The following discussion and analysis of financial condition and results of operations should be read together with the Unaudited Condensed Consolidated Financial Statements and accompanying Notes included elsewhere in this report, and the Consolidated Financial Statements and accompanying Notes included in our Annual Report on Form 10-K.

Note About "Forward-Looking Statements"

This Quarterly Report on Form 10-Q (including the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section) contains "forward-looking statements", as defined in Section 21E of the United States Securities Exchange Act of 1934, as amended, regarding our business, financial condition, results of operations, and prospects, including, without limitation, statements about our expectations, beliefs, intentions, anticipated developments, and other information concerning future matters. Words such as "may", "will", "could", "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", "should", "target", "projects", "contemplates", "predicts", "potential", "continue" and similar expressions or variations of such words are intended to identify forward-looking statements, but are not the exclusive means of identifying forward-looking statements in this Quarterly Report on Form 10-Q.

Although forward-looking statements in this Quarterly Report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on current expectations and assumptions. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and the actual results and outcomes could differ from what is expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include, without limitation, those discussed under the headings "Item 1A. Risk Factors" in our 2008 Annual Report on Form 10-K and "Part II, Item 1A. Risk Factors" in this Quarterly Report on Form 10-Q, and in other filings made from time to time with the United States Securities and Exchange Commission ("SEC") after the date of this Quarterly Report on Form 10-Q. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to (and we expressly disclaim any obligation to) revise or update any forward-looking statement, whether as a result of new information, subsequent events, or otherwise (except as may be required by law), in order to reflect any event or circumstance which may arise after the date of this Quarterly Report on Form 10-Q. Readers are urged to carefully review and consider the various disclosures made in this Quarterly Report on Form 10-Q.

PICO Holdings, Inc. is a diversified holding company. In this Quarterly Report, PICO and its subsidiaries are collectively referred to as "PICO", "the Company", or by words such as "we" and "our". We seek to build and operate businesses where significant value can be created from the development of unique assets, and to acquire businesses which we identify as undervalued and where our management participation in operations can aid in the recognition of the business's fair value, as well as create additional value.

Our objective is to maximize long-term shareholder value. Our goal is to manage our operations to achieve a superior return on net assets over the long term, as opposed to short-term earnings.

Our business is separated into four operating segments:

· Water Resource and Water Storage Operations;
· Real Estate Operations;
· Insurance Operations in "Run Off"; and
· Corporate.

As of September 30, 2009, our major consolidated subsidiaries are:

· Vidler Water Company, Inc. ("Vidler"), a business that we started more than 11 years ago, which acquires and develops water resources and water storage operations in the southwestern United States, with assets in Nevada, Arizona, Idaho, Colorado, and New Mexico;

· UCP, LLC ("UCP"), a business we started in 2008, which acquires and develops partially-developed and finished residential housing lots in selected markets in California;

· Nevada Land & Resource Company, LLC ("Nevada Land"), an operation that we built since we acquired the company more than 11 years ago, which owns approximately 440,000 acres of former railroad land in Nevada, and certain mineral rights and water rights related to the property;

· Physicians Insurance Company of Ohio ("Physicians"), which is "running off" its medical professional liability insurance loss reserves; and

· Citation Insurance Company ("Citation"), which is "running off" its property & casualty insurance and workers' compensation loss reserves.

RESULTS OF OPERATIONS--THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008

Shareholders' Equity

At September 30, 2009, PICO had shareholders' equity of $570.4 million ($25.24 per share), compared to $563.2 million ($24.93 per share) at June 30, 2009, and $477.7 million ($25.36 per share) at December 31, 2008.

The $7.2 million increase in shareholders' equity during the third quarter of 2009 was primarily due to an increase of comprehensive income of $5.5 million, principally resulting from a $6.9 million net increase in unrealized appreciation in investments after-tax. Book value per share attributable to PICO shareholders increased by $0.31, or 1.24%, during the third quarter of 2009.

The $92.6 million increase in shareholders' equity during the first nine months of 2009 was primarily due to the sale of 3,750,000 new shares of PICO common stock for net proceeds of $95.7 million in June 2009. Shareholders' equity was decreased by a $7.4 million comprehensive loss, principally resulting from a net loss of $22.7 million, which was partially offset by a $13.4 million net increase in unrealized appreciation in investments after-tax. Book value per share attributable to PICO shareholders decreased by $0.12, or 0.5%, during the first nine months of 2009.

