UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2004

Commission File No. 000-51130

National Interstate Corporation

(Exact name of registrant as specified in its charter)

3250 Interstate Drive

Richfield, Ohio 44286-9000

(330) 659-8900

(Address and telephone number of principal executive offices)

Securities Registered Pursuant to Section 12(b) of the Act:

None

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

Common Stock

(Title of Class)

Other securities for which reports are submitted pursuant to Section (d) of the Act:

None

      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, and (2) has been subject to such filing requirements for the past 90 days.     Yes o          No þ

      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 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.     þ

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

      As of March 1, 2005 there were 18,965,200 shares of the Registrant’s Common Shares ($0.01 par value) outstanding. Prior to an initial public offering completed in February 2005, there was no established public trading market for the Registrant’s Common Stock.

Documents Incorporated by Reference:

      Proxy Statement for 2005 Annual Meeting of Stockholders (portions of which are incorporated by reference into Part III hereof).

National Interstate Corporation

Index to Annual Report on Form 10-K

FORWARD-LOOKING STATEMENTS

      This Form 10-K, contains forward-looking statements. All statements, trend analyses and other information contained in this 10-K relative to markets for our products and trends in our operations or financial results, as well as other statements including words such as “may,” “target,” “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “project,” and other similar expressions, constitute forward-looking statements. We made these statements based on our plans and current analyses of our business and the insurance industry as a whole. We caution that these statements may and often do vary from actual results and the differences between these statements and actual results can be material. Accordingly, we cannot assure you that actual results will not differ from those expressed or implied by the forward-looking statements. Factors that could contribute to these differences include, among other things:

      The forward-looking statements herein are made only as of the date of this report. The Company assumes no obligation to publicly update any forward-looking statements.

PART I

      Please refer to “Forward-Looking Statements” following the Index in the front of this 10-K.

Introduction

      National Interstate Corporation and its subsidiaries (NIC or the Company) operate as an insurance holding company group that underwrites and sells traditional and alternative risk property and casualty insurance products to the passenger transportation industry and the trucking industry, general commercial insurance to small businesses in Hawaii, and personal auto insurance to owners of recreational vehicles throughout the United States. National Interstate Corporation was organized in Ohio in January 1989. In December 1989, Great American Insurance Company (Great American) a wholly-owned subsidiary of American Financial Group, Inc., became our majority shareholder. Our principal executive offices are located at 3250 Interstate Drive, Richfield, Ohio, 44286 and our telephone number is (330) 659-8900. SEC filings, news releases, our code of ethics and conduct and other information may be accessed free of charge through our website at www.NationalInterstate.com. Information on the website is not part of this Form 10-K.

      At December 31, 2004, the Company was a 64.0% (on a fully diluted basis) owned subsidiary of Great American. In an initial public offering completed in February 2005, NIC sold 3,350,000 shares generating approximately $40.6 million of net proceeds and other shareholders sold 1,074,000 shares of common stock. Following the initial public offering, Great American owned 52.9% (on a fully diluted basis) of NIC. The Company used the net proceeds for the repayment in full of a $15.0 million loan and the accrued interest on the loan from Great American and the remainder will be used for other general purposes including surplus contributions to its insurance company subsidiaries.

      The Company has three property and casualty insurance subsidiaries, National Interstate Insurance Company (NIIC), Hudson Indemnity, Ltd. (HIL) and National Interstate Insurance Company of Hawaii, Inc. (NIIC-HI) and four other subsidiaries. NIIC is licensed in all 50 states and the District of Columbia. NIIC-HI is licensed in Hawaii, Michigan and New Jersey. HIL is domiciled in the Cayman Islands and conducts insurance business outside the United States. Approximately 13.7% of the Company’s premiums are written in the state of California, and an additional 24.8%, collectively, in the states of Hawaii, Florida and North Carolina. The Company also assumes a portion of premiums written by other affiliate companies whose passenger transportation insurance business it manages. Insurance products are marketed through affiliates and independent agents and brokers. In addition, the Company has agency and service subsidiaries.

Property and Casualty Insurance Operations

      We are a specialty property and casualty insurance company with a niche orientation and a focus on the transportation industry. Founded in 1989, we have had an uninterrupted record of profitability in every year since 1990, our first full year of operation. We have also reported an underwriting profit in 14 of the 16 years we have been in business. We have grown our fully diluted net income per share from $0.25 in 2000 to $1.47 in 2004 (representing a compounded annual growth rate of 55.7%). For the year ended December 31, 2004, we had gross written premiums (direct and assumed) of $225.0 million and net income of $22.8 million.

      We believe, based upon an informal survey of brokers specializing in transportation insurance, that we are the second largest writer of insurance for the passenger transportation industry in the United States behind Lancer Insurance Company and that very few companies write coverage for several of the classes of passenger transportation insurance written by NIC. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry. We believe these niche markets typically are too small, too remote or too difficult to attract or sustain most competitors. Examples of products that we write for these markets include traditional property and casualty insurance for transportation companies (39.9% of 2004 gross written premiums), group captive programs for transportation companies that we refer to as our alternative risk transfer operations

(32.0%), specialty personal lines, primarily recreational vehicle coverage (16.5%) and transportation and general commercial insurance in Hawaii (9.7%).

      While many companies write property and casualty insurance for transportation companies, we believe, based on financial responsibility filings with the Federal Motor Carrier Safety Administration, that few write passenger transportation coverage nationwide. We know of only one other insurance company, Lancer Insurance Company that has offered high limits coverage to motorcoach, school bus and limousine operators in all states or nearly all states for more than a year or two. We believe that National Interstate and Lancer Insurance Company have been the only insurance companies to consistently provide passenger transportation insurance across all passenger transportation classes and all regions of the country for at least the past ten years. In addition to being one of only two national passenger transportation underwriters, we also believe, based on our discussions with brokers and customers in the passenger transportation insurance market, that we are the only insurance company offering homogeneous (i.e., to insureds in the same industry) group captive insurance programs to this industry.

      Product Management Organization. We believe we have a competitive advantage in our major lines of business as a result, in part, of our product management focus. Each of our product lines is headed by a manager solely responsible for achieving that product line’s planned results. We believe that the use of a product management organization provides the focus required to successfully offer and manage a diverse set of product lines. For example, we are willing to design custom insurance programs, such as unique billing plans and deductibles, for our large transportation customers based on their needs. Our claims, accounting, information technology and other support functions are organized to align their resources with specific product line initiatives and needs. We know of only one other insurance company that uses this type of hybrid product management organization. Most insurance companies rely upon organization structures aligned around functional specialties such as underwriting, actuarial, operations, marketing and claims. The managers of each of these functions typically provide service and support to multiple insurance products under the traditional functional organization. At National Interstate, product managers are responsible for the underwriting, pricing and marketing and they are held accountable for underwriting profitability of a specific insurance product. Other required services and support are provided across product lines by functional managers.

