Edgar Filing: PROCENTURY CORP

ProCentury Corporation 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2007


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

For the transition period from to .

000-50641

(Commission File Number)

PROCENTURY CORPORATION

(Exact name of Registrant as specified in its charter)


Ohio		31-1718622
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

465 Cleveland Avenue
Westerville, Ohio		43082
(Address of principal executive offices)		(Zip Code)

(614) 895-2000
(Registrant’s telephone number, including area code)

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

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

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

o Yes þ No

As of November 9, 2007, the registrant had 13,358,867 outstanding Common Shares, without par value.

PROCENTURY CORPORATION

QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended September 30, 2007

INDEX


		Page
PART I: FINANCIAL INFORMATION

Item 1. Financial Statements
Consolidated Condensed Statements of Operations (unaudited) — For the three and nine months ended September 30, 2007 and 2006		3
Consolidated Condensed Balance Sheets — September 30, 2007 (unaudited) and December 31, 2006		4
Consolidated Condensed Statements of Shareholders’ Equity and Comprehensive Income (unaudited) — For the nine months ended September 30, 2007 and 2006		5
Consolidated Condensed Statements of Cash Flows (unaudited) — For the nine months ended September 30, 2007 and 2006		6
Notes to Consolidated Condensed Financial Statements (unaudited) — September 30, 2007		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3. Quantitative and Qualitative Disclosures About Market Risk		34
Item 4. Controls and Procedures		34

PART II: OTHER INFORMATION

Item 1. Legal Proceedings		35
Item 1A. Risk Factors		35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		37
Item 3. Defaults Upon Senior Securities		37
Item 4. Submission of Matters to a Vote of Security Holders		37
Item 5. Other Information		37
Item 6. Exhibits		37
SIGNATURES		38
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Operations

(Unaudited)

(Dollars in thousands, except per share data)


	Three Months Ended September 30,					Nine Months Ended September 30,
	2007			2006		2007			2006
Premiums earned	$	55,873			55,425		166,958			156,992
Net investment income		5,571			4,999		16,497			14,114
Net realized investment (losses) gains		(355	)		4		(593	)		(37	)
Other income		159			101		379			353

Total revenues		61,248			60,529		183,241			171,422

Losses and loss expenses		33,037			34,393		100,038			97,407
Amortization of deferred policy acquisition costs		14,068			14,440		42,456			39,402
Other operating expenses		5,190			3,719		13,394			11,969
Interest expense		684			608		2,038			1,718

Total expenses		52,979			53,160		157,926			150,496

Income before income tax expense		8,269			7,369		25,315			20,926
Income tax expense		2,510			2,236		7,709			6,168

Net income	$	5,759			5,133		17,606			14,758


Basic net income per share	$	0.43			0.39		1.33			1.13

Diluted net income per share	$	0.43			0.39		1.31			1.11


Weighted average of shares outstanding — basic		13,252,010			13,133,711		13,237,198			13,116,317

Weighted average of shares outstanding — diluted		13,365,584			13,270,589		13,402,224			13,239,563

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Balance Sheets

(In thousands, except share data)


	September 30,
	2007			December 31,
	(Unaudited)			2006
Assets
Investments
Fixed maturities:
Available-for-sale, at fair value (amortized cost 2007, $397,587; 2006, $362,066)	$	387,969			358,422
Held-to-maturity, at amortized cost (fair value 2007, $1,106; 2006, $1,101)		1,103			1,114
Equities (available-for-sale):
Equity securities, at fair value (cost 2007, $31,851; 2006, $28,112)		29,437			28,188
Bond mutual funds, at fair value (cost 2007, $14,706; 2006, $14,876)		14,297			14,755
Short-term investments, at amortized cost		24,258			25,623

Total investments		457,064			428,102
Cash and equivalents		13,183			7,960
Premiums in course of collection, net		37,813			37,428
Deferred policy acquisition costs		26,497			26,915
Prepaid reinsurance premiums		15,631			14,051
Reinsurance recoverable on paid losses, net		5,808			7,524
Reinsurance recoverable on unpaid losses, net		37,757			36,104
Deferred federal income tax asset		15,235			11,561
Income taxes recoverable		644			—
Other assets		10,338			9,403

Total assets	$	619,970			579,048

Liabilities and Shareholders’ Equity
Loss and loss expense reserves	$	275,082			250,672
Unearned premiums		126,717			127,620
Long term debt		25,000			25,000
Line of credit		4,650			4,000
Accrued expenses and other liabilities		16,614			9,778
Reinsurance balances payable		6,307			7,706
Collateral held		10,888			10,370
Income taxes payable		—			1,514

Total liabilities		465,258			436,660

Shareholders’ equity:
Common stock, without par value:
Common shares — Issued and outstanding 13,358,867 shares at September 30, 2007 and 13,248,323 shares issued and outstanding at December 31, 2006		—			—
Additional paid-in capital		102,967			100,954
Retained earnings		59,833			43,830
Accumulated other comprehensive loss, net of taxes		(8,088	)		(2,396	)

Total shareholders’ equity		154,712			142,388

Total liabilities and shareholders’ equity	$	619,970			579,048

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Shareholders’ Equity
and Comprehensive Income

(Unaudited)

(In thousands)


	Nine Months Ended September 30,
	2007			2006
Shareholders’ Equity
Capital stock:
Beginning of period	$	—			—
Stock issued		—			—

End of period		—			—

Additional paid-in capital:
Beginning of period		100,954			100,202
Impact of adoption of SFAS 123R		—			(695	)
Shares issued under share compensation plans		985			989
Tax benefit on share compensation plans		331			6
Exercise of share options		697			91

End of period		102,967			100,593

Retained earnings:
Beginning of period		43,830			24,846
Net income		17,606			14,758
Dividend declared (2007, $0.12/share and 2006, $0.105/share)		(1,603	)		(1,389	)

End of period		59,833			38,215

Unearned share compensation:
Beginning of period		—			(695	)
Impact of adoption of SFAS 123R		—			695

End of period		—			—

Accumulated other comprehensive loss, net of taxes:
Beginning of period		(2,396	)		(3,150	)
Unrealized holding (losses) gains arising during the period, net of reclassification adjustment		(5,692	)		1,247

End of period		(8,088	)		(1,903	)

Total shareholders’ equity	$	154,712			136,905

Comprehensive (Loss) Income
Net income	$	17,606			14,758
Other comprehensive (loss) income:
Unrealized (losses) gains on securities:
Unrealized holding (losses) gains arising during the period:
Gross		(9,345	)		1,772
Related federal income tax benefit (expense)		3,268			(549	)

Net unrealized (losses) gains		(6,077	)		1,223

Reclassification adjustment for losses included in net income
Gross		(593	)		(37	)
Related federal income tax benefit		208			13

Net reclassification adjustment		(385	)		(24	)

Other comprehensive (loss) income		(5,692	)		1,247

Total comprehensive income	$	11,914			16,005

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows

(Unaudited)

(In thousands)


	Nine Months Ended September 30,
	2007			2006
Cash flows provided by operating activities:
Net income	$	17,606			14,758
Adjustments:
Net realized investment losses		593			37
Deferred federal income tax benefit		(614	)		(1,280	)
Share-based compensation expense		985			989
Changes in assets and liabilities:
Premiums in course of collection, net		(385	)		(3,724	)
Deferred policy acquisition costs		418			(2,828	)
Prepaid reinsurance premiums		(1,580	)		(2	)
Reinsurance recoverable on paid and unpaid losses, net		63			(2,065	)
Income taxes payable/receivable		(2,158	)		(491	)
Losses and loss expense reserves		24,410			29,272
Collateral held		518			155
Unearned premiums		(903	)		12,595
Other, net		(2,053	)		377

Net cash provided by operating activities		36,900			47,793

Cash flows used in investing activities:
Purchases of equity securities		(12,574	)		(8,829	)
Purchases of fixed maturity securities available-for-sale		(163,046	)		(90,998	)
Proceeds from sales of equity securities		8,914			10,056
Proceeds from sales and maturities of fixed maturities available-for-sale		126,196			52,393
Change in short-term investments		1,365			(14,958	)
Change in securities receivable/payable		7,393			8,590

Net cash used in investing activities		(31,752	)		(43,746	)

Cash flows provided by (used in) financing activities:
Dividend paid to shareholders		(1,603	)		(1,389	)
Exercise of share options		697			6
Tax benefit on share compensation plans		331			91
Draw on line of credit		650			1,000
Principal payment on line of credit		—			(1,000	)

Net cash provided by (used in) financing activities		75			(1,292	)

Increase in cash and equivalents		5,223			2,755
Cash and equivalents at beginning of period		7,960			5,628

Cash and equivalents at end of period	$	13,183			8,383

Supplemental disclosure of cash flow information:
Interest paid	$	2,339			1,734

Federal income taxes paid	$	10,150			7,850

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

September 30, 2007

(Unaudited)

(1)		Basis of Presentation

		The accompanying interim unaudited consolidated condensed financial statements and notes include the accounts of ProCentury Corporation (the “Company” or “ProCentury”), and its wholly owned insurance subsidiaries, Century Surety Company (“Century”) and ProCentury Insurance Company (“PIC”). The interim unaudited consolidated condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Article 10 of Regulation S-X. Accordingly, the interim unaudited consolidated condensed financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of results for the interim periods have been included. These interim unaudited consolidated condensed financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes in the Company’s audited consolidated financial statements, included in the Company’s annual report on Form 10-K for the year ended December 31, 2006. The Company’s results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.

		In preparing the interim unaudited consolidated condensed financial statements, management was required to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

		Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of loss and loss expense reserves, the recoverability of deferred policy acquisition costs, the determination of federal income taxes, the net realizable value of reinsurance recoverables, the valuation of investments and the determination of other-than-temporary declines in the fair value of investments. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.

		All significant intercompany balances and transactions have been eliminated.

(2)		Income per Common Share

		Basic income per share (“EPS”) excludes dilution and is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common shares (common share equivalents) were exercised. When inclusion of common share equivalents increases the EPS or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, diluted net income or net loss per share is computed excluding the common share equivalents.

