Edgar Filing: JAMES RIVER GROUP, INC

Unassociated Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

		For the Quarterly Period Ended June 30, 2007

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

		For the Transition Period from ______________ to ______________

COMMISSION FILE NO. 000-51480

JAMES RIVER GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		05-0539572
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

300 Meadowmont Village Circle, Suite 333 Chapel Hill, North Carolina		27517
(Address of Principal Executive Offices)		(Zip Code)

(919) 883-4171
(Registrant’s Telephone Number, Including Area Code)


(Former Name, Former Address and Former Fiscal Year, If Changed Since Last Report)

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

Non-Accelerated Filer o

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

Yes o No x

On August 1, 2007, 15,138,708 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

INDEX



PART I.		FINANCIAL INFORMATION	Page

	Item 1.	Financial Statements:

		Condensed Consolidated Balance Sheets	1

		Condensed Consolidated Income Statements	3

		Condensed Consolidated Statements of Cash Flows	4

		Notes to Condensed Consolidated Financial Statements	5

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30

	Item 4.	Controls and Procedures	31

PART II.		OTHER INFORMATION

	Item 1.	Legal Proceedings	32

	Item 1A.	Risk Factors	32

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

	Item 4.	Submission of Matters to a Vote of Security Holders	33

	Item 6.	Exhibits	34

		Signatures	36

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

Condensed Consolidated Balance Sheets

	(Unaudited) June 30, 2007		December 31, 2006
	(in thousands)

Assets
Investments available-for-sale, at fair value:
Fixed maturity securities (amortized cost: 2007 - $522,730; 2006 - $488,232)	$	513,411	$	486,016
Equity securities (cost: 2007 - $23,266; 2006 - $8,536)		23,983		8,703
Total investments available-for-sale		537,394		494,719

Cash and cash equivalents		45,305		40,319
Accrued investment income		5,746		5,471
Premiums receivable and agents’ balances		32,473		34,862
Reinsurance recoverable on unpaid losses		97,144		90,495
Reinsurance recoverable on paid losses		4,093		7,041
Prepaid reinsurance premiums		22,362		31,626
Deferred policy acquisition costs		18,086		15,005
Deferred tax assets		18,133		13,016
Federal income taxes receivable		587		-
Due from reinsurers		2,645		-
Other assets		9,555		9,167
Total assets	$	793,523	$	741,721

See accompanying notes.

Condensed Consolidated Balance Sheets (continued)

	(Unaudited) June 30, 2007			December 31, 2006
	(in thousands, except for share data)

Liabilities and stockholders’ equity
Liabilities:
Reserve for losses and loss adjustment expenses	$	350,998		$	300,294
Unearned premiums		133,729			131,286
Payables to reinsurers		-			5,672
Senior debt		15,000			15,000
Junior subordinated debt		43,300			43,300
Funds held		8,609			15,567
Accrued expenses		12,062			11,510
Federal income taxes payable		-			613
Other liabilities		4,046			4,087
Total liabilities		567,744			527,329

Commitments and contingencies

Stockholders’ equity:
Common Stock - $0.01 par value; 100,000,000 shares authorized; 2007: 15,138,708 shares issued and outstanding; 2006: 15,117,308 shares issued and outstanding		151			151
Common stock warrants		524			524
Additional paid-in capital		176,341			175,437
Convertible preferred stock - $0.01 par value; 5,000,000 shares authorized and no shares outstanding		-			-
		177,016			176,112

Notes receivable from employees		(535	)		(535	)
Retained earnings		54,889			40,147
Accumulated other comprehensive loss		(5,591	)		(1,332	)
Total stockholders’ equity		225,779			214,392
Total liabilities and stockholders’ equity	$	793,523		$	741,721

See accompanying notes.

Condensed Consolidated Income Statements (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
	(in thousands, except for share data)

Revenues
Gross written premiums	$	79,449		$	74,634		$	159,537		$	142,799
Ceded written premiums		(7,877	)		(19,810	)		(24,095	)		(34,287	)
Net written premiums		71,572			54,824			135,442			108,512
Change in net unearned premiums		(8,585	)		(2,222	)		(12,206	)		(7,821	)
Net earned premiums		62,987			52,602			123,236			100,691

Net investment income		5,951			4,506			11,722			8,499
Net realized investment losses		(19	)		(49	)		(27	)		(84	)
Other income		68			46			138			88
Total revenues		68,987			57,105			135,069			109,194

Expenses
Losses and loss adjustment expenses		36,954			30,214			71,222			59,431
Other operating expenses		17,659			13,384			33,568			25,409
Interest expense		1,298			896			2,582			1,673
Total expenses		55,911			44,494			107,372			86,513
Income before taxes		13,076			12,611			27,697			22,681
Federal income tax expense		3,920			4,060			8,414			7,301
Net income	$	9,156		$	8,551		$	19,283		$	15,380

Earnings per share:
Basic	$	0.60		$	0.57		$	1.27		$	1.02
Diluted	$	0.56		$	0.53		$	1.19		$	0.96
Cash dividends declared per common share	$	0.15		$	-		$	0.30		$	-

See accompanying notes.

