Forward-Looking Statements
In this Quarterly Report on Form 10-Q, we discuss and make statements regarding our intentions, beliefs, current expectations, and projections regarding our company's future operations and performance. Such statements are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as "anticipates," "believes," "expects," "will," "should," and "intends" and their negatives. We caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in our future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. "Risk Factors" below. These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors may emerge from time to time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. We make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.

Introduction
We offer property and casualty insurance products and human resource administration outsourcing services through our various subsidiaries. We classify our businesses into two operating segments: (i) Insurance Operations, which consists of commercial lines ("Commercial Lines") and personal lines, including our flood line of business ("Personal Lines") and (ii) Investments. These segments reflect a change from our historical segments of: Insurance Operations, Investments, and Diversified Insurance Services (which included federal flood insurance administrative services ("Flood") and human resource administration outsourcing ("HR Outsourcing")). In the process of periodically reviewing our operating segments, we reclassified our Flood operations in the first quarter of 2009 to be included within our Insurance Operations segment, which reflects the way we are now managing this business. We believe these reporting changes will better enable investors to view us the way our management views our operations and provide more consistency with how our peers report their business. During Third Quarter 2009, we entered into a plan to dispose our HR Outsourcing segment, which caused the elimination of this operating segment. Our revised segments are reflected throughout this report for all periods presented. See Note 15. "Discontinued Operations" in Item
1."Financial Statements" of this Form 10-Q for additional information.

The purpose of the Management's Discussion and Analysis ("MD&A") is to provide an understanding of the consolidated results of operations and financial condition and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our Annual report on Form 10-K for the year ended December 31, 2008 ("2008 Annual Report").

In the MD&A, we will discuss and analyze the following:
· Critical Accounting Policies and Estimates;

· Financial Highlights of Results for Third Quarter 2009 and Nine Months 2009;

· Results of Operations and Related Information by Segment;

· Federal Income Taxes;

· Financial Condition, Liquidity, and Capital Resources;

· Off-Balance Sheet Arrangements; and

· Contractual Obligations and Contingent Liabilities and Commitments.

Critical Accounting Policies and Estimates These unaudited interim consolidated financial statements include amounts based on our informed estimates and judgments for those transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the consolidated financial statements. Those estimates and judgments most critical to the preparation of the financial statements involved the following: (i) reserves for losses and loss expenses; (ii) deferred policy acquisition costs;
(iii) pension and postretirement benefit plan actuarial assumptions; (iv) other-than-temporary investment impairments; (v) goodwill; and (vi) reinsurance. These estimates and judgments require the use of assumptions about matters that are highly uncertain and, therefore, are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements. For additional information regarding our critical accounting policies, refer to our 2008 Annual Report, pages 43 through 51, except for the other-than-temporary-impairment ("OTTI") discussion, which is updated below.

Other-Than-Temporary Investment Impairments An investment in a fixed maturity, equity security or an other investment (i.e., an alternative investment), is impaired if its fair value falls below its cost/amortized cost and the decline is considered to be other than temporary. We regularly review our entire investment portfolio for declines in fair value. If we believe that a decline in the value of an available-for-sale ("AFS") security is temporary, we record the decline as an unrealized loss in accumulated other comprehensive income ("OCI"). Temporary declines in the value of a held-to-maturity ("HTM") security are not recognized in the financial statements. Our assessment of a decline in fair value includes judgment as to the financial position and future prospects of the entity that issued the investment security, as well as a review of the security's underlying collateral. Broad changes in the overall market or interest rate environment generally will not lead to a write-down.

Our evaluation for OTTI of a fixed maturity security or a short-term investment includes, but is not limited to, the evaluation of the following factors:
· Whether the decline appears to be issuer or industry specific;

· The degree to which the issuer is current or in arrears in making principal and interest payments on the fixed maturity security;

· The issuer's current financial condition and ability to make future scheduled principal and interest payments on a timely basis;

· Stress testing of projected cash flows under various economic and default scenarios;

· Buy/hold/sell recommendations published by outside investment advisors and analysts; and

· Relevant rating history, analysis and guidance provided by rating agencies and analysts.

