SUAI Specialty Underwriters Allianc (MM)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended September 30, 2008

Or

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

For the transition period from                      to                     

Commission File Number: 000-50891

SPECIALTY UNDERWRITERS’ ALLIANCE, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		20-0432760
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification Number)

222 South Riverside Plaza, Chicago, Illinois		60606
(Address of Principal Executive Offices)		(Zip Code)

(888) 782-4672

(Registrant’s Telephone Number, Including Area Code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o No þ

     As of November 1, 2008, there were 14,437,355 shares of our common stock, $0.01 par value, or the Common Stock, outstanding and 1,151,320 shares of our Class B common stock, $0.01 par value, or the Class B Shares, outstanding.

 

 

SPECIALTY UNDERWRITERS’ ALLIANCE, INC.

TABLE OF CONTENTS

				Page
PART I — FINANCIAL INFORMATION
Item 1.		Financial Statements		3
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		17
Item 4.		Controls and Procedures		18
PART II — OTHER INFORMATION
Item 1.		Legal Proceedings		19
Item 1A.		Risk Factors		19
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		19
Item 3.		Defaults Upon Senior Securities		19
Item 4.		Submission of Matters to a Vote of Security Holders		19
Item 5.		Other Information		19
Item 6.		Exhibits		21
EX-31.1
EX-31.2
EX-32.1
EX-32.2

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

PART I — FINANCIAL INFORMATION

Item 1. Business

Specialty Underwriters’ Alliance, Inc.
Consolidated Balance Sheets
As of September 30, 2008 and December 31, 2007
(in thousands)

		9/30/2008				12/31/2007
		(unaudited)
ASSETS
Fixed maturity investments, at fair value (amortized cost: $216,130 and $176,592)		$	208,155			$	177,735
Short-term investments, at amortized cost (which approximates fair value)			45,928				51,652
Total Investments			254,083				229,387
Cash			519				968
Insurance premiums receivable			60,078				68,887
Reinsurance recoverable on paid and unpaid loss and loss adjustment expenses			74,148				77,204
Prepaid reinsurance premiums			690				631
Investment income accrued			2,177				1,909
Equipment and capitalized software at cost (less accumulated depreciation of $13,858 and $8,927)			13,167				12,796
Intangible assets			10,745				10,745
Deferred acquisition costs			17,322				17,495
Deferred tax asset			3,396				—
Other assets			2,192				2,512
Total Assets		$	438,517			$	422,534
LIABILITIES & STOCKHOLDERS’ EQUITY
Liabilities
Loss and loss adjustment expense reserves		$	202,310			$	184,736
Unearned insurance premiums			83,447				86,741
Insured deposit funds			13,510				12,515
Accounts payable and other liabilities			6,989				7,405
Total Liabilities			306,256				291,397
Stockholders’ equity
Common stock at $.01 par value per share — authorized: 30,000,000 shares; issued: 14,712,355 shares and 14,697,355 shares; and outstanding: 14,437,355 shares and 14,697,355 shares			147				147
Class B common stock at $.01 par value per share — authorized: 2,000,000 shares; issued and outstanding: 1,094,339 shares and 869,738 shares			11				9
Paid-in capital — common stock			129,786				129,431
Paid-in capital — class B common stock			7,255				6,139
Accumulated earnings (deficit)			1,284				(5,732	)
Treasury stock			(1,347	)			—
Accumulated other comprehensive income (loss)			(4,875	)			1,143
Total Stockholders’ Equity			132,261				131,137
Total Liabilities & Stockholders’ Equity		$	438,517			$	422,534

The accompanying notes are an integral part of these consolidated financial statements.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Consolidated Statements of Operations and Comprehensive Income
For the Three and Nine Months Ended September 30, 2008 and 2007
(Unaudited — in thousands, except for earnings per share)

		Three Months Ended								Nine Months Ended
		9/30/2008				9/30/2007				9/30/2008				9/30/2007
Revenues
Earned insurance premiums		$	37,208			$	40,377			$	107,153			$	112,933
Net investment income			2,662				2,517				7,985				6,935
Net realized gains (losses)			(845	)			1				(807	)			28
Total revenue			39,025				42,895				114,331				119,896
Expenses
Loss and loss adjustment expenses			22,444				24,047				64,443				66,077
Acquisition expenses			8,531				9,683				24,501				27,583
Other operating expenses			6,234				5,741				17,573				16,656
Total expenses			37,209				39,471				106,517				110,316
Pretax income			1,816				3,424				7,814				9,580
Income tax expense			(515	)			(61	)			(798	)			(185	)
Net income			1,301				3,363				7,016				9,395
Net change in unrealized gains and losses for investments held, after tax			(3,785	)			2,121				(6,018	)			336
Comprehensive income (loss)		$	(2,484	)		$	5,484			$	998			$	9,731
Earnings per share available to common stockholders (in dollars)
Basic		$	0.08			$	0.22			$	0.45			$	0.61
Diluted		$	0.08			$	0.22			$	0.45			$	0.61
Weighted average shares outstanding
Basic			15,516				15,431				15,587				15,404
Diluted			15,567				15,431				15,743				15,404