Condensed Consolidated Statements of Cash Flows (Unaudited)

		Six Months Ended June 30,
		2007			2006
		(in thousands)

Operating activities

Net cash provided by operating activities	$	60,309		$	72,610

Investing activities
Securities available-for-sale:
Purchases - fixed maturity securities		(102,434	)		(142,375	)
Purchases - equity securities		(15,964	)		-
Maturities and calls - fixed maturity securities		23,737			14,700
Sales - fixed maturity securities		43,114			24,105
Sales - equity securities		1,311			-
Net payable to securities brokers		270			1,671
Purchases of property and equipment		(560	)		(195	)
Investment in real estate joint venture		(620	)		-
Net cash used in investing activities		(51,146	)		(102,094	)

Financing activities
Proceeds from issuance of Common Stock		219			173
Excess tax benefits from stock option exercises		145			75
Issuance of junior subordinated debt		-			20,000
Issuance costs		-			(27	)
Dividends paid to common stockholders		(4,541	)		-
Net cash (used in) provided by financing activities		(4,177	)		20,221

Change in cash and cash equivalents		4,986			(9,263	)
Cash and cash equivalents at beginning of period		40,319			41,029
Cash and cash equivalents at end of period	$	45,305		$	31,766

See accompanying notes.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

June 30, 2007

1. Accounting Policies and Basis of Presentation

Basis of Presentation

The accompanying condensed consolidated financial statements and notes have been prepared in accordance with United States generally accepted accounting principles for interim financial information and do not contain all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. Readers are urged to review the Company’s 2006 audited consolidated financial statements contained in Form 10-K for a more complete description of the Company’s business and accounting policies. In the opinion of management, all adjustments necessary for a fair presentation of the condensed consolidated financial statements have been included. Such adjustments consist only of normal recurring items. Interim results are not necessarily indicative of results of operations for the full year. The consolidated balance sheet as of December 31, 2006 was derived from the Company’s audited annual consolidated financial statements.

Significant intercompany transactions and balances have been eliminated.

Estimates and Assumptions

Preparation of the condensed consolidated financial statements in conformity with United States generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying disclosures. Those estimates are inherently subject to change, and actual results may ultimately differ from those estimates.

New Accounting Standards

In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertain tax positions. 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. The Company adopted FIN 48 on January 1, 2007, and adoption of FIN 48 had no effect on the Company’s financial position or results of operations.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (Statement 157). Statement 157 defines fair value, establishes a framework for measuring fair value in United States generally accepted accounting principles and expands disclosures about fair value measurements. Statement 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 with earlier application encouraged. The Company is currently evaluating the impact of adopting Statement 157 on its financial statements.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Liabilities, (Statement 159). Statement 159 permits entities to choose to measure many financial instruments and certain other items at fair value with changes in fair value included in current earnings. The election is made on specified election dates, can be made on an instrument-by-instrument basis and is irrevocable. Statement 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting Statement 159 on its financial statements.

2. Proposed Transaction

On June 11, 2007, the Company entered into an Agreement and Plan of Merger (the Merger Agreement), with Franklin Holdings (Bermuda), Ltd., a Bermuda company (Parent) and Franklin Acquisition Corp., a Delaware corporation and a wholly-owned direct subsidiary of Parent (Merger Sub). Under the terms of the Merger Agreement, Merger Sub will be merged with and into the Company, and as a result, the Company will continue as the surviving corporation and a wholly-owned subsidiary of Parent (the Merger). Parent is a Bermuda-based holding company and member of the D. E. Shaw group, a global investment management firm. The Company is

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

2. Proposed Transaction (continued)

permitted, under the terms of the Merger Agreement, to continue to pay regular quarterly cash dividends until the consummation of the Merger, such amount not to exceed $0.15 per share per quarter.

Subject to the terms and conditions set forth in the Merger Agreement, at the effective time of the Merger, each outstanding share of Common Stock, other than shares as to which appraisal rights under Delaware law may have been perfected, will be canceled and converted into the right to receive $34.50 in cash per share, without interest (the Merger Consideration). In addition, at the effective time of the Merger, (a) each outstanding option to purchase Common Stock (vested or unvested) will be canceled and the holder will be entitled to receive an amount of cash equal to the difference between the Merger Consideration and the exercise price of the applicable stock option without interest and less any required withholding taxes, and (b) each outstanding warrant to purchase Common Stock will be converted into the right to receive, upon exercise of such warrant, the Merger Consideration the holder of such warrant would have been entitled to receive upon consummation of the Merger if such holder had been, immediately prior to the Merger, the holder of the number of shares of Common Stock then issuable upon exercise in full of such warrant or, if the holder and the Company agree, canceled and extinguished, and the holder thereof will be entitled to receive, following exercise or cancellation, as the case may be, an amount in cash equal to the excess (if any) of (a) the product of (x) the number of shares of Common Stock subject to the warrant and (y) the Merger Consideration, minus (b) the aggregate exercise price of the warrant, without interest and less any required withholding taxes.

The closing of the Merger is expected to occur in the fourth quarter of 2007, subject to the receipt of stockholder approval and regulatory approvals and satisfaction or waiver of other customary closing conditions. The Company and Parent filed notification and report forms relating to the Merger under the Hart-Scott-Rodino Act (the HSR Act) with the Federal Trade Commission (the FTC) and the Department of Justice. On July 20, 2007, the FTC granted early termination of the waiting period under the HSR Act with respect to the Merger. Parent made the required filings for regulatory approval relating to the Merger with the insurance commissioners of North Carolina and Ohio, the states in which the Company's insurance subsidiaries are domiciled, on July 11, 2007. The Merger is not subject to a financing condition and equity commitments for the full amount of the Merger Consideration plus funds sufficient to pay all related fees and expenses required to be paid or funded as of or prior to the consummation of the Merger have been received by Parent from affiliates of the D.E. Shaw group.

The Company and Parent each have certain termination rights under the terms of the Merger Agreement, including the right by either party to terminate the Merger Agreement if the Merger has not been consummated on or before December 15, 2007. In the event that the Merger Agreement is terminated under certain circumstances set forth in the Merger Agreement, the Company will be required to pay a fee of approximately $11.5 million to Parent and reimburse Parent for an amount not to exceed approximately $3.6 million for transaction fees and expenses incurred by Parent and its affiliates.

On August 3, 2007, the Company filed a preliminary proxy statement with the Securities and Exchange Commission containing information about the Merger and a special meeting of stockholders, to be called, at which the Company’s stockholders will be asked to vote on a proposal to approve the Merger Agreement. The definitive proxy statement, when filed, will include the date of the special meeting of stockholders and the record date for the special meeting. On August 5, 2007, the Company’s right to solicit competing proposals ended under the terms of the Merger Agreement. The Company did not receive any competing proposals during the solicitation period.