If there is a decline in fair value on a fixed maturity security that we intend to sell or, more-likely-than-not, may be required to sell, the impairment is considered other-than-temporary and is charged to earnings as a component of realized losses. However, if we do not intend to sell the security and if we do not believe we will be required to sell the security, we then determine whether the amortized cost basis of the security is expected to be recovered. If we do not expect recovery to occur, the impairment is considered other than temporary and is charged to earnings as a component of realized losses. When assessing the recoverability of the amortized cost basis, we compare the present value of the cash flows that we expect to be collected from the security to the amortized cost basis of the security. Any shortfall in the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as a "credit impairment." Any shortfall between the present value of expected cash flows to be collected in relation to the fair value of the security is referred to as a "non-credit impairment." Credit impairments are charged to earnings as a component of realized losses while non-credit impairments are recorded to OCI as a component of unrealized losses.

We perform impairment assessments for the structured securities in our fixed maturity portfolio (including, but not limited to, commercial mortgage-backed securities ("CMBS"), residential mortgage-backed securities ("RMBS"), asset-backed securities ("ABS"), and collateralized debt obligations ("CDOs")), and corporate debt, including an evaluation of the underlying collateral of these structured securities. This assessment takes into consideration the length of time for which the security has been in an unrealized loss position, but primarily focuses on the performance of the underlying collateral under various economic and default scenarios that may involve subjective judgments and estimates by management. Our modeling of these securities involves various factors, such as projected default rates, the nature and realizable value of the collateral, the ability of the security to make scheduled payments, historical performance, and other relevant economic and performance factors. If an OTTI determination is made, we perform a discounted cash flow analysis to ascertain the amount of the credit impairment.

Our evaluation for OTTI of an equity security, includes, but is not limited to, the evaluation of the following factors:
· Whether the decline appears to be issuer or industry specific;

· The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;

· The price-earnings ratio at the time of acquisition and date of evaluation;

· The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer's operations, coupled with our intention to hold the securities in the near term;

· The recent income or loss of the issuer;

· The independent auditors' report on the issuer's recent financial statements;

· The dividend policy of the issuer at the date of acquisition and the date of evaluation;

· Buy/hold/sell recommendations or price projections published by outside investment advisors;

· Rating agency announcements; and

· The length of time and the extent to which the fair value has been less than the carrying value.

If there is a decline in fair value on an equity security that we do not intend to hold, or if we determine the decline is other than temporary, we write down the carrying value of the investment and record the charge through earnings as a component of realized losses.

Our evaluation for OTTI of an other investment (i.e., an alternative investment) includes, but is not limited to, conversations with the management of the alternative investment concerning the following:
· The current investment strategy;

· Changes made or future changes to be made to the investment strategy;

· Emerging issues that may affect the success of the strategy; and

· The appropriateness of the valuation methodology used regarding the underlying investments.

If there is a decline in fair value on an other investment that we do not intend to hold, or if we determine the decline is other than temporary, we write down the carrying value of the investment and record the charge through earnings as a component of realized losses.

Financial Highlights of Results for Third Quarter 2009 and Nine Months 2009

Financial Highlights                   Unaudited                                       Unaudited
                                     Quarter ended           Change                Nine Months ended           Change
                                     September 30,            % or                   September 30,              % or
($ in thousands, except per
share amounts)                    2009          2008         Points              2009            2008          Points

Revenues                        $ 390,175       389,211             - %       $ 1,124,216       1,232,995            (9 ) %
Net income from continuing
operations                         20,606         8,240           150              23,014          56,280           (59 )
Net income                         13,007         8,992            45              15,818          58,146           (73 )
Diluted net income per share
from continuing operations           0.38          0.16           138                0.43            1.06           (59 )
Diluted net income per share         0.24          0.17            41                0.30            1.09           (72 )
Diluted weighted-average
outstanding shares                 53,548        52,994             1              53,312          53,397             -
GAAP combined ratio                 100.0 %       100.3          (0.3 )pts           99.7 %          99.9          (0.2 )pts
Statutory combined ratio             99.8 %        97.6           2.2                99.6 %          98.2           1.4
Annualized return on average
equity                                5.4 %         3.6           1.8 pts             2.2 %           7.5          (5.3 )pts

