UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

(Amendment No. 1)

ANNUAL REPORT PURSUANT TO SECTION 13 OR

15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2005

Commission File Number 0-07477

THE ENSTAR GROUP, INC.

(Exact name of registrant as specified in its charter)

(334) 834-5483

(Registrant’s telephone number, including area code)

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

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

Title of Class

Common Stock, $.01 par value

(including rights attached thereto)

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

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

          Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x     No 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 Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     x

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

Large Accelerated Filer o          Accelerated Filer x          Non-Accelerated Filer o

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

          The aggregate market value of the Registrant’s Common Stock held by non-affiliates of the Registrant as of June 30, 2005, was $252,279,716 (based on the closing price on such date of the Registrant’s Common Stock on The Nasdaq National Market).

          The number of shares of the Registrant’s Common Stock, $.01 par value per share, outstanding at September 19, 2006 was 5,739,384.

DOCUMENTS INCORPORATED BY REFERENCE

          Portions of the Proxy Statement for the 2006 Annual Meeting of Shareholders are incorporated herein by reference in Part II and Part III.

EXPLANATORY NOTE

      The Enstar Group, Inc. (the “Company” or “Enstar”) is filing this Amendment No. 1 on Form 10-K/A (this “Form 10-K/A”) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, initially filed with the Securities and Exchange Commission (the “SEC”) on March 16, 2006 (the “Original 10-K Filing”), to restate the disclosures in the notes to its consolidated financial statements included in Item 8 of Part II — “Financial Statements and Supplementary Data.” This restatement had no impact on the net income, net income per share or shareholders’ equity of the Company or its partially owned affiliates and no material weakness in the Company’s internal control over financial reporting existed. The Company has also updated Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 9A of Part II, “Controls and Procedures” to give effect to the restatement. The restatement is described in more detail in Note 2 to the Company’s consolidated financial statements.

      In addition, the Company has amended Item 1A of Part I, “Risk Factors,” to provide a more detailed description of the risks associated with the Company and Item 15 of Part IV to reflect the filing of currently dated certifications from the Company’s Chief Executive Officer and Chief Financial Officer, as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of the Company’s Chief Executive Officer and Chief Financial Officer are attached to this Form 10-K/A as Exhibits 31.1, 31.2, 32.1, and 32.2. No other information in this Form 10-K/A has been updated to reflect any subsequent information or events since the date of the Original 10-K Filing. For the convenience of the reader, this Form 10-K/A sets forth the Original 10-K Filing in its entirety, as amended. Concurrently with the filing of this Form 10-K/A, we are filing amendments on Form 10-Q/A to our Quarterly Reports on Form 10-Q for the period ended March 31, 2006 and for the period ended June 30, 2006.

TABLE OF CONTENTS

      THIS FORM 10-K/A AND OTHER STATEMENTS ISSUED OR MADE FROM TIME TO TIME BY THE ENSTAR GROUP, INC. OR MEMBERS OF ITS MANAGEMENT TEAM CONTAIN STATEMENTS WHICH MAY CONSTITUTE “FORWARD-LOOKING STATEMENTS” WITHIN THE MEANING OF THE SECURITIES ACT OF 1933, AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED BY THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, 15 U.S.C. SECTIONS 77Z-2 AND 78U-5 (SUPP. 1996). THOSE STATEMENTS INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF THE ENSTAR GROUP, INC. AND MEMBERS OF ITS MANAGEMENT TEAM, AS WELL AS THE ASSUMPTIONS ON WHICH SUCH STATEMENTS ARE BASED. PROSPECTIVE INVESTORS ARE CAUTIONED THAT ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE RISKS AND UNCERTAINTIES, AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY SUCH FORWARD-LOOKING STATEMENTS. THERE ARE A NUMBER OF IMPORTANT FACTORS THAT COULD CAUSE OUR ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. THESE FACTORS INCLUDE, WITHOUT LIMITATION, THOSE SET FORTH IN ITEM 1A. “RISK FACTORS.” THE ENSTAR GROUP, INC. UNDERTAKES NO OBLIGATION TO UPDATE OR REVISE FORWARD-LOOKING STATEMENTS TO REFLECT CHANGED ASSUMPTIONS, THE OCCURRENCE OF UNANTICIPATED EVENTS OR CHANGES TO FUTURE OPERATING RESULTS OVER TIME.

PART I

General

      Enstar is a publicly traded company engaged in the operation of several equity affiliates in the financial services industry. Enstar also continues its active search for one or more additional operating businesses which meet its acquisition criteria. See “— Strategy for Business Acquisitions.”

      Through the operations of its partially owned equity affiliates, Castlewood Holdings Limited (“Castlewood Holdings”) and B.H. Acquisition Limited (“B.H. Acquisition”), and their subsidiaries, the Company acquires and manages insurance and reinsurance companies in run-off (insurance and reinsurance companies that have ceased the underwriting of new policies). The management of these businesses includes claims administration, adjustment and settlement together with the collection of reinsurance recoveries. Castlewood Holdings, a Bermuda-based company, also provides management, consulting and other services to the insurance and reinsurance industry for both fixed and success-based fee arrangements. In general, reinsurance is an arrangement in which the reinsurer agrees to indemnify an insurance or reinsurance company against all or a portion of the risks underwritten by such insurance or reinsurance company under one or more insurance or reinsurance contracts.

      For a discussion of certain risks and uncertainties relating to the Company’s participation in the reinsurance industry, see Item 1A. “Risk Factors.” For business segment information, see Note 12 of the Notes to Consolidated Financial Statements.

Activities Related to the Reinsurance Industry

      In July 2000, the Company, through B.H. Acquisition, a joint venture with Castlewood Limited (“Castlewood”) and an entity controlled by Trident II, L.P. (“Trident”), acquired as an operating business two reinsurance companies, Brittany Insurance Company Ltd. (“Brittany”) and Compagnie Europeenne d’Assurances Industrielles S.A. (“CEAI”). Brittany and CEAI are principally engaged in the active management of books of reinsurance business from international markets. The Company owns 50% of the voting stock and a 33% economic interest in B.H. Acquisition. Castlewood owns 33% of the voting stock and a 45% economic interest in B.H. Acquisition. The Company’s ownership in B.H. Acquisition is accounted for using the equity method of accounting.

      In November 2001, the Company, together with Trident and the shareholders and senior management of Castlewood (the “Castlewood Principals”), completed the formation of a new venture, Castlewood Holdings, to acquire and manage insurance and reinsurance companies, including companies in run-off, and to provide management, consulting and other services to the insurance and reinsurance industry (the “Castlewood Holdings Transaction”). The Company owns 50% of the voting stock of Castlewood Holdings and the Castlewood Principals and Trident each own 25% of Castlewood Holdings’ voting stock. The Company owns a 32.63% economic interest in Castlewood Holdings. Castlewood is a private Bermuda-based firm, experienced in managing and acquiring reinsurance operations. The Company’s ownership in Castlewood Holdings is accounted for using the equity method of accounting.

      As a result of this transaction, the Company’s 33% direct economic interest in B.H. Acquisition increased by an additional indirect economic interest through Castlewood Holdings. At December 31, 2005, the Company’s beneficial ownership in B.H. Acquisition was 47.68%. The Company’s combined voting interest in B.H. Acquisition is limited to 50%.

      In conjunction with the closing of the Castlewood Holdings Transaction, a wholly owned subsidiary of Castlewood Holdings completed the acquisition of two reinsurance companies in run-off, River Thames

Insurance Company Limited (“River Thames”), based in London, England, and Overseas Reinsurance Corporation Limited (“Overseas Reinsurance”), based in Bermuda (collectively, the “River Thames Transaction”). The total purchase price of River Thames and Overseas Reinsurance was approximately $15.2 million.

      In August 2002, Castlewood Holdings purchased Hudson Reinsurance Company Limited (“Hudson”), a Bermuda-based company, for approximately $4.1 million. Hudson reinsured risks relating to property, casualty and workers’ compensation, on a worldwide basis, and is now administering the run-off of its claims.

      Also in 2002, Castlewood Holdings capitalized Fitzwilliam (SAC) Insurance Limited (“Fitzwilliam”), a wholly owned subsidiary. Fitzwilliam, based in Bermuda, offers specialized reinsurance protections to related companies, clients of Castlewood Holdings and other third-party companies.

      In March 2003, Castlewood Holdings and Shinsei Bank, Limited (“Shinsei”) completed the acquisition of all of the outstanding capital stock of The Toa-Re Insurance Company (UK) Limited (“Toa-UK”), a London-based subsidiary of The Toa Reinsurance Company, Limited, for approximately $46 million. Toa-UK underwrote reinsurance business throughout the world between 1980 and 1994, when it stopped writing new business and is currently operating in run-off. The acquisition was effected through Hillcot Holdings Ltd. (“Hillcot”), a newly formed Bermuda company, in which Castlewood Holdings has a 50.1% economic interest and a 50% voting interest. Upon completion of the transaction, Toa-UK’s name was changed to Hillcot Re Limited. Hillcot is included in Castlewood Holdings’ consolidated financial statements, with the remaining 49.9% economic interest reflected as minority interest. J. Christopher Flowers (“Mr. Flowers”), a member of the Company’s board of directors and the Company’s largest shareholder, is a director and the largest shareholder of Shinsei. Castlewood Holdings’ results of operations include the results of Toa-UK from the date of acquisition in March 2003.

      In August 2004, Castlewood Holdings implemented an employee stock-based compensation plan. The plan allows for the award of Castlewood Holdings’ Class D non-voting shares to certain senior employees up to a maximum of 7.5% of the total issued share capital of Castlewood Holdings. As a result of awards made in 2005 and 2004, the Company’s economic interest in Castlewood Holdings of 33¹/3% has been diluted by 0.70% to 32.63% as of December 31, 2005. As awarded shares vest and as additional shares are awarded in the future, the Company’s economic interest could decrease to a minimum of 30.83%. The Company’s voting interest will remain at 50%.

      During 2004, Castlewood Holdings, through one of its subsidiaries, invested a total of approximately $9.1 million in Cassandra Equity LLC and Cassandra Equity (Cayman) LP, (collectively, “Cassandra”), for a 27% interest in each. Cassandra was formed to invest in equity shares of a publicly traded international reinsurance company. J.C. Flowers I LP also owned a 27% interest in Cassandra. J.C. Flowers I LP is a private investment fund, the general partner of which is JCF Associates I LLC. Mr. Flowers is the managing member of JCF Associates I LLC. In March 2005, Cassandra sold all of its holdings for total proceeds of approximately $40.0 million. Castlewood Holdings’ proportionate share of the proceeds was approximately $10.8 million.

      Also during 2004, Castlewood Holdings, through one of its subsidiaries, completed the acquisition of Mercantile Indemnity Company Ltd. (“Mercantile”), Harper Insurance Limited (“Harper”) (formerly Turegum Insurance Company) and Longmynd Insurance Company Ltd. (“Longmynd”) (formerly Security Insurance (UK) Ltd.) for a total purchase price of approximately $4.5 million. Castlewood Holdings recorded an extraordinary gain of approximately $21.8 million relating to the excess of the fair value of the net assets acquired over the cost of these acquisitions.

      In May 2005, Castlewood Holdings, through one of its subsidiaries, purchased Fieldmill Insurance Company Limited (formerly known as Harleysville Insurance Company (UK) Limited) for approximately $1.4 million.

      In December 2005, Castlewood Holdings and Shinsei signed definitive agreements for the purchase of Aioi Insurance Company of Europe Limited (“Aioi Europe”), a London-based subsidiary of Aioi Insurance Company, Limited. Aioi Europe has underwritten general insurance and reinsurance business in Europe for its

own account until 2002 when it generally ceased underwriting, and placed into run-off, its general insurance and reinsurance business. The aggregate purchase price to be paid for Aioi Europe is £62 million (approximately $108 million), with £50 million in cash upon the closing of the transaction and £12 million in the form of a promissory note, payable twelve months from the date of the closing. The acquisition will be effected through Hillcot, a Bermuda-based company, which is jointly owned by Castlewood Holdings and Shinsei. Subject to regulatory approval, the acquisition is expected to be completed during the first quarter of 2006.

Other Activities

      The Company owned membership units of B-Line LLC (“B-Line”) from November 1998 to December 2003. Based in Seattle, Washington, B-Line provides services to credit card issuers and other holders of similar receivables. B-Line also purchases credit card receivables and recovers payments on these accounts. In December 2003, the Company sold its entire interest in B-Line to B-Line Holdings LLC, an affiliate of Golden Gate Capital, for cash of approximately $7.8 million, net of expenses, resulting in a pre-tax gain of approximately $3.3 million.

      During 2003, the Company funded approximately $15.3 million to JCF CFN LLC and related entities (collectively, the “JCF CFN Entities”) in exchange for a 60% interest in such entities. In addition, Castlewood Holdings funded approximately $10.2 million to the JCF CFN Entities in exchange for a 40% interest, which is reflected in the Company’s financial statements as a minority interest. The JCF CFN Entities were formed to serve as members of Green Tree Investment Holdings LLC (formerly known as CFN Investment Holdings LLC) and related entities (collectively, “Green Tree”), which, in turn, were formed to effect the acquisition of a portfolio of home equity and manufactured housing loan securities and the associated servicing businesses from Conseco Finance Corp. (“Conseco Finance”).

      In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” as amended by FIN 46R issued in December 2003, which requires consolidation by a business enterprise of variable interest entities (“VIE”) if the enterprise is determined to be the primary beneficiary. In accordance with FIN 46R, the Company has consolidated the JCF CFN Entities since their inception.

      The JCF CFN Entities invested in Green Tree together with affiliates of J.C. Flowers I LP, affiliates of Fortress Investment Group LLC and affiliates of Cerberus Capital Management, L.P. In June 2003, the JCF CFN Entities invested approximately $25.1 million in exchange for a 3.995% interest in Green Tree. Green Tree completed the purchase of certain assets of Conseco Finance for approximately $630 million in cash plus certain assumed liabilities. J.C. Flowers I LP is a private investment fund, the general partner of which is JCF Associates I LLC. The managing member of JCF Associates I LLC is Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. The JCF CFN Entities accounted for the investment in Green Tree under the equity method of accounting. Because the JCF CFN Entities are consolidated, Green Tree was treated as a partially owned equity affiliate of the Company.

      In July 2004, the JCF CFN Entities, along with certain affiliates of J.C. Flowers I LP, completed the sale of their entire interests in Green Tree to FIT CFN Holdings LLC, an affiliate of Fortress Investment Group LLC, and Cerberus Green Tree Investments, LLC and Cerberus JCF Coinvest, LLC, each an affiliate of Cerberus Capital Management L.P. In exchange for their entire interest, the JCF CFN Entities received aggregate sales proceeds of approximately $40 million in cash. Of this amount, Castlewood Holdings received aggregate sales proceeds of approximately $16 million. The proceeds received by the JCF CFN Entities at completion of the sale were reduced by prior cash distributions of approximately $7.2 million made by Green Tree during 2004. The Company recorded a pre-tax realized gain of approximately $6.9 million on the sale. The JCF CFN Entities have been inactive since July 2004.

