Edgar Filing: 21ST CENTURY INSURANCE GROUP

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

Commission File Number 0-6964

(Exact name of registrant as specified in its charter)

	Delaware		95-1935264
	(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

	6301 Owensmouth Avenue
	Woodland Hills, California		91367
	(Address of principal executive offices)		(Zip Code)

	(818) 704-3700		www.21st.com
	(Registrant’s telephone number, including area code)		(Registrant’s web site)
	Securities registered pursuant to Section 12(b) of the Act:

	Title of each class		Name of each exchange on which registered
	Common Stock, Par Value $0.001		New York Stock Exchange

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Act. (Check one):

Large accelerated filer ¨

Accelerated filer x

Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of the voting stock held by non-affiliates of 21st Century Insurance Group, based on the average high and low prices for shares of the registrant’s Common Stock on June 30, 2006, as reported by the New York Stock Exchange, was approximately $441,000,000.

There were 87,242,150 shares of common stock outstanding on February 3, 2007.

Documents Incorporated By Reference:

Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive proxy statement for the Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission within 120 days after the close of the year ended December 31, 2006.

TABLE OF CONTENTS

Description		Page Number
Part I
Item 1.	Business	3
Item 1A.	Risk Factors	19
Item 1B.	Unresolved Staff Comments	24
Item 2.	Properties	25
Item 3.	Legal Proceedings	25
Item 4.	Submission of Matters to a Vote of Security Holders	25
Part II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	25
Item 6.	Selected Financial Data	27
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	49
Item 8.	Financial Statements and Supplementary Data	51
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	90
Item 9A.	Controls and Procedures	90
Item 9B.	Other Information	90
Part III
Item 10.	Directors, Executive Officers and Corporate Governance	91
Item 11.	Executive Compensation	91
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	91
Item 13.	Certain Relationships and Related Transactions, and Director Independence	91
Item 14.	Principal Accounting Fees and Services	91
Part IV
Item 15.	Exhibits, Financial Statement Schedules	92
Signatures		100

Exhibit Index		93
21	Subsidiaries of Registrant
23	Consent of Independent Registered Public Accounting Firm
31.1	Certification of President and Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a)
31.2	Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a)
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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PART I

ITEM 1.

BUSINESS

GENERAL

21st Century Insurance Group is an insurance holding company registered on the New York Stock Exchange. For convenience, the terms “Company”, “21st”, “we”, “us”, or “our”, unless the context requires otherwise, are used to refer collectively to 21st Century Insurance Group and its consolidated subsidiaries, all of which are wholly-owned: 21st Century Insurance Company (our primary insurance company), 21st Century Casualty Company, 21st Century Insurance Company of the Southwest, 20th Century Insurance Services, Inc., and i21 Insurance Services. The latter two companies are not property and casualty insurance subsidiaries, and their results are immaterial.

Founded in 1958, we are a direct-to-consumer provider of personal auto insurance. With $1.4 billion of revenue in 2006, we insure over 1.5 million vehicles in Arizona, California, Florida, Georgia, Illinois, Indiana, Nevada, New Jersey, Ohio, Oregon, Pennsylvania, Texas, Washington, Colorado, Minnesota, Missouri, and Wisconsin. We provide superior policy features and customer service at a competitive price. Customers can receive a quote, purchase insurance, service their policy, or report a claim at www.21st.com or on the phone with our licensed insurance professionals at 1-800-211-SAVE. Service is offered in English and Spanish, both over the phone and on the web, 24 hours a day, 365 days a year.

The common stock of the Company is traded on the New York Stock Exchange under the trading symbol “TW.” Through several of its subsidiaries, American International Group, Inc. (“AIG”) currently owns approximately 62% of the Company’s outstanding common stock. Effective December 4, 2003, 21st Century Insurance Group was incorporated under the laws of the State of Delaware. Previously, the Company was incorporated in California.

The Company sells personal automobile insurance polices, and accordingly collects premium payments, incurs costs for acquiring its customers, settling claims, servicing policies, and for other operating expenses and then invests the remaining proceeds to earn investment income. In most industries, the cost of a product is known before it is priced and sold. In insurance, products are sold, but their costs are not known until a later date. Therefore, the pricing must employ sophisticated methods to predict the product’s cost.

Business Strategies

We have been consistently communicating our strategies to investors in press releases, Securities and Exchange Commission (“SEC”) filings, and earnings calls. Prior to 2003, a majority of the Company’s time and effort was directed at (1) building and implementing our information technology platform, (2) managing legacy earthquake and homeowners exposures, (3) refining our reserving process that would maintain adequate reserves, and (4) building the Company’s regular business. Since 2003, senior management has communicated a four-point strategy: (1) geographic expansion, (2) superior product and service offering, (3) sophisticated pricing segmentation and (4) maintaining the Company’s position as a low cost provider of auto insurance.

Geographic Expansion

Geographic expansion has several long-term benefits to the Company:

It increases the number of consumers and total market potential available to the Company. While California is the single largest personal auto insurance market, it represents only 12% of the U.S. total personal auto market. In 2006, the Company entered eight new states, increasing the total to 17 states and raising the percentage of the U.S. market in which it operates from 34% at year-end 2005 to 60% at year-end 2006.

Having more potential customers makes the Company’s marketing and advertising programs more cost effective. Buying national television is typically more cost effective than buying local television.

Having multiple states to operate in reduces the risk from legislative, regulatory, and judicial changes in any market.

Having multiple states to operate in and, over time, diversifying the Company’s distribution of customers reduces the Company’s risk to catastrophic events, which typically are local or regional in nature.

Having offices in multiple locations and time zones makes the process of providing unending 24/7 service less difficult, plus allows the Company to focus hiring of new staff in states and jurisdictions with favorable characteristics.

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Superior Product and Service Offering

By providing a superior product and service offering, we believe we attract customers and retain them for longer periods of time. Generally, policy features such as full permissive driver coverage, full replacement if a new car is totaled in the first year, complimentary towing and roadside assistance, and free coverage for students during holiday periods come standard with a 21st policy contract, subject in all cases to policy terms and conditions. Similar features cost extra with most of our competitors. On the service side, we operate 24 hours a day, seven days a week, in English and Spanish, on the phone and on the web. Our web site also offers sophisticated coverage and price comparison tools that prospective customers can utilize to select the right coverage for their financial situation and then comparison shop with quotes from other leading companies. If they ever have questions after using these on-line tools, they can reach one of our licensed representatives on the phone anytime.

Sophisticated Pricing Segmentation

Pricing segmentation is a very important competitive factor, as it helps a company write profitable business. If a company’s pricing is unsophisticated and is not linked to a system that can accurately predict the probability of loss, that company’s pricing will only reflect external competitive factors. This leads to cyclical results, as companies compete on price without knowing or factoring in their own risk of loss. 21st employs a systematic pricing methodology that we believe allows us to predict the risk of loss more accurately than less-sophisticated competitors. This creates numerous competitive advantages: (1) when commencing business in a new market, we can more accurately find customers that are over-priced and offer them a superior policy and service package at a lower price, which will be more profitable to us. More importantly, we can more accurately identify customers that are under-priced and leave these to our competitors, (2) we can factor risk of loss in our own pricing, maintain pricing discipline and not be as subject to external market forces, and (3) maintain profitability by precisely adjusting pricing in our own book of business when we see statistical anomalies.

Low Cost Provider

The Company strives to have a low expense structure to allow it to offer auto insurance products with superior features and service that are priced competitively. One of the advantages of being a direct-to-consumer writer of auto insurance is the lack of commission fees for renewals since we do not utilize external agents or marketing firms. Information extracted from statutory filings by Highline Data for the top ten California personal automobile insurance companies for 2005, the most recent year available, indicates that our direct statutory underwriting expense ratio for private passenger auto (defined as direct underwriting expenses on a statutory basis divided by direct premiums written) was lower than 5 of our 9 largest competitors in California for 2005.

Direct vs. Agent Distribution

Agent-based organizations accounted for 85% ($137 billion), of the private passenger auto market share in 2005, while direct-to-consumer organizations accounted for the remainder. The leading agent-based insurers are State Farm and Allstate, while the leading direct-to-consumer insurers are GEICO, USAA, Progressive (Direct), along with 21st Century Insurance. However, between 1999 and 2005, we estimate that direct-to-consumer insurers have gained 4.6% of market share from the agent-based organizations. We believe that the direct-to-consumer distribution model has significant competitive advantages over the agent-based distribution model, such as there are no dependencies on outside agents or marketing organizations and therefore, we do not have to pay a recurring agent commission, resulting in lower underwriting expenses. The direct model offers operating flexibility, which allows direct companies to react quickly to attractive markets, as well as unattractive markets. Most importantly, direct-to-consumer companies own the customer relationship. In the independent agent model, the agent owns the customer relationship and can, at any time, move the business to another carrier. We further believe the direct-to-consumer model is more in line with changing consumer preferences. Fewer and fewer consumers are willing to pay a large fee just to renew their auto insurance. Similar to the changes in the airline industry, in the past, consumers used travel agents because the agent had access to all the relevant information. Today, all of the information consumers need is available on-line, so they feel more comfortable accessing travel services without the help of an agent, or paying a large agent fee.

Long-Term Financial Goals

We have four key long-term financial goals:

96% combined ratio

15% growth in direct premiums written

15% return on equity

Strong financial ratings

Our long-term financial goals are the framework we use for making business decisions regarding market entries, marketing programs, product offerings and operating plans. Although we may not achieve each of these goals in a given calendar year, we believe that achieving them over the long-term will help us to provide superior returns to our shareholders.

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96% Combined Ratio Long-Term Goal

This ratio measures an insurance company’s total underwriting profitability. It is an important measure of our overall business profitability and effects return on equity and influences our financial ratings. Consequently, we consider our 96% or less combined ratio goal as the most important of our long-term financial goals. We strive to achieve a 96% or less combined ratio by accurately pricing our risks, being a disciplined underwriter, expertly handling customer service and claims, retaining our customers and controlling expenses. If the combined ratio is at or above 100%, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient).

15% Growth Long-Term Goal

We aim to grow our direct premiums written profitably at a rate that exceeds the overall growth rate for our industry and key competitors. Although we may not achieve our 15% growth goal in a given calendar year, over the long-term, we plan to achieve our growth goal by establishing and expanding our business in markets outside of California, and through innovation in our marketing methods and product offerings.

15% Return on Equity (“ROE”) Long-Term Goal

ROE is net income (loss) divided by average stockholders’ equity and is affected by our underwriting profit, investment yield, and our capital structure. Our goal is to achieve an ROE that exceeds the average ROE for our industry.

Strong Financial Ratings

A strong financial rating is an important element of our public profile. Ratings provide third party verification of the Company’s financial position and minimize our borrowing costs. Ratings are also a proxy for financial strength, as they require companies to maintain minimum levels of capital to support various strategic, operational, and financial risks. We engage independent rating agencies to measure our overall credit worthiness and financial strength. Our goal is to achieve and maintain financial strength ratings that are investment grade, as defined by the relevant rating agency.