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

3. Stock Based Compensation

A summary of stock option activity is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2007		2006		2007		2006
	($ in thousands, except for share data)

Other operating expenses recognized for stock based compensation	$	275	$	238	$	540	$	461
Related tax benefits of stock based compensation	$	96	$	84	$	189	$	162

Option Grant Activity:
Number of options granted		-		45,000		17,500		45,000
Weighted-average fair value on the date of grant	$	-	$	11.71	$	11.00	$	11.71

Option Exercise Activity:
Cash received from stock options exercised	$	25	$	-	$	219	$	173
Shares of common stock issued in connection with stock options exercised		2,500		-		21,400		17,255
Intrinsic value of options exercised	$	56	$	-	$	416	$	217
Income tax benefit of options exercised	$	19	$	-	$	145	$	75

The Company uses a Black-Scholes-Merton option pricing model in determining the fair value of the options granted. The following table summarizes the assumptions used to estimate the fair value of the Company’s share-based awards issued during the six months ended June 30, 2007:

Weighted-average expected life		7 years
Expected stock price volatility		35.00%
Risk-free interest rate		4.67%
Dividend yield		2.00%

For all awards, the expected life is based on the midpoint between the vesting period and the contractual term of the award. Stock price volatility is estimated based on stock price volatility data for similar property/casualty companies in the period following their respective initial public offerings. The risk-free interest rate assumption is based on the seven-year U.S. Treasury rate at the date of grant. The dividend yield assumption is based upon the rate of expected future dividend payments over the life of the options at the time that the options were granted.

As of June 30, 2007, there was $2.5 million of estimated unrecognized compensation cost related to non-vested option awards expected to be charged to earnings over a weighted-average period of 2.4 years.

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

4. Earnings Per Share

	Three Months Ended June 30,				Six Months Ended June 30,
	2007		2006		2007		2006
	(in thousands, except for share data)

Net income - numerator for basic and diluted earnings per share	$	9,156	$	8,551	$	19,283	$	15,380
Weighted - average common shares outstanding - denominator for basic earnings per share		15,137,856		15,087,308		15,131,149		15,081,571
Dilutive potential common shares:
Options		984,639		823,822		958,308		779,293
Warrants		104,230		91,945		102,171		87,802
Weighted - average common shares and dilutive potential common shares outstanding - denominator for diluted earnings per share		16,226,725		16,003,075		16,191,628		15,948,666

Earnings per share:
Basic	$	0.60	$	0.57	$	1.27	$	1.02
Diluted	$	0.56	$	0.53	$	1.19	$	0.96

5. Income Taxes

Income tax expense differs from the amounts computed by applying the Federal statutory income tax rate to income before income taxes primarily due to interest income on tax-advantaged state and municipal securities. The Company did not have any unrecognized tax benefits at June 30, 2007 or January 1, 2007, the date FIN 48 was adopted. Tax year 2003 and all subsequent tax years remain subject to examination by the Internal Revenue Service.

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

6. Reserve for Losses and Loss Adjustment Expenses

A $2.8 million reserve redundancy developed in the three months ended June 30, 2007 on the direct business written arising from prior accident years. Of this development, $3.9 million of favorable development occurred in the Excess and Surplus Insurance segment’s casualty lines primarily related to the 2005 and 2004 accident years. The Excess and Surplus Insurance segment’s property lines experienced $534,000 of adverse development primarily related to hurricane losses in the 2005 accident year. Adverse development on prior accident years for direct business for the Workers’ Compensation Insurance segment in the three months ended June 30, 2007 was $512,000, with $711,000 of adverse development on the 2006 accident year exceeding $199,000 of favorable development on the 2005 and 2004 accident years.

A $2.0 million reserve redundancy developed in the three months ended June 30, 2006 on direct business written arising from prior accident years. Of this development, $1.5 million of favorable development occurred in the Excess and Surplus Insurance segment’s casualty lines, with $1.2 million of this favorable development coming from the 2004 accident year. Favorable development in the Excess and Surplus Insurance segment’s property lines of $513,000 primarily related to the 2005 accident year.

A $5.8 million reserve redundancy developed in the six months ended June 30, 2007 on direct business written arising from prior accident years. Of this development, $6.0 million of favorable development occurred in the Excess and Surplus Insurance segment’s casualty lines primarily related to the 2005 and 2004 accident years. Adverse development in the Excess and Surplus Insurance segment’s property lines during the six months ended June 30, 2007 of $645,000 primarily related to hurricane losses in the 2005 accident year. Favorable development on prior accident years for the Workers’ Compensation Insurance segment in the six months ended June 30, 2007 was $415,000.

A $4.4 million redundancy developed in the six months ended June 30, 2006 on the direct business written arising from prior accident years. Of this development, $3.0 million of favorable development occurred in the Excess and Surplus Insurance segment’s casualty lines, with $2.4 million of this favorable development coming from the 2004 accident year. Favorable development in the Excess and Surplus Insurance segment’s property lines of $1.1 million primarily related to the 2005 accident year. Favorable development for direct business written by the Workers’ Compensation Insurance segment totaled $242,000.

