UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

DIRECT GENERAL CORPORATION

(Exact name of registrant as specified in its charter)

Tennessee		62-1564496
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
1281 Murfreesboro Road, Nashville, TN		37217
(Address of principal executive offices)		(Zip Code)

(615) 399-0600

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Title of each class Common stock, no par value		Name of each exchange on which registered The Nasdaq National Market

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes o No þ

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o No þ

     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 þ No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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.                o

     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 Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o

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

     The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of the most recently completed second fiscal quarter (quotation date of June 30, 2005 $18.61), based on the price at which the common equity was last sold on such date: $291,198,300.

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 20,347,675 shares of common stock, no par value, at March 13, 2006.

     All of the information called for by Part III of this report is incorporated by reference to the Proxy Statement for our 2006 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission no later than April 30, 2006.

 

 

PART I

Item 1. Business.

     Direct General Corporation, headquartered in Nashville, Tennessee, was incorporated in 1993 and is a financial services holding company whose principal operating subsidiaries provide non-standard personal automobile insurance, term life insurance, premium finance and other consumer products and services primarily on a direct basis and primarily in the southeastern United States. Direct General Corporation owns five property/casualty insurance companies, two life/health insurance companies, two premium finance companies, twelve insurance agencies, two administrative service companies and one company that provides non-insurance consumer products and services.

Our Business Model

     Our model emphasizes the distribution of our products and services through neighborhood sales offices staffed by employee-agents as opposed to commissioned agents. In contrast to the independent agency distribution model relied upon by many of our insurance competitors, our business model allows us to generate significant revenue from sources other than premiums from our core product, non-standard personal automobile insurance. These additional revenues include premium finance revenues, commissions from the sale of non-core insurance products and other revenues, none of which entails insurance underwriting risk. In the independent agency distribution model, these additional revenues would typically be paid to an unaffiliated premium finance company, independent agent, or other third party.

Our Products and Services

     Our core business involves issuing non-standard personal automobile insurance policies. These policies, which generally are issued for the minimum limits of coverage required by state laws, provide coverage to drivers who generally cannot obtain insurance from standard carriers due to a variety of factors, including the lack of flexible payment plans, the failure to maintain continuous coverage, age, prior accidents, driving violations, occupation and type of vehicle.

     Through our premium finance subsidiaries, we finance the majority of the insurance policies that we sell. Premium finance involves making a loan to the customer backed by the unearned portion of the insurance premiums being financed, which is the portion of the loan attributable to future periods of coverage. We offer our customers a variety of flexible payment plans that allow for low down payments which we believe is a significant factor our customers consider when purchasing insurance.

     We offer a variety of other insurance products designed to benefit and appeal to purchasers of our non-standard personal automobile insurance policies, including term life insurance offered through our wholly-owned life insurance subsidiaries, as well as vehicle protection insurance, travel protection insurance and hospital indemnity insurance underwritten by unaffiliated insurers for which we receive a commission but do not bear insurance underwriting risk. Since 2004, we have offered private labeled prepaid Visa^® debit cards to our customers. The cards are administered by a third party processor, and we receive issuance and transaction fees. We also commenced offering payday consumer loans in certain of our Louisiana offices in 2004 and have subsequently expanded this product into Kentucky, Mississippi and Tennessee. We plan to begin offering payday consumer loans in Florida and Missouri in 2006; however, these loans will not be offered in every office located in these states because of regulatory or lease restrictions.

     Our strategy also contemplates the sale of additional insurance products to our customers. In early 2006, we commenced selling motorcycle policies in Tennessee, which we plan to roll out to the majority of our other states over the course of the year. We are retaining the underwriting risk for this coverage. We are exploring the possibility of offering additional insurance products, such as renters’, homeowners’ (including mobile homeowners’), and boat and personal watercraft policies. These additional insurance products may either be underwritten by us or by unaffiliated insurers from which we would receive a commission. We will assess the underwriting risk with respect to the products underwritten by us and may cede some portion of the risk to unaffiliated reinsurers.

     The following table summarizes the components of our gross revenues for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Gross premiums:
Gross premiums written — automobile		$	433.1			$	463.5			$	421.7
Gross premiums written — life			19.9				18.4				13.5
Total gross premiums		$	453.0			$	481.9			$	435.2
Ancillary income (1):
Finance income			44.4				49.2				44.9
Commission and service fee income			46.8				48.6				33.6
Total ancillary income			91.2				97.8				78.5
Net investment income excluding realized gains (losses) on securities			14.7				10.8				6.7
Gross revenues (2)		$	558.9			$	590.5			$	520.4

Our Favorable Cost Structure

     We emphasize the use of neighborhood sales offices staffed by employee-agents as opposed to commissioned agents, thereby replacing a variable operating cost structure with a largely fixed operating cost structure. Our sales offices staffed by company employees enable us to capture a significant source of ancillary income that does not entail insurance underwriting risk. Compared to companies operating under the traditional non-standard automobile insurance business model, where revenues from underwriting operations must cover the operating costs, our ancillary income provides us with a significant source of additional revenues.

