Zenith National Insurance (ZNT)

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Zenith National Insurance 10-Q 2009

Documents found in this filing:

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2009

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

For the transition period from to

Commission file number 1-9627

ZENITH NATIONAL INSURANCE CORP.

Incorporated in Delaware		I.R.S. Employer Identification No.
21255 Califa Street, Woodland Hills, California		95-2702776
91367-5021
(818) 713-1000

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

Yes x

No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o

No o

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

Large accelerated filer	x	Accelerated filer	o

Non-accelerated filer (do not check
if a smaller reporting company)	o	Smaller reporting company	o

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

Yes o

No x

At October 15, 2009, there were 37,367,000 shares of Zenith National Insurance Corp. common stock outstanding.

Zenith National Insurance Corp. and Subsidiaries

Form 10-Q

For the Quarter Ended September 30, 2009

Table of Contents

		Page

Part I – Financial Information

Item 1.	Financial Statements (unaudited):

	Consolidated Balance Sheets – September 30, 2009 and December 31, 2008	3

	Consolidated Statements of Operations – Three and Nine Months Ended September 30, 2009 and 2008	4

	Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2009 and 2008	5

	Consolidated Statements of Stockholders’ Equity and Comprehensive Income - Nine Months Ended September 30, 2009 and 2008	7

	Notes to Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations	24

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	44

Item 4.	Controls and Procedures	45

Part II – Other Information

Item 6.	Exhibits	46

Signatures		47

Part I – FINANCIAL INFORMATION

Item 1. Financial Statements

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	September 30,		December 31,
(Dollars and shares in thousands)	2009		2008
Assets:
Investments:
Fixed maturity securities:
At fair value (amortized cost $1,427,505 in 2009 and $1,479,295 in 2008)	$	1,478,914	$	1,406,891
At amortized cost (fair value $211,128 in 2008)			203,349
Equity securities, at fair value (cost $28,450 in 2009 and $52,888 in 2008)	32,639		47,742
Short-term investments, at fair value (amortized cost $479,333 in 2009 and $241,452 in 2008)	479,352		241,715
Other investments	62,063		58,297
Total investments	2,052,968		1,957,994
Cash	15,981		10,478
Accrued investment income	21,346		23,147
Premiums receivable	10,619		14,815
Reinsurance recoverables	259,316		285,269
Deferred policy acquisition costs	7,285		7,274
Deferred tax asset	17,180		70,469
Income tax receivable	9,905		33,448
Goodwill	20,985		20,985
Other assets	93,194		102,143
Total assets	$	2,508,779	$	2,526,022

Liabilities:
Unpaid losses and loss adjustment expenses	$	1,214,571	$	1,274,586
Unearned premiums	46,112		45,226
Policyholders’ dividends accrued	25,644		37,253
Redeemable securities payable	58,362		58,357
Other liabilities	82,883		87,163
Total liabilities	1,427,572		1,502,585

Commitments and contingencies (see Note 11)

Stockholders’ equity:
Preferred stock, $1 par value, 1,000 shares authorized; none issued or outstanding in 2009 and 2008
Common stock, $1 par value, 100,000 shares authorized; issued 37,367 in 2009 and 45,019 in 2008; outstanding 37,367 in 2009 and 37,324 in 2008	37,367		45,019
Additional paid-in capital	359,861		472,312
Retained earnings	647,827		722,996
Accumulated other comprehensive income (loss)	36,152		(50,238		)
Treasury stock, at cost (7,695 shares in 2008) (see Note 7)			(166,652		)
Total stockholders’ equity	1,081,207		1,023,437
Total liabilities and stockholders’ equity	$	2,508,779	$	2,526,022

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

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(Dollars in thousands, except per share data)	2009			2008			2009			2008

Revenues:
Net premiums earned	$	115,702		$	152,962		$	350,308		$	466,362
Net investment income	20,541			22,873			68,108			68,405
Net realized gains (losses) on investments	20,645			(8,883		)	26,162			(6,695		)
Total revenues	156,888			166,952			444,578			528,072

