James River Group, INC
Information required by this item is incorporated herein by reference to the information appearing under ‘‘Security Ownership of Certain Beneficial Owners and Management’’ in the 2006 Proxy Statement. Equity Compensation Plan Information The following table sets forth certain information regarding the Company’s equity compensation plans as of December  31, 2005:                       Plan category  Number of Securities tobe Issued Upon Exerciseof Outstanding Options,Warrants and Rights (a)  Weighted-averageExercise Price ofOutstanding Options,Warrants and Rights (b)  Number of SecuritiesRemaining Available forFuture Issuance UnderEquity Compensation Plans(Excluding Securities Reflected in Column (a)) (c) (1)   Equity compensation plans approved by security holders    2,128,359    $ 11.79      2,338,624 (2)    Equity compensation plans not approved by security holders    —      —      —     Total    2,128,359    $ 11.79      2,338,624                (1) On March  23,  2006, the Company terminated the 2003 Incentive Plan with regard to new awards.         (2) Includes 1,097,028 shares remaining available for issuance under the 2003 Incentive Plan at December  31,  2005.   Item 13.    Certain Relationships and Related Transactions. Information required by this item is incorporated herein by reference to the information appearing under ‘‘Certain Relationships and Related Transactions’’ in the 2006 Proxy Statement. Item 14.    Principal Accounting Fees and Services. Information required by this item is incorporated herein by reference to the information appearing under ‘‘Principal Accounting Firm Fees and Services’’ in the 2006 Proxy Statement. 64     PART IV Item 15.    Exhibits and Financial Statement Schedules. (a)    Documents filed as part of this report The financial statements and financial statement schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules are filed as part of this report. The exhibits listed in the accompanying Index to Exhibits are filed as part of this report. (b)    Exhibits See Item 15(a). (c)    Schedules See Item 15(a). All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore, have been omitted. 65     SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.                  JAMES RIVER GROUP, INC.   Date: March  23,  2006  By:/s/ J. Adam Abram                      J. Adam Abram President and Chief Executive Officer        Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.                   Signature  Title  Date   By:/s/ Richard W. Wright  Chairman of the Board  March 23, 2006   Richard W. Wright         By:/s/ J. Adam Abram  President, Chief Executive Officer and  March  23, 2006   J. Adam Abram  Director      By:/s/ Michael T. Oakes  Executive Vice President and  March  23, 2006   Michael T. Oakes  Chief Financial Officer      By:/s/ Michael E. Crow  Senior Vice President — Finance;  March  23, 2006   Michael E. Crow  Chief Accounting Officer      By:/s/ Matthew Bronfman  Director  March  23, 2006   Matthew Bronfman         By:/s/ Alan N. Colner  Director  March  23, 2006   Alan N. Colner         By:/s/ Joel L. Fleishman  Director  March  23, 2006   Joel L. Fleishman         By:/s/ Dallas W. Luby  Director  March  23, 2006   Dallas W. Luby         By:/s/ John T. Sinnott  Director  March  23, 2006   John T. Sinnott         By:/s/ Michael H. Steinhardt  Director  March  23, 2006   Michael H. Steinhardt         By:/s/ A. Wellford Tabor  Director  March  23, 2006   A. Wellford Tabor         By:/s/ James L. Zech  Director  March  23, 2006   James L. Zech         By:/s/ Nicolas D. Zerbib  Director  March  23, 2006   Nicolas D. Zerbib              66     INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES                  Page   Report of Independent Registered Public Accounting Firm  F-1   Consolidated Balance Sheets as of December  31,  2005 and 2004  F-2   Consolidated Statements of Operations for the Years Ended December  31,  2005, 2004 and 2003  F-4   Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December  31, 2005, 2004 and 2003  F-5   Consolidated Statements of Cash Flows for the Years Ended December  31,  2005, 2004 and 2003  F-6   Notes to Consolidated Financial Statements for the Years Ended December  31,  2005, 2004 and 2003  F-7          Schedule I            Summary of Investments  S-1   Schedule II           Condensed Financial Information of Registrant  S-2   Schedule III         Supplementary Insurance Information  S-6            REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of DirectorsJames River Group, Inc. We have audited the accompanying consolidated balance sheets of James River Group, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedules listed in the Index at Item 15(c). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of James River Group, Inc. and subsidiaries at December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with United States generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Richmond, VirginiaFebruary 13, 2006 F-1     JAMES RIVER GROUP, INC. AND SUBSIDIARIESConsolidated Balance Sheets                      December 31,      2005  2004      (in thousands)   Assets                 Investments:                 Fixed maturity securities available-for-sale, at fair value (amortized cost: 2005 – $344,636; 2004 – $172,889)  $ 339,512    $ 172,731     Equity securities available-for-sale, at fair value (cost: 2004 – $2,300)    —      2,290     Total investments    339,512      175,021     Cash and cash equivalents    41,029      20,210     Accrued investment income    3,988      1,809     Premiums receivable and agents’ balances    32,521      18,265     Reinsurance recoverable on unpaid losses    110,514      15,200     Reinsurance recoverable on paid losses    11,544      —     Prepaid reinsurance premiums    25,922      12,003     Deferred policy acquisition costs    13,899      11,344     Intangible insurance assets    4,184      4,184     Property and equipment, net    2,741      3,239     Deferred tax assets    7,999      3,598     Federal income tax receivable    788      —     Other assets    2,403      2,075     Total assets  $ 597,044    $ 266,948          See accompanying notes. F-2     JAMES RIVER GROUP, INC. AND SUBSIDIARIESConsolidated Balance Sheets (continued)                      December 31,      2005  2004      (in thousands, except for share data)   Liabilities and Stockholders’ Equity                 Liabilities:                 Reserve for losses and loss adjustment expenses  $ 226,493    $ 62,243     Unearned premiums    115,765      78,290     Payables to reinsurers    11,316      326     Accrued expenses    4,635      4,182     Federal income taxes payable    —      1,010     Senior debt    15,000      15,000     Junior subordinated debt    22,681      22,681     Funds held    21,992      —     Other liabilities    3,007      2,521     Total liabilities    420,889      186,253     Commitments and contingent liabilities                 Stockholders’ equity:                 Common stock – $0.01 par value; 2005 – 100,000,000 shares authorized; 15,070,053 shares issued and outstanding; 2004  – 2,000,000 shares authorized; 10 shares issued and outstanding    150      —     Common stock warrants    524      524     Additional paid-in capital    173,903      —     Convertible preferred stock – $0.01 par value; 2005 – 5,000,000 shares authorized and no shares outstanding; 2004  – 1,500,000 shares authorized                 Series A – 2004 – 85,000 shares authorized, issued and outstanding; liquidation preference of $15,527    —      8,439     Series B – 2004 – 713,500 shares authorized, issued and outstanding; liquidation preference of $71,350    —      71,117          174,577      80,080     Notes receivable from employees and directors    (535 )     (2,565 )    Retained earnings    5,444      3,289     Accumulated other comprehensive loss    (3,331 )     (109 )    Total stockholders’ equity    176,155      80,695     Total liabilities and stockholders’ equity  $ 597,044    $ 266,948          See accompanying notes. F-3     JAMES RIVER GROUP, INC. AND SUBSIDIARIESConsolidated Statements of Operations                          Year ended December 31,      2005  2004  2003      (in thousands, except for share data)   Revenues                        Direct written premiums  $ 236,617    $ 142,539    $ 36,764     Assumed written premiums    4,400      —      —     Ceded written premiums    (100,427 )     (22,361 )     (9,339 )    Net written premiums    140,590      120,178      27,425     Change in net unearned premiums    (23,090 )     (44,415 )     (22,338 )    Net earned premiums    117,500      75,763      5,087     Net investment income    10,212      3,626      407     Realized investment losses    (252 )     (71 )     —     Other income    133      144      56     Total revenues    127,593      79,462      5,550     Expenses                        Losses and loss adjustment expenses    79,214      47,588      3,372     Other operating expenses    28,446      20,690      6,842     Interest expense    2,667      793      —     Compensation expense on common stock warrant issuance    —      —      524     Total expenses    110,327      69,071      10,738     Income (loss) before taxes    17,266      10,391      (5,188 )    Federal income tax expense (benefit):                        Current    7,868      5,175      —     Deferred    (2,666 )     (3,539 )     —          5,202      1,636      —     Net income (loss)  $ 12,064    $ 8,755    $                (5,188 )    Earnings (loss) per share:                        Basic  $ 1.56    $ 399,167.20    $                (738,106.00 )    Diluted  $ 0.94    $ 0.93    $                (738,106.00 )    Weighted-average common shares outstanding:                        Basic    5,844,904      10      10     Diluted    12,793,243      9,433,300      10          See accompanying notes. F-4     JAMES RIVER GROUP, INC. AND SUBSIDIARIESConsolidated Statements of Changes in Stockholders’ Equity(in thousands, except for share data)                                                           ConvertiblePreferred Stock  NotesReceivablefromEmployeesAndDirectors  CommonStock  CommonStockWarrants  AdditionalPaid inCapital  RetainedEarnings(Loss)  AccumulatedOtherComprehensiveIncome (Loss)  Total      Series A  Series B   Balances at December 31, 2002  $ —    $ —    $ —    $         —    $ —    $ —    $                (278 )   $ —    $                (278 )    Net loss    —      —      —      —      —      —      (5,188 )     —      (5,188 )    Other comprehensive loss:                                                                  Net unrealized losses, net of tax of $0    —      —      —      —      —      —      —      (300 )     (300 )    Total comprehensive loss                                                            (5,488 )    Issuance of common stock warrants    —      —      —      —      524      —      —      —      524     Issuance of preferred stock    8,500      70,000      —      —      —      —      —      —      78,500     Issuance costs    (61 )     (236 )     —      —      —      —      —      —      (297 )    Notes receivable from employees and directors    —      —      (2,565 )     —      —      —      —      —      (2,565 )    Balances at December 31, 2003    8,439      69,764      (2,565 )     —      524      —      (5,466 )     (300 )     70,396     Net income    —      —      —      —      —      —      8,755      —      8,755     Other comprehensive income:                                                                  Net unrealized gains, net of tax of ($59)    —      —      —      —      —      —      —      191      191     Total comprehensive income                                                            8,946     Issuance of preferred stock    —      1,350      —      —      —      —      —      —      1,350     Issuance costs    —      3      —      —      —      —      —      —      3     Balances at December 31, 2004    8,439      71,117      (2,565 )     —      524      —      3,289      (109 )     80,695     Net income    —      —      —      —    —    —      12,064      —      12,064     Other comprehensive income:                                                              Net unrealized losses, net of tax of ($1,734)    —      —      —      —    —    —      —      (3,222 )     (3,222 )    Total comprehensive income                                                        8,842     Issuance of 5,110,600 Common Stock shares    —      —      —      51    —    91,940      —      —      91,991     Issuance of 9,956,413 Common Stock shares in the preferred stock conversion    (8,439 )     (71,117 )     —      99    —    89,366      (9,909 )     —      —     Issuance costs    —      —      —      —    —    (7,435 )     —      —      (7,435 )    Repayment of notes receivable from employees and directors    —      —      2,030      —    —    —      —      —      2,030     Issuance of 3,030 Common Stock shares under stock option plans    —      —      —      —    —    30      —      —      30     Tax effect of exercise of non-qualified stock options    —      —      —      —    —    2      —      —      2     Balances at December 31, 2005  $ —    $ —    $                (535 )   $ 150    $524  $ 173,903    $ 5,444    $                (3,331 )   $ 176,155           See accompanying notes  F-5     JAMES RIVER GROUP, INC. AND SUBSIDIARIESConsolidated Statements of Cash Flows                          Year ended December 31,      2005  2004  2003      (in thousands)   Operating activities                        Net income (loss)  $ 12,064    $ 8,755    $                (5,188 )    Adjustments to reconcile net income (loss) to net cash provided by operating activities:                        Deferred policy acquisition costs    (19,782 )     (20,088 )     (5,085 )    Amortization of policy acquisition costs    17,227      12,853      976     Realized investment losses    252      71      —     Deferred federal income taxes    (2,666 )     (3,539 )     —     Provision for depreciation    934      814      220     Provision for amortization    2,064      1,110      193     Compensation expense on common stock warrant issuance    —      —      524     Change in operating assets and liabilities:                        Accrued investment income    (2,179 )     (1,301 )     (350 )    Premiums receivable and agents’ balances    (14,256 )     (7,812 )     (10,453 )    Reserve for losses and loss adjustment expenses    164,250      44,826      3,791     Unearned premiums    37,475      48,854      29,207     Reinsurance balances, net    (87,795 )     (8,996 )     (4,027 )    Accrued expenses    453      3,123      1,018     Federal income taxes payable    (1,798 )     1,010      —     Payables to related parties    —      —      (196 )    Other    541      775      344     Net cash provided by operating activities    106,784      80,455      10,974     Investing activities                        Acquisitions, net of cash acquired    —      —      (28,914 )    Securities available-for-sale:                        Purchases – fixed maturity securities    (200,806 )     (124,037 )     (44,175 )    Purchases – equity securities    (1,000 )     (2,300 )     —     Sales – fixed maturity securities    4,968      3,466      —     Maturities and calls – fixed maturity securities    22,087      5,979      153     Sales – equity securities    3,263      —      —     Payable to security brokers    (647 )     —      —     Net sales of short-term investments    —      1,482      7,606     Purchases of property and equipment    (446 )     (908 )     (2,428 )    Net cash used in investing activities    (172,581 )     (116,318 )     (67,758 )    Financing activities                        Proceeds from issuance of Common Stock    92,021      —      —     Proceeds from issuance of Series A Preferred Stock    —      —      8,500     Proceeds from issuance of Series B Preferred Stock    —      1,350      67,435     Issuance of senior debt    —      15,000      —     Issuance of junior subordinated debt    —      22,000      —     Issuance costs    (7,435 )     (1,049 )     (297 )    Repayment of notes receivable from officers and directors    2,030      —      —     Investor funds received pending issuance of Series A Preferred     Stock shares    —      —      (6,865 )    Net cash provided by financing activities    86,616      37,301      68,773     Change in cash and cash equivalents    20,819      1,438      11,989     Cash and cash equivalents at beginning of period    20,210      18,772      6,783     Cash and cash equivalents at end of period  $ 41,029    $ 20,210    $ 18,772     Federal income taxes paid  $ 9,664    $ 4,164    $ —     Interest paid  $ 2,598    $ 588    $ —           See accompanying notes.  