		Based on the above and pursuant to disclosure requirements contained in SFAS No. 128, Earnings Per Share, the following information represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the Company’s interim unaudited consolidated condensed financial statements:


	Three Months Ended September 30, 2007
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	5,759		13,252,010	$	0.43
Effect of Dilutive Securities
Restricted common shares and share options		—		113,574		—

Diluted EPS
Net income	$	5,759		13,365,584	$	0.43


	Three Months Ended September 30, 2006
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	5,133		13,133,711	$	0.39
Effect of Dilutive Securities
Restricted common shares and share options		—		136,878		—

Diluted EPS
Net income	$	5,133		13,270,589	$	0.39


	Nine Months Ended September 30, 2007
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	17,606		13,237,198	$	1.33
Effect of Dilutive Securities
Restricted common shares and share options		—		165,026		(0.02	)

Diluted EPS
Net income	$	17,606		13,402,224	$	1.31


	Nine Months Ended September 30, 2006
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	14,758		13,116,317	$	1.13
Effect of Dilutive Securities
Restricted common shares and share options		—		123,246		(0.02	)

Diluted EPS
Net income	$	14,758		13,239,563	$	1.11

(3)		Investments

		The Company invests primarily in investment-grade fixed income securities. The amortized cost, gross unrealized gains and losses and estimated fair value of fixed maturities classified as held-to-maturity were as follows:


	September 30, 2007
			(In thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
U.S. Treasury securities	$	87		10		—			97
Agencies not backed by the full faith and credit of the U.S. Government		1,016		—		(7	)		1,009

Total	$	1,103		10		(7	)		1,106


	December 31, 2006
			(In thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
U.S. Treasury securities	$	88		10		—			98
Agencies not backed by the full faith and credit of the U.S. Government		1,026		—		(23	)		1,003

Total	$	1,114		10		(23	)		1,101

The amortized cost, gross unrealized gains and losses, and estimated fair value of fixed-maturity and equity securities classified as available-for-sale were as follows:


	September 30, 2007
			(In thousands)
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Fixed maturities:
U.S. Treasury securities	$	2,403		17		(13	)		2,407
Agencies not backed by the full faith and credit of the U.S. Government		14,562		42		(76	)		14,528
Obligations of states and political subdivisions		181,158		336		(1,237	)		180,257
Corporate securities		36,398		43		(565	)		35,876
Mortgage-backed securities		69,469		26		(1,456	)		68,039
Collateralized mortgage obligations		55,794		186		(1,462	)		54,518
Asset-backed securities		37,803		194		(5,653	)		32,344

Total fixed maturities		397,587		844		(10,462	)		387,969

Equities:
Equity securities		31,851		12		(2,426	)		29,437
Bond mutual funds		14,706		1		(410	)		14,297

Total equities		46,557		13		(2,836	)		43,734

Total	$	444,144		857		(13,298	)		431,703


	December 31, 2006
			(In thousands)
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Fixed maturities:
U.S. Treasury securities	$	3,636		—		(49	)		3,587
Agencies not backed by the full faith and credit of the U.S. Government		13,793		—		(258	)		13,535
Obligations of states and political subdivisions		150,981		445		(795	)		150,631
Corporate securities		35,058		125		(730	)		34,453
Mortgage-backed securities		59,599		34		(1,108	)		58,525
Collateralized mortgage obligations		49,486		152		(622	)		49,016
Asset-backed securities		49,513		316		(1,154	)		48,675

Total fixed maturities		362,066		1,072		(4,716	)		358,422

Equities:
Equity securities		28,112		346		(270	)		28,188
Bond mutual funds		14,876		62		(183	)		14,755

Total equities		42,988		408		(453	)		42,943

Total	$	405,054		1,480		(5,169	)		401,365

		Other-than-temporary impairment losses result in permanent reductions to the cost basis of the underlying investments and are recorded as realized losses in the interim unaudited consolidated condensed statements of operations. Other-than-temporary losses of $764,000 and $1.6 million were realized on fixed maturity securities during the three and nine months ended September 30, 2007. These losses related to ten and twenty eight asset-backed securities that were written down in accordance with EITF 99-20 in the three and nine months ended September 30, 2007, respectively. In addition, five equity securities were written down in the amount of $308,000 during the three and nine months ended September 30, 2007. Other-than-temporary impairments of $202,000 were realized during the three and nine months ended September 30, 2006.

		The estimated fair value, related gross unrealized loss, and the length of time that the securities have been impaired for held-to-

maturity securities that are considered temporarily impaired at September 30, 2007 are as follows:


	September 30, 2007
	Less than 12 months				12 months or longer					Total
	Estimated		Gross		Estimated		Gross			Estimated		Gross
	fair		unrealized		fair		unrealized			fair		unrealized
	value		loss		value		loss			value		loss
					(In thousands)
Fixed Maturity Securities:
U.S. Treasury Securities	$	—		—		—		—			—		—
Agencies not backed by the full faith and credit of the U.S. Government		—		—		1,009		(7	)		1,009		(7	)

Total	$	—		—		1,009		(7	)		1,009		(7	)

The estimated fair value, related gross unrealized losses, and the length of time that the securities have been impaired for available-for-sale securities that are considered temporarily impaired at September 30, 2007 are as follows:


	September 30, 2007
	Less Than 12 Months					12 Months or Longer					Total
	Estimated		Gross			Estimated		Gross			Estimated		Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loss
						(In thousands)
Fixed maturity securities:
U.S. Treasury securities	$	0		0			1,302		(13	)		1,302		(13	)
Obligations of U.S. government corporations and agencies		0		0			6,714		(76	)		6,714		(76	)
Obligations of states and political subdivisions		88,149		(836	)		37,650		(401	)		125,799		(1,237	)
Corporate securities		5,906		(122	)		25,933		(443	)		31,839		(565	)
Mortgage-backed securities		37,195		(564	)		29,716		(892	)		66,911		(1,456	)
Collateralized mortgage obligations		15,450		(1,071	)		16,432		(391	)		31,882		(1,462	)
Asset-backed securities		10,925		(3,108	)		10,690		(2,545	)		21,615		(5,653	)

Total		157,625		(5,701	)		128,437		(4,761	)		286,062		(10,462	)
Equities:
Equity securities		24,757		(2,301	)		3,830		(125	)		28,587		(2,426	)
Bond mutual funds		8,743		(243	)		5,258		(167	)		14,001		(410	)

Total		33,500		(2,544	)		9,088		(293	)		42,588		(2,836	)

Grand Total	$	191,125		(8,245	)		137,525		(5,054	)		328,650		(13,298	)

At September 30, 2007, the Company had 182 fixed income securities and 8 equity securities that have been in an unrealized loss position for one year or longer. Of the fixed income securities, 160 are investment grade, of which 147 of these securities are rated A1/A or better (including 106 securities which are rated AAA). The 22 remaining non-investment grade fixed income securities have an aggregate fair value equal to 69.3% of their book value as of September 30, 2007. Of the equity securities, three that have been in an unrealized loss position for one year or longer relate to investments in closed or open ended bond or preferred stock funds. Each of these investments continues to pay its regularly scheduled monthly dividend and there have been no material changes in credit quality for any of these funds over the past twelve months. Finally, the five remaining equity securities that have been in an unrealized loss position for one year or longer relate to preferred share investments in issuers each of which has shown an improved or stable financial performance during the past twelve months. In addition, these five equity securities have an aggregate fair market value equal to 93.1% of their book value as of September 30, 2007. All 182 of the fixed income securities are current on interest and principal and all of the equity securities continue to pay dividends at a level consistent with the prior year. Management believes that it is probable that all contract terms of each security will be satisfied. The unrealized loss position for all investments, including equity securities, is due to the changes in interest rate environment and current capital market conditions and the Company has the positive intent and ability to hold these securities until they mature or recover in value.

(4)		Loss and Loss Expense Reserves

		Loss and loss expense reserves represent our best estimate of ultimate amounts for losses and related expenses from claims that have been reported but not paid, and those losses that have occurred but have not yet been reported to us. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates, actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to us, a review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability, and many other factors. In establishing reserves, we also take into account estimated recoveries, reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ.

		Net loss and loss expenses incurred were $33.0 million for the quarter ended September 30, 2007, compared to $34.4 million for the quarter ended September 30, 2006. In the third quarter of 2007, the Company recorded $34.0 million of incurred losses and loss expenses attributable to the 2007 accident year, which was partially offset by favorable development of $946,000 attributable to events of prior years. In the third quarter of 2006, the Company recorded $35.6 million of incurred losses and loss expenses attributable to the 2006 accident year and $1.2 million of favorable development attributable to events of prior years.

		Net loss and loss expenses incurred were $100.0 million for the nine months ended September 30, 2007, compared to $97.4 million for the nine months ended September 30, 2006. In the first nine months of 2007, the Company recorded $104.5 million of incurred losses and loss expenses attributable to the 2007 accident year, which were partially offset by favorable development of $4.5 million attributable to events of prior years, as discussed below. For the nine months ended September 30, 2006, the Company recorded $97.0 million of incurred losses and loss expenses attributable to the 2006 accident year and $353,000 attributable to events of prior years.

		For the three months ended September 30, 2007, the Company experienced favorable non-catastrophe case reserve development within the property line, producing a reduction in ultimate loss and loss expenses by $1.8 million primarily for the 2005 and 2006 accident years. Within the casualty line, the Company experienced $981,000 of unfavorable development primarily related to the settlement of one claim and an increase in projected construction defect claim counts.

		For the three months ended September 30, 2006, the Company experienced favorable non-catastrophe case reserve development within the property line, producing a reduction in ultimate loss and loss expenses by $3.3 million, primarily for the 2004 and 2005 accident years. This favorable development was offset by an increase of $200,000 in casualty reserves during the three month period as a result of a small amount of adverse development in the casualty line related to one specific claim. Additionally, the Company recorded approximately $1.9 million of unfavorable development during the three months ended September 30, 2006 primarily related to estimated costs associated with possible reinsurance collection issues on the 1998 through 1999 workers compensation reinsurance treaties.

		The favorable development during the nine months ended September 30, 2007 resulted primarily from reductions in the ultimate loss ratios for accident years 2005 and 2006 on the claims made contractor liability business included in our property and casualty segment. The Company reduced carried reserves related to the 2005 and 2006 casualty business based on the Company’s internal actuarial reserve recommendations. The 2005 and 2006 casualty reserves have performed better than expected to date, and previously carried reserves exceeded the current indications for each of the estimation methods applied in the Company’s internal actuarial analysis. At the beginning of 2005, the Company began writing certain contractors’ liability business on a claims made form, replacing the occurrence form which had previously been utilized through 2004. The Company wrote a significant volume of claims made contractor business in both 2005 and 2006, and this business has continued to perform better than expected. The Company continues to monitor loss emergence on this book and adjusts assumptions and estimates as needed. The Company continues to write contractor business on an occurrence form on a limited basis, in certain jurisdictions and for certain classes of business. In addition, this favorable development was supplemented in the third quarter of 2007 by $1.8 million of favorable development in our property line as a result of favorable case reserve development that was below our expectations, resulting in a reduction of our ultimate loss and loss expenses for the 2005 and 2006 accident years.

		For the nine months ended September 30, 2006, the Company experienced favorable non-catastrophe property case reserve development producing a reduction in ultimate loss and loss expenses by $7.0 million primarily for the 2004 and 2005 accident years. The Company also changed its estimates during such nine month period on catastrophe losses by reducing its estimates on Hurricane Wilma by $1.2 million due to actual incurred losses being lower than original estimates. This favorable development

		was offset by an increase of $4.3 million in casualty reserves during such nine-month period as a result of a small amount of adverse development in the casualty line and a result of a refinement to the internal actuarial reserving technique concerning the weighting of reserve indications and supplemental information concerning claims severities. The Company’s casualty reserves moved to a higher point on the range of loss and loss expense reserve estimate, despite the fact that overall, the Company’s casualty book of business performed within the range of expectations for the quarter and nine months ended September 30, 2006. The Company also incurred approximately $1.4 million of adverse development during the nine months ended September 30, 2006 due to an increase in legal severities on construction defect claims. Additionally, the Company recorded approximately $2.9 million of unfavorable development during the nine months ended September 30, 2006 related to estimated costs associated with possible reinsurance collection issues on two separate casualty claims and the 1998 and 1999 workers compensation reinsurance treaties.

		Management believes the loss and loss expense reserves make a reasonable provision for expected losses, however, ultimate settlement of these amounts could vary significantly from the amounts recorded.

(5)		Reinsurance

		In the ordinary course of business, Century and PIC assume and cede reinsurance with other insurers and reinsurers. These arrangements provide greater diversification of business and limit the maximum net loss potential on large risks. There have been no significant changes in the Company’s reinsurance program, since December 31, 2006. The amounts of ceded loss and loss expense reserves and ceded unearned premiums would represent a liability of the Company in the event that its reinsurers would be unable to meet existing obligations under reinsurance agreements.