Expenses:
Losses and loss adjustment expenses incurred	80,310			75,297			249,791			195,618
Underwriting and other operating expenses:
Policy acquisition costs	22,151			27,543			67,426			83,296
Underwriting and other costs	28,832			31,146			89,323			93,422
Policyholders’ dividends	(5,328		)	5,604			(1,514		)	17,641
Interest expense	1,284			1,284			3,852			3,870
Total expenses	127,249			140,874			408,878			393,847
Income before tax	29,639			26,078			35,700			134,225
Income tax expense	10,439			9,478			12,100			47,325
Net income	$	19,200		$	16,600		$	23,600		$	86,900

Net income per common share:
Basic	$	0.51		$	0.45		$	0.62		$	2.34
Diluted	0.51			0.44			0.62			2.32

Cash dividends declared per common share	$	0.50		$	0.50		$	1.50		$	1.50

Net realized gains (losses) on investments, before tax
Other-than-temporary impairment losses:
Total impairment losses on fixed maturity securities							$	(19,424	)
Non-credit portion of impairment losses on fixed maturity securities recognized in other comprehensive income							8,762
Other-than-temporary impairment losses on fixed maturity securities				$	(10,352	)	(10,662		)	$	(13,224	)
Other-than-temporary impairment losses on equity securities				(4,939		)	(8,418		)	(10,606		)
Other net realized gains	$	20,645		6,408			45,242			17,135
Net realized gains (losses) on investments, before tax	$	20,645		$	(8,883	)	$	26,162		$	(6,695	)

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

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Nine Months Ended September 30,
(Dollars in thousands)	2009			2008

Cash flows from operating activities:
Premiums collected	$	368,148		$	483,579
Investment income received	70,228			64,191
Losses and loss adjustment expenses paid	(285,586		)	(297,046		)
Underwriting and other operating expenses paid	(162,581		)	(188,040		)
Interest paid	(5,069		)	(5,107		)
Income taxes refunded (paid)	18,200			(56,694		)
Net cash provided by operating activities	3,340			883

Cash flows from investing activities:
Purchases of investments:
Fixed maturity securities available-for-sale	(794,566		)	(696,311		)
Equity securities available-for-sale	(27,613		)	(104,354		)
Other investments	(5,434		)	(37,190		)
Proceeds from maturities and redemptions of investments:
Fixed maturity securities held-to-maturity				20,997
Fixed maturity securities available-for-sale	73,121			70,508
Other investments	2,790			1,528
Proceeds from sales of investments:
Fixed maturity securities available-for-sale	950,850			719,552
Equity securities available-for-sale	44,449			105,131
Net increase in short-term investments	(180,326		)	(20,408		)
Capital expenditures and other	(4,424		)	(5,299		)
Net cash provided by investing activities	58,847			54,154

Cash flows from financing activities:
Cash dividends paid to common stockholders	(56,695		)	(56,420		)
Excess tax benefit on stock-based compensation	11			340
Net cash used in financing activities	(56,684		)	(56,080		)

Net increase (decrease) in cash	5,503			(1,043		)
Cash at beginning of period	10,478			6,933
Cash at end of period	$	15,981		$	5,890

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

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

(UNAUDITED)

	Nine Months Ended September 30,
(Dollars in thousands)	2009			2008

Reconciliation of net income to net cash provided by operating activities:

Net income	$	23,600		$	86,900
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	6,108			6,369
Net amortization (accretion)	244			(5,037		)
Net realized (gains) losses on investments	(26,162		)	6,695
Decrease (increase) in:
Accrued investment income	1,751			1,425
Premiums receivable	4,114			4,830
Reinsurance recoverables	25,938			46,524
Net income tax	30,300			(10,569		)
(Decrease) increase in:
Unpaid losses and loss adjustment expenses	(60,015		)	(147,574		)
Unearned premiums	886			(1,838		)
Policyholders’ dividends accrued	(11,609		)	8,139
Other	8,185			5,019
Net cash provided by operating activities	$	3,340		$	883

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

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(UNAUDITED)

	Nine Months Ended September 30,
(Dollars in thousands, except per share data)	2009			2008

Preferred stock, $1 par value	None			None

Common stock, $1 par value:
Beginning of period	$	45,019		$	44,802
Treasury stock retirement (see Note 7)	(7,695		)
Restricted stock vested	43			78
Conversion of Convertible Senior Notes Payable				69
End of period	37,367			44,949