7. Comprehensive Income

The following table summarizes the components of comprehensive income:

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
	(in thousands)

Net unrealized losses arising during the period, before taxes	$	(7,477	)	$	(4,078	)	$	(6,580	)	$	(8,593	)
Income taxes		2,617			1,426			2,303			3,007
Net unrealized losses arising during the period, net of taxes		(4,860	)		(2,652	)		(4,277	)		(5,586	)
Less reclassification adjustment:
Net losses realized in net income		(19	)		(49	)		(27	)		(84	)
Income taxes		6			17			9			29
Reclassification adjustment for losses realized in net income		(13	)		(32	)		(18	)		(55	)
Other comprehensive loss		(4,847	)		(2,620	)		(4,259	)		(5,531	)
Net income		9,156			8,551			19,283			15,380
Comprehensive income	$	4,309		$	5,931		$	15,024		$	9,849

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

8. Contingent Liabilities

The Company is aware of one lawsuit filed in connection with the proposed Merger of the Company with members of the D. E. Shaw group. On June 13, 2007, Levy Investments filed a purported class action (the Levy complaint) in the Superior Court for Orange County, North Carolina against the Company, all of the directors of the Company and the D. E. Shaw group. The Levy complaint alleges, among other things, that the Company’s directors breached their fiduciary duties to stockholders in approving the Merger Agreement and that the negotiation and structure of the proposed Merger are the result of an unfair process. The Levy complaint seeks, among other things, class certification and an injunction preventing the completion of the Merger, and a declaration that the directors breached their fiduciary duties. The Company believes the Levy complaint is without merit and plans to defend it vigorously.

The Company is a party to various lawsuits arising in the ordinary course of its operations. The Company believes that the ultimate resolution of these matters will not materially impact its financial position or results of operations.

9. Segment Information

The Company has three reportable segments: the Excess and Surplus Insurance segment, the Workers’ Compensation Insurance segment and the Corporate and Other segment. Segment profit (loss) is measured by underwriting profit (loss), which is generally defined as net earned premiums less loss and loss adjustment expenses and other operating expenses of the insurance segments. Segment results are reported prior to the effects of the intercompany reinsurance pooling agreement between the Company’s insurance subsidiaries. The following table summarizes segment results:

	Excess and Surplus Insurance		Workers’ Compensation Insurance		Corporate and Other			Total
	(in thousands)
Three Months Ended June 30, 2007
Gross written premiums	$	64,469	$	14,980	$	-		$	79,449
Net earned premiums		48,744		14,243		-			62,987
Segment revenues		53,729		15,275		(17	)		68,987
Underwriting profit of insurance segments		11,019		225		-			11,244
Net investment income		4,839		1,018		94			5,951
Interest expense		-		-		1,298			1,298
Segment assets		659,899		112,418		21,206			793,523

Three Months Ended June 30, 2006
Gross written premiums	$	63,788	$	10,846	$	-		$	74,634
Net earned premiums		43,316		9,286		-			52,602
Segment revenues		46,754		9,972		379			57,105
Underwriting profit of insurance segments		9,760		410		-			10,170
Net investment income		3,487		674		345			4,506
Interest expense		-		-		896			896
Segment assets		558,025		83,659		30,680			672,364

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

9. Segment Information (continued)

	Excess and Surplus Insurance		Workers’ Compensation Insurance			Corporate and Other		Total
	(in thousands)
Six Months Ended June 30, 2007
Gross written premiums	$	129,948	$	29,589		$	-	$	159,537
Net earned premiums		96,133		27,103			-		123,236
Segment revenues		105,798		29,128			143		135,069
Underwriting profit of insurance segments		19,191		3,070			-		22,261
Net investment income		9,527		1,994			201		11,722
Interest expense		-		-			2,582		2,582
Segment assets		659,899		112,418			21,206		793,523

Six Months Ended June 30, 2006
Gross written premiums	$	121,556	$	21,243		$	-	$	142,799
Net earned premiums		82,900		17,791			-		100,691
Segment revenues		89,382		19,086			726		109,194
Underwriting profit (loss) of insurance segments		17,891		(233	)		-		17,658
Net investment income		6,566		1,272			661		8,499
Interest expense		-		-			1,673		1,673
Segment assets		558,025		83,659			30,680		672,364

The following table reconciles the underwriting profit (loss) of the insurance segments by individual segment to consolidated income before taxes:

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
	(in thousands)

Underwriting profit (loss) of insurance segments:
Excess and Surplus Insurance	$	11,019		$	9,760		$	19,191		$	17,891
Workers’ Compensation Insurance		225			410			3,070			(233	)
Total underwriting profit of insurance segments		11,244			10,170			22,261			17,658
Other operating expenses of the Corporate and Other segment		(2,870	)		(1,166	)		(3,815	)		(1,807	)
Underwriting profit (a)		8,374			9,004			18,446			15,851
Net investment income		5,951			4,506			11,722			8,499
Net realized investment losses		(19	)		(49	)		(27	)		(84	)
Other income		68			46			138			88
Interest expense		(1,298	)		(896	)		(2,582	)		(1,673	)
Consolidated income before taxes	$	13,076		$	12,611		$	27,697		$	22,681

(a)	Other operating expenses of the Corporate and Other segment for the three months and six months ended June 30, 2007 include $2.0 million of legal, accounting, and investment banking fees associated with the proposed transaction. (See Note 2)

Notes to Condensed Consolidated Financial Statements

(Unaudited) (continued)

10. Other Operating Expenses

Other operating expenses consist of the following:

	Three Months Ended June 30,				Six Months Ended June 30,
	2007		2006		2007		2006
	(in thousands)

Other underwriting expenses of the insurance segments	$	5,033	$	3,856	$	10,887	$	7,563
Amortization of policy acquisition costs		9,756		8,362		18,866		16,039
Other operating expenses of the Corporate and Other segment		2,870		1,166		3,815		1,807
Total	$	17,659	$	13,384	$	33,568	$	25,409

11. Investment in Joint Venture

During the second quarter of 2007, the Company invested $620,000 as a one-third owner of a real estate joint venture, Forest Avenue Office, LLC. This joint venture will own and construct a commercial office building which will eventually house the Company’s Richmond, Virginia operations. The investment is recorded in “other assets” in the accompanying balance sheet.

12. Subsequent Events

On July 2, 2007, the Company completed an acquisition of 100% of the stock of Align Financial Group, a wholesale and retail insurance agency with principal offices in San Diego, California.

In July 2007, the Company invested an additional $1.6 million to a real estate joint venture (see Note 11), bringing the Company’s total investment in the real estate joint venture to $2.3 million.