		The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and loss expenses incurred were as follows:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
Premiums written:
Direct	$	63,934			68,849			186,950			190,612
Assumed		1,202			454			4,425			2,400
Ceded		(9,304	)		(8,638	)		(26,899	)		(23,426	)

Net premiums written	$	55,832			60,665			164,476			169,586

Premiums earned:
Direct		63,019			62,831			187,206			177,977
Assumed		1,567			523			5,072			2,440
Ceded		(8,713	)		(7,929	)		(25,320	)		(23,425	)

Net premiums earned	$	55,873			55,425			166,958			156,992

Losses and loss expenses incurred:
Direct	$	36,468			34,133			107,982			106,993
Assumed		213			481			974			838
Ceded		(3,644	)		(221	)		(8,918	)		(10,424	)

Net losses and loss expenses incurred	$	33,037			34,393			100,038			97,407

		The Company’s allowance for uncollectible reinsurance was $3.4 million at September 30, 2007. The allowance for uncollectible reinsurance was $4.1 million at December 31, 2006. During the third quarter of 2007, the Company settled with one of its reinsurers and established a $200,000 allowance related to arbitration costs associated with a dispute with another reinsurer.

		Management believes that the reserves for uncollectible reinsurance constitute a reasonable provision for expected costs and recoveries related to the collection of the recoverables on these claims; however, actual legal costs and settlements of these claims could vary significantly from the current estimates recorded.

(6)		Deferred Policy Acquisition Costs

		The following reflects the amounts of policy acquisition costs deferred and amortized:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
Balance at beginning of period	$	26,782			22,906			26,915			20,649
Policy acquisition costs deferred		13,783			15,011			42,038			42,230
Amortization of deferred policy acquisition costs		(14,068	)		(14,440	)		(42,456	)		(39,402	)

Balance at end of period	$	26,497			23,477			26,497			23,477

		As of September 30, 2007, the Company expensed $41,000 of unamortized deferred policy acquisition costs related to the auto physical damage program. This expense was a result of the fact that the program’s loss and loss expense ratio exceeded our expectations causing the program to fall below the profitability levels required for continued deferral of the additional policy acquisition costs. As of September 30, 2006, the Company expensed $766,000 of unamortized deferred policy acquisition costs related to the auto physical damage program.

(7)		Federal Income Taxes

		The income tax provision for the three and nine months ended September 30, 2007 has been computed based on our estimated annual effective tax rate of 30.5% which differs from the federal income tax rate of 35% principally because of tax-exempt investment income. The income tax provision for the three and nine months ended September 30, 2006 of 30.3% and 29.5%, respectively, was computed based on our estimated annual effective tax rate of 29.5% which differs from the federal income tax rate of 35% principally because of tax-exempt investment income.

(8)		Commitments and Contingencies

		We are party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Certain of the lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer, the liabilities for which we believe have been adequately included in our loss and loss adjustment expense reserves. Also, from time to time, we are party to lawsuits, arbitrations and other proceedings that relate to disputes over contractual relationships with third parties or that involve alleged errors and omissions on the part of our insurance subsidiaries. We provide accruals for these items to the extent we deem the losses probable and reasonably estimable.

		The outcome of litigation is subject to numerous uncertainties. Although the ultimate outcome of pending matters cannot be determined at this time, based on present information, we believe the resolution of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

		In August of 2007, the Board of Directors approved a $10.0 million share repurchase plan. As of September 30, 2007, no shares have been repurchased under this plan.

(9)		Employee Benefits

		During 2004, the Company adopted and the shareholders approved a stock option plan that provided for tax-favored incentive share options (qualified options), non-qualified share options to employees and board members that do not qualify as tax-favored incentive share options (non-qualified options), time-based restricted shares that vest solely on service provided, restricted shares that vest based on achieved performance metrics and non-restricted shares that are issued in conjunction with the Company’s annual bonus plan. The Company accounts for this plan in accordance with FAS 123R. Any compensation cost recorded in accordance with FAS 123R is recorded in the same captions as the salary expense of the employee (i.e. the compensation cost for the Chief Investment Officer is recorded in net investment income). The Company will issue authorized but unissued shares or treasury shares to satisfy restricted share awards or the exercise of share options.

		With respect to qualified options, an employee may be granted an option to purchase shares at the grant date fair market value, payable as determined by the Company’s board of directors. An optionee must exercise an option within 10 years from the grant date. Full vesting of option grants occurs at the end of four years.

		With respect to non-qualified options, an employee or a board member may be granted an option to purchase shares at the grant date fair market value, payable as determined by the Company’s board of directors. An optionee must exercise an option within 10

		years from the grant date. Full vesting of option grants occurs at the end of three years for the board of directors and four years for employees.

		For both non-qualified and qualified options, the option exercise price equals the stock’s fair market value on the date of the grant. Compensation expense is measured on the grant date fair value using a Black Scholes model. The compensation cost is recognized over the respective service period, which typically matches the vesting period.

		The time-based restricted shares are granted to key executives and vest in equal installments upon the lapse of a period of time, typically over four-and five-year periods; and include both monthly and annual vesting periods. Compensation expense for time-based restricted shares is measured on the grant date fair value and then recognized over the respective service period, which typically matches the vesting period.

		The performance-based restricted shares are granted to key executives and vest annually over a four-year period based on achieved specified performance metrics. Compensation expense for performance-based restricted share awards is recognized based on the fair value of the awards on the date of grant.

		The non-restricted shares are granted to key executives pursuant to the stock option plan in conjunction with the Company’s annual bonus plan and are fully vested on the date of grant. These shares are granted to the executive when the annual bonus plan calculation exceeds the employee’s target bonus. Under the annual bonus plan the portion of the bonus that is less than or equal to the executive’s target bonus is paid in cash and any amount greater than the target bonus is paid in non-restricted shares. Compensation expense for non-restricted shares is recognized based on the grant date fair value.

		The Company may grant awards for up to 1.2 million shares under the plan. Through September 30, 2007, the Company had granted 311,000 non-qualified options, 292,500 qualified options, 156,000 time-based restricted shares, 127,353 performance- based restricted shares, and 8,661 non-restricted shares under the share plan.

		The Company did not grant any awards during the three months ended September 30, 2007. During the second quarter of 2007, the Company granted 12,000 non-qualified options to members of its board of directors which vest monthly over a three-year period. During the quarter ended March 31, 2007, the Company awarded certain employees 85,000 share options which vest monthly over a four-year period. The weighted average fair value of options granted during the nine months ended September 30, 2007 was $6.46. A summary of the status of the option plan at September 30, 2007, and changes during the three and nine months then ended is presented in the following table:


	For the Three Months Ended					For the Nine Months Ended
	September 30, 2007					September 30, 2007
				Weighted-					Weighted-
	Number of			Average		Number of			Average
	Shares			Exercise Price		Shares			Exercise Price
Outstanding at beginning of period		536,642		$	12.26		505,900		$	10.58
Changes during the period:
Granted		—			—		97,000			19.81
Exercised		—			—		(66,258	)		10.51
Forfeited		(4,088	)		15.15		(4,088	)		15.15
Expired		—			—		—			—

Outstanding at end of period		532,554		$	12.24		532,554		$	12.24

Exercisable at end of period		367,774		$	10.84		367,774		$	10.84

The fair market value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants issued during the nine months ended September 30, 2007:


	Nine Months
	Ended September 30,
	2007
Risk-free interest rate		4.51	%
Expected dividends		0.74	%
Expected volatility		25.45	%
Weighted average expected term	6.28		Years

Information on the range of exercise prices for options outstanding at September 30, 2007, is as follows:


			Options Outstanding
			Weighted							Options Excercisable
			Average		Weighted							Weighted
			Remaining		Average		Aggregate					Average		Aggregate
	Outstanding		Contractual		Exercise		Intrinsic			Exercisable		Exercise		Intrinsic
Price Range	Options		Term		Price		Value			Options		Price		Value
$10.20		11,386		7.7	$	10.20	$	50,440			9,156	$	10.20	$	40,561
$10.50		309,349		6.6	$	10.50	$	1,277,611			296,112	$	10.50	$	1,222,944
$10.64		106,042		8.3	$	10.64	$	423,108			45,562	$	10.64	$	181,792
$13.04		10,721		8.7	$	13.04	$	17,046			5,156	$	13.04	$	8,198
$18.70		10,056		9.7	$	18.70	$	(40,928	)		1,176	$	18.70	$	(4,786	)
$19.97		85,000		9.4	$	19.97	$	(453,900	)		10,612	$	19.97	$	(56,668	)

							$	1,273,377						$	1,392,041

A summary of all employee time-based restricted share activity during the three and nine months ended September 30, 2007 is as follows:


	For the Three Months Ended September 30, 2007					For the Nine Months Ended September 30, 2007
				Weighted					Weighted
	Number of			Average		Number of			Average
	Shares			Grant Price		Shares			Grant Price
Outstanding at beginning of period		35,699		$	10.15		45,156		$	10.19
Changes during the period:
Granted		—			—		—			—
Vested		(10,678	)		10.15		(20,135	)		10.24
Cancelled		—			—		—			—

Outstanding at end of period		25,021		$	10.15		25,021		$	10.15

In March 2007, the Company granted 35,625 performance-based restricted shares to certain executives that vest annually over a four-year period subject to the achievement of certain performance metrics. The Company accounts for these awards as fixed awards that are recorded at fair value on the date of grant. A summary of all employee performance-based restricted share activity during the three and nine months ended September 30, 2007 is as follows:


	For the Three Months					For the Nine Months
	Ended September 30, 2007					Ended September 30, 2007
				Weighted					Weighted
	Number of			Average		Number of			Average
	Shares			Grant Price		Shares			Grant Price
Outstanding at beginning of period		91,012		$	15.82		64,728		$	12.76
Changes during the period:
Granted		—			—		35,625			19.97
Vested		(9,176	)		14.49		(18,517	)		12.48
Cancelled		—			—		—			—

Outstanding at end of period		81,836		$	15.96		81,836		$	15.96

		As of September 30, 2007, total compensation cost related to nonvested share options or restricted shares was $1.7 million, which is expected be recorded over 2.4 years. Total compensation cost for share-based awards was $281,000 and $376,000 for the three months ended September 30, 2007 and 2006, respectively. For the nine months ended September 30, 2007 and 2006, total compensation cost was $985,000 and $989,000, respectively. The tax benefit included in the accompanying statements of operations related to the compensation cost was $11,000 and $46,000 for the three months ended September 30, 2007 and 2006, respectively. For the nine months ended September 30, 2007 and 2006 the tax benefit included in the accompanying statements of operations related to the compensation cost was $331,000 and $91,000, respectively. For the three and nine months ended September 30, 2007, the Company had $47,000 and $165,000 of compensation cost for share-based awards capitalized with deferred policy acquisition costs.

(10)		Segment Reporting Disclosures

		The Company operates in the Property and Casualty Segment (including general liability, multi-peril, commercial property, garage liability and auto physical damage).

		The Company’s Other Segment (including exited lines) includes the surety business and the Company’s exited lines, such as workers’ compensation and commercial auto/trucking. A limited amount of surety business is written in order to maintain Century’s U.S. Treasury listing.

		All investment activities are included in the Investing operating segment.

		The Company considers many factors, including economic similarity, the nature of the underwriting unit’s insurance products, production sources, distribution strategies and regulatory environment in determining how to aggregate operating segments.