Additional paid-in capital:
Beginning of period	472,312			464,932
Treasury stock retirement (see Note 7)	(116,890		)
Recognition of stock-based compensation expense	4,446			4,504
Conversion of Convertible Senior Notes Payable				1,223
Excess tax (short-fall) benefit on stock-based compensation	(7		)	283
End of period	359,861			470,942

Retained earnings:
Beginning of period	722,996			718,175
Treasury stock retirement (see Note 7)	(42,067		)
Net income	23,600			86,900
Cash dividends declared to common stockholders	(56,702		)	(56,465		)
End of period	647,827			748,610

Accumulated other comprehensive (loss) income:
Beginning of period	(50,238		)	12,100
Net change in unrealized gains (losses) on available-for-sale investments, net of tax and reclassification adjustment	85,721			(65,394		)
Net change in other-than-temporary impairments for which the credit related portion was recognized in net realized gains, net of tax	669
End of period	36,152			(53,294		)

Treasury stock:
Beginning of period	(166,652		)	(166,652		)
Treasury stock retirement (see Note 7)	166,652
End of period				(166,652		)

Total stockholders’ equity	$	1,081,207		$	1,044,555

Stockholders’ equity per outstanding common share	$	28.93		$	28.04

	Nine Months Ended September 30,
(Dollars in thousands)	2009		2008
Comprehensive income:
Net income	$	23,600	$	86,900
Net change in unrealized gains (losses) on available-for-sale investments, net of tax and reclassification adjustment	85,721		(65,394		)
Net change in other-than-temporary impairments for which the credit related portion was recognized in net realized gains, net of tax	669
Comprehensive income	$	109,990	$	21,506

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

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Basis of Presentation

Zenith National Insurance Corp. (“Zenith National”) is a holding company engaged, through its wholly-owned subsidiaries (primarily Zenith Insurance Company (“Zenith Insurance”)), in the workers’ compensation insurance business, nationally. Unless otherwise indicated, all references to “Zenith,” “we,” “us,” “our,” the “Company” or similar terms refer to Zenith National together with its subsidiaries. The accompanying unaudited Consolidated Financial Statements of Zenith National and subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information; with the instructions to Form 10-Q; and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including normal, recurring adjustments) necessary for a fair statement of our financial position and results of operations for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. For further information, refer to the audited Financial Statements and Notes thereto included in the Zenith National Insurance Corp. Annual Report on Form 10-K for the year ended December 31, 2008.

We evaluated subsequent events through the date and time the Consolidated Financial Statements were issued on October 20, 2009.

Reclassifications. Certain prior year amounts in the accompanying Consolidated Financial Statements have been reclassified to conform to the current year presentation.

Note 2. Net Income and Dividends per Share

The following table sets forth the computation of basic and diluted net income per common share and cash dividends declared per common share:

			Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars and shares in thousands, except per share data)			2009		2008		2009		2008
Net income as reported			$	19,200	$	16,600	$	23,600	$	86,900
Net income allocated to unvested restricted stock shares (see below)			233				292
(A)	Net income allocated to common shares		$	18,967	$	16,600	$	23,308	$	86,900
(B)	Interest expense on the Convertible Senior Notes Payable, net of tax								$	11
(C)	Weighted average shares outstanding – basic		37,353		37,248		37,342		37,190
	Weighted average shares issued under the Restricted Stock Plan (see below)				176				174
	Weighted average shares issued in 2008 upon conversion of the Convertible Senior Notes Payable								23
(D)	Weighted average shares outstanding – diluted		37,353		37,424		37,342		37,387
Net income per common share:
(A)/(C)		Basic	$	0.51	$	0.45	$	0.62	$	2.34
((A)+(B))/(D)		Diluted	0.51		0.44		0.62		2.32
Cash dividends declared per common share			$	0.50	$	0.50	$	1.50	$	1.50

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

On January 1, 2009, we adopted the accounting guidance on “Participating Securities and the Two-Class Method,” which required that unvested restricted stock with a right to receive nonforfeitable dividends be included in the two-class method of computing earnings per share. The weighted average shares outstanding and net income per common share for the three and nine months ended September 30, 2009 are presented in accordance with this guidance. Prior period amounts were not restated due to immateriality.

Note 3. Investments

At September 30, 2009, all of our investments in fixed maturity and equity securities and short-term investments were classified as available-for-sale and reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity, net of tax.