Comprehensive Income (Loss)

PICO reports comprehensive income or loss as well as net income or loss from the condensed consolidated statement of operations. Comprehensive income or loss measures changes in shareholders' equity, and includes unrealized items which are not recorded in the consolidated statement of operations, for example, foreign currency translation and the net change in unrealized investment gains and losses on available-for-sale securities.

For the third quarter of 2009, PICO recorded comprehensive income of $5.5 million. This consisted of a $6.9 million net increase in unrealized appreciation in investments and a $403,000 foreign currency translation gain, which were partially offset by the third quarter's $1.8 million net loss.

For the first nine months of 2009, PICO recorded a comprehensive loss of $7.4 million. This consisted of a net loss of $22.7 million, which was partially offset by a $13.4 million net increase in unrealized appreciation in investments, and a $1.8 million foreign currency translation gain.

Segment Results of Operations

Segment revenues and income (loss) before taxes and noncontrolling interest for
the third quarter and first nine months of 2009 and 2008 were:

                                             Three Months Ended September 30,          Nine Months Ended September 30,
                                                 2009                  2008                2009                  2008
Revenues:
Water Resource and Water Storage
Operations                                 $         390,000       $   9,145,000     $       3,975,000       $ 10,343,000
Real Estate Operations                               926,000             954,000             3,903,000          4,120,000
Insurance Operations in "Run Off"                    360,000            (508,000 )          (4,232,000 )        5,999,000
Corporate                                           (711,000 )           241,000            (4,007,000 )       47,771,000
Total Revenues (Charges)                   $         965,000       $   9,832,000     $        (361,000 )     $ 68,233,000

Income (Loss) before income taxes and
noncontrolling interest:
Water Resource and Water Storage
Operations                                 $      (2,131,000 )     $   7,375,000     $     (14,927,000 )     $  5,187,000
Real Estate Operations                              (712,000 )          (481,000 )          (2,783,000 )          382,000
Insurance Operations in "Run Off"                     35,000          (1,010,000 )          (5,793,000 )        4,698,000
Corporate                                         (4,821,000 )         1,790,000           (21,052,000 )       45,692,000
Total Income (Loss) before income taxes
and noncontrolling interest                $      (7,629,000 )     $   7,674,000     $     (44,555,000 )     $ 55,959,000

Third Quarter Net Income (Loss)

The focus of our operations is building long-term shareholder value. Our revenues and results of operations (that is, income or loss before income taxes and noncontrolling interests) can fluctuate widely from period to period. For example, we only recognize revenue from the sale of real estate and water assets when specific transactions close, so sales of real estate and water assets for any individual quarter are not necessarily indicative of revenues for future quarters or the full financial year.

Our results of operations were $15.3 million lower in the third quarter of 2009 than in the third quarter of 2008. The following more significant items comprise the majority of the decline in year over year results of operations:

· In the third quarter of 2008, the Water Resource and Water Storage segment recorded a gain of $8.7 million from the sale of our interest in the Semitropic water storage facility. We did not have a similar gain in the third quarter of 2009.
· We recorded a $2 million unfavorable change in net foreign currency expense year over year.
· We recorded a $5.2 million net unfavorable change in net deferred compensation revenues and expenses year over year.

Third quarter revenues were $965,000 in 2009, compared to $9.8 million in 2008, a decrease of $8.9 million year over year, principally due to revenues of $8.7 million recorded on the sale of our interest in the Semitropic water storage facility in the third quarter of 2008 with no equivalent revenues in 2009.

Third quarter costs and expenses were $8.6 million in 2009, compared to $2.2 million in 2008, a net $6.4 million expense increase. This net increase was primarily due to a $4.4 million increase in deferred compensation expense year over year and a $2 million unfavorable change in foreign exchange gain.

For the three months ended September 30, 2009, PICO reported a net loss of $1.8 million ($0.08 per share). In the third quarter of 2008, PICO reported net income of $533,000 ($0.02 per diluted share).