      In June 2005, the Company committed to contribute up to $10 million for a 14%, non-voting interest in Affirmative Investment LLC (“Affirmative Investment”), a newly formed Delaware limited liability company. J.C. Flowers I LP committed the capital necessary for the remaining 86% interest in Affirmative Investment. Both J.C. Flowers I LP and Affirmative Associates LLC, the managing member of Affirmative Investment, are controlled by Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. In July 2005, the Company funded its initial capital contribution of approximately $2.6 million. Since that time, the Company has funded additional capital contributions of approximately $5.7 million. At December 31, 2005, the Company’s total investment in Affirmative Investment was approximately $8.5 million, including equity in earnings from July 1 to December 31, 2005. The Company’s ownership in Affirmative Investment is accounted for using the equity method of accounting.

      Also in June 2005, Affirmative Investment acquired 1,183,000 shares of common stock of Affirmative Insurance Holdings, Inc. (“Affirmative Insurance”), through open market purchases. In August, Affirmative Investment acquired 50% of the membership interests of New Affirmative LLC (“NAL”), a newly formed Delaware limited liability company, for approximately $40.7 million in cash and the 1,183,000 shares of Affirmative Insurance. The remaining 50% of the membership interests of NAL were acquired by Delaware Street Capital Master Fund, LP or its affiliates (“DSC”) for approximately $37.5 million in cash and 1,459,699 shares of Affirmative Insurance common stock. In turn, NAL, pursuant to a Stock Purchase Agreement with Vesta Insurance Group, Inc. (“VIG”) and Vesta Fire Insurance Corporation, a subsidiary of VIG (together with VIG, “Vesta”), acquired from Vesta an aggregate of 5,218,228 shares of Affirmative Insurance common stock for a purchase price of $15.00 per share. Upon the closing of the transaction with Vesta and the transfer of the shares of Affirmative Insurance from Affirmative Investment and DSC, NAL’s ownership percentage in Affirmative Insurance was approximately 52.9%. Affirmative Investment’s ownership in NAL is accounted for using the equity method of accounting. Affirmative Investment accounts for its investment in NAL three months in arrears.

      In December 2005, the Company invested approximately $3.5 million in New NIB Partners LP (“NIB Partners”), a newly formed Province of Alberta limited partnership, in exchange for an approximately .2% limited partnership interest. Castlewood Holdings, through two of its wholly-owned subsidiaries, also invested approximately $24.5 million in NIB Partners for an approximately 1.4% interest. NIB Partners was formed for the purpose of purchasing, together with certain affiliated entities, 100% of the outstanding share capital of NIBC N.V. (formerly, NIB Capital N.V.) and its affiliates (“NIBC”). NIBC is a merchant bank focusing on the mid-market segment in northwest Europe with a global distribution network.

      New NIB Partners and certain related entities are indirectly controlled by New NIB Limited, an Irish corporation. Mr. Flowers is a director of New NIB Limited and is on the supervisory board of NIBC. Certain affiliates of J.C. Flowers I LP also participated in the acquisition of NIBC.

Organizational Structure

      The Company’s executive offices are located at 401 Madison Avenue, Montgomery, Alabama 36104, and its telephone number is (334) 834-5483. The Company has six employees whose principal duties currently include managing the assets of the Company, seeking and evaluating potential acquisition candidates, fulfilling reporting requirements associated with being a publicly traded company, and handling various other accounting and tax matters. The Company is a Georgia corporation and successor by a 1996 merger to a Delaware corporation of the same name.

Subsidiaries

      At December 31, 2005, the Company had two wholly-owned subsidiaries: Enstar Financial Services, Inc., a Florida corporation, and Enstar Group Operations, Inc., a Georgia corporation, both of which are currently inactive. In addition, the Company consolidates the JCF CFN Entities, recording a minority interest for

Castlewood Holdings’ 40% interest. Since the sale of their interests in Green Tree in July 2004, the JCF CFN Entities have been inactive.

Strategy for Business Acquisitions

      The Company’s strategy for making a suitable acquisition is to utilize the considerable experience, knowledge and business contacts of the Company’s executive officers and directors. Each of the Company’s directors has been asked by management to assist the Company actively in pursuing potential acquisitions. Management follows up on the leads and meets with various prospective targets. This pursuit occupies a significant amount of the time of the Company’s senior officers. The Company conducts rigorous financial and legal due diligence with respect to any entity about which it has a strong interest.

      The Company primarily focuses on potential acquisitions in the financial services industry which complement its current operating businesses, investigating acquisition opportunities both within and outside the United States when management believes that such opportunities might be attractive. The Company may pay consideration in the form of cash, securities of the Company or some combination of both. The Company may also borrow money in connection with an acquisition. If debt is involved, the Company’s shareholders would be subject to the risks normally associated with leveraged transactions. Depending upon the level of indebtedness, a leveraged transaction could have important consequences to the Company, including the following: (i) if the acquired business is unable to achieve satisfactory operating results, the Company could prove unable to service such indebtedness; (ii) a substantial portion of the Company’s cash flow from operations may be dedicated to the payment of principal and/or interest on its indebtedness and would not be available for other purposes; (iii) the Company’s ability to obtain additional financing in the future for working capital, capital expenditures or other acquisitions may be limited; and (iv) the Company’s level of indebtedness could limit its flexibility in planning for, or reacting to, changes in its industry.

Competition

      The Company, along with its partially owned equity affiliates, Castlewood Holdings and B.H. Acquisition, and their subsidiaries (collectively, with the Company, the “Group”), compete in international markets with domestic and international reinsurance companies to acquire reinsurance companies in run-off. The acquisition of reinsurance companies in run-off is highly competitive. Some of these competitors have greater financial resources than the Group, have been operating for longer than the Group and have established long-term and continuing business relationships throughout the reinsurance industry, which can be a significant competitive advantage. As such, the Group may not be able to compete successfully in the future for suitable acquisition candidates.

      Additionally, the Company faces intense competition in its search for operating businesses outside of the reinsurance industry. In this regard, the Company competes with strategic buyers, financial buyers and others who are looking to acquire suitable operating businesses, many of whom have greater financial resources than the Company or have greater flexibility in structuring acquisition transactions or strategic relationships.

Where You Can Find More Information

      The Company makes its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) available (free of charge) on or through its Internet website located at http://www.enstargroup.com, as soon as reasonably practicable after they are filed with or furnished to the Securities and Exchange Commission.

Item 1A.     Risk Factors

      The following risk factors, in addition to other information provided in the Company’s periodic and interim reports, should be considered when evaluating the Company. The risks described below are not the only ones that the Company faces. There may be additional risks and uncertainties. If any of the following

risks actually occur, the Company’s business, financial condition or results of operations could be materially and adversely affected and the trading price of the Company’s common shares could decline significantly.

Risks Related to the Company’s Business

      The Company and its partially owned equity affiliates, Castlewood Holdings and B.H. Acquisition, and their subsidiaries, have made several acquisitions and investments and expect to continue to make such acquisitions and investments. See “Business — Activities Related to the Reinsurance Industry” and “Business — Other Activities” included in Item 1 of this Annual Report on Form 10-K/A. The Company cannot assure you that any of these acquisitions or investments will be financially advantageous for the Company or its shareholders. In addition, as described below, the Company’s entry into the reinsurance industry, through the operations of its partially-owned equity affiliates, Castlewood Holdings and B.H. Acquisition, and their subsidiaries, exposes the Company to risks and uncertainties inherent in the reinsurance industry which could materially and adversely affect the business, financial condition and results of operations of the Company.

      The business of any future acquisition target may be subject to numerous, unpredictable risks. For example, an acquisition target may be subject to government regulation. In sum, the Company cannot assure you that it will make any acquisition that will bring value or prove financially advantageous to the Company or its shareholders.

      The Company’s business strategy has emphasized growth through acquisitions, but it may not be able to continue to identify operating businesses for acquisition or it may not be able to make acquisitions on terms that it considers economically acceptable. The Company faces intense competition in its search for one or more operating businesses. The Company competes with strategic and financial buyers and others looking to acquire suitable operating businesses, who have greater financial resources and greater flexibility in structuring acquisition transactions or strategic relationships than the Company. In addition, there may be certain financing contingencies that will restrict the ability of the Company to make a given acquisition.

      The success of the Company is highly dependent on the ability of Nimrod T. Frazer, the Company’s Chairman and Chief Executive Officer, and the other executive officers and directors of the Company to identify and consummate acquisitions on favorable terms. J. Christopher Flowers has been a director since October 1996 and for the period December 1998 to July 2003 served as Vice Chairman of the Board of Directors. Additionally, in March 2000, John J. Oros was named Executive Vice President and elected as a director of the Company. Mr. Oros was subsequently elected President and Chief Operating Officer in June 2001. The Company believes Mr. Flowers’ and Mr. Oros’ extensive business and financial talent and experience greatly enhance the Company’s ability to locate operating businesses. The Company would be materially and adversely affected if it were unable to retain the services of Messrs. Frazer, Flowers or Oros.

      Additionally, the success of the Company is also dependent, in part, on key personnel at its partially-owned equity affiliates. The experiences and reputations of the key personnel in the reinsurance industry are important factors in their ability to attract new business.

      The market price for the Company’s common stock may fluctuate substantially due to, among other things, the following factors:

      The Company has experienced price volatility in the past. For example, during the period from January 1, 2006 through March 15, 2006, the lowest closing price for shares of Enstar common stock was $65.00 (occurring on January 5, 2006) and the highest closing price for shares of Enstar common stock was $81.94 (occurring on February 22, 2006). During 2005, the lowest closing price for shares of Enstar common stock was $49.40 (occurring on April 20, 2005) and the highest closing price for shares of Enstar common stock was $72.58 (occurring on December 15, 2005). In addition, from time to time the stock market experiences significant price and volume fluctuations. This volatility affects the market prices of securities issued by many companies for reasons unrelated to their operating performance.

      Significant price and value fluctuations have occurred with respect to the securities of insurance and insurance-related companies. The Company’s common stock price is likely to be volatile in the future. In the past, following periods of downward volatility in the market price of a company’s securities, class action litigation has often been pursued against such companies. If similar litigation were pursued against the Company, it could result in substantial costs and a diversion of management’s attention and resources.

      A substantial amount of the Company’s common stock becoming available (or being perceived to become available) for sale in the public market could cause the market price of the stock to fall or prevent it from increasing. The Company’s common stock historically has been thinly traded with an average daily trading volume between January 1, 2005 and March 15, 2006 of 3,937 shares. In addition, Enstar generally has not received meaningful analyst coverage. Actual or potential sales by officers, directors or large shareholders of the Company’s stock could be viewed negatively by other investors.

      The Company does not plan to diversify across several industries. In fact, the Company may decide to acquire additional businesses operating in a single industry. The concentration of investments in the insurance industry makes the Company more vulnerable to adverse effects of occurrences that may affect this industry.

      The Company’s Articles of Incorporation and Bylaws contain provisions that may discourage other persons from attempting to acquire control of the Company. Such provisions include, among others, a classified board of directors and procedural requirements in connection with shareholder nominations for election of directors.

      The Company is a Georgia corporation and has elected to be governed by the “business combination” provisions of the Georgia Code, that could be viewed as having the effect of discouraging an attempt to obtain control of the Company. The business combination provisions generally would prohibit the Company from engaging in various business combination transactions with any interested stockholder for a period of five years after the date of the transaction in which the person became an interested stockholder unless certain designated conditions are met.

      The Company has also adopted a share purchase rights plan, which could make it uneconomical for a third party to acquire the Company on a hostile basis. The market price of the Company’s common stock may be affected by the forgoing provisions and agreements which inhibit or discourage take-over attempts.

      The Company’s directors and executive officers may have ownership interests or other involvement with entities that could compete against it, either in the pursuit of acquisition targets or in general business operations. The Company has procedures in place to ensure that directors do not deliberate or vote on transactions where the Company’s interests conflict with those of entities with which the director is involved. However, these procedures cannot guarantee that the Company will pursue all advantageous transactions that it would otherwise pursue in the absence of a conflict of interest.

      The Company has claimed deductions for net operating loss carryforwards (“NOLs”) totaling approximately $94.8 million on its federal income tax returns for its taxable years ended August 31, 1997 through 2004. Although the Company believes that it is entitled to the deductions for NOLs that it has claimed on its federal income tax returns for the taxable years ended August 31, 1997 through 2004, there can be no assurance that the Internal Revenue Service will not challenge the Company’s position or as to the result of any such challenge.

      The Group maintains a portion of its investment portfolio in investments denominated in currencies other than United States dollars. Consequently, the Company may experience foreign exchange losses.

      The Company publishes its consolidated financial statements in U.S. dollars. Therefore, fluctuations in exchange rates used to convert other currencies, particularly other European currencies including the Euro and British pound, into U.S. dollars will impact the Company’s reported consolidated financial condition, results of operations and cash flows from year to year.

Risks Related to the Reinsurance Industry

      Through the Company’s partially owned equity affiliates, Castlewood Holdings and B.H. Acquisition, and their subsidiaries, the Company has acquired and manages books of reinsurance business. The Company is exposed to the following risks and uncertainties, among others, through its participation in the reinsurance industry.

      The reinsurance industry historically has been subject to significant fluctuations and uncertainties. Factors that affect the industry in general could also cause the Group’s operating results to fluctuate. The industry’s profitability may be affected significantly by:

      The reinsurance subsidiaries of Castlewood Holdings and B.H. Acquisition (the “Reinsurance Subsidiaries”) are required to maintain reserves to cover their estimated ultimate liability of losses and loss adjustment expenses for both reported and unreported claims incurred. These reserves are only estimates of what the Reinsurance Subsidiaries think the settlement and administration of claims will cost based on facts and circumstances known to the Reinsurance Subsidiaries. The Castlewood Holdings subsidiaries’ commutation activity and claims settlement and development in recent years resulted in net reductions in provisions for loss and loss adjustment expenses of $96.0 million, $13.7 million and $24.0 million for the years ended December 31, 2005, December 31, 2004 and December 31, 2003, respectively. The B.H. Acquisition subsidiaries’ commutation activity and claims settlement and development in recent years resulted in net reductions in provisions for loss and loss adjustment expenses of $0.5 million and $0.2 million for the years ended December 31, 2005 and December 31, 2003, respectively, and an increase of $0.4 million for the year ended December 31, 2004. Although this recent experience indicates that their loss reserves have been adequate to meet their liabilities, because of the inherent uncertainties that surround estimating loss reserves and loss adjustment expenses, the Reinsurance Subsidiaries cannot be certain that ultimate losses will not exceed these estimates of losses and loss adjustment reserves. If the Reinsurance Subsidiaries’ reserves are insufficient to cover their actual losses and loss adjustment expenses, the Reinsurance Subsidiaries would have to augment their reserves and incur a charge to their earnings. These charges could be material and could ultimately reduce the Company’s net income.