		Segment profit or loss for each of the Company’s segments is measured by underwriting profit or loss. The property and casualty insurance industry commonly defines underwriting profit or loss as earned premium net of loss and loss expenses and underwriting, acquisition and insurance expenses. Underwriting profit or loss does not replace operating income or net income computed in accordance with GAAP as a measure of profitability. Segment profit for the Investing operating segment is measured by net investment income and net realized gains or losses. The Company does not allocate assets, including goodwill, to the Property and Casualty and Other operating segments for management reporting purposes. The total investment portfolio and cash are allocated to the Investing operating segment.

		Following is a summary of segment disclosures:


	For the Three Months					For the Nine Months
	Ended September 30,					Ended September 30,
	2007		2006			2007		2006
	(In thousands)					(In thousands)
Segment revenue:
Property and Casualty	$	54,474		55,044			162,501		155,005
Investing		5,216		5,003			15,904		14,077
Other (including exited lines)		1,399		381			4,457		1,987

Segment revenue	$	61,089		60,428			182,862		171,069


Segment profit:
Property and Casualty	$	3,459		4,208			11,177		9,088
Investing		5,216		5,003			15,904		14,077
Other (including exited lines)		380		(994	)		914		(276	)

Segment profit	$	9,055		8,217			27,995		22,889


Segment assets:
Investing	$	457,064		413,606			457,064		413,606
Assets not allocated		162,906		127,028			162,906		127,028

Total consolidated assets	$	619,970		540,634			619,970		540,634

The following summary reconciles significant segment items to the Company’s interim unaudited consolidated condensed financial statements:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
	(In thousands)						(In thousands)
Total revenues:
Segment revenues	$	61,089			60,428			182,862			171,069
Other		159			101			379			353

Total consolidated revenues	$	61,248			60,529			183,241			171,422

Income before income tax expense:
Segment profit	$	9,055			8,217			27,995			22,889
Unallocated amounts:
Other income		159			101			379			353
Corporate expenses		(261	)		(341	)		(1,021	)		(598	)
Interest expense		(684	)		(608	)		(2,038	)		(1,718	)

Income before income tax expense	$	8,269			7,369			25,315			20,926

The following is a summary of earned premium by group of products:


	Property		Casualty		Other		Consolidated
			(In thousands)
Three Months Ended September 30, 2007
Property and Casualty	$	19,019		35,455		—		54,474
Other (including exited lines)		—		—		1,399		1,399

Earned premiums	$	19,019		35,455		1,399		55,873


Three Months Ended September 30, 2006
Property and Casualty	$	15,779		39,265		—		55,044
Other (including exited lines)		—		—		381		381

Earned premiums	$	15,779		39,265		381		55,425


	Property		Casualty		Other		Consolidated
			(In thousands)
Nine Months Ended September 30, 2007
Property and Casualty	$	57,391		105,110		—		162,501
Other (including exited lines)		—		—		4,457		4,457

Earned premiums	$	57,391		105,110		4,457		166,958


Nine Months Ended September 30, 2006
Property and Casualty	$	45,251		109,754		—		155,005
Other (including exited lines)		—		—		1,987		1,987

Earned premiums	$	45,251		109,754		1,987		156,992

		The Company does not manage property and casualty products at this level of detail.

(11)		Dividends to Common Shareholders

		On March 8, 2007, the Board of Directors declared a dividend of $0.04 per common share that was paid on April 18, 2007 to shareholders of record as of March 27, 2007. In addition, on May 17, 2007, the Board of Directors declared a dividend of $0.04 per common share that was paid on June 6, 2007 to shareholders of record as of May 24, 2007. On August 16, 2007, the Board of Directors declared a dividend of $0.04 per common share was paid on September 19, 2007 to shareholders of record as of August 29, 2007.

		On March 13, 2006, the Board of Directors declared a dividend of $0.03 per common share that was paid on April 17, 2006 to shareholders of record as of March 27, 2006. In addition, on May 15, 2006, the Board of Directors declared a dividend of $0.035 per common share that was paid on June 7, 2006 to shareholders of record as of May 24, 2006. On August 16, 2006, the Board of Directors declared a dividend of $0.04 per common share that was paid on September 20, 2006 to shareholders of record as of August 30, 2006.

(12)		Line of Credit

		The Company has a $10.0 million line of credit with a maturity date of September 30, 2009, and interest only payments due quarterly based on LIBOR plus 1.2% of the outstanding balance. All of the outstanding shares of Century are pledged as collateral. The Company did not make any draws on the line of credit during the third quarter of 2007. During the first nine months of 2007, the Company made draws totaling $650,000 on the line of credit for general corporate purposes. At September 30, 2007, there was $4.7 million outstanding under the line of credit. Interest expense for the three and nine months ended September 30, 2007 was approximately $77,000 and $246,000, respectively. The Company did not have any borrowings outstanding under the line of credit at September 30, 2006. Interest expense for the three and nine months ended September 30, 2006 was $6,000.

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our interim unaudited consolidated condensed financial statements and the notes to those statements included in this Form 10-Q. Some of the statements in this report, including those set forth in the discussion and analysis below, are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are derived from information that we currently have and assumptions that we make and may be identified by words such as “believes,” “anticipates,” “expects,” “plans,” “should,” “estimates” and similar expressions. We cannot assure you that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties we face. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. Factors that could cause actual results to differ materially from our forward-looking statements are described under the heading “Risks Related to Our Business and Industry” in our Annual Report on Form 10-K for the year ended December 31, 2006, and elsewhere in this report, and include, but are not limited to, the following factors:

	•		our business is cyclical in nature and our industry is currently experiencing softening market conditions which may affect our financial performance, our ability to grow and the price of our common shares;

	•		our success depends on our ability to appropriately price the risks we underwrite;

	•		our actual incurred losses may be greater than our loss and loss expense reserves, which could cause our future earnings, liquidity and financial rating to decline;

	•		severe weather conditions and other catastrophes, including the wild fires in Southern California, may result in an increase in the number and amount of claims experienced by our insureds;

	•		a decline in our financial rating assigned by A.M. Best & Company may result in a reduction of new or renewal business;

	•		if we are unable to compete effectively with the large number of companies in the insurance industry for underwriting revenues, we may incur increased costs and our underwriting revenues and net income may decline;

	•		we distribute our products through a select group of general agents, five of which account for a significant part of our business, and such relationships could be discontinued or cease to be profitable;

	•		we may not be successful in developing our new specialty lines or new classes of insureds through our program unit that could cause us to experience losses;

	•		we may not find suitable acquisition candidates or new insurance ventures and even if we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures;

	•		our investment results and, therefore, our financial condition may be impacted by changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in government monetary policies, general economic conditions and overall capital market conditions, all of which impact interest rates;

	•		our investment performance may suffer as a result of adverse capital market developments or other factors, which may affect our financial results and ability to conduct business;

	•		if we are not able to renew our existing reinsurance or obtain new reinsurance, either our net exposure would increase or we would have to reduce the level of our underwriting commitment;

	•		our reinsurers may not pay claims made by us on losses in a timely fashion or may not pay some or all of these claims, in each case causing our costs to increase and our revenues to decline;

	•		we are subject to extensive regulation and judicial decisions affecting insurance and tort law, which may adversely affect our ability to achieve our business objectives. In addition, if we fail to comply with such regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations;

	•		as a holding company, we are dependent on the results of operations of our insurance subsidiaries and the regulatory and contractual capacity of our subsidiaries to pay dividends to us. Some states limit the aggregate amount of dividends our subsidiaries may pay to us in any twelve-month period, thereby limiting our funds to pay expenses and dividends;

	•		although we have paid cash dividends in the past, we may not pay cash dividends in the future;

	•		if we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered;

	•		managing technology initiatives and meeting new data security requirements present significant challenges to us;

	•		our general agents may exceed their authority and bind us to policies outside our underwriting guidelines, and until we effect a cancellation of a policy, we may incur loss and loss expenses related to that policy;

	•		our reliance on our agents subjects us to credit risk; and

	•		we are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act of 2002.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of their respective dates.

Overview

ProCentury is a holding company that underwrites selected property and casualty and surety insurance through its subsidiaries collectively known as Century Insurance Group^®. As a specialty insurer, we offer insurance products designed to meet specific insurance needs of targeted insured groups. The excess and surplus lines market provides an alternative market for customers with hard-to-place risks and risks that insurance companies licensed by the state in which the insurance policy is sold, which are also referred to as “admitted insurers,” typically do not cover. As an underwriter within the excess and surplus lines market, we are selective in the lines of business and types of risks we choose to write. We develop these specialty insurance products through our own experience or knowledge or through proposals brought to us by agents with special expertise in specific classes of business.

We evaluate our insurance operations by monitoring key measures of growth and profitability. The following provides further explanation of the key financial measures that we use to evaluate our results:

Written and Unearned Premium. Written premium is recorded based on the insurance policies that have been reported to us and, beginning in the fourth quarter of 2006, the policies that have been written by agents but not yet reported to us. We must estimate the amount of written premium not yet reported based on judgments relative to current and historical trends of the business being written. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date. For additional information regarding our written and unearned premium refer to Note 5 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Loss and Loss Expense Ratio. Loss and loss expense ratio is the ratio (expressed as a percentage) of losses and loss expenses incurred to premiums earned. Our net loss and loss expense ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating expenses to premiums earned and measures a company’s operational efficiency in producing, underwriting and administering its insurance business. Interest expense is not included in the calculation of the expense ratio.

Combined Ratio. Combined ratio is the sum of the loss and loss expense and the expense ratio and measures a company’s overall underwriting profit. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). We use the combined ratio in evaluating our overall underwriting profitability and as a measure for comparing our profitability relative to the profitability of our competitors.

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of other-than-temporary declines in the fair value of investments, the determination of loss and loss expense reserves, the net realizable value of reinsurance recoverables, the recoverability of deferred policy acquisition costs, and the determination of federal income taxes. Although considerable variability is inherent in these estimates, management believes that the amounts provided are reasonable. These estimates are continually reviewed and adjusted as necessary. Such adjustments are reflected in current operations.

Loss and Loss Expense Reserves. Loss and loss expense reserves represent an estimate of the expected cost of the ultimate settlement and administration of losses based on facts and circumstances then known. We use actuarial methodologies to assist us in establishing these estimates, including judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate resolution, consideration of new judicial decisions in tort and insurance law, emerging theories or liabilities and other factors beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may be different from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. Additional information regarding our loss and loss expense reserves can be found in “Results of Operations — Expenses — Losses and Loss Expenses” and Note 4 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Reinsurance Recoverables. Reinsurance recoverables on paid and unpaid losses, net, are established for the portion of our loss and loss expense reserves that are ceded to reinsurers. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers that can be significant considering that certain of the reserves remain outstanding for an extended period of time. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. See Note 5 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Impairment of Investments. Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. Under our accounting policy for equity securities and fixed-maturity securities that can be contractually prepaid or otherwise settled in a way that may limit our ability to fully recover cost, an impairment is deemed to be other-than-temporary unless we have both the ability and intent to hold the investment until the security’s forecasted recovery and evidence exists indicating that recovery will occur in a reasonable period of time.