The Company’s financial stability is demonstrated by our A+ financial strength rating, our high capital adequacy ratios and the fact that we have been in business for nearly 50 years. The following are our financial ratings by rating agency:

	Financial Ratings by Rating Agency
	2006	2005	2004	2003	2002
A.M. Best	A+	A+	A+	A+	A+
Standard & Poor’s	A+	A+	A+	A+	A+
Fitch	A+	A+	A	—	—

SOME USEFUL DEFINITIONS

The insurance industry uses terminology that is unfamiliar to some people. Included here are definitions and descriptions that should be useful as you read this report.

Not all financial measures used by the insurance industry are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Throughout this Annual Report on Form 10-K, the Company presents its operations in the way it believes will be most meaningful, as well as most transparent. For an explanation of why the Company’s management considers these “non-GAAP” measures useful to investors and for reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures, see Item 7. Management’s Discussion and Analysis - Results of Operations and Liquidity and Capital Resources. Non-GAAP financial measures are not intended to replace, and should be read in conjunction with, the GAAP financial results.

Balance Sheet terms

Deferred policy acquisition costs (“DPAC”) - The unamortized portion of the policy acquisition costs described below.

Unpaid losses and loss adjustment expenses - The estimated liabilities for Losses and Loss Adjustment Expenses (“LAE”) include the accumulation of estimates of losses for claims reported on or prior to the balance sheet dates, estimates (based upon actuarial analysis of historical data) of losses for claims incurred but not reported, the development of case reserves to ultimate values, and estimates of expenses for investigating, adjusting and settling all incurred claims. Amounts reported are estimates of the ultimate costs of settlement, net of estimated salvage and subrogation.

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Reinsurance receivables and recoverables - These amounts are reflected as assets on the consolidated balance sheets and consist of two components: the ceded portion of the reserves described in unpaid losses and LAE above are classified as recoverables, and the actual billings due from our reinsurers on ceded portions of payments of losses and LAE paid as receivables.

Unearned premiums - That portion of our direct premiums written that has not yet been earned. It is the amount of premium we would return to policyholders if all policies were cancelled as of the balance sheet date. The ceded portion of this liability is shown as an asset labeled “Prepaid reinsurance premiums.”

Statutory surplus - Represents equity as of the end of a fiscal period for the Company’s insurance subsidiaries, determined in accordance with statutory accounting principles prescribed by insurance regulatory authorities. Stockholders’ equity is the most directly comparable GAAP measure.

Income statement terms

Direct premiums written - This statutory measure represents the total policy premiums, net of cancellations, associated with policies underwritten and issued. We use this non-GAAP measure, which excludes the impact of premiums ceded to reinsurers, to assess the underlying growth of our insurance business from period to period. We do not currently assume premiums from other companies.

Net premiums written - This statutory measure represents the sum of direct premiums written less ceded premiums written. Ceded premiums written is the portion of our direct premiums written that we transfer to our reinsurers in accordance with the terms of our reinsurance contracts, based upon the risks they accept. Similar to direct premiums written, we use this non-GAAP measure to assess growth. See Note 10 of the Notes to Consolidated Financial Statements for a summary of our reinsurance agreements.

Net premiums earned - Represents the portion of net premiums written that is recognized as income in the consolidated financial statements for the periods presented and earned on a pro rata basis over the term of the policies.

Net losses and loss adjustment expenses incurred - Includes the payments, as well as the change in estimates for unpaid liabilities for the indemnity and settlement costs of all insured events occurring during the period. These estimates are necessarily subject to the outcome of future events, such as changes in medical and repair costs as well as economic and social conditions that impact the settlement of claims. The methods of making such estimates and for establishing the resulting reserves are reviewed and updated as applicable, and any resulting adjustments are reflected in current operations.

Policy acquisition costs - Consist of premium taxes, advertising, and variable costs incurred with writing new and renewal business. These costs are deferred and amortized over the typical six-month policy period in which the related premiums are earned.

Other underwriting expenses - Consist of all other costs involved in the support of the insurance business other than losses, LAE and policy acquisition costs. This includes servicing policies and all other corporate support functions.

Underwriting profit (loss) - Underwriting profit (loss) is a statutory measure that consists of net premiums earned less losses from claims, loss adjustment expenses, policy acquisition costs, and underwriting expenses, as determined using GAAP. 21st believes that underwriting profit (loss) provides investors with financial information that is not only meaningful, but important to understanding the results of property and casualty insurance operations. The results of operations of a property and casualty insurance company include three components: underwriting profit (loss), net investment income and realized capital gains (losses). Without disclosure of underwriting profit (loss), it is difficult to determine how successful an insurance company is in its core business activity of assessing and underwriting risk, as including investment income and realized capital gains (losses) in the results of operations without disclosing underwriting profit (loss) can mask underwriting losses. Underwriting profit (loss) is not a GAAP measure. A reconciliation of underwriting profit (loss) to net income is located in Item 7. Management’s Discussion and Analysis - Results of Operations.

Income Statement Performance Ratios

The following operating ratios are used to measure our performance, not only period-to-period, but as a common comparison tool against our peers in the marketplace, and is useful in understanding our profitability. The three most common ratios follow:

Loss and LAE ratio - The result of dividing net losses and LAE incurred by net premiums earned. It is a measure of the percentage of our premium revenue that goes towards investigating and settling claims.

Underwriting expense ratio - The result of dividing the sum of policy acquisition costs and other underwriting expenses by net premiums earned. It is a measure of how efficiently we attract, acquire, and service the business we write.

Combined ratio - The sum of the loss and LAE ratio and the underwriting expense ratio. This ratio measures a company’s overall underwriting profitability. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). For example, one of our long-term financial goals as a Company is to maintain a combined ratio of 96% or less. This means that for every $1.00 of premium that we earn, we will incur $0.96 or less in related costs. The $0.04 margin is referred to as our underwriting profit and, when coupled with our investment results, other income and other expenses, becomes our pre-tax income. As noted above, underwriting profit (loss) is not a GAAP measure.

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Types and Limits of Insurance Coverage

The following coverages are generally made available on our private passenger auto insurance contract: bodily injury liability; property damage; medical payments; personal injury protection, uninsured and underinsured motorist; rental reimbursement; uninsured motorist property damage; towing; comprehensive; and collision. All of these policies are written for a six-month term except for Involuntary Market policies assigned to us, which are for twelve months.

Minimum levels of bodily injury and property damage are required by state law and typically cover the other party’s claims when our policyholder is at fault. Uninsured and underinsured motorist typically are optional coverages and cover our policyholder when the other party is at fault and has insufficient liability insurance to cover the insured’s injuries and loss of income. Comprehensive and collision coverages are also optional and cover damage to the policyholder’s automobile whether or not the insured is at fault. Medical payments coverage typically is optional. In some states, we are required to offer personal injury protection coverage.

Various limits of liability are underwritten with maximum limits of $500,000 per person and $500,000 per accident. Our most popular bodily injury liability limits are $100,000 per person and $300,000 per accident.

Our personal umbrella policy (“PUP”) is written with a twelve-month policy term with liability coverage limits of $1 million to $5 million in excess of the underlying automobile liability coverage we write. Since May 2002, we have required minimum underlying automobile limits, written by us, of $250,000 per person and $500,000 per accident for PUP policies sold. We reinsure 90% of any PUP loss.

GEOGRAPHIC CONCENTRATION OF BUSINESS

The following table shows vehicles in force at the end of each of the past five years:

December 31,	2006		2005		2004		2003		2002
California vehicles in force¹		1,290,498		1,413,909		1,463,469		1,369,049		1,169,880
Non-California vehicles in force		255,121		127,001		62,922		33,332		27,174
Total vehicles in force		1,545,619		1,540,910		1,526,391		1,402,381		1,197,054

California vehicles in force¹	83.5	%	91.8	%	95.9	%	97.6	%	97.7	%
Non-California vehicles in force	16.5		8.2		4.1		2.4		2.3
Total vehicles in force	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

The following table presents a geographical summary of our direct premiums written for the past five years:

AMOUNTS IN MILLIONS	Direct Premiums Written
Years Ended December 31,	2006		2005		2004		2003		2002
California²	$	1,166.0	$	1,262.3	$	1,290.9	$	1,194.6	$	969.7
Non-California		149.1		84.1		46.3		28.9		28.5
Total direct premiums written	$	1,315.1	$	1,346.4	$	1,337.2	$	1,223.5	$	998.2

California²	88.7	%	93.8	%	96.5	%	97.6	%	97.1	%
Non-California	11.3		6.2		3.5		2.4		2.9
Total direct premiums written	100.0	%	100.0	%	100.0	%	100.0	%	100.0	%

Most of our policyholders are based in California, however, all of our net 2006 growth came from expansion outside of California. Direct premiums written outside of California comprised 2.4% of total direct premiums written in 2003, and have increased to 11.3% of total premiums written in 2006 as a result of our geographic expansion efforts.

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¹	Includes motorcycle.

Includes $0.1 million and $2.4 million of homeowner and earthquake direct premiums written in 2003 and 2002, respectively. We no longer have any homeowner policies in force. We ceased writing earthquake coverage in 1994, but we had remaining loss reserves from the 1994 Northridge earthquake. See further discussion in Note 17 to the Notes to Consolidated Financial Statements.

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The following timeline of our geographic expansion efforts describes our transformation from a business that operated in 18 percent of the market in 2003 to a national competitor that operates in 60 percent of the market in 2006:

First quarter of 2004 - added eight percent of the market when we began writing personal auto policies in Illinois, Indiana, and Ohio.

Third quarter of 2004 - opened a service center in Dallas, diversifying our call center operations.

First quarter of 2005 - added seven percent of the market when we began writing personal auto policies in Texas.

Second quarter of 2006 - added 15 percent of the market when we began writing personal auto policies in Florida, Georgia and Pennsylvania.

Fourth quarter of 2006 - added eleven percent of the market when we began writing personal auto policies in New Jersey, Colorado, Minnesota, Missouri, and Wisconsin.

Summary of California Distribution

The table below summarizes the concentrations within California of our vehicles in force for the personal auto lines, excluding Involuntary Market policies and personal umbrella and motorcycle coverages as of the end of each of the past five years. December 31, 2005 data from the California Department of Motor Vehicles (the most recent available) indicates that 22.5% of its registrations were for vehicles in Los Angeles County. Primarily as a result of our growth in other areas of California, our concentration of Los Angeles County vehicles insured has declined from 37.2% in 2002 to 27.8% at the end of 2006, approaching a natural distribution of business in the state.

