The following discussion and analysis should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and the Notes thereto included elsewhere in this report and our Annual Report on Form 10-K for the year ended December 31, 2008, particularly "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations." References to "we," "our" and "us" are references to the Company.

The following discussion of our financial condition and results of operations contains certain forward-looking statements related to our anticipated future financial condition and operating results and our current business plans. When we discuss our future operating results or plans, or use words such as "will," "should," "likely," "believe," "expect," "anticipate," "estimate" or similar expressions, we are making forward-looking statements. These forward-looking statements represent our outlook only as of the date of this report.

We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all of our forward-looking statements. While we believe that our forward-looking statements are reasonable, you should not place undue reliance on any such forward-looking statements. Because these forward-looking statements are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond our control or are subject to change, actual results could be materially different. Factors that might cause such a difference include, without limitation, the risks and uncertainties discussed from time to time in this report and our other reports filed with the Securities and Exchange Commission, including those listed in our most recent Annual Report on Form 10-K under "Item 1A - Risk Factors," and the following:

• Increased competition could adversely affect our ability to sell our products at premium rates we deem adequate, which may result in a decrease in premium volume.

• Our reserves for unpaid losses and loss adjustment expenses are based on estimates that may prove to be inadequate to cover our losses.

• An interruption or change in current marketing and agency relationships could reduce the amount of premium we are able to write.

• If we are unable to obtain or collect on ceded reinsurance, our results of operations and financial condition may be adversely affected.

• Our geographic concentration in certain Midwestern states and New Mexico ties our performance to the business, economic, regulatory and legislative conditions in those states.

• A downgrade in the A.M. Best Company rating of our primary insurance subsidiary could reduce the amount of business we are able to write.

• Changes in interest rates could adversely impact our results of operation, cash flows and financial condition.

• Market illiquidity and volatility associated with the current financial crisis makes the fair values of our investments increasingly difficult to estimate, and may have other unforeseen consequences that we are currently unable to predict.

• The unpredictability of court decisions could have a material impact on our operations.

• Our business could be adversely affected by the loss of one or more key employees.

• The insurance industry is subject to regulatory oversight that may impact the manner in which we operate our business, our ability to obtain future premium rate increases, the type and amount of our investments, the levels of capital and surplus deemed adequate to protect policyholder interests, or the ability of our insurance subsidiaries to pay dividends to the holding company.

• Our status as an insurance holding company with no direct operations could adversely affect our ability to meet our debt obligations and fund future cash dividends and share repurchases.

• Legislative or judicial changes in the tort system may have adverse or unintended consequences that could materially and adversely affect our results of operations and financial condition.

• Applicable law and various provisions in our articles and bylaws may prevent and discourage unsolicited attempts to acquire APCapital that you may believe are in your best interests or that might result in a substantial profit to you.

Other factors not currently anticipated by management may also materially and adversely affect our financial position and results of operations. We do not undertake, and expressly disclaim, any obligation to update or alter our statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

Overview of APCapital

We are an insurance holding company whose financial performance is heavily dependent upon the results of operations of our insurance subsidiaries. Our insurance subsidiaries are property and casualty insurers that write almost exclusively medical professional liability insurance for physicians and other healthcare professionals throughout the United States, but principally in the Midwest and New Mexico. As a property and casualty insurer, our profitability is primarily driven by our underwriting results, which are measured by subtracting incurred loss and loss adjustment expenses and underwriting expenses from net premiums earned. While our underwriting gain (loss) is a key performance indicator of our operations, it is not uncommon for a property and casualty insurer to generate an underwriting loss, yet earn a profit overall, because of the availability of investment income to offset the underwriting loss.

An insurance company earns investment income on what is commonly referred to as the "float." The float is money that we hold, in the form of investments, from premiums that we have collected. While a substantial portion of the premiums we collect will ultimately be used to make claim payments and to pay for claims adjustment expenses, the period that we hold the float prior to paying losses can extend over several years, especially with a long-tailed line of business such as medical professional liability. The key factors that determine the amount of investment income we are able to generate are the rate of return, or yield, on invested assets and the length of time we are able to hold the float. We focus on the after-tax yield of our investments, as significant tax savings can be realized on bonds that pay interest that is exempt from federal income taxes.

For further information regarding the operations of our medical professional liability insurance business see "Item 1. Business - Medical Professional Liability Operations" of our most recent Annual Report on Form 10-K.

Description of Ratios and Other Metrics Analyzed

We measure our performance using several different ratios and other key metrics. These ratios and other metrics are calculated on a GAAP basis and include:

Underwriting Gain or Loss: This metric measures the overall profitability of our insurance underwriting operations. It is the gain or loss that remains after deducting net loss and loss adjustment expenses and underwriting expenses incurred from net premiums earned. We use this measure to evaluate the underwriting performance of our insurance operations in relation to peer companies.