      The difficulty in estimating the Reinsurance Subsidiaries’ reserves is increased because the Reinsurance Subsidiaries’ loss reserves include reserves for potential asbestos and environmental liabilities. At December 31, 2005, the Castlewood Holdings subsidiaries reported gross asbestos and environmental loss reserves of $578.1 million, or 71.7% of the total gross loss reserves. Net asbestos and environmental loss reserves at December 31, 2005 amounted to $384.0 million, or 64.7% of total net loss reserves. At December 31, 2005, the B.H. Acquisition subsidiaries reported gross asbestos and environment loss reserves of $33.6 million and net asbestos and environmental loss reserves of $29.8 million. Asbestos and environmental liabilities are especially hard to estimate for many reasons, including the long waiting periods between exposure and manifestation of any bodily injury or property damage, difficulty in identifying the source of the asbestos or environmental contamination, long reporting delays and difficulty in properly allocating liability for the asbestos or environmental damage. Developed case law and adequate claim history do not exist for such claims, especially because significant uncertainty exists about the outcome of coverage litigation and whether past claim experience will be representative of future claim experience. In view of the changes in the legal and tort environment that affect the development of such claims, the uncertainties inherent in valuing asbestos and environmental claims are not likely to be resolved in the near future. Ultimate values for such claims cannot be estimated using traditional reserving techniques and there are significant uncertainties in estimating the amount of the Reinsurance Subsidiaries’ potential losses for these claims. The Reinsurance Subsidiaries have not made any changes in reserve estimates that might arise as a result of any potential federal reform of asbestos litigation. Although Castlewood Holdings’ subsidiaries increased their asbestos and environmental gross loss reserves by $32.4 million in 2003 (and increased net reserves by $38.9 million), they reduced those gross loss reserves by $13.7 million in 2004 and $172.3 million in 2005 (and decreased net reserves by $33.4 million in 2004 and $100.6 million in 2005) as a result of industry-wide adverse claims development, subsequent successful commutations, policy buybacks and favorable claims settlements. Despite the reduction in asbestos and environmental loss reserves in 2004 and 2005, there can be no assurance that the reserves

established by the Reinsurance Subsidiaries will be adequate or will not be adversely affected by the development of other latent exposures.

      The fair market value of the fixed income securities classified as available-for-sale and equity securities in the Reinsurance Subsidiaries’ investment portfolios, amounting to $216.6 million at December 31, 2005, and the investment income from these assets fluctuate depending on general economic and market conditions. For example, the fair market value of the Reinsurance Subsidiaries’ fixed income securities generally increases or decreases in an inverse relationship with fluctuations in interest rates. The fair market value of their fixed income securities can also decrease as a result of any downturn in the business cycle that causes the credit quality of those securities to deteriorate. The net investment income that the Reinsurance Subsidiaries realize from investments in fixed income securities will generally increase or decrease with interest rates. The changes in the market value of the Reinsurance Subsidiaries’ securities that are classified as available-for-sale are reflected in their financial statements. As a result, a decline in the value of the securities in the Reinsurance Subsidiaries portfolio could reduce their net income or cause them to incur a loss.

      The Reinsurance Subsidiaries are subject to credit risk with respect to their reinsurers because the transfer of risk to a reinsurer does not relieve the Reinsurance Subsidiaries of their liability to the insured. In addition, reinsurers may be unwilling to pay the Reinsurance Subsidiaries even though they are able to do so. At December 31, 2005, the Castlewood Holdings subsidiaries’ balances receivable from reinsurers amounted to $250.2 million of which $164.4 million was associated with a single reinsurer with a credit rating of A, which represented 10% or more of the total balance. At December 31, 2005, the B.H. Acquisition subsidiaries’ balances receivable from reinsurers amounted to $3.8 million of which $0.9 million was associated with two reinsurers, which represented 10% or more of the total balance. The failure of one or more of the Reinsurance Subsidiaries’ reinsurers to honor their obligations in a timely fashion would impact the Reinsurance Subsidiaries’ and the Group’s cash flows and reduce their net income, and could cause the Reinsurance Subsidiaries and the Company to incur a significant loss.

      The Group competes in international markets with domestic and international reinsurance companies. Some of these competitors have greater financial resources than the Group, have been operating for longer than the Group and have established long-term and continuing business relationships throughout the reinsurance industry, which can be a significant competitive advantage. As such, the Group may not be able to compete successfully in the future.

      The Group, through its Reinsurance Subsidiaries, is subject to extensive regulation under foreign insurance laws. These laws limit the amount of dividends that can be paid to the Company, Castlewood Holdings and B.H. Acquisition by their Reinsurance Subsidiaries, impose restrictions on the amount and type of investments that they can hold, prescribe solvency standards that must be met and maintained by them and require them to maintain reserves. The Group’s failure to comply with these laws could subject it to fines and penalties and restrict it from conducting business. The application of these laws could affect the Company’s liquidity and ability to pay dividends on its common shares and could restrict the Company’s ability to expand its business operations through acquisitions involving the Company’s partially owned affiliates and their subsidiaries. At December 31, 2005, the required statutory capital and surplus of the Bermuda, U.K. and Swiss insurance and reinsurance companies owned by Castlewood Holdings amounted to $48.9 million compared to the actual statutory capital and surplus of $285.6 million. At December 31, 2005, the required

statutory capital and surplus of the Bermuda and Belgian insurance and reinsurance companies owned by B.H. Acquisition amounted to $7.6 million compared to the actual statutory capital and surplus of $32.2 million.

      The Company cannot assure that the Group has or can maintain all required licenses and approvals or that its business fully complies with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations. In addition, some regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If the Group does not have the requisite licenses and approvals or does not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend the Group from carrying on some or all of its activities or monetarily penalize the Group. These types of actions could have a material adverse effect on the Company’s business.

Item 1B.     Unresolved Staff Comments

      None.

      The Company’s corporate headquarters are located at 401 Madison Avenue, Montgomery, Alabama. In December 2004, the Company signed a one year lease beginning January 1, 2005 on this office building. The lease also provides renewal options for three periods of one year each. In December 2005, the Company signed a one year renewal option beginning January 1, 2006. Additionally, pursuant to an oral agreement, the Company leases space in a warehouse at 703 Howe Street, Montgomery, Alabama on a month-to-month basis. The Company leases the office building and warehouse space from unaffiliated third parties for $3,000 and $350 per month, respectively. The Company believes the rental amounts are competitive with market rates and that the cancellation or termination of either of these leases would not have a material adverse effect on the Company’s results of operations. In September 2005, the Company entered into an agreement with J.C. Flowers & Co. LLC continuing through October 2014 for the use of certain office space and administrative services from J.C. Flowers & Co. LLC for monthly payments of $4,146. Either party may, at its option with or without cause, terminate this agreement upon thirty (30) days prior written notice to the other party. J.C. Flowers & Co. LLC is managed by Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. The Company does not own any real property.

      The Company is not a party to any pending litigation and no proceeding was terminated during the fourth quarter of 2005.

      No matters were submitted to a vote of shareholders of the Company during the quarter ended December 31, 2005.

PART II

      The Company’s common stock (the “Common Stock”) is traded on The Nasdaq National Market (“Nasdaq”) under the ticker symbol ESGR. The following table reflects the range of high and low selling prices of the Company’s Common Stock by quarter for 2005 and 2004, as reflected in the Nasdaq Trade and Quote Summary Reports:

      At March 3, 2006, there were approximately 2,676 holders of record of the Company’s Common Stock.

      The Company has not declared or paid a cash dividend on any of its securities since 1989. The Company currently intends to retain its earnings to finance the growth and development of its future business and does not anticipate paying cash dividends in the foreseeable future. The payment of cash dividends in the future will depend upon such factors as the Company’s earnings, capital requirements, financial condition, contractual restrictions and other factors deemed relevant by the Board of Directors. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

      The information required by this Item with respect to securities authorized for issuance under equity compensation plans is included under the section entitled “Equity Compensation Plan Information” of the Proxy Statement for the 2006 Annual Meeting of Shareholders (the “Proxy Statement”) and such section is deemed incorporated herein by reference.

      The following table sets forth selected financial information with respect to the Company for each of the five years in the period ended December 31, 2005 and is derived in part from the audited consolidated financial statements of the Company. The data set forth below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and the audited consolidated financial statements, including the related notes thereto.

      The following tables set forth selected financial information of B.H. Acquisition and Castlewood Holdings for each of the five years in the period ended December 31, 2005. The table for Green Tree sets forth selected financial information for the period of ownership in 2003 and 2004.

          B.H. Acquisition:

      The 2002 accounting change for B.H. Acquisition relates to the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.”

          Castlewood Holdings:

      Net income for Castlewood Holdings for the year 2001 is reported for the period August 16, 2001 (date of incorporation) to December 31, 2001. The 2004 extraordinary gain relates to the excess of the net assets acquired over the cost in the acquisition of Mercantile, Harper and Longmynd by Castlewood Holdings.

          Green Tree:

      Net income for Green Tree for the year 2003 is reported from the date of inception to December 31, 2003. Net income for Green Tree for the year 2004 is reported from January 1 to July 15, 2004, the date of sale of the JCF CFN Entities’ entire interest in Green Tree.

          Affirmative Investment:

      In July 2005, the Company acquired a 14% ownership percentage in Affirmative Investment.

      The following discussion should be read in conjunction with the Selected Financial Data (Item 6) and the audited consolidated financial statements, including the related footnotes thereto. Historical results of operations and the percentage relationships among any amounts included in the Consolidated Statements of Income, and any trends which might appear to be inferable therefrom, are not necessarily indicative of trends in operations or the results of operations for any future period.

Overview

      Through the operations of the Company’s partially owned equity affiliates, Castlewood Holdings and B.H. Acquisition, and their subsidiaries, the Company acquires and manages insurance and reinsurance companies in run-off. The management of these businesses includes claims administration, adjustment and settlement together with the collection of reinsurance recoveries. Castlewood Holdings, a Bermuda-based company, also provides management, consulting and other services to the insurance and reinsurance industry for both fixed and success-based fee arrangements. In general, reinsurance is an arrangement in which the reinsurer agrees to indemnify an insurance or reinsurance company against all or a portion of the risks underwritten by such insurance or reinsurance company under one or more insurance or reinsurance contracts. For a discussion of certain risks and uncertainties relating to the Company’s participation in the reinsurance industry see Item 1A. “Risk Factors.”

      The Company is also actively engaged in the search for one or more additional operating businesses which meet the Company’s acquisition criteria. See Item 1. “Business — Strategy for Business Acquisitions.”

Restatement of Financial Statements

      The Company has amended certain disclosures in its Form 10-K/A as a result of restated information from its partially owned equity affiliates, Castlewood Holdings and B.H. Acquisition. The following management’s discussion and analysis of financial condition and results of operations give effect to the restatement. This restatement had no impact on the net income, net income per share or shareholders’ equity of Enstar or its partially owned equity affiliates. For a more detailed description of the restatement, see Note 2, “Restatement of Financial Statements” to the accompanying consolidated financial statements.

Recent Accounting Pronouncements

      In January 2003, the FASB issued FIN 46R which requires consolidation by a business enterprise of a VIE if the enterprise is determined to be the primary beneficiary. The Company believes that each of the JCF CFN Entities qualifies as a VIE and that the Company is the primary beneficiary of each such entity. As such, the JCF CFN Entities are included in the accompanying consolidated financial statements, with Castlewood Holdings’ 40% interest in the JCF CFN Entities reflected as a minority interest in the Company’s

financial statements. The JCF CFN Entities have been inactive since the sale of their entire interests in Green Tree in July 2004.

      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). SFAS 123R supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and amends SFAS No. 95, “Statement of Cash Flows.” The approach in SFAS 123R generally is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the earnings statements based on their grant date fair values. Pro forma disclosure will no longer be an alternative.

      The Company adopted SFAS 123R as of January 1, 2006 using the modified-prospective method. Under this transition method, compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date. As permitted by SFAS 123, through December 31, 2005 the Company accounted for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally has not recognized compensation cost for employee stock options. We estimate that 2006 pretax compensation expense for stock options will be approximately $213,000.

      SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as previously required. This requirement will reduce net operating cash flows and increase net financing cash flows. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when stock options will be exercised), the amounts of operating cash flows recognized in prior periods for such excess tax deductions were $0 and $606,000 in 2005 and 2004, respectively.

Critical Accounting Policies

      In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The most significant accounting estimates inherent in the preparation of the Company’s consolidated financial statements include estimates associated with its evaluation of income tax valuation allowance.

      Income Tax Valuation Allowance — The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. The effect of temporary differences on the financial statements includes certain operating losses of partially owned foreign subsidiaries and tax credit carryforwards. The Company has established a valuation allowance for the uncertainty of the realization of these and any other net deferred tax assets. However, utilization of the remaining deferred tax assets at December 31, 2005, is based on management’s assessment of the Company’s earnings history, expectations of future taxable income, and other relevant considerations.

      Certain amounts in Castlewood Holdings’ and B.H. Acquisition’s consolidated financial statements are the result of transactions that require the use of best estimates and assumptions to determine reported values. These amounts could ultimately be materially different than what has been provided for in their consolidated financial statements. The assessment of loss reserves and reinsurance recoverable are considered to be the values requiring the most inherently subjective and complex estimates. In addition, the assessment of the possible impairment of goodwill involves certain estimates and assumptions. As such, the accounting policies for these amounts are of critical importance to their consolidated financial statements.

      Loss and Loss Adjustment Expenses — Because a significant amount of time can lapse between the assumption of risk, the occurrence of a loss event, the reporting of the event to an insurance or reinsurance company and the ultimate payment of the claim on the loss event, Castlewood Holdings’ and B.H. Acquisition’s liability for unpaid losses and loss expenses is based largely upon estimates. Castlewood Holdings’ and B.H. Acquisition’s management must use considerable judgment in the process of developing these estimates. The liability for unpaid losses and loss expenses for property and casualty business includes amounts determined from loss reports on individual cases and amounts for losses incurred but not reported. Such reserves are estimated by management based upon reports received from ceding companies, supplemented by Castlewood Holdings’ and B.H. Acquisition’s own estimates of reserves for which ceding company reports have not been received, and independent actuarial estimates of ultimate unpaid losses. Castlewood Holdings’ and B.H. Acquisition’s reserves are largely comprised of casualty exposures including asbestos and environmental exposures and therefore these claims are subject to a higher degree of estimation volatility as a result of changes in the legal environment, jury awards, medical cost trends and general inflation. Castlewood Holdings and B.H. Acquisition regularly review and update these estimates using the most current information available and employing various actuarial methods. The ultimate liability for a loss is likely to differ from the original estimate due to the factors discussed above. Adjustments resulting from changes in our estimates are recorded in the period such adjustments are determined. The establishment of reserves, or the adjustment of reserves for reported losses, could result in significant upward or downward changes to our financial condition or results of our operations in the period such amounts are reported.

