The discussion in this Item includes forward-looking statements and should be read in the context of the risks, uncertainties and other variables referred to below under the caption "Forward-Looking Statements."

Business Operations

Overview

The Company reported net income of $1.6 million for the second quarter of 2009, compared to net income of $1.0 million for the second quarter of 2008. The Company reported net income of $3.7 million for the first six months ended June 30 2009, compared to net income of $1.1 million for the six months ended June 30 2008. For the first six months of 2009, the Company recorded net realized gains of approximately $0.5 million on investments; which includes approximately $2.6 million related to write downs for other-than-temporary declines in fair value of various investments of which $2.4 million of the other-than-temporary impairment was recognized in other comprehensive loss, a component of shareholders' equity. Net premiums earned were $48.1 million and $44.6 million in the second quarter of 2009 and 2008, respectively, and were $94.1 million and $87.9 million for the six months ended June 30, 2009 and 2008, respectively. Gross premiums written were $45.0 million and $39.8 million in the second quarter of 2009 and 2008, respectively, and were $98.2 million and $91.7 million for the six months ended June 30, 2009 and 2008, respectively.

As of June 30, 2009, the statutory surplus of its insurance subsidiary was $92.2 million compared to $89.8 million as of December 31, 2008. The unpaid claims and claim adjustment expenses was $76.6 million at June 30, 2009 and $75.5 million at December 31, 2008, of which unpaid claims and claim adjustment expenses attributable to ongoing nonstandard personal automobile lines was $69.4 million and $66.0 million, respectively.

As discussed further below, the Company experienced an increase in its C & CAE ratio for nonstandard personal auto insurance in the second quarter of 2009 (75.9%) as compared with the second quarter of 2008 (74.8%). For the six months ended June 30, 2009, the Company experienced a C & CAE ratio for nonstandard personal auto insurance of 73.8% as compared with the six months ended June 30, 2008 of 74.8%. We believe the increase in the C & CAE ratio for the second quarter of 2009 as compared to the second quarter of 2008 is primarily due to an increase in accident frequency, particularly in Florida. The Company's ability to maintain or improve upon this C & CAE ratio is subject to the significant risks and uncertainties identified in the Annual Report on Form 10-K for the year ended December 31, 2008 (the "Form 10-K"), including the risks associated with growth in premiums and the fact that new business generally produces higher claims ratios than renewal business; see ITEM 1A. Risk Factors in the Form 10-K.

The Company markets its policies through approximately 5,000 independent agency locations in Arizona, Florida, Georgia, Nevada, New Mexico, South Carolina and Texas and one general agency in California that markets through approximately 1,000 insurance broker locations.

A one-for-five reverse split of the Company's Common Stock, which was approved by shareholders in May of 2009, became effective in June of 2009. See "Capital Transactions - 2009 One-for-Five Reverse Split of Common Stock."

The following table presents selected financial information in thousands of dollars:

                                                 Three months ended June 30,                           Six months ended June 30,
                                                2009                         2008                     2009                   2008
                                                                        (Dollar Amounts in thousands)
Gross premiums written                   $            45,001                   39,761                  98,151                 91,727

Net premiums earned                      $            48,141                   44,577                  94,140                 87,917

Net income                               $             1,612                      967                   3,659                  1,134


GAAP C & CAE ratio (1)                                  73.6 %                   71.9 %                  72.0 %                 73.3 %
GAAP Expense ratio (2) (3)                              25.2 %                   26.4 %                  25.3 %                 26.1 %

GAAP Combined ratio (2)                                 98.8 %                   98.3 %                  97.3 %                 99.4 %

(1) C & CAE is an abbreviation for Claims and Claims Adjustment expenses, stated as a percentage of net premiums earned.
(2) The Expense and Combined ratios do not reflect expenses of the holding company which include interest expense on the note payable and subordinated debentures.
(3) Commissions, change in deferred acquisition costs, underwriting expenses and operating expenses (insurance subsidiary only) are offset by agency revenues and are stated as a percentage of net premiums earned.