For fixed-maturity and equity securities that can not be contractually prepaid or otherwise settled, an other-than-temporary impairment charge is taken when we do not have the ability and intent to hold the security until the forecasted recovery or maturity or if it is no longer probable that we will recover all amounts due under the contractual terms of the security. Many criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security; the amount and length of time a security’s fair value has been below amortized cost or cost; specific credit issues and financial prospects related to the issuer; our intent to hold or dispose of the security; and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment.

Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), FASB Emerging Task Force (EITF) 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets,” requires us to periodically update our best estimate of cash flows over the life of the security. If management determines that the fair value of a securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other-than-temporary impairment is recognized.

For additional detail regarding our investment portfolio at September 30, 2007 and December 31, 2006, including disclosures

regarding other-than-temporary declines in investment value, see “Investment Portfolio” below and Note 3 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. Acquisition costs are reduced by ceding commission income. These costs, net of ceded commission income, are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the written premiums. See Note 6 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Federal Income Taxes. We provide for federal income taxes based on amounts we believe we ultimately will owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain items and the realization of certain tax credits. In the event the ultimate deductibility of certain items or the realization of certain tax credits differs from estimates, we may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements. Any such change could significantly affect the amounts reported in the consolidated statements of income.

We utilize the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. See Note 7 to our interim unaudited consolidated condensed financial statements included in this Form 10-Q.

Results of Operations

The table below summarizes our operating results and key measures we use in monitoring and evaluating our operations. The information is intended to summarize and supplement information contained in our consolidated financial statements and to assist the reader in gaining a better understanding of our results of operations:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
	(In thousands)						(In thousands)
Selected Financial Data:
Gross written premiums	$	65,136			69,303			191,375			193,012
Premiums earned		55,873			55,425			166,958			156,992
Net investment income		5,571			4,999			16,497			14,114
Net realized investment (losses) gains		(355	)		4			(593	)		(37	)
Total revenues		61,248			60,529			183,241			171,422
Total expenses		52,979			53,160			157,926			150,496
Net income		5,759			5,133			17,606			14,758
Key Financial Ratios:
Loss and loss expense ratio		59.1	%		62.1	%		59.9	%		62.0	%
Expense ratio		34.5	%		32.8	%		33.5	%		32.7	%

Combined ratio		93.6	%		94.9	%		93.4	%		94.7	%

Overview of Operating Results

Net income was $5.8 million for the three months ended September 30, 2007 compared to net income of $5.1 million for the three months ended September 30, 2006. For the nine months ended September 30, 2007, net income was $17.6 million compared to net income of $14.8 million for the nine months ended September 30, 2006.

The increase in net income for the three and nine months ended September 30, 2007 was primarily attributable to an increase in earned premium and net investment income, coupled with a lower combined ratio. The increase in net earned premium resulted from our growth in gross written premiums in 2006 that is being earned in 2007. This increase was slightly offset by a decrease in gross written premium in the third quarter of 2007. Our gross written premiums decreased 6.0% for the third quarter of 2007 and .8% for the nine months ended September 30, 2007 compared to the same periods in 2006. During the third quarter, we continued to experience increased competition across our product lines with indications of other carriers continuing to lower their rates and expand their risk profile. Despite this increase in competition, we maintained our underwriting discipline. The increase in earned premium was supplemented by a 11.4% and 16.9% increase in net investment income for the three and nine months ended September 30, 2007, respectively, compared to the same periods in 2006. This is due to continued positive cash flows from operations. Our tax equivalent yield for the three and nine months ended September 30, 2007 was 5.6% and 5.7%, respectively, compared to 5.8% for the same periods in 2006. Net realized investments losses were $355,000 and $593,000 for the three and nine months ended September 30, 2007, respectively. This compares to net realized investment gains/(losses) of $4,000 and $(37,000) for the three and nine months ended September 30, 2006.

Total expenses remained stable at $53.0 million for the three months ended September 30, 2007 compared to the same period in 2006. For the nine months ended September 30, 2007, expenses increased to $157.9 million from $150.5 million for the same period in 2006. The increase in other operating expenses in the first nine months of 2007 is due to higher than expected costs related to our agent contingent commission program and $300,000 of professional and other fees expensed, which related primarily to an aborted public equity offering. The increases were partially offset by recoveries received from our corporate insurance policy. The combined ratio for the three months ended September 30, 2007 was 93.6% compared to 94.9% for the same period in 2006. For the first nine months of 2007, the combined ratio was 93.4% compared to 94.7% for the same period of 2006. For the quarter ended September 30, 2007, the loss and loss expense ratio was 59.1% compared to 62.1% and for the nine months ended September 30, 2007, our loss and loss expense ratio was 59.9% compared to 62.0%. For the three and nine months ended September 30, 2007, total loss and loss expenses related to the 2007 accident year was $34.0 million and $104.5 million respectively, which was partially offset by $946,000 and $4.5 million, respectively of favorable reserve development on prior accident years. This compares to $35.6 million and $97.0 million of current accident year loss and loss expenses and $1.2 million of favorable and $353,000 of unfavorable reserve development on prior accident years for the three and nine months ended September 30, 2006, respectively. The increase in loss and loss expenses for the nine months ended September 30, 2007 related to the current accident year is primarily due to the growth in earned premium as well as increases in losses primarily from the auto physical damage program. The favorable development for the nine months ended September 30, 2007 primarily related to our claims made contractors casualty business written in 2005 and 2006 and our property business written in 2005 and 2006. This business continued to perform better than our original estimates.

The expense ratio for the three months ended September 30, 2007 and 2006 was 34.5% and 32.8%, respectively. For the nine months ended September 30, 2007, our expense ratio was 33.5% compared to 32.7% for the same period in 2006. The increase in the expense ratio is directly attributable to higher contingent commissions due to the favorable loss experience, lower growth in earned premium and approximately $300,000 of professional fees and other costs incurred in the second quarter of 2007 related primarily to an aborted public equity offering. In addition, we incurred a higher blended commission rate due to a greater percentage of binding business that has a higher commission rate than that of brokerage business during the third quarter of 2007 and for the nine months ended September 30, 2007.

Revenues

Premiums

Premiums include insurance premiums underwritten by our insurance subsidiaries (which are referred to as direct premiums) and insurance premiums assumed from other insurers (which are referred to as assumed premiums). We refer to direct and assumed premiums together as gross premiums.

Written premium is recorded based on the insurance policies that have been reported to us and, beginning in the fourth quarter of 2006, the policies that have been written by agents but not yet reported to us. We estimate the amount of written premium not yet reported based on judgments relative to current and historical trends of the business being written. Such estimates are regularly reviewed and updated and any resulting adjustments will be included in the current year’s results. Written premiums are the total

amount of premiums billed to the policyholder less the amount of premiums returned, generally because of cancellations, during a given period.

We have historically relied on quota share, excess of loss, and catastrophe reinsurance primarily to manage our regulatory capital requirements and to limit our exposure to loss. We record the cost of reinsurance (ceded premium) as an offset to our gross written premiums. We refer to our gross written premiums less our ceded premiums as net written premiums. Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order to maintain net written premiums to statutory surplus ratio of less than 2-to-1.

Net written premiums become premiums earned as the policy ages. An unearned premium reserve is established to reflect the unexpired portion of each policy at the financial reporting date. Barring premium changes, if an insurance company writes the same mix of business each year, written premiums and premiums earned will be equal, and the unearned premium reserve will remain constant. During periods of growth, the unearned premium reserve will increase, causing premiums earned to be less than written premiums. Conversely, during periods of decline, the unearned premium reserve will decrease, causing premiums earned to be greater than written premiums.

Our underwriting business is currently divided into two primary segments:

	•		property/casualty; and

	•		other (including exited lines).

Our property/casualty segment primarily includes general liability, commercial property and multi-peril insurance for small and mid-sized businesses. The other (including exited lines) segment primarily includes our surety business, including landfill and specialty surety that is written in order to maintain Century’s U.S. Treasury listing.

The following table presents our gross written premiums in our primary segments and provides a summary of gross, ceded and net written premiums and net premiums earned for the periods indicated.


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
	(In thousands)						(In thousands)
Gross written premiums Property/casualty	$	63,597			68,442			186,896			190,322
Other (including exited lines)		1,539			861			4,479			2,690

Total gross written premiums		65,136			69,303			191,375			193,012
Ceded written premiums		9,304			8,638			26,899			23,426

Net written premiums	$	55,832			60,665			164,476			169,586


Net premiums earned	$	55,873			55,425			166,958			156,992


Net written premiums to gross written premiums		85.7	%		87.5	%		85.9	%		87.9	%
Net premiums earned to net written premiums		100.1	%		91.4	%		101.5	%		92.6	%
Net writings ratio (1)		1.5			1.8			1.4			1.7


(1)		The ratio of net written premiums to our insurance subsidiaries’ combined statutory surplus. Management believes this measure is useful in gauging our exposure to pricing errors in the current book of business. It may not be comparable to the definition of net writings ratio used by other companies.

Gross Written Premiums

Gross written premiums decreased by $4.2 million to $65.1 million for the three months ended September 30, 2007 from $69.3 million for the same period in 2006. For the nine months ended September 30, 2007, gross written premiums decreased $1.6 million to $191.4 million compared to $193.0 million for the comparable period in 2006. During the third quarter of 2007 and first nine months of 2007, we continued to experience an increase in competition with indications that we believe show other carriers are striving to increase their market share by reducing prices and providing broader coverage forms. These softening market conditions were most prevalent in our casualty market where we saw a decrease in premiums from our casualty book resulting from other carriers offering broader coverages at a lower price on certain classes of business. In addition, due to the unfavorable underwriting results from our auto physical damage book written in 2006, we significantly decreased the amount of business written in the program for the three and nine months ended September 30, 2007 compared to the same periods in 2006.

We have written a lower amount of business in the auto physical damage program and continue to encounter an increase in competition. However, we have experienced growth from our garage and ocean marine business. We have had moderate rate decreases in our core property and casualty business thus far in 2007. The increase in other, including exited lines, is due to higher assumed bonding business.

Net Written and Earned Premiums

Net written premiums decreased by $4.8 million to $55.8 million for the third quarter 2007 compared to the third quarter of 2006. For the nine months ended September 30, 2007, net written premiums decreased by $5.1 million compared to the same period in 2006. These decreases were due to lower gross written premiums and higher ceded premium. The additional ceded premium in the three and nine months ended September 30, 2007 compared to the same periods in 2006 is due to a change in the mix of business to the total business, which has a higher ceding rate than our casualty line.

Net written premiums represented 85.7% and 85.9% of gross written premiums for the three and nine months ended September 30, 2007, respectively, compared to 87.5% and 87.9% for the same periods, respectively in 2006. The lower relationship of net written premiums to gross written premiums for the three and nine months ended September 30, 2007 reflects an increase in ceded premiums in the current year, as noted above.

The ratio of premiums earned to net written premiums for the third quarter of 2007 and 2006 was 100.1% and 91.4%, respectively. Premiums earned represent 101.5% of net written premiums for the nine months ended September 30, 2007 compared to 92.6% for the first nine months ended September 30, 2006. The relationship of premiums earned to net written premiums during the third quarter and first nine months of 2007 was higher compared to the same period in 2006, reflecting a decrease in the growth rate of premiums in 2007 compared to the same periods in 2006.

Net Investment Income

Our investment portfolio generally consists of liquid, readily marketable and investment-grade fixed-maturity and equity securities. Net investment income is primarily comprised of interest and dividends earned on these securities, net of related investment expenses.