      We offer 19 product lines in the specialty property and casualty insurance market, which we group into four general business components (transportation, alternative risk transfer, specialty personal lines and Hawaii) based on the class of business, insureds’ risk participation or geographic location. The following table sets forth an analysis of gross premiums written by business component during the periods indicated:

      For 2004, the annual premium average for our business components and the average range of their premiums were as follows:

      Transportation. We believe that we are the second largest writer of insurance for the passenger transportation industry in the United States. In our transportation component, we underwrite commercial auto liability, general liability, physical damage and motor truck cargo coverages for truck and passenger operators. Passenger transportation operators include charter and tour bus companies, municipal transit systems, school transportation contractors, limousine companies, inter-city bus services and community service and paratransit operations. No one customer in our transportation business accounted for 10.0% or more of the revenues of this component of our business during 2004. We also assume all of the net risk related to policies for transportation risks underwritten by us and issued by Great American, which accounted for 4.2% of our gross premiums written for the year ended December 31, 2004. We do not have similar arrangements with any other companies.

      Alternative Risk Transfer. We also underwrite, market and distribute alternative risk insurance products, also known as captives, to truck and passenger transportation operators. Group captives are insurance or reinsurance companies that are owned or “rented” by the participants in the group captive insurance program. Program participants share in the underwriting profits or losses and the investment results associated with the risks being insured by the captive insurance company. Participants in these programs typically are interested in the improved risk control, increased participation in the claims settlement process and asset investment features associated with a captive insurance program.

      We support two forms of group captive programs — member-owned and rented. In a member-owned captive, the policyholders form, capitalize and manage their own reinsurance company. In a rental group captive, the reinsurance company is formed, capitalized and managed by someone other than the policyholders. The participants in a rental group captive program pay a fee to the reinsurance company owner to use the reinsurance facility in their captive program; in other words, the policyholders “rent” it. In both member-owned and rented captives, National Interstate underwrites and prices the risk, issues the policies and adjusts the claims. A portion of the risk and premium is ceded to the captive insurance company. That captive insurance company serves the same purpose for the group captive participants regardless of whether they own the reinsurance company or rent it.

      The revenue we earn, our profit margins and the risks we assume are substantially consistent in member owned group captives and rented group captives. The primary differences to us are the expenses associated with these programs and who ultimately bears those expenses. In a member owned group captive, the policyholders own and manage their own reinsurance company. Managing an off-shore insurance company includes general management responsibilities, financial statement preparation, actuarial analysis, investment management, corporate governance, regulatory management and legal affairs. If the actual expenses associated with managing a member owned group captive exceed the funded projections, the participants pay for these added expenses outside the insurance transaction. We charge participants in our group rental captive programs a higher premium to fund our expenses related to the managing of our Cayman Island reinsurer used for this purpose. Investment management expenses also are included in the rental fees and we cap the participant’s expense contribution regardless of whether or not we collect adequate funds to operate the off-shore reinsurance company.

      All other loss, expense and profit margin components are substantially the same for our member owned or rental group captive insurance programs. The advantage of a member owned captive program to the participants is the ability to change policy issuing companies and service providers without changing the makeup of their group. Rented group captive participants are not obligated to capitalize their own reinsurer.

They generally enjoy a slightly lower expense structure and their captive program expenses are fixed for the policy year regardless of the amount of expenses actually incurred to operate the reinsurer and facilitate participant meetings.

      The premiums generated by each of the group captive insurance programs offered by National Interstate are developed in a similar manner. The most important component of the premium charged is the development of the participants’ loss fund. The loss fund represents the amount of premium needed to cover the participants’ expected losses in the layer of risk being ceded to the captive reinsurer. This loss layer may be the first $50,000 of loss per occurrence, the first $100,000, the first $250,000 or the first $350,000 depending on the captive program selected. Once the participants’ loss fund is established, all other expenses related to the coverages and services being provided are derived by a formula agreed to in advance by the captive participants and the service providers. We are the primary or only service provider to every group captive program we support. The service providers issue policies, adjust claims, provide loss control consulting services, assume the risk for losses exceeding the captive program retention and either manage the member owned reinsurance company needed to facilitate the transfer of risk to the participants or provide the rental reinsurance facility that serves the same purpose. In our group captive programs, these fees range from approximately 29.0% to 70.0% of a $1 million policy premium depending on the program structure and the loss layer ceded to the captive.

      We entered the alternative risk transfer market in December of 1995 through an arrangement with an established captive insurance consultant. Together, we created what we believe, based on our discussions with brokers and customers in the passenger transportation insurance market, was the first homogeneous, member-owned group captive insurance program, known as TRAX Insurance, Ltd., for passenger transportation operators. Since 1996, we have established four additional transportation group captives, Calypso for passenger transportation risks, Voyager and Venture for commercial truck operators and PEG for liquefied petroleum gas distributors. As of December 31, 2004, we insured more than 120 transportation companies in group captive insurance programs. No one customer in our alternative risk transfer business accounted for 10.0% or more of the revenues of this component of our business during 2004. We also have partnered with insureds and agents in captive programs, whereby the insured or agent shares in underwriting results and investment income with our Cayman Islands-based reinsurance subsidiary. Our role in the captive programs is to underwrite the coverages, issue the policies and to act as a reinsurer of the risks. Our affiliated broker frequently serves as the insured’s broker in placing business with our captive insurance programs. We do not provide management services to, or participate in the management or operation of, member-owned captives not affiliated with us. Where participants “rent” a captive program from us, we manage and operate the captive.

      Specialty Personal Lines. We believe our specialty recreational vehicle, or RV insurance program, differs from those offered by traditional personal auto insurers because we offer coverages written specifically for RV owners, including those who live in their RV full-time. We offer coverage for campsite liability, vehicle replacement coverage and coverage for trailers, golf carts and campsite storage facilities. In addition to our RV product, we also offer companion personal auto coverage to RV policyholders. This product covers the automobiles owned by our insured RV policyholders. One feature of our companion auto product that we believe is not generally available from other insurers is the application of a single deductible when an insured RV and the insured companion auto being towed are both damaged in an accident. We also assume all of the net risk related to policies for recreational vehicle risks underwritten by us and issued by Great American, our majority shareholder. Another specialty product that we introduced in November 2004 was a personal use watercraft product. We currently offer our watercraft program in 40 states.