F-6      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 1.    Accounting Policies Organization James River Group, Inc. (with its subsidiaries, referred to as the Company) is a Delaware-domiciled holding company organized in September 2002 for the purpose of acquiring and managing insurance entities. The consolidated financial statements include the results of James River Group, Inc. and the following wholly-owned subsidiaries from their respective dates of inception or acquisition, as applicable: James River Insurance Company (James River Insurance) is an Ohio-domiciled excess and surplus lines insurance company authorized to write business in 48 states and the District of Columbia. James River Management Company, Inc. provides management services to James River Insurance. Potomac Risk Services, Inc. (Potomac) was formed in 2004 to provide surplus lines brokerage services. Potomac had no operating activities in 2004 or 2005. Stonewood Insurance Company (Stonewood Insurance) is a North Carolina-domiciled workers’ compensation insurance company licensed in November 2003 to write insurance in North Carolina. Stonewood Insurance was licensed to write insurance in South Carolina in December 2005. Stonewood Insurance Management Company, Inc. provides management services to Stonewood Insurance. Stonewood Insurance began writing insurance on January 1, 2004. Basis of Presentation The consolidated financial statements and notes are prepared in accordance with United States generally accepted accounting principles, which, as to the insurance company subsidiaries, vary in some respects from statutory accounting practices which are prescribed or permitted by the various state insurance departments. All significant intercompany transactions and balances have been eliminated. Prior to July 1, 2003, the Company was a development-stage company. Certain reclassifications of prior year amounts have been made to conform with the 2005 presentation. These reclassifications have no effect on net income (loss), stockholders’ equity, or cash flow from operating activities of the prior years. Specifically, $4,639 previously classified as short-term investments on the consolidated balance sheet at December  31,  2004 was reclassified to cash and cash equivalents because the assets were highly liquid investments with maturities of three-months or less at the date of purchase. The consolidated statement of cash flows reflects this reclassification and the reclassification of $9,420 previously classified as short-term investments at December  31,  2003 to cash and cash equivalents. Preparation of the 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 consolidated financial statements and accompanying disclosures. Those estimates are inherently subject to change, and actual results may ultimately differ from those estimates. F-7      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 1.    Accounting Policies (continued) Investments Securities classified as ‘‘available-for-sale’’ are carried at fair value and unrealized gains and losses on such securities, net of deferred taxes, are reported as a separate component of accumulated other comprehensive income (loss). The Company does not have any securities classified as ‘‘held-to-maturity’’ or ‘‘trading’’. Fair value generally represents quoted market value prices for securities traded in the public marketplace or prices analytically determined using bid or closing prices for securities not traded in the public marketplace. Premiums and discounts on mortgage-backed securities and asset-backed securities are amortized or accrued using the constant yield method which considers anticipated prepayments at the date of purchase. To the extent that the estimated lives of such securities change as a result of changes in estimated prepayment rates, the adjustments are included in net investment income using the retrospective method. Realized investment gains or losses are determined on a specific identification basis. The Company evaluates its investments regularly to determine whether there are declines in value that are other-than-temporary. When the Company determines that a security has experienced an other-than-temporary impairment, the impairment loss is recognized as a realized investment loss. The factors that the Company considers in evaluating whether such an other-than-temporary impairment has occurred include the amount and percentage that fair value is below amortized cost, the length of time that fair value has been below amortized cost and the credit quality ratings for the security, with a special emphasis on securities downgraded below investment grade. The Company also considers its intent and ability to hold the security for a sufficient period of time to allow for a recovery in value. Short-term investments are reported at cost and include investments both readily convertible to known amounts of cash and having maturities of 12 months or less upon acquisition by the Company. Cash Equivalents The Company considers highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Premiums Premiums are earned on a pro rata basis over the terms of the policies, generally 12 months. The portion of premiums written applicable to the unexpired terms of the policies in force is recorded as unearned premiums. Premiums Receivable and Agents’ Balances Premiums receivable and agents’ balances are carried at face value net of any allowance for doubtful accounts, which approximates fair value. The allowance for doubtful accounts represents an estimate of amounts considered uncollectible based on the Company’s assessment of the collectibility of receivables that are past due. The allowance for doubtful accounts was $485 and $86 at December 31, 2005 and December  31,  2004, respectively. Bad debt expense was $444 for 2005, $86 for 2004 and $0 for 2003. Receivables written off against the allowance for doubtful accounts totaled $45 for 2005 and $0 for 2004 and 2003. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. F-8      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 1.    Accounting Policies (continued) Deferred Policy Acquisition Costs Costs which vary with and are primarily related to the production of insurance business are deferred. The principal costs deferred are commissions to agents and certain policy underwriting and issue costs, net of ceding commissions related to reinsurance ceded. Amortization of such policy acquisition costs is charged to expense in proportion to premium earned over the estimated policy life. To the extent that unearned premiums on existing policies are not adequate to cover related costs and expenses, deferred policy acquisition costs are charged to earnings. The Company considers anticipated investment income in determining whether a premium deficiency exists. Reserve for Losses and Loss Adjustment Expenses The reserve for losses and loss adjustment expenses (LAE) represents the estimated ultimate cost of all reported and unreported losses and LAE incurred and unpaid at the balance sheet date. The Company does not discount its reserve for losses and LAE. The reserve for losses and LAE is estimated using individual case-basis valuations and statistical analyses. Those estimates are subject to the effects of trends in loss severity and frequency. Management has limited historical loss information available in making loss reserve estimates. The Company utilized two primary actuarial methods to arrive at the loss reserve estimates. One of the primary methods utilizes management’s initial expected loss ratio (the ratio of losses and LAE incurred to net earned premiums), expected reporting patterns for losses based on insurance industry data and the Company’s actual reported losses and LAE to estimate the reserve. The other primary method estimates the reserve by applying an expected loss ratio to net earned premiums by line of business. Management has generally selected the actuarial method that yields the highest reserve for each line of business as its best estimate. Management believes that the practice of using the higher of the two methods is appropriate since the Company has limited historical experience and the two primary actuarial methods utilize industry data, the losses on the Company’s casualty business often take a number of years to develop and the Company writes difficult classes of business which do not typically meet the risk criteria of standard carriers. In estimating the reserve for losses and LAE for Hurricanes Katrina and Wilma, each of which occurred in 2005, management used case reserve estimates based on information obtained from site inspections by the Company's adjustors and the terms of coverage provided in the policies. Management estimated reserves for incurred but not reported claims for Hurricanes Katrina and Wilma using judgment based on an assessment of our property insurance exposures in the path of the storms. At December  31,  2005, the aggregate reserve for losses and LAE is the sum of the results from the selected actuarial method for each line of business plus the reserve for losses and LAE associated with Hurricanes Katrina and Wilma that is estimated as described above. Although management believes that the reserve for losses and LAE is reasonable, it is possible that the Company’s actual incurred losses and LAE will not conform to the assumptions inherent in the determination of these reserves. Specifically, the Company’s actual ultimate loss ratio could differ from management’s initial expected loss ratio or the Company’s actual reporting patterns for losses could differ from the expected reporting patterns based on industry data. Accordingly, the ultimate settlement of losses and the related LAE may vary significantly from the estimates included in the Company’s financial statements. These estimates are reviewed continually by management and are adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current operations. F-9      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 1.    Accounting Policies (continued) Reinsurance Certain premiums and losses are ceded to other insurance companies under various excess of loss and quota share reinsurance contracts. The Company enters into these reinsurance contracts to limit its exposure to large losses and to provide additional capacity for growth. Reinsurance premiums, commissions, losses and LAE on reinsured business are accounted for on a basis consistent with that used in accounting for the original policies issued and the terms of the reinsurance contracts. Reinsurance recoverables and prepaid reinsurance premiums are reported as assets. Other amounts payable to reinsurers or receivable from reinsurers are netted where the right of offset exists. The Company receives ceding commissions in connection with certain ceded reinsurance. The ceding commissions are recorded as a reduction of other operating expenses. Income Taxes Deferred tax assets, net of any applicable valuation allowance, and deferred tax liabilities are provided for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Intangible Insurance Assets The Company accounts for intangible assets in accordance with Financial Accounting Standards Board (FASB) Statement No. 142, Goodwill and Other Intangible Assets (Statement 142). Management has determined that the Company’s intangible assets have an indefinite life. Statement 142 requires that intangible assets with indefinite useful lives be capitalized and tested for impairment at least annually. In evaluating whether there has been impairment to the intangible asset, management determines the fair value of the intangible asset and compares the resulting fair value to the carrying value of the intangible asset. If carrying value exceeds fair value, the intangible asset is written down to fair value, and the impairment is reported through earnings. Property and Equipment, Net Property and equipment is reported at cost less accumulated depreciation and is depreciated principally on a straight-line basis over the estimated useful lives, generally three to ten years, of the depreciable assets. F-10      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 1.    Accounting Policies (continued) Stock Options The Company grants stock options to employees and directors for a fixed number of shares with an exercise price equal to or greater than the fair value of the shares at the date of grant. The Company accounts for stock option grants using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB Opinion No. 25), and accordingly, recognizes no compensation expense for the stock option grants. For purposes of pro forma disclosures required by FASB Statement No. 123, Accounting for Stock Based Compensation (Statement 123), the estimated value of options is amortized to expense over each option's vesting period. For awards issued prior to May  3,  2005 (the date the Company filed its initial Form S-1 with the Securities and Exchange Commission), the minimum value method is used to determine the value. For awards issued after May  3,  2005, the fair value method is used. The following table summarizes the effect on net income (loss) and earnings (loss) per share of such expense recognition:                          Year ended December 31,      2005  2004  2003   Net income (loss) – as reported  $ 12,064    $ 8,755    $                (5,188 )    Stock-based compensation expense determined using the fair value or minimum value method, net of tax    (917 )     (772 )     (369 )    Net income (loss) – pro forma  $ 11,147    $ 7,983    $                (5,557 )    Earnings (loss) per share – as reported:                        Basic  $ 1.56    $ 399,167.20    $                (738,106.00 )    Diluted  $ 0.94    $ 0.93    $                (738,106.00 )    Earnings (loss) per share – pro forma:                        Basic  $ 1.40    $ 321,968.40    $                (775,091.00 )    Diluted  $ 0.88    $ 0.85    $                (775,091.00 )         F-11      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 1.    