We believe product enhancements, rate adjustments and expanding marketing efforts in the Southeast region are the main reasons for the increase in gross premiums written and net premiums earned for the comparative years. The increase in the C & CAE ratio for the second quarter of 2009 from the second quarter of 2008 was primarily due to an increase in accident frequency, particularly in Florida. The decrease in the C & CAE ratio for the first six months of 2009 from the first six months of 2008 periods was primarily due to favorable development for claims occurring in prior accident years in our runoff lines and improvement in the first quarter of 2009 accident period as compared to the first quarter of 2008 accident period for the nonstandard personal auto lines.

The Company believes it is pursuing a strategy that has the potential to build a competitively distinctive and successful franchise in the nonstandard personal auto business over time and is endeavoring to manage its investments and risks to achieve this result. These risks and other challenges are occurring in rapidly changing economic, financial, competitive, regulatory and claims environments. The Company's operating and financial results vary from period to period as a result of numerous factors inherent in the insurance business, many of which are affected by such changes.

Discontinuance of Commercial Lines

The Company continues to settle and reduce its inventory of commercial lines claims. As of June 30, 2009, there were 28 claims associated with the Company's runoff book of business versus 30 as of December 31, 2008. As of June 30, 2009, in respect of its runoff lines, the Company had $4.9 million in net unpaid claims and claim adjustment expenses ("C & CAE") compared to $7.1 million as of December 31, 2008. For the periods presented, the Company has recorded favorable development in unpaid C & CAE from the runoff lines with the settlement and reduction in the inventory of commercial lines claims. See "Results of Operations - Claims and claim adjustment expenses." Due to the long tail and litigious nature of these claims, the Company anticipates it will take a substantial number of years to complete the adjustment and settlement process with regard to existing claims and the additional claims it expects to receive in the future from its past business writings. Most of the remaining claims are in suit and the Company's future results may or may not be impacted either negatively or positively based on its ability to settle the remaining claims and new anticipated claims within its established reserve levels.

Results of Operations

The discussion below primarily relates to the Company's insurance operations, although the selected consolidated financial data appearing elsewhere is on a consolidated basis. The expense item "Underwriting and operating expenses" includes the operating expenses of the holding company, GAN.

Revenue

Gross premiums written in the second quarter of 2009 increased 13% as compared to the second quarter of 2008 and increased 7% from the first six months of 2009 as compared to the first six months of 2008. We believe the primary reasons for the increase to be the result of product enhancements, rate adjustments and expanding marketing efforts in the Southeast region. The following table presents gross premiums written by region in thousands of dollars:

                                          Three months ended June 30,             Six months ended June 30,
                                            2009                 2008               2009               2008
                                                               (Amounts in thousands)
Region:
Southeast (Florida, Georgia, South
Carolina)                             $   26,616     59 %    22,172    56 %     60,991     62 %    52,422    57 %
South Central (Texas)                     10,951     24      10,475    26       21,154     22      23,107    25
Southwest (Arizona, Nevada, New
Mexico)                                    6,964     16       6,412    16       15,135     15      14,870    16
West (California)                            470      1         702     2          871      1       1,328     2

Total                                 $   45,001    100 %    39,761   100 %     98,151    100 %    91,727   100 %

The percent of premium increase (decrease) by region for 2009 from 2008 is as follows: Quarterly, Southeast 20%, South Central 5%, Southwest 9% and West
(33)%; Six months, Southeast 16%, South Central (8)%, Southwest 2% and West
(34)%. In the second quarter, we believe the growth in the regions, other than in the West, is the result of product enhancements, rate adjustments and expanding marketing efforts. Net premiums earned increased 8% in the second quarter of 2009 from the second quarter of 2008 and increased 7% in the first six months of 2009 from the first six months of 2008 primarily as a result of an increase in gross premiums written in the current quarter and the previous two quarters from the respective prior years' comparable quarters.

Net investment income decreased $137,000 (8%) in the second quarter of 2009 from the second quarter of 2008 and decreased $574,000 (15%) in the first six months of 2009 from the first six months of 2008, primarily due to the decline in short-term interest rates. At June 30, 2009, Bonds available for sale comprised 73% of Investments versus 64% at June 30, 2008. The annualized return on average investments was 3.7% for the first six months of 2009 versus 4.5% for the first six months of 2008.