      Hawaii. We entered the Hawaii insurance market in 1996 following the withdrawal of Pacific Insurance, Ltd., a major insurance provider in that market. We entered the Hawaii market by employing several of the employees and assuming the agency relationships left by Pacific Insurance, Ltd. Since 1996, we believe that we have become the leading writer of transportation insurance in Hawaii. We also provide general commercial insurance to Hawaiian small businesses and write auto physical damage insurance for Hawaiian police officers through an arrangement with their union.

      The following table sets forth the geographic distribution of our direct written premiums for the periods indicated:

      The following table sets forth our direct written premiums by statutory line of business for the periods indicated:

      We employ a pricing segmentation approach that makes extensive use of proprietary data and pricing models. Our pricing strategy enables our product managers to change the rate structure by evaluating detailed policyholder information, such as loss experience based on driver characteristics, financial responsibility scores (where legally permissible) and the make/model of vehicles. This pricing segmentation approach differs by product line and requires extensive involvement of product managers, who are responsible for the underwriting profitability of a specific product line with direct oversight of product design and rate level structure by our most senior managers. Individual product managers work closely with our pricing and database managers to generate rate level indications and other relevant data. We use this data coupled with the actuarial loss costs from the Insurance Services Office, an insurance industry advisory service organization, as a benchmark in the formulation of pricing for our products. We believe the quality of our proprietary data combined with our rigorous approach has permitted us to respond more quickly than our competitors to adverse trends such as the increased auto liability loss severity experienced since 1999 and to obtain accurate pricing and risk selection for each individual account.

      Risk selection and pricing decisions are discussed on a weekly basis by product line underwriters and product managers. We believe this group input and deliberation on pricing and risk selection reaffirms our philosophy and underwriting culture, and aids in avoiding unknown exposures. All underwriting files at both our regional and corporate offices are audited by senior management on a regular basis for compliance with our price and risk selection criteria. Product managers are responsible for the underwriting profitability of these risk selection and pricing decisions and the incentive-based portion of their compensation is determined in part on that profitability.

      We offer our products through multiple distribution channels including independent agents and brokers, through affiliated agencies and via the Internet. During the year ended December 31, 2004, approximately 83.0% of our direct and assumed premiums written were generated by independent agents and brokers and approximately 17.0% were generated by our affiliated agencies. Together, our top two independent agents/brokers accounted for an aggregate of 11.1% of our direct premiums written during 2004. Our top two independent brokers at December 31, 2004, were Aon Risk Services of Sacramento and R.V. Alliance America.

      We are involved in both the cession and assumption of reinsurance. We reinsure a portion of our business to other insurance companies. Ceding reinsurance permits diversification of our risks and limits our maximum loss arising from large or unusually hazardous risks or catastrophic events. We are subject to credit risk with respect to our reinsurers, because the ceding of risk to a reinsurer generally does not relieve us of liability to our insureds until claims are fully settled. To attempt to mitigate this credit risk, we cede business only to reinsurers if they meet our credit ratings criteria of an A.M. Best rating of A- or better. If a reinsurer’s A.M. Best rating falls below A-, our contract with them generally requires that they secure outstanding obligations with cash or a letter of credit that we deem acceptable.

      The following table sets forth our six largest reinsurers in terms of amounts receivable as of December 31, 2004. Also shown are the premiums written ceded by us to these reinsurers during 2004.

      We are party to agreements with Great American pursuant to which we assume a majority of the premiums written by Great American for transportation and RV risks and we pay Great American a service fee based on these premiums. We also provide Great American administrative services in connection with the public transportation risks that we underwrite on their policies.

      We believe that effective claims management is critical to our success and that our process is cost efficient, delivers the appropriate level of claims service and produces superior claims results. We are focused on controlling claims from their inception with thorough investigation, accelerated communication to insureds and claimants and compressing the cycle time of claim resolution to control both loss cost and claim handling

cost. In 2004, 72% of our first party comprehensive and collision claims were closed within 30 days and 77% of third party property damage claims were investigated and closed within 60 days.

      Claims arising under our insurance policies are reviewed, supervised, and handled by our internal claims department. As of December 31, 2004, our claims organization employed 65 people (26% of our employee group) and operated out of two regional offices. All of our claims employees have been trained to handle claims according to our customer-focused claims management processes and procedures and are subject to periodic audit. We systematically conduct continuing education for our claims staff in the areas of best practices, fraud awareness, legislative changes and litigation management. We use third party administrators only in adjusting property losses on a limited basis, primarily in Hawaii. We retain these independent administrators to appraise and adjust losses in a program insuring personal automobiles of Hawaii police officers. However, even in this case, our Hawaii claims staff audits the property appraisals each quarter, re-inspects the property and retains ultimate authority to settle claims. We do not delegate liability settlement authority to third party administrators. All large claim reserves are reviewed on a monthly basis by executive claims management, and adjusters frequently participate in audits and large loss reviews with participating reinsurers. We also employ a formal large loss review methodology that involves senior company management, executive claims management and adjusting staff in a quarterly review of all large loss exposures.

      We provide 24-hour, 7 days per week, toll-free service for our policyholders to report claims. In 2004, adjusters were able to initiate contact with approximately 92% of policyholder claimants within 24 hours of first notice of a loss and approximately 87% of third-party claimants. When we receive the first notice of loss, our claims personnel open a file and establish appropriate reserving to maximum probable exposure (based on our historical claim settlement experience) as soon as practicable and continually revise case reserving as new information develops. We maintain and implement a fraud awareness program designed to educate our claims employees and others throughout the organization of fraud indicators. Potentially fraudulent claims are referred for special investigation and fraudulent claims are contested.

      Our physical damage claims processes involve the utilization and coordination of internal staff, vendor resources and property specialists. We pay close attention to the vehicle repair process, which we believe reduces the amount we pay for repairs, storage costs and auto rental costs. During 2004, our physical damage settlements in the continental United States averaged savings of 13.0%, and 14.6% savings in Hawaii for the same periods when compared to claimed damages.

      Our captive and specialty programs have dedicated claims personnel and claims services tailored to each captive program. Each captive program has a dedicated claims manager, receives extra communications pertaining to reserve changes and/or payments, and has dedicated staff resources. In the captive programs, 93.9% of customers completing our survey in 2004 rated us as timely in our claims handling, and over 94.0% for the same period rated their claims as thoroughly investigated.