Net investment income was $5.6 million and $16.5 million for the three and nine months ended September 30, 2007, compared to $5.0 million and $14.1 million for the same periods in 2006. The increase was primarily due to an increase in assets available for investment, including cash. Invested assets, including cash, increased by $34.1 million to $470.2 million as of September 30, 2007 from $436.1 million as of September 30, 2006. The pre-tax investment yield for the three and nine months ended September 30, 2007 was 5.0% and 5.1%, compared to 5.2% and 5.1% for the same periods in 2006. Our taxable equivalent yield for the three and nine months ended September 30, 2007 was 5.6% and 5.7%, respectively, compared to 5.8% for the same periods in 2006.

Realized Gains (Losses) on Securities

Realized gains and losses on securities are principally affected by changes in interest rates, the timing of sales of investments and changes in credit quality of the securities we hold as investments.

We realized net investment losses of $355,000 and $593,000 on the sale or write downs of securities for the three and nine months ended September 30, 2007, respectively. For the three and nine months ended September 30, 2006, we realized net investment gains of $4,000 and net investment losses of $37,000, respectively on the sale and write down of securities. Other-than-temporary losses of $764,000 and $1.6 million were realized on fixed maturity securities during the three and nine months ended September 30, 2007. These losses related to ten and twenty-eight asset-backed

securities that were written down in accordance with EITF 99-20 for the three and nine months ended September 30, 2007, respectively. In addition, 5 equity securities were written down in the amount of $308,000 in the three and nine months ended September 30, 2007. An other-than-temporary loss of $202,000 was realized during the three and nine months ended September 30, 2006.

Expenses

Losses and Loss Expenses

We are liable for covered losses and incurred loss expenses under the terms of the insurance policies that we write. In many cases, several years may elapse between the occurrence of an insured loss, the reporting of the loss to us and our settlement of that loss. We reflect our liability for the ultimate payment of all incurred losses and loss expenses by establishing loss and loss expense reserves as balance sheet liabilities for both reported and unreported claims. Loss and loss expenses represent our largest expense item and include (1) payments made to settle claims, (2) estimates for future claim payments and changes in those estimates for current and prior periods and (3) costs associated with settling claims.

Loss and loss expense reserves represent our best estimate of ultimate amounts for losses and related expenses from claims that have been reported but not paid, and those losses that have occurred but have not yet been reported to us. Loss reserves do not represent an exact calculation of liability, but instead represent our estimates, generally utilizing individual claim estimates and actuarial expertise and estimation techniques at a given accounting date. The loss reserve estimates are expectations of what ultimate settlement and administration of claims will cost upon final resolution. These estimates are based on facts and circumstances then known to us, a review of historical settlement patterns, estimates of trends in claims frequency and severity, projections of loss costs, expected interpretations of legal theories of liability, and many other factors. In establishing reserves, we also take into account estimated recoveries, reinsurance, salvage and subrogation. The reserves are reviewed regularly by a team of actuaries we employ and annually reviewed by an outside independent actuarial firm primarily for the purpose of obtaining an opinion on our reserves for our statutory financial statements and for regulatory purposes.

Our reinsurance program significantly influences our net retained losses. In exchange for premiums ceded to reinsurers under quota share and excess of loss reinsurance agreements, our reinsurers assume a portion of the losses and loss expenses we incur under the policies we write. We remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations under the agreements (due to, for example, disputes with the reinsurer or the reinsurer’s insolvency).

The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, claim personnel, economic inflation, legal trends, and legislative changes, among others. The impact of many of these items on ultimate costs for loss and loss expense is difficult to estimate. Loss reserve estimations also differ significantly by coverage due to differences in claim complexity, the volume of claims, the policy limits written, the terms and conditions of the underlying policies, the potential severity of individual claims, the determination of occurrence date for a claim, and reporting lags (the time between the occurrence of the policyholder events and when it is actually reported to us). We attempt to consider all significant facts and circumstances known at the time loss reserves are established. In addition, we continually refine our loss reserve estimates as historical loss experience develops and additional claims are reported and settled.

We exercise a considerable degree of judgment in evaluating the numerous factors involved in the estimation of reserves. Different actuaries will choose different assumptions when faced with such uncertainty, based on their individual backgrounds, professional experiences and areas of focus. Hence, the estimate selected by various actuaries may differ materially. We consider this uncertainty by examining our historical reserve accuracy.

Given the significant impact of the reserve estimates on our financial statements, we subject the reserving process to significant diagnostic testing. We have incorporated data validity checks and balances into our front-end processes. Leading indicators such as actual versus expected emergence and other diagnostics are also incorporated into the reserving processes.

Due to the inherent uncertainty underlying loss reserve estimates, including but not limited to the future settlement environment, final resolution of the estimated liability for a claim or category of claims will be different from that anticipated at the reporting date. Therefore, actual paid losses in the future may yield a materially higher or lower amount than currently reserved.

The amount by which estimated losses differ from those originally recorded for a period is known as “development.” Development is unfavorable when the losses ultimately settle for more than the levels at which they were reserved or subsequent estimates indicate a basis for increasing loss reserves on unresolved claims. Development is favorable when losses ultimately settle

for less than the amount reserved or subsequent estimates indicate a basis for reducing loss reserves on unresolved claims. We reflect favorable or unfavorable developments of loss reserves in the results of operations for the period in which the estimates are changed.

We record two categories of loss and loss expense reserves – case-specific reserves and incurred but not reported (“IBNR”) reserves.

When a claim is reported, our claim department establishes a case reserve for the estimated probable ultimate cost to resolve a claim as soon as sufficient information is available to evaluate a claim. We open most claim files with a “formula reserve” (a normal fixed amount) for the type of claim involved. The Company’s formula reserve amounts are regularly reviewed but have not been changed during the three years ended December 31, 2006 in order to maintain stability in this aspect of the claim reserving process. We adjust the formula reserve to the probable ultimate cost for that claim as soon as sufficient information is available. It is our goal to reserve each claim at its probable ultimate cost no later than 30 days after the claim file is opened on property claims or 90 days following receipt of the claim on casualty claims. During the life cycle of a particular claim, more information may materialize that causes us to increase or decrease the estimate of the ultimate value of the claim. We may determine that it is appropriate to pay portions of the reserve to the claimant or related settlement expenses before final resolution of the claim. The amount of the individual claim reserve would then be adjusted accordingly based on the most recent information available.

We establish IBNR reserves to estimate the amount we will have to pay for claims that have occurred, but have not yet been reported to us; claims that have been reported to us that may ultimately be paid out differently than expected by our case-specific reserves; and claims that have been paid and closed, but may reopen and require future payment. Case reserves and IBNR reserves comprise the total loss and loss expense reserves.

We periodically review our reserves for loss and loss expenses, and based on new developments and information, we include adjustments of the probable ultimate liability in operating results for the periods in which the adjustments are made. In general, our initial reserves are based upon the actuarial and underwriting data utilized to set pricing levels and are reviewed as additional information, including claims experience, becomes available. The establishment of loss and loss expense reserves makes no provision for the broadening of coverage by legislative action or judicial interpretation or for the extraordinary future emergence of new types of losses not sufficiently represented in our historical experience or which cannot yet be quantified. We regularly analyze our reserves and review our pricing and reserving methodologies so that future adjustments to prior year reserves can be minimized. However, given the complexity of this process, reserves require continual updates and the ultimate liability may be higher or lower than previously indicated.

Due to the inherent uncertainty in estimating reserves for losses and loss expenses, there can be no assurance that the ultimate liability will not materially exceed amounts reserved, with a resulting adverse effect on our results of operations and financial condition. Based on the current assumptions used in calculating reserves, management believes our overall recorded reserves at September 30, 2007 make a reasonable provision for our future obligations.

Our reserve for losses and loss expenses at September 30, 2007 was $275.1 million (before the effects of reinsurance) and $237.3 million (after the effects of reinsurance), as estimated through our actuarial analysis. During the first nine months of 2007, we concluded through our actuarial analysis that the December 31, 2006 reserve for losses and loss expenses of $214.6 million (after the effects of reinsurance) was redundant by $4.5 million, primarily due to favorable development in our claims made casualty reserves on business written in the 2005 and 2006 years and our property reserves on business written in the 2005 and 2006 years. Our case and IBNR reserve for losses and loss expenses (net of the effects of reinsurance) and the effects of reinsurance at September 30, 2007 and December 31, 2006 by line is summarized as follows:


	September 30, 2007						December 31, 2006
	Case		IBNR		Total		Case		IBNR		Total
Property and Casualty:
Casualty	$	55,529		152,204		207,733		59,801		128,569		188,370
Property		12,326		13,571		25,897		13,506		8,796		22,302
Other (including exited lines):
Commercial auto		98		4		102		147		—		147
Workers’ compensation		1,033		2,040		3,073		1,164		2,056		3,220
Surety		—		519		519		—		529		529

Net reserves for losses and loss expenses		68,986		168,338		237,324		74,618		139,950		214,568
Plus reinsurance recoverables on unpaid losses at end of period		9,632		28,126		37,758		11,723		24,381		36,104

Gross reserves for losses and loss expenses	$	78,618		196,464		275,082		86,341		164,331		250,672

Net loss and loss expenses incurred were $33.0 million for the quarter ended September 30, 2007, compared to $34.4 million for the quarter ended September 30, 2006. In the third quarter of 2007, the Company recorded $34.0 million of incurred losses and loss expenses attributable to the 2007 accident year, which was partially offset by favorable development of $946,000 attributable to events of prior years. In the third quarter of 2006, the Company recorded $35.6 million of incurred losses and loss expenses attributable to the 2006 accident year and $1.2 million of favorable development attributable to events of prior years.

Net loss and loss expenses incurred were $100.0 million for the nine months ended September 30, 2007, compared to $97.4 million for the nine months ended September 30, 2006. In the first nine months of 2007, the Company recorded $104.5 million of incurred losses and loss expenses attributable to the 2007 accident year, which were partially offset by favorable development of $4.5 million attributable to events of prior years, also described above. For the nine months ended September 30, 2006, the Company recorded $97.0 million of incurred losses and loss expenses attributable to the 2006 accident year and $353,000 attributable to events of prior years.

For the three months ended September 30, 2007, we experienced favorable non-catastrophe case reserve development, within the property line, producing a reduction in ultimate loss and loss expenses by $1.8 million primarily for the 2005 and 2006 accident years. Within the casualty line, we experienced $981,000 of unfavorable development primarily related to the settlement of one claim and an increase in projected construction defect claim counts.

For the three months ended September 30, 2006, within the property line, we experienced favorable non-catastrophe case reserve development producing a reduction in ultimate loss and loss expenses by $3.3 million primarily for the 2004 and 2005 accident years. This favorable development was offset by an increase of $200,000 in casualty reserves during the three-month period as a result of a small amount of adverse development in the casualty line related to one specific claim. Additionally, we recorded approximately $1.9 million of unfavorable development during the three months ended September 30, 2006 primarily related to estimated costs associated with possible reinsurance collection issues on the 1998 through 1999 workers compensation reinsurance treaties.