The accompanying notes are an integral part of these consolidated financial statements.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Consolidated Statement of Stockholders’ Equity
As of September 30, 2008
(Unaudited — in thousands)

																										Accumulated
																										Other Comp-				Total
		Common				Paid-in				Common				Paid-in				Retained								rehensive				Stock-
		Stock				Capital				Stock				Capital				Earnings				Treasury				Income				holders’
		Class A				Class A				Class B				Class B				(Deficit)				Stock				(Loss)				Equity
Balance at Dec. 31, 2007		$	147			$	129,431			$	9			$	6,139			$	(5,732	)		$	—			$	1,143			$	131,137
Net income																			7,016												7,016
Net change in unrealized investment gains, net of tax																											(6,018	)			(6,018	)
Stock issuance							74				2				1,116																1,192
Treasury stock purchases																							(1,347	)							(1,347	)
Stock based compensation							281																								281
Balance at Sept. 30, 2008		$	147			$	129,786			$	11			$	7,255			$	1,284			$	(1,347	)		$	(4,875	)		$	132,261

The accompanying notes are an integral part of these consolidated financial statements.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2008 and 2007
(Unaudited — in thousands)

		Nine Months Ended
		9/30/2008				9/30/2007
Cash flows from operations
Net income		$	7,016			$	9,395
Charges (credits) to reconcile net income to cash flows from operations:
Change in deferred income tax			(309	)			(50	)
Net realized losses (gains)			807				(28	)
Amortization of bond premium (discount)			71				(6	)
Depreciation			4,931				3,416
Net change in:
Reinsurance recoverable on unpaid loss and loss adjustment expense reserves			3,056				4,812
Loss and loss adjustment expense reserves			17,574				27,776
Insurance premiums receivable			8,809				4,653
Unearned insurance premiums			(3,294	)			(4,190	)
Deferred acquisition costs			173				2,335
Prepaid reinsurance premiums			(59	)			3,400
Insured deposit funds			995				1,129
Other, net			4				2,786
Total adjustments			32,758				46,033
Net cash flows provided by operations			39,774				55,428
Cash flows from investing activities
Net (increase) decrease in short-term investments			5,724				(31,379	)
Redemptions, calls and maturities of fixed maturity investments			21,416				14,233
Purchases of fixed maturity investments			(61,832	)			(33,449	)
Purchase of equipment and capitalized software			(5,302	)			(6,818	)
Net cash flows used for investing activities			(39,994	)			(57,413	)
Cash flows from financing activities
Issuance of common stock			1,118				488
Treasury stock purchases			(1,347	)			—
Net cash provided by (used for) financing activities			(229	)			488
Net decrease in cash during the period			(449	)			(1,497	)
Cash at beginning of the period			968				2,375
Cash at the end of the period		$	519			$	878

The accompanying notes are an integral part of these consolidated financial statements.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Notes to Consolidated Financial Statements
(unaudited — in thousands, except earnings per share)

Note 1. Basis of Presentation

     The Consolidated Financial Statements (unaudited) include the accounts of Specialty Underwriters’ Alliance, Inc., and its consolidated subsidiary, SUA Insurance Company, together referred to as SUA or the Company. SUA completed an initial public offering, or IPO, of its common stock on November 23, 2004. Concurrent with the IPO, SUA completed the acquisition of Potomac Insurance Company of Illinois, or Potomac. Potomac has subsequently been renamed SUA Insurance Company.

     The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, or GAAP. Certain financial information that is normally included in annual financial statements, including certain financial statements footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in SUA’s Annual Report on Form 10-K for the year ended December 31, 2007 filed with the Securities and Exchange Commission, or SEC.

     The interim financial data as of September 30, 2008, and for the three and nine month periods ended September 30, 2008 and September 30, 2007 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the Company’s results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Certain reclassifications have been made to prior period financial statement line items to enhance the comparability of the results presented.

Note 2. Earnings Per Share

     Basic earnings per share are based on the weighted average number of common shares outstanding during the period, while diluted earnings per share includes the weighted average number of common shares and potential dilution from shares issuable pursuant to equity incentive compensation using the treasury stock method. The following table shows the computation of the Company’s earnings per share:

		Three Months Ended								Nine Months Ended
		9/30/08				9/30/07				9/30/08				9/30/07
Numerator for earnings per share
Net income		$	1,301			$	3,363			$	7,016			$	9,395
Denominator for earnings per share
Weighted average shares outstanding used in computation of earnings per share
Common stock (class A and B) issued			15,791				15,431				15,685				15,404
Common stock in treasury			275				—				98				—
Weighted average shares outstanding — basic			15,516				15,431				15,587				15,404
Effect of dilutive securities 1 Stock awards			51				—				156				—
Weighted average shares outstanding — diluted			15,567				15,431				15,743				15,404
Earnings per share
Basic		$	0.08			$	0.22			$	0.45			$	0.61
Diluted		$	0.08			$	0.22			$	0.45			$	0.61

Note 3. Income Taxes

     As of September 30, 2008 and December 31, 2007 the Company had tax basis net operating loss carry forwards of $0 and $2,135, respectively. The Company also accumulated start-up and organization expenditures through December 31, 2004 of $2,364 that are deductible over a 60 month period commencing on November 23, 2004. The

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Notes to Consolidated Financial Statements
(unaudited — in thousands, except earnings per share)

unamortized portions of these costs were $519 and $873 at September 30, 2008 and December 31, 2007, respectively.