      We employ what we believe to be highly qualified and experienced liability adjusters who are responsible for overseeing all injury-related losses including those in litigation. We identify and retain specialized outside defense counsel to litigate such matters. We negotiate fee arrangements with retained defense counsel and attempt to limit our litigation costs. The liability focused adjusters manage these claims by placing a priority on detailed file documentation and emphasizing investigation, evaluation and negotiation of liability claims.

      We estimate liabilities for the costs of losses and loss adjustment expense for both reported and unreported claims based on historical trends adjusted for changes in loss costs, underwriting standards, policy provisions, product mix and other factors. Estimating the liability for unpaid losses and loss adjustment expense is inherently judgmental and is influenced by factors that are subject to significant variation. We monitor items such as the effect of inflation on medical, hospitalization, material repair and replacement costs, general economic trends and the legal environment. While the ultimate liability may be greater than recorded loss reserves, the reserve tail for transportation coverage is generally shorter than that associated with many other casualty coverages and, therefore, generally can be established with less uncertainty than coverages having longer reserve tails.

      We review loss reserve adequacy and claims adjustment effectiveness quarterly. We focus significant management attention on claims reserved above $50,000. Further, our reserves are certified by accredited actuaries from Great American Insurance Company to state regulators annually. Reserves are routinely adjusted as additional information becomes known. These adjustments are reflected in current year operations.

      The following tables present the development of our loss reserves, net of reinsurance, on a GAAP basis for the calendar years 1994 through 2004. The top line of each table shows the estimated liability for unpaid losses and loss adjustment expense recorded at the balance sheet date for the indicated years. The next line, “Liability for Unpaid Losses and Loss Adjustment Expenses — As re-estimated at December 31, 2004,” shows the re-estimated liability as of December 31, 2004. The remainder of the table presents intervening development from the initially estimated liability. This development results from additional information and experience in subsequent years. The middle line shows a net cumulative (deficiency) redundancy which represents the aggregate percentage (increase) decrease in the liability initially estimated. The lower portion of the table indicates the cumulative amounts paid as of successive periods.

      The following is a reconciliation of our net liability to the gross liability for unpaid losses and loss adjustment expense (in millions):

      These tables do not present accident or policy year development data. Furthermore, in evaluating the re-estimated liability and cumulative (deficiency) redundancy, it should be noted that each amount includes the effects of changes in amounts for prior periods. Conditions and trends that have affected development of the liability in the past may not necessarily exist in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.

Investments

      We employ what we consider to be a conservative approach to investment and capital management with the intention of supporting insurance operations by providing a stable source of income to offset underwriting risk and growing income to offset inflation. The primary goal of our investment policy is to preserve principal while optimizing income. Our Board of Directors has established investment guidelines and reviews the portfolio performance quarterly for compliance with its established guidelines.

      The following tables present the percentage distribution and yields of our investment portfolio for the dates given:

      The table below compares total returns on our fixed maturities and equity securities to comparable public indices. While there are no directly comparable indices to our portfolio, the two shown below are widely used benchmarks in the industry. Both our performance and the indices include changes in unrealized gains and losses.

      Our fixed maturity portfolio is invested primarily in investment grade bonds. The National Association of Insurance Commissioners, or NAIC, assigns quality ratings that range from Class 1 (highest quality) to Class 6 (lowest quality). The following table shows our bonds by NAIC designation and comparable Standard & Poor’s Corporation rating as of December 31, 2004:

      The maturity distribution of fixed maturity investments held as of December 31, 2004 and 2003 is as follows:

      Fixed income investment funds are generally invested in securities with short-term and intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions and maintaining sufficient liquidity to meet policyholder obligations. At December 31, 2004, the weighted average modified duration (unadjusted for call provision) was approximately 5.8, the weighted average effective duration was 2.8 and the average maturity was 7.1 years. The concept of weighted average effective duration takes into consideration the probability of having the various call features associated with many of the fixed-income securities we hold exercised. Fixed income securities are frequently issued with call provisions that provide the option of accelerating the maturity of the security at the option of the issuer.

Future Operations in the U.S. Virgin Islands

      In August 2004, we submitted an application to the U.S. Virgin Islands Economic Development Commission relating to the formation of a new corporate subsidiary in St. Thomas, U.S. Virgin Islands. This new subsidiary, Hudson Management Group, Ltd., is expected to conduct a captive insurance program management and investment management business in the U.S. Virgin Islands. If our application is granted, the Economic Development Commission will exempt Hudson Management Group, Ltd. from 90% of U.S. Virgin Islands corporate income taxes associated with profits from approved activities conducted by Hudson Management Group, Ltd. in the U.S. Virgin Islands for a period of 10 or more years. Economic development certificates are subject to renewal upon application and approval. If we are granted a certificate, we will be required to observe the employment, professional training, local purchasing and charitable contribution terms of the Economic Development Commission program.

Competition

      The commercial transportation insurance industry is highly competitive and, except for regulatory considerations, there are relatively few barriers to entry. We compete with numerous insurance companies and reinsurers, including large national underwriters and smaller niche insurance companies. In particular, in the specialty insurance market we compete against, among others, Lancer Insurance Company, Lincoln General Insurance Company (a subsidiary of Kingsway Financial Services, Inc.), RLI Corporation, Progressive Corporation, Northland Insurance Company (a subsidiary of St. Paul Travelers Corporation), Island Insurance Company, Clarendon Insurance Company, Great West Casualty Company (a subsidiary of Old Republic International Corporation) and American Modern Home Insurance Company (a subsidiary of the Midland Company). We compete in the property and casualty insurance marketplace with other insurers on the basis of price, coverages offered, product and program design, claims handling, customer service quality, agent commissions where applicable, geographic coverage, reputation and financial strength ratings by independent rating agencies. We compete by developing product lines to satisfy specific market needs and by maintaining relationships with our independent agents and customers who rely on our expertise. This expertise, along with our reputation for offering specialty underwriting products, is our principal means of distinguishing ourselves from our competitors.

      We believe we have a competitive advantage in our major lines of business as a result of the extensive experience of our long-tenured management and staff, our superior service and products, our willingness to design custom insurance programs for our large transportation customers and the extensive use of technology with respect to our insureds and independent agent force. However, we are not “top-line” oriented and will readily sacrifice premium volume during periods that we believe exhibit unrealistic rate competition. Accordingly, should competitors determine to “buy” market share with unprofitable rates, our insurance subsidiaries will generally experience a decline in business until market pricing returns to what we view as profitable levels.