      Reinsurance Balances Receivable — One of the ways loss exposure is managed is through the use of reinsurance. While reinsurance arrangements are designed to limit losses and to permit recovery of a portion of direct unpaid losses, reinsurance does not relieve Castlewood Holdings or B.H. Acquisition of their liabilities to their insureds. Accordingly, loss reserves represent total gross losses, and reinsurance recoverable represents anticipated recoveries of a portion of those unpaid losses as well as amounts recoverable from reinsurers with respect to claims, which have already been paid.

      Goodwill — On January 1, 2002, Castlewood Holdings and B.H. Acquisition adopted SFAS 142. This statement requires that goodwill be assessed for impairment on at least an annual basis. In determining goodwill, Castlewood Holdings must determine the fair values of the assets of an acquired company. The determination of fair value necessarily involves many assumptions. Fair values of reinsurance assets and liabilities acquired are derived from probability weighted ranges of the associated projected cash flows, based on actuarially prepared information and management run-off strategy. Fair value adjustments are based on the estimated timing of loss and loss adjustment expense payments and an assumed interest rate, and are amortized over the estimated payout period, as adjusted for accelerations on commutation settlements, using the constant yield method options. If the assumptions made in initially valuing the assets change significantly in the future, Castlewood Holdings may be required to record impairment charges which could have a material impact on the financial statements.

      Castlewood Holdings assessed its recorded goodwill in 2005 in accordance with SFAS 142 and determined that there had been no impairment in its carrying value.

      SFAS 142 also requires that negative goodwill be reversed immediately. During 2004, Castlewood Holdings took negative goodwill into earnings upon the acquisition of three companies, and presented it as an extraordinary gain.

Recent Developments

      In December 2005, Castlewood Holdings and Shinsei signed definitive agreements for the purchase of Aioi Europe, a London-based subsidiary of Aioi Insurance Company, Limited. The aggregate purchase price to be paid for Aioi Europe is £62 million (approximately $108 million), with £50 million in cash upon the closing of the transaction and £12 million in the form of a promissory note, payable twelve months from the date of the closing. The acquisition will be effected through Hillcot, a Bermuda-based company, which is jointly owned by Castlewood Holdings and Shinsei. Castlewood Holdings’ commitment is proportionate to its 50.1% ownership percentage to Hillcot. Subject to regulatory approval, the acquisition is expected to be

completed during the first quarter of 2006. J. Christopher Flowers (“Mr. Flowers”), a member of the Company’s board of directors and the Company’s largest shareholder, is a director and the largest shareholder of Shinsei.

      In February 2006, the Company announced that it approved a commitment of up to $25.0 million in J.C. Flowers II LP (the “J.C. Flowers Fund”), a private investment fund to be formed by J.C. Flowers & Co. LLC. The transaction is expected to close in the second quarter of 2006. The Company intends to use cash on hand to fund its commitment.

      In March 2006, the Company announced that its partially owned equity affiliate, Castlewood Holdings, approved a commitment of up to $75.0 million in the J.C. Flowers Fund. Castlewood Holdings intends to use cash on hand to fund its commitment.

      J.C. Flowers & Co. LLC is controlled by Mr. Flowers. No fees will be payable by the Company or Castlewood Holdings to J.C. Flowers II LP, J.C. Flowers & Co. LLC, or Mr. Flowers in connection with the Company’s or Castlewood Holdings’ investment in the J.C. Flowers Fund.

Liquidity and Capital Resources

      The Company’s primary uses of liquidity include, but are not limited to, funding normal operating expenses as well as various expenses incurred in connection with the Company’s search for one or more suitable acquisitions. In addition, the Company uses cash on hand to fund commitments made in connection with the purchase of its partially owned equity affiliates and other investment opportunities. The primary sources of the Company’s liquidity include the receipt of dividends and distributions from partially owned equity affiliates.

      Net cash used in operating activities was approximately $2.0 million in 2005 compared to net cash provided by operating activities of approximately $8.6 million in 2004. This decrease was primarily due to the substantial reduction in distributions from partially owned equity affiliates from 2004 to 2005. The Company received distributions of $11,000 in 2005 from Affirmative Investment compared to distributions of approximately $7.2 million from Green Tree and a $3.0 million dividend from Castlewood Holdings in 2004.

      Net cash used in investing activities was approximately $25.6 million for 2005. During 2005 the Company funded capital contributions to Affirmative Investment of approximately $8.4 million and invested approximately $3.5 million in NIB Partners. In addition, the Company purchased marketable securities for approximately $9.5 million. These amounts were partially offset by the receipt of approximately $11.2 million in proceeds from the sale of marketable securities. The Company also purchased approximately $15.5 million of certificates of deposit in excess of maturities.

      Net cash provided by investing activities was approximately $32.9 million for 2004 and consisted primarily of proceeds received from the sale of Green Tree. In July 2004, the JCF CFN Entities, along with certain affiliates of J.C. Flowers I LP, completed the sale of their entire interests in Green Tree. In exchange for their entire interests, the JCF CFN Entities received aggregate sales proceeds of approximately $40.0 million in cash. The proceeds received by the JCF CFN Entities at completion of the sale were reduced by cash distributions of approximately $7.2 million made by Green Tree in 2004 prior to the completion of the sale.

      Net cash used in financing activities was approximately $15.6 million in 2004. During 2004, approximately $16.1 million was distributed to Castlewood Holdings as the minority interest portion of the approximately $40.0 million in distributions received from Green Tree. This amount was partially offset by the receipt of $555,000 from the exercise of certain stock options in May 2004. There were no cash flows from financing activities during 2005.

      The Company’s assets, aggregating approximately $185.2 million at December 31, 2005, include approximately $54.0 million in cash and cash equivalents and approximately $19.7 million in short-term certificates of deposit. The Company believes its current liquidity is adequate to fund any foreseeable cash requirements including its $25.0 million commitment in the J.C. Flowers Fund.

Contractual Obligations and Commitments

      In December 2004, the Company signed a one year lease beginning January 1, 2005 on an office building at 401 Madison Avenue, Montgomery, Alabama which serves as the corporate headquarters. The lease also provides renewal options for three periods of one year each. In December 2005, the Company signed a one year renewal option beginning January 1, 2006. Additionally, pursuant to an oral agreement, the Company leases space in a warehouse at 703 Howe Street, Montgomery, Alabama on a month-to-month basis. The Company leases the office building and warehouse space from unaffiliated third parties for $3,000 and $350 per month, respectively. The Company believes the rental amounts are competitive with market rates and that the cancellation or termination of either of these leases would not have a material adverse effect on the Company’s results of operations. In September 2005, the Company entered into an agreement with J.C. Flowers & Co. LLC continuing through October 2014 for the use of certain office space and administrative services from J.C. Flowers & Co. LLC for monthly payments of $4,146. Either party may, at its option with or without cause, terminate this agreement upon thirty (30) days prior written notice to the other party. J.C. Flowers & Co. LLC is managed by Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. The Company does not own any real property. Including payments made to J.C. Flowers & Co. LLC, the Company incurred rent expense in the amount of $77,000, $80,000 and $80,000 for the three years ended December 31, 2005, 2004 and 2003, respectively.

      In February 2006, the Company announced that it approved a commitment of up to $25.0 million in the J.C. Flowers Fund, a private investment fund to be formed by J.C. Flowers & Co. LLC. The transaction is expected to close in the second quarter. The Company intends to use cash on hand to fund its commitment.

      In March 2006, the Company announced that its partially owned equity affiliate, Castlewood Holdings, approved a commitment of up to $75.0 million in the J.C. Flowers Fund. Castlewood Holdings intends to use cash on hand to fund its commitment.

      J.C. Flowers & Co. LLC is controlled by J. Christopher Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. No fees will be payable by the Company or Castlewood Holdings to J.C. Flowers II LP, J.C. Flowers & Co. LLC, or J. Christopher Flowers in connection with the Company’s investment in the J.C. Flowers Fund.

Results of Operations

      Interest income was approximately $2.3 million in 2005 compared to $983,000 in 2004. Interest income was earned from cash, cash equivalents and certificates of deposit. Interest income increased substantially during 2005 as a result of the receipt of approximately $24.0 million in proceeds from the sale of Green Tree in July 2004, which caused the Company’s average cash and certificate of deposit balance to be approximately $79.4 million in 2005 compared to $74.5 million in 2004. In addition, interest rates earned on the Company’s cash, cash equivalents and certificates of deposit increased during 2005 as evidenced by federal funds interest rate increases of 3.25% from June 2004 through December 2005.

      Other investment income of approximately $1.8 million in 2005 resulted from gains on the sale of certain marketable securities from June through December 2005 and the receipt of dividends on those marketable securities.

      Earnings of partially owned equity affiliates were approximately $26.5 million in 2005 compared to $8.3 million in 2004. The Company recorded equity in earnings of $59,000 and $118,000 from B.H. Acquisition in 2005 and 2004, respectively. The Company recorded equity in earnings of approximately $26.3 million in 2005 from Castlewood Holdings compared to approximately $4.0 million in 2004. The Company recorded equity in earnings from Affirmative Investment of $120,000 for the period from July 1 to December 31, 2005 (the Company made its initial capital contribution to Affirmative Investment on July 1, 2005). The Company reported equity in earnings of approximately $4.3 million from Green Tree for the period from January 1 to July 15, 2004 (the Company sold its entire interest in Green Tree in July 2004). The Company’s reported income was reduced by approximately $3.0 million in 2004 to reflect Castlewood

Holdings’ minority interest in Green Tree. Also in 2004, the Company reported income of approximately $4.4 million, net of income taxes, as its proportionate share of the excess of the net assets acquired over the cost in the acquisition of Mercantile, Harper and Longmynd by Castlewood Holdings. For further discussion of the reasons underlying the changes in earnings of partially owned equity affiliates, see “— Results of Operations — Partially Owned Equity Affiliates”.

      In 2004, the Company recorded a gain on the sale of its entire interest in Green Tree of approximately $6.9 million. There were no sales of partially owned equity affiliates during 2005.

      Other income was $402,000 in 2005 compared to $498,000 in 2004. These amounts include a quarterly investment advisory fee of $100,000 from Castlewood Holdings and B.H. Acquisition for each of the four quarters in 2005 and 2004.

      General and administrative expenses were approximately $3.1 million and approximately $3.0 million in 2005 and 2004, respectively. Of these amounts, approximately $1.3 million, including non-cash compensation of $33,000 in 2004, related to employee expenses in both 2005 and 2004, respectively. General and administrative expenses also include legal and professional fees as well as travel expenses incurred in connection with the Company’s search for one or more additional operating companies. Additionally, the Company incurs legal and professional fees in connection with reporting requirements associated with being a publicly traded company, and in connection with handling various other accounting and tax matters. Legal and professional fees and travel expenses were approximately $1.2 million and approximately $1.0 in 2005 and 2004, respectively.

      Income tax expense was approximately $8.9 million and approximately $4.8 million in 2005 and 2004, respectively. The effective tax rate for 2005 differed from the statutory rate primarily due to changes in the valuation allowance related to deferred tax assets and changes in tax contingencies. The Company’s effective tax rate for 2004 approximated the statutory rates.

      Consolidated net income was approximately $19.0 million in 2005 compared to approximately $10.4 million in 2004. The increase in net income for 2005 compared to 2004 is primarily a result of an increase in earnings from partially owned equity affiliates of approximately $18.2 million, an increase in interest income of approximately $1.4 million, the inclusion of other investment income of approximately $1.8 million in 2005 and the lack of any reduction for minority interest, which was approximately $3.0 million in 2004. This increase was partially offset by the gain on sale of partially owned equity affiliates of approximately $6.9 million and the extraordinary gain, net of income taxes, of approximately $4.4 million, both of which occurred in 2004.

      Interest income was $983,000 in 2004 compared to $821,000 in 2003. Interest income was earned from cash, cash equivalents and certificates of deposit. Interest income increased during 2004 as a result of the receipt of approximately $24.0 million in July 2004, representing the Company’s share of proceeds from the sale of Green Tree. In addition, interest rates earned on the Company’s cash, cash equivalents and certificates of deposit increased during the last quarter of 2004.

      Earnings of partially owned equity affiliates were approximately $8.3 million in 2004 compared to $15.9 million in 2003. The Company recorded equity in earnings of $118,000 and $293,000 from B.H. Acquisition in 2004 and 2003, respectively. The Company recorded equity in earnings of approximately $4.0 million in 2004 from Castlewood Holdings compared to approximately $9.6 million in 2003. The Company’s equity in earnings from B-Line was approximately $1.7 million in 2003 (the Company sold its entire interest in B-Line in December 2003). The Company reported equity in earnings of approximately $4.3 million from Green Tree for the period from January 1 to July 15, 2004 (the Company sold its entire interest in Green Tree in July 2004) compared to approximately $4.2 million for the period from June 23 to December 31, 2003 (the Company made its investment in Green Tree in June 2003). The Company’s reported income was reduced by approximately $3.0 million and approximately $1.1 million in 2004 and 2003, respectively, to reflect Castlewood Holdings’ minority interest in Green Tree. In addition, the Company

reported income of approximately $4.4 million, net of income taxes, as its proportionate share of the excess of the net assets acquired over the cost in the acquisition of Mercantile, Harper and Longmynd by Castlewood Holdings. For further discussion of the reasons underlying the changes in earnings of partially owned equity affiliates, see “— Results of Operations — Partially Owned Equity Affiliates”.

      In July 2004, the JCF CFN Entities completed the sale of their entire interests in Green Tree. In exchange for their entire interest, the JCF CFN Entities received aggregate sales proceeds of approximately $40 million in cash. Of this amount, Castlewood Holdings received aggregate sales proceeds of approximately $16 million. The proceeds received by the JCF CFN Entities at completion of the sale were reduced by prior cash distributions of approximately $7.2 million made by Green Tree during 2004. The Company recorded a gain of approximately $6.9 million on the sale. In December 2003, the Company sold its entire interest in B-Line for approximately $7.8 million in cash, resulting in a gain of approximately $3.3 million.

      Other income was $498,000 in 2004 compared to $484,000 in 2003. These amounts include a quarterly investment advisory fee of $100,000 from Castlewood Holdings and B.H. Acquisition for each of the four quarters in 2004 and 2003.

      General and administrative expenses were approximately $3.0 million and approximately $3.1 million in 2004 and 2003, respectively. Of these amounts, approximately $1.3 million and $1.4 million, including non-cash compensation, related to employee expenses in 2004 and 2003, respectively. General and administrative expenses also include legal and professional fees as well as travel expenses incurred in connection with the Company’s search for one or more additional operating companies. Additionally, the Company incurs legal and professional fees in connection with reporting requirements associated with being a publicly traded company, and in connection with handling various other accounting and tax matters. Legal and professional fees and travel expenses were approximately $1.0 million and $950,000 in 2004 and 2003, respectively.

      Income tax expense was approximately $4.8 million and approximately $3.0 million in 2004 and 2003, respectively. The Company’s effective tax rate for 2004 approximated the statutory rate. The effective tax rate for 2003 differed from the statutory rate primarily due to changes in the valuation allowance related to deferred tax assets.