     Beginning in first quarter of 2008, based on continuing profitability trends, the Company believes that it is more likely than not that the deferred income tax assets will be realized. As such, the Company elected to eliminate its valuation allowance and establish the full net deferred tax asset.

The components of current and deferred income taxes for the three months and nine months ended September 30, 2008 and 2007 are as follows:

		Three Months Ended								Nine Months Ended
		9/30/08				9/30/07				9/30/08				9/30/07
Current tax expense		$	517			$	85			$	1,107			$	235
Deferred tax (benefit)/expense			(2	)			(24	)			(309	)			(50	)
Total income tax expense		$	515			$	61			$	798			$	185

Note 4. Unpaid Loss and Loss Adjustment Expense Reserves

     Loss and loss adjustment expense (or LAE) reserves are estimates of amounts needed to pay claims and related expenses in the future for insured events that have already occurred. The Company establishes estimates of amounts recoverable from its reinsurers in a manner consistent with the claims liability covered by the reinsurance contracts, net of an allowance for uncollectible amounts. The Company’s loss and LAE reserves represent management’s best estimate of reserves based on a composite of the results of various actuarial methods, as well as consideration of known facts and trends.

     At September 30, 2008, the Company reported gross loss and LAE reserves of $202,310, of which $56,074 represented the gross direct loss and LAE reserves of Potomac, which is fully reinsured by OneBeacon Insurance Company, or OneBeacon. At December 31, 2007, the Company reported gross loss and LAE reserves of $184,736, of which $63,529 represented the gross direct loss and LAE reserves of Potomac, which are fully reinsured by OneBeacon. Included in the reserves for the Company are tabular reserve discounts for workers’ compensation and excess workers’ compensation pension claims of $2,130 as of September 30, 2008 and $1,505 as of December 31, 2007. The reserves are discounted on a tabular basis at four percent using the 2001 United States Actuarial Life Tables for Female and Male population.

     Potomac was a participant in the OneBeacon Amended and Restated Reinsurance Agreement. Under that agreement, Potomac ceded all of its insurance assets and liabilities into a pool, or Pool, and assumed a 0.5% share of the Pool’s assets and liabilities. On April 1, 2004, Potomac ceased its participation in the Pool and entered into reinsurance agreements whereby Potomac reinsured all of its business written with OneBeacon effective as of January 1, 2004. As a result, Potomac will not share in any favorable or unfavorable development of prior losses recorded by it or the Pool after January 1, 2004, unless OneBeacon fails to perform on its reinsurance obligation.

Note 5. Recent Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements regarding fair value measurement. Where applicable, SFAS No. 157 simplifies and codifies previously issued guidance on fair value. The Company’s adoption of FAS 157, effective January 1, 2008, results in additional financial statement disclosures and has no effect on the conduct of the Company’s business, its financial condition and results of operations.

     SFAS No. 157 establishes a fair value hierarchy which requires maximizing the use of observable inputs and minimizing the use of unobservable inputs when measuring fair value.

     As of September 30, 2008, assets measured at fair value on a recurring basis are summarized below:

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Notes to Consolidated Financial Statements
(unaudited — in thousands, except earnings per share)

						Fair Value Measurement Using:
						Quoted Prices in				Significant
						Active Markets				Other				Significant
						for Identical				Observable				Unobservable
		Fair Value at				Assets				Inputs				Inputs
Category		9/30/08				(Level 1)				(Level 2)				(Level 3)
U.S. Treasury		$	10,338			$	-			$	10,338			$	-
U.S. Government Agency			35,848								35,848
Municipal			49,948								49,948
Corporate Fixed Maturity			49,374								49,374
Agency Mortgage Backed			40,022								40,022
Non-Agency Mortgage Backed			6,411												6,411
Commercial Mortgage Backed			12,821												12,821
Asset-Backed			3,393												3,393
Total Fixed Maturity Investments		$	208,155			$	-			$	185,530			$	22,625

     The following table presents a reconciliation of the beginning and ending balances for all investments measured at fair value using Level 3 inputs during the three and nine months ended September 30, 2008:

		Three Months Ended				Nine Months Ended
		9/30/2008				9/30/2008
Level 3 investments as of beginning of period		$	7,171			$	-
Transfers into level 3 (at beginning period value)			18,410				29,332
Purchases, sales, issuances, and settlements (net)			(987)				(2,068)
Total gains or losses (realized/unrealized):
Included in earnings			(849)				(849)
Included in comprehensive income			(1,120)				(3,790)
Level 3 investments as of September 30, 2008		$	22,625			$	22,625

     The Company uses an independent pricing service to determine the fair value of substantially all of our investment assets. As of September 30, 2008, a total of eight securities with a total fair market value of $6,367 were not priced by our independent pricing service, of which five were Level 3 securities and three were Level 2 securities. The Company uses the following pricing methodology for each instrument in its portfolio.