At December 31, 2008, in addition to our available-for-sale securities, our investments portfolio also included certain fixed maturity securities classified as held-to-maturity and reported at amortized cost. We reclassified our entire held-to-maturity investment portfolio with an amortized cost of approximately $200 million at the date of transfer to available-for-sale during the first quarter 2009 because the unprecedented events in the financial markets resulted in market and economic risks that were not present at the time we elected to hold these securities to maturity. We determined that we no longer had the positive intent to hold these securities to maturity because of these unusual events and substantial economic changes. In March 2009, we sold all of our mortgage-backed securities issued by the Government National Mortgage Association, most of which were originally classified as held-to-maturity, resulting in a realized gain of $8.8 million before tax.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

The cost or amortized cost, fair value and carrying value of available-for-sale investments at September 30, 2009 and held-to-maturity and available-for-sale investments at December 31, 2008 were as follows:

	Cost or Amortized		Gross Unrealized					Fair		Carrying
(Dollars in thousands)	Cost		Gains		(Losses)			Value		Value
September 30, 2009
Fixed maturity securities available-for-sale:
Corporate debt	$	1,215,754	$	53,633	$	(8,712	)	$	1,260,675	$	1,260,675
State and local government debt	118,188		6,389		(1		)	124,576		124,576
Mortgage-backed securities	9,732		368					10,100		10,100
Foreign government debt	2,670		27					2,697		2,697
Redeemable preferred stocks	26,875		241		(595		)	26,521		26,521
U.S. Government debt	54,286		59					54,345		54,345
Total fixed maturity securities available-for-sale	1,427,505		60,717		(9,308		)	1,478,914		1,478,914
Equity securities	28,450		4,233		(44		)	32,639		32,639
Short-term investments	479,333		247		(228		)	479,352		479,352
Total available-for-sale investments	$	1,935,288	$	65,197	$	(9,580	)	$	1,990,905	$	1,990,905

December 31, 2008
Fixed maturity securities held-to-maturity:
Mortgage-backed securities	$	175,737	$	7,285				$	183,022	$	175,737
State and local government debt	22,612		521		$	(43	)	23,090		22,612
Foreign government debt	5,000		16					5,016		5,000
Total fixed maturity securities held-to-maturity	$	203,349	$	7,822	$	(43	)	$	211,128	$	203,349
Fixed maturity securities available-for sale:
Corporate debt	$	1,280,354	$	18,058	$	(90,480	)	$	1,207,932	$	1,207,932
State and local government debt	175,516		3,450		(3,214		)	175,752		175,752
Mortgage-backed securities	14,866		638					15,504		15,504
Redeemable preferred stocks	4,505				(892		)	3,613		3,613
U.S. Government debt	4,054		36					4,090		4,090
Total fixed maturity securities available-for-sale	1,479,295		22,182		(94,586		)	1,406,891		1,406,891
Equity securities	52,888		1,680		(6,826		)	47,742		47,742
Short-term investments	241,452		273		(10		)	241,715		241,715
Total available-for-sale investments	$	1,773,635	$	24,135	$	(101,422	)	$	1,696,348	$	1,696,348

Fixed maturity securities, including short-term investments, by contractual maturity were as follows at September 30, 2009:

(Dollars in thousands)	Amortized Cost		Fair Value
Due in 1 year or less	$	606,242	$	608,072
Due after 1 year through 5 years	1,035,185		1,078,373
Due after 5 years through 10 years	233,008		239,357
Due after 10 years	32,403		32,464
Total	$	1,906,838	$	1,958,266

Investments that we currently own could be subject to default by the issuer or could suffer declines in fair value that become other-than-temporary. We continually assess the prospects for individual securities as part of our ongoing portfolio management, including the identification of other-than-temporary declines in fair values. Our other-than-temporary assessment includes reviewing the

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

extent and duration of declines in fair values of investments below the amortized cost basis, the seniority and duration of the securities, historical and projected company financial performance, company-specific news and other developments, the outlook for industry sectors, credit ratings and macro-economic changes, including government policy initiatives. For over seventeen years, we have consistently applied the presumption that an unrealized loss of 20% or more continuously for six months or more is other-than-temporary, in addition to issuer specific events. The accounting guidance on “Recognition and Presentation of Other-Than-Temporary Impairments” that we adopted effective January 1, 2009 amended the determination of other-than-temporary impairments for debt securities, but not for equity securities. For debt securities, the amount of an other-than-temporary impairment related to a credit loss or an impairment on a security that, at the balance sheet date, we intend to sell before recovery is recognized in earnings and reflected as a reduction in the cost basis of the security. The amount of an other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of stockholders’ equity in other comprehensive income or loss with no change to the cost basis of the security. For equity securities, the amount of an other-than-temporary impairment due to the extent and duration that fair value is below cost, in addition to issuer specific events, is recognized in earnings and reflected as a reduction in the cost basis of the security.