Accounting Policies (continued) Recent Accounting Pronouncements On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment (Statement 123(R)), which is a revision to Statement 123, supersedes APB Opinion No. 25 and amends FASB Statement No. 95, Statement of Cash Flows. Statement 123(R) requires all share-based payments to employees, including grants of stock options, to be recognized in the financial statements based on their fair values. Under Statement 123(R), pro forma disclosure is no longer an alternative to financial statement recognition for stock option awards made after the Company adopts Statement 123(R). The Company will adopt Statement 123(R) on January 1, 2006. For awards issued prior to May 3, 2005, the Company uses the minimum value method to calculate the pro forma disclosures required by Statement 123. When the Company adopts Statement 123(R) on January 1, 2006, it will continue to account for the portion of awards outstanding prior to May 3, 2005 using the provisions of APB Opinion No. 25 and its related interpretive guidance. For awards issued on or after May 3, 2005, and for awards modified, repurchased or cancelled on or after that date, the Company uses the fair value method to calculate the pro forma disclosures required by Statement 123. When the Company adopts Statement 123(R) on January 1, 2006, it will begin recognizing the expense associated with these awards in the consolidated statement of operations over each award’s remaining vesting period using the modified prospective method. Compensation expense in 2006 associated with options granted subsequent to May  3,  2005 is expected to be approximately $900. Because the amount, terms and fair values of awards to be issued in the future are uncertain, the full impact of the adoption of Statement 123(R) on the Company’s financial statements is not known at this time. In November  2005, the FASB issued FSP FAS No. 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (FSP 115-1), which addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 amends FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, and nullifies certain requirements of EITF 03-1, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments. FSP 115-1 is effective for reporting periods beginning after December  15,  2005. The Company believes its existing policies for recognizing other-than-temporary impairments are consistent with the guidance in FSP 115-1; therefore, the adoption of FSP 115-1 is not expected to have a material impact on the Company’s consolidated balance sheet or results of operations. F-12      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 2.    Acquisition On June 30, 2003, the Company acquired all of the outstanding stock of Fidelity Excess and Surplus Insurance Company (Fidelity) for a cash purchase price totaling $28,929, including $84 of acquisition costs incurred. Fidelity’s results of operations from July 1, 2003 forward are included in the accompanying consolidated statements of operations. The Company’s primary reason for acquiring Fidelity was to obtain regulatory approvals to write insurance on an excess and surplus lines basis in a large number of states. The purchase price allocation to the regulatory approvals resulted in intangible insurance assets of $4,184. A condensed balance sheet disclosing the values assigned to assets and liabilities of the acquired company at the acquisition date is as follows:               Assets          Cash and invested assets  $ 24,644     Reinsurance recoverable    13,626     Intangible insurance assets    4,184     Prepaid reinsurance premiums    228     Accrued investment income    158     Total assets  $ 42,840     Liabilities and Stockholders’ Equity          Reserve for losses and LAE  $ 13,626     Unearned premiums    228     Other liabilities    57     Total liabilities    13,911     Stockholders’ equity    28,929     Total liabilities and stockholders’ equity  $ 42,840          On June 30, 2003, Fidelity had certain insurance liabilities that were ceded to its parent, American Empire Surplus Lines Insurance Company (American Empire) under a reinsurance agreement (the Reinsurance Agreement). On June 30, 2003, immediately prior to the closing, the Reinsurance Agreement was amended such that Fidelity ceded all of its liabilities resulting from direct and assumed business written through June 30, 2003 to American Empire. The Reinsurance Agreement, as amended, is secured by a trust agreement between Fidelity and American Empire (the Trust Agreement) and a guarantee by Great American Insurance Company, an affiliate of American Empire. Fidelity changed its name to James River Insurance Company in July  2003. F-13      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 3.    Earnings (Loss) Per Share                          Year ended December 31,      2005  2004  2003   Net income (loss) – numerator for diluted earnings per share for 2005 and 2004  $ 12,064    $ 8,755    $                (5,188 )    Dividends in arrears    (2,940 )     (4,763 )     (2,193 )    Net income (loss) available to common shareholders – numerator for basic earnings per share and for diluted earnings per share for 2003 due to the anti-dilutive effect of dividends in arrears  $ 9,124    $ 3,992    $                (7,381 )    Weighted average common shares outstanding – denominator for basic earnings per share    5,844,904      10      10     Dilutive potential common shares:                        Series A Preferred Stock    1,043,288      1,700,000      —     Series B Preferred Stock    4,378,740      7,088,160      —     Preferred stock dividends    1,057,887      596,130      —     Options    420,848      44,840      —     Warrants    47,576      4,160      —     Weighted average common shares and diluted potential common shares outstanding – denominator for diluted earnings per share    12,793,243      9,433,300      10     Earnings (loss) per share:                        Basic  $ 1.56    $ 399,167.20    $                (738,106.00 )    Diluted  $ 0.94    $ 0.93    $                (738,106.00 )    Anti-dilutive securities excluded from diluted earnings (loss) per share:                        Warrants and options    35,084      46,470      1,427,070     Preferred stock and dividends    —      —      8,820,120          35,084      46,470      10,247,190          Earnings (loss) per share for the years ended December 31, 2004 and 2003 reflect the 10 for 1 split of the Company’s Common Stock effective August  9,  2005 in connection with the Company’s initial public offering as of the beginning of the period. F-14      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 4.    Investments The Company’s investments in available-for-sale securities are summarized as follows:                           December 31, 2005  Amortized Cost  Gross Unrealized Gains  Gross Unrealized Losses  Fair Value   Fixed maturity securities:                               Corporate  $ 97,807    $ 15    $                (1,923 )   $ 95,899     U.S. treasury securities and obligations of U.S. government agencies    46,868      66      (1,005 )     45,929     State and municipal    99,047      111      (997 )     98,161     Mortgage-backed    65,319      —      (895 )     64,424     Asset-backed    35,595      4      (500 )     35,099     Total  $ 344,636    $ 196    $                (5,320 )   $ 339,512                                    December 31, 2004  Cost or Amortized Cost  Gross Unrealized Gains  Gross Unrealized Losses  Fair Value   Fixed maturity securities:                               Corporate  $ 56,055    $ 323    $                (336 )   $ 56,042     U.S. treasury securities and obligations of U.S. government agencies    38,177      146      (365 )     37,958     State and municipal    33,068      91      (95 )     33,064     Mortgage-backed    30,796      192      (92 )     30,896     Asset-backed    14,793      44      (66 )     14,771          172,889      796      (954 )     172,731     Equity securities    2,300      —      (10 )     2,290     Total  $ 175,189    $ 796    $                (964 )   $ 175,021          F-15      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 4.    Investments (continued) The amortized cost and fair value of investments in fixed maturity securities at December 31, 2005 are summarized, by contractual maturity, as follows:                      Amortized Cost  Fair Value   Due in:                 One year or less  $ 7,538    $ 7,465     After one year through five years    88,620      86,771     After five years through ten years    76,383      75,004     After ten years    71,181      70,749          243,722      239,989     Mortgage-backed    65,319      64,424     Asset-backed    35,595      35,099     Total  $ 344,636    $ 339,512          Actual maturities may differ for some securities because borrowers have the right to call or prepay obligations with or without penalties. The following table shows the Company’s gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:                                      December 31, 2005      Less Than 12 Months  12 Months or More  Total      Fair Value  Gross UnrealizedLosses  Fair Value  Gross UnrealizedLosses  Fair Value  Gross UnrealizedLosses   Fixed maturity securities:                                             Corporate  $ 59,385    $                (1,001 )   $ 28,416    $                (922 )   $ 87,801    $                (1,923 )    U.S. Treasury securities and obligations of U.S. government agencies    21,638      (322 )     19,006      (683 )     40,644      (1,005 )    State and municipal    76,896      (863 )     4,696      (134 )     81,592      (997 )    Mortgage-backed    59,142      (778 )     3,984      (117 )     63,126      (895 )    Asset-backed    26,352      (425 )     4,787      (75 )     31,139      (500 )    Total  $ 243,413    $                (3,389 )   $ 60,889    $                (1,931 )   $ 304,302    $                (5,320 )         F-16      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 4.    Investments (continued)                                      December 31, 2004      Less Than 12 Months  12 Months or More  Total      Fair Value  Gross UnrealizedLosses  Fair Value  Gross UnrealizedLosses  Fair Value  Gross UnrealizedLosses   Fixed maturity securities:                                             Corporate  $ 32,574    $                (279 )   $ 2,138    $                (57 )   $ 34,712    $                (336 )    U.S. Treasury securities and obligations of U.S. government agencies    19,645      (145 )     6,932      (220 )     26,577      (365 )    State and municipal    13,103      (86 )     1,099      (9 )     14,202      (95 )    Mortgage-backed    8,695      (92 )     —      —      8,695      (92 )    Asset-backed    9,722      (66 )     —      —      9,722      (66 )         83,739      (668 )     10,169      (286 )     93,908      (954 )    Equity securities    2,290      (10 )     —      —      2,290      (10 )    Total  $ 86,029    $                (678 )   $ 10,169    $                (286 )   $ 96,198    $                (964 )         The majority of the unrealized losses on fixed maturity securities are interest rate related. All but two of the fixed maturity securities with unrealized losses at December 31, 2005 had fair values that were greater than 93% of amortized cost and were rated investment grade by Standard & Poor’s or received an equivalent rating from another nationally recognized rating agency. As of December  31,  2005, the Company held 343 securities that were in an unrealized loss position with a total fair value of $304,302 and gross unrealized losses of $5,320. None of the fixed maturity securities with unrealized losses has ever missed, or been delinquent on, a scheduled principal or interest payment. At December  31,  2005, 97.7% of the fixed maturity security portfolio was rated ‘‘A−’’ or better by Standard & Poor’s or received an equivalent rating from another nationally recognized rating agency. In the fourth quarter of 2005, management concluded that one of the two securities in our portfolio that was not rated investment grade by Standard & Poor’s, a fixed maturity security issued by the finance company of a United States automobile manufacturer, had experienced an impairment that was other-than-temporary, and accordingly, the Company realized an impairment write down of $92 on that security. This conclusion was due primarily to the difficult operational and industry issues facing the issuer, the fact that the security was downgraded from investment grade to below investment grade by two nationally recognized rating agencies during the fourth quarter of 2005 and because there did not appear to be any imminent events or transactions that would cause the value of the security to increase significantly in the foreseeable future. The other security in the Company’s portfolio that is rated below investment grade had an unrealized loss of $72 at December 31,  2005, and management has concluded that this security had not experienced an other-than-temporary impairment at December 31,  2005. Management has also concluded that none of the other available-for-sale securities with unrealized losses at December 31,  2005 had experienced an other-than-temporary impairment. In determining that securities with unrealized losses at December 31,  2005 had not experienced an other-than-temporary impairment, management considered the Company’s ability and intent to hold the securities for a sufficient amount of time to allow for a recovery in value. F-17      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 4.    Investments (continued) Major categories of the Company’s net investment income are summarized as follows:                          Year ended December 31,      2005  2004  2003   Fixed maturity securities  $ 10,197    $ 4,057    $ 410     Equity securities    67      42      —     Cash, cash equivalents and short-term investments    757      145      144     Gross investment income    11,021      4,244      554     Investment expenses    (809 )     (618 )     (147 )    Net investment income  $ 10,212    $ 3,626    $ 407          The Company’s realized gains and losses on investments are summarized as follows:                          Year ended December 31,      2005  2004  2003   Fixed maturity securities:                        Gross realized gains  $ —    $ —    $ —     Gross realized losses    (213 )     (69 )     —          (213 )     (69 )     —     Equity securities:                        Gross realized gains    —      —      —     Gross realized losses    (37 )     —      —          (37 )     —      —     Short-term investments and cash equivalents:                        Gross realized gains    —      —      —     Gross realized losses    (2 )     (2 )     —          (2 )     (2 )     —     Total  $                (252 )   $                (71 )   $ —          The following table summarizes the change in the Company’s gross unrealized gains (losses) by investment type:                          Year ended December 31,      2005  2004  2003   Change in gross unrealized gains (losses):                        Fixed maturity securities  $                (4,966 )   $ 142    $                (300 )    Equity securities    10      (10 )     —     Total  $                (4,956 )   $ 132    $                (300 )         At December 31, 2005 and 2004, investments with a fair value of $9,049 and $9,405, respectively, were on deposit with state insurance departments to satisfy regulatory requirements. F-18      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 5.    