In the second quarter of 2009 and first six months of 2009, the Company recorded net realized gains of approximately $738,000 and $509,000, respectively, which included approximately $46,000 and $194,000 in net realized losses related to other-than-temporary impairments of various investments. For the first six months of 2009, the Company recorded approximately $2,555,000 related to write downs for other-than-temporary declines in fair value of various investments of which $2,361,000 of the other-than-temporary impairment was recognized in other comprehensive loss, a component of shareholders' equity, due to the adoption of FSP 115-2 and FAS 124-2.

Agency revenues increased $190,000 (6%) in the second quarter of 2009 from the second quarter of 2008, and increased $406,000 (7%) in the first six months of 2009 from the first six months of 2008 primarily as a result of the increase in writings in the current quarter and the previous two quarters from the respective prior years' comparable quarters. Agency revenues are primarily fees charged on insureds' premiums due.

Expenses

Claims and claim adjustment expenses increased $3,402,000 (11%) in the second quarter of 2009 as compared with the second quarter of 2008. The C & CAE ratio was 73.6% in the second quarter of 2009 versus 71.9% in the second quarter of 2008. The runoff lines recorded favorable development for prior accident years of approximately $1,056,000 in the second quarter of 2009 versus $1,281,000 in the second quarter of 2008. The C & CAE ratio for nonstandard personal auto was 75.9% for the second quarter of 2009 versus 74.8% for the second quarter of 2008. The increase in the C & CAE ratio in the second quarter of 2009 from the second quarter of 2008 was primarily due to an increase in accident frequency, particularly in Florida.

Claims and claims adjustment expenses increased $3,347,000 (5%) in the first six months of 2009 from the first six months of 2008. The C & CAE ratio was 72.0% in the first six months of 2009 versus 73.3% in the first six months of 2008. The runoff lines recorded favorable development for prior accident years of approximately $1,522,000 in the first six months of 2009 and $1,323,000 during the first six months of 2008. The C & CAE ratio for nonstandard personal auto was 73.8% for the first six months of 2009 versus 74.8% for the first six months of 2008. The decrease in the C & CAE ratio was primarily due to improvement in the first quarter of 2009 accident period as compared to the first quarter of 2008 accident period.

The following table presents the (unfavorable) favorable development in nonstandard personal auto for claims occurring in prior accident years for each region in the second quarter and first six months of 2009:

                                               Three months ended             Six months ended
                                                 June 30, 2009                 June 30, 2009
Region:
Southeast (Florida, Georgia, South
Carolina)                                     $           (712,000 )         $          (48,000 )
South Central (Texas)                                      609,000                    1,652,000
Southwest (Arizona, Nevada, New
Mexico)                                                  1,154,000                    1,834,000
West (California)                                           76,000                      (49,000 )

Net favorable development                     $          1,127,000           $        3,389,000

The net favorable development for prior accident years for nonstandard personal auto in the second quarter of 2009 is primarily the result of actual and projected decreases in severity associated with most of our coverages, particularly material damage claims. The favorable development for prior accident years was offset by approximately $811,000 recognized in the first six months of 2009 relating to "extra-contractual" claims, in which claimants seek to recover amounts significantly in excess of applicable policy limits. In the first six months of 2008, the Company incurred "extra-contractual" claims of approximately $385,000 primarily related to prior accident years; see ITEM 1A. Risk Factors - "Litigation may adversely affect our financial condition, results of operations and cash flows" in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

Claims for "extra-contractual" liability arise when a claim is originally denied or the claimant asserts that a claim has been handled inappropriately, and the claimant further asserts that such denial or allegedly inappropriate response was improper or in "bad faith." In such cases, which tend to arise in cases involving serious injury or death, it is not unusual for the amount of the claim to exceed by a substantial amount the policy limits that would otherwise be applicable. Where the Company becomes aware of such a potential claim, it typically consults with outside counsel and, if appropriate, seeks to settle the claim on terms as favorable as possible in light of all the relevant circumstances. The amounts required for settlement of such claims, and the potential award if a case cannot be settled on acceptable terms, vary widely depending on the specific facts of the claim, the applicable law and other factors.

We believe it is reasonably likely that our loss costs could increase or decrease by 2% from current estimates, as remaining claims are recorded and resolved. Loss costs reflect the incurred loss per unit of exposure and are the product of frequency and severity. A 2% increase or decrease in our loss costs would result in unfavorable or favorable development of $9.7 million (based on C & CAE incurred as of June 30, 2009). This estimate of sensitivity is informational only, is not a projection of future results and does not take into account possible effects of extraordinary litigation events (such as class action claims).