In determining whether a credit loss existed on debt securities as of each balance sheet date, we estimated the present value of cash flows expected to be collected from the fixed maturity securities. Considerable judgment is required in determining estimated cash flows for any individual security and we use market observable data as well as management judgment. The cash flow estimates incorporate our assumption regarding the probability of default, and the timing and amount of recoveries associated with a default. We develop our estimates using information based on market observable data such as industry analysts’ reports and forecasts, analysis of investment yield spreads to comparable peer company securities where there are no indications of credit related impairments, analysis of credit default swap spreads and other data relevant to the collectability of a security.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

There were no other-than-temporary impairments recorded during the three months ended September 30, 2009. The following table presents other-than-temporary impairments for the nine months ended September 30, 2009 and shows the amounts recognized in earnings and the amounts recorded as a component of stockholders’ equity as of the date of impairment. For the three and nine months ended September 30, 2008, we recognized other-than-temporary impairments in earnings before tax of $15.3 million and $23.8 million, respectively.

	Nine Months Ended September 30, 2009
(Dollars in thousands)	Realized Losses Recognized in Earnings		Unrealized Losses Recognized as a Component of Stockholders’ Equity
Fixed maturity securities:
With credit related losses	$	9,700	$	8,762
With intent to sell	962
Equity securities	8,418

Total other-than-temporary impairments, before tax	$	19,080	$	8,762

Total other-than-temporary impairments, after tax	$	12,402	$	5,695

We recognized in earnings the credit related impairments of $9.7 million before tax for two corporate debt securities based on estimated cash flows as of March 31, 2009. We estimated the cash flows at 60% of par value for one of the debt securities and 90% of par value for the other debt security, and discounted the cash flows using the effective interest rate of 6.6% and 5.49% implicit in the two debt securities at the date of acquisition.

The $5.7 million unrealized loss after tax was not credit related and was recognized as a component of stockholders’ equity at March 31, 2009, the date of impairment. As of September 30, 2009, this non-credit related loss has fully recovered to a $0.7 million unrealized gain due to the appreciation in fair values and partial sales of the related securities.

The following table presents the change in other-than-temporary credit related impairments before tax recognized in earnings:

(Dollars in thousands)
Beginning balance for securities owned as of December 31, 2008	$	0
Not previously recognized	9,700
Reduction for securities sold subsequent to impairment	(5,952		)
Ending balance for securities owned as of September 30, 2009	$	3,748

Beginning balance for securities owned as of June 30, 2009	7,096
Reduction for securities sold subsequent to impairment	(3,348		)
Ending balance for securities owned as of September 30, 2009	$	3,748

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

The following table presents the fair value of securities classified as available-for-sale with unrealized losses, aggregated by investment category and length of time the securities have been in a continuous unrealized loss position at September 30, 2009 and December 31, 2008:

(Dollars in thousands)	Fair Value		Unrealized Losses			Number of Issues
September 30, 2009
Less than 12 months:
Corporate debt	$	75,565	$	(1,254	)	14
Short-term investments	20,088		(228		)	2
State and local government debt	1,052		(1		)	1
Total less than 12 months	$	96,705	$	(1,483	)	17
Greater than 12 months:
Corporate debt	$	115,260	$	(7,458	)	16
Redeemable preferred stocks	3,910		(595		)	2
Equity securities	302		(44		)	1
Total greater than 12 months	$	119,472	$	(8,097	)	19
Total available-for-sale:
Corporate debt	$	190,825	$	(8,712	)	30
Redeemable preferred stocks	3,910		(595		)	2
Short-term investments	20,088		(228		)	2
State and local government debt	1,052		(1		)	1
Equity securities	302		(44		)	1
Total available-for-sale investments	$	216,177	$	(9,580	)	36