Deferred Policy Acquisition Costs An analysis of deferred policy aquisition costs is as follows:                          Year ended December 31,      2005  2004  2003   Balance at beginning of year  $ 11,344    $ 4,109    $ —     Policy acquisition costs deferred:                        Commissions    10,767      13,361      3,718     Underwriting and other issue expenses    9,015      6,727      1,367          19,782      20,088      5,085     Amortization of policy acquisition costs    (17,227 )     (12,853 )     (976 )    Net change    2,555      7,235      4,109     Balance at end of year  $ 13,899    $ 11,344    $ 4,109          6.    Intangible Insurance Assets Intangible insurance assets consist of the authority to write insurance on an excess and surplus lines basis in 40 states and the District of Columbia that were acquired in the Fidelity acquisition during 2003. The intangible assets arise from regulatory approvals granted by the various state insurance departments to write insurance business in the respective states on a non-licensed basis. The insurance authorities, once granted, are routinely renewed at little cost provided that the insurer has complied with rules and regulations. Cash flows related to the regulatory approvals to transact insurance business are expected to continue indefinitely, and management has concluded that these intangible assets have an indefinite life. No impairment write down was recognized in 2005, 2004 or 2003. 7.    Property and Equipment, Net Property and equipment consists of the following:                      December 31,      2005  2004   Electronic data processing hardware and software  $ 3,908    $ 3,635     Furniture and equipment    781      639     Property and equipment, at cost    4,689      4,274     Accumulated depreciation    (1,948 )     (1,035 )    Property and equipment, net  $ 2,741    $ 3,239          F-19      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 8.    Reserve for Losses and Loss Adjustment Expenses The following table provides a reconciliation of the beginning and ending reserve balances for losses and LAE, net of reinsurance, to the gross amounts reported in consolidated the balance sheet.                          Year ended December 31,      2005  2004  2003   Reserve for losses and LAE net of reinsurance recoverables at beginning of year  $ 47,043    $ 3,183    $ —     Add: Incurred losses and LAE net of reinsurance:                        Current year    84,122      47,744      3,372     Prior years    (4,908 )     (156 )     —     Total incurred losses and LAE    79,214      47,588      3,372     Deduct: Loss and LAE payments net of reinsurance:                        Current year    2,943      3,402      189     Prior years    7,335      326      —     Total loss and LAE payments    10,278      3,728      189     Reserve for losses and LAE net of reinsurance recoverables at end of year    115,979      47,043      3,183     Add: Reinsurance recoverables on unpaid losses and LAE at end of year    110,514      15,200      14,234     Reserve for losses and LAE gross of reinsurance recoverables on unpaid losses and LAE at end of year  $ 226,493    $ 62,243    $ 17,417          The foregoing reconciliation shows that a $4,908 redundancy developed in 2005 on the reserve for losses and LAE held at December 31,  2004. This favorable reserve development consisted of $5,433 of favorable development in the Excess and Surplus Insurance segment offset by $525 of adverse development in the Workers’ Compensation Insurance segment. The Excess and Surplus Insurance segment favorable development included $2,484 of favorable development on casualty lines for the 2004 accident year, $2,351 of favorable development on property lines for the 2004 accident year and $593 of favorable development on casualty lines for the 2003 accident year. The Workers’ Compensation Insurance segment reserve development consisted of $696 of adverse development related to the Company’s share of the North Carolina involuntary workers’ compensation pool’s 2004 accident year results offset by $171 of favorable development on the direct business written by the Workers’ Compensation Insurance segment for the 2004 accident year. The foregoing reconciliation also shows that a $156 redundancy developed in 2004 on the reserve for losses and LAE held at December 31, 2003. The Company has not provided insurance coverage that could reasonably be expected to produce material levels of asbestos claims activity. In addition, the Company does not believe it is exposed to any environmental liability claims other than those which it has specifically underwritten and priced as an environmental exposure. Any asbestos or environmental exposure on policies issued by Fidelity prior to July 1, 2003 is subject to the Reinsurance Agreement and the Trust Agreement. F-20      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 9.    Reinsurance The Company’s insurance subsidiaries remain liable to their policyholders if their reinsurers are unable to meet their contractual obligations under applicable reinsurance agreements. To minimize exposure to significant losses from reinsurance insolvencies, the Company evaluates the financial condition of its reinsurers and monitors concentrations of credit risk. The Company’s reinsurance contracts generally require reinsurers that are not authorized as reinsurers under state insurance regulations or that experience rating downgrades below specified levels from rating agencies to fund their share of the Company’s ceded outstanding losses and LAE reserves, typically through the use of an irrevocable and unconditional letter of credit. At December  31,  2005, the Company had reinsurance recoverables on unpaid losses of $110,514 and reinsurance recoverables on paid losses of $11,544. All but $2,093 of the Company's reinsurance recoverables at December 31,  2005 are from companies with A.M. Best ratings of ‘‘A’’ (Excellent) or better or are collateralized with letters of credit or by the Trust Agreement with American Empire. At December 31, 2005, reinsurance recoverables on paid and unpaid losses from three reinsurers were $23,979, $12,869 and $8,102, representing approximately 36.8% of the total balance. Reinsurance recoverables from American Empire totaled $2,800, representing approximately 2.3% of the total balance of reinsurance recoverables outstanding at December 31, 2005. At December 31, 2005, prepaid reinsurance premiums to three reinsurers totaled $5,393, $4,297 and $4,088, representing approximately 53.2% of the balance. The Company entered into a quota share reinsurance contract effective January  1,  2005 that transfers a portion of the risk related to certain property/casualty insurance business written by James River Insurance in 2005 to reinsurers in exchange for a portion of the direct written premiums on that business. Transferring risk to the reinsurers also reduced the amount of capital required to support the insurance operations of James River Insurance. Under this quota share reinsurance contract, the Company receives a ceding commission equal to 25% of ceded earned premium and pays a reinsurance margin equal to 4.5% of ceded earned premium. The reinsurers do not receive a margin when they are in a loss position on the contract. The ceding commission can not be reduced, but under certain circumstances, based on underwriting results, the Company is entitled to an additional profit contingent commission up to an amount equal to all of the reinsurers’ profits above the margin. The Company did not earn an additional profit contingent commission in 2005 based on the underwriting results on business ceded under the treaty. The Company maintains a funds held account which is credited interest at a rate of 3.75% annually. The funds held account is shown as a liability on the accompanying consolidated balance sheets, and at December  31,  2005, the balance of the account was $21,992. The funds held account balance represents the excess of ceded earned premium and interest credited over ceded paid losses and LAE, the Company’s ceding commission and the reinsurers’ margin. Assets supporting the funds held liability are not segregated or restricted. The contract has a loss ratio cap of 115%, which means that the Company cannot cede any losses in excess of 115% of ceded earned premiums to the reinsurers. For 2005, ceded earned premiums related to this quota share reinsurance treaty were $40,000, ceded losses and LAE were $36,458, reinsurance ceding commissions were $9,725 and the reinsurers’ margin was $0. Under the terms of a Trust Agreement (see Note 2), American Empire must maintain assets with a current fair value greater than or equal to the ultimate net aggregate losses recoverable under the Reinsurance Agreement. In addition, an affiliate of American Empire, Great American Insurance Company, has irrevocably and unconditionally guaranteed the performance of American Empire on all of its obligations under the Reinsurance Agreement, as amended, and the Trust Agreement. As of December 31, 2005, the fair value of assets in the trust totaled $4,076. F-21      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 9.    Reinsurance (continued) Reinsurance activity is summarized as follows:                          Year Ended December 31,      2005  2004  2003   Direct earned premiums  $ 200,745    $ 93,658    $ 7,557     Add: Assumed earned premiums    2,798      —      —     Less: Ceded earned premiums    (86,043 )     (17,895 )     (2,470 )    Net earned premiums  $ 117,500    $ 75,763    $ 5,087     Direct losses and LAE incurred  $ 201,962    $ 53,628    $ 4,498     Add: Assumed losses and LAE incurred    2,663      —      —     Less: Ceded losses and LAE incurred    (125,411 )     (6,040 )     (1,126 )    Net incurred losses and LAE incurred  $ 79,214    $ 47,588    $ 3,372          Assumed earned premiums as a percentage of net earned premiums were 2.4% for the year ended December  31,  2005 and 0% for the years ended December  31,  2004 and 2003. 10.    Senior Debt On May 26, 2004, James River Group, Inc. issued $15,000 of unsecured, floating rate senior debentures (the Senior Debt), due April 29, 2034 unless accelerated earlier, through an indenture. The Senior Debt is not redeemable by the holder and is not subject to sinking fund requirements. Net proceeds to the Company totaled $14,508 and were used to provide capital to the Company’s insurance subsidiaries and additional working capital to the Company. Interest accrues quarterly and is payable in arrears at a per annum rate of the three-month LIBOR on the Determination Date (as defined in the indenture) plus 3.85%. The Senior Debt is redeemable prior to its stated maturity at the option of the Company (a) in whole or in part, on or after May 15, 2009 or (b) in its entirety at any time prior to May 15, 2009 upon the occurrence and continuation of a certain tax event, generally defined as a change in the United States tax law whereby the interest payable by the Company is no longer deductible for federal income tax purposes. The terms of the indenture generally provide that so long as the Senior Debt is outstanding, neither the Company nor any of its subsidiaries may:       •  assume or permit to exist any indebtedness that is secured by any encumbrance on the capital stock of the Company or any of its subsidiaries which is senior to the Senior Debt; or         •  issue, sell, transfer or otherwise dispose of any shares of, securities convertible into, or warrants, rights or options to subscribe for or purchase shares of, capital stock of any subsidiary.   The Company is in compliance with all covenants in the indenture at December 31, 2005. Interest payable is included in accrued expenses on the accompanying consolidated balance sheets. F-22      JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial Statements Years ended December 31,  2005, 2004 and 2003(in thousands, except for share data) 11.    Junior Subordinated Debt James River Group, Inc. arranged for the sale of trust preferred securities (Trust Preferred Securities) through James River Capital Trust I and James River Capital Trust II (each, a Trust; collectively, the Trusts), Delaware statutory trusts sponsored and wholly-owned by the Company. Each Trust was created solely for the purpose of issuing the Trust Preferred Securities. In accordance with FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, the Trusts have not been consolidated with the Company in these financial statements. Each Trust used proceeds from the sale of its Trust Preferred Securities to purchase the Company’s floating rate junior subordinated debentures (the Junior Subordinated Debt) issued to the Trust under an indenture (each, an Indenture; collectively, the Indentures). The Junior Subordinated Debt is the sole asset of each Trust, and the Trust Preferred Securities are the sole liabilities of each Trust. The Company purchased all of the outstanding common stock of the Trusts, and the Company’s investment in the Trusts is included in other assets in the accompanying consolidated balance sheets. The following table summarizes the nature and terms of the Junior Subordinated Debt and Trust Preferred Securities:                      James River Capital Trust I  James River Capital Trust II   Issue date  May 26, 2004  December 15, 2004   Principal amount of Trust Preferred Securities  $7,000  $15,000   Principal amount of Junior Subordinated Debt  $7,217  $15,464   Maturity date of Junior Subordinated Debt, unless accelerated earlier  May 24, 2034  December 15, 2034   Trust common stock  $217  $464   Interest rate, per annum  Three-Month LIBOR plus 4.0%  Three-Month LIBOR plus 3.4%   Redeemable at 100% of principal amount at option of Company on or after  May 24, 2009  December 15, 2009        Interest on the Trust Preferred Securities and interest paid by the Company to the Trusts on the Junior Subordinated Debt is payable quarterly in arrears at a per annum rate of the three-month LIBOR on the Determination Date (as defined in the Indentures) plus a margin as described in the table above. The Company has the right to defer interest payments on the Junior Subordinated Debt for up to five years without triggering an event of default. The Trust Preferred Securities are subject to mandatory redemption in a like amount (a) upon repayment of all of the Junior Subordinated Debt on the stated maturity date, (b) contemporaneously with the optional prepayment of all of the Junior Subordinated Debt by the Company in conjunction with a special event (as defined) and (c) five years or more after the issue date, contemporaneously with the optional prepayment, in whole or in part, of the Junior Subordinated Debt. The Company has provided a full, irrevocable and unconditional guarantee of payments of amounts due on the Trust Preferred Securities. The Indentures contain certain organizational covenants of which the Company is in compliance as of December 31, 2005. Interest payable is included in accrued expenses on the accompanying consolidated balance sheets. F-23     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  12.    