Item 2.

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

On June 11, 2007, the Company announced that it had signed a definitive merger agreement under which a Bermuda-based holding company and member of the D. E. Shaw group, a global investment management firm, would acquire the Company. In connection with the transaction, during the second quarter, the Company incurred $2.0 million of pre-tax transaction costs ($1.3 million after-tax, or $0.08 per diluted share) for legal, accounting and investment banking services. See - “Proposed Transaction”.

OVERVIEW

James River Group, Inc. is an insurance holding company that primarily owns and manages property/casualty insurance companies focused on specialty insurance niches. We seek to:

·	earn a profit from underwriting; and
·	produce a return on average equity of 15% or greater.

Earning a profit from underwriting means that we intend for the premiums we earn in any period to be sufficient to pay all of the losses and loss adjustment expenses we incur during the period as well as all of the expenses associated with our operations. We use underwriting profit or loss as a basis for evaluating our underwriting performance. Our strategy is to operate at a lower expense ratio than many of our competitors; focus our efforts on the specialty insurance market where profits have historically been better than in the standard market; underwrite each risk individually in order to apply our expertise to each risk we underwrite; use technology to provide our employees and managers with timely and accurate information about our business; and actively manage claims in accordance with the terms of our insurance contracts. Our underwriting profit for the three months ended June 30, 2007 (which included the $2.0 million of transaction costs as noted above) was $8.4 million, a decrease from the underwriting profit of $9.0 million reported for the same period last year. For the six months ended June 30, 2007, our underwriting profit was $18.4 million, an increase over the underwriting profit of $15.9 million reported for the same period last year. Excluding the transaction costs noted above, our adjusted underwriting profit for the three-month and six-month periods ended June 30, 2007 was $10.4 million and $20.5 million, respectively. These adjusted amounts represent a 15.4% and 29.1% increase over the underwriting profit of the prior year, respectively.

We calculate return on equity by dividing net income by average stockholders’ equity for the period on an annualized basis. Our overall financial goal is to produce an annual return on equity of at least 15.0%. Our annualized return on equity, including the transaction costs noted above, was 16.3% for the quarter ended June 30, 2007 and 17.5 % for the six months ended June 30, 2007, compared to the return for the same periods in 2006 which were 18.6% and 17.0%, respectively.

We are organized into three reportable segments, which are separately managed business units:

·	The Excess and Surplus Insurance segment offers commercial excess and surplus lines liability and property insurance in 48 states and the District of Columbia through James River Insurance Company (James River Insurance);
·	The Workers’ Compensation Insurance segment offers workers’ compensation coverage primarily for the residential construction industry in North Carolina and, in 2007, Virginia through Stonewood Insurance Company (Stonewood Insurance); and
·	The Corporate and Other segment consists of management and treasury activities of our holding company and interest expense associated with our debt.

James River Insurance and Stonewood Insurance each have a financial strength rating of “A-” (Excellent) from A.M. Best.

RESULTS OF OPERATIONS

The following table compares the components of net income for the three and six months ended June 30, 2007 and 2006:

	Three Months Ended June 30,									Six Months Ended June 30,
	2007			2006			% Change			2007			2006			% Change
	($ in thousands)

Gross written premiums	$	79,449		$	74,634			6.5	%	$	159,537		$	142,799			11.7	%
Net retention (a)		90.1	%		73.5	%					84.9	%		76.0	%
Net written premiums	$	71,572		$	54,824			30.5	%	$	135,442		$	108,512			24.8	%

Net earned premiums	$	62,987		$	52,602			19.7	%	$	123,236		$	100,691			22.4	%
Losses and loss adjustment expenses		(36,954	)		(30,214	)		22.3	%		(71,222	)		(59,431	)		19.8	%
Other operating expenses (b)		(17,659	)		(13,384	)		31.9	%		(33,568	)		(25,409	)		32.1	%
Underwriting profit (c)		8,374			9,004			(7.0	%)		18,446			15,851			16.4	%
Net investment income		5,951			4,506			32.1	%		11,722			8,499			37.9	%
Net realized investment losses		(19	)		(49	)		(61.2	%)		(27	)		(84	)		(67.9	%)
Other income		68			46			47.8	%		138			88			56.8	%
Interest expense		(1,298	)		(896	)		44.9	%		(2,582	)		(1,673	)		54.3	%
Federal income tax expense		(3,920	)		(4,060	)		(3.4	%)		(8,414	)		(7,301	)		15.2	%
Net income	$	9,156		$	8,551			7.1	%	$	19,283		$	15,380			25.4	%
Ratios:
Loss ratio		58.7	%		57.4	%		-			57.8	%		59.0	%		-
Expense ratio (b)		28.0	%		25.4	%		-			27.2	%		25.2	%		-
Combined ratio (b)		86.7	%		82.9	%		-			85.0	%		84.3	%		-

(a) Net retention is defined as the ratio of net written premiums to gross written premiums.

(b) Includes $2.0 million of transaction costs for the quarter and six months ended June 30, 2007.

Results of Operations

Net income was $9.2 million, or $0.56 per diluted share, for the three months ended June 30, 2007, compared to $8.6 million, or $0.53 per diluted share, for the three months ended June 30, 2006. For the six-month period ended June 30, 2007, net income was $19.3 million, or $1.19 per diluted share, compared to the prior year’s net income of $15.4 million, or $0.96 per diluted share. Net income for the 2007 periods included $2.0 million of pre-tax transaction costs (or $0.08 per diluted share) for legal, accounting and investment banking services. Weighted-average diluted shares outstanding were 16.2 million and 16.0 million for the quarter ended June 30, 2007 and 2006, respectively (16.2 million and 15.9 million on a year-to-date basis, respectively).