Voluntary Personal Auto Lines	Distribution of California Vehicles in Force
December 31,	2006			2005			2004			2003			2002
Los Angeles County		27.8	%		28.8	%		30.3	%		32.3	%		37.2	%
San Diego County		14.5			13.8			13.6			13.5			13.4
Southern California, excluding Los Angeles and San Diego Counties³		20.0			20.0			20.3			21.4			23.5
Central and Northern California⁴		37.7			37.4			35.8			32.8			25.9
Total		100.0	%		100.0	%		100.0	%		100.0	%		100.0	%

OPERATIONAL OVERVIEW

Underwriting and Pricing

General

For us, underwriting is the process of confirming that rating information (such as the Vehicle Identification Number (“VIN”), identification of all drivers in the household, accident and violation history, etc.) is accurate, complete and properly applied in our rating approach. The underwriting process occurs at the inception of the policy, whenever a change is requested and at renewal. In certain circumstances, we will non-renew a policy due to a substantial increase in risk.

We have developed a highly segmented and sophisticated pricing model that is one of the best pricing models in the industry. Through a combination of rating variables and interactions among variables, we believe we are able to achieve higher levels of pricing accuracy than have historically been employed. This model, which we employ in active markets outside of California, allows us to grow by out-segmenting established competitors while providing greater stability in our results.

Our objective is to offer a price that, to the fullest extent possible, reflects the loss and expense expectations for every customer. Accurate pricing is important because it rewards and encourages safe driving and increases stability in our results, reducing the impact of mix changes in our book of business.

California

We are required to offer insurance to any California applicant who meets the California statutory definition of a “good driver.” This definition includes, but is not limited to, all drivers licensed during the previous three years with no more than one violation point count under criteria contained in the California Vehicle Code. These criteria include a variety of moving violations and certain at-fault accidents.

California law defines the primary rating characteristics that must be used for California automobile policies and include driving record (e.g., history of accidents and moving violations), annual mileage and number of years the driver has been licensed. A number of other “optional” rating factors are also permitted and used in California, which include characteristics such as make and model of automobile, policy limits and deductibles, and gender and marital status.

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³	Includes the following counties: Imperial, Kern, Orange, Riverside, Santa Barbara, San Bernardino and Ventura.

⁴	Includes all California counties other than Los Angeles County, San Diego County, and those specified above in Footnote 3.

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The regulatory system in California requires the prior approval of insurance rates. Within the regulatory framework, we establish our premium rates based primarily on actuarial analyses of our own historical loss and expense data. This data is compiled and analyzed to establish overall rate levels as well as classification differentials.

Our rates are established at levels intended to generate underwriting profits and vary for individual policies based on a number of rating characteristics. These rates are a blend of base rates and class plan filings made with the California Department of Insurance (“CDI”). Base rates are the primary amount projected to generate an adequate underwriting profit. Class plan changes are filings that serve to modify the factors that impact the base rates so that each individual receives a rate, to the extent permitted by regulation, that reflects their respective risk to losses and expenses. Class plan changes are intended to be revenue neutral to us.

In July 2006, the CDI issued changes to regulations relating to automobile insurance rating factors, particularly concerning territorial rating (the “Auto Rating Factor Regulations”). The new rules required automobile insurance companies to make a class plan and rate filing during the third quarter of 2006 to bring their automobile insurance rates in California into compliance with the Auto Rating Factor Regulations. Litigation to preliminarily enjoin the implementation of the Auto Rating Factor Regulations and have them declared in violation of California law has been unsuccessful. As a result, the Company submitted class plan and rate filings to the CDI for its review. The Company’s rate filing proposed an overall rate decrease of 5% of premium. The CDI approved the Company’s class plan and rate filings. The new rates took effect January 3, 2007.

Marketing

Our marketing and underwriting strategy is to appeal to careful and responsible drivers who desire a feature-rich product at a competitive price. We use direct mail, broadcast and print media, outdoor, community events and the Internet to generate inbound telephone calls, which are served by company employees who are licensed insurance agents. Because our centralized operations are company staffed in two major locations, we can deliver a highly efficient and professional experience to our callers 24 hours per day, 365 days per year through a convenient, toll-free 800-211-SAVE telephone number. Consumers may also obtain an auto rate quotation and purchase a policy on our web site at www.21st.com.

According to data published in the 2006 Nielsen Universe Estimates, 73% of all Spanish-speaking residents in the United States live in the following states that we write business: California, Arizona, Illinois, Indiana, Ohio, New Jersey, Florida, Georgia, Pennsylvania, and Texas. We offer full customer service, including policy purchase, in Spanish via our web site and bilingual professionals 24 hours per day, 365 days per year through a dedicated toll-free telephone number at 888-920-2121. Additionally, we utilize Spanish language advertising and marketing materials.

The following table summarizes advertising expenditures and new policies written for the past five years:

AMOUNTS IN MILLIONS, EXCEPT POLICY DATA	Advertising Expenditures and New Policies Written
Years Ended December 31,	2006		2005		2004		2003		2002
Total advertising expenditures	$	74.9	$	70.1	$	66.7	$	53.9	$	43.3
New policies written		172,899		170,224		225,349		265,589		189,652

Customer Service

We offer policy support for our customers directly with our own licensed professionals. We operate 24/7/365 and provide service in both English and Spanish. Customers contact us through their method of choice - phone call, interactive voice response, mail, email, or web site. A full service, bilingual web site includes options to buy a policy, pay a bill, make a policy change, or report a claim. Our goal is accurate, prompt, comprehensive and enthusiastic customer service, and we strive for superior customer retention. To maximize efficiencies, 21st Century Insurance links its multiple call centers into one “virtual” resource. APS is our state-of-the-art, real time policy service system. We completed the APS conversion of our California 21st Century Insurance auto policies during 2005, utilized APS for all of our 2006 market entries, and plan to convert our other personal auto policies to APS in 2007.

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Claims

It is the mission of our claims operation to settle claims fairly and promptly while fully complying with all applicable laws and regulations. We recognize that it is important to support not only our customers’ financial recovery from an accident, but also their emotional recovery from an unpleasant and disruptive accident experience.

The task of delivering on the claims promise to our customers is a challenging one, particularly in today’s legal and regulatory environment. Of the thousands of new claims reported weekly, involving automobile thefts, traffic accidents, or other types of damages or injuries, each one entails relating on an empathetic level with a person suffering a loss who deserves individual attention. Yet our adjusters at the same time must remain objective and focused on the activity necessary to investigate the facts of the loss and determine the resulting damages. In every case, acting promptly to resolve the claim while treating people fairly is the way we keep lawsuits to a minimum, especially while faced with demanding claimants and their attorneys. The claim operation functions within the bounds of an ever-expanding field of insurance regulations, which were put in place to protect the public and ensure fairness. The task is made more difficult by the incidence of insurance fraud and padding of claims committed by a small percentage of claimants and unscrupulous attorneys, medical providers and the like. A study released by the Insurance Research Council in January 2006, for example, states that 22% of all claims for bodily injury arising from automobile accidents in California involve elements of fraud or buildup. So, while we wish to see that legitimate claims are fairly and quickly paid, it is also important that our adjusters be vigilant to recognize and investigate suspicious claims.

The handling of claims is the subject of regulation by the States. Extensive civil case law also exists on most issues covered by insurance. Laws and regulations vary from state to state, with new laws and regulations added every year. It is the adjuster’s job to investigate and make fair determinations of liability under the law while resolving the claim in compliance with regulations. Adjusters must be trained and knowledgeable to be able to comply with the requirements that affect their handling of each claim. We could not face these challenges without attracting and retaining outstanding professionals through careful hiring practices and one of the most comprehensive adjuster training programs in the industry. Through retention of quality people, we have a very seasoned management staff and an average tenure in the claims area of over nine years.

The adjustment of claims is an involved process requiring the coordination of many tasks. The claim operation is charged with confirming coverage for the type of loss, investigating liability to determine responsibility for the accident, assessing damages resulting from the loss, and negotiating a fair resolution. For our products to remain competitive and affordable, claim settlements must be fair and legitimate, and the design of our claim process must operate efficiently and in a cost effective manner.

Our claim process is designed to deliver what customers expect: friendly, convenient and efficient service. Reports of accidents are taken by telephone or over the web at www.21st.com. Our claim call centers operate 24 hours a day, 365 days a year and can assist customers in Spanish as well as in English. Translation services for other languages are readily available to our staff. The report is digitally recorded with the customer’s permission, which means in most cases the customer need only describe the accident to us one time. A variety of inspection and car repair options are offered to the customer to suit their particular needs. At the conclusion of the claim report, an assignment is routed electronically to inspect the vehicle at a location of the customer’s choosing, or to dispatch a tow truck to bring a heavily damaged vehicle to one of our Vehicle Inspection Centers. Mobile inspection and repair services are available for minor damage. Our Direct Repair Program (“DRP”) is a particularly easy way to get repairs done, chosen by about 30% of our customers. The DRP is a carefully selected network of 278 repair shops that meet our high standards for service, work quality, equipment and training. DRPs guarantee their repairs for as long as the claimant owns their vehicle. Repairs at a DRP shop are scheduled electronically and managed by the shop. Quality of the repairs and accuracy of the repair invoice is closely monitored by a thorough re-inspection program by our staff who regularly visit the DRP shops and re-inspect 39% of the vehicles in various stages of the repair process. By integrating technology with personalized service, one call to 21st is all that is necessary to expedite an automobile damage claim.

At the center of our claim handling operation is our new claim system known as APS. Deployed in August of 2004, APS has been used for all auto claims reported since that time, and over 97% of the Company’s pending claims are now on the new system. Claims are automatically assigned to adjusters by the type of claim and handling required. Our adjusters work in specialized areas that include liability and damages investigations, material damage estimating, total loss evaluations, litigation and subrogation. With APS, information is available seamlessly to each of these specialties at all times. For example, an adjuster assigned to contact the parties and investigate liability for an accident will view the repair estimate and digital photos taken by the adjuster in the field. Documents received in the mail such as medical bills or obtained over the web such as police reports are scanned into the electronic claim file. This allows more than one person to work on different aspects of the claim at the same time, communicate with each other and, more importantly, with the customer, about the claim. APS enables any adjuster in any of our locations to provide service on any claim regardless of where it occurred, reducing the need to maintain staff in every geographic territory.

Litigation can result when disputes of fact or damage arise among the people involved in an accident, and when they remain unresolved after discussion and negotiation. Claim litigation usually involves personal injury claims made by third parties against our insureds. It may also entail the arbitration of uninsured/underinsured motorist claims by insureds. By providing a legal defense of the policyholder faced with a lawsuit, we deliver another very important part of the insurance promise. In California, our house counsel handle the vast majority of this litigation. Cases involving conflict or special circumstances may be assigned to outside defense attorneys. Outside counsel are also used in states other than California.

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We maintain a Special Investigations Unit (“SIU”) to investigate claims of a suspicious nature. The SIU is also responsible for providing training to claims and other employees on fraud detection. The SIU works closely with members of law enforcement, the Department of Insurance and the National Insurance Crime Bureau. Our SIU is highly regarded in the insurance industry and is known as being very effective in its efforts to detect and deter fraud.