Capital Stock Common Stock On May  3, 2005, the Company filed a registration statement on Form S-1 with the Securities Exchange Commission for the purpose of making an initial public offering of Common Stock. The Company’s registration statement was declared effective on August  8,  2005. On August  9,  2005, the Company increased the number of authorized shares of Common Stock from 2,000,000 to 100,000,000 and affected a 10 for 1 split of the Company’s Common Stock to shareholders of record on that date. All Common Stock share and per share amounts have been restated to give retroactive effect to the stock split. Immediately prior to the closing of the initial public offering on August  12,  2005, all of the Company’s outstanding Series A Convertible Preferred Stock (Series A Preferred Stock) and Series B Convertible Preferred Stock (Series B Preferred Stock), including shares representing accrued but unpaid dividends, were converted into 9,956,413 shares of Common Stock. The conversion of the Preferred Stock dividends had the effect of decreasing retained earnings by $9,909, increasing Common Stock by $11 and increasing additional paid-in capital by $9,898. Gross proceeds from the sale of 4,444,000 shares of Common Stock, at an initial public offering price per share of $18.00, totaled $79,992. Costs associated with the initial public offering included $5,600 of underwriting costs and $995 of other issuance costs. On August  26,  2005, the underwriters of the initial public offering exercised their over-allotment option in which an additional 666,600 shares of Common Stock were issued at the $18.00 initial public offering price per share. Gross proceeds from this transaction were $11,999 and underwriting costs were $840. The Company did not pay any cash dividends to common stockholders in 2005, 2004 or 2003. The following table summarizes the number of shares of Common Stock issuable and reserved for future issuance at December 31, 2005:                  Issuable Shares   Upon exercise of options    2,128,359     Upon exercise of warrants    149,625     Total    2,277,984          Convertible Preferred Stock On August  9,  2005, the Company set the number of authorized shares of preferred stock (Preferred Stock) at 5,000,000.  Series A and Series B Convertible Preferred Stock  On January 15, 2003, the Company designated 85,000 shares of its Preferred Stock as Series A Preferred Stock and on January 21, 2003 issued all such shares. Gross proceeds from the transaction totaled $8,500, and the Company incurred syndication costs of $61. On June 20, 2003, the Company designated 500,000 shares of its Preferred Stock as Series B Preferred Stock and on June 30, 2003 issued all such shares. Gross proceeds from the transaction totaled $50,000. On September 4, 2003, the Company’s Board approved the increase in the number of shares designated as Series B Preferred Stock from 500,000 shares to 700,000 shares and extended its Series B Preferred Stock offering. In connection with the extended Series B Preferred Stock offering, the Company issued 200,000 Series B Preferred Stock shares on October 31, 2003 in the form of 191,450 Series B Preferred Stock shares and 8,550 Series B Preferred Stock units (Series B Units). Each Series B Unit consists of one F-24     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  12.    Capital Stock (continued)  Convertible Preferred Stock (continued) Series B Preferred Stock share and one Warrant for the purchase of 17.5 shares of common stock at an exercise price of $10.00 per share of Common Stock, subject to adjustment (the Warrants) (see Note 13). Gross proceeds from the transaction totaled $20,000. On May 5, 2004, the Company increased the number of shares designated as Series B Preferred Stock from 700,000 to 713,500 and extended its Series B Preferred Stock offering. In connection with this offering, the Company issued 13,500 Series B Preferred Stock shares. Gross proceeds from the transaction totaled $1,350. The Company incurred syndication costs of $233 in its Series B Preferred Stock offerings. The holders of Series A Preferred Stock and Series B Preferred Stock were entitled to cumulative, non-compounding dividends at the rate of 6.0% per annum (as a percentage of the Preferred Stock purchase price). Prior to the initial public offering, no preferred dividends had been declared. Immediately prior to the closing of the Company’s initial public offering on August  12,  2005, all of the Company’s outstanding Preferred Stock including shares representing accrued but unpaid dividends was converted into 9,956,413 shares of Common Stock. The Series A Preferred Stock liquidation preference amount disclosed on the face of the balance sheet at December  31,  2004 varies from the proceeds received on the Series A Preferred Stock primarily due to the $100 per share purchase price and the $50 per share conversion price. 13.    Stock Options and Warrants In 2005, the Company adopted the 2005 Incentive Plan. Key employees, directors and third party service providers (generally, consultants, agents, advisors or independent contractors not involved in marketing or selling the Company’s securities) are eligible to receive share awards, subject to individual, annual and aggregate award limits, in the form of options, share appreciation rights, restricted share awards or units, performance shares or units and other share-based awards as well as cash-based awards. The maximum number of shares available for issuance to participants under the 2005 Incentive Plan is 1,691,075. All options granted in 2005 were issued under the 2005 Incentive Plan. In 2003, the Company adopted the 2003 Incentive Plan. Under the 2003 Incentive Plan, certain directors, officers, and key employees were eligible to be granted various stock-based awards. No additional awards will be made under the 2003 Incentive Plan. F-25     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  13.    Stock Options and Warrants (continued) Information concerning the stock option plan is summarized below:                                      Year ended December 31,      2005  2004  2003      Number ofShares  Weighted-AverageExercise Price  Number ofShares  Weighted-AverageExercise Price  Number ofShares  Weighted-AverageExercise Price   Outstanding, beginning of year    1,703,180    $ 10.07      1,277,450    $ 10.00      —    $ —     Granted    451,979      18.23      431,820      10.27      1,277,450      10.00     Exercised    (3,030 )     10.00      —      —      —      —     Forfeited    (23,770 )     10.84      (6,090 )     10.00      —      —     Outstanding, end of year    2,128,359    $ 11.79      1,703,180    $ 10.07      1,277,450    $ 10.00     Exercisable, end of year    738,574    $ 10.04      317,790    $ 10.00      —    $ —          The following table summarizes certain stock option information by exercise price at December 31, 2005:                                  Options Outstanding  Options Exercisable   Exercise Price  Number of Shares  Weighted-AverageRemainingContractual Life  Weighted-AverageExercise Price  Number of Shares  Weighted-AverageExercise Price   $10.00-$12.50    1,678,880    7.6 years  $ 10.07      738,574    $ 10.04     $18.00-$21.00    449,479    9.6 years    18.23      —      —          2,128,359    8.0 years  $ 11.79      738,574    $ 10.04          Currently, all of the options vest over a four year period commencing from the date of grant and are exercisable for ten years following the date of grant. Certain of the options will immediately vest in the event of a change in control of the Company. For purposes of the pro forma information required by Statement No. 123, the value of options granted was estimated at the date of the grant using the Black Scholes option pricing model for grants in 2005 after the Company’s initial public offering and the Minimum Value option pricing model for grants in 2004 and 2003, with the following assumptions:                          Year Ended December 31,      2005  2004  2003   Weighted-average risk-free interest rate    4.32%    3.44%    3.20%   Dividend yield    0.00%    0.00%    0.00%   Expected stock price volatility  35.00%    0.00%    0.00%   Weighted-average expected life  7 years  7 years  7 years        The Black Scholes option pricing model and the Minimum Value option pricing model were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. F-26     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  13.    Stock Options and Warrants (continued) The Minimum Value option pricing model used for grants in 2004 and 2003 does not consider expected stock price volatility in valuing options granted. The Black Scholes option pricing model used for 2005 grants considers expected stock price volatility in valuing options granted. Because the Company became publicly traded in August  2005, there is not sufficient historical stock price information available on the Company to estimate stock price volatility. As a result, the Company utilized stock price volatility data for similar property/casualty companies in the period after their initial public stock offerings as the basis for determining the expected stock price volatility to use in valuing the Company’s 2005 stock option grants. The weighted average value of options issued in 2005, 2004 and 2003 determined as described above was $8.31, $2.21, and $2.01, respectively. As part of the extended Series B Preferred Stock offering, the Company issued 8,550 Series B Units. Each Series B Unit consists of one Series B preferred share and one Warrant for the purchase of 17.5 shares of Common Stock at an exercise price of $10.00 per share of Common Stock, subject to adjustment. There is no vesting period associated with the exercise of the Warrants, and the Warrants expire on October 31, 2013. Compensation expense of $524 was recognized on these Warrants in 2003 representing a value of $61.29 per Warrant. The fair value of these Warrants was estimated using the Minimum Value pricing model with the following assumptions: risk-free interest rate of 4.23%, a dividend yield of 0.00%, an expected stock price volatility of 0.00% and an expected life of the warrants of ten years. James River Group, Inc. has an employment agreement with its President and Chief Executive Officer. Under the terms of the agreement, the President will be granted, in certain circumstances, options for the purchase of Common Stock equal to 5.0% of the total number of shares of Common Stock or securities convertible into Common Stock offered by us in future equity financing transactions until such time that the Company has raised an aggregate of $250,000 in equity. The exercise price of the options to be issued will be equal to the per share fair market value of the Company's Common Stock at the closing date of the equity offering. 14.    Income Taxes The Company files a consolidated federal income tax return with all of the subsidiaries consolidated in these financial statements. At December 31, 2003, the Company had net operating loss carryforwards of $4,686. These net operating loss carryforwards were used to offset taxable income during the year ended December 31, 2004. The Company’s effective income tax rate on pre-tax income (loss) differs from the prevailing corporate federal income tax rate and is summarized as follows:                          Year ended December  31,      2005  2004  2003   Income tax expense (benefit) at federal rate of 35.0% in 2005 and 2004 and 34.0% in 2003  $ 6,043    $ 3,637    $                (1,764 )    Change in deferred tax valuation allowance    —      (1,899 )     1,802     Tax-exempt income    (731 )     (98 )     —     Other    (110 )     (4 )     (38 )    Total  $ 5,202    $ 1,636    $ —          F-27     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  14.    Income Taxes (continued) The significant components of the net deferred tax asset at the current prevailing tax rate are summarized as follows:                      December 31,      2005  2004   Deferred tax assets:                 Unearned premiums  $ 6,699    $ 4,673     Reserve for losses and loss adjustment expenses    5,197      2,341     Net unrealized losses    1,794      59     Other    594      1,329     Total deferred tax assets    14,284      8,402     Deferred tax liabilities:                 Deferred policy acquisition costs    4,865      3,970     Property and equipment    564      690     Other    856      144     Total deferred tax liabilities    6,285      4,804     Net deferred tax assets  $ 7,999    $ 3,598          Management periodically reviews the need for a valuation allowance related to its deferred tax assets. Prior to 2004, management established a tax valuation allowance equal to total deferred tax assets net of existing deferred tax liabilities and current income tax expense. During 2004, management concluded that it was more likely than not that the Company would realize its entire deferred tax asset. Management based this conclusion primarily on the fact that the Company had generated taxable income on an inception-to-date basis sufficient to exhaust all of the Company’s net operating loss carryforwards created in its start-up phase. No valuation allowance was established against the Company’s deferred tax assets at December  31,  2005 or 2004. The components of the changes in the deferred tax valuation allowance were recorded as follows:                          Year Ended December  31,      2005  2004  2003   Change recorded in operations  $ —    $                (1,899 )   $ 1,802     Change recorded in stockholders’ equity:                        Net unrealized losses    —      (105 )     105     Total change in the deferred tax valuation allowance  $ —    $                (2,004 )   $ 1,907          F-28     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  15.    Other Operating Expenses Other operating expenses consist of the following:                          Year ended December 31,      2005  2004  2003   Other underwriting expenses  $ 10,040    $ 6,958    $ 2,352     Amortization of policy acquisition costs    17,227      12,853      976     Operating expenses of insurance segments prior to commencing insurance operations    —      —      3,703     Other costs (recoveries)    1,179      879      (189 )    Total  $ 28,446    $ 20,690    $ 6,842          16.    Employee Benefits The Company offers savings plans (the Savings Plans), which qualify under Section 401(k) of the Internal Revenue Code. Participants may contribute certain percentages of their pre-tax salary to the Savings Plans subject to statutory limitations. The Company matches employee contributions at the rate of 100% up to a maximum contribution of 6% of the participant’s earnings subject to certain statutory limits. For the years ended December 31, 2005, 2004 and 2003, the Company’s expense associated with the Savings Plans totaled $540, $386 and $167, respectively. 17.    