Loss Ratio: This ratio compares our losses and loss adjustment expenses incurred, net of reinsurance, to our net premiums earned, and indicates how much we expect to pay policyholders for claims and related settlement expenses compared to the amount of premiums we earn. The calendar year loss ratio uses all losses and loss adjustment expenses incurred in the current calendar year (i.e., related to all accident years). The accident year loss ratio, which is a non-GAAP financial measure, uses only those loss and loss adjustment expenses that relate to the current accident year (i.e., excludes the effect of development on prior year loss reserves). We believe the accident year loss ratio is useful in evaluating our current underwriting performance, as it focuses on the relationship between current premiums earned and losses incurred related to the current year. In the case of each loss ratio, calendar year or accident year, the lower the percentage, the more profitable our insurance business is, all else being equal.

Underwriting Expense Ratio: This ratio compares our expenses to obtain new business and renew existing business, plus normal operating expenses, to our net premiums earned. The ratio is used to measure how efficient we are at obtaining business and managing our underwriting operations. The lower the percentage, the more efficient we are, all else being equal. Sometimes, however, a higher underwriting expense ratio can result in better business as more rigorous risk management and underwriting procedures may result in the non-renewal of higher risk accounts, which can in turn improve our loss ratio, and overall profitability. The determination of which expenses should be classified as underwriting expenses can vary from company to company. Accordingly, comparability of underwriting expense ratios among and between various companies may be limited.

Combined Ratio: This ratio equals the sum of our loss ratio and underwriting expense ratio. The lower the percentage, the more profitable our insurance business is. This ratio excludes the effects of investment income. As the underwriting expense ratio is a component of the overall combined ratio, comparability between companies may be limited for the reasons discussed above.

Investment Yield: Investment yield represents the average return on investments as determined by dividing investment income for the period by the average ending monthly investment balance for the period. As we use average month ending balances, the yield for certain individual asset classes that are subject to fluctuations in a given month, such as cash and cash equivalents, may be skewed slightly. However, we believe that when calculated for the cash and invested asset portfolio in its entirety, the overall investment yield is an accurate and reliable measure for evaluating investment performance. We calculate investment yields using pre-tax investment income, which excludes the tax savings benefits of certain tax-exempt securities. Our calculation of investment yields may differ from those employed by other companies.

These ratios, when calculated using our reported statutory results, will differ from the GAAP ratios as a result of differences in accounting between the statutory basis of accounting and GAAP. Additionally, the denominator for the underwriting expense ratio for GAAP is net premiums earned, compared to net premiums written for the statutory underwriting expense ratio.

In addition to these measures of operating performance, we also use certain measures to monitor our premium writings and price level changes. We measure policy retention by comparing the number of policies that were renewed during a given period with the number of policies that expired. This retention ratio helps us to measure our success at retaining insured accounts. We also monitor our insured physician count, which counts the number of doctor equivalents associated with all policies. For this purpose a corporation or ancillary health care provider on a policy is assigned a value of one doctor equivalent. When used in conjunction with the retention ratio, the insured physician count helps us to monitor the overall increase or decrease in insureds that comprise our premium base.

As a way of evaluating our capital management strategies we measure and monitor our return on equity, or ROE, in addition to our results of operations. We measure ROE as our net income for the period, annualized if necessary, divided by our total shareholders' equity as of the beginning of the period. Other companies sometimes calculate ROE by dividing annualized net income by an average of beginning and ending shareholders' equity. Accordingly, the ROE percentage we provide may not be comparable with those provided by other companies. We use a modified version of ROE as the basis for determining performance-based compensation.

We also track the book value per common share outstanding, which is calculated by dividing shareholders' equity as of the end of the period by the total number of common shares outstanding at that date. Evaluating the relationship between the book value per common share and the cost of a common share in the open market helps us compare our stock value with that of our peers and to determine the relative premium that the market places on our stock and the stock of our peers.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, or GAAP, requires us to make estimates and assumptions that affect amounts reported in the accompanying unaudited Condensed Consolidated Financial Statements and Notes thereto. These estimates and assumptions are evaluated on an on-going basis based on historical developments, market conditions, industry

trends and other information we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, or that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. Adjustments related to changes in estimates are reflected in our results of operations in the period in which those estimates changed.

Our "critical" accounting policies are those policies that we believe to be most sensitive to estimates and judgments. These policies are more fully described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Policies" of our most recent Annual Report on Form 10-K. There have been no material changes to these policies since the most recent year end.

Results of Operations - Three Months Ended March 31, 2009 Compared to the Three
Months Ended March 31, 2008

The following table shows our underwriting results, as well as other revenue and
expense items included in our unaudited Condensed Consolidated Statements of
Income, for the quarter ended March 31, 2009 and 2008.