Ratings

      In June 2004, A.M. Best assigned our insurance company subsidiaries a group rating of “A” (Excellent). According to A.M. Best, “A” ratings are assigned to insurers that have, on balance, excellent balance sheet strength, operating performance and business profile when compared to the standards established by A.M. Best and, in A.M. Best’s opinion, have a strong ability to meet their ongoing obligations to policyholders. A.M. Best bases its ratings on factors that concern policyholders and not upon factors concerning investor protection. Any changes in our rating category could affect our competitive position.

Regulation

      Our insurance subsidiaries are subject to regulation in all fifty states, Washington D.C. and the Cayman Islands. The extent of regulation varies, but generally derives from statutes that delegate regulatory, supervisory and administrative authority to a department of insurance in each state in which the companies transact insurance business. These statutes and regulations generally require each of our insurance subsidiaries to register with the state insurance department where the company is domiciled and to furnish annually financial and other information about the operations of the company. Certain transactions and other activities by our insurance companies must be approved by Ohio, Hawaii or Cayman Islands regulatory authorities before the transaction takes place.

      The regulation, supervision and administration also relate to statutory capital and reserve requirements and standards of solvency that must be met and maintained, the payment of dividends, changes of control of insurance companies, the licensing of insurers and their agents, the types of insurance that may be written, the regulation of market conduct, including underwriting and claims practices, provisions for unearned premiums, losses, loss adjustment expenses, and other obligations, the ability to enter and exit certain insurance markets, the nature of and limitations on investments, premium rates, or restrictions on the size of risks that may be insured under a single policy, privacy practices, deposits of securities for the benefit of policyholders, payment of sales compensation to third parties, and the approval of policy forms and guaranty funds.

      State insurance departments like Ohio and Hawaii also conduct periodic examinations of the business affairs of our insurance companies and require us to file annual financial and other reports, prepared under Statutory Accounting Principles, or SAP, relating to the financial condition of companies and other matters. These insurance departments conduct periodic examinations of the books and records, financial reporting, policy filings and market conduct of our insurance companies domiciled in their states, generally once every three to five years, although target financial, market conduct, and other examinations may take place at any time. These examinations are generally carried out in cooperation with the insurance departments of other states in which our insurance companies transact insurance business under guidelines promulgated by the National Association of Insurance Commissioners, or NAIC. National Interstate’s last financial examination was completed by the Ohio Department of Insurance on June 18, 2003 for the period ended December 31, 2001. We have not been notified by any regulatory agency that we are in violation of any of the applicable laws and regulations referred to above nor are we aware of any such violation.

      Generally, all material transactions among affiliated companies in our holding company system to which any of our insurance subsidiaries is a party, including sales, loans, reinsurance agreements, management agreements, and service agreements with the non-insurance companies within the companies or any other insurance subsidiary must be fair and reasonable. In addition, if the transaction is material or of a specified category, prior notice and approval (or absence of disapproval within a specified time limit) by the insurance department where the subsidiary is domiciled is required.

      Statutory accounting principles, or SAP, are a basis of accounting developed to assist insurance regulators in monitoring and regulating the solvency of insurance companies. One of the primary goals is to measure an insurer’s statutory surplus. Accordingly, statutory accounting focuses on valuing assets and liabilities of our insurance subsidiaries at financial reporting dates in accordance with appropriate insurance law and regulatory provisions applicable in each insurer’s domiciliary state. Insurance departments utilize SAP to help determine whether our insurance companies will have sufficient funds to timely pay all the claims of our policyholders and creditors. GAAP gives more consideration to matching of revenue and expenses than does SAP. As a result, different assets and liabilities and different amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as compared to SAP.

      Statutory accounting principles established by the NAIC and adopted, for the most part, by the various state insurance regulators determine, among other things, the amount of statutory surplus and statutory net income of our insurance subsidiaries and thus determine, in part, the amount of funds they have available to pay as dividends to us.

      State insurance law restricts the ability of our insurance subsidiaries to declare shareholder dividends and requires our insurance companies to maintain specified levels of statutory capital and surplus. The amount of an insurer’s surplus following payment of any dividends must be reasonable in relation to the insurer’s outstanding liabilities and adequate to meet its financial needs. Limitations on dividends are generally based on net earnings or statutory surplus.

      The maximum amount of dividends that our insurance companies could pay to us in 2005 without seeking regulatory approval is $20.5 million. In 2004 and 2003, our insurance subsidiaries paid $2.1 million and $3.0 million respectively, in dividends without the need for regulatory approval.

      Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by insureds as a result of the insolvency of other insurers. Significant assessments could limit the ability of our insurance subsidiaries to recover such assessments through tax credits or other means. We paid assessments of $1.5 million, $1.2 million and $0.9 million in the years ended 2004, 2003 and 2002, respectively. Our estimated liability for anticipated assessments was $6.5 million as of December 31, 2004.

      In order to enhance the regulation of insurer solvency, the NAIC has adopted formulas and model laws to determine minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. The model law provides for increasing levels of regulatory intervention as the ratio of an insurer’s total adjusted capital and surplus decreases relative to its risk based capital, culminating with mandatory control of the operations of the insurer by the domiciliary insurance department at the so-called “mandatory control level.” At December 31, 2004, the capital ratios of all of our insurance companies substantially exceeded the RBC requirements.

      Many states in which we conduct business have laws and regulations that limit the ability of our insurance companies licensed in that state to exit a market, cancel policies, or not renew policies. Some states prohibit us from withdrawing one or more lines of business from the state, except pursuant to a plan approved by the state insurance regulator, which may disapprove a plan that may lead to market disruption.

      The federal government generally does not directly regulate the insurance business. However, federal legislation and administrative policies in several areas, including, age and sex discrimination, privacy laws, terrorism and federal taxation, do affect our insurance business.

      On November 26, 2002, the Terrorism Risk Insurance Act was enacted to ensure the availability of insurance coverage for terrorist acts occurring in the United States. This law requires insurers writing certain lines of property and casualty insurance to offer coverage against certain acts of terrorism causing damage within the United States or to U.S.-flagged vessels or aircraft. In return, the law requires the federal government to indemnify such insurers for 90% of insured losses resulting from covered acts of terrorism, subject to a premium-based deductible. Any existing policy exclusions for such coverage were immediately nullified by the law, although such exclusions may be reinstated if either the insured consents to reinstatement or fails to pay any applicable increase in premium resulting from the additional coverage within 30 days of being notified of such an increase. Our insurance subsidiaries, in their capacity as primary insurer, would, with respect to our product lines for which we cannot exclude acts of terrorism, have a significant gap in their reinsurance protection and would be exposed to substantial potential losses as a result of any act of terrorism. An “act of terrorism” as defined by the law excludes purely domestic terrorism. For an act of terrorism to have occurred, the U.S. Secretary of the Treasury must make several findings, including that the act was committed on behalf of a foreign person or foreign interest. The law expires automatically at the end of 2005, although discussions are ongoing in the U.S. Congress concerning possible extension of the law. The law may be extended, and if extended, different terms and conditions may apply in the future.