December 31, 2008
Less than 12 months:
Corporate debt	$	640,894	$	(57,606	)	120
Equity securities	16,163		(6,826		)	9
State and local government debt	67,330		(3,214		)	18
Redeemable preferred stocks	2,956		(644		)	1
Short-term investments	112,435		(10		)	1
Total less than 12 months	$	839,778	$	(68,300	)	149
Greater than 12 months:
Corporate debt	$	107,060	$	(32,874	)	13
Redeemable preferred stocks	657		(248		)	1
Total greater than 12 months	$	107,717	$	(33,122	)	14
Total available-for-sale:
Corporate debt	$	747,954	$	(90,480	)	133
Equity securities	16,163		(6,826		)	9
State and local government debt	67,330		(3,214		)	18
Redeemable preferred stocks	3,613		(892		)	2
Short-term investments	112,435		(10		)	1
Total available-for-sale investments	$	947,495	$	(101,422	)	163

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

The unprecedented events in the capital and credit markets have resulted in extreme volatility and disruption to the financial markets over the past twelve months. The fair value of our available-for-sale investment portfolio improved from an unrealized loss before tax of $77.3 million at December 31, 2008 to an unrealized gain before tax of $55.6 million at September 30, 2009, an increase of $132.9 million. The unrealized gain on our available-for-sale investment portfolio as of September 30, 2009 is net of unrealized losses on individual fixed maturity and equity securities.

The change in unrealized gains (losses) on our available-for-sale investment portfolio were as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
(Dollars in thousands)	2009		2008			2009		2008
Change in unrealized gains (losses) on available-for-sale investments:
Fixed maturity securities, including short-term investments	$	45,341	$	(61,253	)	$	123,569	$	(86,036	)
Equity securities	111		(4,962		)	9,335		(14,571		)
Total change in unrealized gains (losses):
Before tax	$	45,452	$	(66,215	)	$	132,904	$	(100,607	)
After tax	29,546		(43,038		)	86,390		(65,394		)

We believe that our unrealized losses on individual fixed maturity and equity securities at September 30, 2009 are not material and are not indicative of impaired values. We base this conclusion on our current understanding of the issuers of these securities. As of September 30, 2009, we have not made a decision to sell any of these securities with unrealized losses and we have adequate liquidity and will not be required to sell these securities before recovery of their cost basis. It is possible that we could recognize future impairments on some securities we owned at September 30, 2009 if future events, information and the passage of time cause us to determine that a decline in value is other-than-temporary.

Net realized gains (losses) on all of our investments were as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
(Dollars in thousands)	2009		2008			2009			2008
Fixed maturity securities, including short-term investments	$	19,031	$	2,493		$	41,215		$	5,462
Equity securities	648		3,620			815			10,971
Partnerships and limited liability companies	966		278			2,710			679
WorldCom settlement and other			17			502			23
Other-than-temporary impairment losses on fixed maturity securities			(10,352		)	(10,662		)	(13,224		)
Other-than-temporary impairment losses on equity securities			(4,939		)	(8,418		)	(10,606		)
Net realized gains (losses) on investments	$	20,645	$	(8,883	)	$	26,162		$	(6,695	)

For the three and nine months ended September 30, 2009 and 2008, the gross realized gains and the gross realized losses on sales of investments classified as available-for-sale were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands)	2009			2008			2009			2008
Gross realized gains	$	21,916		$	7,170		$	46,717		$	25,130
Gross realized losses	(2,237		)	(1,057		)	(4,687		)	(8,697		)

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

Net investment income before tax was as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in thousands)	2009		2008		2009		2008
Fixed maturity securities	$	20,367	$	21,445	$	68,356	$	62,550
Short-term investments	723		1,411		1,635		6,884
Equity securities	212		470		1,029		1,671
Other	1,189		1,075		2,015		2,046
Subtotal	22,491		24,401		73,035		73,151
Investment expenses	1,950		1,528		4,927		4,746
Net investment income	$	20,541	$	22,873	$	68,108	$	68,405

Note 4. Fair Value Measurements

Our available-for-sale investment portfolio consists of fixed maturity and equity securities and short-term investments and is recorded at fair value in the accompanying Consolidated Balance Sheets.

Fair value is the price that would be received to sell an asset or would be paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, we primarily use prices and other relevant information generated by market transactions involving identical or comparable assets (“market approach”). We also consider the impact of a significant decrease in volume and level of activity for an asset or liability when compared with normal activity to identify transactions that are not orderly.

