses based on the historical ratio of paid adjustment expenses to paid losses by line of business.

Estimates of liabilities for losses and loss adjustment are necessarily based on estimates, and the amount of losses and loss adjustment expenses ultimately paid may be more or less than such estimates. Changes in the estimates for losses and loss adjustment expenses are recognized in the period in which they are determined.

(m) Share-Based Compensation

The Group can make 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 exercise prices that are not less than market price at the date of grant, vest over a period of three or five years, and are outstanding for 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 to five years.

The Group recognizes the expense in its financial statements based on the fair value of the grants on the grant date. The after-tax compensation expense recorded in the consolidated statements of earnings for stock options (net of forfeitures) for the years ended December 31, 2009, 2008 and 2007 was $166, $234, and $439 respectively. The after-tax compensation expense recorded in the consolidated statements of earnings for restricted stock (net of forfeitures) for the years ended December 31, 2009, 2008, and 2007 was $110, $195, and $336 respectively.

As of December 31, 2009, the Group has $0.1 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 1.0 years, based on the estimated grant date fair value.

(n) Income Taxes

The Group uses the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of the Group’s assets and liabilities and operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. 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.

(o) Goodwill and Intangible Assets

Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Group determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Group has two reporting units with goodwill as of December 31, 2009

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and 2008. The Group performed the annual impairment tests as of December 31, 2009 and 2008, and the results indicated that the fair value of the reporting units exceeded their carrying amounts.

Intangible assets held by the Group have definite lives and the value is amortized on a straight-line basis over their useful lives, ranging from eight to fourteen years. The carrying amount of these intangible assets are regularly reviewed for indicators of impairments in value. Impairment is recognized only if the carrying amount of the intangible asset is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the fair value of the asset.

(p) 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. 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.

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 valuations received from the financial institution counterparties.

(q) Earnings per Share

Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of Diluted EPS reflects the effect of potentially dilutive securities. The denominator for basic and diluted EPS includes ESOP shares committed to be released.

(r) Recent Accounting Pronouncements

In February 2008, the FASB provided guidance which delayed the application of 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 delayed application did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

In April 2009, the FASB issued guidance modifying the requirements for recognizing other-than-temporarily impaired debt securities and significantly changes the existing impairment model for such securities. This guidance also modifies the presentation of other-than-temporary impairment losses. Such modifications include changing the amount of the other-than-temporary impairment that is recognized in earnings when there are credit losses on a debt security that the entity does not intend to sell and it is not more-likely-than-not that the entity will be required to sell prior to recovery. In these situations, the portion

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of the total impairment that is related to the credit loss would be recognized as a charge against operations, and the remaining portion would be included in other comprehensive income. The guidance also increases the frequency of and expands already required disclosures about the other-than-temporary impairment of debt and equity securities. This guidance is effective for fiscal years ending after June 15, 2009.

As of the beginning of the period of adoption of this guidance, entities are required to recognize a cumulative-effect adjustment to reclassify the non-credit component of a previously recognized other-than-temporary impairment loss from beginning retained earnings to beginning accumulated other comprehensive income if the entity does not intend to sell the security and it is not more-likely-than-not that the entity will be required to sell the security before recovery.

The Group adopted this guidance as of January 1, 2009. As the Group did not hold any debt securities at January 1, 2009 that were the subject of previous other than temporary impairment charges which were non-credit in nature, the adoption of this guidance did not result in the recognition of a cumulative-effect adjustment. Adoption of this guidance did not have a material impact to the Group’s results of operations, financial condition, or liquidity. In April 2009, the FASB issued guidance 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 guidance 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. The guidance is effective for interim and annual reporting periods ending after June 15, 2009. Adoption did not have a material impact on the Group’s results of operations, financial condition, or liquidity.

In May 2009, the FASB issued guidance which establishes the standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The Company adopted this standard, which did not have a material impact on the Company’s consolidated financial statements.

(2)	INVESTMENTS

Net investment income, net realized investment gains (losses), and change in unrealized gains (losses) on investment securities are as follows.

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Net investment income and net realized investment gains (losses):

	2009			2008			2007
Investment income:
Fixed income securities	$	15,949			14,871			13,356
Equity securities		283			351			319
Cash and equivalents		86			369			613
Other		73			104			829
Gross investment income		16,391			15,695			15,117
Less investment expenses		2,193			1,759			2,064
Net investment income		14,198			13,936			13,053
Net realized gains (losses):
Fixed income securities		(293	)		(3,832	)		-
Equity securities, net		395			(1,740	)		798
Mark-to-market valuation for interest rate swaps		519			(1,500	)		(774	)
Net realized investment gains (losses)		621			(7,072	)		24
Net investment income and net realized investment gains	$	14,819			6,864			13,077

Investment expenses include salaries, advisory fees and other miscellaneous expenses attributable to the maintenance of investment activities.

The changes in net unrealized gains (losses) of securities are as follows:

	2009		2008			2007
Fixed-income securities	$	13,817		752			3,575
Equity securities		997		(4,459	)		(152	)
	$	14,814		(3,707	)		3,423

The cost and estimated market value of available-for-sale fixed-income and equity investment securities at December 31, 2009 and 2008 are shown below.

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			Gross		Gross		Estimated
			Unrealized		Unrealized		Fair
	Cost (1)		Gains		Losses		Value
2009
Fixed-income securities, available for sale:
U.S. government and government agencies (2)	$	68,864		3,209		52		72,021
Obligations of states and political subdivisions		136,706		6,743		156		143,293
Industrial and miscellaneous		124,135		6,380		292		130,223
Mortgage-backed securities		18,930		1,008		11		19,927
Total fixed maturities		348,635		17,340		511		365,464
Equity securities:
At estimated market value		7,516		2,001		33		9,484
Total	$	356,151		19,341		544		374,948

			Gross		Gross		Estimated
			Unrealized		Unrealized		Fair
	Cost (1)		Gains		Losses		Value
2008
Fixed-income securities, available for sale:
U.S. government and government agencies (2)	$	84,747		3,242		14		87,975
Obligations of states and political subdivisions		143,042		3,206		1,123		145,125
Industrial and miscellaneous		77,859		1,404		1,764		77,499
Mortgage-backed securities		25,427		122		2,061		23,488
Total fixed maturities		331,075		7,974		4,962		334,087
Equity securities:
At estimated market value		9,232		1,365		394		10,203
Total	$	340,307		9,339		5,356		344,290

___________________

(1)	Original cost of equity and fixed-income securities adjusted for other than temporary impairment writedowns and amortization of premium and accretion of discount.

(2)	Includes approximately $55,092 and $66,576 (cost) and $57,874 and $68,696 (fair value) of mortgage-backed securities implicitly or explicitly backed by the U.S. government and government agencies as of December 31, 2009 and 2008, respectively.

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

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

Industrial and miscellaneous
Fixed income securities
Financial	$	29,612	$	31,537	$	36,520	$	36,065
Retail specialty		42,211		43,897		27,561		27,810
Energy		30,685		32,317		9,680		9,444
Pharmaceutical		9,367		9,744		2,249		2,320
Information Technology		12,260		12,728		1,849		1,860
Total	$	124,135	$	130,223	$	77,859	$	77,499


Equity securities
Financial	$	1,293	$	1,505	$	2,329	$	2,343
Retail specialty		3,488		4,216		4,117		4,565
Energy		407		636		746		1,135
Pharmaceutical		1,333		1,764		794		974
Information Technology		995		1,363		1,246		1,186
Total	$	7,516	$	9,484	$	9,232	$	10,203

The estimated market value and unrealized loss for securities in a temporary unrealized loss position as of December 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

U.S. Treasury securities and
obligations of U.S. government
corporations and agencies	$	4,571	$	52	$	-	$	-	$	4,571	$	52
Obligations of states and political
subdivisions		1,889		61		1,478		95		3,367		156
Corporate securities		18,561		256		460		36		19,021		292
Mortgage-backed securities		768		8		256		3		1,024		11
Total fixed maturities		25,789		377		2,194		134		27,983		511
Total equity securities		349		25		388		8		737		33
Total securities in a temporary
unrealized loss position	$	26,138	$	402	$	2,582	$	142	$	28,720	$	544

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security in an unrealized loss position. The Group currently has the ability and intent to hold these securities until recovery.