      Legislation has been introduced in the U.S. Congress that would allow state-chartered and regulated insurance companies to opt out of the state regulatory system and elect to be regulated exclusively by a federal insurance regulator, and to expand risk retention groups, that are subject to less stringent regulation than insurance companies. There is also legislation pending in the U.S. Congress and in various states designed to provide additional privacy protections to consumers of financial institutions. These statutes, including the Fair Credit Reporting Act, and similar legislation and regulations in the United States or other jurisdictions, could affect our ability to market our products or otherwise limit the nature or scope of our insurance operations.

      To our knowledge and based on our internal review and control process for compliance, we believe that for the last three years we have been in compliance in all material respects with the laws, rules and regulations described above.

Employees

      At December 31, 2004, we employed 248 people. None of our employees are covered by collective bargaining arrangements.

      We own our corporate headquarters building and the surrounding real estate located in Richfield, Ohio. The site consists of approximately 98,000 square feet of office space on ten acres. We occupy approximately

72,000 square feet and lease the remainder to unaffiliated tenants. We lease office space in Duluth, Georgia; Honolulu, Hawaii; Mechanicsburg, Pennsylvania; and Cayce, South Carolina. These leases account for approximately 14,000 square feet of office space. Most of these leases expire within three to sixty-two months. The monthly rents to lease these facilities currently total approximately $18,000. We believe that these leases could be renewed or replaced at commercially reasonable rates without material disruption to our business.

      Please refer to “Forward-Looking Statements” following the Index in front of this Form 10-K.

      We are occasionally involved in litigation both as a defendant and as a plaintiff. In addition, regulatory bodies, such as state insurance departments, the Securities and Exchange Commission, the Department of Labor and other regulatory bodies may make inquiries and conduct examinations or investigations concerning our compliance with insurance laws, securities laws, labor laws and the Employee Retirement Income Security Act of 1974, as amended, among other things.

      Our insurance companies have lawsuits pending where the plaintiff seeks extra-contractual damages from us in addition to damages claimed under an insurance policy. These lawsuits generally mirror similar lawsuits filed against other carriers in the industry. Although we are vigorously defending these lawsuits, the lawsuits are in the early stages of litigation and their outcomes cannot be determined at this time. However, we do not believe these lawsuits will have a material adverse effect on our business, financial condition or results of operations based on our belief that any adverse outcomes have either been provided for in our loss reserves or such unfavorable result would be immaterial.

      In addition, from time to time, we are subject to other legal proceedings and claims in the ordinary course of business.

      None.

PART II

      Please refer to “Forward-Looking Statements” following the Index in front of this Form 10-K.

      On February 2, 2005, the Company completed its sale of 3,350,000 shares of common stock in an initial public offering at $13.50 a share and began trading its common shares, par value $0.01 per share, on The Nasdaq National Market under the symbol NATL. Prior to such date, there was no established public trading market for our common stock. There were approximately 80 shareholders of record of our common stock at March 21, 2005.

Dividend Policy

      The Company has neither paid nor declared any dividends for the two most recent fiscal years. Management has recommended that our Board of Directors authorize the payment of dividends on our common shares equal to $0.04 per share per year, payable annually, beginning in 2005. The declaration and payment of dividends is subject to the discretion of our Board of Directors, and will depend on, among other things, our financial condition, results of operations, capital and cash requirements, future prospects, regulatory and contractual restrictions on the payment of dividends by our insurance company subsidiaries, and other factors deemed relevant by the Board. In addition, our ability to pay dividends would be restricted in the event of a default on our junior subordinated debentures, our failure to make payment obligations with respect to such debentures or our election to defer interest payments on the debentures.

      We are a holding company without significant operations of our own; our principal sources of funds are dividends and other distributions from our subsidiaries including our insurance company subsidiaries. Our ability to receive dividends from our insurance company subsidiaries is also subject to limits under applicable state insurance laws.

Equity Compensation Plan Information

      The following reflects certain information about shares of National Interstate Common Stock authorized for issuance (at December 31, 2004) under compensation plans.

Recent Sales of Unregistered Securities

      The following is a summary of transactions during 2004 involving sales of our securities. Each such sale was exempt from registration under the Securities Act of 1934 in reliance on Section 4(2) of the Securities Act as a transaction not involving any public offering. Each of these limited offerings made to employees of the Company as part of compensation and incentive plans were not a part of any public offering or widely distributed offering. Each of these offerings were made to persons who were then employees, officers or Directors of the Company. Each offering involved less than 35 unaccredited investors, and there was no general solicitation or general advertising (as such terms are defined for purposes of Regulation D under the Securities Act) in connection with such issuances. All of these shares are listed on a post-split basis:

Use of Proceeds

      On January 28, 2005, our initial public offering of 3,350,000 common shares plus 497,000 common shares from selling shareholders at $13.50 per share was launched, and closed on February 2, 2005. The effective date of our registration statement on Form S-1 (File No. 333-119270) was January 27, 2005. On February 1, 2005, the underwriters purchased an additional 577,000 common shares from selling shareholders at the public offering price of $13.50 per share, less the underwriting discount, in connection with the underwriters’ overallotment. We did not receive any additional proceeds from exercise of the overallotment options. The managing underwriters of our initial public offering were Merrill Lynch, Pierce, Fenner & Smith Incorporated, KeyBanc Capital Markets, a division of McDonald Investments Inc. and Morgan Keegan & Company, Inc.

      Based on our initial public offering price of $13.50 per share, we received aggregate proceeds from this offering of approximately $45.2 million. The following table sets forth the fees and expenses we incurred in connection with the offering:

      No other fees and expenses that were incurred in connection with the offering were paid, directly or indirectly, to any of our officers or directors or any of their associates, to any persons owning 10% or more of our outstanding common shares or to any of our affiliates. After deducting the foregoing expenses, out net proceeds were $40.6 million. We used $15.1 million of the net proceeds to repay in full the $15.0 million loan and accrued interest from our majority shareholder, Great American. The remainder of the net proceeds we contributed to other general corporate purposes, including the repayment when due of debt obligations and will invest the proceeds in short-term or medium-term securities.