	•		First, the Company requests a single non-binding price from our independent pricing service.
	•		Second, if no price is available from the pricing service for the instrument, the Company requests one or more non-binding broker—dealer quotes. A single quote is sought from a broker—dealer who has significant knowledge of the instrument being priced. If such broker-dealer is not available to quote, then an average is used from quotes solicited from multiple broker—dealers.
	•		Third, if a broker—dealer quote is unavailable for the instrument, the Company uses a matrix pricing formula based on various factors provided from multiple broker—dealers including yield spreads, reported trades, sector or grouping information and for certain securities, other factors such as timeliness of payment, default experience and prepayment speed assumptions.

     The Company then validates the price or quote received by examining its reasonableness. The Company’s review process includes (i) quantitative analysis (including yield spread and interest rate and price fluctuations on a monthly basis); (ii) initial and ongoing evaluation of methodologies used by outside parties to calculate fair value; and (iii) comparing the fair value estimates to its knowledge of the current market. If a price or a quote as provided is deemed unreasonable, which to date has not occurred, the Company will use the second or the third pricing methodology to determine the fair value of the instrument.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Specialty Underwriters’ Alliance, Inc.
Notes to Consolidated Financial Statements
(unaudited — in thousands, except earnings per share)

     In order to determine the proper SFAS 157 classification for each instrument, the Company obtains from its outside pricing sources the pricing procedures and inputs used to price the instrument. The Company analyzes this information taking into account asset type, rating and liquidity to determine what inputs are observable and unobservable and thereby determines the suggested SFAS 157 Level.

     The transfer into Level 3 during the third quarter of 2008 of securities with a fair value, as of June 30, 2008, of $18,410 was primarily the result of reduced liquidity, and therefore reduced price transparency, related to mortgage backed and asset backed securities.

     In October 2008, the FASB issued FASB Staff Position No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP FAS 157-3”). FSP FAS 157-3 clarifies the application of SFAS No. 157, Fair Value Measurements, in a market that is not active. The Company adopted FSP FAS 157-3 on issuance, applicable to the third quarter 2008 financial statements. The adoption of this standard did not have any impact on the Company’s financial statements.

Note 6. Investments

     The Company’s structured securities are subject to Emerging Issues Task Force  Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets and are monitored for significant adverse changes in cash flow projections. If there are adverse changes in cash flows, the amount of accretive yield is prospectively adjusted and an other-than-temporary impairment (“OTTI”) loss is recognized. For the three months ended September 30, 2008, there were OTTI losses of $0.8 million recorded for which the most recent evaluation showed an adverse change in cash flows.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

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

      This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws, which are intended to be covered by the safe harbors created thereby. Those statements include, but may not be limited to, the discussions of our operating and growth strategy. Investors are cautioned that all forward-looking statements involve risks and uncertainties including, without limitation, those set forth under the caption “Risk Factors” in Item 1A of this Quarterly Report on Form 10-Q and in the Business section of our Annual Report on Form 10-K for the year ended December 31, 2007. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could prove to be inaccurate, and therefore, there can be no assurance that the forward-looking statements included in this Quarterly Report on Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We undertake no obligation to publicly release any revisions to any forward-looking statements contained herein to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

Overview

     We were formed on April 3, 2003 for the purpose of offering products in the specialty commercial property and casualty insurance market by using an innovative business model. Specialty insurance typically serves niche groups of insureds that require highly specialized knowledge of a business class to achieve underwriting profits. This segment has traditionally been underserved by most standard commercial property and casualty insurers, due to the complex business knowledge and the investment required to achieve attractive underwriting profits. Competition in this segment is based primarily on client service, availability of insurance capacity, specialized policy forms, efficient claims handling and other value-based considerations, rather than just price.

     On November 23, 2004 we completed our IPO and concurrent private placements and completed the acquisition of Potomac. After giving effect to the acquisition, we changed the name of Potomac to SUA Insurance Company. On January 1, 2005 we commenced our insurance operations.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Three Months Ended September 30, 2008 as compared to the Three Months Ended September 30, 2007

RESULTS OF OPERATION

		Three Months Ended
		9/30/2008				9/30/2007				% Change
		(in millions, except for earnings per share)
Gross written premiums		$	44.2			$	33.5				31.9	%
Net written premiums			42.1				30.9				36.2	%
Earned premiums		$	37.2			$	40.4				-7.9	%
Net investment income			2.6				2.5				4.0	%
Net realized gains (losses)			(0.8	)			-				*
Total revenues			39.0				42.9				-9.1	%
Net loss and loss adjustment expense			22.4				24.1				-7.1	%
Acquisition expenses			8.5				9.7				-12.4	%
Other operating expenses			6.3				5.7				10.5	%
Total expenses			37.2				39.5				-5.8	%
Pre-tax income			1.8				3.4				-47.1	%
Federal income tax			(0.5	)			-				*
Net income		$	1.3			$	3.4				-61.8	%
Earnings per share available to common stockholders
Basic		$	0.08			$	0.22				-63.6	%
Diluted		$	0.08			$	0.22				-63.6	%
Weighted average shares outstanding
Basic			15.5				15.4				0.6	%
Diluted			15.6				15.4				1.3	%
Key operating ratios
Net loss and loss adjustment expense ratio			60.3%				59.6%				1.2%
Ratio of acquisition expense to earned premiums			22.9%				23.8%				-3.8%
Ratio of all other expenses to gross written premiums			14.1%				17.4%				-19.0%