      Consolidated net income was approximately $10.4 million in 2004 compared to approximately $13.2 million in 2003. The change in net income for 2004 compared to 2003 is primarily a result of a decrease in earnings from partially owned equity affiliates of approximately $7.5 million, an increase in the gain on sale of partially owned equity affiliates of approximately $3.7 million, an increase in income taxes of approximately $1.8 million, an increase in minority interest of approximately $1.9 million and an increase from the extraordinary gain, net of income taxes, of approximately $4.4 million.

Results of Operations — Partially Owned Equity Affiliates

      Since a substantial portion of the Company’s results of operations are comprised of the results of operations of Castlewood Holdings and B.H. Acquisition, we have provided the following additional summary information with respect to those companies’ results of operations. This discussion and analysis should be read in conjunction with the audited consolidated financial statements of the partially owned equity affiliates and related notes that are included in this Annual Report.

      Castlewood Holdings earned consulting fees of approximately $22.0 million and $23.7 million for the years ended December 31, 2005 and 2004, respectively. Castlewood Holdings generates its consulting fees based on a combination of fixed and success-based fee arrangements. Consulting income will vary depending on the success and timing of completion of success-based fee arrangements. Included in these amounts were approximately $1.3 million in consulting fees charged to B.H. Acquisition, a related party, in both 2005 and 2004.

      Net investment income, including realized gains and losses, for the year ended December 31, 2005 increased $19.0 million to $29.5 million compared to $10.5 million for the year ended December 31, 2004. The increase was attributable to having a larger average cash and investment balance in 2005 ($913.9 million) versus 2004 ($446.8 million) and the increase in investment yield in the year. The average investment return on the cash and fixed maturities investments for the year ended December 31, 2005 was 3.1% compared to the average return of 2.3% for the year ended December 31, 2004.

      Net reduction in loss and loss adjustment expense liabilities for the years ended December 31, 2005 and 2004 was $96.0 million and $13.7 million, respectively. The net reduction in loss and loss adjustment expense liabilities for both 2005 and 2004 was attributable to the reduction in estimates of ultimate losses that arose from commutations, policy buy-backs and settlement of losses in the year below carried reserves and the resulting reductions in actuarial estimates of losses incurred but not reported.

      Salaries and benefits, which include accrued bonuses, were $40.8 million and $26.3 million for the years ended December 31, 2005 and 2004, respectively. Castlewood Holdings is a service based company and, as such, employee salaries and benefits are its largest cost. Castlewood Holdings has in place a discretionary bonus plan. Included as part of the salary cost is an accrual relating to this plan. The increase in 2005 compared to 2004 was primarily due to an increased number of employees and an increase in the bonus accrual.

      General and administrative expenses were $11.0 million and $10.7 million for the years ended December 31, 2005 and 2004, respectively. General and administrative expenses include rent and rent related costs, professional fees (legal, investment, audit and actuarial) and travel expenses. Castlewood Holdings operates in both the UK and Bermuda, and staff travel frequently in connection with Castlewood Holdings’ search for acquisition opportunities and in the general management of the business.

      Castlewood Holdings has recorded a foreign exchange loss of $4.6 million compared to a foreign exchange gain of $3.7 million in 2004. Through its subsidiaries, Castlewood Holdings conducts business in a variety of foreign (non-U.S.) currencies, the principal exposures being Euros and British pounds. At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of Castlewood Holdings are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the year. The resulting exchange gains or losses are included in net income. The loss in the current year arose as a result of Castlewood Holdings having surplus British pounds and Euro’s at various points in the year. For 2004, the foreign exchange gain arose primarily as a result of the Company disposing of its surplus Swiss Franc cash balances.

      Castlewood Holdings’ share of equity in earnings of partly-owned companies for the years ended December 31, 2005 and 2004, was $192,000 and $6.9 million, respectively. The 2005 amount represents Castlewood Holdings’ proportionate share of equity in the earnings of B.H. Acquisition and Cassandra Equity (Cayman) LP. The 2004 amount also included Castlewood Holdings’ proportionate share of earnings of the JCF CFN Entities.

      Income taxes of $914,000 and $1.9 million were recorded for the years ended December 31, 2005 and 2004, respectively. Under current Bermuda law, Castlewood Holdings and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Castlewood Holdings and its Bermuda subsidiaries have received an undertaking from the Bermuda government that, in the event of income or capital gains taxes being imposed, Castlewood Holdings and its Bermuda subsidiaries will be exempted from such taxes until the year 2016. United Kingdom subsidiaries record income taxes based on their graduated statutory rates, net of tax benefits arising from tax loss carryforwards.

      Castlewood Holdings has recorded a minority interest in earnings of $9.7 million and $3.1 million in 2005 and 2004, respectively, reflecting the remaining 49.9% economic interest in the earnings from Hillcot.

      Castlewood Holdings reported consolidated net earnings of approximately $80.7 million in 2005 compared to approximately $38.3 million in 2004. The increase in 2005 from 2004 was primarily a result of an increase in investment income and a decrease in loss and loss adjustment expense liabilities offset by

higher salaries and benefits costs, a foreign exchange loss and in 2004, the recording of $21.8 million in negative goodwill.

      Castlewood Holdings earned consulting fees of approximately $23.7 million and $24.7 million for the years ended December 31, 2004 and 2003, respectively. Castlewood Holdings generates its consulting fees based on a combination of fixed and success-based fee arrangements. Consulting income will vary depending on the success and timing of completion of success-based fee arrangements. Included in these amounts were approximately $1.3 million in consulting fees charged to B.H. Acquisition, a related party, in both 2004 and 2003.

      Net investment income, excluding unrealized gains and losses, for the years ended December 31, 2004 and 2003, was $10.5 million and $7.1 million, respectively. The increase was attributable to the combination of the acquisition of Harper Insurance Limited’s investment portfolio of $536.9 million in October 2004 and the increase in the investment yield during 2004. In addition, in 2003, Castlewood Holdings recognized a realized loss on derivative instruments of $862,000.

      Net reduction in loss and loss adjustment expense liabilities for the years ended December 31, 2004 and 2003 was $13.7 million and $24.0 million, respectively. The net reduction in loss and loss adjustment expense liabilities for both 2004 and 2003 was attributable to the settlement of losses for amounts below carried reserve balances and the re-evaluation of required insurance reserves for loss and loss adjustment expenses in its subsidiaries. This re-evaluation was made based on an independent actuarial review.

      Salaries and benefits, which include accrued bonuses, were $26.3 million and $15.7 million for the years ended December 31, 2004 and 2003, respectively. Castlewood Holdings is a service based company and, as such, employee salaries and benefits are its largest cost. Castlewood Holdings has in place a discretionary bonus plan. Included as part of the salary cost is an accrual relating to this plan. The increase in 2004 compared to 2003 was primarily due to an increased number of employees, the implementation of an employee share plan and a reduction in the 2003 bonus accrual due to a change in methodology adopted in that year.

      General and administrative expenses were $10.7 million and $7.0 million for the years ended December 31, 2004 and 2003, respectively. General and administrative expenses include rent and rent related costs, professional fees (legal, investment, audit and actuarial) and travel expenses. Castlewood Holdings operates in both the UK and Bermuda, and staff travel frequently in connection with Castlewood Holdings’ search for acquisition opportunities and in the general management of the business.

      Castlewood Holdings has recorded foreign exchange gains of $3.7 million and $2.4 million for the years ended December 31, 2004 and 2003, respectively. Through its subsidiaries, Castlewood Holdings conducts business in a variety of foreign (non-U.S.) currencies, the principal exposures being Euros and British pounds. At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of Castlewood Holdings are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the year. The resulting exchange gains or losses are included in net income. The foreign exchange gain in 2004 arose primarily as a result of the Company disposing of its surplus Swiss Franc cash balances obtained as part of the Harper acquisition. For 2003, the gain was attributable to the company disposing of its British pound available for sale investment portfolio.

      Castlewood Holdings’ share of equity in earnings of partly-owned companies for the years ended December 31, 2004 and 2003, was $6.9 million and $1.6 million, respectively. This amount represents Castlewood Holdings’ proportionate share of equity in the earnings of B.H. Acquisition and JCF CFN in 2004 and 2003 and Cassandra in 2004.

      Income taxes of $1.9 million and $1.5 million were recorded for the years ended December 31, 2004 and 2003, respectively. Under current Bermuda law, Castlewood Holdings and its Bermuda subsidiaries are not required to pay taxes in Bermuda on either income or capital gains. Castlewood Holdings and its Bermuda

subsidiaries have received an undertaking from the Bermuda government that, in the event of income or capital gains taxes being imposed, Castlewood Holdings and its Bermuda subsidiaries will be exempted from such taxes until the year 2016. United Kingdom subsidiaries record income taxes based on their graduated statutory rates, net of tax benefits arising from tax loss carryforwards.

      Castlewood Holdings has recorded a minority interest in earnings of $3.1 million and $5.1 million in 2004 and 2003, respectively, reflecting the remaining 49.9% economic interest in the earnings from Hillcot.

      Negative goodwill of $21.8 million was recorded for the year ended December 31, 2004. This amount represents the excess of the fair value of net assets acquired of $26.2 million over the cost of $4.4 million in the acquisition of Mercantile, Harper and Longmynd. This excess has, in accordance with SFAS 141 “Business Combinations,” been recognized as an extraordinary gain in 2004. The fair values of the reinsurance assets and liabilities acquired are derived from probability weighted ranges of the associated projected cash flows, based on actuarially prepared information and management run-off strategy. Any amendment to the fair values resulting from changes in such information or strategy will be recognized when they occur.

      Castlewood Holdings reported consolidated net earnings of approximately $38.3 million in 2004 compared to approximately $30.6 million in 2003. The increase in 2004 from 2003 was primarily a result of an extraordinary gain of $21.8 million in 2004, partially offset by a substantial increase in the loss and loss adjustment expense liabilities and a substantial increase in salaries and benefit expense.

      Net investment income for the year ended December 31, 2005 was $2.4 million compared to $1.5 million for the year ended December 31, 2004. Investment income consists primarily of interest income earned from cash, cash equivalents and investments. The increase in net investment income in 2005 was attributable to an increase in the average cash balances along with an increase in interest rates in the year.

      B.H. Acquisition reported a net increase in loss and loss adjustment expense liabilities of $552,000 for the year ended December 31, 2005 compared to a decrease of $428,000 for the year ended December 31, 2004.

      General and administrative expenses were $2.3 million for the year ended December 31, 2005 compared to $2.8 million for the year ended December 31, 2004. General and administrative expenses include professional fees (legal, audit and actuarial), management and consulting expenses, and provisions for doubtful accounts. The decrease in 2005 compared to 2004 was primarily a result of a decrease in legal fees.

      B.H. Acquisition recorded foreign exchange losses of $67,000 and $142,000 for the years ended December 31, 2005 and 2004, respectively. Through its subsidiaries, B.H. Acquisition conducts business in a variety of foreign (non-U.S.) currencies, the principal exposures being Euros and British pounds. At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of B.H. Acquisition are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the years. The resulting exchange gains or losses are included in net income.

      Amortization of the run-off provision was $667,000 and $1.3 million for the years ended December 31, 2005 and 2004, respectively. The Company established a provision at the date of acquisition equal to the anticipated expenses to be incurred over the expected life of the run-off. This provision is amortized on a straight-line basis over this period. In 2005 an additional provision of $667,000 was established and the expected life of the run-off was extended one year.

      Net earnings for the year ended December 31, 2005 were $179,000 compared to $359,000 for the year ended December 31, 2004.

      Net investment income for the year ended December 31, 2004 was $1.5 million compared to $1.3 million for the year ended December 31, 2003. Investment income consists primarily of interest income earned from cash, cash equivalents, debt securities and mutual funds. The increase in net investment income in 2004 was attributable to an increase in interest rates earned on the cash, cash equivalents and investments.

      B.H. Acquisition reported a net decrease in loss and loss adjustment expense liabilities of $428,000 for the year ended December 31, 2004 compared to a increase of $230,000 for the year ended December 31, 2003.

      General and administrative expenses were $2.8 million for the year ended December 31, 2004 compared to $1.6 million for the year ended December 31, 2003. General and administrative expenses include professional fees (legal, audit and actuarial), management and consulting expenses, and provisions for doubtful accounts. In 2003, there was an adjustment to the provision for doubtful accounts associated with reinsurance recoverables of $693,000, resulting in a reduction to general and administrative expenses in that year. There was no such adjustment in 2004. The remaining increase in general and administrative expenses for 2004 was mainly a result of increased legal and audit fees.

      B.H. Acquisition recorded a foreign exchange loss of $142,000 for the year ended December 31, 2004 compared to a gain of $927,000 for the year ended December 31, 2003. Through its subsidiaries, B.H. Acquisition conducts business in a variety of foreign (non-U.S.) currencies, the principal exposures being Euros and British pounds. At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency of B.H. Acquisition are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the years. The resulting exchange gains or losses are included in net income. In 2004, B.H. Acquisition made an attempt to more closely match its foreign currency exposure, resulting in a small loss for the year. For 2003, the gain generated was attributable to B.H. Acquisition having a surplus Euro position at various points during the year.

      Amortization of the run-off provision was $1.3 million and $500,000 for the years ended December 31, 2004 and 2003, respectively. The Company established a provision at the date of acquisition equal to the anticipated expenses to be incurred over the expected life of the run-off. This provision is amortized on a straight-line basis over this period. In 2003 an additional provision of $2.1 million was established and the expected life of the run-off was extended two years.

      Net earnings for the year ended December 31, 2004 were $359,000 compared to $888,000 for the year ended December 31, 2003.

Related Party Transactions

      In 2002, the Company entered into an investment advisory agreement with Castlewood Holdings and B.H. Acquisition for an annual fee of $400,000. This amount is included in other income in the Company’s consolidated statements of income for each of the three years ended December 31, 2005.

      During 2003, the Company invested approximately $15.3 million in the JCF CFN Entities. In July 2004, the JCF CFN Entities completed the sale of their entire interest in Green Tree for aggregate sales proceeds of approximately $40 million in cash. Of this amount, Castlewood Holdings’ aggregate sales proceeds were approximately $16 million. The proceeds received by the JCF CFN Entities at completion of the sale were reduced by prior cash distributions of approximately $7.2 million made by Green Tree during 2004. The Company recorded a pre-tax realized gain of approximately $6.9 million on the sale. Each of the JCF CFN Entities is controlled by JCF Associates I LLC, the managing member of which is Mr. Flowers. No fees were paid by the Company or will be payable by the Company to J.C. Flowers I LP, JCF Associates I LLC, or Mr. Flowers in connection with the Company’s investment in JCF CFN. In March 2003, Castlewood Holdings and Shinsei completed the acquisition of all of the outstanding capital stock of Toa-UK, a London-based company, for approximately $46 million. The acquisition was effected through Hillcot, a newly formed Bermuda company, in which Castlewood Holdings has a 50.1% economic interest and a 50% voting interest. Upon completion of the transaction, Toa-UK’s name was changed to Hillcot Re Limited. Hillcot is included

in Castlewood Holdings’ consolidated financial statements, with the remaining 49.9% economic interest reflected as minority interest. Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder, is a director of Shinsei.