      The following table sets forth selected consolidated financial information for the periods ended and as of the dates indicated. The selected data presented below under the captions “Operating Data” and “Balance Sheet Data” for, and as of, each of the periods in the five-year period ended December 31, 2004 are derived from our consolidated financial statements that have been audited by Ernst & Young LLP, an independent registered public accounting firm. The consolidated financial statements as of December 31, 2004 and 2003 and for each of the periods in the three-year period ended December 31, 2004, and their report thereon, are included elsewhere in this Form 10-K. These historical results are not necessarily indicative of the results to be expected from any future period. You should read this selected consolidated financial data together with our consolidated financial statements and the related notes and the section of the Form 10-K entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

      Please refer to “Forward Looking Statements” following the Index in front of this 10-K.

      The following discussion and analysis of the historical consolidated financial statements of National Interstate should be read in conjunction with our audited consolidated financial statements and the related notes included elsewhere in this Form 10-K. All historical per share amounts reflect a 200-for-1 share split as discussed elsewhere in this Form 10-K and the reclassification of all Class A common shares as common shares effective December 6, 2004. Our actual results could differ materially from those anticipated in these

forward-looking statements as a result of various factors including those discussed below and elsewhere in this 10-K.

Overview

      National Interstate Corporation (NIC) is a holding company with operations being conducted by subsidiaries.

      Our specialty property and casualty insurance operations are licensed in all 50 states, the District of Columbia and the Cayman Islands. We generate underwriting profits by providing what we view as specialized insurance products, services and programs not generally available in the marketplace. While many companies write property and casualty insurance for transportation companies, we believe that few write passenger transportation coverage nationwide and very few write coverage for several of the classes of passenger transportation insurance written by National Interstate. We focus on niche insurance markets where we offer insurance products designed to meet the unique needs of targeted insurance buyers that we believe are underserved by the insurance industry. These niche markets typically possess what we view as barriers to entry, such as being too small, too remote or too difficult to attract or sustain most competitors. Examples of products that we write for these markets include property and casualty insurance for transportation companies (39.9% of 2004 gross written premiums), group captive programs for transportation companies that we refer to as our alternative risk transfer operations (32.0%), specialty personal lines, primarily recreational vehicle coverage (16.5%) and transportation and general commercial insurance in Hawaii (9.7%). We strive to become a market leader in the specialty markets that we choose and serve by offering what we believe are specialized products, excellent customer service and superior claims response.

      National Interstate writes insurance for various sizes of transportation fleets. We do not believe that smaller fleets that generate annual premiums of less than $100,000 are large enough to retain the risks associated with participation in one of the group captive programs we currently offer. Because there are more smaller fleets, we have more opportunities to write smaller risks than larger ones. As general economic conditions improve, entrepreneurs are encouraged to start new transportation companies, which typically commence operations as a smaller risk and a potential traditional insurance customer for NIC. During periods of economic downturn, such as immediately following September 11, 2001, the smaller risks are more prone to failure because leisure travel decreases and there is consolidation in the industry. An increase in the number of larger risks results in more prospective captive insurance customers. By offering insurance products to all sizes of risks, we believe we have hedged against the possibility that there will be a reduction in demand for the products we offer. We believe that we will continue to have opportunities to grow and profit with both traditional and alternate risk transfer customers based on our assumptions regarding future economic and competitive conditions. We introduced a new personal watercraft product for vessels less than 30 feet in the specialty personal lines insurance market in 33 states during November of 2004. We generally incur low start-up costs for new businesses, typically less than $500,000 incurred over several quarters. We believe our flexible processes and scalable systems, along with controlled ramp up of businesses, allow us to manage costs and match them with the revenue flow.

      The factors that impact our growth rate are consistent across all products. However, the trends impacting each of these factors may vary from time to time for individual products. Those factors are as follows:

      The property and casualty insurance industry is cyclical. Historically, the industry has been characterized by periods of price competition and excess capacity followed by periods of high premium rates and shortages of underwriting capacity. We believe that we are currently in the part of the cycle that can best be described as softening as compared to the peak of the hard market in 2002 and 2003. In 2001, we perceived the market starting to firm and we believe it remained hard in 2002 and through the first half of 2003. In the second half of 2003, we perceived early indications of some softening. The cyclical nature of the industry impacts our business operations. Distressed passenger transportation operators (whether distressed due to being insured by other insurance companies that have raised rates or exited the market or due to having less than desirable risk characteristics) continue to be heavily marketed to by brokers causing an increase in our new business declination rates. In addition, renewal retention rates continue at levels we view as favorable, however; our renewal rate increases have been lower in 2004 than the increases attained from mid-2001 through 2003.

      Increased rate levels beyond that necessary to keep up with inflation and achieve our planned financial targets have resulted in National Interstate attaining combined ratios in recent periods that have enabled us to achieve our corporate objective of maintaining a combined ratio of 96.0% or lower. While our combined ratio may fluctuate from year to year, over the past five years we have exceeded our underwriting profit objective by achieving an average GAAP combined ratio of 90.2%. Our GAAP combined ratio was 83.5% in 2004, 80.3% in 2003, 91.3% in 2002, 102.9% in 2001 and 92.9% in 2000. We believe the following factors have contributed to this performance:

      Additionally, our business may be affected by the risks impacting the property and casualty insurance industry related to severe weather conditions, explosions, terrorist attacks and riots.

      For weather-related events such as hurricanes, tornados and hailstorms, we conduct an analysis at least annually pursuant to which we input our in-force exposures (vehicle values in all states and property limits in Hawaii) into an independent catastrophe model that predicts our probable maximum loss at various statistical confidence levels. Our estimated probable maximum loss is impacted by changes in our in-force exposures as well as changes to the assumptions inherent in the catastrophe model. Hurricane and other weather-related events have not had a material negative impact on our past results (e.g., severe hurricanes in the third quarter of 2004 resulted in approximately $2.4 million in total incurred losses).

      Our transportation insurance business in particular also is affected by cost trends that negatively impact profitability such as inflation in vehicle repair costs, vehicle replacement parts costs, used vehicle prices and medical care costs. We routinely obtain independent data for vehicle repair inflation, vehicle replacement parts costs, used vehicle prices and medical care costs and adjust our pricing routines to attempt to more accurately project the future costs associated with insurance claims. Historically, these increased costs have not had a material adverse impact on our results. Of course, we would expect a negative impact on our future results if we fail to properly account for and project for these inflationary trends. Increased litigation of claims may also negatively impact our profitability.