The estimated market value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2008 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

U.S. Treasury securities and
obligations of U.S. government
corporations and agencies	$	2,460	$	4	$	951	$	10	$	3,411	$	14
Obligations of states and political
subdivisions		25,847		564		2,108		559		27,955		1,123
Corporate securities		39,226		1,528		2,535		236		41,761		1,764
Mortgage-backed securities		19,277		1,241		2,761		820		22,038		2,061
Total fixed maturities		86,810		3,337		8,355		1,625		95,165		4,962
Total equity securities		2,232		363		69		31		2,301		394
Total securities in a temporary
unrealized loss position	$	89,042	$	3,700	$	8,424	$	1,656	$	97,466	$	5,356

Fixed maturity investments with unrealized losses for less than twelve months are primarily due to changes in the interest rate environment. At December 31, 2008 the Group had 11 fixed maturity securities with unrealized losses for more than twelve months. Of the 11 securities with unrealized losses for more than twelve months, all of them had fair values of no less than 72% of book value.

There are 12 common stock securities that are in an unrealized loss position at December 31, 2008. All of these securities had been in an unrealized loss position for less than 6 months. There were 4 preferred stock securities that were in an unrealized loss position at December 31, 2008. Three preferred stock securities had been in an unrealized loss position for less than 8 months. One preferred stock security had been in an unrealized loss position for more than twelve months.

The amortized cost and estimated fair value of fixed-income securities at December 31, 2009, by contractual maturity, are shown below (note that mortgage-backed securities in the below table include securities backed by the U.S. government and agencies). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Estimated
	Cost		Fair Value

Due in one year or less	$	22,071		22,579
Due after one year through five years		93,520		98,530
Due after five years through ten years		145,745		152,851
Due after ten years		13,277		13,703
		274,613		287,663
Mortgage-backed securities		74,022		77,801
	$	348,635		365,464

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The gross realized gains and losses on investment securities are as follows:

	2009		2008			2007
Gross realized gains:
Gains on sale of securities	$	1,267		1,698			1,034
Mark-to-market for interest rate swaps		519		-			-
Total		1,786		1,698			1,034
Gross realized losses:
Losses on sale of securities		358		1,066			98
Other than temporary impairment write-downs		807		6,204			138
Mark-to-market for interest rate swaps		-		1,500			774
Total		1,165		8,770			1,010

Net realized gain (loss)	$	621		(7,072	)	$	24

In 2009, the Group recorded a pre-tax charge to earnings of $0.8 million for write-downs of other-than-temporarily impaired securities, of which $0.4 million related to fixed income securities, and $0.4 million related to equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.3 million) which experienced increased delinquency and default rates, as well as two asset-backed securities whose underlying collateral deteriorated. All write-downs of fixed income securities were attributable to credit issues, and accordingly recognized as realized investment losses in the consolidated statement of earnings. The equity security impairments related to thirteen common stock securities and two preferred stock securities, which demonstrated weakening fundamentals in their businesses.

During the second half of 2008, there were significant disruptions to the financial and equity markets. This 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 in addition to a dramatic widening in credit spreads. Such impacts affected the valuations of both the fixed income and equity securities held by the Group, and resulted in pre-tax charge to earnings of $6.2 million for write-downs of other-than-temporarily impaired securities. Of the $6.2 million in 2008 impairments $3.9 million related to 11 fixed-income securities, and $2.3 million related to 33 equity securities. The fixed income security impairments related to one residential mortgage-backed security ($0.5 million) which experienced increased delinquency and default rates, four asset-backed securities ($0.8 million) whose underlying collateral deteriorated, and six corporate bonds ($2.6 million) whose issuers were a experiencing deteriorating financial condition. The equity security impairments related to twenty-nine common stock securities and four preferred stock securities, which demonstrated weakening fundamentals in their businesses.

A roll-forward of the amount related to credit losses for fixed income securities recognized in earnings is presented in the following table:

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	April 1
	to
	December 31
	2009


Beginning balance of cumulative credit loss for securities held	$	5,625
Additional credit loss for securities previously other-than-temorarily impaired		67
credit loss for securities not previously other-than-temorarily impaired		-
Reduction in credit loss for securities disposed or collected		(1,960	)
Reduction in credit loss for securities other-than-temporarily impaired which were		-
intended to be or were required of necessity to be sold
Change in credit loss due to accretion of increase in cash flows for securities		-
previously other-than-temporarily impaired
Ending balance December 31, 2009	$	3,732

Proceeds from sales and maturities of securities were $66,975, $46,845 and $39,027 in 2009, 2008, and 2007, respectively.

Accumulated other comprehensive income was net of deferred income taxes of $6,390 and $1,353 applicable to net unrealized investment gains at December 31, 2009 and 2008, respectively.

The amortized cost of invested securities on deposit with regulatory authorities at December 31, 2009 and 2008 was $4,819 and $4,911, respectively.

(3)	DEFERRED POLICY ACQUISITION COSTS

Changes in deferred policy acquisition costs are as follows:

	2009			2008			2007

Balance, January 1	$	20,193			20,528			16,708
Acquisition costs deferred		37,488			41,349			42,583
Amortization charged to earnings		(38,805	)		(41,684	)		(38,763	)
Balance, December 31	$	18,876			20,193			20,528

(4)	PROPERTY AND EQUIPMENT

Property and equipment was as follows:

	2009			2008
Property and equipment:
Land	$	2,566		$	1,720
Buildings and improvements		12,761			7,846
Furniture, fixtures, and equipment		23,320			20,606
		38,647			30,172
Accumulated depreciation		(17,131	)		(14,028	)
	$	21,516			16,144

In 2009, the Group constructed a new 41,000 square foot building for its office in Rocklin, California at a cost of $5,110. This office space replaced 25,000 square feet the Group previously leased in Rocklin for its west coast operations.

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(5)	LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liabilities for losses and loss adjustment expenses is summarized as follows:

	2009			2008			2007
Balance at January 1	$	304,000		$	274,399		$	250,455
Less reinsurance recoverable on unpaid losses and loss expenses		(86,038	)		(82,382	)		(85,933	)
Net balance, January 1		217,962			192,017			164,522
Incurred related to:
Current year		86,046			89,088			83,015
Prior years		96			6,131			8,171
Total incurred		86,142			95,219			91,186
Paid related to:
Current year		25,328			24,521			22,589
Prior years		47,752			44,753			41,102
Total paid		73,080			69,274			63,691
Net balance, December 31		231,024			217,962			192,017
Plus reinsurance recoverable on unpaid losses and loss expenses		80,324			86,038			82,382
Balance at December 31	$	311,348		$	304,000		$	274,399

The balance at December 31, 2009, 2008, and 2007 is recorded net of reserves for salvage and subrogation in the amounts of $8,561, $7,629, and $6,140, respectively.

As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expenses increased by $0.1 million, $6.1 million and $8.2 million in 2009, 2008 and 2007, respectively.

The following table presents the (increase) decrease in the liability for unpaid losses and loss adjustment expenses attributable to insured events of prior years incurred in the year ended December 31, 2009 by line of business:

				Loss events of indicated prior years
	Total			2008			2007			2006			2005 and Prior
	(In Thousands)

Commercial multi-peril	$	(5,331	)	$	1,972		$	(1,721	)	$	(187	)	$	(5,395	)
Commercial automobile		4,221			1,155			3,015			183			(132	)
Other liability		1,310			1,001			332			(194	)		171
Workers' compensation		9			(533	)		675			225			(358	)
Homeowners		559			379			117			(73	)		136
Personal automobile		(214	)		56			(192	)		36			(114	)
Other lines		(650	)		(573	)		460			283			(820	)

Net 2009 (unfavorable) favorable
prior year development	$	(96	)	$	3,457		$	2,686		$	273		$	(6,512	)

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Prior year favorable (unfavorable) development, by line of business, reported in:
	Year Ended December 31,
	2009			2008			2007
	(In Thousands)

Commercial multi-peril	$	(5,331	)	$	(9,220	)	$	(5,911	)
Commercial automobile		4,221			3,041			2,504
Other liability		1,310			869			(4,388	)
Workers' compensation		9			413			787
Homeowners		559			(1,093	)		(1,220	)
Personal automobile		(214	)		(98	)		(101	)
Other lines		(650	)		(43	)		158

Net unfavorable prior year development	$	(96	)	$	(6,131	)	$	(8,171	)

We evaluate our estimated ultimate liability by line of business on a quarterly basis. The establishment of loss and loss adjustment expense reserves is an inherently uncertain process and reserve uncertainty stems from a variety of sources. Court decisions, regulatory changes and economic conditions, among other factors, can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Similarly, actual experience, including the number of claims and the severity of claims, to the extent it varies from data previously used or projected, will be used to update the projected ultimate liability for losses, by accident year and line of business. Changes in estimates, or differences between estimates and amounts ultimately paid, are reflected in the operating results of the period during which such changes are made. A discussion of factors contributing to an (increase) decrease in the liability for unpaid losses and loss adjustment expenses (as shown in the chart immediately above) for the Group’s major lines, representing 92% of net loss and loss adjustment reserves at December 31, 2009, follows:

Commercial multi-peril

With $180.0 million, $163.0 million, and $140.0 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008 and 2007, respectively, commercial multi-peril is the line of business that carries the largest net loss and loss adjustment expense reserves, representing 78%, 75%, and 73%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008, and 2007.