     Historically, we have relied on distribution relationships with independent agencies, generally as a transitional step in the acquisition of those agencies. In pursuing our strategy of expansion in selected states, since 1991, we have acquired 14 independent insurance agencies with over 250 sales offices in six states.

     We seek to attract customers by developing strong brand name recognition in our markets through our television advertising campaigns that emphasize our low down payments, flexible payment plans, convenient neighborhood locations and customer service. Our television advertising campaign is designed to generate telephone inquiries to our neighborhood sales offices or our centralized call center where indications of estimated premiums are given to prospective customers, who are then directed to the nearest neighborhood sales office.

     Our neighborhood offices serve as a channel for both product delivery and payment collection. Our widespread and convenient local presence appeals to our customers, most of whom would prefer to conduct business face-to-face rather than by telephone or the Internet. Policy applications are generally completed in the neighborhood sales offices, and most of our customers revisit these offices at least monthly to make their periodic payments.

     We have also been pursuing initiatives to broaden our distribution to include sales over the telephone and through the Internet. While we believe that the majority of our business will continue to be conducted through our neighborhood sales offices, we also believe that some customers in the non-standard market prefer the convenience of being able to complete their transactions over the telephone or through the Internet. We commenced selling policies over the phone in Tennessee during the fourth quarter of 2005 and intend to make this alternative distribution available in the majority of our states by the end of the second quarter of 2006.

     We have been testing Internet sales in Florida through an unaffiliated insurance agency over the past two years. In 2005, this agency produced $4.5 million of automobile insurance premiums for us in Florida. In 2006, we plan to expand our Internet distribution to our other states through both our own website and the website of the unaffiliated agency.

     The following table summarizes our operating costs and the percentage of such costs covered by ancillary income for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Ancillary income		$	91.2			$	97.8			$	78.5
Operating expenses
Selling, general and administrative costs		$	133.6			$	108.5			$	74.5
Interest expense			8.3				5.5				6.4
Total operating expenses		$	141.9			$	114.0			$	80.9
Ratio of ancillary income to total operating expenses			64.3	%			85.8	%			97.0	%

Our Strengths

     We believe that our strengths provide a foundation for profitable growth.

	•		Our integrated business model enables us to better manage our business and capture a significant amount of premium finance revenues, term life insurance premiums, commissions from the sale of non-core insurance products and other revenues that would typically be paid, in an independent agency distribution model, to an unaffiliated premium finance company, independent agent or other third party.
	•		Our broad sales office network, which emphasizes the use of employee-agents, is the cornerstone of our relationship with our customers, who typically would prefer to conduct business face-to-face than by telephone or on the Internet.
	•		Our premium finance operations, which support the majority of the policies that we sell, provide attractive payment plans for our policyholders and allow us to adjust payment plan structures to meet changes in market demands more quickly than most of our competitors.
	•		Our favorable cost structure enables us to leverage our largely fixed cost neighborhood sales offices staffed by company employees and reduce our marginal operating cost as we increase revenues.
	•		Our ancillary revenues, including premium finance revenues, commissions from the sale of non-core insurance products and other revenues, none of which currently entails insurance underwriting risk, defray a significant amount of our operating expenses.
	•		Our claims settlement philosophy and procedures have been designed with a clear emphasis on controlling costs through the use of our employee-staffed claims operations.
	•		Our controlled policy underwriting and pricing are supported by an integrated point of sale agency system and back office control system.
	•		Strong name branding in our markets results from our extensive use of television advertising and the presence of our neighborhood sales offices throughout the states in which we operate.

Our Future Growth

     We intend to continue our growth primarily through:

•

Increasing Revenues in Existing Markets. We are focused on increasing revenues in our existing markets by:

	•		generating new customers through our advertising campaigns; and
	•		increasing the sales of our non-core insurance and non-insurance products and services.

	•		Expanding Our Product and Service Offerings. We intend to expand the range of non-core insurance and non-insurance products and services we offer.
	•		Expanding Our Distribution Network. We intend to expand into new states through acquisitions of local agencies and the opening of new sales offices. We expect to continue to develop additional sales offices in our expansion states of Texas, Missouri and Virginia and throughout 2006. We also plan to provide alternative distribution channels for our products including sales over the telephone and through the Internet in all of our states by the end of 2006.