     Net income for the quarter ended September 30, 2008 was $1.3 million, compared to net income of $3.4 million for the quarter ended September 30, 2007. Earnings per share for the quarter ended September 30, 2008 was $0.08, versus earnings per share of $0.22 for the quarter ended September 30, 2007. The decrease in our net income was due to a decrease in our pre-tax income and an increase in our taxes resulting from the full utilization of tax loss carry forwards which occurred in the second quarter of 2008. The decrease in our pre-tax income was primarily due to a decrease in our earned premiums resulting from reductions in our workers’ compensation rates and weak economic conditions. In addition there were other-than-temporary impairment write-downs of investment assets for a realized loss of $0.8 million.

     Gross written premiums were $44.2 million for the three months ended September 30, 2008 compared to $33.5 million for the three months ended September 30, 2007. The increase in gross written premiums was attributable to premiums written under our public entity business program offset by decreasing premiums in our other lines as a result of the continuing deterioration in economic conditions.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

     Our gross written premiums by partner agent for the three months ended September 30, 2008 and 2007 was as follows:

		9/30/2008								9/30/2007
						% of Total								% of Total
		Gross Written				Gross Written				Gross Written				Gross Written
		Premium				Premium				Premium				Premium
		(in millions)
Specialty Risk Solutions, LLC		$	16.1				36.5	%		$	1.8				5.4	%
Risk Transfer Holdings, Inc.			12.5				28.3	%			12.1				36.1	%
American Team Managers			6.2				14.0	%			7.1				21.2	%
AEON Insurance Group, Inc.			5.1				11.5	%			7.9				23.6	%
Appalachian Underwriters, Inc.			1.6				3.6	%			2.7				8.0	%
Northern Star Management, Inc.			1.6				3.6	%			—				0.0	%
First Light Program Manager, Inc.			0.6				1.4	%			—				0.0	%
Insential, Inc			0.3				0.7	%			0.5				1.5	%
Flying Eagle Insurance Service, Inc			0.1				0.2	%			1.2				3.6	%
Other			0.1				0.2	%			0.2				0.6	%
Total		$	44.2				100.0	%		$	33.5				100.0	%

     Our gross written premiums for the three months ended September 30, 2008 and 2007 by state was as follows:

		9/30/2008								9/30/2007
						% of Total								% of Total
		Gross Written				Gross Written				Gross Written				Gross Written
		Premium				Premium				Premium				Premium
		(in millions)
California		$	26.0				58.8	%		$	14.1				42.1	%
Texas			6.9				15.6	%			6.3				18.8	%
Florida			3.3				7.5	%			2.8				8.4	%
Other States			8.0				18.1	%			10.3				30.7	%
Total		$	44.2				100.0	%		$	33.5				100.0	%

     Our gross written premiums by line of business for the three months ended September 30, 2008 and 2007 was as follows:

		9/30/2008								9/30/2007
						% of Total								% of Total
		Gross Written				Gross Written				Gross Written				Gross Written
		Premium				Premium				Premium				Premium
		(in millions)
General liability		$	18.8				42.5	%		$	9.5				28.3	%
Workers’ compensation			15.7				35.5	%			14.3				42.7	%
Commercial automobile			9.0				20.4	%			8.5				25.4	%
All Other			0.7				1.6	%			1.2				3.6	%
Total		$	44.2				100.0	%		$	33.5				100.0	%

     The change in our mix of business by agent, state and line of business was influenced by a large account we wrote in the third quarter of 2008 in our public entity customer class which was partially offset by a continued reduction in our contractors business due to the downturn in the construction industry.

     Earned premiums were $37.2 million for the quarter ended September 30, 2008 compared to $40.4 million for the quarter ended September 30, 2007.

     Net investment income was $2.6 million for the three months ended September 30, 2008 versus $2.5 million for the three months ended September 30, 2007. While investments increased $39.1 million from $215.0 million to

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

$254.1 million at September 30, 2008, investment income increased only $0.1 million due to significantly decreased short-term yields and a shift into tax-exempt securities of $49.9 million.

     Acquisition expenses were $8.5 million for the three months ended September 30, 2008 compared to $9.7 million for the quarter ended September 30, 2007. The decrease in our acquisition expense is the result of a decrease in premiums.

     Other operating expenses were $6.3 million for the quarter ended September 30, 2008 compared to $5.7 million for the quarter ended September 30, 2007.

     For the third quarter of 2008, our net loss and loss adjustment expense ratio was 60.3%, compared to 59.6% for the comparable quarter in 2007. This increase was primarily driven by higher loss ratios in our workers’ compensation book of business due to lower rates. This was partially offset by favorable prior year loss development for the third quarter of 2008 of $0.4 million primarily attributable to improved loss development in our general liability line of business. For the three months ended September 30, 2007 we experienced favorable prior year loss development of $1.6 million primarily within our workers’ compensation and general liability lines of business.