Net income from continuing operations increased in Third Quarter 2009 compared to Third Quarter 2008 due to:
† Pre-tax realized losses on investment securities that decreased $17.6 million, to $5.0 million, primarily driven by a decline in non-cash OTTI charges of $30.6 million, to $4.2 million in Third Quarter 2009 from $34.9 million in Third Quarter 2008, due to the equity market disruption and unprecedented collateral deterioration across the credit markets during Third Quarter 2008.

Partially offsetting this item was:
o The federal income tax benefit that decreased $8.0 million, to $1.2 million, due to lower pre-tax realized losses during the current period. For additional information, see Note 10. "Federal Income Taxes" in Item 1. "Financial Statements" of this Form 10-Q.

Net income from continuing operations decreased in Nine Months 2009 compared to Nine Months 2008 due to:
† Pre-tax net investment income that decreased $33.8 million, to $78.7 million. This decrease was primarily driven by losses on our other investments portfolio, which includes alternative investments. Alternative investment pre-tax losses of $26.7 million for Nine Months 2009, compared to pre-tax gains of $5.4 million for Nine Months 2008, were a result of a decline in asset values due to the continued volatility in the global capital markets and the dislocation of the credit markets that occurred during Third Quarter 2008 and continued through the first half of 2009. Our alternative investments, which are accounted for under the equity method, primarily consist of investments in limited partnerships that primarily report results to us on a one quarter lag. As a result, the above mentioned pre-tax losses reflect the performance for the majority of these investments through June 30, 2009.

† Pre-tax realized losses on investment securities that increased $21.2 million, to $40.3 million. While we sold equity positions in both Nine Months 2009 and 2008 in an effort to reduce overall portfolio risk, the 2009 sales resulted in net realized gains of $1.5 million, while the 2008 sales resulted in net realized gains of $29.9 million, a reduction of $28.4 million. Partially offsetting these losses were net realized gains on the sale of AFS fixed maturity securities in Nine Months 2009. For additional information regarding our realized gains and losses, refer to the section below entitled "Investments."

† The tax impact of the items above resulted in a reduction in federal tax expense from continuing operations of $16.2 million, to a federal tax benefit of $9.9 million, which also lowered the comparative period's effective tax rate. For additional information, see Note 10. "Federal Income Taxes" in Item
1. "Financial Statements" of this Form 10-Q.

In addition to the above items, net income includes the operating results of Selective HR Inc., which comprised our HR Outsourcing reporting unit, for which we entered into a definitive agreement to sell on October 27, 2009. This reporting unit has been classified as a discontinued operation as of September 30, 2009 and its operating results reflect the impact of a $7.9 million after-tax goodwill impairment charge as our financial projections for this business were not sufficient to support its carrying value. See Note 15. "Discontinued Operations" for additional information.

Results of Operations and Related Information by Segment

Insurance Operations
Our Insurance Operations segment writes property and casualty insurance business through seven insurance subsidiaries (the "Insurance Subsidiaries"). Our Insurance Operations segment sells property and casualty insurance products and services primarily in 22 states in the Eastern and Midwestern U.S. through approximately 960 independent insurance agencies. Our Insurance Operations segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 84% of net premium written ("NPW"), and (ii) Personal Lines, which markets primarily to individuals and represents approximately 16% of NPW. The underwriting performance of these lines is generally measured by four different statutory ratios: (i) loss and loss expense ratio; (ii) underwriting expense ratio; (iii) dividend ratio; and (iv) combined ratio. For further details regarding these ratios, see the discussion in the "Insurance Operations Results" section of Item 1. "Business." of our 2008 Annual Report. As mentioned above in the section entitled, "Introduction," effective as of the first quarter of 2009, the results of our Flood operations are now included within our Insurance Operations segment, consistent with our management of these operations. This change to our segment reporting is reflected throughout this report for all periods presented.