21st settles heavily damaged vehicle claims as total losses where warranted. As a part of the settlement we may take title to the totaled vehicle and sell it as salvage. An outside salvage company conducts the auction and forwards these recovery proceeds, less their fee, to 21st. Vehicles so severely damaged as to have no salvage value are crushed to prevent the VIN from being used for fraudulent purposes.

We have team members who specialize in subrogation, or the recovery of monies we have paid on claims where a third party is legally responsible. We also aim to recover the deductible for our insureds. Some collection efforts, particularly those against uninsured motorists, are outsourced to a collection vendor in exchange for a contingency fee upon successful collection.

We understand that the claim experience is a moment of truth for the customer and the customer’s decision to continue a relationship with us depends on that experience. We believe we deliver high quality claim service and we continuously seek improvements in our processes.

Unpaid Losses and Loss Adjustment Expenses

The cost to settle a customer’s claim includes two major components: losses and loss adjustment expenses (“LAE”). Losses in connection with third party coverages represent damages as a result of an insured’s act that results in property damage or bodily injury. First party losses involve damage or injury to the insured’s property or person. In either case, the ultimate cost of the loss is not always immediately known and, over time, may be higher or lower than initially estimated. When establishing initial and subsequent estimates, the amount of loss is reduced for salvage (e.g., proceeds from the disposal of the wrecked automobile) and subrogation (e.g., proceeds from another party who is fully or partially liable, such as the insurer of the driver who caused the accident involving one of our policyholders).

Loss adjustment expenses represent the costs of adjusting, investigating and settling claims, and are primarily comprised of the cost of our claims department, external inspection services, and internal and external legal counsel. Corporate support areas such as Human Resources and Information Technology provide services to our overall operations, and, accordingly, a portion of their operational costs are also allocated to LAE. The LAE-allocable portion of such corporate support cost is reviewed periodically as changes occur in our organization.

Accounting for losses and LAE is highly subjective because these costs must be estimated often weeks, months or even years in advance of when the payments are actually made to claimants, attorneys, claims personnel and others involved in the claims settlement process.

Accounting principles require insurers to record estimates for losses and LAE in the periods in which the insured events, such as automobile accidents, occur. This estimation process requires us to estimate both the number of accidents that have occurred (called “frequency”) and the ultimate amount of loss and LAE (called “severity”) related to each accident. We employ actuaries who are professionally trained and certified in the process of establishing estimates for frequency and severity. Historically, our actuaries have not projected a range around the carried reserves for losses and LAE. Rather, they have used several methods and different underlying assumptions to produce a number of point estimates for the required reserves. Management carefully reviews the appropriateness of the assumptions underlying the various indicated loss and LAE ratios, and selects the ultimate loss and LAE ratios and the carried reserves.

Estimating the Frequency of Auto Accidents. Actuaries study the historical lag between the actual date of loss and the date that the accident is reported by the customer to the claims department, and can make a reasonable, yet never perfect, estimate for frequency, or the number of claims that ultimately will be reported for a given period. The difference between the estimated ultimate number of claims that will be made and the number that have actually been reported in any given period is referred to as incurred but not reported (“IBNR”) claims.

Estimating the Severity of Auto Claims. For both property damage and injury claims our adjusters determine what exposures exist in open reserves. All property damage claims and injury claims estimated to be less than $15,000 are set at “average amounts” determined by our actuaries. For both bodily injury and uninsured motorist claims estimated to have value in excess of $15,000, adjusters in our claims department establish loss estimates based upon various factors such as the extent of the injuries, property damage sustained, and the age of the claim. Our actuaries review these estimates, giving consideration to the adjusters’ historical ability to accurately estimate the ultimate claim and length of time it will take to settle the claim, and provide for development in the adjusters’ estimates as applicable. Generally, the longer it takes to settle a claim, the higher the ultimate claim cost. The ultimate amount of the loss is considered the “severity” of the claim. In addition, the actuaries estimate the severity of the IBNR claims.

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The severities are estimated by our actuaries quarterly based on historical studies of average claim payments and the patterns of how the claims were paid. Again, the fundamental assumption used in making these estimates is that past events are reliable indicators of future outcomes.

Estimating Losses and LAE for Lines in Runoff. Homeowners and earthquake lines are “in runoff” because we no longer have policies in force. As discussed in Note 17 of the Notes to Consolidated Financial Statements, we have not written any earthquake policies since 1994 and we ceased writing homeowners coverage at the beginning of 2002. The Company has no open earthquake cases and only immaterial reserves remaining at December 31, 2006. In prior years, developing reserve estimates for the earthquake line was particularly subjective because most of the remaining earthquake claims were in litigation.

Loss and LAE Reserve Development

Management believes that our reserves are adequate and represent our best estimate based on the information currently available. However, because reserve estimates are necessarily subject to the outcome of future events, changes in estimates are unavoidable in the property and casualty insurance business. These changes sometimes are referred to as “loss development” or “reserve development.” See Critical Accounting Estimates - Losses and Loss Adjustment Expenses for an explanation of our reserve estimating process.

For the personal auto lines, our actuaries prepare a quarterly evaluation of loss and LAE indications by accident month, and based on these evaluations, we assess whether there is a need to adjust reserve estimates. As claims are reported and settled and as other new information becomes available, changes in estimates are made and are included in earnings of the period of the change.

The losses and LAE incurred, net of reinsurance, attributable to prior accident years, that we recorded in each of the past five calendar years, are summarized below:

AMOUNTS IN THOUSANDS	Losses and LAE Incurred, Net of Reinsurance, Attributable to Prior Accident Years
Years Ended December 31,	2006			2005			2004			2003		2002
Personal auto	$	(52,648	)	$	(27,473	)	$	(2,936	)	$	11,159	$	16,200
Homeowner and earthquake⁵		751			2,333			2,831			40,048		56,158
Total	$	(51,897	)	$	(25,140	)	$	(105	)	$	51,207	$	72,358

Bracketed amounts represent redundancies, while unbracketed amounts represent deficiencies in prior year loss and LAE reserves.

To understand the changes in estimates, it is useful to put them in the context of the cumulative reserve development experienced by the Company over a longer time frame. The tables on the following pages present the development of loss and LAE reserves for the personal auto lines (Table 1) and for the homeowner and earthquake lines in runoff (Table 2), for the years 1996 through 2006. The figures in both tables are shown gross of reinsurance.

In Tables 1 and 2 on the following pages, a redundancy (deficiency) exists when the original reserve estimate is greater (less) than the re-estimated reserves. Each amount in the tables includes the effects of all changes in amounts for prior periods. The tables do not present accident year or policy year development data. Conditions and trends that have affected the development of liabilities in the past may not necessarily occur in the future. Therefore, it would not be appropriate to extrapolate future deficiencies or redundancies based on the table. A detailed discussion of loss and LAE reserve development follows the tables.

The top line of each table shows the reserves at the balance sheet date for each of the years indicated. The upper portion of the table indicates the cumulative amounts paid as of subsequent year ends with respect to that reserve liability. The lower portion of the table indicates the re-estimated amount of the previously recorded reserves based on experience as of the end of each succeeding year, including cumulative payments made since the end of the respective year. The estimates change as more information becomes known about the frequency and severity of claims for individual years.

_____________________

⁵

We no longer have any homeowner policies in force. We ceased writing earthquake coverage in 1994, but we had remaining loss reserves from the 1994 Northridge earthquake. See further discussion in Item 7 under the captions Results of Operations - Homeowner and Earthquake Lines in Runoff Results, Critical Accounting Estimates - Losses and Loss Adjustment Expenses, and Note 17 to the Notes to Consolidated Financial Statements.

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TABLE 1 - Auto Lines as of December 31,
(Amounts in thousands, except claims)	1996		1997		1998		1999			2000			2001			2002			2003		2004		2005		2006


Reserves for losses and LAE, direct	$	468,257	$	403,263	$	329,021	$	261,990		$	286,057		$	301,985		$	333,113		$	419,913	$	489,411	$	521,528	$	480,731
Paid (cumulative) as of:
One year later		260,287		253,528		247,317		242,579			268,515			239,099			249,815			280,534		283,068		301,703
Two years later		336,538		319,064		307,797		311,659			332,979			312,909			328,951			359,719		385,135
Three years later		354,854		333,349		324,778		324,740			352,592			333,955			349,763			392,665
Four years later		357,913		340,907		326,932		327,745			358,806			339,004			356,198
Five years later		363,068		341,446		327,418		328,557			360,191			340,961
Six years later		362,824		341,374		327,162		328,359			361,104
Seven years later		362,508		341,076		326,823		328,309
Eight years later		362,216		340,772		326,638
Nine years later		361,959		340,582
Ten years later		361,764
Reserves re-estimated as of:
One year later		365,566		359,262		313,192		309,953			352,709			323,791			348,865			417,225		462,682		469,132
Two years later		366,858		337,258		321,711		340,914			354,720			338,338			354,784			407,344		440,974
Three years later		359,925		335,246		341,695		328,190			361,264			339,965			360,308			407,362
Four years later		357,607		355,605		326,506		329,182			361,068			342,321			360,878
Five years later		377,414		340,537		326,565		329,318			362,066			342,993
Six years later		361,980		340,552		327,626		329,042			362,142
Seven years later		361,865		341,396		327,243		328,756
Eight years later		362,541		340,967		326,920
Nine years later		362,042		340,714
Ten years later		361,839
Redundancy (Deficiency)	$	106,418	$	62,549	$	2,101	$	(66,766	)	$	(76,085	)	$	(41,008	)	$	(27,765	)	$	12,551	$	48,437	$	52,396

Supplemental Auto Claims Data:
Claims reported during the year		310,475		305,600		335,245		313,182			370,521			354,968			350,693			381,238		414,310		419,214		399,596
Claims pending at year end		58,430		56,495		57,027		59,768			58,100			55,642			58,127			65,303		67,352		63,898		59,169

See Note 8 of the Notes to Consolidated Financial Statements for reconciliation to gross liability on the balance sheet.