The favorable development during the nine months ended September 30, 2007 resulted primarily from reductions in the ultimate loss ratios for accident years 2005 and 2006 on the claims made contractor liability business included in our property and casualty segment. We reduced carried reserves related to the 2005 and 2006 casualty business based on our internal actuarial reserve recommendations. The 2005 and 2006 casualty reserves have performed better than expected to date, and previously carried reserves exceeded the current indications for each of the estimation methods applied in our internal actuarial analysis. At the beginning of 2005, we began writing certain contractors’ liability business on a claims made form, replacing the occurrence form which had previously been utilized through 2004. We wrote a significant volume of claims made contractor business in both 2005 and 2006, and this business has continued to perform better than expected. We continue to monitor loss emergence on this book and we adjust assumptions and estimates as needed. We continue to write contractor business on an occurrence form on a limited basis, in certain jurisdictions and for certain classes of business. In addition, this favorable development was supplemented in the third quarter of 2007 by $1.8 million of favorable development in our property line as a result of favorable case reserve development that was below our expectations, resulting in a reduction of our ultimate loss and loss expenses for the 2005 and 2006 accident years.

For the nine months ended September 30, 2006, within the property line, we experienced favorable non-catastrophe case reserve development producing a reduction in ultimate loss and loss expenses by $7.0 million primarily for the 2004 and 2005 accident years. We also changed our estimates during such nine month period on catastrophe losses by reducing its estimates on Hurricane Wilma by $1.2 million due to actual incurred losses being lower than original estimates. This favorable development was offset by an increase of $4.3 million in casualty reserves during such nine month period as a result of a small amount of adverse development in the casualty line and a result of a refinement to the internal actuarial reserving technique concerning the weighting of reserve indications and supplemental information concerning claims severities. Our reserves moved to a higher point on the range of loss and loss expense reserve estimate, despite the fact that overall, our casualty book of business performed within the range of expectations for the quarter and nine months ended September 30, 2006. We also incurred approximately $1.4 million of adverse development during the nine months ended September 30, 2006 due to an increase in legal severities on construction defect claims. Additionally, we recorded approximately $2.9 million of unfavorable development during the nine months ended September 30, 2006 related to estimated costs associated with possible reinsurance collection issues on two separate casualty claims and the 1998 and 1999 workers compensation reinsurance treaties.

Operating Expenses

Operating expenses include the costs to acquire a policy (included in amortization of deferred policy acquisition costs), other operating expenses (including corporate expenses) and interest expense. The following table presents our amortization of deferred policy acquisition costs, other operating expenses and related ratios and interest expense for the periods indicated:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
	(In thousands)						(In thousands)
Amortization of deferred policy acquisition costs (“ADAC”)	$	14,068			14,440			42,456			39,402
Other operating expenses		5,190			3,719			13,394			11,969

ADAC and other operating expenses		19,258			18,159			55,850			51,371
Interest expense		684			608			2,038			1,718

Total operating expenses	$	19,942			18,767			57,888			53,089


Expense ratio:
ADAC		25.2	%		26.1	%		25.4	%		25.1	%
Other operating expenses		9.3	%		6.7	%		8.1	%		7.6	%

Total expense ratio (1)		34.5	%		32.8	%		33.5	%		32.7	%


(1)		Interest expense is not included in the calculation of the expense ratio.

Operating expenses increased by 6.3% and 9.0% for the three and nine months ended September 30, 2007, respectively compared to the same periods in 2007. The overall expense ratio for the three and nine months ended September 30, 2007 was 34.5% and 33.5%, respectively, compared to 32.8% and 32.7% for the same periods in 2006. The increase in other operating expenses for the three months ended September 30, 2007 compared to the same periods in 2006, is due to higher agent contingent commissions, resulting from the favorable loss experience that we experienced in the third quarter of 2007.

For the nine months ended September 30, 2007, we experienced a slight increase in our ADAC portion of the expense ratio as a result of a higher amount of binding business which has higher acquisition costs relative to brokerage business, a higher amount of assumed bonding business that has higher acquisition costs relative to our direct business and a lower amount of acquisition expenses that were able to be deferred related to the auto physical damage program. During the third quarter of 2006, the loss and loss expense ratio related to this program exceeded our expectations causing the program to fall below the profitability levels required for continued deferral of the additional policy acquisition costs. This resulted in $41,000 of additional expense for the nine months ended September 30, 2007, compared to additional expense of $766,000 for the three and nine months ended September 30, 2006.

The increase in other operating expenses in the first nine months of 2007 is due to higher than expected costs related to our agent contingent commission program and $300,000 of professional and other fees expensed, which related primarily to an aborted public equity offering. The increases were partially offset by recoveries received from our corporate insurance policy.

Interest expense increased on our variable rate Trust Preferred securities due to the increase in LIBOR during 2007. In addition, we incurred $77,000 and $246,000 of interest expense related to our line of credit for the three and nine months ended September 30, 2007, compared to $6,000 for the same periods in 2006.

Income Taxes

We have historically filed a consolidated federal income tax return that has included all of our subsidiaries. The income tax provision for the three and nine months ended September 30, 2007 has been computed based on our estimated annual effective tax rate of 30.5% which differs from the federal income tax rate of 35% principally because of tax-exempt investment income. The income tax provision for the three and nine months ended September 30, 2006 of 30.3% and 29.5%, respectively have been computed based on our estimated annual effective tax rate of 29.5%, which differs from the federal income tax rate of 35% principally because of tax-exempt investment income.

Liquidity and Capital Resources

ProCentury is a holding company, the principal asset of which is the common shares of Century Surety Company or Century. Although we have the capacity to generate cash through loans from banks and issuances of debt and equity securities, our primary source of funds to meet our short-term liquidity needs, including the payment of dividends to our shareholders and corporate expenses, is dividends from Century. Century’s principal sources of funds are underwriting operations, investment income, proceeds from sales and maturities of investments and dividends from ProCentury Insurance Company or PIC. Century’s primary use of funds is to pay claims and operating expenses, to purchase investments and to make dividend payments to us. ProCentury’s future liquidity is dependent on the ability of Century to pay dividends.

Our insurance subsidiaries are restricted by statute as to the amount of dividends they may pay without the prior approval of regulatory authorities. Century and PIC may pay dividends without advance regulatory approval only from unassigned surplus and only to the extent that all dividends in the trailing twelve months do not exceed the greater of 10% of total statutory surplus as of the end of the prior fiscal year or statutory net income for the prior year. Using these criteria, the total ordinary dividend available to be paid from Century to ProCentury during 2007 is $18.4 million. The ordinary dividend available to be paid from PIC to Century during 2007 is $1.6 million.

Century paid ordinary dividends of $1.3 million for the three months ended September 30, 2007. No dividends were paid for the three months ended September 30,2006. For the nine months ended September 30, 2007 and 2006, ordinary dividends of $3.9 million and $2.6 million were paid, respectively. PIC did not pay dividends to Century in 2007 or 2006. Century’s ability to pay future dividends to ProCentury without advance regulatory approval is dependent upon maintaining a positive level of unassigned surplus, which in turn, is dependent upon Century generating net income in excess of dividends to ProCentury.

Our insurance subsidiaries are required by law to maintain a certain minimum level of surplus on a statutory basis. Surplus is calculated by subtracting total liabilities from total admitted assets. The National Association of Insurance Commissioners (“NAIC”) has a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of December 31, 2006, Century’s and PIC’s statutory surplus was in excess of the prescribed risk-based capital requirements that correspond to any level of regulatory action. Century’s statutory surplus at December 31, 2006 was $137.5 million and the authorized control level was $36.3 million. As of September 30, 2007, Century’s statutory surplus was $153.3 million.

In August of 2007, our Board of Directors approved a $10.0 million share repurchase plan. As of September 30, 2007, no shares have been repurchased under this plan.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006. Consolidated net cash provided by operating activities was $36.9 million for the first nine months of 2007, compared to $47.8 million for the same period in 2006.

The majority of the decrease is due to the lower amount of growth in premiums for the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006.

Consolidated net cash used in investing activities was $31.8 million for the first nine months of 2007, compared to $43.7 million for the same period in 2006. The decrease resulted from a lower amount of operational cash available for investing at September 30, 2007 compared to the same period in 2006.

Consolidated net cash provided by financing activities was $75,000 for the first nine months of 2007, compared to net cash used in financing activities of approximately $1.3 million for the same period in 2006. This increase is primarily the result of $697,000 of proceeds from the exercise of share options and $650,000 draw on the line of credit, which were partially offset by higher dividends paid to shareholders during the nine months ended September 30, 2007 compared to the same period in 2006.

Interest on our debt issued to a related party trust is variable and resets quarterly based on a spread over three-month London Interbank Offered Rates (“LIBOR”). As part of our asset/liability matching program, we have short-term investments, investments in bond mutual funds, as well as available cash balances from operations and investment maturities, that are available for reinvestment during periods of rising or falling interest rates.

Line of Credit. The Company has a $10.0 million line of credit with a maturity date of September 30, 2009, and interest only payments due quarterly based on LIBOR plus 1.2% of the outstanding balance. All of the outstanding shares of Century are pledged as collateral. The Company did not make any draws on the line of credit during the third quarter of 2007. During the first nine months of 2007, the Company made draws totaling $650,000 on the line of credit for general corporate purposes. At September 30, 2007, there was $4.7 million outstanding under the line of credit. Interest expense for the three and nine months ended September 30, 2007 was approximately $77,000 and $246,000, respectively. The Company did not have any borrowings outstanding under the line of credit at September 30, 2006. Interest expense for the three and nine months ended September 30, 2006 was $6,000.

Given our historical cash flow, we believe cash flow from operating activities in 2007 will provide sufficient liquidity for our operations, as well as to satisfy debt service obligations and to pay other operating expenses. Although we anticipate that we will be able to meet our cash requirements, we can give no assurance in this regard.

Investment Portfolio

Our investment strategy is designed to capitalize on our ability to generate positive cash flow from our underwriting activities. Preservation of capital is our first priority, with a secondary focus on maximizing appropriate risk adjusted return. We seek to maintain sufficient liquidity from operations, investing and financing activities to meet our anticipated insurance obligations and operating and capital expenditure needs. The majority of our fixed-maturity portfolio is rated investment grade to protect investments. Our investment portfolio is managed by three outside independent investment managers that operate under investment guidelines approved by Century’s investment committee. Century’s investment committee meets at least quarterly and reports to ProCentury’s board of directors. In addition, we employ stringent diversification rules and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security or type of security. In limited circumstances, we will invest in non-investment grade fixed-maturity securities that have an appropriate risk adjusted return, subject to satisfactory credit analysis performed by us and our investment managers.

Our cash and investment portfolio increased to $470.2 million at September 30, 2007 from $436.1 million at December 31, 2006 and is summarized by type of investment in Note 3 to the interim unaudited consolidated condensed financial statements included in this Form 10-Q filing. Our taxable equivalent yield was 5.7% and 5.8% for the nine months ended September 30, 2007 and the year ended December 31, 2006, respectively. The fair value of our fixed maturities at September 30, 2007 increased to $389.1 million from $359.5 million at December 31, 2006. The fair value of our equity securities increased to $43.7 million at September 30, 2007 from $42.9 million at December 31, 2006. As of September 30, 2007, the duration of the fixed income portfolio was 4.5 years, slightly longer than the duration of 4.1 years at December 31, 2006. The average credit quality of the portfolio remained investment grade.

Accounting Standards

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both an income

statement (“rollover”) and balance sheet (“iron curtain”) approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior years are not restated, the cumulative effect adjustment is recorded in opening accumulated earnings as of the beginning of the fiscal year of adoption. SAB 108 is effective for fiscal years ending on or after November 15, 2006, with earlier adoption encouraged. We adopted SAB 108 in the fourth quarter of 2006 and it did not have a material effect on our consolidated financial condition or results of operations.

In July 2006, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 effective January 1, 2007 and it did not have a material impact on our consolidated financial condition or results of operations.