Our combined ratio for the three months ended June 30, 2007 was 86.7%. The combined ratio is a measure of underwriting performance and represents the relationship of incurred losses, loss adjustment expenses and other operating expenses to net earned premiums. A combined ratio of less than 100% indicates an underwriting profit, while a combined ratio greater than 100% reflects an underwriting loss. The combined ratio for the quarter included $2.8 million, or 4.5 percentage points, of net favorable reserve development on direct business written by the Company on prior accident years including $3.9 million of favorable reserve development from the Excess and Surplus Insurance segment’s casualty business offset by $534,000 of adverse development from the Excess and Surplus Insurance segment’s property business and $512,000 of adverse development from the Workers’ Compensation Insurance segment.

The combined ratio for the six months ended June 30, 2007 of 85.0% included $5.8 million, or 4.7 percentage points, of net favorable reserve development on direct business written by the Company from prior accident years including $6.0 million of favorable reserve development from the Excess and Surplus Insurance segment’s casualty business and $415,000 of favorable reserve development from the Workers’ Compensation Insurance segment offset by $645,000 of adverse development from the Excess and Surplus Insurance segment’s property business.

Included in our combined ratio, our expense ratio increased to 28.0% for the second quarter of 2007 compared to 25.4% for the second quarter of 2006. For the six-month period ended June 30, 2007 our expense ratio increased from 25.2% in 2006 to 27.2% for the six-month period ended June 30, 2007. This increase was primarily attributable to the $2.0 million in transaction costs (representing 3.2 percentage points and 1.6 percentage points in our expense ratio for the three-month and six-month periods, respectively).

In the prior year, the combined ratio for the three months ended June 30, 2006 was 82.9%. It included $2.0 million or 3.9 percentage points, of favorable reserve development on direct business written by the Company from prior accident years. This favorable development arose as follows: $1.5 million of favorable development from the Excess and Surplus Insurance segment’s casualty business, $513,000 of favorable development from the Excess and Surplus Insurance segment’s property business and $19,000 of favorable development for the Workers’ Compensation Insurance segment.

In the prior year, the combined ratio for the six months ended June 30, 2006 was 84.3%. It included $4.4 million, or 4.3 percentage points, of net favorable reserve development on direct business written by the Company from prior accident years. This net favorable development arose as follows: $3.0 million of favorable development from the Excess and Surplus Insurance segment’s casualty business, $1.1 million of favorable development from the Excess and Surplus Insurance segment’s property lines and $242,000 of favorable development for the Workers’ Compensation Insurance segment.

Adjusted Results of Operations Excluding Transaction Costs of $2.0 Million

The following presentation of adjusted results of operations excludes $2.0 million of pre-tax transaction costs (or $0.08 per diluted share) for legal, accounting and investment banking services. See - “Reconciliation of Non-GAAP Measures”.

Adjusted net income was $10.5 million, or $0.64 per diluted share, for the three months ended June 30, 2007, compared to $8.6 million, or $0.53 per diluted share, for the three months ended June 30, 2006. For the six-month period ended June 30, 2007, adjusted net income was $20.6 million, or $1.27 per diluted share, compared to the prior year’s net income of $15.4 million, or $0.96 per diluted share.

Our adjusted combined ratio for the three months ended June 30, 2007 was 83.5%. It included $2.8 million, or 4.5 percentage points, of net favorable reserve development on direct business written by the Company on prior accident years. This is fairly consistent with the combined ratio for the prior year’s second quarter of 82.9% which is noted above.

The adjusted combined ratio for the six months ended June 30, 2007 of 83.4% included $5.8 million, or 4.7 percentage points, of net favorable reserve development on direct business written by the Company on prior accident years. This is lower than the combined ratio for the first six months of the prior year of 84.3%, which is noted above.

Included in our adjusted combined ratio, our adjusted expense ratio decreased to 24.8% for the second quarter of 2007 compared to 25.4% for the second quarter of 2006. For the six-month period ended June 30, our adjusted expense ratio remained relatively stable from 25.2% in 2006 to 25.6% in 2007.

Premiums

The following table summarizes the growth in premium volume by component and business segment:

	Three Months Ended June 30,							Six Months Ended June 30,
	2007		2006		% Change			2007		2006		% Change
	($ in thousands)
Gross written premiums:
Excess and Surplus Insurance	$	64,469	$	63,788		1.1	%	$	129,948	$	121,556		6.9	%
Workers’ Compensation Insurance		14,980		10,846		38.1	%		29,589		21,243		39.3	%
	$	79,449	$	74,634		6.5	%	$	159,537	$	142,799		11.7	%

Net written premiums:
Excess and Surplus Insurance	$	57,696	$	45,368		27.2	%	$	107,319	$	89,944		19.3	%
Workers’ Compensation Insurance		13,876		9,456		46.7	%		28,123		18,568		51.5	%
	$	71,572	$	54,824		30.5	%	$	135,442	$	108,512		24.8	%

Net earned premiums:
Excess and Surplus Insurance	$	48,744	$	43,316		12.5	%	$	96,133	$	82,900		16.0	%
Workers’ Compensation Insurance		14,243		9,286		53.4	%		27,103		17,791		52.3	%
	$	62,987	$	52,602		19.7	%	$	123,236	$	100,691		22.4	%

The excess and surplus insurance industry has been facing a softening market where price competition from other carriers as well as the standard insurance market has begun to intensify. Despite this, gross written premiums for the second quarter and six months ended June 30, 2007 for the Excess and Surplus Insurance segment grew 1.1% and 6.9%, respectively. The increases reflect an increase in renewal business as well as penetration and growth in this segment’s broker network. The number of brokers submitting business to the Excess and Surplus Insurance segment grew 11.9% from 219 for the three months ended June 30, 2006 to 245 for the three months ended June 30, 2007.