First Nine Months Net Income (Loss)

Our results of operations were $100.5 million lower in the first nine months of 2009 compared to the corresponding period of 2008. The following more significant items comprise the majority of the decline in year over year results of operations:

· In the first nine months of 2008, our results of operations included a $46.1 million realized gain on the sale of our interest in Jungfraubahn Holding AG ("Jungfraubahn"), an equity security that was held in the Corporate segment. We did not have a similar gain in 2009.
· In the first nine months of 2009, our results of operations were reduced by a $12.4 million charge for the impairment of our water assets in the Tule Desert Groundwater Basin in Lincoln County, Nevada, after the Nevada State Engineer ruled to award only a fraction of the water rights the Company had expected to receive. See Part II, Item 1, Legal Proceedings." We did not have a similar charge in 2008.
· We experienced an unfavorable change of $9.6 million in net realized investment gains and losses of our insurance companies' investment portfolios in the first nine months of 2009 compared to the corresponding period in 2008 primarily as a result of other-than-temporary impairments of certain securities held in these portfolios.
· We recorded a $7.5 million unfavorable change in net foreign currency expense year over year.
· We recorded a $13.1 million unfavorable change in net deferred compensation revenues and expenses year over year.

Revenues for the first nine months were charges of $361,000 in 2009, compared to revenues of $68.2 million in 2008, a decrease of $68.6 million year over year. This decline is due principally to the $46.1 million realized gain on the sale of our interest in Jungfraubahn recorded as revenue in 2008, and a $14.7 million unfavorable change in net realized investment gain or loss on the sale or impairment of securities in some of the investments held in our insurance company and deferred compensation portfolios.

Cost and expenses for the first nine months were $44.2 million in 2009, compared to $12.3 million in 2008. A few expenses changed significantly year over year, combining to result in a $31.9 million expense increase. This increase is due primarily to an impairment charge of $12.4 million related to our Tule Desert water assets, a $7.5 million unfavorable change in foreign exchange gain or loss and a $7.5 million increase in deferred compensation expense in 2009.

For the first nine months of 2009, PICO reported a net loss of $22.7 million ($1.11 per share). For the first nine months of 2008, PICO reported net income of $27.1 million ($1.44 per diluted share).

Noncontrolling Interest In Subsidiaries

On January 1, 2009, we adopted the new accounting pronouncement over noncontrolling interests in our condensed consolidated financial statements. We added back net losses to our condensed consolidated statement of operations of $832,000 in the third quarter of 2009, and $3 million in the first nine months of 2009, which represent the interest of noncontrolling shareholders in the losses of consolidated subsidiaries where the Company owns less than 100% of the subsidiary.

Our most significant subsidiary that is not wholly owned is Fish Springs Ranch, LLC ("FSR"). Most of the losses attributable to the noncontrolling interests in our subsidiaries relate to our 49% partner's share of the financing cost charged to FSR by our wholly-owned subsidiary, Vidler, on expenditures incurred for the Fish Springs pipeline project.

                  WATER RESOURCE AND WATER STORAGE OPERATIONS

                                                 Three Months Ended                  Nine Months Ended
                                                   September 30,                       September 30,
                                               2009              2008              2009              2008
Revenues:
Sale of real estate and water assets       $      16,000     $  8,849,000     $    3,197,000     $  9,095,000
Net investment income                            173,000          144,000            215,000          893,000
Other                                            201,000          152,000            563,000          355,000
Segment total revenues                     $     390,000     $  9,145,000     $    3,975,000     $ 10,343,000

Expenses:
Cost of real estate and water assets
sold                                       $     (4,000)     $    (29,000 )   $    (224,000)          (70,000 )
Impairment of water assets                                                      (12,378,000)
Depreciation and amortization                  (273,000)         (265,000 )        (808,000)         (825,000 )
Overhead                                       (675,000)         (791,000 )      (2,227,000)       (2,363,000 )
Project expenses                             (1,569,000)         (685,000 )      (3,265,000)       (1,898,000 )
Segment total expenses                     $ (2,521,000)     $ (1,770,000 )   $ (18,902,000)     $ (5,156,000 )
Income (Loss) before income taxes and
noncontrolling interests                   $ (2,131,000)     $  7,375,000     $ (14,927,000)     $  5,187,000

Our Water Resource and Water Storage operations are conducted through Vidler and its subsidiaries. Over the past few years, several large sales of real estate and water assets have generated the majority of Vidler's revenues. Since the date of closing generally determines the accounting period in which the sales revenues and cost of sales are recorded, Vidler's reported revenues and income fluctuate from quarter to quarter depending on the dates when specific transactions close. Consequently, sales of real estate and water assets for any individual quarter are not necessarily indicative of likely revenues for future quarters or the full financial year.