Summary of Insurance Operations

All Lines                            Unaudited                                      Unaudited
                                   Quarter ended           Change               Nine Months ended           Change
                                   September 30,            % or                  September 30,              % or
($ in thousands)                2009          2008         Points             2009            2008          Points
GAAP Insurance Operations
Results:
NPW                           $ 376,718       402,739            (6 ) %      1,117,764       1,184,087            (6 ) %
Net premium earned ("NPE")      355,906       374,708            (5 )        1,078,090       1,135,349            (5 )
Less:
Losses and loss expenses
incurred                        242,032       254,548            (5 )          733,275         760,428            (4 )
Net underwriting expenses
incurred                        113,025       120,203            (6 )          339,620         370,117            (8 )
Dividends to policyholders          991         1,151           (14 )            2,268           3,265           (31 )
Underwriting (loss) income    $    (142 )      (1,194 )          88 %            2,927           1,539            90 %
GAAP Ratios:
Loss and loss expense ratio        68.0 %        67.9           0.1 pts           68.0 %          67.0           1.0 pts
Underwriting expense ratio         31.7 %        32.1          (0.4 )             31.5 %          32.6          (1.1 )
Dividends to policyholders
ratio                               0.3 %         0.3             -                0.2 %           0.3          (0.1 )
Combined ratio                    100.0 %       100.3          (0.3 )             99.7 %          99.9          (0.2 )
Statutory Ratios:
Loss and loss expense ratio        68.1 %        67.9           0.2               68.0 %          67.0           1.0
Underwriting expense ratio         31.4 %        29.4           2.0               31.4 %          30.9           0.5
Dividends to policyholders
ratio                               0.3 %         0.3             -                0.2 %           0.3          (0.1 )
Combined ratio                     99.8 %        97.6           2.2 pts           99.6 %          98.2           1.4 pts

· NPW decreased in both Third Quarter and Nine Months 2009 compared to Third Quarter and Nine Months 2008 due to the continued economic recession and the competitive insurance marketplace. We have experienced the most significant NPW decreases in our workers compensation and general liability lines of businesses due to reduced levels of exposure given the reduction in payroll and sales consistent with the current unemployment level and economic slowdown. These factors are evidenced by the following:

o Reductions in endorsement and audit activity of $17.1 million, to a net return premium of $18.0 million, in Third Quarter 2009 and $46.2 million, to a net return premium of $55.2 million, in Nine Months 2009;

o Reductions in net renewals of $4.7 million, to $324.7 million, in Third Quarter 2009 and $23.4 million, to $966.8 million, in Nine Months 2009, including a reduction in Commercial Lines retention of 2 points in Third Quarter 2009, to 75%, and 2 points, to 76%, in Nine Months 2009; and

o Reductions in new business premiums of $4.8 million, to $79.7 million in Third Quarter 2009.

Partially offsetting the Nine Months 2009 items discussed above was an improvement in new business premium, which increased by $11.4 million, to $244.9 million, compared to the same period last year.

Although renewal premiums are down, renewal pure price increased by 1.5% for Third Quarter 2009, resulting in the second consecutive quarter of Commercial Lines pure price increases. This increase is compared to a decrease in renewal pure price of 3.2% for Third Quarter 2008. For Nine Months 2009, renewal pure price is up 0.4% compared to a decrease of 3.1% for Nine Months 2008.

· NPE decreases in Third Quarter 2009 and Nine Months 2009 compared to the same periods last year, are consistent with the fluctuation in NPW for the twelve-month period ended September 30, 2009 as compared to the twelve-month period ended September 30, 2008. This decrease was primarily driven by a decrease in exposure coupled with premiums written in 2008, which experienced a decrease in pure price of 3.1% in 2008, earning in over the course of 2009.