Our Market

     The personal automobile insurance market is comprised of preferred, standard and non-standard insurance segments. The coverages offered by these segments generally include liability (coverage for losses suffered by third parties), physical damage, personal injury protection (no-fault) and uninsured/underinsured motorist coverages. The non-standard automobile insurance coverages, which are generally issued for the minimum limits of coverage required by state laws, provide coverage to drivers who cannot obtain insurance from standard carriers due to a variety of factors, including lack of flexible payment plans, the failure to maintain continuous coverage, age, prior accidents, driving violations, occupation and type of vehicle. In general, customers in the non-standard market have higher average premiums for a comparable amount of coverage than customers who qualify for the standard market. The higher average premiums compared to the standard market generally result from an increased frequency of losses, which is partially offset by the lower severity of losses resulting from lower limits of coverage. While there is no established industry-recognized demarcation between non-standard and other personal automobile insurance markets, based upon data compiled from A.M. Best, we believe that, as of December 31, 2004, the size of the non-standard automobile market segment in the United States was approximately $36 billion, representing approximately 23% of the total personal automobile insurance market.

     In our experience, customers of the non-standard segment generally consider four primary factors when purchasing a personal automobile insurance policy:

	•		down payment;
	•		payment frequency and amount;
	•		total policy premium; and
	•		customer service.

     Our products, premium financing capabilities, neighborhood accessibility, policyholder service, and claims service are designed to meet the needs of our customers, in a manner that recognizes and accommodates our customers’ lifestyles and financial capabilities.

Our Competition

     The non-standard automobile insurance business is highly competitive. Since we emphasize sales of insurance policies through neighborhood sales offices staffed by employee-agents, we primarily compete against

independent agencies that market insurance on behalf of a number of insurers. We compete with these other insurers based on factors such as price, availability of flexible payment plans, customer service, and claims service. Competition is also based on the availability and quality of products, financial strength, distribution systems and technical expertise.

     Based upon data compiled from A.M. Best, we believe that, as of December 31, 2004, ten insurance groups accounted for approximately 72% of the approximately $36 billion non-standard market segment. We believe that our primary insurance company competition comes not only from national companies or their subsidiaries, such as the Progressive insurance group, the Allstate insurance group, the Infinity insurance group, the State Farm insurance group, the Berkshire Hathaway insurance group (including GEICO) and the Bristol West insurance group, but also from non-standard insurers and independent agents that operate in a specific region or single state in which we operate. Based upon our direct written premiums for 2004, we believe that, as of December 31, 2004, we would be ranked 15th nationally and eighth in the twelve states in which we operated among non-standard automobile insurers, using the 2004 market data compiled from A.M. Best.

Marketing and Distribution

     Television advertising is our most heavily used and, we believe, our most effective advertising medium for reaching our customers. We believe that our local sales office presence, along with our extensive television and yellow page advertising, have allowed us to generate strong brand name recognition in our markets. In addition to our emphasis on television and yellow page advertising, we have begun to explore and implement grass roots marketing efforts that are designed to capitalize on the uniqueness of the designated marketing areas (DMA) in which we operate.

     Television Advertising. Our commercials are frequently aired over all of our markets, primarily on network-affiliated stations and a limited number of cable networks. Our advertisements present potential customers with a local phone number, as well as a toll free number for our customer service center in Baton Rouge, Louisiana, and encourage the potential customer to call us for information. Indications of estimated premiums are provided by our employee-agents in our neighborhood sales offices or our representatives located in our customer service center in Baton Rouge. Once the preliminary estimates have been provided over the phone, prospective customers are directed to the nearest neighborhood sales office where our employee-agents assist in the completion of the policy application, provide an explanation of coverages and policy options, perform an inspection of the insured vehicle and finalize the quote for the coverages selected. Employee-agents then complete the premium finance agreement and collect all amounts that are immediately due under the policy or premium finance agreement. With the implementation of our telephone sales initiative, customers have the option of completing their transaction over the phone by paying their premiums in full or by electing an installment billing option.

     Grass Roots Marketing. During late 2005, we began to focus on developing certain grass roots marketing efforts. While these efforts are not direct response in nature, we believe that our grass roots campaign will complement our historical advertising efforts. Over time, we believe our grass roots marketing efforts will provide a better brand awareness in the communities in which we operate, thus increasing our new business opportunities and improving our visibility with our existing customer base. We currently expect our grass roots efforts may include such items as sponsoring community events or youth sports, advertising in local newspapers, and networking with local car dealerships. For 2006, we expect to allocate approximately $2 million or just over 10% of our total advertising budget toward the development of this strategy.