The Company regularly reviews its real estate and water assets for events or changes in circumstances that might indicate that their carrying amounts may not be recoverable. During the nine months ended September 30, 2009, the only impairment charge required was on the Tule Desert Groundwater Basin. Segment Revenues

Vidler generated total revenues of $390,000 in the third quarter of 2009 compared to $9.1 million in the corresponding period of 2008, and $4 million in the first nine months of 2009 compared to $10.3 million in the corresponding period of 2008.

The decrease in revenues for both the three and nine month periods ended September 30, 2009 compared to the corresponding periods of 2008 is due primarily to the sale of Vidler's remaining interest in the Semitropic Water Banking program for net revenue of $8.7 million which occurred in the third quarter of 2008. In 2009, the most significant sale of real estate and water assets was our entire inventory of water in California (10,252 acre-feet) for $300 per acre-foot. This transaction contributed $3.1 million to total segment revenues in the first nine months of 2009. There were no significant real estate and water asset sales in the third quarter of 2009.

Net investment income has been earned primarily from the temporary investment of cash proceeds from the February 2007 equity offering by PICO. The February 2007 stock offering raised net proceeds of $100.1 million, which were principally allocated to Vidler for new water resource and water storage acquisitions. Throughout 2008, Vidler acquired several real estate and water assets with these proceeds, primarily in the western Nevada region, resulting in $678,000 lower investment income earned on liquid funds in the first nine months of 2009 compared to the corresponding period in 2008. Net investment income in the third quarter of 2009 was higher by $29,000 than the third quarter of 2008 despite the reduction in liquid funds largely due to interest earned on notes issued as partial consideration for the sale of water assets. Other revenues include farm lease income and water service fees.

Tule Desert Groundwater Basin and Impairment of Water Assets

The Lincoln County Water District and Vidler ("Lincoln/Vidler") have entered into a water delivery teaming agreement to locate and develop water resources in Lincoln County, Nevada for planned projects under the County's master plan. As previously disclosed, Lincoln/Vidler jointly filed a permit application in 1998 for 14,000 acre-feet of water rights for industrial use from the Tule Desert Groundwater Basin in Lincoln County, Nevada. In November 2002, the Nevada State Engineer awarded Lincoln/Vidler a permit for 2,100 acre-feet of water rights, which Lincoln/Vidler subsequently sold in 2005, and ruled that an additional 7,240 acre-feet could be granted pending additional studies by Lincoln/Vidler (the "2002 Ruling"). Subsequent to the 2002 Ruling and consistent with the Nevada State Engineer's conditions, Vidler engaged independent experts to conduct these additional engineering and scientific studies. These studies indicated that the pumping of an additional 7,240 acre-feet of water for 100 years would not cause unreasonable drawdown in the Tule Desert Groundwater Basin or surrounding basins, and that the recharge to the groundwater basin was as much as 10,500 acre-feet per annum.

During 2008, Lincoln/Vidler submitted comprehensive and substantial evidence to the Nevada State Engineer to support its permit applications as required by the 2002 Ruling. On April 29, 2009, the Nevada State Engineer issued a ruling with respect to such applications (the "2009 Ruling"). In the 2009 Ruling, the Nevada State Engineer determined that the perennial yield of the groundwater recharge in the Tule Desert Groundwater Basin is likely in the range of 2,500 to 5,000 acre-feet per annum. The Nevada State Engineer further concluded that it would permit the appropriation of only one-half of the upper end of that range, or 2,500 acre-feet. Since 2,100 acre-feet had already been appropriated to and permitted to Lincoln/Vidler under the 2002 Ruling, the Nevada State Engineer found that only 396 acre-feet of unappropriated water remained in the Tule Desert Groundwater Basin. Accordingly, the 2009 Ruling granted Lincoln/Vidler 396 acre-feet of additional permitted water rights, instead of the applied for 7,240 acre-feet of water rights.