      During 2004, Castlewood Holdings, through one of its subsidiaries, invested a total of approximately $9.1 million in Cassandra for a 27% interest. Cassandra was formed to invest in equity shares of a publicly traded international reinsurance company. J.C. Flowers I LP also owns a 27% interest in Cassandra. J.C. Flowers I LP is a private investment fund, the general partner of which is JCF Associates I LLC. Mr. Flowers is the managing member of JCF Associates I LLC. In March 2005, Cassandra sold all of its holdings for total proceeds of approximately $40.0 million. Castlewood Holdings’ proportionate share of the proceeds was approximately $10.8 million.

      In June 2005, the Company committed to contribute up to $10 million for a 14%, non-voting interest in Affirmative Investment LLC (“Affirmative Investment”), a newly formed Delaware limited liability company. J.C. Flowers I LP committed the capital necessary for the remaining 86% interest in Affirmative Investment. Both J.C. Flowers I LP and Affirmative Associates LLC, the managing member of Affirmative Investment, are controlled by Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. As of December 31, 2005, the Company has funded capital contributions of approximately $8.3 million.

      In September 2005, the Company entered into an agreement with J.C. Flowers & Co. LLC continuing through October 2014 for the use of certain office space and administrative services from J.C. Flowers & Co. LLC for monthly payments of $4,146. Either party may, at its option with or without cause, terminate this agreement upon thirty (30) days prior written notice to the other party.

      In December 2005, the Company invested approximately $3.5 million in New NIB Partners LP (“NIB Partners”), a newly formed Province of Alberta limited partnership, in exchange for an approximately ..2% limited partnership interest. Castlewood Holdings, through two of its wholly-owned subsidiaries, also invested approximately $24.5 million in NIB Partners for an approximately 1.4% interest. NIB Partners was formed for the purpose of purchasing, together with certain affiliated entities, 100% of the outstanding share capital of NIBC N.V. (formerly, NIB Capital N.V.) and its affiliated (“NIBC”). NIBC is a merchant bank focusing on the mid-market segment in northwest Europe with a global distribution network.

      New NIB Partners and certain related entities are indirectly controlled by New NIB Limited, an Irish corporation. Mr. Flowers is a director of New NIB Limited and is on the supervisory board of NIBC. Certain affiliates of J.C. Flowers I LP also participated in the acquisition of NIBC.

      In December 2005, Castlewood Holdings and Shinsei signed definitive agreements for the purchase of Aioi Europe, a London-based subsidiary of Aioi Insurance Company, Limited. The aggregate purchase price to be paid for Aioi Europe is £62 million (approximately $108 million), with £50 million in cash upon the closing of the transaction and £12 million in the form of a promissory note, payable twelve months from the date of the closing. The acquisition will be effected through Hillcot, a Bermuda-based company, which is jointly owned by Castlewood Holdings and Shinsei. Castlewood Holdings’ commitment is proportionate to its 50.1% ownership percentage in Hillcot. Subject to regulatory approval, the acquisition is expected to be completed during the first quarter of 2006. Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder, is a director of Shinsei.

      Also in December 2005 JCF Re Holdings LP (“JCF Re”), a Cayman Limited partnership, entered into a subscription and shareholders agreement with Fitzwilliam (SAC) Insurance Limited (“Fitzwilliam”), a wholly owned subsidiary of Castlewood Holdings, for the establishment of a segregated cell and paid approximately $1.9 million to Fitzwilliam as capital and contributed surplus. During 2005, Fitzwilliam booked management fees of $40,000 from JCF Re.

      In February 2006, the Company announced that it approved a commitment of up to $25.0 million in J.C. Flowers II LP (the “J.C. Flowers Fund”), a private investment fund to be formed by J.C. Flowers & Co. LLC. The transaction is expected to close in the second quarter of 2006. The Company intends to use cash on hand to fund its commitment.

      In March 2006, the Company announced that its partially owned equity affiliate, Castlewood Holdings, approved a commitment of up to $75.0 million in the J.C. Flowers Fund. Castlewood Holdings intends to use cash on hand to fund its commitment.

      J.C. Flowers & Co. LLC is controlled by J. Christopher Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. No fees will be payable by the Company or Castlewood Holdings to J.C. Flowers II LP, J.C. Flowers & Co. LLC, or J. Christopher Flowers in connection with the Company’s or Castlewood Holdings’ investment in the J.C. Flowers Fund.

Forward-Looking Statements

      Certain statements made in this report, and other written or oral statements made by or on behalf of the Company, may constitute “forward-looking statements” under the federal securities laws. Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on beliefs and assumptions of our management, which in turn are based on currently available information. The forward-looking statements also involve risks and uncertainties, which could cause actual results to differ materially from those contained in any forward-looking statement. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements. These factors include, without limitation, those set forth in Item 1A. “Risk Factors.”

      We believe these forward-looking statements are reasonable. However, you should not place undue reliance on any forward-looking statements, which are based on current expectations. Furthermore, forward-looking statements reflect information as of the date they are made, and we undertake no obligation to publicly update them in light of new information or future events.

      The Company is exposed to market risk from changes in interest rates. At December 31, 2005, the Company had cash and cash equivalents of approximately $54.0 million in interest bearing accounts (interest at floating rates) and approximately $19.7 million of short-term certificates of deposit (interest at fixed rates). Accordingly, each one percent change in market interest rates would change interest income by approximately $737,000 per year. However, any future transactions affecting the Company’s cash and cash equivalents and certificates of deposit will change this estimate. Additionally, although interest rate changes would affect the fair value of the Company’s certificates of deposits, the weighted average original term of certificates held by the Company at December 31, 2005 was approximately five months. The short-term nature of these certificates limits the Company’s risk of changes in the fair value of these certificates.

      The Company is also exposed to three types of market risk through its holdings in partially owned equity affiliates and their subsidiaries: interest rate risk, foreign currency risk and credit risk.

      The portfolios of fixed income securities of Castlewood Holdings and B.H. Acquisition are exposed to interest rate risk. Fluctuation in interest rates have a direct impact on the market valuation of these securities. In general, the fair market value of a portfolio of fixed income securities increases or decreases inversely with changes in market interest rates. Castlewood Holdings and B.H Acquisition attempt to manage this interest rate risk by monitoring the duration and structure of their investment portfolios relative to the duration and structure of their liability portfolios.

      Foreign currency risk is the risk that the Company will incur economic losses due to adverse changes in foreign currency exchange rates. Castlewood Holdings and B.H. Acquisition conduct business in a variety of foreign (non-U.S.) currencies, the principal exposures being in Euros and British pounds. Assets and liabilities denominated in foreign currencies are exposed to risk stemming from changes in currency exchange rates. These entities attempt to manage their exposure to foreign currency exchange risk by broadly matching assets against liabilities. Exchange rate fluctuations impact the Company’s and its partially owned equity affiliates’ reported consolidated financial condition, results of operations and cash flows from year to year.

      Castlewood Holdings and B.H. Acquisition are also exposed to credit risk on losses recoverable from reinsurers. These companies’ credit risk exposure was assumed at the time they acquired various subsidiaries. They manage this risk by conducting a detailed review of each potential acquisition’s reinsurance portfolio during the due diligence process.

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

      The Enstar Group, Inc.’s (the “Company’s”) management is responsible for establishing and maintaining adequate internal control over financial reporting. Pursuant to the rules and regulations of the Securities and Exchange Commission, internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that:

      Management has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2005 based on the control criteria established in a report entitled Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on such evaluation, we have concluded that the Company’s internal control over financial reporting is effective as of December 31, 2005.

      The independent registered public accounting firm of Deloitte & Touche LLP, as auditors of the Company’s consolidated financial statements, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting, which report is included herein.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

     The Enstar Group, Inc.:

      We have audited management’s assessment, included in the accompanying Management Report on Internal Control over Financial Reporting, that The Enstar Group, Inc. and Subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

      We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

      A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

      We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2005 and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for the year then ended, and our report dated March 16, 2006 expressed an unqualified opinion on those financial statements.

/s/ Deloitte & Touche LLP

Birmingham, Alabama

March 16, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

     The Enstar Group, Inc.:

      We have audited the accompanying consolidated balance sheets of The Enstar Group, Inc. and Subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits. We did not audit the 2003 financial statements of Green Tree Investment Holdings II, LLC and Green Tree Investment Holdings III, LLC, the Company’s investment in which is accounted for by use of the equity method. The Company’s interest of $4,235,824 in Green Tree Investment Holdings II, LLC and Green Tree Investment Holdings III, LLC’s net income for the year ended December 31, 2003, is included in the accompanying consolidated financial statements. The 2003 financial statements of Green Tree Investment Holdings II, LLC and Green Tree Investment Holdings III, LLC were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for such companies, is based solely on the reports of such other auditors.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.

      In our opinion, based on our audits and the report of other auditors such consolidated financial statements present fairly, in all material respects, the financial position of The Enstar Group, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

      We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 16, 2006 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

      As discussed in Note 2, the accompanying notes to the consolidated financial statements have been restated.

/s/ Deloitte & Touche LLP

Birmingham, Alabama
March 16, 2006
(September 18, 2006 as to the effects of the restatement discussed in Note 2)

REPORT OF INDEPENDENT AUDITORS

The Members

Green Tree Investment Holdings II, LLC

      We have audited the accompanying consolidated balance sheet of Green Tree Investment Holdings II, LLC (the Company) as of December 31, 2003, and the related consolidated statements of operations, members’ equity, and cash flows for the period from March 26, 2003 (inception) through December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2003, and the consolidated results of its operations and its cash flows for the period from March 26, 2003 (inception) through December 31, 2003, in conformity with accounting principles generally accepted in the United States.

/s/ Ernst & Young LLP

Minneapolis, Minnesota
February 13, 2004

REPORT OF INDEPENDENT AUDITORS

The Members

Green Tree Investment Holdings III, LLC

      We have audited the accompanying consolidated balance sheet of Green Tree Investment Holdings III, LLC (the Company) as of December 31, 2003, and the related consolidated statements of operations, members’ equity, and cash flows for the period from May 20, 2003 (inception) through December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

      We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2003, and the consolidated results of its operations and its cash flows for the period from May 20, 2003 (inception) through December 31, 2003, in conformity with accounting principles generally accepted in the United States.

/s/ Ernst & Young LLP

Minneapolis, Minnesota

February 13, 2004

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

The accompanying notes are an integral part of the consolidated financial statements.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

      The Enstar Group, Inc. and Subsidiaries, (“Enstar” or the “Company”), is a publicly traded company engaged in the operation of several equity affiliates in the financial services industry. Enstar also continues its active search for one or more additional operating businesses which meet its acquisition criteria.

      The Company, through the operations of its partially owned equity affiliates, Castlewood Holdings Limited (“Castlewood Holdings”) and B.H. Acquisition Limited (“B.H. Acquisition”), and their subsidiaries, acquires and manages insurance and reinsurance companies in run-off. The management of these businesses includes claims administration, adjustment and settlement together with the collection of reinsurance recoveries. Castlewood Holdings, a Bermuda-based company, also provides management, consulting and other services to the insurance and reinsurance industry for both fixed and success-based fee arrangements. In general, reinsurance is an arrangement in which the reinsurer agrees to indemnify an insurance or reinsurance company against all or a portion of the risks underwritten by such insurance or reinsurance company under one or more insurance or reinsurance contracts.

      The Company consolidates JCF CFN LLC and related entities (collectively, the “JCF CFN Entities”). The JCF CFN Entities were formed to serve as members of Green Tree Investment Holdings LLC (formerly known as CFN Investment Holdings LLC) and related entities (collectively, “Green Tree”), which, in turn, were formed to effect the acquisition of a portfolio of home equity and manufactured housing loan securities and the associated servicing businesses from Conseco Finance Corp. (“Conseco Finance”). In July 2004, the JCF CFN Entities completed the sale of their entire interest in Green Tree and since that time have been inactive. See Note 5 for further discussion of this transaction.

      Subsequent to the issuance of the Company’s consolidated financial statements for the year ended December 31, 2005, the consolidated financial statements of the Company’s partially owned equity affiliates, Castlewood Holdings and B.H. Acquisition, were restated to reflect certain reclassifications described below. As a result of these restatements, the Company has restated certain disclosures in the notes to the consolidated financial statements relating to financial information of Castlewood Holdings and B.H. Acquisition. These restatements had no impact on the net income, net income per share or shareholders’ equity of Enstar or its partially owned equity affiliates.

      The reclassifications made by Castlewood Holdings and B.H. Acquisition were between certain line items of income and expenses on their respective consolidated statements of earnings. Underwriting income, previously included in income, was renamed “Net reduction in loss and loss adjustment expense liabilities” and reclassified as an expense item. In addition, Castlewood Holdings’ net foreign exchange loss (gain) was also reclassified from income to expense. These reclassifications are reflected in the Company’s consolidated financial statements in Note 5(f) “Partially Owned Equity Affiliates Summarized Financial Information” and Note 12 “Segment Information.”

      (a) Principles of Consolidation — The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Enstar Financial Services, Inc. and Enstar Group Operations, Inc, both of which are currently inactive. In addition, the Company consolidates the JCF CFN Entities, recording a minority interest in its financial statements for Castlewood Holdings’ 40% interest. All significant intercompany balances and transactions have been eliminated in consolidation.

      (b) Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The estimates susceptible to significant change are those related to the valuation allowance for deferred tax assets and loss and loss adjustment expenses included in earnings of partially owned equity affiliates.

      (c) Cash Equivalents — Cash equivalents consist of short term, highly liquid investments with original purchased maturities of three months or less.

      (d) Partially Owned Equity Affiliates — Partially owned equity affiliates are accounted for under the equity method of accounting. Equity method investments are recorded at cost and are adjusted periodically to recognize the Company’s proportionate share of the affiliate’s income or loss, additional contributions made and dividends and capital distributions received. In the event any of the partially owned equity affiliates were to incur a loss and the Company’s cumulative proportionate share of the loss exceeded the carrying amount of the equity method investment, application of the equity method would be suspended and the Company’s proportionate share of further losses would not be recognized until the Company committed to provide further financial support to the affiliate. The Company would resume application of the equity method once the affiliate becomes profitable and the Company’s proportionate share of the affiliate’s earnings equals the Company’s cumulative proportionate share of losses that were not recognized during the period the application of the equity method was suspended.

      (e) Property and Equipment — Property and equipment, which consists of leasehold improvements and furniture and fixtures, is stated at cost less accumulated depreciation and is depreciated using the straight line method over the estimated useful lives of the related assets, principally 3 to 7 years. Property and equipment is included in other assets in the Company’s consolidated balance sheets. Property and equipment was immaterial as of December 31, 2005 and 2004.