With regard to environmental and product liability claims, the Company has an immaterial amount of exposure. The Company did not provide environmental impairment coverage and excluded pollution and asbestos related coverages in its policies. A portion of the Company's remaining claims is related to construction defects.

Inflation impacts the Company by causing higher claim settlements than may have originally been estimated. Inflation is implicitly reflected in the reserving process through analysis of cost trends and review of historical reserve results.

Policy acquisition costs include commissions, premium taxes, marketing and underwriting expenses and the amortization of the premium deficiency. The expenses are charged to operations over the period in which the related premiums are earned. The increase of $137,000 (2%) in the second quarter of 2009 from the second quarter of 2008 and of $538,000 (4%) in the first six months of 2009 from the first six months of 2008 was primarily due to increases in commission and marketing expenses. Commissions increased as a result of the increase in premiums. The increase in marketing expenses occurred primarily as a result of an increase in underwriting reports and travel expenses. Commissions are paid to the independent agents based upon premium writings. The marketing expenses are primarily salaries, telephone and travel expenses of our territory managers who oversee the efforts of the agents within a geographical area. Their time is focused on the supervision, relationship management and support of existing agents and recruiting new agents, as well as actively soliciting new business from these agents. Accordingly, these costs vary with and are primarily related to the acquisition of new and renewal insurance policies. The ratio of Policy acquisition costs to Net premiums earned was 17% and 18% for the second quarter of 2009 and 2008, respectively. The decrease in the ratios is primarily due to a decrease in the aggregate commission rate. It was 17% for the first six months of 2009 and for the first six months of 2008, respectively.

Underwriting and operating expenses increased $322,000 (4%) in the first quarter of 2009 from the first quarter of 2008 and increased $486,000 (3%) in the first six months of 2009 from the first six months of 2008 primarily due to an increase in compensation expense. Underwriting and operating expenses as a percent of Net premiums earned and Agency revenues were 16% and 17% for the second quarter of 2009 and 2008, respectively, 16% and 17% for the first six months of 2009 and 2008, respectively.

The decrease in interest expense of $180,000 (25)% in the first quarter of 2009 from the first quarter of 2008 and of $525,000 (31)% in the first six months of 2009 from the first six months of 2008 primarily due to the decline in the 3-month London Interbank Offered Rate for U.S. dollar deposits and its related impact on the interest expense of subordinated debentures.

Capital Transactions

Reverse Split of Common Stock

A one-for-five reverse split of the Company's Common Stock was approved by shareholders in May of 2009 and became effective in June of 2009. Each five shares of the Company's outstanding Common Stock, par value $0.10 per share were converted into one share of Common Stock, par value $0.10 per share, and the number of authorized shares of Common Stock was reduced proportionately.

As a result of the one-for-five reverse split of Common Stock in June 2009, the number of shares of Common Stock outstanding at December 31, 2008 was retroactively adjusted to 4,786,920. Treasury stock held at December 31, 2008 was retroactively adjusted to 252,729. At June 30, 2009 and December 31, 2008, Goff Moore Strategic Partners, LP owned approximately 34% of the outstanding Common Stock, Robert W. Stallings owned approximately 23% and James R. Reis owned approximately 12%.

Liquidity and Capital Resources

Parent Company

GAN provides administrative and financial services for its wholly owned subsidiaries. GAN needs cash during 2009 primarily for administrative expenses and interest on the Subordinated debentures and the Note payable. GAN has approximately $3.3 million in cash and marketable securities that can be used for general corporate purposes. Another source of cash to meet obligations is statutorily permitted dividend payments from its insurance subsidiary, which requires approval from the Texas Department of Insurance (see note 9 of Notes to Condensed Consolidated Financial Statements which appear in Item 1 of this Report). GAN believes the cash available from its cash and marketable securities, available dividends from its insurance subsidiary, if permitted, and dividends from its agency subsidiary should be sufficient to meet its expected obligations for 2009.

Net Operating Loss Carryforwards

Deferred tax assets are evaluated and a valuation allowance is established if it is more likely than not that all or a portion of the deferred tax asset will not be realized. See note 1(d) "Federal Income Taxes" in Notes to Consolidated Financial Statement appearing under Part 1. Financial Information - Item 1. "Financial Statements" of this report for further discussion.