                                                                                           Change
                                                    2009           2008          Dollar        Percentage(2)
                                                                    (Dollars in thousands)

Direct premiums written                           $ 30,121       $ 33,671       $ (3,550 )              (10.5 )%

Net premiums written                              $ 28,720       $ 32,175       $ (3,455 )              (10.7 )%

Net premiums earned                               $ 29,306       $ 31,647       $ (2,341 )               (7.4 )%
Losses and loss adjustment expenses
Current year losses                                 23,836         24,618           (782 )                3.2 %
Prior year losses                                   (8,224 )       (8,420 )          196                 (2.3 )%

Total                                               15,612         16,198           (586 )                3.6 %
Underwriting expenses                                7,132          7,016            116                 (1.7 )%

Total underwriting gain                              6,562          8,433         (1,871 )              (22.2 )%
Other revenue (expense) items
Investment income                                    8,190          9,957         (1,767 )              (17.7 )%
Net realized losses                                      -           (782 )          782                100.0 %
Other income                                           223            189             34                 18.0 %
Other expenses(1)                                     (972 )       (1,217 )          245                 20.1 %

Total other revenue and expense items                7,441          8,147           (706 )               (8.7 )%

Income before federal income taxes                  14,003         16,580         (2,577 )              (15.5 )%
Federal income tax expense                           3,916          5,206         (1,290 )               24.8 %

Net income                                        $ 10,087       $ 11,374       $ (1,287 )              (11.3 )%

Loss Ratio:
Accident year                                         81.3 %         77.8 %                               3.5 %
Prior years                                          (28.0 )%       (26.6 )%                             (1.4 )%

Calendar year                                         53.3 %         51.2 %                               2.1 %
Underwriting expense ratio                            24.3 %         22.2 %                               2.1 %
Combined ratio                                        77.6 %         73.4 %                               4.2 %
Pre-tax investment yield                              3.98 %         4.71 %                              (0.7 )%
Net-of-tax investment yield                           3.11 %         3.43 %                              (0.3 )%

(1) Other expenses includes investment expenses, interest expense, general and administrative expenses and other expenses as reported in the unaudited Condensed Consolidated Statements of Income included elsewhere in this report.

(2) The percentage change represents the items change relative to its impact on net income. A positive percentage change indicates a change in that line item representing an increase to net income, while a negative percentage change represents a decrease to net income.

Overview

Net income for the first quarter of 2009 was $1.3 million less than the first quarter of 2008. The decrease in net income was the result of decreases in the gain from underwriting and investment income. The decrease in the underwriting gain was principally due to the decline in net premiums earned, which was the result of declining net premiums written over the last several quarters. Investment income was down due to the decreases in short-term interest rates in 2008 and our increased position in tax exempt securities. As a result of our increased position in tax exempt securities, our effective tax rate decreased to 28.0% in the first quarter of 2009 compared with 31.4% in the first quarter of last year. The $1.3 million decrease in federal income tax expense, along with decreases in realized losses and interest expense, partially offset the effects of the decreases in underwriting gains and investment income on net income.

Premiums Written and Earned

The following table shows our direct premiums written by major geographical
market, as well as the relationship between direct and net premiums written, for
the quarters ended March 31, 2009 and 2008.


                                                                                         Change
                                                     2009          2008         Dollar        Percentage
                                                                   (Dollars in thousands)

Direct premiums written
Michigan                                           $  8,669      $  9,840      $ (1,171 )           (11.9 )%
Illinois                                              8,347         8,554          (207 )            (2.4 )%
Ohio                                                  5,873         7,447        (1,574 )           (21.1 )%
New Mexico                                            4,809         5,072          (263 )            (5.2 )%
Kentucky                                              1,863         2,137          (274 )           (12.8 )%
Other                                                   560           621           (61 )            (9.8 )%

Total                                              $ 30,121      $ 33,671      $ (3,550 )           (10.5 )%

Net premiums written                               $ 28,720      $ 32,175      $ (3,455 )           (10.7 )%

Ratio of net premiums written to direct                95.3 %        95.6 %                          (0.3 )%

The medical professional liability insurance market remains highly competitive, which continues to place downward pressure on premium rates. As a result of premium rate decreases and the loss of accounts to competitors, we wrote $3.6 million, or 10.5%, less direct premiums in the first quarter of 2009 than in the first quarter of 2008. Despite the loss of policies in the first quarter of 2009, our retention ratio was again strong at 88.3% for the quarter, up slightly from the 87.8% in the first quarter of 2008.