Nine Months Ended September 30, 2008 as compared to the Nine Months Ended September 30, 2007

RESULTS OF OPERATION

		Nine Months Ended
		9/30/2008				9/30/2007				% Change
		(in millions, except for earnings per share)
Gross written premiums		$	110.0			$	117.1				-6.1	%
Net written premiums			103.8				108.7				-4.5	%
Earned premiums		$	107.2			$	112.9				-5.0	%
Net investment income			7.9				7.0				12.9	%
Net realized gains (losses)			(0.8	)			—				*
Total revenues			114.3				119.9				-4.7	%
Net loss and loss adjustment expense			64.4				66.1				-2.6	%
Acquisition expenses			24.5				27.6				-11.2	%
Other operating expenses			17.6				16.6				6.0	%
Total expenses			106.5				110.3				-3.4	%
Pre-tax income			7.8				9.6				-18.8	%
Federal income tax			(0.8	)			(0.2	)			*
Net income		$	7.0			$	9.4				-25.5	%
Earnings per share available to common stockholders
Basic		$	0.45			$	0.61				-26.2	%
Diluted		$	0.45			$	0.61				-26.2	%
Weighted average shares outstanding
Basic			15.6				15.4				1.3	%
Diluted			15.7				15.4				1.9	%
Key operating ratios
Net loss and loss adjustment expense ratio			60.1%				58.5%				2.7	%
Ratio of acquisition expense to earned premiums			22.9%				24.2%				-5.4	%
Ratio of all other expenses to gross written premiums			16.0%				14.4%				11.1	%

     Net income for the nine months ended September 30, 2008 was $7.0 million, compared to net income of $9.4 million for the nine months ended September 30, 2007. Earnings per share for the nine months ended September 30, 2008 was $0.45 versus earnings per share of $0.61 for the nine months ended September 30, 2007. The decrease in our net income was due to a decrease in our pre-tax income and an increase in our taxes resulting from the full

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

utilization of tax loss carry forwards which occurred in the second quarter of 2008. The decrease in our pre-tax income was primarily due to a decrease in our earned premiums offset by the increase in our investment income. The decrease in our earned premium was due to reductions in our workers’ compensation rates and weak economic conditions. In addition there were other-than-temporary impairment write-downs of investment assets for a realized loss of $0.8 million.

     Gross written premiums were $110.0 million for the nine months ended September 30, 2008 compared to $117.1 million for the comparable period ended September 30, 2007. The decrease in gross written premiums is attributable to decreasing premiums in most of our lines of business as a result of the continuing deterioration in economic conditions.

     Our gross written premiums by partner agent for the nine months ended September 30, 2008 and 2007 was as follows:

		9/30/2008								9/30/2007
						% of Total								% of Total
		Gross Written				Gross Written				Gross Written				Gross Written
		Premium				Premium				Premium				Premium
		(in millions)
Risk Transfer Holdings, Inc.		$	44.0				40.0	%		$	49.6				42.3	%
American Team Managers			18.9				17.2	%			27.3				23.3	%
Specialty Risk Solutions, LLC			17.0				15.4	%			3.0				2.6	%
AEON Insurance Group, Inc.			15.8				14.4	%			19.7				16.8	%
Appalachian Underwriters, Inc.			5.5				5.0	%			12.9				11.0	%
Northern Star Management, Inc.			3.6				3.3	%			-				0.0	%
First Light Program Manager, Inc.			2.0				1.8	%			-				0.0	%
Insential, Inc			1.0				0.9	%			1.3				1.1	%
Flying Eagle Insurance Service, Inc			0.6				0.5	%			2.3				2.0	%
Other			1.6				1.5	%			1.0				0.9	%
Total		$	110.0				100.0	%		$	117.1				100.0	%

     Our gross written premiums for the nine months ended September 30, 2008 and 2007 by state was as follows:

		9/30/2008								9/30/2007
						% of Total								% of Total
		Gross Written				Gross Written				Gross Written				Gross Written
		Premium				Premium				Premium				Premium
		(in millions)
California		$	51.7				47.0	%		$	42.8				36.6	%
Florida			15.7				14.3	%			25.3				21.6	%
Texas			13.1				11.9	%			12.1				10.3	%
Other States			29.5				26.8	%			36.9				31.5	%
Total		$	110.0				100.0	%		$	117.1				100.0	%

     Our gross written premiums by line of business for the nine months ended September 30, 2008 and 2007 was as follows:

		9/30/2008								9/30/2007
						% of Total								% of Total
		Gross Written				Gross Written				Gross Written				Gross Written
		Premium				Premium				Premium				Premium
		(in millions)
Workers’ compensation		$	53.9				49.0	%		$	60.2				51.4	%
Commercial automobile			27.0				24.5	%			25.8				22.0	%
General liability			26.9				24.5	%			28.1				24.0	%
All Other			2.2				2.0	%			3.0				2.6	%
Total		$	110.0				100.0	%		$	117.1				100.0	%

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

     The change in our mix of business by agent, state and line of business was influenced by a large account we wrote in the third quarter of 2008 in our public entity customer class which was partially offset by a continued reduction in our contractors program as a result of fewer construction projects being started. Our workers’ compensation business has been impacted by rate decreases in Florida and California during 2007 and the first quarter of 2008 as well as decreases in payrolls.