Fair value measurements are determined under a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value, distinguishing between market participant assumptions developed based on market data obtained from sources independent of the reporting entity (“observable inputs”) and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (“unobservable inputs”). The hierarchy level assigned to each security in our available-for-sale investment portfolio is based on our assessment of the transparency and reliability of the inputs used in the valuation of each instrument at the measurement date. The highest priority is given to unadjusted quoted prices in active markets for identical assets (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Securities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The three hierarchy levels are as follows:

· Level 1—Valuations based on unadjusted quoted market prices in active markets for identical securities. The fair values of fixed maturity and equity securities and short-term investments included in the Level 1 category were based on quoted prices that are readily and regularly available in an active market. Our Level 1 category includes publicly traded equity securities, highly liquid U.S. Government notes and treasury bills, highly liquid cash management funds, and short-term certificates of deposit.

· Level 2—Valuations based on observable inputs (other than Level 1 prices), such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly. The fair values of fixed maturity securities and short-term investments included in the Level 2 category were based on market values obtained from independent pricing services that were evaluated using pricing models that vary by asset class and incorporate available trade, bid and other

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

market information and price quotes from well-established independent broker-dealers. The independent pricing services monitor market indicators, industry and economic events, and for broker-quoted only securities, obtain quotes from market makers or broker-dealers that they recognize to be market participants. Our Level 2 category includes corporate bonds, municipal bonds, short-term commercial paper and redeemable preferred stocks.

· Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement and involve management judgment. The fair values of certain privately held or thinly traded securities are determined using internal analytical methods based on the best information available. The estimated fair values of our Level 3 securities consist primarily of the following: 1) An equity security of a company based in the United Kingdom with fair value approximating its net asset value because a significant portion of the net asset value, excluding cash balances, is comprised principally of real estate holdings supported by independent appraisals. The estimated fair value for this investment also includes foreign currency fluctuations and considers the value of an unrecognized tax loss carry forward. 2) A fixed maturity security representing our participation in a commercial senior secured term loan. The fair value of this fixed maturity security was based on discounted expected cash flows.

The following table presents our available-for-sale investments measured at fair value on a recurring basis as of September 30, 2009 and December 31, 2008 classified by the valuation hierarchy discussed above:

	Fair Value Measurements
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
September 30, 2009
Fixed maturity securities	$	54,345	$	1,415,052	$	9,517	$	1,478,914
Equity securities	1,660				30,979		32,639
Short-term investments	429,377		49,975				479,352
Total	$	485,382	$	1,465,027	$	40,496	$	1,990,905

December 31, 2008
Fixed maturity securities	$	19,594	$	1,377,866	$	9,431	$	1,406,891
Equity securities	19,394				28,348		47,742
Short-term investments	145,883		95,832				241,715
Total	$	184,871	$	1,473,698	$	37,779	$	1,696,348

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

The following table presents changes in our Level 3 fixed maturity and equity securities measured at fair value on a recurring basis for the three and nine months ended September 30, 2009 and 2008:

(Dollars in thousands)	Fixed Maturity Securities			Equity Securities
Balance at June 30, 2009	$	14,494		$	31,855
Realized and unrealized gains included in:
Other comprehensive income (1)	(34		)	(876		)
Net income	57
Maturities	(5,000		)
Balance at September 30, 2009	$	9,517		$	30,979

Balance at December 31, 2008	$	9,431		$	28,348
Realized and unrealized gains included in:
Other comprehensive income (1)				2,631
Net income	86
Maturities	(5,000		)
Reclassification from held-to-maturity (see Note 3)	5,000
Balance at September 30, 2009	$	9,517		$	30,979

Balance at June 30, 2008	$		$	38,472
Change in unrealized gains included in other comprehensive income (1)			(4,089		)
Purchases	9,404
Balance at September 30, 2008	$	9,404	$	34,383

Balance at December 31, 2007	$		$	38,350
Change in unrealized gains included in other comprehensive income (1)			(3,967		)
Purchases	9,404
Balance at September 30, 2008	$	9,404	$	34,383

(1) Changes in unrealized gains for equity securities represent foreign currency fluctuation.