The rate decreases that we have recently taken have been in response to favorable claim trends noted in virtually all markets of the medical professional liability industry. These favorable claim trends have caused other carriers to decrease their rates as well, thus increasing overall competition in the industry. We anticipate that the medical professional liability insurance pricing environment will remain highly competitive in the near future with additional premium rate decreases likely. However, we plan to continue to adhere to our philosophy of underwriting discipline and adequate pricing in this soft market cycle.

The decrease in net premiums written in the first quarter of 2009, compared to the first quarter of 2008, was almost identical with the decrease in direct premiums written. This was expected as the 2009 year reinsurance treaty terms are substantially the same as the terms of the 2008 year treaty.

Net premiums earned decreased only 7.4%. This decrease was less than the net premiums written decrease for the quarter as premiums are earned pro rata over the policy term, typically one year. This means that premiums earned in the first quarter of 2009 are based on premiums written not only during the quarter, but the previous 12 months as well. Net premiums written in calendar year 2008 decreased 8.2% when compared with 2007. We commonly refer to this timing difference between when premiums are written and when they are earned as the "premium lag" effect.

Loss and Loss Adjustment Expenses

Net incurred loss and loss adjustment expenses, which we refer to collectively as losses, for the first quarter of 2009 decreased $0.6 million compared with the first quarter a year ago. The accident year loss ratio for the first quarter of 2009 was 81.3%, up from 77.8% in the first quarter of 2008. The increase in the accident year loss ratio was principally the result of premium rate decreases.

Favorable development on prior years' loss reserves for the first quarter of 2009 was $8.2 million, compared with $8.4 million in the first quarter of 2008. The favorable development in the first quarters of 2009 and 2008, annualized, represented 5.8% of beginning net loss and loss adjustment expense reserves. The $8.2 million of favorable development in 2009 consisted of favorable development on medical professional liability reserves of $10.0 million, partially offset by adverse development on workers' compensation reserves of $1.8 million. The medical professional liability favorable development came from all markets, the most significant of which was Illinois, which generated $4.0 million of the total $10.0 million.

Medical professional liability reported claims in the first quarter of 2009 were 244, a slight increase over the 232 reported during the same period of 2008 and the average reported claim count for the last eight quarters of 232. Paid loss severity during the first quarter of 2009 increased modestly to $74,500, compared with an average of $69,100 over the last eight quarters. We measure paid loss severity as the average net paid loss and loss adjustment expense per claim closed with payment over a four quarter trailing period. The slight increase in average paid loss severity was largely offset by a decrease in the total amount of net paid losses and loss adjustment expenses.

We believe that our current loss reserve estimate represents our best estimate of the ultimate cost to settle our claims obligations as of March 31, 2009. However, should actual loss trends continue to develop more favorably than our prior estimates, we likely will experience additional favorable development in future periods. Historical favorable prior year development is not indicative of future operating results, as the amount, if any, and timing of future favorable development is contingent upon the continued emergence of the claim trends we have noted in recent years, as well as many other internal and external factors, including those discussed in our most recent Annual Report on Form 10-K.

Underwriting Expenses

Underwriting expenses for the first quarter of 2009 increased $116,000 compared to the first quarter of last year. This increase in underwriting expenses was primarily attributable to the implementation of significant portions of our new policy and claims system in the fourth quarter of 2008 and first quarter of 2009. In addition to the amortization expense now being recorded, we have discontinued the capitalization of salary and other benefit costs associated with internal staff that has been working on the project now that it is substantially completed. As a result of the amortization expense and discontinued capitalization of salary and other benefit costs, we anticipate that our underwriting expense ratio will be approximately 1% - 2% higher in 2009 when compared with the same period of 2008. In addition, if our premium volume continues to decrease, the underwriting expense ratio will continue to increase as there will be a lower premium base over which to spread certain fixed overhead and other costs.

Investment Income

Investment income for the first quarter of 2009 was down $1.8 million compared to the first quarter of 2008. The decrease was principally due to the decrease in short-term interest rates and the increase in the allocation of our portfolio to tax-exempt securities and cash. Throughout 2008 we utilized the proceeds from calls of several higher-yielding corporate and government-agency issues to purchase additional tax-exempt securities and to fund our corporate capital initiatives. The increase in our cash and cash equivalents was largely attributable to the uncertainty regarding long-term interest rates and our desire to maintain investment flexibility.

Net Realized Losses

We had no net realized gains or losses during the first quarter of 2009, compared with net realized losses of $782,000 during the first quarter of 2008. The first quarter of 2008 net realized loss was attributable to a pre-tax charge of $858,000 related to the other-than-temporary impairment of CIT Group bonds. Our review of our investment portfolio at March 31, 2009 did not indicate that any securities were other than temporarily impaired.

Other Expenses

The decrease in other expenses was the result of lower interest rates and a lower outstanding principal balance on our long-term debt. The interest rate on the debt is 4.14% plus the three-month London Interbank Offered Rate (LIBOR). . . .