     Neighborhood Sales Offices. Our neighborhood sales office distribution system is comprised of offices that we have developed, offices that we have obtained through strategic acquisitions of agency operations, and a small number of offices of other independent agents. Our strategy is to place our sales offices in a strip mall on a major thoroughfare in well-populated areas of cities and towns with a population of at least 12,000. We currently lease almost all of our offices subject to operating leases with terms ranging from one month to three years.

     We have grown, and we intend to continue to grow, our business by expanding our neighborhood sales office network through the acquisition of independent insurance agencies and the opening of new neighborhood sales offices. The acquisition of independent insurance agencies generally involves the purchase of only the assets of the agency (including customer lists, rights to the agency name and the exclusive right to solicit the customer), and

the assumption of certain agreed upon liabilities (generally, office space and equipment leases). We typically hire the employee-agents of the agency and in many cases hire key managers, as well. The acquisition purchase price, which is based on an arm’s-length negotiation, generally varies with the volume of non-standard personal automobile insurance premiums produced by the agency over the twelve months preceding the acquisition.

     Since our inception, we have used this expansion model to acquire the assets of 14 independent insurance agencies that included over 250 neighborhood offices in six states. Our most recent agency acquisitions occurred in January 2005, when we paid approximately $5.6 million to acquire the assets of three independent insurance agencies operating through 82 sales offices in Texas.

     We believe that our convenient neighborhood sales office concept is an essential component of our business model. Our licensed employee-agents have frequent direct contact with our customers. This direct contact gives us an opportunity to establish a personal relationship with the customer, who in our experience generally prefers face-to-face interaction, and helps us provide quality and efficient service. Our customers use neighborhood sales offices not only to purchase automobile insurance, but also as a convenient location to make their periodic payments and purchase other insurance and non-insurance products and services from us.

     Employee-Agents. We believe that our emphasis on the use of employee-agents has made a significant contribution to the overall success of our business model. At our neighborhood sales offices, our employee-agents provide quotes on insurance premiums and payment plan options, sell non-standard personal automobile insurance policies and other insurance and ancillary products, process the relevant forms, inspect the customer’s vehicle and collect and process payments. Additionally, our agents provide other customer support functions, such as contacting customers when they are late on their payments or advising customers when their policies are up for renewal. This level of personal interaction with our customers helps us identify opportunities to provide additional products and services.

     New State Expansion. Historically, we have expanded into new states through either the development of neighborhood sales offices or the acquisition of independent agencies. The acquisition of independent agencies generally provides for immediate market recognition and an existing book of business that is able to support the agency expenditures and overhead. In contrast, newly developed neighborhood sales offices in new states where we have not yet established significant name brand recognition, typically operate at a loss during the first several months of operation until such time as we can develop a sufficient customer base to support the cost of the new sales offices.

     Alternative Distribution Channels. We believe that a majority of our customer base prefers to conduct business through our neighborhood sales offices. However, we also believe that there is a segment of the non-standard market that has the ability and desire to conduct business over the telephone or through the Internet. We plan to have these alternative distribution channels available in all of our states by the end of 2006.

Our Products and Services

   Non-Standard Personal Automobile Insurance

     Non-standard personal automobile insurance policies constitute our core product. These policies, which generally are issued for the minimum limits of coverage required by state laws, provide coverage to drivers who cannot obtain insurance from standard carriers due to a variety of factors, including the lack of flexible payment plans, the failure to maintain continuous coverage, age, prior accidents, driving violations, occupation and type of vehicle. In general, customers in the non-standard market have higher average premiums for a comparable amount of coverage than customers who qualify for the standard market. The higher average premiums compared to the standard market generally result from an increased frequency of losses, which is partially offset by the lower severity of losses resulting from lower limits of coverage.

     We believe that the majority of our customers do not qualify for insurance from standard carriers because of financial reasons, including the failure to maintain continuous coverage. Historically, over 75% of the drivers included under our insurance policies had no points associated with moving violations on their driving record at the time they purchased their policy.

     The following table provides a summary of gross personal automobile insurance premiums written for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Gross premiums written — Automobile		$	433.1			$	463.5			$	421.7

     In early 2006 we began issuing motorcycle coverage in Tennessee. Because this product is very similar to automobile insurance and we have in-house expertise related to this coverage, we have decided to retain the underwriting risk for this product. We plan to make this product available in the majority of our states in 2006.

