<PAGE>
 
================================================================================
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                               ----------------
 
                                   FORM 10-K
 
 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
 
  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996  COMMISSION FILE NUMBER: 0-9628
                                      OR
 
 [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
 
  FOR THE TRANSITION PERIOD FROM [         ] TO [          ]
 
                               ----------------
 
                       ANCHOR PACIFIC UNDERWRITERS, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                DELAWARE                                 94-1687187
    (STATE OR OTHER JURISDICTION OF                   (I.R.S. EMPLOYER
     INCORPORATION OR ORGANIZATION)                  IDENTIFICATION NO.)

     1800 SUTTER STREET, SUITE 400                          94520
          CONCORD, CALIFORNIA                             (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 682-7707
 
                               ----------------
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
                                     None
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
                         Common stock, $.02 par value
 
  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 such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.    Yes [X]    No [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  [X]
 
  The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 14, 1997 was $2,726,333.
 
  As of March 14, 1997, the Registrant had 4,496,733 shares of common stock
outstanding.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Portions of the Proxy Statement to be mailed to stockholders in connection
with the Registrant's 1997 Annual Meeting of Stockholders are incorporated by
reference into Part III hereof.
 
  Exhibit Index is on page 19
 
================================================================================

<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS
 
SUMMARY
 
  Anchor Pacific Underwriters, Inc. is a Delaware corporation that is
primarily engaged in insurance brokerage and administration through its five
direct and indirect wholly-owned subsidiaries listed in the chart below.
Anchor Pacific Underwriters, Inc. and its subsidiaries are collectively
referred to as "Anchor" unless the context otherwise requires.
 
                       ANCHOR PACIFIC UNDERWRITERS, INC.
                           (a Delaware corporation)
                                Holding Company
                                       |
                                       |
________________________________________________________________________________
           |                           |                         |       
           |                           |                         |
    HARDEN & COMPANY       PUTNAM, KNUDSEN & WIEKING   ANCHOR PACIFIC PREMIUM
INSURANCE SERVICES, INC.  (a California corporation)       FINANCE COMPANY
      (a California           Property & Casualty           (a California
      corporation)                 Insurance                corporation)
    Employee Benefits     Targeted Industry Brokerage    Property & Casualty
      Administrator                                       Premium Financing
 Group Health Insurance
           | 
________________________
     |            |
  BENEFIT      PLANNED
 RESOURCES,     BENEFITS
    INC.       SERVICES,
(an Arizona      INC.
corporation)  (an Arizona
  Employee    corporation)
  Benefits     Insurance
Administrator  Brokerage
   Group
   Health
 Insurance
 
  Anchor provides the following services to private sector small and middle
market companies, groups, trusts, associations, government agencies and
individual consumers: (a) insurance brokerage; (b) third-party claims
administration, employee benefits consulting, underwriting and risk analysis;
and (c) insurance premium financing. Anchor offers its customers, as agent,
broker or administrator, a range of products and services tailored to the
specific needs of such customers.
 
  Anchor markets the products and services of more than 50 commercial
insurance companies and over a dozen managed care and preferred provider
organizations. The marketing of products and services is carried out through
16 direct sales representatives and over 500 independent insurance brokers.
Anchor's customer base is in the Western United States, primarily in
California and Arizona. For the fiscal year ended December 31, 1996, Anchor
generated $7.9 million in revenues.
 
  The principal executive offices of Anchor are located approximately 30 miles
east of San Francisco, California, at 1800 Sutter Street, Suite 400, Concord,
California 94520.
 
                                       2
<PAGE>
 
HISTORY
 
  Anchor was organized in 1986 as a California general partnership for the
specific purpose of acquiring Harden & Company Insurance Services, Inc., a
third-party employee benefits administrator ("Harden"), from Alex Brown
Financial Group. Anchor was reorganized as a private California corporation in
March 1987, and became a public reporting Delaware corporation in January
1995.
 
  Since its inception, Anchor has expanded its insurance and financial service
capabilities through internal growth as well as a series of acquisitions. From
1986 through 1990, Anchor, through Harden, focused on providing administrative
services for group insurance benefit plans. In 1990, Anchor began to diversify
its business by providing property, casualty and workers' compensation
insurance products and services, as well as offering market studies and
program analysis for certain non-profit associations who had endorsed Anchor's
products.
 
  From 1990 through 1992, Anchor expanded its property and casualty business
by: (a) acquiring certain assets, including insurance brokerage accounts, from
four property and casualty brokerage firms; and (b) organizing Anchor Pacific
Premium Finance Company, a California corporation ("APPFCO"), to complement
its property and casualty business by providing premium financing to Anchor's
clients. Anchor continued its expansion strategy by acquiring Benefit
Resources, Inc. ("BRI"), a third-party employee benefits administrator located
in Scottsdale, Arizona in August 1994; Putnam, Knudsen & Wieking, Inc.
("PKW"), a property and casualty insurance brokerage company located in
Oakland, California, in October 1994; certain third-party administration
accounts from Dutcher Insurance Agency, Inc. ("Dutcher"), located in Stockton,
California, in February 1995; R. L. Ferguson Agency ("RLF"), a property and
casualty insurance brokerage company located in Walnut Creek, California, in
March 1996; certain property and casualty accounts from Norman I. Robins
("Robins"), in April 1996; and certain property and casualty accounts from
John R. McPherson ("McPherson"), in May 1996. Anchor expects to continue to
expand its insurance brokerage and administration businesses and to explore
other complementary expansion opportunities.
 
  On January 6, 1995, Anchor merged with System Industries, Inc. ("System").
As a result of the merger, Anchor became a public company. For accounting
purposes, the merger has been treated as a recapitalization of Anchor with
Anchor as the acquirer (reverse acquisition). The historical financial
statements prior to January 6, 1995 are those of Anchor. These historical
financial statements have been restated to give effect to this
recapitalization. Upon consummation of this merger, shareholders of System
received one share of Anchor's common stock and one warrant to purchase one
share of Anchor common stock for every 42.3291 shares of issued and
outstanding System common stock. In addition, certain creditors of System were
to receive 5% of Anchor's common stock and one warrant to purchase one share
of Anchor common stock.
 
OPERATIONS
 
 Insurance Brokerage
 
  Anchor engages in the insurance brokerage business which was started in 1990
through an acquisition and has grown since then principally due to additional
acquisitions, the largest being PKW which was acquired in 1994. This segment
of Anchor's business focuses on property and casualty (both commercial and
personal lines), health, life and disability, as well as workers'
compensation. PKW acts as an agent on behalf of insurers and other
intermediaries in soliciting, negotiating and effecting contracts of
insurance, and as a broker in procuring insurance contracts on behalf of
insureds. Insurance brokerages tend to build long-term relationships with
their clients, with the initial placement of insurance coverage typically
resulting in subsequent annual renewals.
 
  As an insurance agent and broker, PKW derives income from the sale of
insurance products and services and the receipt of commissions generated
therefrom. Commissions, which generally are based on a percentage of gross
premiums, and contingent commissions, which are generally based on the
insurance carriers underwriting profits derived over a given period of time,
can vary substantially within the insurance industry. These commissions depend
on a number of factors, including the type of insurance, the amount of the
premium, the

                                      3
<PAGE>
 
insurance carrier's loss experience with respect to policies placed by Anchor,
and the scope of the services that Anchor renders. Anchor derived 43%, 40% and
27% of its revenues in 1996, 1995 and 1994, respectively, from its insurance
brokerage activities. Since it acquired PKW, Anchor has devoted a substantial
effort to the financial and management reorganization of this business segment
with particular emphasis on improving operating procedures which has resulted in
improved operating results.
 
 Third-Party Claims Administration and Employee Benefits Consulting
 
  The employee benefits business segment of Anchor is conducted through Harden
and BRI and primarily involves third-party health benefits administration
activities. This business segment engages in designing, implementing and
administering health benefit plans for employer groups of various sizes.
Administration services provided by Harden and BRI include receiving and
managing employer plan contributions and/or premium payments, monitoring
employee and dependent eligibility, preparing required government and tax
reports, handling day-to-day administration, reviewing and analyzing claims
data for coverage, and managing the claims settlement process. Anchor, through
Harden and BRI, also helps develop insurance products and services tailored to
the specific needs of the client, provides risk analysis, determines
appropriate benefit and funding levels for particular insurance programs, and
conducts loss control and cost studies for insurance companies and self-
insured employers. As compensation for its claims administration services,
Harden and BRI generally receive fees based on a percentage of premium
collected, or on a per capita basis. Anchor derived 57%, 59% and 72% of its
revenues in 1996, 1995 and 1994, respectively, from its third-party
administration activities.
 