Related Party Transactions In January  2003, the Company entered into a consulting agreement with its Chairman of the Board of Directors. Pursuant to this agreement, the Chairman received an annual fee of $60 in exchange for services in his capacity as Chairman of the Board of Directors and other services. In August  2005, this consulting agreement was terminated. Immediately following the initial public offering, the Company entered into a new consulting agreement whereby the Chairman will receive an annual fee of $40 for his consulting services. This agreement may be terminated by either party with 90 days written notice. Expenses related to this agreement totaled $52 for 2005 and $60 for each of the years ended December 31, 2004 and 2003. As part of its 2003 Series B Preferred Stock offerings, the Company loaned a total of $2,565 to employees and directors to purchase shares in the respective transactions. The notes have an annual interest rate of 4.5% and are reported in the accompanying consolidated balance sheets as a reduction in stockholders’ equity. In April  2005, all $2,020 of the outstanding loans extended to directors and executive officers were repaid in full. An additional $10 was repaid during the third quarter of 2005, leaving $535 of loans outstanding at December  31,  2005. Interest on the notes for the years ended December 31, 2005, 2004 and 2003 totaled $52, $117 and $55, respectively, and is recorded as other income in the accompanying statements of operations. Beginning in 2003, the Company contracted with two investment advisory firms to manage the Company’s investment portfolio. A member of the Company’s Board of Directors is a partner of one of the firms with which the Company contracts. For the years ended December 31, 2005, 2004 and 2003, the Company incurred expenses of $89, $44 and $2, respectively, with that firm. Fees charged under the agreement with that firm are comparable to fees charged by the Company’s other investment advisory service provider. F-29     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  18.    Commitments and Contingent Liabilities The Company leases certain office space under operating leases that expire at various times and are subject to renewal options at market rates prevailing at the time of renewal. Rental expense for such leases was $650, $514 and $252 for the years ended December 31, 2005, 2004 and 2003, respectively. As of December 31, 2005, future minimum payments under non-cancelable operating leases are as follows:               2006  $ 690     2007    705     2008    517     2009    106     2010    —        $ 2,018          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. 19.    Other Comprehensive Income (Loss) The following table summarizes the components of other comprehensive income (loss):                          Year ended December 31,      2005  2004  2003   Unrealized gains (losses) arising during the period, before taxes  $                (5,208 )   $ 61    $                (300 )    Income taxes    1,823      (21 )     105     Change in deferred tax valuation allowance    —      105      (105 )    Unrealized gains (losses) arising during the period, net of taxes    (3,385 )     145      (300 )    Less reclassification adjustment:                        Losses realized in net income (loss)    (252 )     (71 )     —     Income taxes    89      25      —     Reclassification adjustment for losses realized in net income (loss)    (163 )     (46 )     —     Other comprehensive (loss) income  $                (3,222 )   $ 191    $                (300 )         F-30     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  20.    Segment Information The Company has three reportable segments, each of which is a separately managed business unit. The ‘‘Excess and Surplus Insurance’’ segment primarily offers commercial excess and surplus lines liability and property products. The ‘‘Workers’ Compensation Insurance’’ segment offers workers’ compensation insurance coverages. The ‘‘Corporate and Other’’ segment consists of certain management and treasury activities of James River Group, Inc. and interest expense associated with the Company’s Senior Debt and Junior Subordinated Debt. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Segment revenues for each reportable segment consist of net earned premiums, net investment income, realized investment gains (losses) and other income. Segment profit (loss) for each reportable segment is measured by underwriting profit (loss), which is generally defined as net earned premiums less losses and LAE 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.                              Excess andSurplusInsurance  Workers’CompensationInsurance  Corporate andOther  Total   Year ended December 31, 2005                               Direct written premiums  $ 207,396    $ 29,221    $ —    $ 236,617     Net earned premiums    91,427      26,073      —      117,500     Segment revenues    99,263      27,546      784      127,593     Net investment income    7,877      1,532      803      10,212     Interest expense    —      —      2,667      2,667     Underwriting profit    10,199      820      —      11,019     Segment assets    493,756      67,560      35,728      597,044     Year ended December 31, 2004                               Direct written premiums  $ 133,354    $ 9,185    $ —    $ 142,539     Net earned premiums    70,530      5,233      —      75,763     Segment revenues    73,339      5,864      259      79,462     Net investment income    2,873      620      133      3,626     Interest expense    —      —      793      793     Underwriting profit (loss)    10,980      (2,616 )     —      8,364     Segment assets    213,904      30,010      23,034      266,948     Year ended December 31, 2003                               Direct written premiums  $ 36,764    $ —    $ —    $ 36,764     Net earned premiums    5,087      —      —      5,087     Segment revenues    5,432      5      113      5,550     Net investment income    346      5      56      407     Interest expense    —      —      —      —     Underwriting profit (loss)    (1,613 )     —      —      (1,613 )    Segment assets    100,874      20,443      2,244      123,561          F-31     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  20.    Segment Information (continued) The following table reconciles the underwriting profit (loss) of insurance segments by individual segment to consolidated income before taxes:                          Year ended December 31,      2005  2004  2003   Underwriting profit (loss) of the insurance segments:                        Excess and Surplus Insurance  $ 10,199    $ 10,980    $                (1,613 )    Workers’ Compensation Insurance    820      (2,616 )     —     Total underwriting profit (loss) of insurance segments    11,019      8,364      (1,613 )    Net investment income    10,212      3,626      407     Realized investment losses    (252 )     (71 )     —     Other income    133      144      56     Other operating expenses of the Corporate and Other segment    (1,179 )     (879 )     189     Operating expenses of the insurance segments prior to commencing insurance operations    —      —      (3,703 )    Interest expense    (2,667 )     (793 )     —     Compensation expense on common stock warrant insurance    —      —      (524 )    Consolidated income (loss) before taxes  $ 17,266    $ 10,391    $                (5,188 )         The Company has 13 underwriting divisions, 12 of which are in the Excess and Surplus Insurance segment and one of which is in the Workers’ Compensation Insurance segment. Each underwriting division focuses on a specific industry group or coverage. Direct written premiums by underwriting division are presented below:                          Year ended December 31,      2005  2004  2003   Manufacturers and Contractors  $ 37,620    $ 21,552    $ 5,328     Excess Casualty    30,908      21,565      4,340     General Casualty    30,001      22,456      8,157     Allied Health    29,535      25,682      8,778     Workers’ Compensation    29,221      9,185      —     Professional Liability    22,878      16,838      4,875     Excess Property    20,118      6,456      1,992     Primary Property    12,421      10,375      2,547     Energy    12,221      5,651      747     Healthcare    5,107      1,570      —     Environmental    4,113      1,209      —     Life Sciences    2,295      —      —     Small Business    179      —      —     Total  $ 236,617    $ 142,539    $ 36,764          F-32     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  20.    Segment Information (continued) The Company does business with one broker that generated $46,658 of direct written premiums for the Excess and Surplus Insurance segment, representing 19.7% of consolidated direct written premiums and 22.5% of the Excess and Surplus Insurance segment’s direct written premiums for the year ended December 31, 2005. The Company has agency contracts with various branches within the aforementioned broker. While the loss of this broker in the aggregate could have a material adverse effect on the Company and the Excess and Surplus Insurance segment, the Company does not believe that the loss of a single branch would have a material adverse effect on the Company or the Excess and Surplus Insurance segment. No other broker generated 10.0% or more of the direct written premiums for the Excess and Surplus Insurance segment for the year ended December  31,  2005. Approximately $3,228, or 11.0%, of the Workers’ Compensation Insurance segment’s direct written premiums for the year ended December 31, 2005 were generated by one agency. The loss of this agency could have a material adverse effect on the Workers’ Compensation Insurance segment. No other agency generated 10.0% or more of the direct written premiums for the Workers’ Compensation Insurance segment for the year ended December 31,  2005. 21.    Fair Value The carrying values and fair values of financial instruments are summarized below:                              December 31,      2005  2004      Carrying Value  Fair Value  Carrying Value  Fair Value   Assets                               Fixed maturity securities available-for-sale  $ 339,512    $ 339,512    $ 172,731    $ 172,731     Equity securities available-for-sale    —      —      2,290      2,290     Cash and cash equivalents    41,029      41,029      20,210      20,210     Liabilities                               Senior debt    15,000      15,000      15,000      15,000     Junior subordinated debt    22,681      22,681      22,681      22,861          The fair values of fixed maturity securities and equity securities have been determined using quoted market prices for securities traded in the public market or prices using bid or closing prices for securities not traded in the public marketplace. The fair values of cash and cash equivalents approximate their carrying values due to their short-term maturity. The fair values of Senior Debt and Junior Subordinated Debt approximate their carrying values due to the floating interest rate structure inherent in these instruments. 22.    Statutory Matters and Dividend Restrictions State insurance laws and regulations prescribe accounting practices for determining statutory net income and capital and surplus for insurance companies. In addition, state regulators may permit statutory accounting practices that differ from prescribed practices. Statutory accounting practices prescribed or permitted by regulatory authorities (SAP) for the Company’s insurance subsidiaries differ from accounting principles generally accepted in the United States (GAAP). The principal differences between SAP and GAAP as they relate to the financial statements of the Company’s insurance subsidiaries are (i)  F-33     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  22.    Statutory Matters and Dividend Restrictions (continued)  policy acquisition costs are expensed as incurred under SAP, whereas they are deferred and amortized under GAAP, (ii) certain assets are not admitted for purposes of determining surplus under SAP, (iii) the classification and carrying amounts of investments in certain securities are different under SAP and GAAP and (iv) the criteria for providing asset valuation allowances and the methodologies used to determine the amount thereof are different under SAP and GAAP. Combined net income, statutory capital and surplus and minimum required statutory capital and surplus, as determined in accordance with statutory accounting practices, for the insurance subsidiaries as of December 31, 2005, 2004 and 2003 and for the years then ended are summarized as follows:                          2005  2004  2003   Statutory net income (loss)  $ 7,729    $                (1,544 )   $                (5,286 )    Statutory capital and surplus    157,133      79,378      58,183     Minimum required statutory capital and surplus    7,250      7,250      6,250          The insurance statutes of the insurance subsidiaries’ states of domicile limit the amount of dividends that they may pay annually to the Company without first obtaining regulatory approval. Generally, the limitations are based on statutory net income for the preceding year or 10.0% of statutory surplus at the end of the preceding year. The maximum amount of dividends available to the Company from its insurance subsidiaries during 2006 without regulatory approval is $14,508. Risk-Based Capital (RBC) requirements promulgated by the National Association of Insurance Commissioners require property/casualty insurers to maintain minimum capitalization levels determined based on formulas incorporating various business risks of the insurance subsidiaries. As of December 31, 2005, the insurance subsidiaries’ adjusted capital and surplus exceeds their authorized control level RBC. 23.    Unaudited Selected Quarterly Financial Data The following is a summary of the unaudited quarterly results of operations:                                  2005 Quarter  2005      First  Second  Third  Fourth  Year   Net earned premiums  $ 24,832    $ 31,074    $ 23,455    $ 38,139    $ 117,500     Net investment income    1,745      2,017      2,686      3,764      10,212     Realized investment losses    (25 )     (73 )     (13 )     (141 )     (252 )    Total revenues    26,597      33,049      26,156      41,791      127,593     Net income (loss)    4,606      4,685      (9,481 )     12,254      12,064     Earnings (loss) per share:                                      Basic    342,485.20      349,033.70      (1.24 )     0.81      1.56     Diluted    0.46      0.46      (1.24 )     0.78      0.94          F-34     JAMES RIVER GROUP, INC. AND SUBSIDIARIES    Notes to Consolidated Financial StatementsYears ended December 31, 2005, 2004 and 2003(in thousands, except for share data)  23.    