   Individual Term Life Insurance

     In 1999, we began offering our customers individual term life insurance policies with $10,000 of coverage. These are basic, one-year term policies that are guaranteed to be renewable for two additional one-year periods. Underwriting for this product generally consists of applicants answering certain health related questions. This product, which is sold in our neighborhood sales offices by our licensed employee-agents in each of the states in which we operate, is underwritten by our life insurance subsidiaries. Our employee-agents presently receive a small commission on the sale of this term life product. In 2005, we began to offer similar policies with face amounts of $15,000, $20,000 and $25,000 in selected states.

     The following table provides a summary of gross term life insurance premiums written for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Gross premiums written — Life		$	19.9			$	18.4			$	13.5

   Premium Finance

     In 2005, our premium finance subsidiaries financed the premiums on approximately 96.0% of the insurance policies that we sold, excluding the policies produced in the State of Texas where we are currently in the process of converting from monthly paid-in-full policies to annual policies that are financed. Premium finance involves making a loan to the customer that is backed by the unearned portion of the insurance premiums being financed. We offer our customers a variety of payment plans that allow for low down payments.

     We believe that the amount of down payment and the availability of flexible payment plans are two of the primary factors that our customers consider when purchasing non-standard personal automobile insurance. Down payments and payment plans typically are offered by insurers and agents in the form of either installment billing or premium financing arrangements. Insurers typically use installment billing arrangements to bill for the premium of a single policy. Independent agents, who may offer policies from multiple insurers, use premium financing to finance multiple policies through one premium finance agreement. Under our business model, we generally choose to use premium financing versus installment billing because we believe it offers several advantages, including:

	•		the ability to finance multiple policies through a single premium finance agreement,
	•		returns comparable to or exceeding those of installment billing,
	•		a greater flexibility of payment plan structure and down payment,
	•		the ability to generate revenues in our non-insurance subsidiaries, and

•

a more defined regulatory framework for financing premiums.

     In a typical premium finance arrangement, the premium finance company lends the amount of the premium (minus the insured’s down payment) to the insured and pays it to the insurance company on behalf of the insured. The insured makes periodic payments to the premium finance company over the term of the finance agreement. Our payment plans and down payments are developed giving considerations to expected default rates and their timing and the amount of the unearned portion of the insurance premiums being financed, which provides security for the loan.

     If an insurance policy is cancelled before its term expires, the policyholder has a right to receive a return of the unearned premium. Under a premium finance agreement, however, the policyholder assigns this right to the premium finance company to secure his or her obligations under the loan. If the policyholder defaults on a payment and, after being notified of the default fails to cure the default within the prescribed time period, the premium finance company has the right to order the insurance company to cancel the policy and pay to the premium finance company the amount of any unearned premium on the policy. If the amount of unearned premium exceeds the balance due on the loan plus any interest and applicable fees owed by the policyholder to the premium finance company, then the premium finance company returns the excess amount to the policyholder in accordance with applicable law.

     The regulatory framework under which our premium finance procedures are established is generally set forth in the premium finance statutes of the states in which we operate. Among other restrictions, the interest rate we may charge our customers for financing their premiums is limited by these state statutes. In Arkansas, which has not enacted premium finance legislation or established premium finance regulations, we are generally subject to the usury laws of that state that are applicable to consumer loans. See “Regulatory Environment — Premium Finance Regulation” for additional information about state usury and other regulatory restrictions applicable to our premium finance operations.

     We strive to mitigate the risk to us of potential losses from the insured’s default under the premium finance agreement by designing payment plans that give consideration to the principal amount of the loan that is outstanding and the unearned premium securing the loan (as noted above). In addition, whenever a policyholder fails to timely cure a default on his or her premium finance loan, we act promptly to order the insurance company to cancel the insurance policy and return to us any unearned premium. Our premium finance operations are integrated with our sales office and insurance policy administration systems. Because of the efficiencies derived from the integration of these systems and the attractiveness of our payment plans, our overall profitability is enhanced by our premium finance operations.

     The following table provides a summary of our finance income for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Finance income		$	44.4			$	49.2			$	44.9

   Ancillary Insurance Products

     We also offer ancillary insurance products and services designed to meet the needs of our customers. In doing so, we take advantage of our largely fixed cost neighborhood sales offices staffed by company employees to generate commission income for us with minimal incremental cost. The unaffiliated insurance companies that underwrite these products bear the underwriting risk associated with these policies. The commission income generated from sales of these policies is a revenue source that is not typically available to non-standard personal automobile insurance companies that rely on the independent agency business model.