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TABLE 2 - Homeowner and Earthquake Lines in Runoff as of December 31,
(Amounts in thousands)	1996			1997			1998			1999			2000			2001			2002			2003			2004			2005			2006

Reserves for losses and LAE, direct	$	75,272		$	34,624		$	52,982		$	14,258		$	12,379		$	47,305		$	50,896		$	18,410		$	6,131		$	2,307		$	1,538
Paid (cumulative) as of:
One year later		75,100			30,232			48,848			13,103			30,706			58,274			71,147			16,277			6,498			1,542
Two years later		100,296			74,127			58,281			37,404			78,647			125,447			87,343			22,775			8,040
Three years later		142,850			82,974			81,887			83,985			143,564			140,742			93,828			24,317
Four years later		151,342			106,274			128,266			147,856			157,792			147,101			95,359
Five years later		174,513			152,592			192,121			161,560			163,988			148,744
Six years later		220,805			216,383			205,591			167,615			165,618
Seven years later		284,455			229,808			211,431			169,117
Eight years later		297,754			235,648			212,607
Nine years later		303,591			236,818
Ten years later		304,760
Reserves re-estimated as of:
One year later		101,903			77,445			58,582			18,024			68,245			103,470			89,281			22,406			8,805			3,080
Two years later		145,635			82,716			61,393			72,546			121,176			142,211			93,388			25,081			9,578
Three years later		150,434			85,519			116,429			125,089			159,331			146,152			96,054			25,854
Four years later		153,521			140,532			169,157			163,045			162,998			148,850			96,814
Five years later		208,533			193,375			207,064			166,548			165,593			149,759
Six years later		261,389			231,217			210,486			168,994			166,493
Seven years later		299,109			234,661			212,593			169,786
Eight years later		302,550			236,776			213,224
Nine years later		304,664			237,399
Ten years later		305,288
Redundancy (Deficiency)	$	(230,016	)	$	(202,775	)	$	(160,242	)	$	(155,528	)	$	(154,114	)	$	(102,454	)	$	(45,918	)	$	(7,444	)	$	(3,447	)	$	(773	)

See Notes 8 and 17 of the Notes to Consolidated Financial Statements for reconciliation to gross liability on the balance sheet.

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Auto Lines Reserve Development

As shown in the ten-year development table, our auto lines historically developed redundancies from 1996 to 1998 and exhibited adverse development for 1999 through 2002. Since 2003, there has been favorable development. The period from 1993 to 1999 was quite unusual in that, during that time, we experienced declining frequencies and declining severities in our auto line. As Table 1 shows, we did not immediately have confidence in these declining trends and did not immediately lower our reserve estimates.

Much of the decline in trend occurred between 1996 and 1999 because of moderation in health care costs due to greater use of HMOs, and laws that were enacted in California that limited the ability of uninsured motorists and drunk drivers to collect non-economic damages. During 1999, we assumed that the past trend of declining frequencies and severities would continue. However, in retrospect, it can now be seen that the favorable decline in trends ended and loss costs began to increase. In 2000, we continued to assume lower loss severity primarily because of what then seemed to be an acceleration in the pattern of claims payments and the uncertainty inherent in identifying a change in multi-year patterns. In 2001, we experienced significant, unexpected development in our uninsured motorist coverage while the actuarial indications for most prior accident years were adjusted upward as more data became available. The changes in injury trends affected the entire California market and occurred, to a greater or lesser degree, in virtually every state in the country.

Starting in 2001, we improved the quality and timeliness of the data available to make initial estimates and periodic changes in estimates. We have dedicated more resources to better understand the underlying drivers of the changes in frequency and severity trends as they begin emerging. For example, in the second quarter of 2003 we began making accident month actuarial analyses of our reserves for the auto lines. Our improved methodology is reflected in the small favorable development recorded since 2004 with respect to prior accident years and larger favorable developments of $27.5 million in 2005 and $52.6 million in 2006.

Homeowner and Earthquake Lines in Runoff

During 2006, 2005, 2004, 2003, 2002, and 2001, the Company recorded losses related to Senate Bill 1899 (“SB 1899”) for $0.1 million, $0.4 million, $2.2 million, $37.0 million, $52.6 million, and $70.0 million, respectively. The information below explains historical earthquake developments for which the Company no longer has any significant exposure.

In Table 2, substantially all of the development relates to the earthquake line. A major earthquake occurred on January 17, 1994, centered in the San Fernando Valley community of Northridge (the “Northridge earthquake”). Through December 31, 2006, we have settled over 46,000 Northridge earthquake claims (including auto claims) at a total cost (i.e., loss plus LAE) of over $1.2 billion.

The loss development in Table 2 is easiest to understand by dividing it into “pre-SB 1899” and “post-SB 1899” segments. In September 2000, the State of California enacted SB 1899, which allowed claims from the 1994 Northridge earthquake, barred by contract and the statute of limitations, to be reopened during calendar year 2001. The costs relating to the reopened claims are a 1994 event (since they all related to the Northridge earthquake), even though the legislation allowing the re-opening of certain claims was not passed until almost seven years later. Before SB 1899 was passed in late 2000, we had only approximately 50 earthquake claims remaining to be resolved out of an initial 35,000 homeowner earthquake claims. Although we settled 98% of the claims within a year of the earthquake, many upward changes in estimates were required in 1994 and beyond as new information emerged on the severity of the damages and as settlements of litigated claims occurred. As a result, we recorded the following upward changes in loss estimates after 1994, but before SB 1899 was adopted: 1995 - $57 million; 1996 - $40 million; 1997 - $24.8 million; 1998 - $40 million; 1999 - $2.5 million; and 2000 - $3.5 million.

Calendar year 2001 was the one-year window SB 1899 permitted for claimants to bring additional insurance claims and legal actions allegedly arising out of the Northridge earthquake. Prior to the enactment of this law, such claims were considered by previously applicable law to be fully barred, or settled and closed. Any additional legal actions with respect to such claims were barred under the policy contracts, settlement agreements, and/or applicable statutes of limitation. As a result of the enactment of this unprecedented legislation, claimants asserted additional claims against the Company allegedly related to damages that occurred in the Northridge earthquake, but which were now being reported seven years later in 2001. Plaintiff attorneys and public adjusters conducted extensive advertising campaigns to solicit claimants. Hundreds of claims were filed in the final days and hours before the December 31, 2001 deadline.

Reinsurance

A reinsurance transaction occurs when an insurer transfers, or cedes, a portion of its exposure to another insurer (“reinsurer”) for a ceding premium. The reinsurance cession does not legally discharge the insurer from its liability for a covered loss, but provides for reimbursement from the reinsurer for the ceded portion of the risk. We monitor the appropriateness of our reinsurance arrangements to determine that our retention levels are reasonable and that our reinsurers are financially sound, able to meet their obligations under the agreements and that the contracts are competitively priced.

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Some of our cessions are with AIG subsidiaries, which have earned A.M. Best’s financial rating of A+. The A.M. Best financial ratings of our other reinsurers range from A- to A+. Our reinsurance arrangements are discussed in more detail in Note 10 of the Notes to Consolidated Financial Statements.

Our net retention of insurance risk after reinsurance for auto and motorcycle lines was 97% in 2002. Effective September 1, 2002, we entered into an agreement to cancel future cessions under our quota share with AIG subsidiaries. From 2003 to 2007, the net retention of insurance risk after reinsurance for auto and motorcycle lines has been unchanged at 100%. Our net retention of insurance risk for personal umbrella policies has been 10% from 2002 to 2007. Personal umbrella coverage is only available to our California auto insurance customers. Approximately 2% of auto insurance customers have umbrella coverage. We also have catastrophe reinsurance agreements relating to the auto line, which reinsures any covered events up to $45.0 million in excess of $20.0 million.

Investment Portfolio

We utilize a conservative investment philosophy. We continuously monitor the portfolio to minimize interest rate and reinvestment risk. No derivatives are held in our investment portfolio. At December 31, 2005, the Company held publicly traded equity securities, but all were sold in the first quarter of 2006. Substantially all of our fixed maturity portfolio is investment grade, having a weighted-average Standard & Poor’s credit quality of “AA”. In October 2003, as a result of a competitive bidding process, we entered into an agreement with AIG Global Investment Corp. (“AIGGIC”) to provide investment management and investment accounting services. The fees are determined as a percentage of the average invested asset balance and are included in net investment income. In November of 2006, the Company engaged Cardinal Investment Advisors, LLC as a third party advisor to assist the Company in such things as setting investment strategy, evaluating AIGGIC’s performance, and monitoring the portfolio’s risk/reward profile.

Consumer Advocacy

For the sixth consecutive year, we are actively engaged in a community education effort for the proper installation and use of child safety seats. According to the National Highway Traffic Safety Administration, motor vehicle crashes are the leading cause of death for children from 2 to 14 years of age. More than 50% of passenger vehicle occupants killed from birth through age 15 were completely unrestrained while riding in the motor vehicle. The 21st child safety program is endorsed by partners in eight states, including California, Arizona, Florida, Georgia, Illinois, Indiana, Ohio and Texas. Educational safety events typically include the participation of local media, law enforcement, trained safety technicians and our managers. Since inception, the Company has held more than 94 child safety seat awareness and education events in eight states. At the 21st events, technicians have completed over 10,000 child safety seat inspections and discarded (and then destroyed) more than 3,500 unsafe, broken or recalled child safety seats. 21st has donated over 8,000 brand-new child safety seats so that no family leaves an education event without every child riding in a properly fitted child safety seat.

21st has also partnered with the California Highway Patrol (“CHP”) and the Arizona Department of Public Safety in public education programs on safe driving. Using billboard advertising in English and Spanish, we have educated and hopefully made positive impressions on the serious topics of “Drive Sober” and “Just Drive,” referring to distracted driving (cell phones, eating, reading, etc. while driving). All of the materials are co-branded by 21st, the CHP and the Arizona Department of Public Safety, as applicable.

21st also makes the streets safer through its ongoing support of the Los Angeles Police Academy Magnet School, a unique partnership between 21st, the Los Angeles Unified School District and the Los Angeles Police Department (“LAPD”) that prepares young people for careers in law enforcement. Since 1996, 21st has provided approximately $0.5 million to support the program and provide scholarships to graduating cadets entering college. Since the program began, more than 25 Magnet alumni graduates have become LAPD officers. Currently, 33 Magnet alumni are enrolled in the LAPD Police Academy.

We have several publications and community events designed to assist customers and potential customers in making choices about their auto insurance and automobile safety. We publish the Child Safety Seat: A Parent’s Guide, Crash Test Ratings Guide, and a 30-minute documentary, The Golden Road - Today’s Senior Driver. The Golden Road is designed to help senior drivers and their families correctly assess seniors’ driving abilities and decrease driving dangers. Both guides and The Golden Road are distributed through public events, direct mail promotions and downloads from our web site.

Team Members

The Company employed approximately 2,900 full and part-time team members at December 31, 2006. We provide medical, pension and 401(k) savings plan benefits to eligible team members, according to the provisions of each plan. The Company also utilized approximately 300 contractors primarily for software development projects.

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INDUSTRY AND COMPETITION

Private passenger automobile insurance represents the largest component of the U.S. Property and Casualty (“P&C”) insurance industry. In 2005, direct premiums written in the U.S. private passenger auto market was over $160 billion, or slightly over one-third of the P&C industry total. Market share is concentrated among the top writers, with the top 10 private passenger auto writers accounting for over 60% of market share. Unless otherwise noted, all industry and market share data were derived directly from data reported by Highline Data LLC, or were estimated using Highline Data as the primary source.