Unaudited Selected Quarterly Financial Data (continued)                                  2004 Quarter  2004      First  Second  Third  Fourth  Year   Net earned premiums  $ 9,255    $ 16,081    $ 22,113    $ 28,314    $ 75,763     Net investment income    588      762      1,080      1,196      3,626     Realized investment losses    —      —      (1 )     (70 )     (71 )    Total revenues    9,872      16,909      23,195      29,486      79,462     Net income    581      1,947      2,968      3,259      8,755     Earnings (Loss) per share:                                      Basic    (58,965.30 )     76,288.70      176,399.30      205,444.50      399,167.20     Diluted    (58,965.30 )     0.21      0.31      0.33      0.93          F-35     JAMES RIVER GROUP, INC. AND SUBSIDIARIESSCHEDULE ISummary of Investments — Other than Investments in Related Parties                       Type of Investment  Amortized Cost  Fair Value  Amount at Which Shown in Balance Sheet      (in thousands)   Fixed Maturity Securities:                        Available-for-sale:                        United States Government and government agencies and authorities  $ 115,558    $ 113,620    $ 113,620     States, municipals and political subdivisions    99,047      98,161      98,161     Public utilities    24,183      23,712      23,712     All other corporate bonds    105,848      104,019      104,019     Total investments  $ 344,636    $ 339,512    $ 339,512          S-1     JAMES RIVER GROUP, INC. SCHEDULE IICondensed Financial Information of Registrant Parent Company Balance Sheets                      December 31,      2005  2004      (in thousands)   Assets                 Investments:                 Fixed maturity securities available-for-sale, at fair value (amortized cost: 2005  –  $28,808;  2004 – $16,894)  $ 28,515    $ 16,878     Equity securities available-for-sale, at fair value (cost: 2004 – $2,300)    —      2,290     Total investments    28,515      19,168     Cash and cash equivalents    3,752      424     Accrued investment income    304      182     Investments in consolidated subsidiaries, equity method    179,901      97,426     Property and equipment, net    993      1,313     Deferred tax assets    14      242     Receivables from consolidated subsidiaries    —      56     Other assets    2,150      1,736     Total assets  $ 215,629    $ 120,547                       Liabilities and Stockholders’ Equity                 Accrued expenses  $ 917    $ 1,272     Senior debt    15,000      15,000     Junior subordinated debt    22,681      22,681     Other liabilities    876      899     Total liabilities    39,474      39,852     Commitments and contingent liabilities                 Stockholders’ equity    176,155      80,695     Total liabilities and stockholders’ equity  $ 215,629    $ 120,547           See accompanying notes  S-2     JAMES RIVER GROUP, INC. AND SUBSIDIARIESSCHEDULE IICondensed Financial Information of RegistrantParent Company Statements of Operations                          Year ended December 31,      2005  2004  2003      (in thousands)   Revenues                        Management fee income from consolidated subsidiaries  $ 3,118    $ 2,840    $ 1,801     Net investment income    803      133      56     Realized investment losses    (119 )     —      —     Other income    100      127      55     Total revenues    3,902      3,100      1,912                              Expenses                        Other operating expenses    4,297      3,720      1,611     Interest expense    2,667      793      —     Compensation expense on common stock warrant issuance    —      —      524     Total expenses    6,964      4,513      2,135     Loss before taxes and equity in undistributed earnings (loss) of consolidated subsidiaries    (3,062 )     (1,413 )     (223 )    Federal income tax benefit    1,092      553      —     Equity in undistributed earnings (loss) of consolidated subsidiaries    14,034      9,615      (4,965 )                             Net income (loss)  $ 12,064    $ 8,755    $                (5,188 )          See accompanying notes  S-3     JAMES RIVER GROUP, INC. AND SUBSIDIARIESSCHEDULE IICondensed Financial Information of RegistrantParent Company Statements of Cash Flow                          Year ended December 31,      2005  2004  2003      (in thousands)   Operating activities                        Net income (loss)  $ 12,064    $ 8,755    $                (5,188 )    Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities    (13,976 )     (8,661 )     5,908     Net cash (used in) provided by operating activities    (1,912 )     94      720     Investing activities                        Acquisitions, net of cash acquired    —      —      (28,914 )    Capital contributions to consolidated subsidiaries    (71,500 )     (18,100 )     (46,117 )    Securities available-for-sale:                        Purchases – fixed maturity securities    (25,186 )     (16,935 )     —     Purchases – equity securities    (1,000 )     (2,300 )     —     Sales – fixed maturity securities    500      —      —     Sales – equity securities    3,263      —      —     Maturities and calls – fixed maturity securities    12,559      —      —     Purchases of property and equipment    (12 )     (315 )     (434 )    Net cash used in investing activities    (81,376 )     (37,650 )     (75,465 )    Financing activities                        Proceeds from issuance of Common Stock    92,021      —      —     Proceeds from issuance of Series A Preferred Stock    —      —      8,500     Proceeds from issuance of Series B Preferred Stock    —      1,350      67,435     Issuance of senior debt    —      15,000      —     Issuance of junior subordinated debt    —      22,000      —     Issuance costs    (7,435 )     (1,049 )     (297 )    Repayment of notes receivable from officers and directors    2,030      —      —     Investor funds received pending issuance of Series A Preferred Stock shares    —      —      (6,865 )    Net cash provided by financing activities    86,616      37,301      68,773     Change in cash and cash equivalents    3,328      (255 )     (5,972 )    Cash and cash equivalents at beginning of period    424      679      6,651     Cash and cash equivalents at end of period  $ 3,752    $ 424    $ 679           See accompanying notes  S-4     JAMES RIVER GROUP, INC. AND SUBSIDIARIESSCHEDULE IICondensed Financial Information of RegistrantParent Company Notes to Condensed Financial StatementsYears Ended December  31,  2005, 2004 and 2003(in thousands)       1.  Accounting Policies   Organization James River Group, Inc. (the Company) is a Delaware-domiciled holding company organized for the purpose of acquiring and managing insurance entities. Basis of Presentation The condensed financial statements and notes are prepared in accordance with United States generally accepted accounting principles. The accompanying condensed financial statements have been prepared using the equity method. Under the equity method, the investment in consolidated subsidiaries is stated at cost plus equity in undistributed earnings (loss) of consolidated subsidiaries since the date of acquisition. These condensed financial statements should be read in conjunction with the Company's consolidated financial statements. Estimates and Assumptions Preparation of the condensed financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying disclosures. Those estimates are inherently subject to change, and actual results may ultimately differ from those estimates.       2.  Senior Debt   On May 26,  2004, the Company issued $15,000 of unsecured, floating rate senior debentures due April  29,  2034 unless accelerated earlier, through an indenture. See Note 10 to the consolidated financial statements of James River Group, Inc. and Subsidiaries for a description of these senior debentures.       3.  Junior Subordinate Debt   The Company arranged for the sale of trust preferred securities (Trust Preferred Securities) through James River Capital Trust I and James River Capital Trust II (each, a Trust; collectively, the Trusts), Delaware statutory trusts sponsored and wholly-owned by the Company. Each Trust used proceeds from the sale of its Trust Preferred Securities to purchase the Company's floating rate junior subordinated debentures issued to the Trust under an indenture. See Note 11 to the consolidated financial statements of James River Group, Inc. and Subsidiaries for a description of these junior subordinated debentures.       4.  Commitments and Contingent Liabilities   The Company leases certain office space under an operating lease that expires in 2008 and is subject to renewal options at market rates prevailing at the time of renewal. Rental expense for such leases was $69, $68 and $44 for the years ended December  31,  2005 and 2004 and 2003, respectively. As of December  31,  2005, future minimum payments under this noncancelable operating lease are as follows:               2006  $ 71     2007    73     2008    74        $ 218          S-5      JAMES RIVER GROUP, INC. AND SUBSIDIARIES Schedule IIISupplementary Insurance Information (in thousands)                                                  DeferredPolicyAcquisitionCosts  Liability forUnpaid Lossesand LossAdjustmentExpenses  Unearned Premiums  Earned Premiums  NetInvestmentIncome  Losses andLossAdjustmentExpenses  Amortizationof DeferredPolicyAcquisitionCosts  OtherUnderwritingExpenses  Net PremiumsWritten   Year ended December 31, 2005                                                                  Excess and Surplus Insurance  $ 13,092    $ 209,577    $ 108,869    $ 91,427    $ 7,877    $ 62,868    $ 13,835    $ 4,525    $ 111,074     Workers’ Compensation Insurance    807      16,916      6,896      26,073      1,532      16,346      3,392      5,515      29,516     Corporate and Other    —      —      —      —      803      —      —      —      —     Total  $ 13,899    $ 226,493    $ 115,765    $ 117,500    $ 10,212    $ 79,214    $ 17,227    $ 10,040    $ 140,590     Year ended December 31, 2004                                                                  Excess and Surplus Insurance  $ 10,821    $ 59,070    $ 75,316    $ 70,530    $ 2,873    $ 43,740    $ 12,030    $ 3,780    $ 112,427     Workers’ Compensation Insurance    523      3,173      2,974      5,233      620      3,848      823      3,178      7,751     Corporate and Other    —      —      —      —      133      —      —      —      —     Total  $ 11,344    $ 62,243    $ 78,290    $ 75,763    $ 3,626    $ 47,588    $ 12,853    $ 6,958    $ 120,178     Year ended December 31, 2003                                                                  Excess and Surplus Insurance  $ 4,109    $ 17,417    $ 29,436    $ 5,087    $ 346    $ 3,372    $ 976    $ 2,352    $ 27,425     Workers’ Compensation Insurance    —      —      —      —      5      —      —      —      —     Corporate and Other    —      —      —      —      56      —      —      —      —     Total  $ 4,109    $ 17,417    $ 29,436    $ 5,087    $ 407    $ 3,372    $ 976    $ 2,352    $ 27,425          S-6      INDEX TO EXHIBITS               Number  Exhibit     3.1    Third Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K dated August  12,  2005 (File No. 000-51480)).     3.2    Form of Third Amended and Restated By-Laws (incorporated herein by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K dated August 12,  2005 (File No. 000-51480)).     4.1    Specimen Stock Certificate, representing James River Group, Inc. common stock, par value $0.0l per share (incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).          4.2    Form of Warrant relating to Series B Convertible Preferred Stock (incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.3    Registration Rights Agreement dated January  21,  2003, by and among James River Group, Inc. and certain stockholders as named therein (incorporated by reference to Exhibit 4.6 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.4    Indenture dated as of May  26,  2004, by and between James River Group, Inc. and Wilmington Trust Company, as Trustee, relating to Floating Rate Senior Debentures Due 2034 (incorporated by reference to Exhibit 4.8 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.5    Indenture dated as of May  26,  2004, by and between James River Group, Inc. and Wilmington Trust Company, as Trustee, relating to Floating Rate Junior Subordinated Debentures Due 2034 (incorporated by reference to Exhibit 4.9 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.6    Amended and Restated Declaration of Trust of James River Capital Trust I dated as of May 26, 2004, by and among James River Group, Inc., the Trustees (as defined therein) and the holders, from time to time, of undivided beneficial interests in James River Capital Trust I (incorporated by reference to Exhibit 4.10 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.7    Preferred Securities Guarantee Agreement dated as of May  26,  2004, by James River Group, Inc., as Guarantor and Wilmington Trust Company, as Preferred Guarantee Trustee, for the benefit of the Holders (as defined therein) of James River Capital Trust I (incorporated by reference to Exhibit 4.11 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.8    Indenture dated December  15,  2004, by and between James River Group, Inc. and Wilmington Trust Company, as Trustee, relating to Floating Rate Junior Subordinated Deferrable Interest Debentures Due 2034 (incorporated by reference to Exhibit 4.12 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     4.9    Amended and Restated Declaration of Trust of James River Capital Trust II dated as of December  15,  2004, by and among James River Group, Inc., the Trustees (as defined therein), the Administrators (as named therein), and the holders, from time to time, of undivided beneficial interests in the James River Capital Trust II (incorporated by reference to Exhibit 4.13 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).                          Number  Exhibit     4.10    Guarantee Agreement dated as of December  15,  2004, by James River Group, Inc., as Guarantor, and Wilmington Trust Company, as Guarantee Trustee, for the benefit of the Holders (as defined therein) from time to time of the capital securities of James River Capital Trust II (incorporated by reference to Exhibit 4.14 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     10.1    James River Group, Inc. 2003 Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.2    First Amendment to the James River Group, Inc. 2003 Incentive Plan (incorporated by reference to Exhibit 10.2 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.3    Form of Non-Qualified Option Grant Certificate Pursuant to the James River Group, Inc. 2003 Incentive Plan (incorporated by reference to Exhibit 10.3 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.4    Form of Non-Qualified Option Grant Certificate for Entities Pursuant to the James River Group, Inc. 2003 Incentive Plan (incorporated by reference to Exhibit 10.4 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.5    Form of Incentive Stock Option Grant Certificate for Employees Pursuant to the James River Group, Inc. 2003 Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.6    James River Group, Inc. 2005 Incentive Plan (incorporated by reference to Exhibit 10.6 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.7    Employment Agreement dated and effective as of November  15,  2002 by and between James River Group, Inc. and J. Adam Abram (incorporated by reference to Exhibit 10.7 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.8    Amendment to Employment Agreement dated September  4,  2003 by and between James River Group, Inc. and J. Adam Abram (incorporated by reference to Exhibit 10.8 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.9    Second Amendment to Employment Agreement dated and effective as of August  12,  2005 by and between James River Group, Inc. and J. Adam Abram.