     The ancillary insurance products we currently offer include vehicle protection, travel protection, and hospital indemnity. These insurance policies generally provide coverage and options that include reimbursement for

medical expenses and hospital room coverage as a result of injuries sustained in automobile accidents, reimbursement for premiums for bail bonds, ambulance assistance in the event of automobile accidents, automobile rental reimbursement if the insured vehicle is involved in an accident or is stolen, and reimbursement for personal effects losses caused by damage to rented automobiles.

     Our agency and administrative subsidiaries produce and service non-standard personal automobile insurance and ancillary insurance products for other insurers. We receive administrative service fees for the agency, underwriting, policy administration and claims adjusting services performed on behalf of these unaffiliated insurers. Additionally, through reinsurance agreements, our insurance subsidiaries generally assume a portion of the non-standard personal automobile business, and in some cases assume the entire premium and related insurance risk.

     The following table provides a summary of our commission and service fee income generated from sales of ancillary insurance products and the administration of products on behalf of unaffiliated insurers for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Commission and service fee income		$	46.8			$	48.6			$	33.6

     We are exploring the possibility of offering additional insurance products, such as renters’, homeowners’ (including mobile homeowners’), boat and personal watercraft policies. These additional insurance products may either be underwritten by unaffiliated insurers, from which we would receive a sales commission, or underwritten by one of our insurance subsidiaries. We will assess the underwriting risk with respect to the products underwritten by us and may cede some portion of that risk to unaffiliated reinsurers.

   Other Products and Services

     We offer other non-insurance products and services designed to benefit and appeal to our customers. Our intention is to continue to expand the number of insurance and non-insurance products and services offered to our existing customers and to attract new customers to our neighborhood sales offices. We anticipate that the additional flow of potential customers will provide us with the increased opportunity to sell our core product and generate additional revenue streams that further leverage our largely fixed cost distribution system. Revenues from sales of our other non-insurance products and services have not been meaningful to date.

     Direct Prepaid Visa^®, a Debit Card Program. Our private label Visa^® debit card program allows our customers to purchase a card that can be loaded with cash only while our customer is in one of our sales offices. The program, which is available in all of our states, is administered by a third party processor and we receive a fee upon the issuance of each card and on each subsequent transaction in which our customer uses the card. We retain some financial risk if amounts are improperly charged to the card in excess of the pre-funded balance on the card. During 2005, we issued about 192,000 cards to our customers who have loaded approximately $27.7 million on the cards.

     Direct Cash Advance, a Payday Consumer Loan Program. In late 2004, through our consumer products subsidiary, we commenced offering payday consumer loans in certain of our Louisiana sales offices under the trade name Direct Cash Advance. During 2005, we began offering loans in certain of our Kentucky, Mississippi and Tennessee sales offices. We currently are under an agreement with a third party payday consumer loan company to assist us with the implementation, training, administration and collections related to this program. Our loans are generally available for amounts up to $300 and mature two weeks from the date of issuance. We use a variety of underwriting guidelines in our loan approval process in order to mitigate the risk of loss on these transactions. We finance and service the loans, and we retain the risk for uncollectible amounts.

     To the extent feasible, and where permitted by law, we intend to offer payday consumer loans in our existing states and, as we expand, introduce them into our new states. We intend to begin offering this product in Florida and Missouri in 2006.

     We have designed our Direct Cash Advance program to comply with each individual state’s regulations and, as such, we will likely not offer this product in certain states due to the lack of state enabling legislation. We may also be limited as to where we can offer this product for a variety of other reasons including certain lease restrictions related to our sales offices.

Underwriting and Pricing

     Non-Standard Personal Automobile Insurance. We strive to diligently price and closely control the underwriting standards for our non-standard personal automobile insurance policies that we sell. We generally do not sell personal automobile insurance policies to persons whom we deem to have an excessive number of points on their driving record. Our underwriting and rating systems are fully automated, including on-line driving records and on-line credit scoring in some of the states in which we operate. We believe that our automated underwriting and pricing systems provide a significant competitive advantage to us, because these systems give us the ability to capture relevant pricing information, improve efficiencies, increase the accuracy and consistency of underwriting decisions and reduce training costs. Our systems can be changed easily on a state-by-state basis to reflect new rates and underwriting guidelines necessary to compete effectively in our markets.