We have been the seventh largest writer of personal automobile insurance in California. Market shares in California of the top ten writers of personal automobile insurance, based on direct premiums written, according to Highline Data, for the past five years were as follows:

	Market Share in California Based on Direct Premiums Written
Years Ended December 31,	2005			2004			2003			2002			2001
21st Century Insurance Group		6	%		7	%		6	%		6	%		6	%
State Farm Group		13			14			14			14			13
Farmers Group		10			10			10			11			12
Mercury General Group		9			9			9			9			8
Automobile Club of Southern California Group		9			9			9			9			9
California State Auto Group		9			9			9			9			10
Allstate Insurance Group		9			8			8			9			11
Progressive Insurance Group		4			3			3			2			2
USAA Group		3			3			3			3			3
Government Employees Group (GEICO)		3			3			3			3			3

REGULATORY ENVIRONMENT

State Regulation of Insurance Companies

Insurance companies are subject to regulation and supervision by the insurance departments of the various states. The insurance departments have broad regulatory, supervisory and administrative powers, such as:

·	Licensing of insurance companies, claim adjusters, and agents;

·	Prior approval, in California and some other jurisdictions, of premium rates;

·	Establishment of capital and surplus requirements and standards of solvency;

·	Nature of, and limitations on, investments insurers are allowed to hold;

·	Periodic examinations of the affairs of insurers;

·	Annual and other periodic reports of the financial condition and results of operations of insurers;

·	Establishment of statutory accounting rules;

·	Issuance of securities by insurers;

·	Restrictions on payment of dividends; and

·	Restrictions on transactions with affiliates.

Currently, the CDI has primary regulatory jurisdiction over two of our subsidiaries, 21st Century Insurance Company and 21st Century Casualty Company, including prior approval of premium rates. The CDI typically conducts a financial examination of our affairs every three years. On June 15, 2004, the CDI finalized its examination reports on the statutory financial statements of the Company’s two California-domiciled insurance subsidiaries for the three-year period ended December 31, 2002. The reports did not contain any findings or adjustments. In general, the current regulatory requirements in the other states in which our subsidiaries are licensed insurers are less restrictive than in California. The CDI and Texas Department of Insurance are currently examining the three-year period ended December 31, 2005.

In addition to regulation by the CDI, the Company and the personal lines insurance business in general are also subject to legislative, judicial and political action, as well as the normal business forces of competition between companies and the choices consumers make based on their preferences.

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To our knowledge, no new laws or regulations were enacted in 2006 by any state in which we do business that are expected to have a material impact on the auto insurance industry. In 2006, the California Commissioner adopted regulations that would restrict the use of territory in automobile insurance rating, which potentially could adversely affect the Company’s book of business. The Company has until late 2008 to fully comply with the regulations. Litigation by an insurance trade association challenging the validity of the regulations is currently in progress. Also in 2006, the CDI promulgated regulations specifying various expense, investment income and profitability factors to be used by the CDI in reviewing and approving insurers’ rates. These regulations, which will become effective April 3, 2007, may also negatively affect our California business. See Item 1A. Risk Factors for more information regarding these regulations.

Holding Company Regulation

We are also subject to regulation by the CDI pursuant to the provisions of the California Insurance Holding Company System Regulatory Act (the “Holding Company Act”). Transactions defined to be of an “extraordinary” nature may not be effected without the prior approval of the CDI. The Holding Company Act limits the amount of dividends our insurance subsidiaries may pay. An extraordinary transaction includes a dividend which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurance company’s policyholders’ surplus as of the preceding December 31 or (ii) the insurance company’s statutory net income for the preceding calendar year.

The Company’s insurance subsidiaries currently have $771.0 million of statutory surplus. Approximately $124.0 million of this amount (the 2006 net income of the Company’s primary insurance subsidiary) could be paid as dividends to the parent company without prior approval from the CDI in 2007. In 2006, our primary insurance subsidiary paid $110.0 million in dividends to our holding company. Previously, no dividends had been paid since 2001.

Involuntary Business

All 50 states and the District of Columbia have established a mechanism to assure that automobile insurance is available to any consumer that otherwise would not be written voluntarily by the private market; this is called the involuntary or residual market. These programs were established by the respective state regulators and are administered by a governing board represented by insurance companies and other representatives. The involuntary market consists of those consumers who, due to a variety of factors such as their driving record or status as first time drivers, represent a high risk. Rates for the involuntary market can be significantly higher than the voluntary market given the cost expectations. The number of private passenger automobiles insured through the involuntary market mechanisms is not distributed evenly among all the states. Depending upon such factors as government regulations, the adequacy of pricing of the involuntary market mechanisms, and industry competition, the size of the involuntary market varies dramatically from one state to another and over time.

Over the 10-year period from 1997 to 2006, the involuntary market has decreased both in absolute and relative terms. The percentage of vehicles insured in the involuntary market is declining in part because of sophisticated pricing models, which enable companies to appropriately price for a larger percentage of risks.

The California Automobile Assigned Risk Plan (“CAARP”) is the involuntary private passenger automobile market program in California. The number of assignments for each insurer is based on the total applications received by the plan and the insurer’s market share. As of December 31, 2006, the number of assigned risk insured vehicles was 437 compared to 1,129 at the end of 2005. As of December 31, 2006, this business represented less than 1% of our total direct premiums written. Underwriting profits were $0.5 million in 2006, compared to underwriting profits of $1.0 million in 2005 and underwriting losses of $0.9 million in 2004.

Insurers offering homeowner insurance in California are required to participate in the California FAIR Plan (“FAIR Plan”). FAIR Plan is a state administered pool of difficult-to-insure homeowners. Each participating insurer is allocated a percentage of the total premiums written and losses incurred by the pool according to its share of total homeowner direct premiums written in California. Participation in FAIR Plan operations is based a company’s writings from two years prior. Since 21st ceased writing homeowners business in 2002, the Company no longer receives assignments for plan years beyond 2004, but continues to participate in prior plan year activity, which is in runoff. Our FAIR Plan underwriting results for 2006, 2005, and 2004 were immaterial.

Availability of Filings

Copies of our filings with the SEC on Form 10-K, Form 10-Q, Form 8-K and proxy statements are available, along with copies of earnings releases, in the Investor Relations section of the Company’s web site at www.21st.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Copies may also be obtained free of charge directly from the Company’s Investor Relations Department (6301 Owensmouth Avenue, Woodland Hills, California 91367, phone 818-673-3996).

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The public may also read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at Station Place, 100 F Street, N.E., Room 1580, Washington, D.C. 20549 (information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330). The SEC also maintains a web site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

ITEM 1A.

RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the following factors, which could materially affect our business, financial condition or future results. The risks described below are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

We compete in the automobile insurance market, which is highly competitive.

We face vigorous competition from large, well-capitalized national companies as well as smaller regional insurers. Other large national and international insurance or financial services companies may also enter these markets in the future. Many of these companies may have greater financial, marketing and management resources than we have. In addition, competitors may offer consumers combinations of auto policies and other insurance products or financial services, which we do not offer. We could be adversely affected by a loss of business to competitors offering similar insurance products at lower prices or offering bundled products or services and by other competitor initiatives.

From time to time, we undertake distinctive advertising campaigns and other efforts to improve brand recognition and generate growth. If these campaigns or efforts are unsuccessful or are less effective than those of competitors, our business could be materially adversely affected.

The highly competitive nature of the markets in which we compete could also result in the failure of one or more major competitors. In the event of a failure of a major insurer, we could be adversely affected, as our Company and other insurance companies may be required under state-mandated plans to absorb the losses of the failed insurer, and we could be faced with an unexpected surge in new business from the failed insurer’s former policyholders.

The ability of the Company to attract, develop and retain talented employees, managers and executives, and to maintain appropriate staffing levels, is critical to the Company’s success.

Our success depends on our ability to attract, develop and retain talented employees, including executives and other key managers. Our loss of certain key officers and employees or the failure to attract and develop talented new executives and managers could have a materially adverse effect on our business.

In addition, we must forecast the changing business environments in many geographic markets with reasonable accuracy and adjust our hiring programs and/or employment levels accordingly. Our failure to recognize the need for such adjustments, or our failure or inability to react appropriately on a timely basis, could lead either to over-staffing, which would adversely affect our cost structure, or under-staffing, impairing our ability to service our ongoing and new business in one or more business units or locations. In either such event, our financial results could be materially adversely affected.

We further believe that our success depends, in large part, on our ability to maintain and improve the staffing models and employee culture that we have developed over the years. Our ability to do so may be impaired as a result of litigation against us, legislation or regulations at the state or federal level or other factors in the employment marketplace. In such events, the productivity of certain of our workers could be adversely affected, which could lead to an erosion of our operating performance and margins.

The Company’s insurance subsidiaries are subject to a variety of complex state laws and regulations.

The insurance industry is highly regulated and constantly subject to changes in these regulations, many of which could negatively affect our business. Our insurance company subsidiaries are subject to extensive laws and regulations in their states of domicile as well as in each of the jurisdictions in which they are licensed or authorized to do business. Governmental agencies have broad administrative power to regulate many aspects of the insurance business, including trade and claim handling practices, accounting methods, premium pricing, marketing practices, advertising, policy forms, insurance products, and capital adequacy. These agencies are concerned primarily with the protection of policyholders rather than shareholders or creditors. Moreover, insurance laws and regulations, among other things:

Establish solvency requirements, including minimum reserves and capital and surplus requirements;

Limit the amount of dividends, intercompany loans and other intercompany payments our insurance company subsidiaries can make without prior regulatory approval;

Impose restrictions on the amounts and types of investments we may hold;

Control the amount and exposure of losses in Involuntary Markets that companies must bear;

Require assessments to pay claims of insolvent insurance companies; and

Require that we submit to periodic financial and operational examinations by the state of domicile of our respective insurance company subsidiaries.

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The failure to comply with these laws and regulations also could result in actions by regulators or other law enforcement officials, potentially leading to fines and penalties, adverse publicity and damage to our reputation in the marketplace, and in extreme cases, revocation of a subsidiary’s authority to do business in one or more jurisdictions. In addition, 21st and its subsidiaries can face individual and class action lawsuits by its insureds and other parties for alleged violations of certain of these laws or regulations.

New legislation or regulations may be adopted in the future, which could adversely affect our operations or ability to write business profitably in one or more states. In addition, from time to time, the United States Congress and certain federal agencies investigate the current condition of the insurance industry to determine whether federal regulation is necessary. We are unable to predict whether any such laws will be enacted and how and to what extent such laws and regulations would affect our businesses.

Although in the past years we have been successful in gaining regulatory approval for rate increases, there can be no assurance that insurance regulators will grant future rate increases which may be necessary to offset possible future increases in claims cost trends. As a result of such uncertainties, underwriting losses could occur in the future. Further, we could be required to liquidate investments to pay claims, possibly during unfavorable market conditions, which could lead to the realization of losses on sales of investments. Adverse outcomes to any of the foregoing uncertainties would create some degree of downward pressure on the insurance subsidiaries’ earnings or cash flows, which in turn could negatively impact our liquidity.

The insurance industry has been the target of litigation.

In recent years, insurance companies have been named as defendants in lawsuits including class actions, relating to pricing, sales practices and practices in claims handling, among other matters. A number of these lawsuits have resulted in substantial jury awards or settlements involving other insurers. Future litigation relating to these or other business practices may negatively affect us by requiring us to pay substantial awards or settlements, increasing our legal costs, diverting management attention from other business issues or harming our reputation with customers. Such litigation is inherently unpredictable. Except to the extent we have established reserves with respect to particular lawsuits that are currently pending against us, we are unable to predict the effect, if any, that these pending or future lawsuits may have on our business, operations, profitability or financial condition. For further information on pending litigation, see Notes 12 and 19 of the Notes to Consolidated Financial Statements.

Our success is reliant on our ability to properly assess underwriting risks and charge appropriate premiums to policyholders.

Our financial condition, liquidity, cash flows and results of operations are reliant on our ability to accurately assess our underwriting risks and charge appropriate premiums based on these risks. The premium we charge must be sufficient to offset losses, loss adjustment expenses, and underwriting expenses, and allow us to earn a profit.

Our ability to price accurately is subject to a number of risks and uncertainties, including, without limitation:

The availability of sufficient reliable data;

Uncertainties inherent in estimates and assumptions, generally;

Our ability to conduct a complete and accurate analysis of available data;

Our ability to timely recognize changes in trends and to project both the severity and frequency of losses with reasonable accuracy;

Our ability to project changes in certain operating expenses with reasonable certainty;

The development, selection and application of appropriate rating formulae or other pricing methodologies;

Our ability to innovate with new pricing strategies, and the success of those innovations;

Our ability to predict policyholder retention accurately;

Unanticipated court decisions, legislation or regulatory action;

Ongoing changes in our claim settlement practices;

Unexpected changes in the medical sector of the economy;

Unanticipated changes in auto repair costs, auto parts prices and used car prices; and

Changing driving patterns.

The realization of such risks may result in our pricing being based on stale, inadequate or inaccurate data or inappropriate analyses, assumptions or methodologies, and may cause us to estimate incorrectly future changes in the frequency or severity of claims. As a result, we could underprice risks, which would negatively affect our margins, or we could overprice risks, which could reduce our volume and competitiveness. In either event, our operating results, financial condition and cash flows could be materially adversely affected.

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We are primarily a personal automobile insurance carrier, and therefore our business may be adversely affected by conditions in this industry.

As a result of our focus on personal automobile insurance business, negative developments in the economic, competitive or regulatory conditions affecting the personal automobile insurance industry could have a material adverse effect on our results of operations and financial condition. Factors that negatively affect cost trends and our profitability include inflation in automobile repair costs, automobile parts, used car prices and medical care costs. Increased litigation of claims may also adversely affect loss costs. In addition, these developments in the personal automobile insurance industry would have a disproportionate affect on us, compared to insurers that are more diversified across multiple business lines.

As a property and casualty insurer, we may face significant losses from catastrophic events.

We are subject to claims arising from natural catastrophic events such as earthquakes, tornadoes, hurricanes, hailstorms, wildfires, and from man-made events such as riots and terrorism. There is typically an increase in the frequency and severity of auto claims whenever one of these events occur. We cannot accurately predict when or where these events will occur and, though we believe we have in place strong catastrophe management initiatives, we are still exposed to catastrophic events and cannot guarantee that our business will not be materially adversely affected should one occur.

Further, subsequent to a catastrophic event there can be increases in involuntary market assessments to pay for insolvent companies and uninsured individuals as well as restrictions on the Company’s operations imposed by regulatory entities.

Inaccuracies in assumptions used in calculating reserve amounts could have a material adverse impact on our net income.

The reserves for losses and LAE that we have established represent our best estimates of amounts needed to pay reported and unreported claims and related expenses, after considering known facts and our interpretation of circumstances. Reserve estimates are based on historical claims information, industry statistics and other factors. The establishment of appropriate reserves is an inherently uncertain process. This uncertainty arises from a number of factors, including:

The availability of sufficient reliable data;

The difficulty in predicting the rate and direction of changes in frequency and severity trends in multiple markets;

Unexpected changes in medical and repair costs;

Unanticipated changes in governing statutes and regulations;

New or changing interpretations of insurance policy provisions by courts;

Inconsistent decisions in lawsuits regarding coverage and changing theories of liability;

Ongoing changes in claims settlement practices;

The accuracy of our estimates of the number or severity of claims that have been incurred but not reported as of the date of the financial statement;

The accuracy and adequacy of actuarial techniques and databases used in estimating loss reserves; and

The accuracy of estimates of total loss and loss adjustment expenses as determined by our employees for different categories of claims.

There can be no assurance that our ultimate liability will not materially exceed our reserves. If loss reserves are not sufficient to cover our actual losses, our results of operations, liquidity, and financial position may be materially adversely affected. See further discussion in Item 1. Business - Loss and LAE Reserve Development.

The Company relies on its information technology systems to manage many aspects of its business, and any failure of these systems to function properly or any interruption in their operation could result in a material adverse effect on the Company’s business, financial condition and results of operations.

We are highly dependent upon technology systems to effectively manage areas of our business including: underwriting, acquisition of policies, policy servicing, claims handling, accounting and reporting, actuarial reserving functions, and to maintain our policyholder data. We have developed a new information technology platform that is intended to allow us to more efficiently manage our operations as we expand into new states. The failure of any part of this system could cause a disruption to our operations, which could result in a loss of premiums, increased operating costs, an inability to provide customer service or process claims, and delays to or incorrect reporting. Although decreasing over time, we still rely to some extent on the capabilities of our previous system.

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A security breach of our computer systems could also interrupt or damage our operations or harm our reputation. In addition, we could be subject to liability if confidential customer information is misappropriated from our computer systems. Despite the implementation of security measures, including hiring an independent firm to perform intrusion vulnerability testing of our computer systems, these systems may be vulnerable to physical break-ins, computer viruses, programming errors, attacks by third parties or similar disruptive problems. Any compromise of security could deter people from entering into transactions that involve transmitting confidential information to our systems, which could have a material, adverse effect on our business.

We write a substantial portion of our business in California, and therefore our business may be adversely affected by judicial, legislative, and, regulatory decisions in California, in addition to civil unrest or natural catastrophes.

Approximately 89% of our direct premiums written for the year ended December 31, 2006, were generated in California. Our revenues and profitability are therefore subject to prevailing regulatory, economic, demographic, competitive and other conditions, including catastrophic events, and adverse judicial and legislative decisions in California. Changes in any of these conditions or adverse legislation or judicial decisions could make it more costly or difficult for us to conduct our business. In addition, these developments would have a disproportionate effect on us, compared to insurers that do not have such a geographic concentration.

In July 2006, the CDI issued changes to regulations relating to automobile insurance rating factors, particularly concerning territorial rating (the “Auto Rating Factor Regulations”). The previous regulation had been validated by a court decision. The new rules required automobile insurance companies to make a class plan and rate filing during the third quarter of 2006 to bring their automobile insurance rates in California into compliance with the Auto Rating Factor Regulations (the current percentage of compliance required is 15% of what will ultimately be required if the regulations remain in effect). Litigation to preliminarily enjoin the implementation of the Auto Rating Factor Regulations and have them declared in violation of California law has been unsuccessful. As a result, the Company submitted class plan and rate filings to the CDI for its review. The Company’s rate filing proposed an overall rate decrease of 5% of premium. The CDI approved the Company’s class plan and rate filings. The new rates took effect January 3, 2007. Because the new Auto Rating Factor Regulations required every company to make a rate filing, competitive rate levels have changed and consumer shopping behavior may increase in the future. As of this date, most of the Company’s main competitors have also had approved overall rate decreases of varying amounts, while some have not substantially changed overall rate levels while attempting to comply with the new regulations. It is not possible at this time to predict the ultimate impact of these proceedings and changes, which could have either a materially favorable or materially adverse impact on the Company.

Also in July 2006, the CDI proposed new amended rate approval regulations (the “Rate Approval Regulations”) that would determine how insurance rates for personal auto and most other lines of personal and commercial property and casualty lines of business are established in California. In October 2006, the CDI issued additional amendments to the Rate Approval Regulations. These regulations were submitted in November 2006 to the Office of Administrative Law (the “OAL”) and were approved in January of 2007. The amended regulations will become effective on April 3, 2007. Multiple changes from the current regulations include capping the maximum permitted after-tax rate of return on derived capital at a floating rate equal to a “risk free” rate of return plus 6% for all affected lines of insurance. The amended Rate Approval Regulations do provide for several “variances” from the rates specified by the formula, upon approval by the Insurance Commissioner. The amended Rate Approval Regulations could have a materially adverse impact on the Company’s results. If the newly elected insurance commissioner does not modify, suspend or withdraw the regulations before they become effective, an industry lawsuit could be brought to challenge the regulations as contrary to current law. Also, the Company could consider bringing its own legal action, once the regulations are applied to it.

We cannot assure you that our growth strategy will be effective.

Our future financial performance and success are dependent in part upon our ability to successfully implement our growth strategy. Implementation of our growth strategy could be affected by a number of factors beyond our control, such as increased competition, judicial or legislative developments, general economic conditions or increased operating costs. We cannot assure you that we will be able to successfully implement our growth strategy or be able to improve our operating results.

The Company may be adversely affected by the cyclical nature of the property and casualty business.

The property and casualty market is cyclical and has experienced periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively lower levels of competition, more selective underwriting standards and relatively high premium rates. A downturn in the profitability cycle of the property and casualty business could have a material adverse effect on our financial condition and results of operations.

Changes in accounting standards issued by the Financial Accounting Standards Board (“FASB”) or other standard-setting bodies may adversely affect the Company’s consolidated financial statements.

Our financial statements are subject to the application of GAAP, which is periodically revised and/or expanded. Accordingly, we are required to adopt new or revised accounting standards from time to time issued by recognized authoritative bodies, including the FASB. It is possible that future changes we are required to adopt could change the current accounting treatment that we apply to our consolidated financial statements and that such changes could have a material adverse effect on our results and financial condition. For a description of potential changes in accounting standards that could affect us currently, see Note 2 of the Notes to Consolidated Financial Statements.

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The performance of our fixed maturity securities portfolio is subject to investment risks.

Our fixed maturity securities portfolio is subject to a number of risks, including:

Interest rate risk - The Company’s investment portfolio contains interest rate sensitive investments, such as municipal and corporate bonds. Increases in market interest rates may have an adverse impact on the value of the investment portfolio by decreasing unrealized capital gains on fixed income securities. Declining market interest rates could have an adverse impact on the Company’s investment income as it invests positive cash flows from operations and as it reinvests proceeds from maturing and called investments into new investments that could yield lower rates than the Company’s investments have historically generated. Interest rates are highly sensitive to many factors, including governmental monetary policies, domestic and international economic and political conditions and other factors beyond the Company’s control. Although the Company takes measures to manage the risks of investing in a changing interest rate environment, it may not be able to mitigate interest rate sensitivity effectively. The Company’s mitigation efforts include maintaining a high quality portfolio with a relatively short duration to reduce the effect of interest rate changes on book value. Despite its mitigation efforts, a significant increase in interest rates could have a material adverse effect on the Company’s book value.

Credit risk - The risk that issuers of bonds that we hold will not pay principal or interest when due. Credit defaults and impairments may result in a charge to income as we are forced to write-down the value of bonds we hold. Credit rating agencies have downgraded, and may downgrade in the future, certain issuers of fixed maturity securities. At December 31, 2006, our bond portfolio consisted of investment grade securities. Widespread deterioration in the credit quality of issuers could materially impact the value of our invested assets, as well as our earnings, liquidity, and capital.

Concentration risk - The risk that the portfolio may be too heavily concentrated in the securities of one or more issuers, sectors or industries, which could result in a significant decrease in the value of the portfolio in the event of a deterioration of the financial condition of those issuers or the market value of their securities.

Prepayment or extension risk (applicable to certain securities in the portfolio, such as residential mortgage-backed securities) - The risk that, as interest rates change, the principal of such securities may be repaid earlier than anticipated, adversely affecting the value of, or income from, such securities and the portfolio.

Reinvestment risk - The risk that an investor will not be able to reinvest funds at as favorable a yield as the original investment yields.

In addition, the assets in our defined benefit pension plan are invested in a combination of high credit quality fixed maturity securities and equity securities. Adverse changes in the equity markets, reductions in long-term interest rates and defaults in the bond market could have a significant effect on our earnings through increased pension costs. If the equity and fixed income markets perform poorly, reducing the value of assets in the defined benefit pension plan, we may incur additional funding costs.

Our insurance subsidiaries are limited in the amount of dividends that they can pay to the holding company, which in turn may limit the holding company’s ability to pay dividends to shareholders, repay indebtedness or make capital contributions to its other subsidiaries or affiliates.

Our Company is a holding company with no business operations of its own. Consequently, if our subsidiaries are unable to pay dividends or make other distributions to the holding company, or are able to pay only limited amounts, we may be unable to pay dividends to shareholders, make payments on its indebtedness, meet its other obligations, or make capital contributions to or otherwise fund its subsidiaries.

Each insurance subsidiary’s ability to pay dividends to the holding company may be limited by one or more of the following factors:

State insurance regulatory authorities require insurance companies to maintain specified minimum levels of statutory capital and surplus.

Competitive pressures require our insurance subsidiaries to maintain financial strength ratings.

In certain situations, prior approval must be obtained from state regulatory authorities for the insurance subsidiaries to pay dividends or make other distributions to affiliated entities, including the holding company.

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Our access to capital markets, our financing arrangements, and our business operations are dependent on favorable evaluations and ratings by credit and other rating agencies.

Financial strength and claims-paying ability ratings issued by firms such as Standard & Poor’s, Fitch, Moody’s, and A.M. Best have become an increasingly important factor in establishing the competitive position of insurance companies. Our ability to attract and retain policies is affected by our ratings with these agencies. Rating agencies assign ratings based upon their evaluations of an insurance company’s ability to meet its financial obligations.

Our financial strength ratings with A.M. Best, Standard & Poor’s, and Fitch are A+, A+, and A+, respectively; our respective debt ratings are aa-, BBB+, and BBB+; and our outlook is stable with all three agencies. Since these ratings are subject to continuous review, we cannot guarantee the continuation of our favorable ratings. If our ratings were lowered significantly by any one of these agencies relative to those of our competitors, our ability to market products to new customers and to renew the policies of current customers could be harmed. A lowering of our ratings could also limit our access to the capital markets or provide us with less than deserved pricing on new debt sought in the capital markets. These events, in turn, could have a material adverse effect on our net income and liquidity.

The majority owner of our stock may take actions conflicting with your interests.

The majority owner of our common stock can control the outcome of shareholder votes. In addition, four of our eleven directors, including our Chairman, are current or former officers and employees of the majority holder or its subsidiaries. Through its majority ownership of our stock, the majority holder has the ability to and may influence actions that may conflict with the interest of other shareholders and holders of debt securities. For example, the majority holder may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in its judgment, could enhance its equity investment, even though such transactions might involve risks to you, as holders of our stock. In addition, subsidiaries of the majority holder sell personal automobile insurance policies in competition with us.

On January 24, 2007, the majority owner, AIG, made a proposal to acquire the remaining shares of the Company common stock it does not own. The proposal is subject to several conditions, including the approval of the transaction by a Special Committee of the Company’s Board of Directors who are independent of AIG. The pendency of this proposal for an extended period of time, as well as the failure of the proposed transaction to ultimately be consummated, may have a negative impact on the Company’s ability to attract and retain qualified management and employees and consequently effectively carry out its business plans. Please see Note 19 of the Notes to the Consolidated Financial Statements for further information on this proposal.

Failure to maintain an effective system of internal control over financial reporting may have an adverse effect on the Company’s stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations promulgated by the SEC require the Company to include in its Form 10-K a report by its management regarding the effectiveness of the Company’s internal control over financial reporting. The report includes, among other things, an assessment of the effectiveness of the Company’s internal control over financial reporting as of the end of its fiscal year, including a statement as to whether or not the Company’s internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in the Company’s internal control over financial reporting identified by management. Areas of the Company’s internal control over financial reporting may require improvement from time to time. If management is unable to assert that the Company’s internal control over financial reporting is effective now or in any future period, or if the Company’s auditors are unable to express an opinion on the effectiveness of those internal controls, investors may lose confidence in the accuracy and completeness of the Company’s financial reports, which could have an adverse effect on its stock price.

General economic factors may adversely affect the Company’s business, financial condition and results of operations.

General economic conditions in one or more of the current markets we write business in may adversely affect our financial performance. An increase in interest rates, inflation, energy costs, unemployment levels, consumer debt levels, tax rates, and other economic factors may adversely affect consumer preferences and buying habits. These factors, along with an increase in medical and repair costs could also have an adverse effect on the Company’s results of operations.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

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ITEM 2.

PROPERTIES

The following table summarizes our significant properties as of December 31, 2006:

Purpose	Location	Approximate Square Footage	Owned or Leased
Headquarters	Woodland Hills, California	406,000	Leased
Claims offices	Other California	159,000	Leased
Claims offices	Arizona	13,000	Leased
Legal offices	Other California	21,100	Leased
Service Center	Lewisville, Texas	136,000	Owned

We lease office space for our headquarters facilities, which are located in Woodland Hills, California. The lease term expires in February 2015 and the lease may be renewed for two consecutive five-year periods. We also lease office space in 12 other locations. We anticipate no difficulty in extending these leases or obtaining comparable office facilities in suitable locations and consider our facilities to be adequate for our current needs.

The Company purchased a customer service, sales and claims center in Lewisville, Texas, in September 2005 after exercising its option under the terms of its lease agreement to purchase the land and building that house this service center.

ITEM 3.

LEGAL PROCEEDINGS

In the normal course of business, the Company is named as a defendant in lawsuits related to claims and insurance policy issues, both on individual policy files and by class actions seeking to attack the Company’s business practices. A description of the legal proceedings to which the Company is a party is contained in Notes 12 and 19 of the Notes to Consolidated Financial Statements.

ITEM 4.

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2006.

PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

(a)

Price Range of Common Stock

The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) under the ticker symbol “TW”. The following table sets forth the high, low, and close bid prices and dividends per share on the NYSE for our common stock for the indicated periods.


Quarter	High		Low		Close		Dividends per Share
2006
1	$	17.02	$	15.28	$	15.80	$	0.08
2		16.49		13.58		14.40		0.08
3		15.98		14.04		14.95		0.08
4		18.02		14.63		17.65		0.08
2005
1	$	14.35	$	13.00	$	13.95	$	0.04
2		15.07		12.90		14.84		0.04
3		16.30		14.40		15.95		0.04
4		17.92		14.83		16.18		0.04

(b)

Holders of Common Stock

The approximate number of holders of record of our common stock on February 3, 2007 was 500.

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(c)

Dividends

On February 21, 2007, the Company's Board of Directors declared a quarterly dividend of $0.16 per share. The frequency and amount of cash dividends paid per share for the last two years are summarized in the table above. The Company’s Board of Directors considers a variety of factors in determining the timing and amount of dividends. Accordingly, the Company’s past history of dividend payments does not assure that future dividends will be paid.

Our insurance subsidiaries are subject to state laws that restrict their ability to distribute dividends. Our primary insurance subsidiary has capacity to pay approximately $124.0 million in dividends to its parent in 2007 without prior approval of the California Department of Insurance. See Notes 13 and 15 of the Notes to Consolidated Financial Statements as well as Liquidity and Capital Resources located in Item 7 of this report for additional information.

(e)

Shareholder Return Performance Graph

Set forth below is a line graph comparing the cumulative total shareholder return on the Company’s Common Stock against the cumulative total return of the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Property & Casualty Insurance Index for the period of five years commencing December 31, 2001, and ended December 31, 2006. The graph and table assume $100 was invested on December 31, 2001, in each of the Company’s Common Stock, the Standard & Poor’s 500 Stock Index and the Standard & Poor’s Property & Casualty Insurance Index, and that all dividends were reinvested.

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ITEM 6.

SELECTED FINANCIAL DATA

The following selected financial data for each of the years in the five-year period ended December 31, 2006, should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes included in Item 8 of this report. All amounts set forth in the following tables are in thousands, except for per share data.

Years Ended December 31,	2006		2005		2004		2003		2002
Total revenues	$	1,375,287	$	1,419,128	$	1,383,332	$	1,246,464	$	981,295
Net income (loss)		97,228		87,426		88,225		53,575		(12,256	)
Basic earnings (loss) per share		1.13		1.02		1.03		0.63		(0.14	)
Diluted earnings (loss) per share		1.12		1.02		1.03		0.63		(0.14	)
Dividends declared per share		0.32		0.16		0.08		0.08		0.26
Total assets		1,951,697		1,920,229		1,864,314		1,738,132		1,470,037
Debt		115,895		127,972		138,290		149,686		60,000
Total liabilities		1,053,148		1,090,257		1,089,913		1,037,442		814,429
Stockholders’ equity		898,549		829,972		774,401		700,690		655,608
Book value per common share		10.39		9.66		9.06		8.20		7.67

Net income in 2006 includes the effect of stock-based compensation expense of $6.9 million, or $0.08 per share after tax that was not present in prior years (see further discussion in Note 14 of the Notes to Consolidated Financial Statements). The adoption of Statement 158 reduced stockholders’ equity by approximately $14.2 million as of December 31, 2006 (see Note 11 of the Notes to Consolidated Financial Statements).

The Company entered into a $60.0 million sale-leaseback transaction in 2002 and issued $100.0 million of Senior Notes in 2003 (see Note 9 of the Notes to Consolidated Financial Statements).

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand the Company, our operations and our present business environment. MD&A should be read in conjunction with the accompanying consolidated financial statements and the accompanying notes thereto contained in Item 8 of this report. MD&A includes the following sections:

Overview

Results of Operations

Financial Condition