*     10.10    Employment and Arbitration Agreement dated and effective as of November 2,  2002 by and between James River Management Company, Inc. and Michael P. Kehoe (incorporated by reference to Exhibit 10.9 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.11    Employment and Arbitration Agreement dated and effective as of October 1,  2003 by and between Stonewood Insurance Management Company, Inc. and C. Kenneth Mitchell (incorporated by reference to Exhibit 10.10 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.12    Employment Agreement dated and effective as of April  29,  2005 by and between James River Group, Inc. and Michael T. Oakes (incorporated by reference to Exhibit 10.11 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.13    Summary of offer letter, as amended, by and between James River Group, Inc. and Michael E. Crow.*     10.14    Summary of Consulting Agreement for Richard W. Wright.*     10.15    Summary of Director Compensation.*                          Number  Exhibit     10.16    Form of Indemnification Agreement between James River Group, Inc. and its directors and executive officers (incorporated by reference to Exhibit 10.14 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.17    Stock Purchase Agreement dated as of April  3,  2003 by and between James River Group, Inc. and American Empire Surplus Lines Insurance Company (incorporated by reference to Exhibit 10.15 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).*     10.18    Reinsurance Agreement effective January 1,  2002 by and between Fidelity Excess and Surplus Insurance Company and American Empire Surplus Lines Insurance Company (incorporated by reference to Exhibit 10.16 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     10.19    Amendment to Reinsurance Agreement effective as of January  1,  2002 by and between Fidelity Excess and Surplus Insurance Company and American Empire Surplus Lines Insurance Company (incorporated by reference to Exhibit 10.17 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     10.20    Guarantee Agreement dated as of June  30,  2003 by and between James River Group, Inc. and Great American Insurance Company (incorporated by reference to Exhibit 10.18 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     10.21    Trust Account Agreement effective March  12,  2003 by and among American Empire Surplus Lines Insurance Company, the Provident Bank and Fidelity Excess and Surplus Insurance Company (incorporated by reference to Exhibit 10.19 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     10.22    Net Quota Share Reinsurance Contract effective as of January  1,  2005 by and among James River Insurance Company and the Subscribing Reinsurers named therein (incorporated by reference to Exhibit 10.20 to the Company’s Registration Statement on Form S-1 (File No. 333-124605)).     11    Statement re computation of per share earnings is included in Note 3 to the Consolidated Financial Statements in Item 8, ‘‘Financial Statements and Supplementary Data’’, of this report on Form 10-K.     21    Subsidiaries of James River Group, Inc.     23    Consent of Independent Registered Public Accounting Firm     31.1    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.     31.2    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.     32.1    Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     32.2    Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                           * Denotes compensatory plan or arrangement for Company officer or director.           GRAPHIC 2 ebox.gif GRAPHIC  begin 644 ebox.gif M1TE&.#EA"@`*`(```````/___R'Y!```````+``````*``H```(1A(\0RVO= - -'G1J!CDQU+'FE!0`.S\_ ` end    GRAPHIC 3 spacer.gif GRAPHIC  begin 644 spacer.gif K1TE&.#EA`0`!`(```````````"'Y!`$`````+``````!``$```("1`$`.S\_ ` end    GRAPHIC 4 xbox.gif GRAPHIC  begin 644 xbox.gif M1TE&.#EA"@`*`(```````/___R'Y!```````+``````*``H```(6A(\0RVNA 2F'K0N0@QS3+Z6TE   EX-10.9 5 file002.htm AMENDMENT TO EMPLOYMENT AGREEMENT         Exhibit 10.9 SECOND AMENDMENT TOEMPLOYMENT AGREEMENT SECOND AMENDMENT TO EMPLOYMENT AGREEMENT (this "Amendment"), dated and effective as of August 12, 2005, between James River Group, Inc., a Delaware corporation (the "Company"), and J. Adam Abram (the "Executive"). WITNESSETH: WHEREAS, the Company and the Executive are parties to that certain Employment Agreement, dated as of November 15, 2002, as amended by that certain First Amendment to Employment Agreement, dated as of September 4, 2003 (collectively, the "Employment Agreement"), pursuant to which, among other things, the Company employed the Executive as President and Chief Executive Officer and the Executive agreed to be so employed; and WHEREAS, the parties hereto desire to amend the Employment Agreement; NOW, THEREFORE, for good and valuable consideration, the receipt of which is hereby acknowledged and agreed, the parties hereto hereby agree as follows: 1.   Amendment to Employment Agreement.    The following paragraph is hereby added to the end of existing paragraph (a) under Section 16 of the Employment Agreement: "Notwithstanding the foregoing, the following terms shall apply to any financing transaction that involves the issuance of common stock or securities convertible, exchangeable or exercisable for common stock of the Company which is consummated after August 12, 2005 (the "IPO Closing") (other than in connection with the exercise of the underwriters' over-allotment option with respect to the Company's initial public offering): (i) The exercise price per share of any 5% Option granted pursuant to this Section 16(a) shall be equal to the fair market value of the Company's common stock on the date of the closing of the financing transaction. (ii) The Company shall have no obligation pursuant to this Section 16(a) to grant any 5% Option to the Executive unless the Company's cumulative return on equity ("Cumulative ROE") exceeds 10%. Cumulative ROE shall be calculated as reported net income from June 30, 2005 to the end of the fiscal quarter immediately preceding the closing of such financing transaction, divided by the average of $176,765,645 and reported stockholders' equity at the end of the fiscal quarter immediately preceding the closing of such financing transaction. (iii) If Cumulative ROE for such financing transaction exceeds 10%, the Executive shall receive (x) the 5% Option relating to that transaction, in accordance with the first paragraph of this Section 16(a), and (y) an additional 5% Option relating to each prior financing transaction following the IPO Closing, if any, that would have triggered a 5% Option but for the fact that Cumulative ROE at the time of such prior transaction did not exceed 10% (the "Look-Back 5% Option"). The Look-Back 5% Option shall be based on the number of shares issued or issuable in the relevant prior financing transaction, at an exercise price per share equal to the fair market value of the Company's common stock at the time the Look-Back 5% Option is granted." 2.   Employment Agreement in Full Force and Effect; Entire Understanding.    Except as expressly modified hereby, the Employment Agreement shall remain unchanged and in full force and effect as executed. The Employment Agreement, as amended hereby, contains the entire understanding of and supersedes all prior agreements, written and verbal, with respect to the subject matter hereof and shall not be modified except in writing executed by the parties hereto. 3.   Miscellaneous.    This Amendment (a) shall be governed by, and construed and enforced in accordance with, the laws of the State of North Carolina, without regard to the principles of conflict of law which might otherwise apply, and (b) may be executed in counterparts, each of which shall be deemed an original and together shall constitute one and the same instrument. 1     IN WITNESS WHEREOF, Company and Executive have duly executed this Amendment as of the date first above written.     COMPANY:        JAMES RIVER GROUP, INC.            By:  /s/ Richard W. Wright  Name: Richard W. Wright Title: Chairman       EXECUTIVE:        /s/ J. Adam Abram  J. Adam Abram    2         EX-10.13 6 file003.htm SUMMARY OF OFFER LETTER         Exhibit 10.13  SUMMARY OF OFFER LETTER BETWEEN THE COMPANY AND MICHAEL E. CROW  The Company extended an offer letter to Michael E. Crow, our Senior Vice President — Finance and Chief Accounting Officer, in April  2003, which was subsequently amended in March  2004. Pursuant to the offer letter, Mr.  Crow is an at-will employee, is paid a base salary and is eligible to receive discretionary bonuses as the Board of Directors may determine. Mr.  Crow may also participate in benefit plans generally available to our executive employees. In the event that Mr.  Crow’s employment is terminated by the Company for a reason other than cause (as defined in the offer letter), Mr.  Crow will be entitled to his base salary for one year, to be paid in accordance with the Company's standard payroll practices at the time. If Mr. Crow finds other employment during that one-year severance period, however, the amount of severance pay will be reduced by the amount of his new salary (and any deferred compensation) earned from the new employment during the severance period. Mr.  Crow is also subject to confidentiality and non-competition covenants.         EX-10.14 7 file004.htm SUMMARY OF CONSULTING AGREEMENT         Exhibit 10.14  SUMMARY OF CONSULTING AGREEMENT FOR RICHARD W. WRIGHT  Effective August 12,  2005, James River Group, Inc. and Richard W. Wright, Chairman, entered into an oral consulting agreement. Pursuant to this agreement, Mr. Wright receives an annual fee of $40,000 for his consulting services. This agreement may be terminated by either party with 90 days written notice.         EX-10.15 8 file005.htm SUMMARY OF DIRECTOR COMPENSATION         Exhibit 10.15 SUMMARY OF DIRECTOR COMPENSATION Directors who are also employees of the Company do not receive compensation for serving as directors. Non-employee directors receive an annual retainer in the amount of $20,000, and the Chairman of the Board receives an additional $20,000 annual retainer. Retainer fees are paid quarterly in arrears. Non-employee directors also receive cash compensation for full Board and committee meetings as follows:                  Per Meeting Fee   Board of Directors  $ 1,500     Audit Committee    1,000     Compensation Committee    500     Investment Committee    500     Nominating and Corporate Governance Committee    500     Special Committees    500                  EX-21 9 file006.htm SUBSIDIARIES         Exhibit 21 SUBSIDIARIES OF JAMES RIVER GROUP, INC.               Name  State of Incorporation   James River Insurance Company  Ohio   James River Management Company, Inc.  Delaware   Potomac Risk Services, Inc.  Virginia   Stonewood Insurance Company  North Carolina   Stonewood Insurance Management Company, Inc.  Delaware   James River Capital Trust I  Delaware   James River Capital Trust II  Delaware                EX-23 10 file007.htm CONSENT OF INDPENDENT REG. PUBLIC ACCOUNTING FIRM         Exhibit 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the Registration Statement (Form S-8 No.333-130399) pertaining to the James River Group, Inc. 2003 Incentive Plan and the James River Group, Inc. 2005 Incentive Plan of our report dated February 13, 2006, with respect to the consolidated financial statements and schedules of James River Group, Inc. included in the Annual Report (Form 10-K) for the year ended December  31,  2005. /s/ Ernst & Young LLP Richmond, VirginiaMarch 24, 2006         EX-31.1 11 file008.htm CERTIFICATION         Exhibit 31.1 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICERPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, J. Adam Abram, certify that:         1.  I have reviewed this annual report on Form 10-K of James River Group, Inc.;           2.  Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;           3.  Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;           4.  The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:           a)  Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;           b)  Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and           c)  Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and           5.  The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):           a)  All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and           b)  Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.   Date: March  23, 2006                     /s/ J. Adam Abram                                             J. Adam Abram   President and Chief Executive Officer                EX-31.2 12 file009.htm CERTIFICATION         Exhibit 31.2 CERTIFICATION OF THE CHIEF FINANCIAL OFFICERPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Michael T. Oakes, certify that:         1.  I have reviewed this annual report on Form 10-K of James River Group, Inc.;           2.  Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;           3.  Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;           4.  The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:           a)  Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;           b)  Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and           c)  Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and           5.  The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):           a)  All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and           b)  Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.   Date: March 23, 2006                     /s/ Michael T. Oakes                                             Michael T. Oakes   Chief Financial Officer                EX-32.1 13 file010.htm CERTIFICATION         Exhibit 32.1 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICERPURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Form 10-K of James River Group, Inc. for the year ended December  31, 2005, I,  J.  Adam Abram, President and Chief Executive Officer of James River Group, Inc., hereby certify pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:       (a)  such Form 10-K for the year ended December  31,  2005 fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934, as amended; and         (b)  the information contained in such Form 10-K for the year ended December  31,  2005 fairly presents, in all material respects, the consolidated financial condition and results of operations of James River Group, Inc. and its subsidiaries as of, and for, the periods presented in such Form 10-K.      By:  /s/ J. Adam Abram                     Date:  March 23, 2006          J. Adam Abram          President and Chief Executive Officer            EX-32.2 14 file011.htm CERTIFICATION         Exhibit 32.2 CERTIFICATION OF THE CHIEF FINANCIAL OFFICERPURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Form 10-K of James River Group, Inc. for the year ended December  31, 2005, I,  Michael T. Oakes, Chief Financial Officer of James River Group, Inc., hereby certify pursuant to 18  U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to my knowledge:       (a)  such Form 10-K for the year ended December  31,  2005 fully complies with the requirements of section 13(a) of the Securities Exchange Act of 1934, as amended; and         (b)  the information contained in such Form 10-K for the year ended December  31,  2005 fairly presents, in all material respects, the consolidated financial condition and results of operations of James River Group, Inc. and its subsidiaries as of, and for, the periods presented in such Form 10-K.      By:  /s/ Michael T. Oakes                     Date:  March 23, 2006          Michael T. Oakes          Chief Financial Officer            -----END PRIVACY-ENHANCED MESSAGE-----