Gross written premiums for the Workers’ Compensation Insurance segment for the three months ended June 30, 2007 increased significantly over the quarter ended June 30, 2006. This is attributable to an 18.7% increase in submissions for the second quarter on new business (21.4% on a year-to-date basis) coupled with an increase in renewals over the prior year. During 2007, the Workers’ Compensation Insurance segment began to write policies in Virginia (although the total gross written premiums during 2007 was only $57,000). The increase in premiums noted above resulted from increased penetration with existing agents as well as a 13.6% increase in new agents (the number of producing agencies in the Workers’ Compensation Insurance network increased from 132 at June 30, 2006 to 150 at June 30, 2007). Additionally, gross written premiums for the three months ended June 30, 2007 and 2006 included $601,000 and $657,000, respectively, of assumed premiums from our allocation from the North Carolina involuntary workers’ compensation pool. For the six months ended June 30, 2007 and 2006, assumed premiums from the pool were $1.4 million and $1.2 million, respectively.

The ratio of net written premiums to gross written premiums is referred to as our net retention. For the three months ended June 30, 2007 and 2006, our net retention was 90.1% and 73.5%, respectively (84.9% and 76.0%, respectively, on a year-to-date basis). The net retention for the Excess and Surplus Insurance segment was 89.5% and 71.1% for the three months ended June 30, 2007 and 2006, respectively (82.6% and 74.0%, respectively, on a year-to-date basis). The increase in net retention in the Excess and Surplus Insurance segment is attributable to a June 1, 2007 change in the Company’s property reinsurance program from quota share to excess of loss. This change resulted in a reduction of ceded written premiums (and a corresponding increase in net written premiums) of $8.6 million in the second quarter of 2007. The net retention for the Worker’s Compensation Insurance segment was 92.6% and 87.2% for the three months ended June 30, 2007 and 2006, respectively (95.0% and 87.4%, respectively, on a year-to-date basis). The increase in net retention in the Workers’ Compensation Insurance segment is attributable, in part, to a change in the segment’s reinsurance program where it increased its retention from $750,000 to $1.0 million per occurrence effective January 1, 2007. The remainder of the increase is attributable to the recording of reinsurance deposit payments.

Premiums are earned ratably over the terms of our insurance policies, generally twelve months, and net earned premiums were affected by the growth in written premiums over the prior year.

Underwriting Results

The following table compares our combined ratios by segment:

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006

Excess and Surplus Insurance		77.4	%		77.5	%		80.0	%		78.4	%
Workers’ Compensation Insurance		98.4	%		95.6	%		88.7	%		101.3	%
Total		86.7	%		82.9	%		85.0	%		84.3	%

Excess and Surplus Insurance

Underwriting results for the Excess and Surplus Insurance segment are as follows:

	Three Months Ended June 30,									Six Months Ended June 30,
	2007			2006			% Change			2007			2006			% Change
	($ in thousands)

Gross written premiums	$	64,469		$	63,788			1.1	%	$	129,948		$	121,556			6.9	%
Net written premiums	$	57,696		$	45,368			27.2	%	$	107,319		$	89,944			19.3	%

Net earned premiums	$	48,744		$	43,316			12.5	%	$	96,133		$	82,900			16.0	%
Losses and loss adjustment expenses		(26,323	)		(23,945	)		9.9	%		(54,226	)		(46,312	)		17.1	%
Underwriting expenses		(11,402	)		(9,611	)		18.6	%		(22,716	)		(18,697	)		21.5	%
Underwriting profit (1)	$	11,019		$	9,760			12.9	%	$	19,191		$	17,891			7.3	%

Ratios:
Loss ratio		54.0	%		55.3	%		-			56.4	%		55.9	%		-
Expense ratio		23.4	%		22.2	%		-			23.6	%		22.6	%		-
Combined ratio		77.4	%		77.5	%		-			80.0	%		78.4	%		-

(1) See - “Reconciliation of Non-GAAP Measures”.

The combined ratio for the Excess and Surplus Insurance segment for the three months ended June 30, 2007 was 77.4%, comprised of a loss ratio of 54.0% and an expense ratio of 23.4%. This included $3.4 million, or 6.9 percentage points, of net favorable reserve development in our loss estimates for prior accident years consisting of $3.9 million arising from casualty business offset by $534,000 of adverse development from property business. This compares to the prior year’s second quarter combined ratio of 77.5%, comprised of a loss ratio of 55.3% and an expense ratio of 22.2%. The prior year’s combined ratio for the second quarter included $2.0 million, or 4.7 percentage points, of favorable development consisting of $1.5 million of favorable development on casualty business and $513,000 on property business.

The expense ratio for the second quarter increased from 22.2% in 2006 to 23.4% for the three months ended June 30, 2007. This is primarily attributable to an increase in compensation-related items.

As a result of the items discussed above, our underwriting profit increased 12.9% from $9.8 million for the three months ended June 30, 2006 to $11.0 million for the three months ended June 30, 2007.

The combined ratio for the Excess and Surplus Insurance segment for the six months ended June 30, 2007 was 80.0%, comprised of a loss ratio of 56.4% and an expense ratio of 23.6%. This included $5.4 million, or 5.6 percentage points, of net favorable development in our loss estimates for prior accident years consisting of $6.0 million arising from casualty business offset by $645,000 of adverse development from property business. This compares to the first six months of the prior year’s combined ratio of 78.4%, comprised of a loss ratio of 55.9% and an expense ratio of 22.6%. The prior year’s combined ratio included $4.1 million, or 5.0 percentage points, of favorable reserve development in our loss estimates for prior accident years which included $3.0 million of favorable development on casualty business and $1.1 million on property business.

The expense ratio for the six months ended June 30 increased from 22.6% in 2006 to 23.6% in 2007. This is primarily attributable to an increase in compensation-related items.

As a result of the items discussed above, underwriting profit of the Excess and Surplus Insurance segment increased 7.3% from $17.9 million for the six months ended June 30, 2006 to $19.2 million for the six months ended June 30, 2007.