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development in 2008 was driven by a decrease in claim frequency for accident years 2003 through 2005 which reflects the impact of both rate increases and changes in underwriting.

The variances from previous expectations in the loss activity described above were taken into account in evaluating the ultimate liability for losses and loss adjustment expenses.

Commercial automobile

The commercial automobile line of business experienced favorable prior year development of $4.2 million in 2009, $3.0 million in 2008, and $2.5 million in 2007.

The variances from previous expectations in the loss activity described above were taken into account in evaluating the ultimate liability for losses and loss adjustment expenses.

Workers compensation

With $8.3 million, $7.6 million, and $7.6 million of recorded reserves, net of reinsurance, at December 31, 2009, 2008, and 2007, respectively, workers compensation represents 4%, 3%, and 4%, respectively, of the Group’s total carried net loss and loss adjustment expense reserves at December 31, 2009, 2008 and 2007. A portion of this business is assumed from the National Involuntary Pool managed by the National Council on Compensation Insurance (NCCI).

Workers compensation reserves developed favorably in 2009 by $0.0 million, in 2008 by $0.4 million, and in 2007 by $0.8 million, respectively.

Workers compensation losses are impacted heavily by medical cost increases which have been significant recently.

The variances from previous expectations in the loss activity described above were taken into account in evaluating the ultimate liability for losses and loss adjustment expenses.

All Other lines

(6)	REINSURANCE

The Group has geographic exposure to catastrophe losses in its operating territories. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosion, severe weather, and fire. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the

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event and the severity of the event. Most catastrophes are restricted to small geographic areas. However, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Group generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance.

In the ordinary course of business, the Group seeks to limit its exposure to loss on individual claims and from the effects of catastrophes by entering into reinsurance contracts with other insurance companies. Reinsurance is ceded on excess of loss and pro-rata bases with the Group’s retention not exceeding $1,000, $850 and $750 per occurrence in 2009, 2008 and 2007, respectively. Insurance ceded by the Group does not relieve it of its primary liability as the originating insurer.

In conjunction with the renewal of the reinsurance program in 2009, and 2008, the prior year reinsurance treaties were terminated on a run-off basis, which requires that for policies in force as of the prior year end, 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 recoverables from these syndicates of reinsurers as the underlying business runs off.

Prior to 2007, some of the Group’s reinsurance treaties (primarily FPIC treaties) included provisions that establish minimum and maximum cessions and allow limited participation in the profit of the ceded business. Generally, the Group shares on a limited basis in the profitability through contingent ceding commissions. Exposure to the loss experience is contractually defined at minimum and maximum levels, and the terms of such contracts are fixed at inception. Since estimating the emergence of claims to the applicable reinsurance layers is subject to significant uncertainty, the net amounts that will ultimately be realized may vary significantly from the estimated amounts presented in the Group’s results of operations.

During the fourth quarter of 2008, the Group commuted all reinsurance agreements with St. Paul Fire and Marine Insurance Company. These reinsurance agreements included participation in the property quota share and casualty excess of loss treaties. As a result of the commutation the Group received a cash payment of $2.5 million, and recorded a pre-tax net gain on commutation of $0.9 million.

The effect of reinsurance on premiums written and earned and losses incurred is as follows:

	2009			2008			2007
Premiums written:
Direct	$	153,045		$	165,377		$	182,907
Assumed		801			1,058			1,383
Ceded		(16,016	)		(19,083	)		(24,623	)
Net premiums written	$	137,830		$	147,352		$	159,667

Premiums earned:
Direct	$	156,735		$	172,817		$	176,395
Assumed		918			1,233			1,801
Ceded		(17,240	)		(21,473	)		(31,521	)
Net premiums earned	$	140,413		$	152,577		$	146,675

Losses and loss expenses incurred:
Direct	$	96,590		$	110,150		$	107,141
Assumed		31			1,043			1,185
Ceded		(10,479	)		(15,974	)		(17,140	)
Net losses and loss expenses incurred	$	86,142		$	95,219		$	91,186

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The effect of reinsurance on unearned premiums as of December 31, 2009 and 2008 is as follows:

	2009		2008
Unearned Premiums:
Direct	$	76,358		80,048
Assumed		243		360
Gross	$	76,601		80,408

The effect of reinsurance on the liability for losses and loss adjustment expenses, and on losses and loss adjustment expenses incurred is as follows:

	2009		2008
Liability:
Direct	$	306,173		297,988
Assumed		5,175		6,012
Gross	$	311,348		304,000

The Group performs credit reviews of its reinsurers, focusing on financial stability. To the extent that a reinsurer may be unable to pay losses for which it is liable under the terms of a reinsurance agreement, the Group is exposed to the risk of continued liability for such losses.

(7)	RETIREMENT PLANS AND DEFERRED COMPENSATION PLAN

The Group maintains a 401(k) qualified retirement savings plan covering substantially all employees. Benefits are based on an employee’s annual compensation, with new employees participating after a six-month waiting period. The Group matches a percentage of each employee's pre-tax contribution and also contributes an amount equal to 2% of each employee’s annual compensation. Deferral amounts in excess of the qualified plan limitations, as well as Group contributions on such compensation, are funded into nonqualified plans benefiting affected individuals. The cost for these benefits was $628, $628 and $510 for 2009, 2008 and 2007, respectively. In addition, the Group generally makes a discretionary contribution each year, based on Group profitability, to both the qualified 401(k) plan, and, where applicable, to the nonqualified plans. The cost for this portion of the retirement plan was $0, $492 and $463 for 2009, 2008 and 2007, respectively.

The Group has an unfunded noncontributory defined benefit plan for its directors. The plan provides for monthly payments for life upon retirement, with a minimum payment period of ten years. The net periodic benefit cost for this plan amounted to $135, $118, and $166 for 2009, 2008, and 2007 respectively. Assumptions used in estimating the projected benefit obligation of the plan are the discount rate (5.65% in 2009 and 6.5% in 2008) and retirement age (65). Benefit payments for the plan were $43 in 2009, and $34 in 2008 and 2007. Costs accrued under this plan amounted to $1,433 and $1,315 at December 31, 2009 and 2008, respectively. In 2009, in order to conform with tax requirements, the plan paid out a settlement of a portion of the benefit, which amounted to $54.

The Group also maintains nonqualified deferred compensation plans for its directors and officers. Under the plans, participants may elect to defer receipt of all or a portion of their fees or salary or bonus amounts, but without any match by the Group. Amounts deferred by directors and officers, together with accumulated earnings, are distributed either as a lump sum or in installments over a period of not greater than ten years. Deferred compensation, including accumulated earnings, amounted to $1,764 and $1,505 at December 31, 2009 and 2008, respectively.

The Group has purchased Company-owned life insurance covering key individuals. The Group’s cost, net of increases in cash surrender value, for the Company-owned life insurance was $(113), $125 and $(208) for the years ended December 31, 2009, 2008 and 2007, respectively. The cash surrender value of the Company-owned life insurance totaled $1,804 and $1,557 at December 31, 2009 and 2008, respectively, and is included in other assets.