     Earned premiums were $107.2 million for the nine months ended September 30, 2008 compared to $112.9 million for the nine months ended September 30, 2007.

     Net investment income was $7.9 million for the nine months ended September 30, 2008 versus $7.0 million for the nine months ended September 30, 2007. The increase in net investment income reflects growth in our total investments from $215.0 million at September 30, 2007 to $254.1 million at September 30, 2008 resulting from positive operating cash flows.

     Acquisition expenses were $24.5 million for the nine months ended September 30, 2008 compared to $27.6 for the nine months ended September 30, 2007. The decrease in our acquisition expense is the result of a decrease in premiums.

     Other operating expenses were $17.6 million for the nine months ended September 30, 2008 compared to $16.6 million for the nine months ended September 30, 2007.

     For the first nine months of 2008, our net loss and loss adjustment expense ratio was 60.1%, compared to 58.5% for the comparable nine months in 2007. This increase was primarily driven by higher loss ratios in our workers’ compensation book of business due to lower rates. This was partially offset by favorable prior year loss development for the nine months ended September 30, 2008 of $1.7 primarily attributable to improved loss development in our commercial automobile and general liability lines of business. For the nine months ended September 30, 2007 we experienced favorable prior year loss development of $2.1 million primarily within our workers’ compensation and general liability lines of business.

Liquidity and Capital Resources

     Specialty Underwriters’ Alliance, Inc. is organized as a holding company and, as such, has no direct operations of its own. Its assets consist primarily of investments in its subsidiary, through which it conducts substantially all of its insurance operations.

     As a holding company, Specialty Underwriters’ Alliance, Inc. has continuing funding needs for general corporate expenses, the payment of principal and interest on future borrowings, if any, taxes and the payment of other obligations. Funds to meet these obligations come primarily from dividends and other statutorily permissible payments from our operating subsidiary. The ability of our operating subsidiary to make payments to us is limited by the applicable laws and regulations of Illinois. There are restrictions on the payment of dividends to us by our insurance subsidiary.

Cash Flows

     A summary of our cash flows is as follows:

		Nine Months Ended
		9/30/2008				9/30/2007
		(in millions)
Cash provided by (used in)
Operating activities		$	39.8			$	55.4
Investing activities			(40.0	)			(57.4	)
Financing activities			(0.2	)			0.5
Change in cash			(0.4	)			(1.5	)

     For the nine months ended September 30, 2008, net cash from operating activities was $39.8 million, principally consisting of premium and deposit collections exceeding losses and expenses paid out. This amount compares to net cash from operating activities of $55.4 million for the nine months ended September 30, 2007. The decrease in net cash provided by operating activities was primarily driven by the increase in loss and LAE payments resulting from the maturation of our book of business.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

     Cash used for investment activities was $40.0 million for the nine months ended September 30, 2008, principally representing purchases of investments and additions to equipment and capitalized software. For the nine months ended September 30, 2007, cash used in investment activities was $57.4 million, also principally representing increases in investments and additions to equipment and capitalized software.

     For the nine months ended September 30, 2008, cash used for financing activities was $0.2 million as a result of the share repurchase program completed in the second quarter of 2008 which was offset by the sales of Class B Shares to partner agents. For the nine months ended September 30, 2007, cash flows from financing activities from sales of Class B Shares to partner agents was $0.5 million.

Fixed Maturity Investments

     Our investment portfolio consists of marketable fixed maturity and short-term investments. All fixed maturity investments are classified as available for sale and are reported at their estimated fair value. Realized gains and losses are credited or charged to income in the period in which they are realized. Changes in unrealized gains or losses are reported as a separate component of comprehensive income, and accumulated unrealized gains or losses are reported as a separate component of accumulated other comprehensive income in stockholders’ equity.

     The aggregate fair market value of our fixed maturity investments at September 30, 2008 was $254.1 million compared to amortized cost of $262.1 million. The aggregate fair market value of our fixed maturity investments at December 31, 2007 was $229.4 million compared to amortized cost of $228.2 million. During the first nine months of 2008 we increased our investment in municipal bonds to $49.9 million from $4.3 million, at fair value, due to their favorable tax treatment.

     For each security for which the fair value as determined is considered impaired, we considered our intent and ability to hold such security for a sufficient time to allow for a recovery in value. We have concluded that certain of our available-for-sale securities with a fair value of $0.9 million and a book value of $1.7 million at September 30, 2008 have experienced an other-than-temporary impairment of $0.8 million.

Item 3: Quantitative and Qualitative Disclosures About Market Risk

     Market risk can be described as the risk of change in fair value of a financial instrument due to changes in interest rates, creditworthiness, foreign exchange rates or other factors. We seek to mitigate that risk by a number of actions, as described below.

Interest Rate Risk

     Our exposure to market risk for changes in interest rates is concentrated in our investment portfolio. We monitor this exposure through periodic reviews of our consolidated asset and liability positions. We model and periodically review estimates of cash flows, as well as the impact of interest rate fluctuations relating to the investment portfolio and insurance reserves.