     We set premium rates based on specific type of vehicle, garage location and the driver’s age, gender, marital status, driving experience and location. Currently, we only use credit scoring as an additional rating factor in Kentucky, South Carolina, and Tennessee. Ultimately, we plan to incorporate credit scoring as a rating factor in the majority of our states unless it is specifically prohibited by state law. We seek to maintain competitive, but adequate, rates to attract those responsible drivers who we believe make up a significant portion of the non-standard market. We review loss trends in every state on a quarterly basis to identify changes in frequency and severity, and to assess the adequacy of our rates and underwriting standards. We are committed to maintaining discipline in our pricing by adjusting rates, as necessary, to maintain or improve profit margins in each market.

     Individual Term Life Insurance. Our underwriting of individual term life insurance polices is limited, due to the maximum face amount of the policies being $25,000. Applicants are required to provide proof of age and answer six underwriting questions that are designed to determine the possible existence of serious health conditions. Our guidelines prohibit issuance of a term life insurance policy to any applicant who currently has any of the conditions mentioned in the underwriting questions.

Claims Handling

     We believe that one of the most significant keys to our success is our disciplined focus on controlling the claims process and claims costs. Since non-standard personal automobile insurance customers as a whole generally have a higher frequency of claims than preferred and standard insurance customers, it is important that we successfully manage the claims process and claims costs to limit our losses. The entire claims process is managed by our in-house claims operation. By controlling this process, rather than having all or parts of it outsourced to third parties, we can quickly assess claims, identify loss trends early and manage against fraud. We can also readily capture information that is useful in establishing loss reserves and determining premium rates. We believe that our claims process is designed to promote expedient, fair and consistent claims handling, while controlling loss adjustment expenses.

     As of February 28, 2006, our claims operation had a staff of 583 employees, including adjusters, appraisers, re-inspectors, special investigators and claims administrative personnel. We conduct our claims operations out of two major regional claims centers and three smaller regional centers. Our employees handle all claims from the initial report of the claim until the final settlement. The regional claims offices are assigned geographic service areas with enough flexibility for any office to handle claims from other areas, as claims volume, workloads and available staff require. We believe that our in-house employment of salaried claims personnel, including appraisers and adjusters, and our control of the entire claims process result in a reduction of our ultimate loss payments, lower loss adjustment expenses and improved customer service.

     All of our claims personnel are hired and trained in our in-house training program regardless of previous experience. In addition to initial training, we support continuing education of seasoned claims staff to ensure that they are up to date in all of the newest claims processes, fraud detection and legislative and litigation issues. In

addition to other qualifications, our field and re-inspection appraisers typically have obtained hands-on experience with automobile body and mechanical repair before we employ them.

     While we are strongly committed to promptly and fairly settling the meritorious claims of our customers and claimants, we are equally committed to defending against non-meritorious claims. Litigated claims and lawsuits are primarily managed by one of our specially trained litigation adjusters. Suspicious claims are referred to our special investigation unit, which we refer to as our SIU. Our SIU routinely investigates claims reflecting repetitive fact patterns or other unusual circumstances. Our SIU has been involved with investigations, assisting local authorities in combating fraud, organized crime and fraud rings in the states in which we conduct business.

     We seek to control our claims litigation defense costs by carefully selecting outside counsel who specialize in automobile insurance claim defense. Generally, the representation fees cover all activity from opening a litigation file through final disposition of the case. We believe that our efforts to obtain high quality claims defense litigation services at a fixed or carefully controlled cost have helped us control claims losses and expenses.

Loss and Loss Adjustment Expense Reserves

     Automobile accidents generally result in insurance companies paying amounts to individuals or companies resulting from physical damage to an automobile or other property and an injury to a person. Months and sometimes years may elapse between the occurrence of an accident, reporting of the accident to the insurer and payment of the claim. Insurers record a liability for estimates of losses that will be paid for accidents reported to it, which we refer to as case reserves. In addition, since accidents are not always reported promptly upon the occurrence, insurers estimate liabilities for accidents that have occurred but have not been reported to the insurer, which we refer to as incurred but not reported, or IBNR, reserves.

     We are directly liable for loss and loss adjustment expenses under the terms of the insurance policies underwritten by our insurance subsidiaries. Each of our insurance subsidiaries establishes a reserve for all unpaid losses and loss adjustment expenses, which we refer to as LAE, including case and IBNR reserves and estimates for the cost to settle the claims. We rely primarily on historical loss experience in determining reserve levels, on the assumption that historical loss experience provides a good indication of future loss experience. We also give consideration to various factors, such as inflation, historical claims, settlement patterns, legislative activity and litigation trends. We continually monitor these estimates and, if necessary, increase or decrease the level of our reserves as experience develops or new information becomes known.