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On December 15, 2003, the Group established an Employee Stock Ownership Plan (ESOP) and issued 626,111 shares to the ESOP at a cost of $10 per share. The ESOP signed a promissory note in the amount of $6,261 to purchase the shares, which is due in 10 equal annual installments with interest at 4%. The shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid, and are allocated to participants based on compensation as provided for in the plan. During 2009, 2008 and 2007, 62,611 shares were allocated to employee participants. Compensation expense equal to the fair value of the shares allocated is recognized ratably over the period that the shares are committed to be allocated to the employees. In 2009, 2008 and 2007 the Group recognized compensation expense of $1,019, $1,014 and $1,175, respectively, related to the ESOP. As of December 31, 2009, the cost of the 187,833 shares issued to the ESOP but not yet allocated to its employee participants is classified within equity as unearned ESOP shares.

(8)	FEDERAL INCOME TAXES

The tax effect of temporary differences that give rise to the Group’s net deferred tax asset as of December 31 is as follows:

	2009		2008

Net loss reserve discounting	$	7,320		7,170
Net unearned premiums		4,831		5,013
Compensation and benefits		1,426		1,339
Market discount on investments		140		220
Contingent ceding commission payable		4,229		3,115
Impairment of investments		1,635		2,311
Other		753		885
Deferred tax assets		20,334		20,053
Deferred policy acquisition costs		6,418		6,866
Unrealized net gain on investments		6,390		1,353
Depreciation		1,746		1,043
Other		839		977
Deferred tax liabilities		15,393		10,239
Net deferred tax asset	$	4,941		9,814

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes it is more likely than not the Group will realize the benefits of the deferred tax assets at December 31, 2009 and 2008.

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Actual income tax expense differed from expected tax expense, computed by applying the United States federal corporate income tax rate of 34% to income before income taxes, as follows:

	2009			2008			2007

Expected tax expense	$	6,410			3,532			6,796
Tax-exempt interest		(1,484	)		(1,545	)		(1,392	)
Dividends received deduction		(57	)		(71	)		(65	)
Non-deductible ESOP expense		134			132			187
Non-deductible options expense		48			68			86
Graduated tax rate adjustment		-			-			190
Company-owned life insurance		(38	)		43			(71	)
Other		18			(3	)		23
Income tax expense	$	5,031			2,156			5,754

The components of the provision for income taxes are as follows:

	2009			2008			2007

Current	$	5,168			3,063			6,721
Deferred		(137	)		(907	)		(967	)
Income tax expense	$	5,031			2,156			5,754

On January 1, 2007, the Group adopted FIN 48. As a result of adoption, the Group recognized a previously unrecognized tax benefit of approximately $0.2 million relating to merger-related expenses for the FPIG acquisition that took place October 1, 2005. The application of FIN 48 for this unrecognized tax benefit resulted in a corresponding reduction to goodwill relating to the FPIG acquisition of $0.2 million. The adoption of FIN 48 did not result in any adjustments to beginning retained earnings, nor have a significant effect on operations, financial condition or liquidity. As of December 31, 2009, the Group has no unrecognized tax benefits. The Group’s policy is to account for interest and penalties as a component of other expenses. The Group files income tax returns in the federal jurisdiction and various states.

(9)	SEGMENT INFORMATION

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

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.

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Financial data by segment is as follows:

	2009			2008			2007
Revenues:
Net premiums earned:
Commercial lines	$	120,871		$	132,425		$	125,427
Personal lines		19,542			20,152			21,248
Total net premiums earned		140,413			152,577			146,675
Net investment income		14,198			13,936			13,053
Net realized investment (losses) gains		621			(7,072	)		24
Other		2,080			2,021			1,929
Total revenues	$	157,312		$	161,462		$	161,681
Income before income taxes:
Underwriting income (loss):
Commercial lines	$	4,332		$	4,246		$	5,964
Personal lines		(956	)		(1,423	)		234
Total underwriting income		3,376			2,823			6,198
Net investment income		14,198			13,936			13,053
Net realized investment (losses) gains		621			(7,072	)		24
Other		657			703			714
Income before income taxes	$	18,852		$	10,390		$	19,989

(10) STATUTORY FINANCIAL INFORMATION

A reconciliation of the Group’s statutory net income and surplus to the Group’s net income and stockholders’ equity, under U.S. generally accepted accounting principles, is as follows:

	2009			2008			2007
Net income:
Statutory net income	$	15,546			10,991			12,280
Deferred policy acquisition costs		(1,318	)		(335	)		3,820
Deferred federal income taxes		308			406			733
Dividends from affiliates		(408	)		(3,036	)		(2,002	)
Parent holding company loss		(1,398	)		(585	)		(1,226	)
Other		1,091			793			630
GAAP net income	$	13,821			8,234			14,235
Surplus:
Statutory surplus	$	145,732			125,964
Deferred policy acquisition costs		18,876			20,193
Deferred federal income taxes		(11,003	)		(1,477	)
Nonadmitted assets		10,390			10,354
Unrealized gain on fixed-income securities		16,829			3,012
Holding company		(27,467	)		(19,758	)
Other		6,851			(1,018	)
GAAP stockholders' equity	$	160,208			137,270

The Group’s insurance companies are required to file statutory financial statements with various state insurance regulatory authorities. Statutory financial statements are prepared in accordance with accounting principles and practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Furthermore, the NAIC adopted the Codification of Statutory Accounting Principles effective January 1, 2001. The codified

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principles are intended to provide a comprehensive basis of accounting recognized and adhered to in the absence of conflict with, or silence of, state statutes and regulations. The effects of such do not affect financial statements prepared under U.S. generally accepted accounting principles.

The NAIC has risk-based capital (RBC) requirements that require insurance companies to calculate and report information under a risk-based formula which measures statutory capital and surplus needs based on a regulatory definition of risk in a company’s mix of products and its balance sheet. All of the Group’s insurance subsidiaries have an RBC amount above the authorized control level RBC, as defined by the NAIC.

(11)	GOODWILL AND INTANGIBLE ASSETS

Intangible assets consist of the following and are carried in Other Assets:

	2009			2008

Intangible assets subject to amortization	$	484			484
Less accumulated amortization		(309	)		(195	)
Net intangible assets subject to amortization	$	175			289

Amortization expense for intangible assets subject to amortization was $114, $73, and $54, in 2009, 2008 and 2007, respectively. Estimated amortization expense for 2010 and future years is as follows:

2010		$	47
2011			47
2012			47
2013			34
	Total amortization	$	175

The Group carries goodwill on its balance sheet in connection with the acquisitions of FHC and FPIG. There was no change in the carrying amount of goodwill for these acquisitions for the years ended December 31, 2009 and 2008, with $5,416 carried as of each of those dates.

Goodwill was reduced by $209 as a result of the adoption of FIN 48 as of January 1, 2007.

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(12)

EARNINGS PER SHARE

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

	Year Ended December 31
	2009		2008		2007
Numerator for basic and diluted earnings per share:
Net income	$	13,821	$	8,234	$	14,235
Denominator for basic earnings per share:
weighted average shares outstanding		6,212		6,217		6,144
Effect of stock incentive plans		133		127		181
Denominator for diluted earnings per share:
weighted average shares outstanding		6,345		6,344		6,325
Basic earnings per share	$	2.23	$	1.32	$	2.32
Diluted earnings per share	$	2.18	$	1.30	$	2.25

The denominator for diluted earnings per share does not include the effect of outstanding stock options that have an anti-dilutive effect. For the years ended December 31, 2009, 2008 and 2007, 40,000, 115,000 and 40,000 stock options, respectively, were considered to be anti-dilutive and were excluded from the earnings per share calculation.

(13)	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 December 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 exercise price may not be less than fair market value on the date of grant. All 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. During 2009 and 2008, the Group made no grants of restricted stock, incentive stock options and non-qualified stock options. There were 2,500 stock options and 1,000 shares of restricted stock forfeited in 2008, and in 2009 10,000 incentive stock options expired unexercised.

In determining the charge to the consolidated statement of earnings for 2009, 2008 and 2007, 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.