In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (“SOP”) 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments,” issued by the FASB. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights or coverages that occurs as a result of the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a new feature or coverage within a contract. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. Retrospective application of SOP 05-1 to previously issued financial statements is not permitted. Initial application of SOP 05-1 is required as of the beginning of an entity’s fiscal year. We adopted SOP 05-1 effective January 1, 2007 and it did not have a material effect on our consolidated financial condition or results of operations.

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 155, “Accounting for Certain Hybrid Financial Instruments” (“SFAS No. 155”). Under current generally accepted accounting principles an entity that holds a financial instrument with an embedded derivative must bifurcate the financial instrument, resulting in the host and the embedded derivative being accounted for separately. SFAS No. 155 permits, but does not require, entities to account for financial instruments with an embedded derivative at fair value thus negating the need to bifurcate the instrument between its host and the embedded derivative. SFAS No. 155 is effective as of the beginning of the first annual reporting period that begins after September 15, 2006. We adopted SFAS No. 155 and it did not have a material effect on our consolidated financial condition or results of operations.

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”), which clarifies that the term fair value is intended to mean a market-based measure, not an entity-specific measure and gives the highest priority to quoted prices in active markets in determining fair value. SFAS No. 157 requires disclosures about (1) the extent to which companies measure assets and liabilities at fair value, (2) the methods and assumptions used to measure fair value, and (3) the effect of fair value measures on earnings. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting SFAS No. 157; however, we do not expect it will have a material effect on our consolidated financial condition or results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115” (“SFAS 159”). The objective of SFAS 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported net income caused by measuring related assets and liabilities differently. This statement permits entities to choose, at specified election dates, to measure eligible items at fair value (i.e., the fair value option). Items eligible for the fair value option include certain recognized financial assets and liabilities, rights and obligations under certain insurance contracts that are not financial instruments, host financial instruments resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument, and certain commitments. Business entities shall report unrealized gains and losses on items for which the fair value option has been elected in net income. The fair value option (a) may be applied instrument by instrument, with certain exceptions; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. SFAS 159 is effective as of the beginning of an entity’s first

fiscal year that begins after November 15, 2007, although early adoption is permitted under certain conditions. Companies must report the effect of the first remeasurement to fair value as a cumulative-effect adjustment to the opening balance of retained earnings. We are currently evaluating the impact of adopting SFAS 159.

Item 3. Quantitative And Qualitative Disclosures About Market Risk

The Company is exposed to market risk, which is the potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk, equity price risk and interest rate risk.

As of September 30, 2007, there had not been a material change in any of the market risk information disclosed by the Company under Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in its Annual Report on Form 10-K for the year ended December 31, 2006.

Item 4. Controls And Procedures

As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chairman and Chief Executive Officer (“CEO”) and the Chief Financial Officer and Treasurer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15 (“Disclosure Controls”).

The Company’s management, including the CEO and CFO, does not expect that its Disclosure Controls will prevent all errors and all fraud. 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. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on management’s evaluation of the Company’s Disclosure Controls as of September 30, 2007, management concluded that the Company’s Disclosure Controls were effective as of such date.

There were no changes in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

We are party to lawsuits, arbitrations and other proceedings that arise in the normal course of our business. Certain of the lawsuits, arbitrations and other proceedings involve claims under policies that we underwrite as an insurer, the liabilities for which we believe have been adequately included in our loss and loss adjustment expense reserves. Also, from time to time, we are party to lawsuits, arbitrations and other proceedings that relate to disputes over contractual relationships with third parties, or that involve alleged errors and omissions on the part of our insurance subsidiaries. We provide accruals for these items to the extent we deem the losses probable and reasonably estimable.

The outcome of litigation is subject to numerous uncertainties. Although the ultimate outcome of pending matters cannot be determined at this time, based on present information, we believe the resolution of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

Item 1A. Risk Factors

The risks below related to our business and industry are in addition to those identified in the Company’s annual report on Form 10-K for the year ended December 31, 2006.

Our success depends on our ability to appropriately price the risks we underwrite.

Our financial condition depends on our ability to underwrite and set premium rates accurately for a wide variety of risks. Rate adequacy is necessary to generate sufficient premiums to pay losses, loss expenses and underwriting expenses and to earn a profit. In order to price our products accurately, we must collect and properly analyze a substantial amount of data, develop, test and apply appropriate rating formulas, closely monitor and timely recognize changes in trends and project both severity and frequency of losses with reasonable accuracy. Our ability to undertake these efforts successfully and price our products accurately is subject to a number of risks and uncertainties, some of which are outside our control, including:

	•		the availability of sufficient reliable data and our ability to properly analyze available data;

	•		the uncertainties that inherently characterize estimates and assumptions;

	•		our selection and application of appropriate rating and pricing techniques; and

	•		changes in legal standards, claim settlement practices, medical care expenses and restoration costs.

Consequently, we could under-price risks, which would negatively affect our profit margins, or we could over-price risks, which could reduce our sales volume and competitiveness. In either event, our profitability could be materially and adversely affected.

We may not find suitable acquisition candidates or new insurance ventures and even if we do, we may not successfully integrate any such acquired companies or successfully invest in such ventures.

As part of our present strategy, we continue to evaluate possible acquisition transactions and the start-up of complementary business ventures on an ongoing basis, and at any given time, we may be engaged in discussions with respect to possible acquisitions and new ventures. We cannot assure you that we will be able to identify suitable acquisition transactions or insurance ventures, that such transactions will be financed and completed on acceptable terms or that our future acquisitions or ventures will be successful. The process of integrating any company involves a number of special risks, including the possibility that management may be distracted from regular business concerns by the need to integrate operations, unforeseen difficulties in integrating operations and systems, problems concerning assimilating and retaining the employees of the acquired company, challenges in retaining customers and potential adverse short-term effects on operating results. In addition, we may incur debt to finance future acquisitions and we may issue securities in connection with future acquisitions which may dilute the holdings of our current and future shareholders. If we are unable to successfully complete and integrate strategic acquisitions in a timely manner, our growth strategy could be adversely affected. Furthermore, our current acquisition strategy may include the evaluation of potential acquisitions of privately-held companies. Because privately-held companies are generally not subject to Section 404 of the Sarbanes-Oxley Act of 2002, such companies may not have adequate internal control procedures, which may, during our integration with any such company, have an adverse affect on our internal controls.

Our investment performance may suffer as a result of adverse capital market developments or other factors, which may affect our financial results and ability to conduct business.

We invest the premiums we receive from policyholders until it is needed to pay policyholder claims or other expenses. Our investment portfolio is managed by two outside independent investment managers and one related party investment manager, all of which operate under investment guidelines approved by our investment committee. Although we seek to maintain sufficient liquidity from operations, investing and financing activities to meet our anticipated insurance obligations and operating and capital expenditure needs, our investments are subject to a variety of risks, including risks relating to general economic conditions, market volatility, interest rate fluctuations, liquidity risk and credit and default risk. In particular, the volatility of our claims may force us to liquidate securities, which may cause us to incur capital losses. If we do not structure our investment portfolio so that it is appropriately matched with our insurance liabilities, we may be forced to liquidate investments prior to maturity at a significant loss to cover such liabilities. Investment losses could significantly decrease our asset base and statutory surplus, thereby affecting our ability to conduct business.

We are subject to judicial decisions affecting insurance and tort law, which may adversely affect our ability to achieve our business objectives.

State courts may render decisions impacting our liability for losses under insurance and tort law. This case law, as well as any legislation enacted in response, can impact the claim severity and frequency assumptions underlying our reserves. Accordingly, our ultimate liability may exceed our estimates due to this variable, among others.

Although we have paid cash dividends in the past, we may not pay cash dividends in the future.

The declaration and payment of dividends is subject to the discretion of our board of directors and will depend on our financial condition, results of operations, cash requirements, future prospects, regulatory and contractual restrictions on the payment of dividends by our subsidiaries and other factors deemed relevant by our board of directors. There is no requirement that we must, and we cannot assure you that we will, declare and pay any dividends in the future. Our board of directions may determine to retain such capital for general corporate or other purposes.

Our reliance on our agents subjects us to credit risk.

Our agents collect premiums from policyholders and forward them to us. In certain jurisdictions, when the insured pays premiums for these policies to agents for payment over to us, the premiums might be considered to have been paid under applicable insurance laws and regulations, and the insured will no longer be liable to us for these amounts, whether or not we actually receive the premiums from the agent. Consequently, we assume a degree of credit risk associated with our agents. Although agents’ failures to remit premiums to us have not caused a material adverse impact on us to date, there have been instances where agents collected premiums and did not remit it to us and we were nonetheless required under applicable law to provide the coverage set forth in the policy despite the absence of premium. Because the possibility of these events is dependent in large part upon the financial condition of our agents, which is not publicly available, we are not able to quantify the exposure presented by this risk. If we are unable to collect premiums from our agents in the future, our financial condition and results of operations could be materially and adversely affected.

We are exposed to risks relating to evaluations of controls required by Section 404 of the Sarbanes-Oxley Act of 2002.

We continue to evaluate our internal controls systems to allow management to report on, and our independent registered public accounting firm to audit, our internal controls over financial reporting and to perform the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002. In the course of this evaluation, we may identify control deficiencies of varying degrees of severity under applicable SEC and Public Company Accounting Oversight board rules and regulations that remain unremediated. As a public company, we are required to report, among other things, control deficiencies that constitute a “material weakness” or changes in internal controls that materially affect, or are reasonably likely to materially affect internal controls over financial reporting. A “material weakness” is a significant deficiency, or combination of significant deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. If we cease to comply with the requirements of Section 404, we might be subject to sanctions or investigation by regulatory authorities such as the SEC or Nasdaq. Additionally, failure to comply with Section 404 or the report by us of a material weakness may cause investors to lose

confidence in our financial statements and our stock price may be adversely affected. If we fail to remedy any material weakness, our financial statements may be inaccurate, we may face restricted access to the capital markets, and your share price may be adversely affected.

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

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

Not applicable.

Item 5. Other Information

On September 19, 2007, the U.S. Securities and Exchange Commission (the “Commission”), issued an Order Instituting Public Administrative Proceedings Pursuant to Rule 102(e) of the Commission’s Rules of Practice, Making Findings and Imposing Remedial Sanctions (the “Order”), against Press C. Southworth III. The Order finds that Mr. Southworth, a retired partner at PricewaterhouseCoopers LLP, engaged in improper professional conduct in connection with the 1998 audit of National Century Financial Enterprises, Inc. (“NCFE”), a healthcare financing company.

Although Mr. Southworth is no longer a certified public accountant and does not practice before the Commission, the order denies him the privilege of appearing or practicing before the Commission as an accountant, with a right to apply for reinstatement after two years. Mr. Southworth consented to the issuance of the Order without admitting or denying any of the Commission’s findings.

Item 6. Exhibits

3.1		Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the Securities and Exchange Commission “SEC” on September 4, 2004.)

3.2		Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the SEC on September 4, 2004.)

31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act

31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act

32.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

32.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)


(1)		These certifications are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. These certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf of the undersigned thereunto duly authorized.


	PROCENTURY CORPORATION
Date November 9, 2007	By:	/s/ Erin E. West
		Erin E. West
		Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

EXHIBIT INDEX

3.1		Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the Securities and Exchange Commission (“SEC”) on September 4, 2004.)

3.2		Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the SEC on September 4, 2004.)

31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act

31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act

32.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

32.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)


(1)		These certifications are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. These certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.

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