      To succeed as a transportation underwriter, we must understand and be able to quantify the different risk characteristics of the operations we consider quoting. Certain coverages are more stable and predictable than others and we must recognize the various components of the risks we assume when we write any specific class of insurance business. Examples of trends that can change and, therefore, impact our profitability are loss frequency, loss severity, geographic loss cost differentials, societal factors impacting loss costs (such as tort reform, punitive damage inflation and increasing jury awards) and changes in regulation impacting the insurance relationship. Any changes in these factors that are not recognized and priced for accordingly will affect National Interstate’s future profitability. We believe our product management organization provides the focus on a specific risk class needed to stay current with the trends affecting each specific class of business we write.

      We derive our revenues primarily from premiums from our insurance policies and income from our investment portfolio. Our underwriting approach is to price our products to achieve an underwriting profit even if it requires us to forgo volume. Since 2000, our insurance subsidiaries have been increasing their premium rates to offset rising losses and reinsurance costs. Rate increases have continued during 2004, but at a reduced pace and level as compared to 2003. As with all property and casualty companies, the beneficial impact of these price increases is reflected in our financial results over time. We implement price increases on our in-force policies as they are renewed, which generally takes twelve months for our entire book of business and up to an additional twelve months to earn a full year of premium at the higher rate.

      There are distinct differences in the timing of written premiums in traditional transportation insurance and our alternative risk transfer (captive) insurance components. We write traditional transportation insurance policies throughout all 12 months of the year and commence new annual policies at the expiration of the old policy. Under the captive programs, all members of the group share a common expiration date. These common expiration dates are scheduled during the first half of the calendar year. Any new captive program participant written during the last half of the calendar year will be written for less than a full annual term so its next renewal date coincides with the common expiration date of the group captive program it has joined. The alternative risk transfer component of our business remained constant at 32.0% of total gross premium written during 2004 as compared to 32.6% in 2003. This includes recognition of National Interstate’s traditional transportation policyholders that elected to convert to a group captive program in 2004. Our traditional transportation insurance premiums have decreased 1.6% in 2004 as compared to 2003, reflecting the conversion of traditional transportation policyholders to the group captive program.

      The projected profitability from the traditional transportation and transportation captive businesses are substantially comparable. Increased investment income opportunities generally are available with traditional insurance but the lower acquisition expenses and persistence of the captive programs generally provide for lower operating expenses from these programs. The lower expenses associated with our captives generally offset the projected reductions in investment income potential. From a projected profitability perspective, we are ambivalent as to whether a transportation operator elects to purchase traditional insurance or one of our captive program options.

      Future growth rates for any National Interstate insurance product will be impacted by changes in general economic and competitive conditions in the market.

      All of our transportation products, traditional or alternate risk transfer, are priced to achieve targeted underwriting margins. Because traditional insurance tends to have a higher operating expense structure, the portion of the premiums available to pay losses tends to be lower for a traditional insurance quote versus an alternate risk transfer insurance quote. We use a cost plus pricing approach that projects future losses based upon the insured’s historic losses and other factors. Operating expenses, premium taxes, expenses and a profit margin are then added to the projected loss component to achieve the total premium to be quoted. The lower the projected losses, expenses and taxes, the lower the total quoted premiums regardless of whether it is a traditional or alternate risk transfer program quotation. Quoted premiums are computed in accordance with our approved insurance department filings in each state.

      We employ what we consider to be a conservative approach to investment and capital management with the intention of supporting insurance operations by providing a stable source of income to offset underwriting risk and growing income to offset inflation. The primary goal of our investment policy is to preserve principal while optimizing income.

      Our expenses consist primarily of losses and loss adjustment expenses, or LAE; commissions and other underwriting expenses; and other operating and general expenses. Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we write and of the loss experience of the underlying risks. We record losses and loss adjustment expenses based on an actuarial analysis of the estimated losses we expect to be reported on contracts written. We seek to establish case reserves at the maximum probable exposure based on our historical claims experience. Our ability to estimate losses and loss adjustment expenses accurately at the time of pricing our contracts is a critical factor in determining our profitability. The amount reported under losses and loss adjustment expenses in any period includes payments in the period net of the change in the value of the reserves for unpaid losses and loss adjustment expenses between the beginning and the end of the period. Commissions and other underwriting expenses consist principally of brokerage and agent commissions that represent a percentage of the premiums on insurance policies and reinsurance contracts written, and vary depending upon the amount and types of contracts written, and to a lesser extent ceding commissions paid to ceding insurers and excise taxes. Other operating and general expenses consist primarily of personnel expenses (including salaries, benefits and certain costs associated with awards under our equity compensation plans) and other general operating expenses. Other than expenses relating to stock options and other equity grants, our personnel expenses are primarily fixed in nature and do not vary with the amount of premiums written. Interest expenses are disclosed separately from operating and general expenses.

Critical Accounting Policies

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates and assumptions that affect amounts reported in the financial statements. As more information becomes known, these estimates and assumptions could change and impact amounts reported in the future. Management believes that the establishment of loss and loss adjustment expense reserves and the determination of “other-than-temporary” impairment on investments are two areas where by the degree of judgment required to determine amounts recorded in the

financial statements make the accounting policies critical. We discuss these two policies below. Our other significant accounting policies are described in Note 1 to our consolidated financial statements.

      Significant periods of time can elapse between the occurrence of an insured loss, the reporting of that loss to us and our final payment of that loss, and its related LAE. To recognize liabilities for unpaid losses, we establish reserves as balance sheet liabilities. At December 31, 2004 and December 31, 2003, we had $171.0 million and $128.7 million, respectively, of gross losses and LAE reserves, representing management’s best estimate of the ultimate loss. Management records on a monthly and quarterly basis its best estimate of loss reserves. For purposes of computing the recorded reserves, management utilizes various data inputs, including analysis that is derived from a review of prior quarter results performed by actuaries employed by Great American Insurance Company, an affiliated company. In addition, on an annual basis, actuaries from Great American Insurance Company review the recorded reserves utilizing current period data and provide a Statement of Actuarial Opinion, required annually in accordance with state insurance regulations, on the reserves recorded by our subsidiaries, National Interstate Insurance Company and National Interstate Insurance Company of Hawaii. Since 1990, our first full year of operations, the actuaries have opined each year that the reserves recorded at December 31 are reasonable. The actuarial analysis of National Interstate Insurance Company’s and National Interstate Insurance Company of Hawaii’s net reserves as of the end of fiscal years ending December 31, 2004, 2003 and 2002 reflected point estimates that were within one-half of 1% of management’s recorded net reserves as of such dates. Using this actuarial data along with its other data inputs, management concluded that the recorded reserves appropriately reflect management’s best estimates of the liability as of each year end.

      The quarterly reviews of unpaid loss and LAE reserves by Great American Insurance Company actuaries are prepared using standard actuarial techniques. These may include (but may not be limited to):