100

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Information regarding 2009 stock option activity in the Plan is presented below:

	Number of Shares			Weighted Average Exercise Price per Share
Outstanding at December 31, 2008		600,700		$	13.24
Granted - 2009		-			-
Exercised - 2009		-			-
Forfeited - 2009		(10,000	)		12.21
Outstanding at December 31, 2009		590,700		$	13.26
Exercisable at:
December 31, 2009		569,700		$	13.13
Weighted-average remaining contractual life				4.5 years
Compensation remaining to be recognized for unvested stock options at December 31, 2009 (millions)				$	0.1
Weighted-average remaining amortization period				1.0 years
Aggregate Intrinsic Value of outstanding options, December 31, 2009 (millions)				$	3.2
Aggregate Intrinsic Value of exercisable options, December 31, 2009 (millions)				$	3.1

Information regarding unvested restricted stock activity in the Plan in 2009 is below:

	Number of Shares			Weighted Average Exercise Price per Share
Unvested restricted stock at December 31, 2008		22,792		$	15.26
Granted - 2009		0			-
Vested - 2009		(19,792	)		14.12
Forfeited - 2009		0			-
Unvested restricted stock at December 31, 2009		3,000		$	22.18
Compensation remaining to be recognized for unvested restricted stock at December 31, 2009 (millions)				$	0.1
Weighted-average remaining amortization period					1.0

Information regarding stock option activity in the Plan in 2008 is presented below:

	Number of Shares			Weighted Average Exercise Price per Share
Outstanding at December 31, 2007		603,200		$	13.24
Granted - 2008		-			-
Exercised - 2008		-			-
Forfeited - 2008		(2,500	)		12.21
Outstanding at December 31, 2008		600,700		$	13.24
Exercisable at:
December 31, 2008	545,867 shares			$	12.57
Weighted-average remaining contractual life				5.5 years
Compensation remaining to be recognized for unvested stock options at December 31, 2008 (millions)				$	0.3
Weighted-average remaining amortization period				1.4 years
Aggregate Intrinsic Value of outstanding options, December 31, 2008 (millions)				$	0.2
Aggregate Intrinsic Value of exercisable options, December 31, 2008 (millions)				$	0.2

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Information regarding unvested restricted stock activity in the Plan in 2008 is below:

	Number of Shares			Weighted Average Exercise Price per Share
Unvested restricted stock at December 31, 2007		44,584		$	14.66
Granted - 2008		-			-
Vested - 2008		(20,792	)		14.12
Forfeited - 2008		(1,000	)		12.21
Unvested restricted stock at December 31, 2008		22,792		$	15.26
Compensation remaining to be recognized for unvested restricted stock at December 31, 2008 (millions)				$	0.2
Weighted-average remaining amortization period				0.9 years

Information regarding stock option activity in the Plan in 2007 is presented below:

	Number of Shares			Weighted Average Exercise Price per Share
Outstanding at December 31, 2006		636,700		$	13.21
Granted - 2007		-			-
Exercised - 2007		(14,100	)		12.43
Forfeited - 2007		(19,400	)		12.85
Outstanding at December 31, 2007		603,200		$	13.24
Exercisable at:
December 31, 2007		509,533		$	12.57
Weighted-average remaining contractual life				6.6 years
Compensation remaining to be recognized for unvested stock options at December 31, 2007 (millions)				$	0.5
Weighted-average remaining amortization period				2.2 years
Aggregate Intrinsic Value of outstanding options, December 31, 2007 (millions)				$	3.2
Aggregate Intrinsic Value of exercisable options, December 31, 2007 (millions)				$	2.8

Information regarding unvested restricted stock activity in the Plan in 2007 is below:

	Number of Shares			Weighted Average Exercise Price per Share
Unvested restricted stock at December 31, 2006		106,334		$	13.61
Granted - 2007		-			-
Vested - 2007		(58,750	)		12.89
Forfeited - 2007		(3,000	)		12.21
Unvested restricted stock at December 31, 2006		44,584		$	14.66
Compensation remaining to be recognized for unvested restricted stock at December 31, 2007 (millions)				$	0.5
Weighted-average remaining amortization period				1.8 years

(14)	COMMITMENTS AND CONTINGENCIES

The Group becomes involved with certain claims and legal actions arising in the ordinary course of business operations. Such legal actions involve disputes by policyholders relating to claims payments as well as other litigation. In addition, the Group’s business practices are regularly subject to review by various state insurance regulatory authorities. These reviews may result in changes or clarifications of the Group’s business practices, and may result in fines, penalties or other sanctions. In the opinion of management, while the ultimate outcome of these actions and these regulatory proceedings cannot be determined at this time, they are not expected to result in liability for amounts material to the financial condition, results of operations, or liquidity, of the Group.

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As of December 31, 2009, the Group leased equipment and vehicles under various operating leases that have remaining non-cancelable lease terms in excess of one year. A summary of minimum future lease commitments as of December 31, 2009 follows:

		Minimum
		Requirements
Year ending December 31:
	2010	$	61
	2011		60
	2012		46
	2013		33
	2014		13
		$	213

Rental expenses of $414, $422, and $437 were incurred for the years ended December 31, 2009, 2008, and 2007, respectively.

In 2009, the Group constructed a new 41,000 square foot building for its office in Rocklin, California for a total cost of $5,110. This office space replaced 25,000 square feet the Group previously leased in Rocklin for its west coast operations.

The Group’s executives are parties to employment agreements with the Group which include customary provisions for severance and change of control.

(15)	RETALIATORY TAX REFUND

As previously disclosed in the Group’s SEC filings, the Group paid an aggregate of $3.5 million, including accrued interest, to the New Jersey Division of Taxation (the “Division”) in retaliatory premium tax for the years 1999-2004. In conjunction with making such payments, the Group filed notices of protest with the Division with respect to the retaliatory tax imposed. The payments were made in response to notices of deficiency issued by the Division to the Group.

Pursuant to the protests, the Group received $4.3 million in 2007 as a reimbursement of protested payments of retaliatory tax, including accrued interest, previously made by the Group for the periods 1999-2004. The refund has been recorded, after reduction for Federal income tax, in the amount of $2.8 million in the 2007 consolidated statement of earnings. The allocation of the refund to pre-tax earnings included an increase to net investment income of $720,000, for the interest received on the refund, and $3.6 million as a reduction to Other Expense to recognize the recovery of amounts previously charged to Other Expense.

(16)	RELATED-PARTY TRANSACTIONS

The Group produces a large percentage of its business through one insurance agent, Davis Insurance Agency (Davis), the owner of which is also a Board member of the Group. In 2009, 2008 and 2007, premiums written through Davis totaled 4%, 4% and 4%, respectively, of the Group’s direct written premiums. Commissions paid to Davis were $1,203, $1,115 and $1,177 in 2009, 2008 and 2007, respectively.

Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided equities investment management services to the Group since the year 1980. Fees to Van Rensselaer, Ltd. amounted to $79, $124 and $128 in 2009, 2008 and 2007, respectively.

Thomas, Thomas & Hafer of Harrisburg, PA is a law firm the Group uses for claims handling assistance. The brother of the Chief Executive Officer of the Group is a partner of the firm. Fees to Thomas,

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Thomas & Hafer amounted to $56, $77 and $60 in 2009, 2008 and 2007, respectively.

(17)	LINE OF CREDIT

As of December 31, 2009 and 2008, FPIG owed $3,000 under a $7,500 bank line of credit. The line of credit bears interest at the bank’s base rate or an optional rate based on LIBOR. The effective annual interest rate as of December 31, 2009 and 2008 was 3.25%. The line of credit includes covenants to maintain certain financial requirements including a minimum A.M. Best rating, minimum statutory surplus and a requirement that no more than 50% of allowable dividends be distributed from subsidiaries. The Company was in compliance with all covenants as of December 31, 2009 and 2008.

(18)	TRUST PREFERRED SECURITIES

The Group had the following Trust Preferred Securities outstanding as of December 31, 2009:
	Issue Date	Amount			Interest Rate	Maturity Date
Financial Pacific Statutory Trust I	12/4/2002	$	5,155		LIBOR + 4.00%	12/4/2032
Financial Pacific Statutory Trust II	5/15/2003		3,093		LIBOR + 4.10%	5/15/2033
Financial Pacific Statutory Trust III	9/30/2003		7,740		LIBOR + 4.05%	9/30/2033
Total Trust Preferred Securities			15,988
Less: Unamortized issuance costs			(396	)
Total		$	15,592

FPIG formed three statutory business trusts for the purpose of issuing Floating Rate Capital Securities (Trust preferred securities) and investing the proceeds thereof in Junior Subordinated Debentures of FPIG. FPIG holds $488 of common stock securities issued to capitalize the Trusts. Trust preferred securities totaling $15,500 were issued to the public.