We believe that the data provided to the Nevada State Engineer appropriately supported our application for the additional 7,240 acre feet of water and was consistent with the 2002 Ruling. Accordingly, on May 27, 2009, Lincoln/Vidler filed an appeal of the 2009 Ruling in Nevada District Court. The outcome of any appeal is inherently uncertain and it may be a considerable period of time before Lincoln/Vidler is able to ascertain the final volume of water rights that will be permitted by the Nevada State Engineer from its applications in the Tule Desert Groundwater Basin. In addition, on July 21, 2009, Lincoln/Vidler filed a federal action in the United States District Court for the District of Nevada against two individuals in their official capacities as the Nevada State Engineer and the Acting Nevada State Engineer. Lincoln/Vidler's action seeks prospective injunctive and declaratory relief against the Nevada State Engineer on the basis of the Nevada State Engineer's failure to provide Lincoln/Vidler with substantive and procedural due process of law. At a hearing held on July 24, 2009, the District Court Judge ruled in favor of Lincoln/Vidler, allowing discovery on various alleged improprieties by the State Engineer. Discovery has been ongoing since August, 2009 in accordance with such District Court's order. The outcome of this federal action is inherently uncertain and it may be a considerable period of time before Lincoln/Vidler is able to obtain relief under this action, if at all.

As of December 31, 2008, our carrying value for the applications for the additional 7,240 acre-feet was $16.4 million, which primarily represented the data collection, drilling and monitoring costs and expenses incurred to collect, interpret and submit the groundwater data to the Nevada State Engineer. Under agreements in place with developers at the time of ruling, Vidler would only record approximately $4 million of revenue from the 396 acre feet of water rights granted in the 2009 Ruling. Due to the 2009 Ruling, for the nine months ended September 30, 2009, the Company has written down the carrying value of these water rights and applications to their estimated recoverable value under the 2009 Ruling, and recorded a loss on impairment of approximately $12.4 million, before any related tax effects.

Other Expenses

Overhead expenses consist of costs which are not related to the development of specific water resources, such as salaries and benefits, rent, and audit fees.

Project expenses consist of costs related to the development of existing water resources, such as maintenance and professional fees. Project expenses are expensed as appropriate under accounting principles generally accepted in the United States ("U.S. GAAP"), and could fluctuate from period to period depending on activity within Vidler's various water resource projects. Costs related to the development of water resources which meet the criteria to be recorded as assets in our financial statements are capitalized as part of the cost of the asset, and charged to cost of sales when revenue is recognized. Project expenses principally relate to:

· the operation and maintenance of the Vidler Arizona Recharge Facility;
· the development of water rights in the Tule Desert groundwater basin (part of the Lincoln County agreement);
· the utilization of water rights at Fish Springs Ranch as a future municipal water supply for the north valleys of the Reno, Nevada area; and
· the operating and financing costs of our farm properties in Idaho and maintenance of the associated water rights.

Overhead expenses were $116,000 lower year over year, at $675,000 in the third quarter of 2009, compared to $791,000 in the third quarter of 2008. However, project expenses in the third quarter of 2009 increased by $884,000 to $1.6 million compared to $685,000 in the third quarter of 2008. This increase was due primarily to additional professional fees incurred in 2009 as Vidler started a new water resource development project located in New Mexico, as well as legal costs incurred in connection with appealing the 2009 Ruling in the Tule Desert Groundwater Basin noted above.

Overhead expenses in the first nine months of 2009 of $2.2 million were slightly lower compared to $2.4 million of overhead expense in the corresponding period in 2008. However, project expenses were $3.3 million in the first nine months of 2009, compared to $1.9 million in the first nine months of 2008. As noted above in the comparison of the year over year change for the third quarter of 2009, the main reasons for the first nine months year over year increase of $1.4 million in project expenses is the commencement of a new water resource development project in New Mexico and increased legal costs as a result of appealing the 2009 Ruling in the Tule Desert Groundwater Basin.

Segment Results

The third quarter year over year decrease in the segment's result before income taxes and noncontrolling interests of $9.5 million was principally due to the sale of Vidler's remaining interest in the Semitropic Water Banking program for net revenue of $8.7 million in the third quarter of 2008. There were no significant sales of real estate and water assets in the third quarter of 2009. In addition, the segment's year over year result for the first nine months before income taxes and noncontrolling interests decreased by $20.1 million, primarily due to the Semitropic transaction in 2008 noted above, as well as the impairment charge of $12.4 million on Vidler's Tule Desert water asset in the first nine months of 2009 (with no similar charge in 2008).

New Mexico Project

As noted above, Vidler has commenced a new water resource development project in the state of New Mexico. At this stage of the project, all expenditures relating to this venture are being expensed through the statement of operations as incurred, until such time we believe we have sufficient evidence that further expenditures will be recovered by subsequent cash flows generated from the sale of permitted water rights. We are in the exploratory stage of the project. We . . .