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August 23, 2011

To Our Shareholders, Friends and Associates:

During the second quarter, your company faced the two most costly catastrophe losses in our 60-year history, each with estimated losses before reinsurance that surpassed our largest prior event, Hurricane Ike in 2008. These devastating storms caused broad loss of lives as well as property, and our associates have grieved along with the affected families and communities. We fully embraced our responsibility to help with financial recovery.

The storms hit us hard, taking six-month results to $13 million of net income and a $38 million net operating loss. You’ll read inside this letter about our prompt claims response to affected policyholders and their agents – and we are pleased to provide an update that 85 percent of second-quarter catastrophe claims have been closed as of August 12.

Our view is that the second quarter was an income statement event for your company, and our balance sheet was largely unscathed. Our reinsurance program worked, protecting us by absorbing more than $200 million of our losses. With good risk management in place, we finished the first half with a strong premium-to-surplus ratio of 0.8-to-1, which is the same as our year-end 2010 ratio. Our book value per share actually rose 10 cents over the year-end amount. Our debt leverage remains low. We are putting the second quarter behind us.

With exceptional capital strength, we will continue to focus on our strategies shaped to build long-term value:

• For personal lines, including homeowners insurance, we will begin in October applying planned rate changes. They provide for a reasonable overall increase, although not every policyholder will see an increase depending on risk characteristics. We continue to carefully limit and manage accounts involving coastal exposures, and we continue to grow our business in states less prone to catastrophes. For commercial lines, we believe predictive analytics tools, recently implemented for some lines and soon to be more broadly used, will give our underwriters confidence to seek price increases where merited and to compete for high quality risks.
• Our commitment remains to offer a viable insurance market for 75 percent of the business that independent agencies typically handle in their communities. Our agents are working with us on plans that target profitable growth in each agency. We will be their reliable partner as they execute those plans.
• We discuss our shareholder cash dividend quarterly with our board, and we respect the board’s decision on August 12 to increase the dividend. While our dividend payout ratio is high, the board was pleased that our income covered the dividend in 2010. Our capital remains in the same strong position it was in at year-end 2010, and we believe that our initiatives to improve operating results will pay off and put us in position to continue with our consistent, long-term dividend policy.

Thank you for your support and confidence in your company and our plans to create shareholder value by being responsive, reasonable and consistent.

Respectfully,

Kenneth W. Stecher Chairman of the Board

Steven J. Johnston President and Chief Executive Officer

Michael J. Sewell, CPA Senior Vice President and Chief Financial Officer

This report contains forward-looking statements that involve potential risks and uncertainties. For factors that could cause results to differ materially from those discussed, please see the most recent edition of our safe harbor statement under the Private Securities Litigation Reform Act of 1995. To view or print the edition in effect as of this report's initial publication date, please view this document as a printable PDF.

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