Financial Pacific Statutory Trust I (Trust I) is a Connecticut statutory business trust. The Trust issued 5,000 shares of the Trust preferred securities at a price of $1 per share for $5,000. The Trust purchased $5,155 in Junior Subordinated Debentures from the Group that mature on December 4, 2032. The annual effective rate of interest at December 31, 2009 is 8.74%.

Financial Pacific Statutory Trust II (Trust II) is a Connecticut statutory business trust. The Trust issued 3,000 shares of the Trust preferred securities at a price of $1 per share for $3,000. The Trust purchased $3,093 in Junior Subordinated Debentures from the Group that mature on May 15, 2033. The annual effective rate of interest at December 31, 2009 is 8.9%.

Financial Pacific Statutory Trust III (Trust III) is a Delaware statutory business trust. The Trust issued 7,500 shares of the Trust preferred securities at a price of $1 per share for $7,500. The Trust purchased $7,740 in Junior Subordinated Debentures from the Group that mature on September 30, 2033. The annual effective rate of interest at December 31, 2009 is 8.89%.

The Group has the right, at any time, so long as there are no continuing events of default, to defer payments of interest on the Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters; but not beyond the stated maturity of the Junior Subordinated Debentures. To date no interest has been deferred. FPIG entered into three interest rate swap agreements to economically hedge the floating interest rate on the Junior Subordinated Debentures (note 19).

The Trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the Junior Subordinated Debentures at maturity or their earlier redemption. The Group has the right to redeem the Junior Subordinated Debentures after December 4, 2007 for Trust I, after May 15, 2008 for Trust II and after September 30, 2008 for Trust III. The Group has not exercised these rights as of December 31, 2009.

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(19)	INTEREST RATE SWAP AGREEMENT FOR VARIABLE-RATE DEBT

The Group had the following interest rate swaps outstanding as of December 31, 2009:

	Effective Date	Notional Amount		Counterparty Pays	Counterparty Receives	Maturity Date
Union Bank of California (Trust I)	12/4/2007	$	5,000	3 Month LIBOR	4.7400% fixed	12/4/2012
Union Bank of California (Trust II)	5/15/2008	$	3,000	3 Month LIBOR	4.8000% fixed	5/15/2013
Union Bank of California (Trust III)	9/30/2008	$	7,500	3 Month LIBOR	4.8400% fixed	9/30/2013

The Group has interest-rate related hedging instruments to manage its exposure on its debt instruments. The type of hedging instruments utilized by the Group are interest rate swap agreements (swaps). Interest differentials to be paid or received because of swap agreements are reflected as interest expense in the consolidated statement of earnings, and changes in the fair value of the swap over the swap period and are recorded as realized gains or losses. By using hedging financial instruments to hedge exposures to changes in interest rates, the Group exposes itself to market risk. The estimated fair value of the interest rate swaps is based on the valuation received from the financial institution counterparty.

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 potential 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.

The Group is party to interest rate swap agreements to hedge the floating interest rate on the Junior Subordinated Debentures purchased by Trust I, Trust II and Trust III. The variable-rate debt obligations expose the Group to variability in interest payments due to changes in interest rates. Management believes it is prudent to limit the variability of its interest payments. To meet this objective, management enters into swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These swaps change the variable-rate cash flow exposure on the debt obligations to fixed-rate cash flows. Under the terms of the interest rate swaps, the Group makes fixed interest rate payments and receives variable interest rate payments, thereby creating the equivalent of fixed-rate debt.

As of December 31, 2009 and 2008 the Group was party to interest-rate swap agreements with an aggregate notional principal amount of $15,500. For the year ended December 31, 2009 and 2008, the Group recognized the change in the estimated fair value of the interest rate swap agreements which is recognized in the consolidated statement of earnings as a realized gain or (loss) of $519 and ($1,500), respectively. The estimated fair value of the interest-rate swap was a liability of $1,360 and $1,879 as of December 31, 2009 and 2008, respectively.

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

	December 31, 2009				December 31, 2008
	Balance Sheet Location	Fair Value liability			Balance Sheet Location	Fair Value liability
Interest rate swaps:

Union Bank of California (Trust I)	Other liabilities	$	(417	)	Other liabilities	$	(546	)
Union Bank of California (Trust II)	Other liabilities		(274	)	Other liabilities		(366	)
Union Bank of California (Trust III)	Other liabilities		(669	)	Other liabilities		(967	)

Total derivatives		$	(1,360	)		$	(1,879	)

A summary of the effect of derivative instruments on the consolidated statements of earnings for the years ended December 31, 2009, 2008, and 2007:

December 31,

2009

December 31,

2008

December 31,

2007

Amount

Location

of Gain

Location

of (Loss)

Location

of (Loss)

of Gain

Recognized

of (loss)

Recognized

of (loss)

Recognized

in Income

Interest rate swaps:

Net realized

Union Bank of California

investment

(Trust I)

gains

129

losses

(421

)

gains

(227

)

Net realized

Union Bank of California

investment

(Trust II)

gains

losses

(274

)

gains

(86

)

Net realized

Union Bank of California

investment

(Trust III)

gains

298

losses

(805

)

gains

(461

)

Total derivatives

519

(1,500

)

(774

)

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(20)	FAIR VALUE OF ASSETS AND LIABILITIES

The Group’s financial 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 discusses the proper classification of such investments with industry contacts and others. 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 their 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

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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 consist of three holdings totaling $1.4 million, or less than 0.44% of the Group’s total investment portfolio. These three securities were valued primarily through the use of non-binding broker quotes.

Equities that trade on a major exchange are assigned a Level 1. Equities not traded on a major exchange are assigned a Level 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 treasuries 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 tables below present the balances of assets and liabilities measured at fair value on a recurring basis at December 31, 2009 and 2008.

	December 31, 2009
(in thousands)	Total		Level 1		Level 2		Level 3

Fixed-income securities, available for sale	$	365,464	$	5,596	$	358,520	$	1,348
Equity securities		9,484		9,417		-		67
Total assets	$	374,948	$	15,013	$	358,520	$	1,415

Other liabilities	$	1,360	$	-	$	1,360	$	-
Total liabilities	$	1,360	$	-	$	1,360	$	-

	December 31, 2008
(in thousands)	Total		Level 1		Level 2		Level 3

Fixed-income securities, available for sale	$	334,087	$	4,362	$	327,958	$	1,767
Equity securities		10,203		9,941		216		46
Total assets	$	344,290	$	14,303	$	328,174	$	1,813

Other liabilities	$	1,879	$	-	$	1,879	$	-
Total liabilities	$	1,879	$	-	$	1,879	$	-

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The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows at December 31, 2009 and 2008:

	For the Year Ended
	December 31, 2009
(in thousands)	Fixed-income securities, available for sale			Equity securities

Balance, beginning of year	$	1,767		$	46
Total net (losses) gains included in net income		-			-
Total net gains (losses) included in other comprehensive income		53			21
Purchases, sales, issuances and settlements, net		-			-
Transfers out of level 3		(472	)		-
Balance, end of year	$	1,348		$	67

	For the Year Ended
	December 31, 2008
(in thousands)	Fixed-income securities, available for sale			Equity securities

Balance, beginning of year	$	2,399		$	823
Total net (losses) gains included in net income		(557	)		657
Total net gains (losses) included in other comprehensive income		9			(682	)
Purchases, sales, issuances and settlements, net		921			(752	)
Transfers out of level 3		(1,005	)		0
Balance, end of year	$	1,767		$	46

For the year ended December 31, 2009, there were no assets or liabilities measured at fair value on a nonrecurring basis.

(21)	FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Group accepts various forms of collateral for issuance of its surety bonds including cash, irrevocable letters of credit and certificates of deposit. The Group’s policy is to record in the accompanying consolidated financial statements only those funds received as cash deposits. The off-balance sheet collateral held by the Group consists solely of irrevocable letters of credit totaling $138 and $278 as of December 31, 2009 and 2008, respectively.