     The table below illustrates the sensitivity of the fair value of our fixed maturity investments, including our short-term investments, to selected hypothetical changes in the market interest rates:

										Estimated Fair
						Assumed Change				Value After				Increase
		Fair Value at				in Relevant				Change in				(Decrease) in
		9/30/2008				Interest Rate				Interest Rate				Fair Value
		(in thousands)
Total Investments		$	254,083			100 bp decrease				$	262,677			$	8,594
						50 bp decrease					258,397				4,314
						50 bp increase					249,763				(4,320	)
						100 bp increase					245,471				(8,612	)

     The average duration of our fixed maturity investments at September 30, 2008 was approximately 3.5 years.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Credit Risk

     Our portfolio includes primarily fixed income securities and short-term investments, which are subject to credit risk. This risk is defined as default or the potential loss in market value resulting from adverse changes in the borrower’s ability to repay the debt. In our risk management strategy and investment policy, we earn competitive relative returns while investing in a diversified portfolio of securities of high credit quality issuers to limit the amount of credit exposure to any one issuer.

     The portfolio of fixed maturities consists solely of high quality bonds at September 30, 2008. The following table summarizes bond ratings at fair value:

		As of 9/30/2008
						Percent of
Bond Ratings		Amount				Portfolio
		(in thousands)
AAA rated and U.S. Government and affiliated agency securities		$	114,223				54.8	%
AA rated			42,270				20.3	%
A rated			46,126				22.2	%
BBB rated			5,536				2.7	%
Total		$	208,155				100.0	%

     We also have other receivable amounts subject to credit risk, including reinsurance recoverables from OneBeacon Insurance Company. To mitigate the risk of counterparties’ nonpayment of amounts due under these arrangements, we established business and financial standards for reinsurer approval, incorporating ratings by major rating agencies and considering then-current market information.

Item 4: Controls and Procedures

      Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures. Disclosure controls and procedures are our controls and procedures that are designed to ensure that information required to be disclosed by us in our reports that we file or submit under the Securities Exchange Act of 1934, or the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

     As required by SEC Rules 13a-15(b) and 15d-15(b), we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. This evaluation was carried out under the supervision and with the participation of our management, including our principal executive officer and principal financial officer. Based on this evaluation, these officers have concluded that the design and operation of our disclosure controls and procedures are effective.

      Changes in Internal Control Over Financial Reporting . There were no changes to our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, these internal controls.

      Inherent Limitations on Effectiveness of Controls. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure controls and procedures and internal control over financial reporting systems are met.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

PART II — OTHER INFORMATION

Item 1: Legal Proceedings

     None.

Item 1A: Risk Factors

      You should carefully consider the following risk. This risk could have a material adverse effect on our business, financial condition, results of operations or prospects and cause the value of our stock to decline. This risk is not exclusive and additional risks to which we are subject include, but are not limited to, the risks of our businesses described elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2007 and the factors mentioned in any forward-looking statements contained herein or therein.

Current difficult conditions in the global financial markets and the economy generally may materially adversely affect our business and results of operations.

      Our results of operations are materially affected by conditions in the global financial markets and the economy generally. The stress experienced by global financial markets that began in the second half of 2007 continued and substantially increased during the third quarter of 2008. The volatility and disruption in the global financial markets have reached unprecedented levels. The availability and cost of credit has been materially affected. These factors, combined with volatile oil prices, depressed home prices and increasing foreclosures, falling equity market values, declining business and consumer confidence and the risks of increased inflation and unemployment, have precipitated an economic slowdown and fears of severe recession.

      The global fixed-income markets are experiencing a period of both extreme volatility and limited market liquidity conditions, which has affected a broad range of asset classes and sectors. As a result, the market for fixed income instruments has experienced decreased liquidity, increased price volatility, credit downgrade events and increased probability of default. These events and the continuing market upheavals have had, and may continue to have, an adverse effect on us. Our revenues could decline in such circumstances, the cost of meeting our obligations to our customers may increase, and our profit margins could erode. In addition, in the event of a prolonged economic downturn, we could incur significant losses in our investment portfolio.

      The demand for our insurance products could be adversely affected in an economic downturn. Our policyholders may choose to defer or stop paying insurance premiums. We cannot predict whether or when such actions may occur, or what impact, if any, such actions could have on our business, results of operations, cash flows and financial condition.

Item 2: Recent Sales of Unregistered Securities

     There were no sales of unregistered securities that have not been previously reported on a Current Report on Form 8-K.

Item 3: Defaults Upon Senior Securities

     None.

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

     None.

Item 5: Other Information

     None.

Item 6: Exhibits

      Exhibits:

Exhibit
Number		Description
31.1		Certification of Courtney C. Smith, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Peter E. Jokiel, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Courtney C. Smith, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Peter E. Jokiel, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

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.

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

Exhibits Index:

Exhibit
Number		Description
31.1		Certification of Courtney C. Smith, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Peter E. Jokiel, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Courtney C. Smith, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Peter E. Jokiel, Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

2008 Third Quarter Form 10-Q
Specialty Underwriters’ Alliance, Inc.

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