Underwriting results by major line of business within the Excess and Surplus Insurance segment are as follows:

	Three Months Ended June 30, 2007									Six Months Ended June 30, 2007
	Casualty Lines			Property Lines			Total			Casualty Lines			Property Lines			Total
	($ in thousands)

Net earned premiums	$	47,503		$	1,241		$	48,744		$	94,389		$	1,744		$	96,133
Losses and loss adjustment expenses	$	24,959		$	1,364		$	26,323		$	51,941		$	2,285		$	54,226
Loss ratio		52.5	%		109.9	%		54.0	%		55.0	%		131.0	%		56.4	%

	Three Months Ended June 30, 2006									Six Months Ended June 30, 2006
	Casualty Lines			Property Lines			Total			Casualty Lines			Property Lines			Total
	($ in thousands)

Net earned premiums	$	41,624		$	1,692		$	43,316		$	79,327		$	3,573		$	82,900
Losses and loss adjustment expenses	$	23,866		$	79		$	23,945		$	45,175		$	1,137		$	46,312
Loss ratio		57.3	%		4.7	%		55.3	%		56.9	%		31.8	%		55.9	%

The loss ratio for property lines for the three and six months ended June 30, 2007 reflects adverse development on prior accident years which had a more prominent effect on the loss ratio due to the low net earned premium volume noted above.

Workers’ Compensation Insurance

Underwriting results for the Workers’ Compensation Insurance segment are as follows:

	Three Months Ended June 30,									Six Months Ended June 30,
	2007			2006			% Change			2007			2006			% Change
	($ in thousands)

Gross written premiums	$	14,980		$	10,846			38.1	%	$	29,589		$	21,243			39.3	%
Net written premiums	$	13,876		$	9,456			46.7	%	$	28,123		$	18,568			51.5	%

Net earned premiums	$	14,243		$	9,286			53.4	%	$	27,103		$	17,791			52.3	%
Losses and loss adjustment expenses		(10,631	)		(6,269	)		69.6	%		(16,996	)		(13,119	)		29.6	%
Underwriting expenses		(3,387	)		(2,607	)		29.9	%		(7,037	)		(4,905	)		43.5	%
Underwriting profit (loss)(1)	$	225		$	410			(45.1	%)	$	3,070		$	(233	)		-

Ratios:
Loss ratio		74.6	%		67.5	%		-			62.7	%		73.7	%		-
Expense ratio		23.8	%		28.1	%		-			26.0	%		27.6	%		-
Combined ratio		98.4	%		95.6	%		-			88.7	%		101.3	%		-

(1) See - “Reconciliation of Non-GAAP Measures”.

The combined ratio for the Workers’ Compensation Insurance segment for the three months ended June 30, 2007 was 98.4%, comprised of a loss ratio of 74.6% and an expense ratio of 23.8%. The loss ratio included $512,000, or 3.6 percentage points, of adverse reserve development on prior accident years for direct business. This compares to the prior year’s second quarter combined ratio of 95.6%, comprised of a loss ratio of 67.5% and an expense ratio of 28.1%. The loss ratio for the second quarter of the prior year included $19,000, or 0.2 percentage points, of favorable development on direct business from prior accident years. The results for the quarter ended June 30, 2007 reflected higher loss activity.

The expense ratio for the second quarter decreased from 28.1% in 2006 to 23.8% for the three months ended June 30, 2007. This decrease primarily reflects the management of growth in underwriting and other expenses while achieving significant growth in earned premiums.

As a result of the items discussed above, our underwriting profit decreased from $410,000 for the three months ended June 30, 2006 to $225,000 for the three months ended June 30, 2007.

The combined ratio for the Workers’ Compensation Insurance segment for the six months ended June 30, 2007 was 88.7%, comprised of a loss ratio of 62.7% and an expense ratio of 26.0%. The loss ratio included $415,000, or 1.5 percentage points, of net favorable reserve development on prior accident years. For the six months ended June 30, 2006, the Workers’ Compensation Insurance segment had a combined ratio of 101.3%, comprised of a loss ratio of 73.7% and an expense ratio of 27.6%. The loss ratio included high loss activity in the first quarter of 2006 offset by $242,000, or 1.4 percentage points, of favorable reserve development on direct business from prior accident years.

The expense ratio of the Workers’ Compensation Insurance segment for the six months ended June 30, 2007 of 26.0% improved over the prior year of 27.6% principally due to the management of growth in underwriting and other expenses while achieving significant growth in earned premiums.

As a result of the items discussed above, our underwriting profit (loss) of the Workers’ Compensation Insurance segment increased from a loss of $233,000 for the six months ended June 30, 2006 to a profit of $3.1 million for the six months ended June 30, 2007.

Reserves

The Company’s gross reserve for losses and loss adjustment expenses at June 30, 2007 was $351.0 million. Of this amount, 75.2% relates to amounts that are incurred but not reported (IBNR). The Company’s gross reserves for losses and loss adjustment expenses by segment are summarized as follows:

	Gross Reserves at June 30, 2007
	Case		IBNR		Total
	(in thousands)
Excess and Surplus Insurance
Casualty Lines	$	51,159	$	224,322	$	275,481
Property Lines		18,295		14,997		33,292
Workers’ Compensation Insurance		17,485		24,740		42,225
Total	$	86,939	$	264,059	$	350,998

At June 30, 2007, the amount of net reserves related to IBNR was 79.2% of the total net reserve for losses and loss adjustment expenses. The Company’s net reserves for losses and loss adjustment expenses by segment are summarized as follows:

	Net Reserves at June 30, 2007
	Case		IBNR		Total
	(in thousands)
Excess and Surplus Insurance
Casualty Lines	$	31,065	$	174,511	$	205,576
Property Lines		4,581		5,129		9,710
Workers’ Compensation Insurance		17,228		21,340		38,568
Total	$	52,874	$	200,980	$	253,854

Other Operating Expenses

Other operating expenses for the Company include both the underwriting, acquisition and insurance expenses of the Excess and Surplus Insurance segment and the Workers’ Compensation Insurance segment as well as the expenses of the Corporate