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(22)	QUARTERLY FINANCIAL DATA (unaudited)

The Group’s unaudited quarterly financial information is as follows:

	First Quarter						Second Quarter					Third Quarter					Fourth Quarter
	2009			2008			2009		2008			2009		2008			2009			2008
	(Unaudited, in thousands, except per share data)
Net premiums written	$	31,856		$	34,539		$	40,326	$	43,749		$	33,355	$	37,575		$	32,293		$	31,489
Net premiums earned		35,582			39,077			34,952		38,644			34,681		37,869			35,198			36,987
Net investment income earned		3,603			3,361			3,625		3,343			3,605		3,469			3,365			3,763
Net realized gains (losses)		(481	)		(820	)		402		157			472		(2,281	)		228			(4,128	)
Net income		2,891			2,592			3,750		3,233			3,554		1,780			3,626			629
Other comprehensive income (loss)		1,945			546			2,928		(3,561	)		7,007		(3,954	)		(2,154	)		4,567
Comprehensive income (loss)	$	4,836		$	3,138		$	6,678	$	(328	)	$	10,561	$	(2,174	)	$	1,472		$	5,196
Net income per share
Basic	$	0.47		$	0.42		$	0.61	$	0.52		$	0.57	$	0.28		$	0.58		$	0.10
Diluted	$	0.46		$	0.41		$	0.60	$	0.51		$	0.56	$	0.28		$	0.56		$	0.10

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. CONTROLS AND PROCEDURES.

(a)	Evaluation of Disclosure Controls and Procedures

Mercer Insurance Group, Inc’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Group’s disclosure controls and procedures as of December 31, 2009, and based on that evaluation they have concluded that these controls and procedures are effective as of that date.

(b)	Changes in Internal Control Over Financial Reporting

There have been no changes in the Group’s internal control over financial reporting during the fourth quarter of 2009 that have materially affected, or are reasonably likely to materially affect, the Group’s internal control over financial reporting.

(c)	Management’s Annual Report on Internal Control Over Financial Reporting

The management of Mercer Insurance Group, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting for the Group. With the participation of the Chief Executive Office r and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2009.

Mercer Insurance Group, Inc.’s Independent Registered Public Accounting Firm, KPMG LLP, has issued an audit report on the effectiveness of our internal control over financial reporting. This audit report appears below.


		Mercer Insurance Group, Inc.

March 16, 2010		By: /s/ Andrew R. Speaker
		Andrew R. Speaker President and Chief Executive Officer

March 16, 2010		By: /s/ David B. Merclean
		David B. Merclean Senior Vice President of Finance and Chief Financial Officer

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc.:

We have audited Mercer Insurance Group. Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) . Mercer Insurance Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing other such procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion Mercer Insurance Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009, and our report dated March 16, 2010, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2010

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ITEM 9B. OTHER INFORMATION.

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information required by Item 10 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2009.

ITEM 11. EXECUTIVE COMPENSATION.

The information required by Item 11 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2009.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The information required by Item 12 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2009.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

The information required by Item 13 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2009.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information required by Item 14 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2009.

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PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

(a) (1)	The following consolidated financial statements are filed as a part of this report in Item 8.

	Report of Independent Registered Public Accounting Firm
	Consolidated Financial Statements:
	Consolidated Balance Sheets as of December 31, 2009 and 2008
	Consolidated Statements of Earnings for Each of the Years in the Three-year Period Ended December 31, 2009
	Consolidated Statements of Stockholders’ Equity for Each of the Years in the Three-year Period Ended December 31, 2009
	Consolidated Statements of Cash Flows for Each of the Years in the Three-year Period Ended December 31, 2009
	Notes to Consolidated Financial Statements

(2)	The following consolidated financial statement schedules for the years 2009, 2008 and 2007 are submitted herewith:

	Financial Statement Schedules:

	Report of Independent Registered Public Accounting Firm
	Schedule I.	Summary of Investments – Other Than Investments in Related Parties
	Schedule II.	Condensed Financial Information of Parent Company
	Schedule III.	Supplementary Insurance Information
	Schedule IV.	Reinsurance
	Schedule V.	Allowance for Uncollectible Premiums and other Receivables
	Schedule VI.	Supplemental Information
	Schedule VI.	Supplemental Insurance Information Concerning Property and Casualty Subsidiaries

All other schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.

(3) Exhibits:

The exhibits required by Item 601 of Regulation SK are listed in the Exhibit Index. Documents not accompanying this report are incorporated by reference as indicated on the Exhibit Index.

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EXHIBIT INDEX

NUMBER		TITLE

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

4.1		Form of certificate evidencing shares of common stock of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

10.1		Mercer Insurance Group, Inc. Employee Stock Ownership Plan (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

10.2		Employment Agreement, dated as of April 1, 2004, among BICUS Services Corporation, Mercer Insurance Company and Andrew R. Speaker (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)

10.3		Employment Agreement, dated as of April 1, 2004, among BICUS Services Corporation, Mercer Insurance Company and Paul D. Ehrhardt (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)

10.4		Amended and Restated Employment Agreement, dated as of March 15, 2007, among BICUS Services Corporation, Mercer Insurance Group, Inc., Mercer Insurance Company and David B. Merclean (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2006.)

10.5		Employment Agreement, dated as of October 1, 2006, among BICUS Services Corporation, Mercer Insurance Group, Inc., Mercer Insurance Company and Paul R. Corkery (incorporated by reference herein to the Company’s Quarterly Report on Form 10-Q, SEC File No. 000-25425, for the quarter ended September 30, 2006.)

10.6		Amendment No. 1 to Employment Agreement, dated as of March 15, 2007, among BICUS Services Corporation, Mercer Insurance Group, Inc., Mercer Insurance Company and Paul R. Corkery (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2006.)

10.7		Mercer Mutual Insurance Company Executive Nonqualified ‘Excess‘ Plan dated June 1, 2002 (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

10.8		Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

10.9		Mercer Insurance Group, Inc. 2004 Stock Incentive Plan, as amended through January 18, 2006 (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2005.)

10.10		Mercer Insurance Group, Inc. 401(k) Mirror Plan (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2006.)

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10.11		Non-Discretionary Investment Advisory Agreement, dated September 1, 2004, between Mercer Insurance Group, Inc. and Van Rensselaer, Ltd., a registered investment advisor (filed herewith)

21.1		List of Subsidiaries (filed herewith)

23		Consent of independent registered public accounting firm (filed herewith.)

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)

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

Mercer Insurance Group, Inc.

By:	/s/ Andrew R. Speaker	March 16, 2010
Andrew R. Speaker
President and Chief Executive Officer and a Director

By:	/s/ David B. Merclean	March 16, 2010
David B. Merclean
Senior Vice President of Finance and Chief Financial Officer Principal Accounting Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.

By	/s/ Roland D. Boehm	March 16, 2010
Roland D. Boehm
Vice Chairman of the Board of Directors

By:	/s/ H. Thomas Davis	March 16, 2010
H. Thomas Davis
Director

By:	/s/ William V. R. Fogler	March 16, 2010
William V. R. Fogler
Director

By:	/s/ William C. Hart	March 16, 2010
William C. Hart
Director

By:	/s/ George T. Hornyak, Jr.	March 16, 2010
George T. Hornyak, Jr.
Chairman of the Board of Directors

By:	/s/ Samuel J. Malizia	March 16, 2010
Samuel J. Malizia
Director

By:	/s/ Richard U. Niedt	March 16, 2010
Richard U. Niedt
Director

By:	/s/ Andrew R. Speaker	March 16, 2010
Andrew R. Speaker
President and Chief Executive Officer and a Director

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc.

Under date of March 16, 2010, we reported on the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009, which are included in the annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules in the annual report on Form 10-K. These financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.