     We believe that the liabilities that we have recorded for unpaid losses and loss adjustment expenses are adequate to cover the ultimate net cost of losses and loss adjustment expenses incurred to date. We periodically review our methods of establishing case and IBNR reserves and update our estimates. Our actuarial staff performs quarterly comprehensive reviews of reserves and loss trends. In addition, our independent consulting actuary provides certification of our reserves at each year end.

     The following table presents development information on changes in reserves for losses and loss adjustment expenses of our insurance subsidiaries for the periods indicated.

		Year Ended December 31,
		2005				2004				2003
		($ in millions)
Balance at beginning of period		$	124.9			$	112.6			$	86.9
Less reinsurance recoverables on unpaid losses			22.9				37.9				29.0
Net balance at beginning of period			102.0				74.7				57.9
Add Losses and LAE incurred, net of reinsurance related to:
Current period			299.0				275.7				168.1
Prior period			6.8				6.3				0.1
Net losses and LAE incurred during the current year			305.8				282.0				168.2
Deduct losses and LAE paid, net of reinsurance, related to:
Current period			210.6				191.2				107.6
Prior period			83.3				63.5				43.8
Net claim payments made during the current period			293.9				254.7				151.4
Net balance at end of period			113.9				102.0				74.7
Plus reinsurance recoverables on unpaid losses			17.5				22.9				37.9
Balance at end of period		$	131.4			$	124.9			$	112.6

     Net loss and LAE incurred included the impact of unfavorable development of $6.8 million and $6.3 million in 2005 and 2004, respectively. Approximately $5.8 million of the unfavorable development during 2005 was related to our business in Florida, and was attributable to higher than expected severity in the personal injury protection coverage and both higher than expected frequency and severity for the property damage coverage. Approximately $4.5 million of the unfavorable development during 2004 was related to our Florida business and approximately $1.1 million was related to Tennessee. The Florida development was largely attributable to increases in expected frequency and severity trends related to the personal injury protection and property damage coverage, while the Tennessee development was generally split between increases to expected bodily injury frequency trends and increases to the expected average severity of property damage claims. For further discussion refer to Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations, Insurance Losses and Loss Adjustment Expenses.

     During 2005, approximately 72% of our net claim payments were related to accidents occurring in the current year and the remaining 28% were attributable to prior accident years. This represents a slight decrease from 2004, when our net claim payments for the 2004 accident year represented 75% of the total and the remaining 25% were related to payments on accidents occurring in prior years.

     The table provided after the following paragraph presents the development of reserves, net of reinsurance, from 1995 through 2005. The top line of the table presents the reserves at the balance sheet date for each of the years indicated. This represents the estimated amounts of losses and loss adjustment expenses for claims arising in all years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported to us. The upper portion of the table presents the cumulative amounts paid as of the end of each successive year with respect to those claims. The lower portion of the table presents 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 estimate changes as more information becomes known about the payments, frequency and severity of claims for individual years. Favorable loss development, shown as a cumulative redundancy in the table, exists when the original reserve estimate is greater than the re-estimated reserves. Information with respect to the cumulative development of gross reserves (that is, without deduction for reinsurance ceded) also appears at the bottom portion of the table.

     In evaluating the information in the table provided below, you should note that each amount entered incorporates the cumulative effects of all changes in amounts entered for prior periods. You should also note that the table does not present accident or policy year development data. In addition, conditions and trends that have affected the development of liability in the past may not necessarily recur in the future. The net cumulative deficiency of

$6.0 million in 1999 and $10.6 million in 2000 included approximately $0.9 million and $6.5 million, respectively, related to the write-off of reinsurance recoverables from Reliance Insurance Company.

		As of December 31,
		1995				1996				1997				1998				1999				2000				2001				2002				2003				2004				2005
		($ in millions)
Net reserves for losses and loss adjustment expense:
Originally estimated		$	16.8			$	16.0			$	18.4			$	31.4			$	33.9			$	34.5			$	37.0			$	57.9			$	74.7			$	102.0			$	113.9
Cumulative amounts paid as of:
One year later			10.1				9.7				9.7				18.4				25.0				31.2				13.1				43.8				63.5				83.2
Two years later			13.3				12.4				12.2				24.8				33.7				35.3				26.9				55.4				75.5
Three years later			14.3				13.2				13.7				27.6				36.1				41.3				32.7				59.7
Four years later			14.6				13.7				14.4				28.7				38.4				43.6				34.7
Five years later			14.9				13.9				14.7				29.3				39.2				44.5
Six years later			15.0				14.0				14.8				29.7				39.6
Seven years later			15.0				14.1				14.9				29.8