Note 5. Goodwill

We test goodwill for impairment annually as of December 31 and more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. A reporting unit is an operating segment or a unit one level below the operating segment. The impairment tests include a comparison of the carrying amount of goodwill to the present value of future cash flows of both our workers’ compensation segment and our Florida workers’ compensation business operation, a reporting unit.

We did not evaluate goodwill for impairment as of September 30, 2009, as no events occurred or circumstances changed that would have more likely than not reduced the fair value of a reporting unit below its carrying amount since December 31, 2008. The carrying value of goodwill was $21.0 million as of September 30, 2009 and December 31, 2008.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

Note 6. Policyholders’ Dividends

Most of our workers’ compensation policies are non-participating; however, we issue certain policies in which the policyholder may participate in favorable claims experience through a dividend. In addition, Florida statutes require payment of additional dividends to policyholders pursuant to a formula based on underwriting results. An estimated provision for workers’ compensation policyholders’ dividends is accrued as the related premiums are earned. At December 31, 2008, we accrued approximately $20 million for Florida dividends payable for prior accident years. In the third quarter 2009 we reduced our estimated Florida policyholders’ dividends for prior accident years by $11.1 million based on our actual filing with the Florida Department of Insurance, which was partially offset by an increase of $3.7 million in our current estimated California policyholders’ dividends.

Note 7. Treasury Stock

On September 30, 2009, we cancelled and retired 7,695,000 shares of treasury stock which had been repurchased by the Company over the years for an aggregate repurchase price of $166.7 million. Upon cancellation and retirement, these shares were returned to the status of authorized and unissued. The excess of the repurchase price of the treasury stock over the par value was allocated between additional paid-in capital and retained earnings. There was no impact on our consolidated stockholders’ equity as a result of the cancellation and retirement.

Note 8. Segment Information

Our business is comprised of the following segments: workers’ compensation, reinsurance and investments. Segments are designated based on the types of products and services provided. Workers’ compensation represents insurance coverage for the statutorily prescribed benefits that employers are required to provide to their employees who may be injured in the course of employment. Reinsurance principally consists of assumed reinsurance of property losses from worldwide catastrophes and large property risks. In September 2005, we exited the assumed reinsurance business and ceased writing and renewing assumed reinsurance contracts with all contracts fully expired at the end of 2006; however, we will be paying assumed reinsurance claims for several years. The results of the reinsurance segment will continue to be included in the results of continuing operations. Income from the workers’ compensation and reinsurance segments is determined by deducting net losses and loss adjustment expenses incurred and underwriting and other operating expenses incurred from net premiums earned (this result is also known as underwriting income or loss). Income from operations of the investments segment includes net investment income and net realized gains or losses on investments. We do not allocate investment income to the results of other segments. The losses from the parent include interest expense and the general operating expenses of Zenith National, a holding company, which owns, directly or indirectly, all of the capital stock of its insurance subsidiaries and other investment securities.

The combined ratio, expressed as a percentage, is a key measurement of profitability traditionally used in the property-casualty insurance business. The combined ratio, also referred to as the “calendar year combined ratio,” is the sum of the losses and loss adjustment expense ratio and the underwriting and other operating expense ratio. The losses and loss adjustment expense ratio is the percentage of net losses and loss adjustment expenses incurred to net premiums earned. The underwriting and other operating expense ratio is the percentage of underwriting and other operating expenses to net premiums earned.

ZENITH NATIONAL INSURANCE CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

Segment information is set forth below, with a reconciliation to the accompanying Consolidated Statements of Operations shown in the total column:

(Dollars in thousands)	Workers’ Compensation			Reinsurance		Investments		Parent			Total
Three Months Ended September 30, 2009
Revenues:
Net premiums earned	$	115,666		$	36						$	115,702
Net investment income						$	20,541				20,541
Net realized gains on investments						20,645					20,645
Total revenues	115,666			36		41,186					156,888
Interest expense								$	(1,284	)	(1,284		)
(Loss) income before tax	(8,526		)	87		41,186		(3,108		)	29,639
Income tax (benefit) expense	(2,636		)	29		14,134		(1,088		)	10,439
Net (loss) income	$	(5,890	)	$	58	$	27,052	$	(2,020	)	$	19,200
Combined ratio	107.4		%	NM

Nine Months Ended September 30, 2009
Revenues:
Net premiums earned	$	350,380		$

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