· For Third Quarter 2009 compared to Third Quarter 2008, the GAAP loss and loss expense ratio increased 0.1 point, reflecting casualty loss costs that have outpaced premiums in the current accident year partially offset by catastrophe losses that were $10.9 million, or 2.9 points, lower in Third Quarter 2009 at $1.9 million.

The 1.0-point increase in the GAAP loss and loss expense ratio for Nine Months 2009 compared to Nine Months 2008 was primarily attributable to casualty loss costs that have outpaced premiums in the current accident year coupled with non-catastrophe property losses that increased 1.8 points, to $155.0 million. Partially offsetting these increases were: (i) catastrophe losses that were 1.9 points lower than last year at $8.5 million; and (ii) favorable prior year casualty development of approximately $23 million, or 2.2 points, in Nine Months 2009 compared to $9.0 million, or 0.8 points, in Nine Months 2008. The development in 2009 is primarily due to favorable results in our 2007 and prior accident years for our workers compensation line, partially offset by unfavorable prior year development in our 2008 accident year on this line.

· Decreases in the GAAP underwriting expense ratio in Third Quarter and Nine Months 2009, were primarily attributable to several expense initiatives implemented in 2008 and during the first quarter of 2009. These initiatives included, but were not limited to: (i) workforce reductions in 2008 that resulted in a $3.4 million charge in the first quarter of 2008; (ii) the re-domestication of two of the Insurance Subsidiaries to Indiana in June 2008;
(iii) targeted changes to agency commissions that were implemented in most states in July 2008; (iv) the consolidation of our purchasing power with fewer vendors and their desire to lock up longer-term contracts; and (v) the elimination of retiree life insurance benefits for current employees amounting to a total benefit of $4.2 million, pre-tax, in the first quarter of 2009. Partially offsetting these actions is the impact of reduced NPE resulting from the economic recession and the competitive nature of the marketplace, as discussed above, which has negatively impacted pricing and exposure over the past year.

Our statutory expense ratios have increased in Third Quarter and Nine Months 2009 compared to the same periods last year due in part, to reduced NPW as discussed above. As these premiums are earned, they will begin to unfavorably impact the GAAP underwriting expense ratio.

Insurance Operations Outlook
During Nine Months 2009, we continued to see a trend toward higher Commercial Lines and Personal Lines pricing in our Insurance Operations segment. As previously discussed, our Commercial Lines renewal pure pricing increased 1.5% for Third Quarter 2009, the second consecutive quarter of Commercial Lines pure price increases. We believe these price increases, which were achieved while maintaining a delicate balance with retention, demonstrate the overall strength of the relationships that we have with our independent agents, even in difficult economic and competitive times. During the second quarter of 2009, our pure price increase of 0.6% was consistent with the 0.5% increase indicated in the Commercial Lines Insurance Pricing Survey ("CLIPS") second quarter 2009 report. As for our Personal Lines operations, we have seen an increase in NPW during Third Quarter 2009 driven by: (i) 21 rate increases that went into effect during Nine Months 2009; and (ii) new business premium, which has increased $4.8 million during the quarter.

We will continue to manage our book of business in the fourth quarter of 2009 by: (i) balancing anticipated Commercial Lines pure price increases with retention; and (ii) anticipating that nine additional rate changes will be effective, which is expected to generate approximately $5 million in additional premium in Personal Lines. We continue to believe that the cycle management tools we have in place are performing as we intended in the current market condition. These tools protect us from writing business that we believe will ultimately be unprofitable and, over the long run as pricing and exposures improve, will better position us to return to targeted return on equity levels.

The overall outlook on the industry for 2009 from key rating agencies is as follows:
· A.M. Best - A.M. Best reported in their report entitled "6-Month Financial Review," that the industry's NPW declined approximately 4.5% during the first half of 2009 due to the prolonged period of a competitive marketplace. They believe that although personal lines rates have started to increase modestly, the overall property and casualty insurance market will not harden until 2010. A.M. Best states that absent a major catastrophic event, the industry's continued focus on disciplined underwriting and prudent capital management should turn an operating profit for 2009.

. . .