      (f) Financial Instruments — The Company holds certificates of deposit (“CDs”) offered by commercial banks. These certificates had a weighted average maturity of approximately five months at December 31, 2005. The estimated fair value of CDs at December 31, 2005 and 2004, based on interest rates available on CDs of comparable amounts, maturities, and credit quality, was approximately equal to their carrying values.

      (g) Income Taxes — The Company computes deferred tax assets and liabilities based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts that are more likely than not to be realized.

      (h) Comprehensive Income — The Company reports comprehensive income in accordance with Statement of Financial Accounting Standards (“SFAS”) 130, “Reporting Comprehensive Income” which defines comprehensive income as certain changes in equity from non-owner sources. The Company recorded other comprehensive income from its partially owned equity affiliates. This other comprehensive income arose from unrealized holding gains and losses from debt and equity securities that are classified as available-for-sale and are carried at fair value, unrealized gains on hedge assets and currency translation adjustments resulting from the translations of financial information of subsidiaries into U.S. dollars.

      The components of accumulated other comprehensive income are as follows:

      (i) Deferred Compensation of Partially Owned Equity Affiliates — The Company records its proportionate share of deferred compensation reported by Castlewood Holdings, one of its partially owned equity

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

affiliates. The deferred compensation arises from stock based compensation awards entered into with certain senior employees of Castlewood Holdings.

      (j) Recent Accounting Pronouncements — In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FIN 46R issued in December 2003, which requires consolidation by a business enterprise of variable interest entities (“VIE”) if the enterprise is determined to be the primary beneficiary. This interpretation was effective for new variable interests created or obtained after January 31, 2003 and for periods beginning after June 15, 2003 for variable interests that were acquired before February 1, 2003. The Company believes that each of the JCF CFN Entities qualifies as a VIE and that the Company is the primary beneficiary of each such entity. As such, the JCF CFN Entities are included in the accompanying consolidated financial statements, with Castlewood Holdings’ 40% interest in the JCF CFN Entities reflected as a minority interest in the Company’s financial statements. The JCF CFN Entities have been inactive since the sale of their entire interests in Green Tree in July 2004.

      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). SFAS 123R supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and amends SFAS No. 95, “Statement of Cash Flows.” The approach in SFAS 123R generally is similar to the approach described in SFAS 123. However, SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the earnings statements based on their grant date fair values. Pro forma disclosure will no longer be an alternative.

      The Company adopted SFAS 123R as of January 1, 2006 using the modified-prospective method. Under this transition method, compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date. As permitted by SFAS 123, through December 31, 2005 the Company accounted for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally has not recognized compensation cost for employee stock options. We estimate that 2006 pretax compensation expense for stock options will be approximately $213,000.

      SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as previously required. This requirement will reduce net operating cash flows and increase net financing cash flows. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when stock options will be exercised), the amounts of operating cash flows recognized in prior periods for such excess tax deductions were $0 and $606,000 in 2005 and 2004, respectively.

      (k) Revenue Recognition — Revenue includes interest income earned from cash, cash equivalents and certificates of deposit, the Company’s proportionate share of earnings from partially owned equity affiliates, gains on sales of marketable securities and other income. Interest income is recorded when earned. The Company’s proportionate share of earnings from partially owned equity affiliates is recorded as such earnings are recognized by the partially owned equity affiliate with the exception of B-Line LLC (“B-Line”). Prior to its sale of B-Line in the fourth quarter of 2003, the Company accounted for its investment in B-Line three months in arrears.

      (l) Stock-Based Compensation  — For the three years ended December 31, 2005, the Company utilized various stock-based compensation plans for the benefit of non-employee directors and certain officers. In 1997, the Company adopted the Deferred Compensation and Stock Plan for Non-Employee Directors and a long-term incentive program made up of three stock option/ incentive plans. Additionally, in 2001, the Company adopted the 2001 Outside Directors’ Stock Option Plan (the “2001 Directors’ Plan”) and amended certain

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

provisions of an existing plan. The Company accounts for these plans under the intrinsic value recognition and measurement principles of APB 25 and related interpretations. Compensation expense for the Deferred Compensation and Stock Plan for Non-Employee Directors is recognized at the first of every quarter for retainer fees and upon the occurrence of various Board of Director and committee meetings. There is no compensation expense recognized in net earnings for grants under stock option/incentive plans that had an exercise price equal to the market value of the Company’s underlying common stock on the date of grant. In connection with options granted in November 2001, the market value of the Company’s common stock on the date of grant exceeded the exercise price, resulting in a charge to earnings for that year. In addition, compensation expense was recognized over the vesting life of these options through June 2004. Had compensation costs for grants under the Company’s stock option/incentive plans been determined based on the fair value recognition provision of SFAS 123, “Accounting for Stock-Based Compensation,” the Company’s pro forma net income and net income per share for 2005, 2004 and 2003 would have been as follows:

      The pro forma stock-based employee compensation reflected above is based on the application of Emerging Issues Task Force No. 00-23, “Issues Related to the Accounting for Stock Compensation Under APB 25 and FASB Interpretation No. 44,” to the straight-line vesting of such awards over the full vesting period.

      The fair values for options granted under the Company’s stock option plans were calculated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:

      Based on these assumptions, the estimated weighted average fair value at the date of grant for options vesting during the years ended December 31, 2005, 2004 and 2003 were $9.50, $5.15 and $5.14, respectively.

      (m) Other Income — Other income includes $400,000 for each of the three years ended December 31, 2005 in investment advisory fees charged to Castlewood Holdings and BH Acquisition, partially owned equity affiliates of the Company.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      (n) Currency Translation Adjustment — The Company records foreign currency translation adjustments as its portion of other comprehensive income from its partially owned equity affiliates. Through their subsidiaries, Castlewood Holdings and B.H. Acquisition conduct business in a variety of foreign (non-U.S.) currencies, the principal exposures being Euros and British pounds. At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency are adjusted to reflect the current exchange rate. Revenue and expense items are translated into U.S. dollars at average rates of exchange for the year. The resulting exchange gains or losses are included in net income.

      In June 2005, the Company purchased certain shares of common stock in a publicly-traded U.S. corporation for approximately $9.5 million. The Company sold these securities for total proceeds of approximately $11.2 million, resulting in a realized gain of approximately $1.8 million. This gain is included in other investment income in the Company’s consolidated statements of income.

      (a) B.H. Acquisition — In July 2000, the Company, through B.H. Acquisition, a joint venture with Castlewood Limited (“Castlewood”) and an entity controlled by Trident II, L.P. (“Trident”), acquired as an operating business two reinsurance companies, Brittany Insurance Company Ltd. (“Brittany”) and Compagnie Europeenne d’Assurances Industrielles S.A. (“CEAI”). Brittany and CEAI are principally engaged in the active management of books of reinsurance business from international markets. The Company owns 50% of the voting stock and a 33% economic interest in B.H. Acquisition. Castlewood owns 33% of the voting stock and a 45% economic interest in B.H. Acquisition. The Company’s ownership in B.H. Acquisition is accounted for using the equity method of accounting.

      (b) Castlewood Holdings Limited — In November 2001, the Company, together with Trident and the shareholders and senior management of Castlewood (the “Castlewood Principals”), completed the formation of a new venture, Castlewood Holdings, to acquire and manage insurance and reinsurance companies, including companies in run-off (insurance and reinsurance companies that have ceased the underwriting of new policies), and to provide management, consulting and other services to the insurance and reinsurance industry (the “Castlewood Holdings Transaction”). The Company owns 50% of the voting stock of Castlewood Holdings and the Castlewood Principals and Trident each own 25% of Castlewood Holdings’ voting stock. The Company owns a 32.63% economic interest in Castlewood Holdings. Castlewood is a private Bermuda-based firm, experienced in managing and acquiring reinsurance operations. The Company’s ownership in Castlewood Holdings is accounted for using the equity method of accounting.

      As a result of this transaction, the Company’s 33% direct economic interest in B.H. Acquisition increased by an additional indirect economic interest through Castlewood Holdings. At December 31, 2005, the Company’s beneficial ownership in B.H. Acquisition was 47.68%. The Company’s combined voting interest in B.H. Acquisition is limited to 50%.

      In conjunction with the closing of the Castlewood Holdings Transaction, a wholly owned subsidiary of Castlewood Holdings completed the acquisition of two reinsurance companies in run-off, River Thames Insurance Company Limited (“River Thames”), based in London, England, and Overseas Reinsurance Corporation Limited (“Overseas Reinsurance”), based in Bermuda (collectively, the “River Thames Transaction”). The total purchase price of River Thames and Overseas Reinsurance was approximately $15.2 million.

      In August 2002, Castlewood Holdings purchased Hudson Reinsurance Company Limited (“Hudson”), a Bermuda-based company, for approximately $4.1 million. Hudson reinsured risks relating to property, casualty and workers’ compensation, on a worldwide basis, and is now administering the run-off of its claims.

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Also in 2002, Castlewood Holdings capitalized Fitzwilliam (SAC) Insurance Limited (“Fitzwilliam”), a wholly owned subsidiary. Fitzwilliam, based in Bermuda, offers specialized reinsurance protections to related companies, clients of Castlewood Holdings and other third-party companies.

      In March 2003, Castlewood Holdings and Shinsei Bank, Limited (“Shinsei”) completed the acquisition of all of the outstanding capital stock of The Toa-Re Insurance Company (UK) Limited (“Toa-UK”), a London-based subsidiary of The Toa Reinsurance Company, Limited, for approximately $46 million. Toa-UK underwrote reinsurance business throughout the world between 1980 and 1994, when it stopped writing new business and is currently operating in run-off. The acquisition was effected through Hillcot Holdings Ltd. (“Hillcot”), a newly formed Bermuda company, in which Castlewood Holdings has a 50.1% economic interest and a 50% voting interest. Upon completion of the transaction, Toa-UK’s name was changed to Hillcot Re Limited. Hillcot is included in Castlewood Holdings’ consolidated financial statements, with the remaining 49.9% economic interest reflected as minority interest. J. Christopher Flowers (“Mr. Flowers”), a member of the Company’s board of directors and the Company’s largest shareholder, is a director and the largest shareholder of Shinsei. Castlewood Holdings’ results of operations include the results of Toa-UK from the date of acquisition in March 2003.

      In August 2004, Castlewood Holdings implemented an employee stock-based compensation plan. The plan allows for the award of Castlewood Holdings’ Class D non-voting shares to certain senior employees up to a maximum of 7.5% of the total issued share capital of Castlewood Holdings. As a result of awards made in 2005 and 2004, the Company’s economic interest in Castlewood Holdings of 33¹/3% has been diluted by 0.70% to 32.63% as of December 31, 2005. As awarded shares vest and as additional shares are awarded in the future, the Company’s economic interest could decrease to a minimum of 30.83%. The Company’s voting interest will remain at 50%.

      During 2004, Castlewood Holdings, through one of its subsidiaries, invested a total of approximately $9.1 million in Cassandra Equity LLC and Cassandra Equity (Cayman) LP, (collectively, “Cassandra”), for a 27% interest in each. Cassandra was formed to invest in equity shares of a publicly traded international reinsurance company. J.C. Flowers I LP also owned a 27% interest in Cassandra. J.C. Flowers I LP is a private investment fund, the general partner of which is JCF Associates I LLC. Mr. Flowers is the managing member of JCF Associates I LLC. In March 2005, Cassandra sold all of its holdings for total proceeds of approximately $40.0 million. Castlewood Holdings’ proportionate share of the proceeds was approximately $10.8 million.

      Also during 2004, Castlewood Holdings, through one of its subsidiaries, completed the acquisition of Mercantile Indemnity Company Ltd., Harper Insurance Limited and Longmynd Insurance Company Ltd. for a total purchase price of approximately $4.5 million. Castlewood Holdings recorded an extraordinary gain of approximately $21.8 million relating to the excess of the fair value of the net assets acquired over the cost of these acquisitions.

      In May 2005, Castlewood Holdings, through one of its subsidiaries, purchased Fieldmill Insurance Company Limited (formerly known as Harleysville Insurance Company (UK) Limited) for approximately $1.4 million.

      In December 2005, Castlewood Holdings and Shinsei signed definitive agreements for the purchase of Aioi Insurance Company of Europe Limited (“Aioi Europe”), a London-based subsidiary of Aioi Insurance Company, Limited. Aioi Europe has underwritten general insurance and reinsurance business in Europe for its own account until 2002 when it generally ceased underwriting, and placed into run-off, its general insurance and reinsurance business. The aggregate purchase price to be paid for Aioi Europe is £62 million (approximately $108 million), with £50 million in cash upon the closing of the transaction and £12 million in the form of a promissory note, payable twelve months from the date of the closing. The acquisition will be effected through Hillcot, a Bermuda-based company, which is jointly owned by Castlewood Holdings and

THE ENSTAR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Shinsei. Subject to regulatory approval, the acquisition is expected to be completed during the first quarter of 2006.

      (c) B-Line — The Company owned membership units of B-Line from November 1998 to December 2003. Based in Seattle, Washington, B-Line provides services to credit card issuers and other holders of similar receivables. B-Line also purchases credit card receivables and recovers payments on these accounts. In December 2003, the Company sold its entire interest in B-Line to B-Line Holdings LLC, an affiliate of Golden Gate Capital, for cash of approximately $7.8 million, net of expenses, resulting in a pre-tax gain of approximately $3.3 million.

      (d) Green Tree — During 2003, the Company funded approximately $15.3 million to the JCF CFN Entities in exchange for a 60% interest in such entities. In addition, Castlewood Holdings funded approximately $10.2 million to the JCF CFN Entities in exchange for a 40% interest.

      The JCF CFN Entities invested in Green Tree together with affiliates of J.C. Flowers I LP, affiliates of Fortress Investment Group LLC and affiliates of Cerberus Capital Management, L.P. In June 2003, the JCF CFN Entities invested approximately $25.1 million in exchange for a 3.995% interest in Green Tree. Green Tree completed the purchase of certain assets of Conseco Finance for approximately $630 million in cash plus certain assumed liabilities. The assets consisted primarily of a portfolio of home equity and manufactured housing loan securities as well as the associated servicing businesses. J.C. Flowers I LP is a private investment fund, the general partner of which is JCF Associates I LLC. The managing member of JCF Associates I LLC is Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. The JCF CFN Entities accounted for the investment in Green Tree under the equity method of accounting. Because the JCF CFN Entities are consolidated, Green Tree was treated as a partially owned equity affiliate of the Company.

      In July 2004, the JCF CFN Entities, along with certain affiliates of J.C. Flowers I LP, completed the sale of their entire interests in Green Tree to FIT CFN Holdings LLC, an affiliate of Fortress Investment Group LLC, and Cerberus Green Tree Investments, LLC and Cerberus JCF Coinvest, LLC, each an affiliate of Cerberus Capital Management L.P. In exchange for their entire interest, the JCF CFN Entities received aggregate sales proceeds of approximately $40 million in cash. Of this amount, Castlewood Holdings received aggregate sales proceeds of approximately $16 million. The proceeds received by the JCF CFN Entities at completion of the sale were reduced by prior cash distributions of approximately $7.2 million made by Green Tree during 2004. The Company recorded a pre-tax realized gain of approximately $6.9 million on the sale.