As a result of losses in prior years, as of June 30, 2009, the Company had net operating loss carryforwards for tax purposes aggregating $68,494,000. These net operating loss carryforwards of $7,323,000, $33,950,000, $13,687,000, $633,000, and $12,901,000, if not utilized, will expire in 2020, 2021, 2022, 2023 and 2027, respectively. As of June 30, 2009, the tax benefit of the net operating loss carryforwards is $23,288,000, which is calculated by applying the Federal statutory income tax rate of 34% against the net operating loss carryforwards of $68,494,000.

As of June 30, 2009 and December 31, 2008, the net deferred tax asset before valuation allowance was $29,678,000 and $32,397,000 and the valuation allowance was $28,643,000 and $29,905,000, respectively. The Company does not record a tax valuation allowance relating to the net unrealized losses on investments, excluding equity securities because it is more likely than not that these losses would reverse or be used in future periods. The Company has the ability and it is the Company's intent to fully recover the principal, which could require the Company to hold these securities until their maturity; therefore, the Company considers the impairment to be temporary.

Subsidiaries, Principally Insurance Operations

The primary sources of the insurance subsidiary's liquidity are funds generated from insurance premiums, net investment income and maturing investments. The short-term investments and cash are intended to provide adequate funds to pay claims without selling fixed maturity investments. At June 30, 2009, the insurance subsidiary held short-term investments and cash that the insurance subsidiary believes are adequate for the payment of claims and other short-term commitments.

With regard to liquidity, the average duration of the investment portfolio is approximately 2.4 years. The fair value of the investment portfolio at June 30, 2009 was $3,019,000 below amortized cost, before taxes (see notes 2 and 3 of Notes to Condensed Consolidated Financial Statements which appear in Item 1 of this Report). Various insurance departments of states in which the Company operates require the deposit of funds to protect policyholders within those states. At June 30, 2009 and December 31, 2008, the balance on deposit for the benefit of such policyholders totaled $5,413,000 and $5,447,000, respectively.

Net cash provided by operating activities decreased to $4,872,000 in the first six months of 2009 versus $6,359,000 in the first six months of 2008. The decrease was primarily the result of a decrease in investment income due to the decline in short-term interest rates.

Investments and Cash increased in the first six months of 2009 primarily as a result of net cash provided by operating activities and the increase in fair value of the investment securities. At June 30, 2009, 79% of the Company's investments were rated investment grade. The average duration was approximately 2.4 years, including approximately 24% of the Investments that were held in Short-term investments. The Company classifies its bond securities as available for sale and trading. The net unrealized loss associated with the investment portfolio was $1,984,000 (net of tax effects) at June 30, 2009 (see note 2 of Notes to Condensed Consolidated Financial Statements which appear in Item 1 of this Report).

Premiums receivable increased primarily due to the increase in premium writings for the six months ended June 30, 2009 over the six months ended December 31, 2008. This balance is comprised primarily of premiums due from insureds. Most of the policies are written with a down payment and monthly payment terms of up to four months on six month policies. The Company recorded an allowance for doubtful accounts of $916,000 and $1,029,000 as of June 30, 2009 and December 31, 2008, respectively, which it considers adequate. The decrease in the allowance for doubtful accounts was due primarily to a decrease in over thirty day receivables.

Deferred Federal income taxes include temporary differences and the tax asset from net operating loss carryforwards less a valuation allowance that fully reserves these two items, see "Liquidity and Capital Resources - Net Operating Loss Carryforwards." The decrease is primarily due to the decrease in unrealized losses on investments, excluding common stocks.

Unpaid C & CAE increased primarily as a result of an increase in outstanding claims due to growth for the nonstandard personal automobile lines. As of June 30, 2009, the Company had $74,315,000 in net unpaid C & CAE (Unpaid C & CAE of $76,596,000 less Ceded unpaid C & CAE of $2,281,000). This amount represents management's best estimate of the ultimate liabilities. The significant operational changes we have recently made in the nonstandard personal auto claims adjustment process and changing claims trends increase the uncertainties which exist in the estimation process and could lead to inaccurate estimates of claim and claim adjustment expense.

The reserve estimates were made by our in-house actuarial staff. An analysis . . .