In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2010

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Mercer Insurance Group, Inc. and Subsidiaries

Schedule I - Summary of Investments - Other than

Investments in Related Parties as of December 31, 2009

Column A	Column B		Column C		Column D

			Market		Balance
Type of Investment	Cost		Value		Sheet
	(Dollars in thousands)
Fixed maturities:
Bonds:
United States Government and government agencies and authorities	$	68,864		72,021		72,021
States, municipalities and political subdivisions		136,706		143,293		143,293
All Other		143,065		150,150		150,150
Total fixed income securities		348,635		365,464		365,464
Equity securities:
Common stocks:
Banks, trust and insurance companies		418		468		468
Industrial, miscellaneous and all other		6,162		7,881		7,881
Preferred stocks:		936		1,135		1,135
Total equity securities		7,516		9,484		9,484

Total investments	$	356,151		374,948		374,948

See accompanying report of independent registered public accounting firm.

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MERCER INSURANCE GROUP, INC.

SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Balance Sheet

December 31, 2009 and 2008

	2009			2008
	(Dollars in thousands)
ASSETS
Investment in common stock of subsidiaries (equity method)	$	167,932		$	139,611
Investment in preferred stock of subsidiaries (equity method)		-			2,475
Cash and cash equivalents		72			1,644
Goodwill		-			1,797
Deferred tax asset		339			379
Other assets		638			512
Total assets	$	168,981		$	146,418

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses	$	1		$	1
Other liabilities		8,772			9,147
Total liabilities		8,773			9,148
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 6,883,498 shares and
6,801,095 shares		-			-
Additional paid-in capital		72,139			71,369
Accumulated other comprehensive income:
Unrealized gains in investments, net of deferred income taxes		12,220			2,494
Retained Earnings		86,101			74,138
Unearned ESOP shares		(1,878	)		(2,505	)
Treasury stock, 632,076 and 621,773 shares		(8,374	)		(8,226	)
Total stockholders' equity		160,208			137,270
Total liabilities and stockholders' equity	$	168,981		$	146,418

See accompanying report of independent registered public accounting firm.

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MERCER INSURANCE GROUP, INC.

SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statement of Earnings

For the Years ended December 31, 2009, 2008 and 2007

	2009			2008			2007
	(In thousands)
Revenue:
Investment income, net of expenses	$	13			40			81
Total revenue		13			40			81
Expenses:
Other expenses		1,049			1,269			1,840
Total expenses		1,049			1,269			1,840
Loss before tax benefit		(1,036	)		(1,229	)		(1,759	)
Income tax benefit		(210	)		(258	)		(374	)
Loss before equity in income of subsidiaries		(826	)		(971	)		(1,385	)
Equity in income of subsidiaries		14,647			9,205			15,620
Net income	$	13,821			8,234			14,235

See accompanying report of independent registered public accounting firm.

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MERCER INSURANCE GROUP, INC.

SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statements of Cash Flows

For the Years ended December 31, 2009, 2008 and 2007

	2009			2008			2007
	(Dollars in thousands)

Cash flows from operating activities:
Net income	$	13,821			8,234			14,235
Dividends from subsidiaries		2,640			2,275			1,500
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed income of subsidiaries		(14,647	)		(9,205	)		(15,620	)
ESOP share commitment		1,019			1,014			1,175
Amortization of restricted stock compensation		345			547			1,043
Deferred income tax		40			(42	)		(35	)
Other		(442	)		(54	)		(305	)
Net cash provided by operating activities		2,776			2,769			1,993
Cash flows from financing activities:
Tax benefit from stock compensation plans		33			40			153
Dividends to shareholders		(1,858	)		(1,709	)		(1,251	)
Capital contributions to subsidiaries		(2,375	)		-			-
Purchase of treasury stock		(148	)		(1,860	)		(45	)
Net cash used in financing activities		(4,348	)		(3,529	)		(1,143	)
Net increase (decrease) in cash and cash equivalents		(1,572	)		(760	)		850
Cash and cash equivalents at beginning of period		1,644			2,404			1,554
Cash and cash equivalents at end of period	$	72			1,644			2,404
Cash paid during the year for:
Interest	$	-			-			-
Income taxes		-			-			-

See accompanying report of independent registered public accounting firm.

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Mercer Insurance Group, Inc. and Subsidiaries

Schedule III - Supplementary Insurance Information

Column A	Column B		Column C		Column D		Column E		Column F

			Future Policy
	Deferred		Benefits,				Other Policy
	Policy		Losses, Claims,				Claims and		Net
	Acquisition		and Loss		Unearned		Benefits		Premium
Segment	costs		Expenses		Premiums		Payable		Earned
	(Dollars in thousands)
December 31, 2009
Commercial lines	$	16,100		301,846		65,509		-		120,871
Personal lines		2,776		9,502		11,092		-		19,542
Total	$	18,876		311,348		76,601		-		140,413

December 31, 2008
Commercial lines	$	17,321		293,612		69,180		-		132,425
Personal lines		2,872		10,388		11,228		-		20,152
Total	$	20,193		304,000		80,408		-		152,577

December 31, 2007
Commercial lines	$	17,679		263,571		76,489				125,427
Personal lines		2,849		10,828		11,535				21,248
Total	$	20,528		274,399		88,024		-		146,675

	Column G		Column H		Column I		Column J		Column K

			Benefits,
			Claims,
	Net		Losses and				Other
	Investment		Settlement		Amortization		Operating		Premiums
	Income		Expenses		of DPAC		Expenses		Written
	(Dollars in thousands)
December 31, 2009
Commercial lines				72,588		33,358		10,594		118,410
Personal lines				13,554		5,447		1,496		19,420
Total	$	14,198		86,142		38,805		12,090		137,830

December 31, 2008
Commercial lines				81,223		36,073		10,883		127,418
Personal lines				13,996		5,611		1,968		19,934
Total	$	13,936		95,219		41,684		12,851		147,352

December 31, 2007
Commercial lines				76,293		33,267		9,903		139,360
Personal lines				14,893		5,496		625		20,307
Total	$	13,053		91,186		38,763		10,528		159,667

See accompanying report of independent registered public accounting firm.

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Mercer Insurance Group, Inc. and Subsidiaries

For the years ended December 31, 2009, 2008 and 2007

Schedule IV- Reinsurance

Column A	Column B		Column C		Column D		Column E		Column F
					Assumed				Percentage
			Ceded to		from				of Amount
	Gross		Other		other		Net		Assumed
Premiums Earned	Amount		Companies		Companies		Amount		to Net
	(Dollars in thousands)

For the year ended December 31, 2009	$	156,735		17,240		918		140,413		0.7	%
For the year ended December 31, 2008	$	172,817		21,473		1,233		152,577		0.8	%
For the year ended December 31, 2007	$	176,395		31,521		1,801		146,675		1.2	%

See accompanying report of independent registered public accounting firm.

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Mercer Insurance Group, Inc. and Subsidiaries

For the years ended December 31, 2009, 2008 and 2007

Schedule V- Allowance for Uncollectible Premiums and Other Receivables

	2009			2008			2007
	(Dollars in thousands)

Balance, January 1	$	410		$	402		$	628
Additions		147			287			102
Deletions		(128	)		(279	)		(328	)
Balance, December 31	$	429		$	410		$	402

See accompanying report of independent registered public accounting firm.

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Mercer Insurance Group, Inc. and Subsidiaries

For the years ended December 31, 2009, 2008 and 2007

Schedule VI - Supplemental Information

Column A

Column B

Column C

Column D

Column E

Column F

Column G

Deferred

Reserve for

Discount

Policy

Losses and

if any

Net

Acquisition

Loss Adj.

Deducted in

Unearned

Earned

Investment

Affiliation with Registrant

Costs

Expenses

Column C

Premiums

Income

(Dollars in thousands)

Year ended December 31, 2009

18,876

311,348

76,601

140,413

14,198

Year ended December 31, 2008

20,193

304,000

80,408

152,577

13,936

Year ended December 31, 2007

20,528

274,399

88,024

146,675

13,053

	Column H				Column I		Column J		Column K

	Losses and LAE						Paid
	Incurred						Losses and		Net
	Current		Prior		Amortization		Adjustment		Written
	Year		Year		of DPAC		Expenses		Premiums
	(Dollars in thousands)

Year ended December 31, 2009	$	86,046		96		38,805		73,080		137,830
Year ended December 31, 2008	$	89,088		6,131		41,684		69,274		147,352
Year ended December 31, 2007	$	83,015		8,171		38,763		63,691		159,667