      (e) Affirmative Investment LLC — In June 2005, the Company committed to contribute up to $10 million for a 14%, non-voting interest in Affirmative Investment LLC (“Affirmative Investment”), a newly formed Delaware limited liability company. J.C. Flowers I LP committed the capital necessary for the remaining 86% interest in Affirmative Investment. Both J.C. Flowers I LP and Affirmative Associates LLC, the managing member of Affirmative Investment, are controlled by Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. In July 2005, the Company funded its initial capital contribution of approximately $2.6 million. Since that time, the Company has funded additional capital contributions of approximately $5.7 million. At December 31, 2005, the Company’s total investment in Affirmative Investment was approximately $8.5 million, including equity in earnings from July 1 to December 31, 2005. The Company’s ownership in Affirmative Investment is accounted for using the equity method of accounting.

      Also in June 2005, Affirmative Investment acquired 1,183,000 shares of common stock of Affirmative Insurance Holdings, Inc. (“Affirmative Insurance”), through open market purchases. In August, Affirmative Investment acquired 50% of the membership interests of New Affirmative LLC (“NAL”), a newly formed Delaware limited liability company, for approximately $40.7 million in cash and the 1,183,000 shares of Affirmative Insurance. The remaining 50% of the membership interests of NAL were acquired by Delaware

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Street Capital Master Fund, LP or its affiliates (“DSC”) for approximately $37.5 million in cash and 1,459,699 shares of Affirmative Insurance common stock. In turn, NAL, pursuant to a Stock Purchase Agreement with Vesta Insurance Group, Inc. (“VIG”) and Vesta Fire Insurance Corporation, a subsidiary of VIG (together with VIG, “Vesta”), acquired from Vesta an aggregate of 5,218,228 shares of Affirmative Insurance common stock for a purchase price of $15.00 per share. Upon the closing of the transaction with Vesta and the transfer of the shares of Affirmative Insurance from Affirmative Investment and DSC, NAL’s ownership percentage in Affirmative Insurance was approximately 52.9%. Affirmative Investment’s ownership in NAL is accounted for using the equity method of accounting. Affirmative Investment accounts for its investment in NAL three months in arrears.

      (f) Summarized Financial Information — In accordance with APB No. 18, “The Equity Method of Accounting for Investments in Common Stock”, the Company prepared summarized financial information for B.H. Acquisition and Castlewood Holdings as of December 31, 2005 and 2004 and for each of the three years ended December 31, 2005. Summarized financial information for Affirmative Investment is presented as of December 31, 2005 and for the period from June 30, 2005 (date of formation) through December 31, 2005. Summarized financial information for Green Tree for 2004 is presented for the period from January 1 to July 15. The information for 2003 is presented as of December 31 and for the period from June 23 to December 31 (Green Tree was acquired in June 2003 and sold in July 2004). Summarized financial information for B-Line is presented for the period from January 1, 2003 through December 23, 2003 (date of sale). The summarized financial information presented below for B.H. Acquisition and Castlewood Holdings is derived from their audited financial statements. The summarized financial information presented below for Affirmative Investment is derived from its 2005 unaudited financial statements. The summarized financial information presented below for Green Tree is derived from its 2003 audited financial statements and 2004 quarterly financial statements. Prior to the fourth quarter of 2003, the Company accounted for its investment in B-Line three months in arrears. In 2003, the Company recorded the results of operations of B-Line through the date of the sale. The summarized information presented below for B-Line has been derived from its unaudited quarterly financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company’s consolidated accumulated deficit includes undistributed earnings of its partially owned equity affiliates of approximately $52.6 million and approximately $26.1 million at December 31, 2005 and 2004, respectively.

      In December 2005, the Company invested approximately $3.5 million in New NIB Partners LP (“NIB Partners”), a newly formed Province of Alberta limited partnership, in exchange for an approximately .2% limited partnership interest. Castlewood Holdings, through two of its wholly-owned subsidiaries, also invested approximately $24.5 million in NIB Partners for an approximately 1.4% interest. NIB Partners was formed for the purpose of purchasing, together with certain affiliated entities, 100% of the outstanding share capital of NIBC N.V. (formerly, NIB Capital N.V.) and its affiliates (“NIBC”). NIBC is a merchant bank focusing on the mid-market segment in northwest Europe with a global distribution network. The Company’s investment in NIB Partners is accounted for at cost.

      New NIB Partners and certain related entities are indirectly controlled by New NIB Limited, an Irish corporation. Mr. Flowers is a director of New NIB Limited and is on the supervisory board of NIBC. Certain affiliates of J.C. Flowers I LP also participated in the acquisition of NIBC.

      In December 2004, the Company signed a one year lease beginning January 1, 2005 on an office building at 401 Madison Avenue, Montgomery, Alabama which serves as the corporate headquarters. The lease also provides renewal options for three periods of one year each. In December 2005, the Company signed a one year renewal option beginning January 1, 2006. Additionally, pursuant to an oral agreement, the Company leases space in a warehouse at 703 Howe Street, Montgomery, Alabama on a month-to-month basis. The Company leases the office building and warehouse space from unaffiliated third parties for $3,000 and

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

$350 per month, respectively. The Company believes the rental amounts are competitive with market rates and that the cancellation or termination of either of these leases would not have a material adverse effect on the Company’s results of operations. In September 2005, the Company entered into an agreement with J.C. Flowers & Co. LLC continuing through October 2014 for the use of certain office space and administrative services from J.C. Flowers & Co. LLC for monthly payments of $4,146. Either party may, at its option with or without cause, terminate this agreement upon thirty (30) days prior written notice to the other party. J.C. Flowers & Co. LLC is managed by Mr. Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. The Company does not own any real property. Including payments made to J.C. Flowers & Co. LLC, the Company incurred rent expense in the amount of $77,000, $80,000 and $80,000 for the three years ended December 31, 2005, 2004 and 2003, respectively.

      In February 2006, the Company announced that it approved a commitment of up to $25.0 million in J.C. Flowers II LP (the “J.C. Flowers Fund”), a private investment fund to be formed by J.C. Flowers & Co. LLC. The transaction is expected to close in the second quarter. The Company intends to use cash on hand to fund its commitment.

      J.C. Flowers & Co. LLC is controlled by J. Christopher Flowers, a member of the Company’s board of directors and the Company’s largest shareholder. No fees will be payable by the Company to J.C. Flowers II LP, J.C. Flowers & Co. LLC, or J. Christopher Flowers in connection with the Company’s investment in the J.C. Flowers Fund.

      The provision for income taxes consists of the following components:

      The reconciliation of income taxes computed at statutory rates to the actual tax provision is as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts reported for income tax purposes. The following items comprise the Company’s deferred taxes at December 31, 2005 and 2004:

      The Company provides U.S. taxes for the anticipated repatriation of certain earnings of foreign subsidiaries. Losses incurred by those foreign subsidiaries result in deferred tax assets. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income in the future in the appropriate jurisdictions. A valuation allowance is recorded when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has provided a valuation allowance for operating losses of partially owned foreign subsidiaries for the years 2005 and 2004, respectively. During 2005 and 2004, the Company changed the valuation allowance by approximately $(189,000) and $640,000, respectively to approximately $5.6 million and $5.8 million, respectively. During 2003, the Company decreased the valuation allowance by approximately $2.8 million to approximately $5.2 million to reflect the utilization of credits.

      The Company has established reserves for tax-related uncertainties based on its best estimates of whether, and the extent to which, additional taxes and interest will be due. These reserves are adjusted in light of changing facts and circumstances. At December 31, 2005, the accrual of $2.3 million for tax contingencies is reflected in accrued taxes on the balance sheet.

      (a) Share Purchase Rights Plan — In January 1997, the Board of Directors of the Company adopted a Share Purchase Rights Plan (the “Rights Plan”). The Rights Plan entitles shareholders to purchase one share of common stock for each outstanding share of common stock of the Company (a “Right”). Until the occurrence of a “Distribution Triggering Event” as described below, all future issuances of common stock by the Company will also carry the Rights. The Rights will have no dividend or voting rights and will expire on the tenth anniversary of their issuance unless exercised or redeemed prior to that time.

      Rights may not be exercised and are not detached from the common stock until ten days after the occurrence of a Distribution Triggering Event. The exercise price of the Rights is fixed at $40. The Rights generally are redeemable by the Board of Directors of the Company at a nominal price of $.01 per Right at any time prior to the time that they are detached from the common stock and separate certificates evidencing the Rights are delivered. As of December 31, 2005, no Rights were exercised.

      Distribution Triggering Events. Shortly after a person or group acquires beneficial ownership of a fifteen percent (15%) interest or announces its intention to commence a tender or exchange offer, the consummation

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of which would result in beneficial ownership of fifteen percent (15%) of the Company’s common stock (a “Distribution Triggering Event”), the Rights will separate from the common stock. Upon distribution of the Rights, they become exercisable and are transferable separately from the Company’s common stock. Each Right (other than Rights beneficially owned by the acquiror) is then immediately converted into the right to buy that number of shares of common stock of the Company (or in certain circumstances, shares of stock of the acquiring company) that has a market value of two times the exercise price of the Right.

      (b) Treasury Stock — In April 1998, the Company announced a stock repurchase program under which the Company could repurchase up to $5.0 million of its common stock in the open market at prices per share deemed favorable from time to time by the Company. The Company repurchased 54,525 shares of its common stock for approximately $815,000 as part of this plan. Through this plan and a similar plan completed in the first quarter of 1998, the Company has repurchased a total of 442,351 shares for approximately $5.8 million as of December 31, 2005.

      (c) Deferred Compensation of Partially Owned Equity Affiliates — The Company recorded its proportionate share of deferred compensation reported by Castlewood Holdings, one of its partially owned equity affiliates. The deferred compensation arose from stock based compensation awards entered into during 2002 with certain senior employees of Castlewood Holdings.

      (a) Deferred Compensation and Stock Plan for Non-Employee Directors — In September 1997, the Company adopted a Deferred Compensation and Stock Plan for Non-Employee Directors. The purposes of this plan are to enable the Company to attract and retain qualified persons to serve as non-employee directors, to solidify the common interests of its non-employee directors and shareholders by enhancing the equity interest of non-employee directors in the Company, and to encourage the highest level of non-employee director performance by providing such non-employee directors with a proprietary interest in the Company’s performance and progress by permitting non-employee directors to receive all or a portion of their retainer and meeting fees in common stock and to defer all or a portion of their retainer and meeting fees in stock units. Approximately $853,000 and $662,000 in stock compensation were deferred under this plan as of December 31, 2005, and 2004, respectively. In May 2004 Jeffrey S. Halis resigned from the Company’s board of directors. Upon his resignation, Mr. Halis was issued 12,156 shares of the Company’s common stock in connection with this plan, representing approximately $225,000 in deferred compensation.

      (b) Long-Term Incentive Program — In January 1997, the Company adopted a long-term incentive program made up of three stock option/incentive plans. Under the program, the Company established the 1997 Amended CEO Stock Option Plan (the “CEO Plan”), the 1997 Amended Outside Directors’ Stock Option Plan (the “1997 Directors’ Plan”), and the 1997 Amended Omnibus Incentive Plan (the “Incentive Plan”). In May 2001, the Company adopted the 2001 Directors’ Plan and amended certain provisions of the Incentive Plan. (Note 3).

      Under the CEO Plan, Nimrod T. Frazer, the Company’s Chief Executive Officer and Chairman, was granted options for 150,000 shares of common stock with an exercise price of $10.50 in 1997. The options granted under the CEO Plan vested in four equal installments of 37,500 options through January 1, 2000, and expire in January 2007.

      Under the 1997 Directors’ Plan, each of the Company’s four outside directors was granted options for 25,000 shares of common stock in 1997. The options have an exercise price of $10.8125 and vested in five equal installments of 5,000 options through January 1, 2001. The options granted under the 1997 Directors’ Plan expire in January 2007. In May 2004, Mr. Halis exercised options for 25,000 shares of the Company’s common stock at a total exercise price of approximately $270,000 in connection with this plan.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Incentive Plan was established for the benefit of key employees and directors and provides generally for stock appreciation awards, incentive stock options and nonqualified stock options. In March 2000, John J. Oros, the Company’s President and Chief Operating Officer, was granted options for 100,000 shares of common stock with an exercise price of $12.75. These options vested in three installments: 50,000 on March 2, 2001 and 25,000 each on March 2, 2002 and 2003. These options expire in February 2010.

      In connection with the consummation of the River Thames Transaction in November 2001, Messrs. Frazer and Oros were granted options under the Incentive Plan to purchase a total of 100,000 shares (50,000 per individual) at $18.00 per share. These options vested on various dates through July 2004 and will expire in June 2011. Since the market price per share of the Company’s common stock on the date of grant exceeded the exercise price, the Company recognized a charge to earnings in 2004 and 2003 of $19,000 and $95,000, respectively.

      In connection with the consummation of the Castlewood Holdings Transaction in November 2001, Messrs. Frazer and Oros were granted options under the Incentive Plan to purchase a total of 100,000 shares (50,000 per individual) at $19.25 per share. These options vested on various dates through July 2004 and will expire in September 2011. Since the market price per share of the Company’s common stock on the date of grant exceeded the exercise price, the Company recognized a charge to earnings in 2004 and 2003 of $14,000 and $71,000, respectively.

      Under the 2001 Directors’ Plan, the Company’s then current outside (non-employee) directors were each granted options in June 2001 for 15,000 shares of common stock with an exercise price of $18.90 per share. Options granted to each of the three outside directors under the plan vested in three equal installments of 5,000 shares in each of January 2002, January 2003 and January 2004. The options granted under this plan must be exercised no later than January 2011. In May 2004, Mr. Halis exercised options for 15,000 shares of the Company’s common stock at a total exercise price of approximately $284,000 in connection with this plan.

      In May 2003, the Company’s shareholders approved certain amendments to the Company’s Incentive Plan. The amendments increased the total number of shares of common stock available to be granted under the plan from 322,500 to 522,500, and increased the aggregate number of shares of common stock that may be granted to any individual participant from 200,000 to 300,000.

      In August 2003, under the Incentive Plan, the Company granted 60,000 options to Mr. Frazer, 100,000 options to Mr. Oros, and 5,000 options to Gregory L. Curl, a member of the Company’s board of directors. The options granted to Messrs. Frazer and Oros vest in four equal annual installments starting January 1, 2005. The options granted to Mr. Curl vested on August 19, 2004. All options have an exercise price of $40.00, the closing market price on the date of grant, and expire in August 2013.

      In April 2005, under the Incentive Plan, the Company granted 5,000 options to Paul J. Collins, a member of the Company’s board of directors. The options granted to Mr. Collins vest on April 4, 2006, have an exercise price of $57.81, the closing market price on the date of grant, and expire in April 2015.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Transactions under the Company’s stock option/incentive plans as of and for the three years ended December 31, 2005 are as follows: