Edgar Filing: MEADOWBROOK INSURANCE GROUP INC

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2013

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 1-14094

Meadowbrook Insurance Group, Inc.

(Exact name of Registrant as specified in its charter)

Michigan		38-2626206
(State of Incorporation)		(IRS Employer Identification No.)

26255 American Drive, Southfield, Michigan 48034

(Address, zip code of principal executive offices)

(248) 358-1100

(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 x No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer o Accelerated filer x Non-accelerated filer o Smaller Reporting Company o

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

The aggregate number of shares of the Registrant’s Common Stock, $.01 par value, outstanding on May 1, 2013, was 49,887,200.

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		Page

PART I – FINANCIAL INFORMATION

ITEM 1 –	FINANCIAL STATEMENTS
	Consolidated Statements of Income (unaudited)	2
	Consolidated Statements of Comprehensive Income (unaudited)	3
	Consolidated Balance Sheets (unaudited)	4
	Consolidated Statement of Shareholders’ Equity (unaudited)	5
	Consolidated Statements of Cash Flows (unaudited)	6
	Notes to Consolidated Financial Statements (unaudited)	7-27

ITEM 2 –	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	28-40

ITEM 3 –	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	41-42

ITEM 4 –	CONTROLS AND PROCEDURES	43


PART II – OTHER INFORMATION

ITEM 1 –	LEGAL PROCEEDINGS	44

ITEM 1A –	RISK FACTORS	44

ITEM 2 –	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	44

ITEM 3 –	DEFAULTS UPON SENIOR SECURITIES	44

ITEM 4 –	MINE SAFETY DISCLOSURES	44

ITEM 5 –	OTHER INFORMATION	44

ITEM 6 –	EXHIBITS	45-46

SIGNATURES		47

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PART 1 - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENTS OF INCOME

For the Three Months Ended March 31,

	2013			2012
	(Unaudited)
	(In thousands, except share data)
Revenues
Premiums earned
Gross	$	264,342		$	227,447
Ceded		(93,754	)		(34,632	)
Net earned premiums		170,588			192,815
Net commissions and fees		9,634			8,965
Net investment income		11,140			13,732
Realized gains (losses):
Total other-than-temporary impairments on securities		-			-
Portion of loss recognized in other comprehensive income		-			-
Net other-than-temporary impairments on securities recognized in earnings		-			-
Net realized gains excluding other-than-temporary impairments on securities		316			732
Net realized gains		316			732
Total revenues		191,678			216,244

Expenses
Losses and loss adjustment expenses		191,974			161,519
Reinsurance recoveries		(70,158	)		(28,772	)
Net losses and loss adjustment expenses		121,816			132,747
Policy acquisition and other underwriting expenses		50,605			63,113
General, selling and administrative expenses		6,023			6,339
General corporate expenses		1,516			1,373
Amortization expense		1,071			1,416
Interest expense		2,197			1,977
Total expenses		183,228			206,965
Income before taxes and equity earnings		8,450			9,279
Federal and state income tax expense		1,836			1,855
Equity earnings of affiliates, net of tax		438			688
Equity earnings (losses) of unconsolidated subsidiaries, net of tax		30			(8	)
Net income	$	7,082		$	8,104

Earnings Per Share
Basic	$	0.14		$	0.16
Diluted	$	0.14		$	0.16

Weighted average number of common shares
Basic		49,823,882			50,915,145
Diluted		49,845,023			50,921,465

Dividends paid per common share	$	0.02		$	0.05

The accompanying notes are an integral part of the Consolidated Financial Statements.

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MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

For the Three Months Ended March 31,

	2013			2012
	(Unaudited)
	(In thousands)
Net income	$	7,082		$	8,104
Other comprehensive loss, net of tax:
Unrealized losses on securities		(2,782	)		(417	)
Unrealized gains in affiliates and unconsolidated subsidiaries		12			149
Increase on non-credit other-than-temporary impairments on securities		-			258
Net deferred derivative gains - hedging activity		805			300
Less reclassification adjustment for investment gains included in net income		(187	)		(462	)
Other comprehensive losses, net of tax		(2,152	)		(172	)
Comprehensive income	$	4,930		$	7,932

The accompanying notes are an integral part of the Consolidated Financial Statements.

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MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED BALANCE SHEETS

	March 31,			December 31,
	2013			2012
	(Unaudited)
	(In thousands, except share data)
ASSETS
Investments
Debt securities available for sale, at fair value (amortized cost of $1,430,000 and $1,211,794)	$	1,496,953		$	1,286,807
Equity securities available for sale, at fair value (cost of $70,073 and $20,389)		75,690			22,661
Cash and cash equivalents		158,678			342,124
Accrued investment income		14,284			11,167
Premiums and agent balances receivable, net		214,146			208,743
Reinsurance recoverable on:
Paid losses		24,827			13,612
Unpaid losses		419,864			381,905
Prepaid reinsurance premiums		122,276			143,180
Deferred policy acquisition costs		51,967			45,417
Deferred income taxes, net		11,821			10,929
Goodwill		121,041			121,041
Other intangible assets		27,193			28,264
Other assets		118,965			97,424
Total assets	$	2,857,705		$	2,713,274

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Losses and loss adjustment expenses	$	1,487,905		$	1,455,980
Unearned premiums		442,741			439,418
Debt		164,110			78,500
Debentures		80,930			80,930
Accounts payable and accrued expenses		27,543			29,190
Funds held and reinsurance balances payable		49,687			49,622
Payable to insurance companies		2,342			5,641
Other liabilities		36,984			15,714
Total liabilities		2,292,242			2,154,995

Shareholders' Equity
Common stock, $0.01 par value; authorized 75,000,000 shares; 49,887,200 and 49,776,011 shares issued and outstanding		506			505
Additional paid-in capital		275,716			272,472
Retained earnings		243,435			237,351
Note receivable from officer		(730	)		(737	)
Accumulated other comprehensive income		46,536			48,688
Total shareholders' equity		565,463			558,279
Total liabilities and shareholders' equity	$	2,857,705		$	2,713,274

The accompanying notes are an integral part of the Consolidated Financial Statements.

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MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

	Common Stock		Additional Paid- In Capital		Retained Earnings			Note Receivable from Officer			Accumulated Other Comprehensive Income			Total Shareholders' Equity
	(Unaudited, In thousands)
Balances December 31, 2012	$	505	$	272,472	$	237,351		$	(737	)	$	48,688		$	558,279
Net income		-		-		7,082			-			-			7,082
Dividends declared		-		-		(998	)		-			-			(998	)
Change in unrealized gain or loss on available for sale securities, net of tax		-		-		-			-			(3,157	)		(3,157	)
Change in valuation allowance on deferred tax assets		-		-		-			-			188			188
Net deferred derivative gain - hedging activity		-		-		-			-			805			805
Stock award		1		107		-			-			-			108
Long term incentive plan; stock award for 2012 and 2013 plan years		-		114		-			-			-			114
Change in investment of affiliates, net of tax		-		-		-			-			(9	)		(9	)
Change in investment of unconsolidated subsidiaries		-		-		-			-			21			21
Stock warrant issuance		-		3,023		-			-			-			3,023
Note receivable from officer		-		-		-			7			-			7
Balances March 31, 2013	$	506	$	275,716	$	243,435		$	(730	)	$	46,536		$	565,463

The accompanying notes are an integral part of the Consolidated Financial Statements.

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MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31,

	2013			2012
	(Unaudited)
	(In thousands)
Cash Flows From Operating Activities
Net income	$	7,082		$	8,104
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of other intangible assets		1,071			1,416
Amortization of deferred debenture issuance costs		31			31
Depreciation of furniture, equipment, and building		1,189			1,400
Net amortization of discount and premiums on bonds		2,249			1,467
Accretion of issued debt/original issue discount		51			-
Amortization of capitalized convertible note fees		14			-
Gain on sale of investments		(288	)		(711	)
Gain on sale of fixed assets		(22	)		(21	)
Long-term incentive plan expense		114			53
Stock award		107			109
Equity earnings of affiliates, net of taxes		(438	)		(688	)
Equity (earnings) losses of unconsolidated subsidiaries, net of tax		(30	)		8
Deferred income tax expense (benefit)		424			(427	)
Changes in operating assets and liabilities:
(Increase) decrease in:
Premiums and agent balances receivable		(5,403	)		(15,445	)
Reinsurance recoverable on paid and unpaid losses		(49,174	)		(17,715	)
Prepaid reinsurance premiums		20,904			(4,349	)
Deferred policy acquisition costs		(6,550	)		(5,236	)
Other assets		(10,432	)		(2,661	)
Increase (decrease) in:
Losses and loss adjustment expenses		31,925			40,234
Unearned premiums		3,323			30,508
Payable to insurance companies		(3,299	)		(907	)
Funds held and reinsurance balances payable		65			1,644
Other liabilities		9,707			1,437
Total adjustments		(4,462	)		30,147
Net cash provided by operating activities		2,620			38,251
Cash Flows From Investing Activities
Purchase of debt securities available for sale		(239,603	)		(111,769	)
Proceeds from sales and maturities of debt securities available for sale		17,718			35,676
Purchase of equity securities available for sale		(54,351	)		-
Proceeds from sales of equity securities available for sale		4,934			275
Capital expenditures		(467	)		(483	)
Other investing activities		90			(2,608	)
Net cash used in investing activities		(271,679	)		(78,909	)
Cash Flows From Financing Activities
Proceeds from line of credit		-			5,000
Proceeds from FHLB advance		-			20,000
Payments on term loan		(1,500	)		(3,688	)
Proceeds from convertible senior notes		96,423			-
Payments for convertible senior notes hedge		(12,942	)		-
Proceeds from issuance of warrants		3,023			-
Book overdrafts		601			(247	)
Dividends paid on common stock (1)		-			-
Share repurchases		-			(5,002	)
Other financing activities		8			8
Net cash provided by financing activities		85,613			16,071
Net decrease in cash and cash equivalents		(183,446	)		(24,587	)
Cash and cash equivalents, beginning of period		342,124			101,757
Cash and cash equivalents, end of period	$	158,678		$	77,170
Supplemental Disclosure of Cash Flow Information:
Interest paid	$	1,808		$	1,831
Net income taxes paid (2)	$	(3,067	)	$	(421	)
Supplemental Disclosure of Non-Cash Investing and Financing Activities:
Stock-based employee compensation	$	107		$	109

(1)	Dividends of $998 and $2,532 were paid on April 4, 2013 and April 5, 2012, respectively.

(2)	Tax return refunds were received in first quarter of 2013 and 2012 for $3,067 and $475, respectively.

The accompanying notes are an integral part of the Consolidated Financial Statements.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – Summary of Significant Accounting Policies

Basis of Presentation and Management Representation

The consolidated financial statements include accounts, after elimination of intercompany accounts and transactions, of Meadowbrook Insurance Group, Inc. (the “Company” or “Meadowbrook”), its wholly owned subsidiary Star Insurance Company (“Star”), and Star’s wholly owned subsidiaries, Savers Property and Casualty Insurance Company (“Savers”), Williamsburg National Insurance Company (“Williamsburg”), and Ameritrust Insurance Corporation (“Ameritrust”). The consolidated financial statements also include Meadowbrook, Inc., Crest Financial Corporation, and their respective subsidiaries. In addition, the consolidated financial statements also include ProCentury Corporation (“ProCentury”) and its wholly owned subsidiaries. ProCentury’s wholly owned subsidiaries consist of Century Surety Company (“Century”) and its wholly owned subsidiary ProCentury Insurance Company (“PIC”). In addition, ProCentury Risk Partners Insurance Company, Ltd., is a wholly owned subsidiary of ProCentury. Star, Savers, Williamsburg, Ameritrust, Century, and PIC are collectively referred to as the Insurance Company Subsidiaries.

In the opinion of management, the consolidated financial statements reflect all normal recurring adjustments necessary to present a fair statement of the results for the interim period. Preparation of financial statements under generally accepted accounting principles (“GAAP”) requires management to make estimates. Actual results could differ from those estimates. The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the results expected for the full year. In addition, certain amounts in the 2012 financial statements have been reclassified to conform to the 2013 presentation as a result of adopting the new Accumulated Other Comprehensive guidance noted below.

These financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements and accompanying notes included in its Annual Report on Form 10-K, as filed with the United States Securities and Exchange Commission, for the fiscal year ended December 31, 2012.

Revenue Recognition

Premiums written, which include direct, assumed and ceded amounts are recognized as earned on a pro rata basis over the life of the policy term. Unearned premiums represent the portion of premiums written that are applicable to the unexpired terms of policies in force. Provisions for unearned premiums on reinsurance assumed from others are made on the basis of ceding reports when received and actuarial estimates.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Assumed premium estimates include business where the company accepts a portion of the risk from a ceding carrier as well as the mandatory assumed pool business from the National Council on Compensation Insurance (“NCCI”), or residual market business. The majority of the assumed premium is from an established book of workers’ compensation business produced by a ceding company in which the Company has an equity stake.

Fee income, which includes risk management consulting, loss control, and claims services, is recognized during the period the services are provided. Depending on the terms of the contract, claims processing fees are recognized as revenue over the estimated life of the claims, or the estimated life of the contract. For those contracts that provide services beyond the expiration or termination of the contract, fees are deferred in an amount equal to management’s estimate of the Company’s obligation to continue to provide services in the future.

Commission income, which includes reinsurance placement, is recorded on the later of the effective date or the billing date of the policies on which they were earned. Commission income is reported net of any sub-producer commission expense. Commission adjustments that occur subsequent to the issuance of the policy because of cancellation, typically are recognized when the policy is effectively cancelled. Profit sharing commissions from insurance companies are recognized when determinable, which is when such commissions are received.

Income Taxes

As of March 31, 2013 and December 31, 2012, the Company did not have any unrecognized tax benefits. As of March 31, 2013 and December 31, 2012, the Company had no accrued interest or penalties related to uncertain tax positions.

Recent Accounting Pronouncements

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive

In February 2013, the FASB issued guidance to improve the reporting of reclassifications out of accumulated other comprehensive income. The guidance requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. The guidance is to be applied prospectively for reporting periods beginning after December 15, 2012. The Company adopted this new guidance on January 1, 2013 and included the required disclosures in note 10 ~ Accumulated Other Comprehensive Income.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – Investments

The cost or amortized cost, gross unrealized gains, losses, non-credit other-than-temporary impairments (“OTTI”) and estimated fair value of investments in securities classified as available for sale at March 31, 2013 and December 31, 2012 were as follows (in thousands):

	March 31, 2013
	Cost or		Gross Unrealized
	Amortized Cost		Gains		Losses			Non-Credit OTTI		Estimated Fair Value
Debt Securities:
U.S. Government and agencies	$	25,213	$	859	$	(28	)	$	-	$	26,044
Obligations of states and political subs		686,729		40,264		(3,537	)		-		723,456
Corporate securities		528,670		24,628		(1,577	)		-		551,721
Redeemable preferred stocks		1,461		422		-			-		1,883
Residential mortgage-backed securities		141,574		3,888		(480	)		-		144,982
Commercial mortgage-backed securities		35,675		1,593		(122	)		-		37,146
Other asset-backed securities		10,678		1,048		(5	)		-		11,721
Total debt securities available for sale		1,430,000		72,702		(5,749	)		-		1,496,953
Equity Securities:
Perpetual preferred stock		6,422		1,666		-			-		8,088
Common stock		63,651		4,376		(425	)		-		67,602
Total equity securities available for sale		70,073		6,042		(425	)		-		75,690
Total securities available for sale	$	1,500,073	$	78,744	$	(6,174	)	$	-	$	1,572,643

	December 31, 2012
	Cost or		Gross Unrealized
	Amortized Cost		Gains		Losses			Non-Credit OTTI		Estimated Fair Value
Debt Securities:
U.S. Government and agencies	$	26,788	$	918	$	(22	)	$	-	$	27,684
Obligations of states and political subs		587,276		43,124		(1,427	)		-		628,973
Corporate securities		482,290		25,569		(858	)		-		507,001
Redeemable preferred stocks		1,743		436		-			-		2,179
Residential mortgage-backed securities		73,530		4,393		(41	)		-		77,882
Commercial mortgage-backed securities		33,732		1,800		-			-		35,532
Other asset-backed securities		6,435		1,125		(4	)		-		7,556
Total debt securities available for sale		1,211,794		77,365		(2,352	)		-		1,286,807
Equity Securities:
Perpetual preferred stock		6,930		1,578		-			-		8,508
Common stock		13,459		901		(207	)		-		14,153
Total equity securities available for sale		20,389		2,479		(207	)		-		22,661
Total securities available for sale	$	1,232,183	$	79,844	$	(2,559	)	$	-	$	1,309,468

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Gross unrealized gains, losses, and non-credit OTTI on available for sale securities as of March 31, 2013 and December 31, 2012 were as follows (in thousands):

	March 31, 2013			December 31, 2012
Unrealized gains	$	78,744		$	79,844
Unrealized losses		(6,174	)		(2,559	)
Non-credit OTTI		-			-
Net unrealized gains		72,570			77,285
Deferred federal income tax expense		(25,399	)		(26,957	)
Net unrealized gains on investments, net of deferred federal income taxes	$	47,171		$	50,328

Net realized gains (losses including OTTI) on securities, for the three months ended March 31, 2013 and 2012 were as follows (in thousands):

	For the Three Months Ended March 31,
	2013			2012
Realized gains (losses):
Debt securities:
Gross realized gains	$	30		$	666
Gross realized losses		(9	)		(12	)
Total debt securities		21			654
Equity Securities:
Gross realized gains		275			57
Gross realized losses		(8	)		-
Total equity securities		267			57
Net realized gains (losses)	$	288		$	711

OTTI included in realized losses on securities above	$	-		$	-

Proceeds from the sales of debt and equity securities available for sale were $6.5 million and $10.8 million for the three months ended March 31, 2013 and 2012, respectively.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

At March 31, 2013, the amortized cost and estimated fair value of available for sale debt securities by contractual maturity are shown below. Expected maturities may differ from contractual maturities, because certain borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands):

	Available for Sale
	Amortized Cost		Estimated Fair Value
Due in one year or less	$	46,685	$	47,239
Due after one year through five years		365,358		383,453
Due after five years through ten years		600,492		639,123
Due after ten years		229,538		233,289
Mortgage-backed securities, collateralized obligations and asset-backed securities		187,927		193,849
	$	1,430,000	$	1,496,953

Net investment income for the three months ended March 31, 2013 and 2012 was as follows (in thousands):

	For the Three Months Ended March 31,
	2013		2012
Net Investment Income Earned From:
Debt securities	$	10,688	$	13,293
Equity securities		620		505
Cash and cash equivalents		194		275
Total gross investment income		11,502		14,073
Less investment expenses		362		341
Net investment income	$	11,140	$	13,732

Other-Than-Temporary Impairments of Securities and Unrealized Losses on Investments

Available for sale securities are reviewed for declines in fair value, excluding other-than-temporary declines. For a debt security, if the Company intends to sell a security and it is more likely than not that the Company will be required to sell a debt security before recovery of its amortized cost basis and the fair value of the debt security is below amortized cost, the Company concludes that an OTTI has occurred and the amortized cost is written down to current fair value, with a corresponding charge to realized loss in the Consolidated Statements of Income. If the Company does not intend to sell a debt security and it is not more likely than not that the Company will be required to sell a debt security before recovery of its amortized cost basis, but the present value of the cash flows expected to be collected is less than the amortized cost of the debt security (referred to as the credit loss), the Company concludes that an OTTI has occurred. In this instance, accounting guidance requires the bifurcation of the total OTTI into the amount related to the credit loss, which is recognized in earnings, and the non-credit OTTI, which is recorded in Other Comprehensive Income as an unrealized non-credit OTTI in the Consolidated Statements of Comprehensive Income.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

When assessing the Company’s intent to sell a debt security, if it is more likely than not that the Company will be required to sell a debt security before recovery of its cost basis, facts and circumstances such as, but not limited to, decisions to reposition the security portfolio, sales of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing, are evaluated. In order to determine the amount of the credit loss for a debt security, the Company calculates the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows expected to be recovered. The discount rate is the effective interest rate implicit in the underlying debt security upon issuance. The effective interest rate is the original yield or the coupon if the debt security was previously impaired. If an OTTI exists and there is not sufficient cash flows or other information to determine a recovery value of the security, the Company concludes the entire OTTI is credit-related and the amortized cost for the security is written down to current fair value with a corresponding charge to realized loss in the Consolidated Statements of Income.

To determine the recovery period of a debt security, the Company considers the facts and circumstances surrounding the underlying issuer including, but not limited to, the following:

Historical and implied volatility of the security;

Length of time and extent to which the fair value has been less than amortized cost;

Conditions specifically related to the security such as default rates, loss severities, loan to value ratios, current levels of subordination, third party guarantees, and vintage;

Specific conditions in an industry or geographic area;

Any changes to the rating of the security by a rating agency;

Failure, if any, of the issuer of the security to make scheduled payments; and/or

Recoveries or additional declines in fair value subsequent to the balance sheet date.

In periods subsequent to the recognition of an OTTI, the security is accounted for as if it had been purchased on the measurement date of the OTTI. Therefore, for a fixed maturity security, the discount or reduced premium is reflected in net investment income over the contractual term of the investment in a manner that produces a constant effective yield.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

For an equity security, if the Company does not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery of the cost of the security in value, the Company concludes that an OTTI has occurred, and the cost of the equity security is written down to the current fair value, with a corresponding charge to realized loss within the Consolidated Statements of Income. When assessing the Company’s ability and intent to hold the equity security to recovery of the cost of the security, the Company considers, among other things, the severity and duration of the decline in fair value of the equity security, as well as the cause of decline, a fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer.

The Company reviewed its investment portfolio in relation to its OTTI policy and determined that the Company did not record a credit related OTTI loss or recognize a non-credit related OTTI loss in other comprehensive income for the three months ended March 31, 2013 and 2012.

The fair value and amount of unrealized losses segregated by the time period the investment has been in an unrealized loss position were as follows (in thousands):

	March 31, 2013
	Less than 12 months							Greater than 12 months							Total
	Number of Issues		Fair Value of Investments with Unrealized Losses		Gross Unrealized Losses and Non-Credit OTTI			Number of Issues		Fair Value of Investments with Unrealized Losses		Gross Unrealized Losses and Non-Credit OTTI			Number of Issues		Fair Value of Investments with Unrealized Losses		Gross Unrealized Losses and Non-Credit OTTI
Debt Securities:
U.S. Government and agencies		3	$	3,494	$	(28	)		-	$	-	$	-			3	$	3,494	$	(28	)
Obligations of states and political subs		56		195,938		(3,537	)		-		-		-			56		195,938		(3,537	)
Corporate securities		58		136,362		(1,577	)		-		-		-			58		136,362		(1,577	)
Redeemable preferred stocks		-		-		-			-		-		-			-		-		-
Residential mortgage-backed securities		5		33,379		(479	)		1		24		(1	)		6		33,403		(480	)
Commercial mortgage-backed securities		3		8,045		(122	)		-		-		-			3		8,045		(122	)
Other asset-backed securities		3		5,197		(4	)		1		11		(1	)		4		5,208		(5	)
Total debt securities		128		382,415		(5,747	)		2		35		(2	)		130		382,450		(5,749	)
Equity Securities:
Perpetual preferred stock		-		-		-			-		-		-			-		-		-
Common stock		6		4,204		(173	)		2		4,557		(252	)		8		8,761		(425	)
Total equity securities		6		4,204		(173	)		2		4,557		(252	)		8		8,761		(425	)
Total securities		134	$	386,619	$	(5,920	)		4	$	4,592	$	(254	)		138	$	391,211	$	(6,174	)

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

	December 31, 2012
	Less than 12 months							Greater than 12 months							Total
	Number of Issues		Fair Value of Investments with Unrealized Losses		Gross Unrealized Losses and Non-Credit OTTI			Number of Issues		Fair Value of Investments with Unrealized Losses		Gross Unrealized Losses and Non-Credit OTTI			Number of Issues		Fair Value of Investments with Unrealized Losses		Gross Unrealized Losses and Non-Credit OTTI
Debt Securities:
U.S. Government and agencies		5	$	7,063	$	(22	)		-	$	-	$	-			5	$	7,063	$	(22	)
Obligations of states and political subs		23		69,016		(1,427	)		-		-		-			23		69,016		(1,427	)
Corporate securities		50		113,348		(858	)		-		-		-			50		113,348		(858	)
Redeemable preferred stocks		-		-		-			-		-		-			-		-		-
Residential mortgage-backed securities		1		10,219		(40	)		1		24		(1	)		2		10,243		(41	)
Commercial mortgage-backed securities		-		-		-			-		-		-			-		-		-
Other asset-backed securities		2		463		(4	)		-		-		-			2		463		(4	)
Total debt securities		81		200,109		(2,351	)		1		24		(1	)		82		200,133		(2,352	)
Equity Securities:
Perpetual preferred stock		-		-		-			-		-		-			-		-		-
Common stock		-		-		-			2		4,583		(207	)		2		4,583		(207	)
Total equity securities		0		-		-			2		4,583		(207	)		2		4,583		(207	)
Total securities		81	$	200,109	$	(2,351	)		3	$	4,607	$	(208	)		84	$	204,716	$	(2,559	)

Changes in the amount of credit loss on fixed maturities for which a portion of an OTTI related to other factors was recognized in other comprehensive income were as follows (in thousands):

Balance as of December 31, 2012	$	(156	)
Additional credit impairments on:
Previously impaired securities		-
Securities for which an impairment was not previously recognized		-
Reductions		-
Balance as of March 31, 2013	$	(156	)

NOTE 3 – Fair Value Measurements

According to accounting guidance for fair value measurements and disclosures, fair value is the price that would be received in the sale of an asset or would be paid in the transfer of a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. The guidance establishes a three-level hierarchy for fair value measurements that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”).

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The estimated fair values of the Company’s fixed investment portfolio are based on prices provided by a third party pricing service and a third party investment manager. The prices provided by these services are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The third party pricing service and the third party investment manager provide a single price or quote per security and the Company has not historically adjusted security prices. The Company obtains an understanding of the methods, models and inputs used by the third party pricing service and the third party investment manager, and has controls in place to validate that amounts provided represent fair values. The Company’s control process includes, but is not limited to, initial and ongoing evaluation of the methodologies used, a review of specific securities and an assessment for proper classification within the fair value hierarchy. The hierarchy level assigned to each security in the Company’s available for sale portfolio is based upon its assessment of the transparency and reliability of the inputs used in the valuation as of the measurement date. The three hierarchy levels are defined as follows:

Level 1 – Valuations that are based on unadjusted quoted prices in active markets for identical securities. The fair value of exchange-traded preferred and common equities, and mutual funds included in the Level 1 category were based on quoted prices that are readily and regularly available in an active market. The fair value measurements that were based on Level 1 inputs comprise 4.9% of the fair value of the total investment portfolio.

Level 2 – Valuations that are based on observable inputs (other than Level 1 prices) such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. The fair value of securities included in the Level 2 category were based on the market values obtained from a third party pricing service that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other observable market information. The third party pricing service monitors market indicators, as well as industry and economic events. The Level 2 category includes corporate bonds, government and agency bonds, asset-backed, residential mortgage-backed and commercial mortgage-backed securities and municipal bonds. The fair value measurements that were based on Level 2 inputs comprise 94.8% of the fair value of the total investment portfolio.

Level 3 – Valuations that are derived from techniques in which one or more of the significant inputs are unobservable and/or involve management judgment and/or are based on non-binding broker quotes. The fair value measurements that were based on Level 3 inputs comprise 0.3% of the fair value of the total investment portfolio.

For corporate, government and municipal bonds, the third party pricing service utilizes a pricing model with standard inputs that include benchmark yields, reported trades, issuer spreads, two-sided markets, benchmark securities, market bids/offers, and other reference data observable in the marketplace. The model uses the option adjusted spread methodology and is a multi-dimensional relational model. All bonds valued under these techniques are classified as Level 2.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

For asset-backed, residential mortgage-backed and commercial mortgage-backed securities, the third party pricing service valuation methodology includes consideration of interest rate movements, new issue data, monthly remittance reports and other pertinent data that is observable in the marketplace. This information is used to determine the cash flows for each tranche and identifies the inputs to be used such as benchmark yields, prepayment assumptions and collateral performance. All asset-backed, residential mortgage-backed and commercial mortgage-backed securities valued under these methods are classified as Level 2.

Also included in Level 2 valuation are interest rate swap agreements the Company utilizes to hedge the floating interest rate on its debt, 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 and measured using discounted cash flow analysis that incorporates significant observable inputs, including the LIBOR forward curve, derivative counterparty spreads, and measurements of volatility.

The Level 3 securities consist of 19 securities totaling $5.3 million or 0.3% of the total investment portfolio. These primarily represent asset-backed securities and corporate debt securities that have a principal protection feature supported by a U.S. Treasury strip. To fair value these securities, the third party investment manager uses a combination of methods. Non-binding broker/dealer quotes are used on 2 holdings. Benchmarking techniques based upon industry sector, rating and other factors are used on 17 holdings.

Also included in Level 3 valuation are the conversion feature within the Notes (as defined below) and the convertible senior notes hedge. The estimated fair values of the both the conversion feature and the convertible senior notes hedge are obtained from the third party financial institution counterparties valued using non-binding broker quotations and significant unobservable inputs.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis, classified by the valuation hierarchy as of March 31, 2013 (in thousands):

				Fair Value Measurements Using
	March 31, 2013			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs			Significant Unobservable Inputs
	Total			(Level 1)		(Level 2)			(Level 3)
Debt Securities:
U.S. Government and agencies	$	26,044		$	-	$	26,044		$	-
Obligations of states and political subs		723,456			-		723,456			-
Corporate securities		551,721			-		550,590			1,131
Redeemable preferred stocks		1,883			1,883		-			-
Residential mortgage-backed securities		144,982			-		144,982			-
Commercial mortgage-backed securities		37,146			-		36,956			190
Other asset-backed securities		11,721			-		7,749			3,972
Total debt securities available for sale		1,496,953			1,883		1,489,777			5,293
Equity Securities:
Perpetual preferred stock		8,088			7,862		226			-
Common stock		67,602			67,602		-			-
Total equity securities available for sale		75,690			75,464		226			-
Total securities available for sale	$	1,572,643		$	77,347	$	1,490,003		$	5,293
Derivatives:
Derivatives - interest rate swaps	$	(3,291	)	$	-	$	(3,291	)	$	-
Cash conversion feature of cash convertible notes		(18,534	)		-		-			(18,534	)
Purchased cash convertible note hedge		18,534			-		-			18,534
Total derivatives	$	(3,291	)	$	-	$	(3,291	)	$	-

Total securities available for sale and derivatives	$	1,569,352		$	77,347	$	1,486,712		$	5,293

The following table presents changes in Level 3 available for sale investments and derivatives measured at fair value on a recurring basis as of March 31, 2013 (in thousands):

	Fair Value Measurement Using Significant Unobservable Inputs - Level 3
Balance as of December 31, 2012	$	5,444

Total gains or losses (realized/unrealized):
Included in earnings		40
Included in other comprehensive income		(70	)

Purchases		18,534
Issuances		(18,534	)
Settlements		(121	)

Transfers in and out of Level 3		-
Balance as of March 31, 2013	$	5,293

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

There were no credit losses for the period included in earnings attributable to the change in unrealized losses on Level 3 assets still held at the reporting date.

The Company’s policy on recognizing transfers between hierarchy levels is applied at the end of a reporting period. During the quarter ended March 31, 2013, no transfers into or out of Levels 1, 2 and 3 were required. During the quarter ended March 31, 2012, there was one asset-backed security transferred into Level 3 from Level 2 as fair value was no longer determined using market inputs that could be directly or indirectly observable.

NOTE 4 – Debt

Credit Facilities

On August 29, 2012, the Company executed $130.0 million in senior credit facilities (the “Credit Facilities”). The Credit Facilities include a $30.0 million term loan facility and a $100.0 million revolving credit facility.

The term loan facility has a four year term with a $30.0 million borrowing limit, which, subject to certain exceptions, can be increased up to an additional $25.0 million. As of March 31, 2013, the outstanding balance on its term loan facility was $27.0 million. The Company had $20.0 million outstanding under its revolving credit facility as of March 31, 2013, and $0.5 million in letters of credit had been issued as of March 31, 2013. The undrawn portion of the revolving credit facility, which was $79.5 million as of March 31, 2013, is available to finance working capital and for other general corporate purposes, including but not limited to, surplus contributions to its Insurance Company Subsidiaries to support premium growth or strategic acquisitions. These Credit Facilities replaced the Company’s former term loan and revolving credit agreement, which were terminated upon the closing of the Credit Facilities. At December 31, 2012, the Company had an outstanding balance of $28.5 million on its term loan and a $20.0 million outstanding balance on its revolving credit facility. There was $0.5 million in letters of credit that had been issued as of December 31, 2012.

The principal amount outstanding under the Credit Facilities provides for interest at either the Alternative Base Rate (“ABR”) or the London interbank offered rate (“LIBOR”). ABR borrowings under the Agreement will bear interest at the greatest of (a) the Administrative Agent’s prime rate, (b) the federal funds effective rate plus 0.5%, or (c) the adjusted LIBOR for a one-month period plus 1.0%, in each case, plus a margin that is adjusted on the basis of Company’s consolidated leverage ratio. Eurodollar borrowings under the Agreement will bear interest at the adjusted LIBOR for the interest period in effect plus a margin that is adjusted on the basis of Company’s consolidated leverage ratio. In addition, the Credit Facilities provide for an unused facility fee ranging between twenty basis points and thirty basis points, based on the Company’s consolidated leverage ratio as defined by the Credit Facilities. At March 31, 2013, the interest rate on the Company’s term loan was 2.72%, which consisted of a weighted fixed rate of 0.72%, plus an applicable margin of 2.00%, as described in Note 5 ~ Derivative Instruments. At March 31, 2013, the interest rate on the Company’s revolving credit facility was 0.31%, plus a 2.00% margin.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The financial covenants applicable to the Credit Facilities consist of: (1) minimum consolidated net worth starting at $473.9 million, (2) minimum Risk Based Capital Ratio for Star of 1.50 to 1.00 and all other Insurance Company Subsidiaries of 1.75 to 1.00, (3) maximum permitted consolidated leverage ratio of 0.35 to 1.00, (4) minimum consolidated fixed charge coverage ratio of 1.25 to 1.00, and (5) minimum A.M. Best rating of “B++.” As of March 31, 2013, the Company was in compliance with these debt covenants.

During 2011, several of the Insurance Company Subsidiaries (Star, Williamsburg, and Ameritrust) became members of the Federal Home Loan Bank of Indianapolis (“FHLBI”). As a member of the FHLBI, these subsidiaries have the ability to borrow on a collateralized basis at relatively low borrowing rates providing a source of liquidity. As of March 31, 2013, the Company had borrowed $30.0 million from the FHLBI after pledging as collateral residential mortgage-backed securities (“RMBS”) having a carrying value of $31.0 million, and making a FHLBI common stock investment of approximately $1.6 million. The Company has the ability to increase its borrowing capacity through purchasing additional investments in FHLBI and pledging additional securities. The Company retains all the rights regarding the collateralized RMBS.

Debentures

The following table summarizes the principal amounts and variables associated with the Company’s debentures (in thousands):

Year of Issuance	Description	Year Callable	Year Due	Interest Rate Terms	Interest Rate at March 31, 2013 (1)			Principal Amount

2003	Junior subordinated debentures	2008	2033	Three-month LIBOR, plus 4.05%		4.33	%	$	10,310
2004	Senior debentures	2009	2034	Three-month LIBOR, plus 4.00%		4.29	%		13,000
2004	Senior debentures	2009	2034	Three-month LIBOR, plus 4.20%		4.49	%		12,000
2005	Junior subordinated debentures	2010	2035	Three-month LIBOR, plus 3.58%		3.86	%		20,620
	Junior subordinated debentures (2)	2007	2032	Three-month LIBOR, plus 4.00%		4.29	%		15,000
	Junior subordinated debentures (2)	2008	2033	Three-month LIBOR, plus 4.10%		4.39	%		10,000
					Total			$	80,930

(1) The underlying three-month LIBOR rate varies as a result of the interest rate reset dates used in determining the three-month LIBOR rate, which varies for each long-term debt item each quarter.

(2) Represents the junior subordinated debentures acquired in conjunction with the ProCentury Merger on July 31, 2008.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Excluding the junior subordinated debentures acquired in conjunction with the ProCentury Merger, the Company received a total of $53.3 million in net proceeds from the issuances of the above long-term debt, of which $26.2 million was contributed to the surplus of its Insurance Company Subsidiaries and the remaining balance was used for general corporate purposes. Associated with the issuance of the above long-term debt, the Company incurred approximately $1.7 million in issuance costs for commissions paid to the placement agents in the transactions.

The issuance costs associated with these debentures have been capitalized and are included in other assets on the balance sheet. As of June 30, 2007, these issuance costs were being amortized over a seven year period as a component of interest expense. The seven year amortization period represented management’s best estimate of the estimated useful life of the bonds related to both the senior debentures and junior subordinated debentures. Beginning July 1, 2007, the Company reevaluated its best estimate and determined a five year amortization period to be a more accurate representation of the estimated useful life. Therefore, this change in amortization period from seven years to five years has been applied prospectively beginning July 1, 2007.

The junior subordinated debentures issued in 2003 and 2005 were issued in conjunction with the issuance of $10.0 million and $20.0 million in mandatory redeemable trust preferred securities to a trust formed by an institutional investor from the Company’s unconsolidated subsidiary trusts, Meadowbrook Capital Trust I and Meadowbrook Capital Trust II, respectively.

The junior subordinated debentures acquired in the ProCentury Merger were issued in conjunction with the issuance of $15.0 million and $10.0 million in floating rate trust preferred securities to a trust formed from the Company’s unconsolidated trust, ProFinance Statutory Trust I and ProFinance Statutory Trust II. The Company also acquired the remaining unamortized portion of the capitalized issuance costs associated with these debentures. The remaining unamortized portion of the issuance costs acquired was $625,000. These issuance costs are included in other assets on the balance sheet. The remaining balance is being amortized over a five year period beginning August 1, 2008, as a component of interest expense.

The junior subordinated debentures are unsecured obligations of the Company and are junior to the right of payment to all senior indebtedness of the Company. The Company has guaranteed that the payments made to the four trusts mentioned above will be distributed to the holders of the respective trust preferred securities.

The Company estimates that the fair value of the above mentioned junior subordinated debentures and senior debentures issued approximate the gross proceeds of cash received at the time of issuance.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Cash Convertible Senior Notes

On March 18, 2013, the Company issued $100.0 million of 5.0% cash convertible senior notes (the “Notes”), which mature on March 15, 2020. Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of each year, commencing September 15, 2013. Until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Notes solely into cash at any time on or after September 15, 2019 or earlier under certain circumstances determined by: (i) the market price of the Company’s stock, (ii) the trading price of the Notes, or (iii) the occurrence of specified corporate transactions. The notes are not convertible into Meadowbrook common stock or any other securities under any circumstances. The initial conversion rate is 108.8732 shares of common stock per $1,000 principal amount of the Notes (equivalent to an initial conversion price of approximately $9.18 per share), subject to adjustment upon the occurrence of certain events. Additionally, in the event of a fundamental change, the holders may require the Company to repurchase the Notes for a cash price equal to 100% of the principal, plus any accrued and unpaid interest. The proceeds from the issuance of the Notes were bifurcated into a debt component and an embedded conversion option component.

Due to the bifurcation, the debt component reflects an original issue discount (“OID”) of $12.9 million. The OID and deferred issuance costs of $3.6 million will be amortized into interest expense over the term of the Notes. After considering the contractual interest payments and amortization of the OID, the Notes’ effective interest rate is 7.4%. Interest expense, including amortization of deferred issuance costs, recognized on the Notes was $244,000 for the period ended March 31, 2013.

The following table shows the amounts recorded for the debt component of the Notes as of March 31, 2013 (in thousands):

Outstanding principal	$	100,000
Unamortized OID		(12,890	)
Total debt component	$	87,110

As the conversion feature is structured under the cash settlement method, the embedded conversion option is reported as a derivative liability.

In connection with the offering of the Notes, the Company also entered into cash convertible senior notes hedge transactions (the “Note Hedges”) and warrant transactions (the “Warrants”) with respect to its common stock with certain counter-parties. Upon conversion, the Note Hedges are intended to offset potential cash payments in excess of the principal of the Notes. The Note Hedges and Warrants are separate transactions, entered into by the Company with certain counter-parties and are not part of the terms of the Notes.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company paid $12.9 million for the Note Hedges, which are exercisable upon conversion of the Notes. The Note Hedges are structured under the cash settlement method and are accounted for as a derivative asset.

The Company received $3.0 million for the warrants sold to certain counter-parties. The warrants have a strike price of $11.69 and will be net share settled; meaning the Company will issue a number of shares per warrant corresponding to the difference between its share price on each warrant exercise date and the exercise price. The warrants meet the definition of derivatives under the guidance in ASC 815; however, because these instruments have been determined to be indexed to the Company’s own stock and meet the criteria for equity classification under ASC 815-40, the warrants have been accounted for as an adjustment to the Company’s paid-in-capital.

If the market value per share of the Company’s common stock exceeds the strike price of the warrants, the warrants will have a dilutive effect on the Company’s net income per share and the Company will use the “treasury stock” method in calculating the dilutive effect on earnings per share.

NOTE 5 – Derivative Instruments

The Company has entered into interest rate swap transactions to mitigate its interest rate risk on its existing debt obligations. These interest rate swap transactions have been designated as cash flow hedges and are deemed highly effective hedges. These interest rate swap transactions are recorded at fair value on the balance sheet and the effective portion of the changes in fair value are accounted for within other comprehensive income. The interest differential to be paid or received is accrued and recognized as an adjustment to interest expense.

The following table summarizes the rates and amounts associated with the Company’s interest rate swaps (in thousands):

Effective Date	Expiration Date	Debt Instrument	Counterparty Interest Rate Terms	Fixed Rate			Fixed Amount at March 31, 2013

4/23/2008	6/30/2013	Junior subordinated debentures (1)	Three-month LIBOR, plus 4.05%		8.020	%	$	10,000
4/29/2008	4/29/2013	Senior debentures (1)	Three-month LIBOR, plus 4.00%		7.940	%		13,000
9/28/2012	8/30/2016	Term loan (2)	Three-month LIBOR		0.724	%		27,000
8/15/2008	8/15/2013	Junior subordinated debentures (1)(3)	Three-month LIBOR		3.780	%		10,000
9/4/2008	9/4/2013	Junior subordinated debentures (1)(3)	Three-month LIBOR		3.790	%		15,000
9/8/2010	5/24/2016	Senior debentures	Three-month LIBOR, plus 4.20%		6.248	%		5,000
9/16/2010	9/15/2015	Junior subordinated debentures	Three-month LIBOR, plus 3.58%		6.160	%		10,000
9/16/2010	9/15/2015	Junior subordinated debentures	Three-month LIBOR, plus 3.58%		6.190	%		10,000
5/24/2011	5/24/2016	Senior debentures	Three-month LIBOR, plus 4.20%		6.472	%		7,000
				Total			$	107,000

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) During the quarter ended June 30, 2012, the Company entered into four forward starting interest rate swaps. The swaps will replace the identified interest rate swap, upon their expiration in 2013. The fixed rates on the forward starting interest rate swaps are approximately 150 basis points less than the fixed rates on the current swaps in place. Additionally, the forward starting interest rate swaps will expire ten years from the effective date.

(2) The Company is required to make fixed rate interest payments on the current balance of the term loan, amortizing in accordance with the term loan amortization schedule. The Company fixed only the variable interest portion of the loan. The actual interest payments associated with the term loan also include an additional rate of 2.00% in accordance with the Credit Facilities.

(3) The Company fixed only the variable interest portion of the debt. The actual interest payments associated with the debentures also include an additional rate of 4.10% and 4.00% on the $10.0 million and $15.0 million debentures, respectively.

In relation to the above interest rate swaps, the net interest expense incurred for the three months ended March 31, 2013 and 2012, was approximately $0.6 million and $0.8 million, respectively.

As of March 31, 2013 and December 31, 2012, the total fair value of the interest rate swaps were unrealized losses of $3.3 million and $4.5 million, respectively. At March 31, 2013 and December 31, 2012, accumulated other comprehensive income included accumulated loss on the cash flow hedge, net of taxes, of approximately $2.1 million and $2.9 million, respectively.

In March 2012, the Company replaced its existing $5.6 million convertible note and $664,000 demand note receivables with an unaffiliated insurance agency into new debt instruments with a related limited liability company. The new instruments were effective January 1, 2012 and consist of a $2 million convertible note and a $4.2 million term loan. The interest rate on the convertible note is 3% and is due on January 1, 2022. This note is convertible at the option of the Company based upon a pre-determined formula. The interest rate on the term loan is 5.5% and is due on April 30, 2016. As security for the note and term loan, the borrower granted the Company a first lien on all of its accounts receivable, cash, general intangibles, and other assets. As additional collateral for the note and term loan, the Company obtained guaranties of payment and performance from certain affiliated companies of the borrower, as well as related individuals, which guaranties are secured by additional collateral.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Cash Convertible Senior Notes and Note Hedges

As discussed in Note 4 ~ Debt, the Company issued the Notes. Holders may convert their cash convertible notes subject to certain conversion provisions. In order to offset the risk associated with the cash conversion feature, the Company entered into convertible note hedges with certain counterparties. Both the cash conversion feature and the purchased convertible note hedges are measured at fair value with gains and losses recorded in the Company’s Consolidated Statements of Income.

NOTE 6 – Restricted and Non-Restricted Stock Awards

On February 23, 2011 and 2010, the Company issued 28,500 and 202,500 restricted stock awards, respectively, to executives of the Company, out of its 2002 Amended and Restated Stock Option Plan (the “Plan”). No restricted stock awards were issued in 2012 or 2013. The restricted stock awards vest over a four year period, with the first twenty percent vesting immediately on the date issued (i.e., February 23) and the remaining eighty percent vesting annually on a straight line basis over the requisite four year service period. The unvested restricted stock awards are subject to forfeiture in the event the employee is terminated for “Good Cause” or voluntarily resigns their employment without “Good Reason” as provided for in the employee’s respective employment agreements. The Company recorded approximately $81,000 and $46,000 of restricted stock awards compensation expense for the three months ended March 31, 2013 and 2012, respectively.

On February 13, 2013, and February 23, 2012 the Company issued 2,400 and 1,500 non-restricted stock awards, respectively, to members of the Board of Directors, which vested immediately. The Company recorded approximately $137,000 and $148,500 of non-restricted stock awards compensation expense for the three months ended March 31, 2013 and 2012, respectively.

NOTE 7 – Shareholders’ Equity

At March 31, 2013, shareholders’ equity was $565.5 million, or a book value of $11.33 per common share, compared to $558.3 million, or a book value of $11.22 per common share, at December 31, 2012.

On October 28, 2011, the Company’s Board of Directors approved a Share Repurchase Plan authorizing management to purchase up to 5.0 million shares of the Company’s common stock in market transactions for a period not to exceed twenty-four months. For the three months ended March 31, 2013, there were no share repurchases. For the three months ended March 31, 2012, the Company purchased and retired approximately 0.5 million shares of common stock for a total cost of approximately $5.0 million.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

For the three months ended March 31, 2013, the Company had $1.0 million of cash dividends payable on April 4, 2013. For the three months ended March 31, 2012, cash dividends payable to common shareholders totaled $2.5 million.

On April 26, 2013, the Company’s Board of Directors declared a quarterly dividend of $0.02 per common share. The dividend is payable on May 28, 2013, to shareholders of record as of May 10, 2013.

When evaluating the declaration of a dividend, the Company’s Board of Directors considers a variety of factors, including but not limited to, cash flow, liquidity needs, results of operations, industry conditions, and our overall financial condition. As a holding company, the ability to pay cash dividends is partially dependent on dividends and other permitted payments from its Insurance Company Subsidiaries.

NOTE 8 – Earnings Per Share

Basic earnings per share are based on the weighted average number of common shares outstanding during the year, while diluted earnings per share includes the weighted average number of common shares and potential dilution from shares issuable pursuant to stock awards using the treasury stock method.

The following table is a reconciliation of the income and share data used in the basic and diluted earnings per share computations for the three months ended March 31 (in thousands, except per share amounts):

	For the Three Months Ended March 31,
	2013		2012
Net income	$	7,082	$	8,104

Common shares:
Basic
Weighted average shares outstanding		49,823,882		50,915,145

Diluted
Weighted average shares outstanding		49,823,882		50,915,145
Dilutive effect of:
Share awards under long term incentive plan		21,141		6,320
Total		49,845,023		50,921,465

Net income per common share
Basic	$	0.14	$	0.16
Diluted	$	0.14	$	0.16

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 9 – Commitments and Contingencies

The Company, and its subsidiaries, are subject at times to various claims, lawsuits and proceedings relating principally to alleged errors or omissions in the placement of insurance, claims administration, consulting services and other business transactions arising in the ordinary course of business. Where appropriate, the Company vigorously defends such claims, lawsuits and proceedings. Some of these claims, lawsuits and proceedings seek damages, including consequential, exemplary or punitive damages, in amounts that could, if awarded, be significant. Most of the claims, lawsuits and proceedings arising in the ordinary course of business are covered by the policy at issue, errors and omissions insurance or other appropriate insurance. In terms of any retentions or deductibles associated with such insurance, the Company has established accruals for such retentions or deductibles, when necessary, based upon currently available information. In accordance with accounting guidance, if it is probable that an asset has been impaired or a liability has been incurred as of the date of the financial statements and the amount of loss is estimable; then an accrual for the costs to resolve these claims is recorded by the Company in the accompanying consolidated balance sheets. Period expenses related to the defense of such claims are included in the accompanying consolidated statements of income. Management, with the assistance of outside counsel, adjusts such provisions according to new developments or changes in the strategy in dealing with such matters. On the basis of current information, the Company does not expect the outcome of the claims, lawsuits and proceedings to which the Company is subject, either individually, or in the aggregate, to have a material adverse effect on the Company’s financial condition. However, it is possible that future results of operations or cash flows for any particular quarter or annual period could be materially affected by an unfavorable resolution of any such matters.

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MEADOWBROOK INSURANCE GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 10 – Accumulated Other Comprehensive Income

The Company’s comprehensive income includes net earnings plus unrealized gain or loss on available-for-sale investment securities, net of tax. In reporting comprehensive earnings on a net basis in the income statement, we used a 35 percent tax rate. The following table illustrates the amounts reclassified from accumulated other comprehensive income:

Reclassifications out of accumulated other comprehensive income: Period Ended March 31, 2013 (in thousands)

Details about accumulated other comprehensive income components	Amount reclassified from accumulated other comprehensive income			Affected line item in the statement where net income is presented

Unrealized gain or loss on available for sale securities
	$	288		Net realized gains
		(101	)	Tax expense
	$	187		Net of tax


Reclassifications out of accumulated other comprehensive income: Period Ended March 31, 2012 (in thousands)

Details about accumulated other comprehensive income components	Amount reclassified from accumulated other comprehensive income			Affected line item in the statement where net income is presented

Unrealized gain or loss on available for sale securities
	$	711		Net realized gains
		(249	)	Tax expense
	$	462		Net of tax

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the Periods ended March 31, 2013 and 2012

Forward-Looking Statements

This quarterly report may provide information including certain statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These include statements regarding the intent, belief, or current expectations of management, including, but not limited to, those statements that use the words “believes,” “expects,” “anticipates,” “estimates,” or similar expressions. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties, and results could differ materially from those indicated by such forward-looking statements. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: actual loss and loss adjustment expenses exceeding our reserve estimates; competitive pressures in our business; the failure of any of the loss limitation methods we employ; our geographic concentration and the business, economic, natural perils, man made perils, and regulatory conditions within our most concentrated region; our ability to appropriately price the risks we underwrite; goodwill impairment risk employed as part of our growth strategy; a decrease in our A.M. Best rating; increased risks or reduction in the level of our underwriting commitments due to market conditions; a failure of our reinsurers to pay losses in a timely fashion, or at all; interest rate changes; continued difficult conditions in the global capital markets and the economy generally; market and credit risks affecting our investment portfolio; liquidity requirements forcing us to sell our investments; a failure to introduce new products or services to keep pace with advances in technology; the new federal financial regulatory reform; our holding company structure and regulatory constraints restricting dividends or other distributions by our Insurance Company Subsidiaries; minimum capital and surplus requirements imposed on our Insurance Company Subsidiaries; a failure of additional capital to be available or only available on unfavorable terms; acquisitions and integration of acquired businesses resulting in operating difficulties, which may prevent us from achieving the expected benefits; our reliance upon producers, which subjects us to their credit risk; loss of one of our core selected producers; our dependence on the continued services and performance of our senior management and other key personnel; our reliance on our information technology and telecommunications systems; managing technology initiatives and obtaining the efficiencies anticipated with technology implementation; a failure in our internal controls; the cyclical nature of the property and casualty insurance industry; severe weather conditions and other catastrophes; the effects of litigation; state regulation; and assessments imposed upon our Insurance Company Subsidiaries to provide funds for failing insurance companies. For additional information with respect to certain of these and other factors, refer to the “Risk Factors” section contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and subsequent filings made with the United States Securities and Exchange Commission. We are not under any obligation to (and expressly disclaim any obligation to) update or alter our forward-looking statements, whether as a result of new information, future events or otherwise.

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Business Overview

We are a specialty niche focused commercial insurance underwriter and insurance administration services company. We market and underwrite specialty property and casualty insurance programs and products on both an admitted and non-admitted basis through a broad and diverse network of independent retail agents, wholesalers, program administrators and general agents, who value service, specialized knowledge, and focused expertise. Program business refers to an aggregation of individually underwritten risks that have some unique characteristic and are distributed through a select group of agents. We seek to combine profitable underwriting, income from our net commissions and fees, investment returns and efficient capital management to deliver consistent long-term growth in shareholder value.

Through our retail property and casualty agencies, we also generate commission revenue, which represents 2.4% of our total consolidated revenues. Our agencies are located in Michigan, California, Massachusetts, and Florida and produce commercial, personal lines, life and accident and health insurance that is placed primarily with unaffiliated insurance carriers. These agencies are a minimal source of business for our Insurance Company Subsidiaries.

We recognize revenue related to the services and coverages within the following categories: net earned premiums, management administrative fees, claims fees, commission revenue, net investment income, and net realized gains (losses).

We compete in the specialty insurance market. Our wide range of specialty niche insurance expertise allows us to accommodate a diverse distribution network ranging from specialized program agents to insurance brokers. In the specialty market, competition tends to place considerable focus on availability, service and other tailored coverages in addition to price. Moreover, our broad geographical footprint enables us to function with a local presence on both a regional and national basis. We also have the capacity to write specialty insurance in both the admitted and non-admitted markets. These unique aspects of our business model enable us to compete on factors other than price.

Recent Developments

On April 19, 2013, A.M. Best Company (“A.M. Best”) announced it had removed the ‘under review’ status and affirmed the financial strength rating and issuer credit rating of our Insurance Company Subsidiaries and our issuer credit rating. A.M. Best had previously announced in October 2012 that they had put the financial strength rating and issuer credit rating of our Insurance Company Subsidiaries and our issuer credit rating under review with negative implications. Our Insurance Company Subsidiaries are rated “A-” (Excellent) by A.M. Best.

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Critical Accounting Policies

In certain circumstances, we are required to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions periodically on an on-going basis based on a variety of factors. There can be no assurance, however, that actual results will not be materially different than our estimates and assumptions, and that reported results of operation will not be affected by accounting adjustments needed to reflect changes in these estimates and assumptions. The accounting estimates and related risks described in our Annual Report on Form 10-K, as filed with the United States Securities and Exchange Commission on March 8, 2013, are those that we consider to be our critical accounting estimates. For the three months ended March 31, 2013, there have been no material changes in regard to any of our critical accounting estimates.

Non-GAAP Financial Measures

Statutory Surplus

Statutory surplus is a non-GAAP measure with the most directly comparable financial GAAP measure being shareholders’ equity. The following is a reconciliation of statutory surplus to shareholders’ equity:

Consolidated Statutory Surplus to GAAP Shareholders' Equity

For Period Ending March 31, 2013

(In thousands)

Statutory Consolidated Surplus			$	501,166

Statutory to GAAP differences:
Deferred policy acquisition costs	51,967
Unrealized gain on securities available for sale	57,749
Non-admitted assets and other	(4,354	)