  Fee revenues generated by Anchor in 1996 from third-party administration
services included revenues generated by Harden and BRI. A significant portion
of Harden and BRI fee revenues generated from new clients relate to an
insurance product underwritten by one insurance carrier, which is an A-
(Excellent) rated insurance carrier.
 
  Harden's third-party administration revenues are substantially derived from:
(a) an insurance product underwritten by two insurance carriers, which are
rated A+ (Superior) and A- (Excellent); and (b) the administration of
insurance programs underwritten by various insurance carriers for a number of
self-insured employers. The insurance product referred to in (a) above,
accounted for approximately 46% of Harden's revenues (or approximately 18% of
Anchor's total revenues) in 1996, and revenues related to the administration
self-insured programs accounted for 52% of Harden's revenues in 1996. Self-
insurance is a program in which a client assumes a manageable portion of its
insurance risks, usually (although not always) placing the less predictable
and larger loss exposure with an excess insurance carrier.
 
  The insurance company which offered the product that accounted for 65% of
Harden's third-party administration revenues in 1994 informed Harden that as a
result of changes in its business strategy, it was discontinuing to offer such
an insurance product by year end 1995. Harden then obtained a binding
commitment on July 20, 1995 from an A+ (Superior) rated insurance carrier to
underwrite the risk and provide a replacement product as of October 1, 1995.
The transition to the new carrier caused some clients to reevaluate their
insurance needs. In conjunction with this transition process, existing clients
were required to satisfy the new insurance carrier's underwriting
requirements. During the first quarter of 1996, one client who represented
approximately 9% of Harden's 1995 revenues (or 3.7% of Anchor's consolidated
revenues) was advised by the new insurance carrier that it did not meet its
underwriting standards. As a result of the transition to the new insurance
carrier, Harden experienced a near term loss of business accounts and
revenues.
 
  The A+ (Superior) rated insurance carrier, which provided the replacement
product as of October 1, 1995, informed Harden in the third quarter of 1996,
that as a result of changes in its business strategy, it would discontinue
offering such an insurance product by the end of February 1997. This product
had represented 39% of Harden and BRI's revenue and 22% of Anchor's total
revenue.

  As of October 31, 1996, Harden obtained a commitment from an A- (Excellent)
rated insurance carrier to underwrite the risk and provide a replacement
product effective December 1, 1996. Unlike the previous transition, management
believes that the transition to the new insurance carrier will be less
disruptive for Harden and BRI's
 
                                       4
<PAGE>
 
clients because the replacement insurance carrier will fully assume all policies
in California and the majority of policies in Arizona, thereby avoiding the loss
of accounts which Harden and BRI experienced earlier. The impact on Harden and
BRI's revenue is expected to be minimal.
 
  The new replacement insurance carrier is a subsidiary of the largest HMO in
Nevada. Management believes that the new insurance carrier will enable Anchor
to provide the small group medical insurance market with stronger managed care
components. The replacement insurance carrier's business strategy is to
aggressively market group health products in a multi-state distribution system
through an exclusive multi-year contract with Harden and BRI. The initial
reaction of the Harden and BRI distributors has been very favorable. Harden
and BRI began to receive revenues from this new business in January 1997.
 
 Insurance Premium Financing
 
  Anchor, through Anchor Pacific Premium Finance Company ("APPFCO"), in the
past has provided insurance premium financing services primarily to property
and casualty clients of PKW. During 1996, Anchor derived less than 1% of its
revenue from its insurance premium financing activities as compared to
approximately 1% in 1995 and 1994. This reduction in revenue was due primarily
to Anchor's placing a greater share of its premium financing through other
financing facilities that were more competitively advantageous to the client.
As a result of this continued reduction in revenue, management is reviewing
whether to close down these insurance premium financing services during 1997,
and in so doing, discontinue APPFCO operations.
 
RECENT DEVELOPMENTS/BUSINESS STRATEGY
 
  Anchor's strategy is to strengthen its core health insurance and property
and casualty (including workers' compensation) insurance businesses by: (a)
continuing to develop specialized affiliated business units that target
selected insurance industry market segments defined by industry type,
geographic location and consumer demographics; (b) establishing new products
and services; (c) strengthening management, sales and marketing staff; and (d)
seeking to acquire and integrate compatible insurance brokerage and
administration businesses in the Western United States. In connection with
this strategy, Anchor regularly considers acquisition opportunities. To date,
acquisitions by Anchor have involved both relatively small acquisitions of
insurance brokerage and administration accounts as well as larger acquisitions
of insurance brokerage companies, such as PKW, and third-party administrators,
such as BRI. Anchor expects to continue to pursue appropriate acquisition
opportunities, and believes that its status as a public company enhances its
ability to make acquisitions and continue its expansion strategy. Anchor
continues to engage in discussions with third parties regarding potential
acquisitions and mergers. As of March 14, 1997, it had entered into one letter
of intent with a third-party administration firm based in Fresno, California.
Management presently anticipates closing this acquisition in the second
quarter of 1997. There are no other pending acquisitions currently under
letter of intent. No assurances can be given with respect to the likelihood,
or financial or business effect, of any possible future acquisition or merger.
 
  As part of its strategy to create the premier regional publicly traded
insurance brokerage/administrator in the Western United States, Anchor has
sought to obtain additional momentum by using its publicly traded shares to
attract additional public and private financing. Such funding would be used to
finance future expansion of Anchor's insurance operations.
 
EMPLOYEES
 
  As of March 14, 1997, Anchor and its subsidiaries employed approximately 115
full-time employees. None of its employees is presently represented by a union
or covered by a collective bargaining agreement. Anchor believes its employee
relations are good.
 
REGULATION
 
  The activities of Anchor that are related to insurance brokerage, agency
services and third-party administration are subject to licensing and
regulation by the jurisdictions in which it conducts such activities. In

                                       5
<PAGE>
 
addition to regulatory requirements applicable to Anchor, most jurisdictions
require that individuals engaged in insurance brokerage and agency activities
be personally licensed. As a result, a number of Anchor's employees are so
licensed. Anchor's operations depend on the validity of and its continued good
standing under the licenses and approvals pursuant to which it operates.
Licensing laws and regulations vary from jurisdiction to jurisdiction. In all
jurisdictions, the applicable licensing laws and regulations are subject to
amendment or interpretation by regulatory authorities. Such authorities
generally are vested with broad discretion as to the granting, renewing, and
revoking of licenses and approvals.
 
  Other factors, such as client uncertainty about the effect of health care
reform, could also affect Anchor's business. Anchor believes that its
expertise in two areas frequently identified in health care reform proposals
(managed care and managed competition), combined with its strategy of serving
middle market clients, leave it well positioned to operate effectively in a
managed care and managed competition environment. Anchor also believes that in
the current political environment, the United States will experience
incremental, rather than sudden comprehensive changes in health care
regulations. It is not possible at this time, however, to predict the effect
that any future health care reform legislation will have on Anchor's business
condition or operations. Anchor is unaware of any current regulatory proposals
that could have any material effect on its liquidity, capital resources or
operations.
 
INFLATION
 
  Historically, inflation has impacted commission revenues by, among other
things, increasing property replacement costs and workers' compensation and
liability claims, thereby causing some clients to seek higher levels of
insurance coverage and, in turn, pay higher premiums. During the past several
years, the United States has experienced very rates of inflation along with
gradual business expansion. Consequently, inflation has had minimal impact on
insurance prices in the United States during the past several years.
 
COMPETITION
 
  The insurance brokerage and service business is highly competitive and there
are many insurance brokerage and service organizations who actively compete
with Anchor in every area of its business. Anchor competes directly with
national insurance brokerages, insurance companies and health maintenance
organizations that market their own products, through independent agencies,
brokers and third-party administrators, as well as with entities which self
insure or sponsor other insurance programs. Many of these competitors are
larger than Anchor and have greater resources. Anchor seeks to compete by
specializing in specific market segments, developing specialty products for
those markets, and maintaining relationships with consumers by providing
personal service normally associated with small local businesses, together
with the expertise, flexibility and diversity of products that can only be
provided by a larger broker. Anchor's claims administration operations compete
with independent claims administration firms and with similar operations
conducted by subsidiaries of large insurance companies and insurance brokerage
companies.
 
  Anchor believes it has several competitive advantages, including: (a) a
growing market share within its current operating territory as one of the top
twelve insurance firms in the Northern California Bay Area; (b) proven ability
to identify and close acquisitions; (c) a public equity currency; and (d) an
experienced management team whose operating philosophy is committed to
preserving and enhancing acquired companies' value.
 
                                       6
<PAGE>
 
ITEM 2. PROPERTIES
 
  Anchor leases approximately 32,099 rentable square feet of office space at
its executive offices at 1800 Sutter Street, Suite 400, Concord, California
94520. From November 1, 1994 through October 31, 1999, Anchor must pay rent of
$1.40 per rentable square foot per month (approximately $44,939 per month),
and from November 1, 1999 through October 31, 2004, Anchor must pay rent of
$1.75 per rentable square foot per month (approximately $56,173 per month).
Anchor also has an option to lease additional office space at its executive
offices in Concord.
 
  In addition to Anchor's leased space, PKW leases approximately 13,128
rentable square feet of office space in Oakland, California, and BRI leases
approximately 6,992 rentable square feet of office space in Scottsdale,
Arizona. PKW must pay rent of between $1.75 and $2.00 per rentable square foot
per month under its lease, which expires on November 30, 1999. Under its
lease, which expires on May 31, 2002, BRI must pay rent of between $0.84 and
$0.90 per rentable square foot per month, plus operating expenses. PKW
relocated its offices in December 1994 to Anchor's office space in Concord,
California and subleased its offices in Oakland. BRI relocated its offices on
February 28, 1997, when its prior lease expired.
 
  In May 1995 and December 1995, PKW entered into subleases with respect to
82% and 10%, respectively, of PKW's prior office space in Oakland. The
amounts, classified as short and long-term liabilities with respect to the PKW
leases, reflect the shortfall between sublease income to be received and PKW's
lease expense to be paid and are based upon the assumptions that: (a) the
subtenant in the May 1995, sublease will exercise its option to extend its
lease through 1999, and (b) the remaining 8% of such office space will be
subleased in 1997.
 
ITEM 3. LEGAL PROCEEDINGS
 
  Anchor and its subsidiaries are parties from time to time to various
lawsuits that arise in the normal course of business. Management is not aware
of any lawsuits to which Anchor or its subsidiaries is currently a party or to
which any property of Anchor or any of its subsidiaries is subject, which
might materially adversely affect the financial condition or results of
operations of Anchor.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  None.
 
EXECUTIVE OFFICERS OF THE REGISTRANT
 
  The following information is provided regarding certain executive officers
of Anchor and/or its subsidiaries.
 
<TABLE>
<CAPTION>
                                                                          HELD
 NAME                          AGE               POSITION                 SINCE
 ----                          ---               --------                 -----
 <C>                           <C> <S>                                    <C>
 James R. Dunathan...........   60 President, Chief Executive Officer     1987
                                   and Director
 Earl Wiklund................   49 Senior Vice President, Chief           1987
                                    Financial Officer, Secretary and
                                    Director
 Lynn A. Boyd................   52 President, Harden                      1996
 Donald B. Putnam............   64 Chairman of Executive Committee, PKW   1994
                                   and Director
 James P. Wieking............   65 Executive Vice President of PKW and    1994
                                   Director
</TABLE>
 
 
                                       7
<PAGE>
 
  JAMES R. DUNATHAN, President, Chief Executive Officer and Director. Mr.
Dunathan has over 38 years of experience in the insurance industry, including
eight years as an officer of an Ohio insurance company, 12 years as President
of an independent insurance holding company in Florida, seven years as Vice
President and General Manager of an insurance system software vendor and
several years as a sales and marketing consultant. He joined Harden in 1985
and initiated the formation of Anchor in late 1986. Mr. Dunathan served as a
member of the Board of Directors of the Professional Insurance Agents
Association for 11 years and as President of such Association from 1975 to
1976. Currently Mr. Dunathan serves on the Business Leaders Alliance for Contra
Costa County, appointed by the Board of Supervisors. Mr. Dunathan completed his
undergraduate studies at Ohio State University in 1954; and served actively in
the U.S. Navy until 1960 as a naval aviator while he continued graduate work at
the U.S. Armed Forces Institute in Japan. His family has been involved in the
insurance industry since 1880.
 
  EARL WIKLUND, Senior Vice President, Chief Financial Officer, Secretary and
Director. Mr. Wiklund is also the Chief Executive Officer of the Company's
Harden and BRI subsidiaries. He has over 25 years of experience in various
operational, administrative and financial management positions. Prior to
joining Harden in 1984, Mr. Wiklund's career included 10 years as
Controller/Treasurer of a retail chain of 165 stores in five western states
with $100 million in annual sales. In addition, he was Managing Director of a
large statewide non-profit trade association, representing the interests of
its members at the California State Legislature. Most recently he served as
Treasurer for the Independent Administrators Association, as member of the
Legislative Committee, as well as member of the Board of Directors of such
Association. Mr. Wiklund graduated from California State University,
Sacramento, with a B.S. degree and received his M.B.A. at St. Mary's College.
He also serves as Chairman of Anchor's Audit, Budget & Finance Committee.
 
  LYNN A. BOYD, CLU, CHFC, President, Harden. Mr. Boyd joined Harden in 1991.
He has over 25 years experience in the group health insurance field including
positions with Blue Cross, Clifton & Company, Curtis Day & Company and Sher
Associates. His sales responsibilities at Harden primarily focus on the
production of self-insured and large case fully insured accounts. Mr. Boyd
also is responsible for general oversight and management of the sales,
underwriting and administration departments of Harden and serves on the Harden
Executive Committee. He received his B.S. and B.A. degrees from the University
of Colorado and the University of Denver with majors in Finance and
Accounting.
 
  DONALD B. PUTNAM, CPCU, Director. Mr. Putnam is Chairman of the Executive
Committee of PKW. An insurance professional with over 38 years of experience,
Mr. Putnam has been actively involved as a director or officer of many
California insurance associations and served as Director of the National
Association of Insurance Brokers (NAIB) and Intersure, an international
affiliation of insurance brokers. He also recently served as Chairman of the
NAIB-PAC. Mr. Putnam is a Business School graduate from the University of
California, Berkeley.
 
  JAMES P. WIEKING, Director. Mr. Wieking is the Executive Vice President and
serves on the Executive Committee of PKW. He has been active in the insurance
business for 38 years. Mr. Wieking was formerly the owner of Wieking Connolly
& Associates in Oakland, which merged with PKW in 1983. Mr. Wieking has been
involved in various civic and professional associations and has served as a
Board member of the Pacific Network Group and the Independent Insurance Agents
Association, in Oakland. He is a graduate of the University of California,
Berkeley.
 
                                       8
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
 
  Prior to the consummation of the merger with System, Anchor was a privately
held California corporation with approximately 63 shareholders. Consequently,
there was no established trading market for Anchor's common stock. As of March
14, 1997, there were approximately 4,496,733 shares of Anchor's common stock
outstanding, held by approximately 2,000 shareholders of record. As of March
14, 1997, there also were warrants to purchase 374,120 shares of common stock
of Anchor outstanding.
 
  Since the January 1995 merger with System, Anchor's shares of common stock
have publicly traded on the OTC Bulletin Board (Symbol: APUX). At such time it
meets certain minimum market capitalization requirements, Anchor intends to
seek to list its shares on The Nasdaq Small-Cap Market; however, there can be
no assurance as to when or whether such shares will be so listed.
 
  Holders of Anchor common stock are entitled to such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. Anchor has not paid any cash or stock dividends to date.
Anchor does not expect to pay dividends in the foreseeable future.
 
ITEM 6. SELECTED FINANCIAL DATA
 
  The following table sets forth certain historical information for Anchor
which is based on, and should be read in conjunction with, Anchor's audited
financial statements that are being filed as part of this report.
 
                       ANCHOR PACIFIC UNDERWRITERS, INC.
                            SELECTED FINANCIAL DATA
 
<TABLE>
<CAPTION>
                            1996         1995         1994         1993        1992
                            ----         ----         ----         ----        ----
<S>                      <C>          <C>          <C>          <C>         <C>
Revenues(/1/)........... $ 7,994,484  $ 8,761,278  $ 6,091,165  $4,767,820  $4,436,728
Income (Loss) before
 other expenses,
 net(/1/)............... $  (703,696) $  (235,999) $    63,349  $  232,674  $  174,567
Net (Loss).............. $(1,405,800) $  (867,029) $  (650,489) $   (1,662) $  (92,585)
Earnings (Loss) Per
 Share(/2/)............. $     (0.37) $     (0.23) $     (0.22) $    (0.01) $    (0.03)
Weighted Average Shares
 Outstanding(/2/) ......   3,759,275    3,819,605    3,022,658   2,715,918   2,690,588
Cash Flow From
 Operations (Deficit)... $  (786,971) $   178,590  $  (537,714) $  345,909  $  289,780
Total Assets............ $10,511,439  $12,732,433  $13,134,383  $7,689,637  $8,177,374
Total Long-Term
 Liabilities............ $   922,950  $ 2,412,852  $ 1,656,269  $  514,651  $  720,302
Shareholders' Equity.... $ 1,107,231  $ 1,563,032  $ 2,740,463  $1,889,987  $1,870,023
</TABLE>
 
 
                                       9
<PAGE>
 
(1) Consistent with Anchor's audited financial statements set forth elsewhere
    in this Annual Report, both revenues and income (Loss) before other
    expenses, net, include interest income.
(2) Earnings (Loss) per share and weighted average shares outstanding have
    been retroactively restated to reflect effects of the 10 for 1 stock split
    effected January 6, 1995.
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
BACKGROUND
 
  Anchor was organized in 1986 as a California general partnership for the
specific purpose of acquiring Harden, a third-party employee benefits
administrator. Anchor was reorganized as a private California corporation in
March 1987, and became a public reporting Delaware corporation on January 6,
1995, when it merged with System.

  Since its inception, Anchor has expanded its insurance and financial service
capabilities through internal growth and a series of acquisitions. Anchor in
August 1994, acquired BRI, a third-party administrator located in Scottsdale,
Arizona; in October 1994, acquired PKW, a property and casualty insurance
brokerage company located in Oakland, California; in February 1995, acquired
certain third-party administration accounts from Dutcher; in March 1996,
acquired RLF, a property and casualty insurance brokerage company located in
Walnut Creek, California; in April 1996, acquired certain property and
casualty accounts from Robins; and in conjunction with PKW, acquired certain
property and casualty accounts from McPherson, in May 1996. Anchor expects to
continue to expand its insurance brokerage and administration businesses and
to explore other complementary expansion opportunities.
 
  Historically, Anchor derived a majority of its revenues from third-party
administration services. As a result of its acquisitions of PKW in October
1994; the March 1996 acquisition of RLF; the April 1996 acquisition of
accounts from Robins; and the May 1996 acquisition of accounts from McPherson,
Anchor has significantly increased the percentage of its revenues that are
derived from property and casualty insurance brokerage activities.
 
RESULTS OF OPERATIONS--YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
 
GENERAL
 
  Anchor derives a substantial portion of its revenues from commissions, which
generally are based on a percentage of premiums produced by Anchor, contingent
commissions, which generally are based on underwriting profits derived over a
given period of time by the insurance carrier, and fees for claims
administration (including underwriting and risk analysis) services, which
generally are based on a percentage of premiums collected, or on a per capita
basis. Anchor does not assume any underwriting risk in connection with its
business.
 
  Fluctuations in premiums charged by insurance companies may materially
affect commission revenues. During the last eight years, the property and
casualty insurance industry has experienced a "soft market" where the
underwriting capacity of insurance companies expanded, stimulating an increase
in competition and a decrease in premium rates, thereby reducing related
commissions and fees. In addition to the soft market for property and casualty
insurance, workers' compensation reform in California has had the effect of
reducing workers' compensation insurance premiums resulting in reduced
commissions generated by the sale of related insurance products. Although some
sources in the insurance industry have predicted future premium increases, the
likelihood of rate increases in the near future remains uncertain. Anchor
believes that revenues generated from anticipated future growth and continued
diversification of its business will offset weaknesses in the property and
casualty market and any loss of revenues that may result from workers'
compensation reform.
 
  Anchor has taken steps to strengthen the sales management at both PKW and
BRI by hiring seasoned sales and marketing executives to take over marketing
responsibilities. Product development and new product sales continue to be a
top priority, as does geographical diversification into other states and
marketing territories. Marketing for new business coinciding with the release
of new products by Harden and BRI began in 1996. Market reaction to these
changes has been encouraging and the increase in new revenue is beginning to
match prior periods of production. 
 
                                      10
<PAGE>
 
Furthermore, Harden and BRI have been successful in securing an alternative
insurance carrier to strengthen and broaden their product offerings in the small
group market, as well as facilitate geographic diversification. This new
insurance carrier has negotiated a multi-year, exclusive contract with Harden
and BRI which management believes will enhance sales opportunities in California
and Arizona. Initial market reaction to this change has been encouraging.
 
REVENUES
 
  Total Revenues. Total revenues for 1996 were $7,994,484, a decrease of
$766,794, or 8.8%, as compared to 1995 revenues. The decrease resulted primarily
from net lost business due to the change in the underwriting requirements
imposed by the new insurance carrier for Harden, as discussed further below.
Anchor's revenues vary from quarter to quarter as a result of the timing of
policy renewals and net new/lost business production, whereas expenses are
fairly uniform throughout the year. Total revenues for 1995 were $8,761,278, an
increase of $2,670,113, or 43.8%, over 1994 revenues of $6,091,165. The increase
resulted primarily from the inclusion of the operations of PKW and BRI for the
entire year in Anchor's consolidated financial statements.
 
  Commissions and fees make up substantially all of Anchor's revenues. The
following table sets forth the percentages of Anchor's revenues attributable
to insurance brokerage services (for which commissions are generated), and
third-party administration, underwriting and risk analysis services (for which
fees are generated), for the three years ended December 31, 1996, 1995 and
1994. Also included is the percentage of revenues generated from premium
finance activities.
 
<TABLE>
<CAPTION>
                                                     YEAR ENDED DECEMBER 31,
                                                   ---------------------------
                                                    1996      1995      1994
                                                    ----      ----      ----
      <S>                                          <C>       <C>       <C>
      Insurance Brokerage Commissions.............      43%       40%       27%
      Third-Party Administration Fees.............      57%       59%       72%
      Premium Financing...........................       0%        1%        1%
                                                   -------   -------   -------
        Total.....................................     100%      100%      100%
                                                   =======   =======   =======
</TABLE>
 
  Historically, Anchor derived a majority of its revenues from third-party
administration services. In light of its acquisitions of PKW in October 1994;
RLF in March 1996; the account acquisitions of Robins in April 1996; and
McPherson in May 1996, Anchor expects to continue to experience an increase in
the percentage of its revenues that are derived from insurance brokerage
activities.
 
  Commissions. Commissions for insurance brokerage services are reported net
of sub-broker commissions and generally are recognized as of the effective
date of the insurance policy, except for commissions on installment premiums
which are recognized periodically as billed. Commissions for 1996 were
$3,370,406, a decrease of $51,908, or 1.5%, as compared to $3,422,314 of
commissions for 1995. The decrease resulted from net lost business largely due
to the continuing soft property and casualty market and the effects of open-
rating in workers' compensation. Commissions for 1994 were $1,647,189. The
higher commissions generated in 1995, as compared to 1994, were attributable
entirely to the PKW acquisition.
 
  Based upon recent experience, management presently anticipates that
commission revenues generated from the sale of workers' compensation
insurance, which accounted for approximately 15% of commission revenues (or 7%
of Anchor's total revenues) in 1996, may decrease in 1997 as a result of
workers' compensation reform in California. Anchor believes, however, that
revenues generated from anticipated growth and continued diversification of
its business will continue to substantially offset any loss of revenues that
may result from workers' compensation reform.
 
                                      11
<PAGE>
 
  Fees. Fees from Anchor's third-party administration (including underwriting
and risk analysis) services for 1996 were $4,510,680, a decrease of $675,622,
or 13.0%, as compared to $5,186,302 in fees for 1995. This loss of fee income
is the direct result of changes in the underwriting insurance carriers for
Harden and BRI and is discussed in more detail below. Fee revenues for 1994
were $4,329,238. The higher fee revenues for 1995, as compared to 1994, were
attributable primarily to the acquisition of BRI.
 
  Fee revenues generated by Anchor in 1996 from third-party administration
services included revenues generated by Harden and BRI. A significant portion
of Harden and BRI fee revenues generated from new clients relate to an
insurance product underwritten by one insurance carrier, which is an A-
(Excellent) rated insurance carrier.
 
  Harden's third-party administration revenues are substantially derived from:
(a) an insurance product underwritten by two insurance carriers, which are rated
A+ (Superior) and A- (Excellent); and (b) the administration of insurance
programs underwritten by various insurance carriers for a number of self-insured
employers. The insurance product referred to in (a) above accounted for
approximately 46% of Harden's revenues (or approximately 18% of Anchor's total
revenues) in 1996, and revenues related to the administration self-insured
programs accounted for 52% of Harden's revenues in 1996. Self-insurance is a
program in which a client assumes a manageable portion of its insurance risks,
usually (although not always) placing the less predictable and larger loss
exposure with an excess insurance carrier.
 
  The insurance company which offered the product that accounted for 65% of
Harden's third-party administration revenues in 1994 informed Harden that as a
result of changes in its business strategy, it was discontinuing to offer such
an insurance product by the 1995 year end. Thereafter, Harden obtained a
binding commitment on July 20, 1995 from an A+ (Superior) rated insurance
carrier to underwrite the risk and provide a replacement product as of October
1, 1995. The transition to the new carrier caused some clients to reevaluate
their insurance needs. In conjunction with this transition process, existing
clients were also required to satisfy the new insurance carrier's underwriting
requirements. During the first quarter of 1996, one client who represented
approximately 9% of Harden's 1995 revenues (or 3.7% of Anchor's consolidated
revenues) was advised by the new insurance carrier that it did not meet its
underwriting standards. As a result of the transition to the new insurance
carrier, Harden experienced a near term loss of business accounts and
revenues.
 
  This new insurance company, the A+ (Superior) rated insurance carrier, which
provided the replacement product as of October 1, 1995, informed Harden in the
third quarter of 1996, that as a result of changes in its business strategy,
it too would discontinue offering such an insurance product by the end of
February 1997. This product had represented 51% of Harden and BRI's revenue
and 27% of Anchor's total revenue.
 
  As of October 31, 1996, Harden obtained a commitment from an A- (Excellent)
rated insurance carrier to underwrite the risk and provide a replacement
product effective December 1, 1996. Management believes that the transition to
the new insurance carrier will be less disruptive for Harden and BRI's clients
than the first transition because the replacement insurance carrier will fully
assume all policies in California and the majority of policies in Arizona
thereby avoiding the loss of accounts which Harden and BRI experienced
earlier. The impact on Harden and BRI's revenue is expected to be minimal.
 
  The new replacement insurance carrier is a subsidiary of the largest HMO in
Nevada. Management believes that the new insurance carrier will enable Anchor
to provide the small group medical insurance market with stronger managed care
components. The replacement insurance carrier's business strategy is to
aggressively market group health products in a multi-state distribution system
through an exclusive multi-year contract with Harden and BRI in California and
Arizona. The initial reaction of the Harden and BRI distributors has been very
favorable. Harden and BRI began to receive revenues from this new business in
January 1997.
 
  Interest Income. Interest income consists of interest earned on insurance
premiums and other funds held in fiduciary accounts and interest earned on
investments. Interest income was $111,656, $145,156 and $112,411 in 1996, 1995
and 1994, respectively. The decrease in interest income in 1996, as compared
to 1995, was primarily caused by reduced insurance premiums and other funds
being held in fiduciary accounts, which is directly related to business lost
due to the change of primary insurance carriers referred to above. The
increase in interest income in 1995, as compared 
 
                                      12
<PAGE>
 
to 1994, resulted primarily from a larger amount of insurance premiums and other
funds held in fiduciary accounts due to the acquisitions of PKW and BRI.
 
EXPENSES
 
  Total Expenses. Total operating expenses for 1996 were $8,698,180, a
decrease of $299,097, or 3.3%, as compared to 1995 operating expenses of
$8,997,277. As discussed below, the decrease in total expenses resulted from a
decrease in employee compensation and benefits offset, in part, by an increase
in selling, general and administrative expenses. Total operating expenses for
1995 increased $2,969,461, or 49.3%, over operating expenses for 1994 of
$6,027,816. The increase resulted primarily from the inclusion of the
operations of PKW and BRI for the entire year in Anchor's consolidated
financial statements.

  Anchor continues to monitor expenses closely as Harden and BRI transition
from one insurance carrier to another for their major indemnity product.
Anchor is also monitoring staffing levels as well as outside professional
services. Management expects to achieve further cost reductions in connection
with the recent termination of an outside vendor supplying systems support.
 
  Employee Compensation and Benefits. Employee compensation and benefits for
1996 were $5,534,549 a decrease of $414,486, or 7.0%, as compared to 1995
employee compensation of $5,949,035. Starting in 1996, PKW went to a
compensation system for all sales personnel based upon commission only versus
the prior practice of paying commission plus salary. The change in 1996 was
made in order to record commissions to properly match with earned revenues. In
addition, this overall decrease was also attributed to normal attrition and
selective downsizing at PKW, Harden and BRI, as well as a reclassification of
certain items to selling, general and administrative expenses. The total
employee compensation and benefits expenses for 1995 increased $2,027,793, or
51.7%, over employee compensation and benefits for 1994 of $3,921,242. The
acquisitions of PKW and BRI accounted for the majority of the increase.
 
  Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $3,163,631, $3,048,242 and $2,106,574 in 1996,
1995 and 1994, respectively. The $115,389, or 3.8%, increase in 1996, as
compared to 1995, resulted primarily from the reclassification of certain
items previously classified as employee compensation and benefits. The
$941,668, or 44.7%, increase in 1995, as compared to 1994, resulted primarily
from the acquisitions of PKW and BRI. General and administrative expenses
include rent, travel, insurance, postage, telephone, supplies and other
miscellaneous expenses.
 
  Interest Expense. Interest expense was $379,071, $161,769 and $35,925 in
1996, 1995 and 1994, respectively. The increase in interest expense in 1996,
as compared to 1995, resulted primarily from an increase in outstanding
borrowings on Anchor's existing line of credit and approximately $95,000 of
expense related to the Series A Debenture and Debentures. With the recent
conversions of the Series A Debenture and Debentures, Anchor will see interest
expense savings of approximately $85,000 in 1997. For further detail refer to
Liquidity and Capital Resources on page 14. The increase in interest expense
in 1995, as compared to 1994, resulted primarily from the assumption of
existing debt in connection with the acquisition of PKW and an increase in
outstanding borrowings on Anchor's existing line of credit.
 
  Amortization of Goodwill and Other Intangibles. Goodwill represents the
excess of the cost of acquisitions over the fair value of net assets acquired.
Other intangibles include covenants not to compete, customer lists and other
contractual rights. Amortization of goodwill and other intangibles was
$380,832, $409,908 and $256,149 in 1996, 1995 and 1994, respectively. The
decrease in amortization of goodwill and other intangibles in 1996, as
compared to 1995, is a result of an adjustment to goodwill in the fourth
quarter of 1995 due to the subsequent adjustment of the PKW acquisition price.
For further information, refer to Adjustment to PKW Purchase Price, below, in
Anchor's Annual Report on Form 10-K for the year ended December 31, 1995. The
increase in amortization of goodwill and other intangibles in 1995, as
compared to 1994, was a result of Anchor's acquisitions of PKW and BRI. A
discussion of amortization is presented in Notes 2 and 5 of the Notes to
Consolidated Financial Statements in Anchor's Annual Report on Form 10-K for
the year ending December 31, 1995.
 
                                      13
<PAGE>
 
INCOME TAXES
 
  Anchor's expense for income taxes was $6,830 in 1996 and $4,800 in 1995 and
1994. The $4,800 expense represents the minimum annual required tax payment
due. An analysis of Anchor's provision for income taxes is presented in Note 9
of the Notes to Consolidated Financial Statements.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  Anchor's business is not capital intensive and Anchor historically has had
sufficient capital to meet its operating needs. Anchor reported net cash flows
(used in) operations of ($786,971) for the twelve months ended December 31,
1996, compared to net cash flows from operations of $173,340 for the twelve
months ended December 31, 1995. During 1996, Anchor met its operating and
capital needs from several sources, including borrowing under its existing
credit agreements and the proceeds from the sale of Bridge Notes, as further
discussed below. As of December 31, 1996, Anchor had approximately $30,000
available on its existing lines of credit and $225,000 available from the
issuance of Bridge Notes. Anchor is currently seeking to raise an additional
$500,000 from the members of the Board of Directors and other qualified
investors through the 1997 Offering (as discussed below) to supplement working
capital. As of March 14, 1997, Anchor had received $150,000 in proceeds from the
1997 Offering with additional funds anticipated by the end of the second
quarter. To further supplement current funding sources, Anchor is presently
seeking alternative bank lines, as described below, and is seeking to raise
additional funds from institutional investors. Liquidity would be impaired if
cash flow from operations were reduced or if existing credit lines and proceeds
from other debt financing were insufficient.
 
  In June 1996, Anchor entered into an engagement letter with Gerbsman
Partners ("Gerbsman"), a business and investment banking firm, to assist
Anchor in developing a strategy to access short-term debt financing sources
for future acquisitions. This engagement letter was canceled on July 31, 1996,
per the terms of the contract, as Gerbsman was unsuccessful in assisting
Anchor in raising short-term debt financing.
 
  The engagement letter with Gerbsman provided for a $25,000 retainer fee
which was due and payable on January 4, 1997, plus reasonable business
expenses through July 31, 1996. Because Gerbsman was unable to obtain short-
term debt financing, no additional fees or options/warrants are due under the
engagement letter. In addition, Gerbsman has agreed, to extend the due date of
the retainer fee and to allow Anchor to retire the obligation over a period of
several months as Anchor's cash flow position improves.
 
  During 1996, Anchor raised $225,000 from five members of the Board of
Directors and other qualified investors through the issuance of 10%
Subordinated Bridge Notes with Warrant to Purchase Shares of Anchor Common
Stock ("Bridge Notes"). The basic terms of the Bridge Notes were: (a) 10%
interest per annum, paid in arrears; (b) one year maturity; (c) for every
$10,000 of principal invested the purchaser received a five year warrant to
acquire 1,000 shares of Anchor common stock at a purchase price of $1.75, per
share; (d) "piggyback" registration rights for three years; and (e)
subordination provisions that subordinate the Bridge Notes to Anchor's "Senior
Debt" (as defined in the Bridge Notes), except that the Bridge Notes are equal
in status to the Debentures issued during 1995, which become due in 1997.
 
  In February 1997, Anchor offered the purchasers of said Bridge Notes an
opportunity to either change the terms of the warrants underlying the Bridge
Notes or to participate in the 1997 Offering (discussed below), by an exchange
of the Bridge Notes. The basic terms of these two alternatives are: (a) in
lieu of receiving 1,000 warrants to purchase 1,000 shares of Anchor common
stock at a purchase price of $1.75 per share for each $10,000 in principal
invested, the purchaser would receive 2,000 warrants to purchase 2,000 shares
of Anchor common stock at a purchase price of $1.35 per share for each $10,000
in principal invested; or (b) participate in the 1997 Offering by exchanging
the Bridge Notes and receiving in return (i) interest at the rate of 10% per
annum up to the date of conversion; (ii) Anchor common stock in place of the
Bridge Notes at a price equal to $0.90 per share; and (iii) five year
warrants, equal to the number of shares issued in place of the Bridge Notes,
with the right to purchase Anchor's common stock at a purchase price of $0.90
per share. As of March 14, 1997, the majority of the purchasers of said Bridge
Notes have indicated to Anchor their decision to change to alternative (a)
above.
 
                                      14
<PAGE>
 
  On December 17, 1996, Anchor entered into a Financial Advisory Agreement
("Agreement") with The Private Financing Group ("TPFG"), to advise and assist
in planning, balance sheet analysis, locating investors, joint ventures,
merger partners, or funding sources, reviewing overall business needs and
promotion of the internal and external business goals of Anchor. If TPFG is
successful in raising financing, the funds raised will be used for debt
consolidation, working capital and to fund future acquisitions or mergers.
Anchor is having discussions with various potential investors, but has not yet
obtained any commitments with respect to such financing. Consequently, there
can be no assurance as to when or whether Anchor will raise additional capital
or what the terms and conditions would be for such capital.

  The Agreement with TPFG provides for an advisory consulting fee of $15,000
per month commencing December 17, 1996, and continuing for a period of six
months, plus reasonable expenses. If TPFG is successful in helping Anchor
raise financing, the Agreement also provides for an advisory bonus to be paid.
Either party may cancel said Agreement with 30 days-written notice. Upon
cancellation all fees then due will be immediately due and payable.
 
  In December 1996, Guarantee Life Insurance Company converted all $600,000 of
the Series A Debenture it held into 444,444 shares of Anchor's common stock at
$1.35 per share. In addition, as of March 14, 1997, investors holding $270,000
of the Debentures, including seven members of the Board of Directors,
converted their Debentures into 200,000 shares of Anchor's common stock at
$1.35 per share. These conversions will save Anchor approximately $85,000 in
interest payments, reduce outstanding indebtedness by $870,000 and, in turn,
increase shareholders' equity by $870,000. For further information regarding
the Series A Debenture and the Debentures, refer to Liquidity and Capital
Resources, page 14, in Anchor's Annual Report on Form 10-K for the year ended
December 31, 1995.
 
  During the first quarter of 1997, Anchor began raising additional funds from
members of the Board of Directors and other qualified investors through a
private offering of Anchor common stock along with warrants to acquire shares
of Anchor common stock (the "1997 Offering"). As of March 14, 1997, Anchor had
received $150,000 from said investors and had additional commitments to
purchase approximately $200,000 in the 1997 Offering before the end of the
second quarter of 1997. Anchor intends to utilize a substantial portion of the
proceeds from the 1997 Offering to support current and future working capital
needs of Anchor. The basic terms of the 1997 Offering are: (a) 550,000 shares
of Anchor common stock available at a purchase price of $0.90 per share;
(b) warrants to acquire one share of Anchor common stock for each share of
Anchor common stock purchased at an exercise price of $0.90 per share; (c)
five year term on the warrants; (d) "piggyback" registration rights for three
years; and (e) anti-dilution protection for stock splits, stock dividends,
recapitalizations and reorganizations. Purchasers of the 1997 Offering, as of
March 14, 1997, consist of five members of the Board of Directors.
 
  Capital and certain acquisition related expenditures were $184,035 and
$457,659 for the twelve months ended December, 1996 and 1995, respectively.
During the first quarter of 1996, RLF, an insurance agency located in Walnut
Creek, California, was acquired and merged into Anchor's insurance brokerage
subsidiary, PKW, located in Concord, California. In addition, during the
second quarter of 1996, certain property and casualty accounts of Robins and
McPherson were acquired and merged into PKW.
 
  Short-term debt, current portion of long-term debt and current portion of
long-term liabilities at December 31, 1996, totaling in the aggregate
$2,424,508 (as compared to $1,830,159 at December 31, 1995), consisted of: (a)
$975,000 outstanding under a $1,000,000 revolving line of credit maintained by
Anchor with a regional San Francisco Bay Area bank; (b) $420,000 outstanding
under a $450,000 unsecured line of credit maintained by Anchor with another
regional San Francisco Bay Area bank; (c) approximately $243,750 of future
fixed payments under a consulting agreement entered into with a company
affiliated with the former shareholders of BRI; (d) $207,500 representing the
current portion of obligations with regard to certain real property leased by
PKW prior to its acquisition by Anchor and relocation to Anchor's executive
offices; (e) $100,000 of Debentures; (f) $225,000 of Bridge Notes; and (g)
approximately $253,258 for certain other current liabilities.
 
  On January 7, 1997, the $1,000,000 line of credit expired. Although Anchor
was within the covenants of the loan on the renewal date and is current with
all interest payments, the bank has notified Anchor that it no longer will
continue to extend credit to Anchor because Anchor's performance has not met
the bank's expectations. The bank has given Anchor an opportunity to make
arrangements to replace the credit facility. Anchor is currently working with
the 

                                      15
<PAGE>
 
bank to move the credit facility to another interested bank; or use proceeds
from potential investors to satisfy the obligation. The interest rate on the
$1,000,000 line of credit is at the lending bank's prime rate.
 
  In 1995, the bank that provided Anchor with the $1,000,000 line of credit
also provided Anchor with equipment financing loans of $125,000 and $62,000
for equipment purchased with operating capital. The proceeds from the $125,000
equipment financing loan were then used to reduce the outstanding balance on
said $1,000,000 line of credit.

  The $500,000 unsecured line of credit which expired on July 30, 1996, has
been renewed with the bank in the amount of $450,000 for twelve months and
matures on October 20, 1997. The interest rate on the $450,000 line of credit
is equal to the lending bank's prime rate plus 1.5%.
 
  At December 31, 1996, long-term liabilities and long-term debt, less the
current portion discussed above, totaled $922,950 (as compared to $2,412,852
at December 31, 1995), and primarily consisted of: (a) approximately $191,250
of future fixed payments under the consulting agreement, mentioned above, with
a company affiliated with the former shareholders of BRI; (b) approximately
$194,000 representing the long-term portion of obligations with regard to
certain real property leased by PKW prior to its acquisition by Anchor and
relocation to Anchor's executive offices; (c) approximately $306,000
representing deferred rent with regard to certain real property currently
leased by Anchor; and (d) approximately $231,700 for certain other long-term
liabilities. In May 1995, PKW entered into a sublease with respect to 82% of
PKW's prior office space. The sublease expires on September 30, 1997 (unless
extended by the subtenant through November 30, 1999, the date on which the
term of the master lease expires) and requires PKW to provide a multi-year
rent subsidy. In December 1995, PKW entered into a sublease with respect to an
additional 10% of PKW's prior office space. The sublease expires on November
30, 1999, and requires PKW to provide a multi- year rent subsidy. The amounts
classified as short and long-term liability with respect to the PKW leases
reflect such subsidy and are based upon the assumptions that: (a) the
subtenant of the May 1995 sublease will exercise its option to extend the
lease through 1999; and (b) the remaining 8% of such office space will be
subleased in 1997.
 
  Anchor has not paid cash dividends in the past and does not expect to pay
cash dividends in the foreseeable future.
 
STRATEGY
 
  Anchor's strategy is to strengthen its core health insurance and property
and casualty (including workers' compensation) insurance businesses by: (a)
continuing to develop specialized affiliated business units that target
selected insurance industry market segments defined by industry type,
geographic location and consumer demographics; (b) establishing new products
and services; (c) strengthening management, sales and marketing staff; and (d)
seeking to acquire and integrate compatible insurance brokerage and
administration businesses in the Western United States. In connection with
this strategy, Anchor regularly considers acquisition opportunities. To date,
acquisitions by Anchor have involved both relatively small acquisitions of
insurance brokerage and administration accounts, as well as larger
acquisitions of insurance brokerage companies, such as PKW, and third-party
administrators, such as BRI. Anchor expects to continue to pursue appropriate
acquisition opportunities, and believes that its status as a public company
enhances its ability to make acquisitions and continue its expansion strategy.
Anchor continues to engage in discussions with third parties regarding
potential acquisitions and mergers. As of March 14, 1997, it had one letter of
intent with a third-party administration firm based in Fresno, California.
Management presently anticipates closing this acquisition in the second
quarter of 1997. There are no other pending acquisitions currently under
letter of intent. No assurances can be given with respect to the likelihood,
or financial or business effect, of any possible future acquisition or merger
 
  As part of Anchor's strategy to create the premier regional publicly traded
insurance brokerage/administrator in the Western United States, it expects to
obtain additional momentum by using its status as a public company to attract
public and private financing. Such funding would be available to Anchor for
future acquisition, expansion and consolidation of its insurance operations.
 
                                      16
<PAGE>
 
RECENTLY ISSUED ACCOUNTING STATEMENTS
 
  In February 1997, the FASB issued Statement of Financial Accounting Standard
No. 128, "Earnings Per Share" ("EPS"), which establishes new standards for
computing and presenting earnings per share. The statement is effective for
financial statements issued for periods ending after December 15, 1997,
including interim periods, and requires restatement of all prior period EPS
data presented. The impact of this statement on reported EPS in the
accompanying consolidated financial statements for the years ended December
31, 1996, 1995 and 1994 has not been determined.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
  The following financial statements for Anchor appear on pages F-1 through 
F-21 of this report:
 
  Report of Independent Auditors
 
  Consolidated Balance Sheets as of December 31, 1996 and 1995
 
  Consolidated Statements of Operations for the years ended December 31,
  1996, 1995 and 1994
 
  Consolidated Statements of Shareholders' Equity for the years ended
  December 31, 1996, 1995 and 1994
 
  Consolidated Statements of Cash Flows for the years ended December 31,
  1996, 1995 and 1994
 
  Notes to Consolidated Financial Statements
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
  The information under the heading "Independent Auditors" from the
Registrant's Proxy Statement to be mailed in connection with the Registrant's
1997 Annual Meeting of Stockholders is hereby incorporated by reference.
 
                                      17
<PAGE>
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
  The information under the headings "Election of Directors" and "Compliance
with Section 16(a) of the Securities Exchange Act of 1934" from the
Registrant's Proxy Statement to be mailed in connection with the Registrant's
1997 Annual Meeting of Stockholders are hereby incorporated by reference.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The information under the headings "Executive Compensation" and "Employment
Agreement with James R. Dunathan" from the Registrant's Proxy Statement to be
mailed in connection with the Registrant's 1997 Annual Meeting of Stockholders
are hereby incorporated by reference.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The information under the headings "Principal Stockholders" and "Stock
Ownership Table" from the Registrant's Proxy Statement to be mailed in
connection with the Registrant's 1997 Annual Meeting of Stockholders are
hereby incorporated by reference.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  The information under the heading "Certain Relationships and Related
Transactions" from the Registrant's Proxy Statement to be mailed in connection
with the Registrant's 1997 Annual Meeting of Stockholders is hereby
incorporated by reference.
 
                                      18
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
  (a)(1)Financial Statements.
 
     Report of Independent Auditors
 
     Consolidated Balance Sheets as of December 31, 1996 and 1995
 
     Consolidated Statements of Operations for the years ended December 31,
     1996, 1995 and 1994
 
     Consolidated Statements of Shareholders' Equity for the years ended
     December 31, 1996, 1995 and 1994
 
     Consolidated Statements of Cash Flows for the years ended December 31,
     1996, 1995 and 1994
 
     Notes to Consolidated Financial Statements
 
  (a)(2)Financial Statement Schedules.
 
  Other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or notes thereto.
 
  (a)(3)Exhibit Index.
 
<TABLE>
 <C>   <S>
  2.1  Amended and Restated Agreement and Plan of Merger dated as of October
       24, 1994, by and between System and Old Anchor, as amended by that
       certain Amendment to the Amended and Restated Agreement and Plan of
       Merger dated as of December 29, 1994, and Agreement of Merger attached
       as an exhibit to the Reorganization Agreement and certified by the
       Delaware Secretary of State on January 6, 1995. Incorporated by
       reference to Exhibit 2.1 of Anchor's Annual Report on Form 10-K for the
       year ended December 31, 1994.
  3.1  Restated Certificate of Incorporation. Incorporated by reference to
       Exhibit 3.1 of Anchor's Annual Report on Form 10-K for the year ended
       December 31, 1994.
  3.2  Bylaws. Incorporated by reference to Exhibit 3.2 of Anchor's Annual
       Report on Form 10-K for the year ended December 31, 1994.
  4.1  Specimen Common Stock Certificate. Incorporated by reference to Exhibit
       4.1 of Anchor's Annual Report on Form 10-K for the year ended December
       31, 1994.
  4.2  Specimen Warrant Certificate. Incorporated by reference to Exhibit 4.2
       of Anchor's Annual Report on Form 10-K for the year ended December 31,
       1994.
  4.3  Warrant Agreement dated as of January 7, 1995, between Anchor and U.S.
       Stock Transfer Corporation. Incorporated by reference to Exhibit 4.3 of
       Anchor's Annual Report on Form 10-K for the year ended December 31,
       1994.
  4.3a Letter dated December 29, 1995, to all stockholders from James R.
       Dunathan extending warrants expiration date to January 6, 1997.
       Incorporated by reference to Exhibit 4.3a of Anchor's Annual Report on
       Form 10-K for the year ended December 31, 1995.
  4.4  Form of 10% Convertible Subordinated Debenture. Incorporated by
       reference to Exhibit 4.1 of Anchor's Form 10-Q for the quarter ending
       March 31, 1995.
</TABLE>
                                      19
<PAGE>
 
<TABLE>
 <C>    <S>
  4.5   Form of 10% Convertible Subordinated Debenture, Series A. Incorporated
        by reference to Exhibit 4.5 of Anchor's Annual Report on Form 10-K for
        the year ended December 31, 1995.
  4.6   Form of 10% Subordinated Bridge Note. Incorporated by reference to
        Exhibit 4.6 of Anchor's Form 10-Q for the quarter ending September 30,
        1996.
  4.6a  Form of Warrant to Purchase Shares of Common Stock of Anchor Pacific
        Underwriters, Inc. Incorporated by reference to Exhibit 4.6a of Anchor's
        Form 10-Q for the quarter ending September 30, 1996.
  4.6b  Form of Offering to change the terms of the Form of Warrant to Purchase
        Shares of Common Stock of Anchor Pacific Underwriters, Inc., which is
        incorporated by reference to Exhibit 4.6a, above.
  4.7   Form of Subscription Agreement for the Offer and Sale of Shares of
        Common Stock of Anchor Pacific Underwriters, Inc.
  4.7a  Form of Warrant to Purchase Shares of Common Stock of Anchor Pacific
        Underwriters, Inc.
  10.1  1994 Stock Option Plan. Incorporated by reference to Exhibit 10.1 of
        Anchor's Annual Report on Form 10-K for the year ended December 31,
        1994.*
  10.2  Lease dated October 29, 1990, as amended on June 10, 1991, April 16,
        1994 and September 9, 1994, between Anchor and Societe Generale
        (regarding 1800 Sutter Street, Concord, California). Incorporated by
        reference to Exhibit 10.2 of Anchor's Annual Report on Form 10-K for
        the year ended December 31, 1994.
  10.3  Lease dated May 29, 1990, as amended on December 1, 1992, between PKW
        and Kaiser Center, Inc. (regarding 300 Lakeside Drive, Oakland,
        California). Incorporated by reference to Exhibit 10.3 of Anchor's
        Annual Report on Form 10-K for the year ended December 31, 1994.
  10.3a Sublease dated May 26, 1995, between PKW and Martin, Ryan & Andrada,
        Inc. (regarding 82% of 300 Lakeside Drive, Oakland, California).
        Incorporated by reference to Exhibit 10.2 of Anchor's Form 10-Q for the
        quarter ending June 30, 1995.
  10.3b Sublease dated December 1, 1995, between PKW and Logiciel, Inc.
        (regarding 10% of 300 Lakeside Drive, Oakland, California).
        Incorporated by reference to Exhibit 10.3b of Anchor's Annual Report on
        Form 10-K for the year ended December 31, 1995.
  10.4  Lease dated July 3, 1989, as amended on February 10, 1994, between BRI
        and Connecticut General Life Insurance Company (regarding 10301 N. 92nd
        Street, Scottsdale, Arizona). Incorporated by reference to Exhibit 10.4
        of Anchor's Annual Report on Form 10-K for year ended December 31,
        1994.
  10.5  Employment Agreement dated August 16, 1994, between Anchor and James R.
        Dunathan. Incorporated by reference to Exhibit 10.5 of Anchor's Annual
        Report on Form 10-K for the year ended December 31, 1994.*
  10.6  Amendment No. 1 to Employment Agreement dated December 19, 1994,
        between Anchor and James R. Dunathan. Incorporated by reference to
        Exhibit 10.6 of Anchor's Annual Report on Form 10-K for the year ended
        December 31, 1994.*
  10.7  Business Loan Agreement dated as of September 27, 1994, between Anchor
        and Concord Commercial Bank, and related documents. Incorporated by
        reference to Exhibit 10.7 of Anchor's Annual Report on Form 10-K for
        the year ended December 31, 1994.
</TABLE>
 
 
                                       20
<PAGE>
 
<TABLE>
 <C>     <S>
  10.8   Business Loan Agreement dated as of September 7, 1994, between PKW and
         CivicBank of Commerce, and related documents. Incorporated by reference
         to Exhibit 10.8 of Anchor's Annual Report on Form 10-K for the year
         ended December 31, 1994.
  10.9   Business Loan Agreement dated as of June 17, 1992, between Harden and
         Concord Commercial Bank, and related documents. Incorporated by
         reference to Exhibit 10.9 of Anchor's Annual Report on Form 10-K for
         the year ended December 31, 1994.
  10.10  Lease of Personal Property dated April 6, 1994, between BRI and
         Winthrop Financial Group, Inc. (regarding computer equipment).
         Incorporated by reference to Exhibit 10.10 of Anchor's Annual Report on
         Form 10-K for the year ended December 31, 1994.
  10.12  Information Management Agreement dated as of May 11, 1993, between
         Harden and CMSI, Inc. Incorporated by reference to Exhibit 10.12 of
         Anchor's Annual Report on Form 10-K for the year ended December 31,
         1994.
  10.12a Mutual Release and Settlement Agreement, Promissory Note and UCC-1
         Financing Statement dated as of March 25, 1996, between Harden and BRC
         (formerly CMSI) of the Information Management Agreement dated as of
         May 11, 1993, between Harden and CMSI, which is incorporated by
         reference to Exhibit 10.12, above. Incorporated by reference to
         Exhibit 10.12a of Anchor's Form 10-Q for the quarter ending March 31,
         1996.
  10.12b Account Transition Agreement, Promissory Note and UCC-1 Financing
         Statement dated as of March 29, 1996, between Harden and BRC (formerly
         CMSI) of the Management Agreement dated as of May 11, 1993, between
         Harden and CMSI, which is incorporated by reference to Exhibit 10.12,
         above. Incorporated by reference to Exhibit 10.12b of Anchor's Form
         10-Q for the quarter ending March 31, 1996.
  10.13  Consulting Agreement dated as of August 1, 1994, between BRI and
         Hightrust, Ltd. Incorporated by reference to Exhibit 10.13 of Anchor's
         Annual Report on Form 10-K for the year ended December 31, 1994.
  10.14  Agreement for Purchase and Sale of Assets dated as of January 18,
         1995, between Harden and Dutcher. Incorporated by reference to Exhibit
         10.14 of Anchor's Annual Report on Form 10-K for the year ended
         December 31, 1994.
  10.15  Amendment to Agreement for Purchase and Sale of Assets dated February
         1, 1995, between Harden and Dutcher. Incorporated by reference to
         Exhibit 10.15 of Anchor's Annual Report on Form 10-K for the year
         ended December 31, 1994.
  10.15a Amendment to Agreement for Purchase and Sale of Assets dated June 10,
         1996, between Harden and Dutcher, which is incorporated by reference
         to Exhibit 10.15, above. Incorporated by reference to Exhibit 10.15a
         of Anchor's Form 10-Q for the quarter ending June 30, 1996.
  10.16  Asset Purchase Agreement dated May 17, 1995 between Putnam, Knudsen &
         Wieking Inc. Insurance Brokers and Crestview Leasing. Incorporated by
         reference to Exhibit 10.1 of Anchor's Form 10-Q for the quarter ending
         June 30, 1995.
  10.17  Settlement Agreement and Mutual Release dated August 22, 1995 between
         Anchor and Donald B. Putnam, James P. Wieking, Ronald J. Marengo, Gary
         N. Lewis, Edward Wieking and Robert Moser. Incorporated by reference
         to Exhibit 10.1 of Anchor's Form 10-Q for the quarter ending September
         30, 1995.*
</TABLE>
                                       21
<PAGE>
 
<TABLE>
 <C>   <S>
  10.18  Purchase and Sale Agreement dated as of March 1, 1996 between Anchor
         and Roland L. Ferguson, doing business as R.L. Ferguson Insurance
         Agency. Incorporated by reference to Exhibit 10.18 of Anchor's Form
         10-Q for the quarter ending March 31, 1996.
  10.19  Purchase and Sale Agreement dated as of April 1, 1996 between Anchor
         and Norman I. Robins. Incorporated by reference to Exhibit 10.19 of
         Anchor's Form 10-Q for the quarter ending June 30, 1996.
  10.20  Purchase and Sale Agreement dated as of May 1, 1996 between Anchor and
         PKW and John R. McPherson. Incorporated by reference to Exhibit 10.20
         of Anchor's Form 10-Q for the quarter ending June 30, 1996.
  10.21  Engagement Letter dated June 27, 1996 between Anchor and Gerbsman
         Partners. Incorporated by reference to Exhibit 10.21 of Anchor's Form
         10-Q for the quarter ending June 30, 1996.
  10.22  Industrial Real Estate Lease (Multi-Tenant Facility) dated September
         12, 1996 between Palo Cristi Airport II, L.L.C., and BRI. Incorporated
         by reference to Exhibit 10.22 of Anchor's Form 10-Q for the quarter
         ending September 30, 1996.
  10.23  Financial Advisory Agreement dated December 17, 1996 between The
         Private Financing Group and Anchor Pacific Underwriters, Inc.
  11.1   Statement Regarding Computation of Per Share Earnings.
  21.1   Subsidiaries of Anchor. Incorporated by reference to Exhibit 21.1 of
         Anchor's Annual Report on Form 10-K for the year ended December 31,
         1994.
  27.0   Financial Data Schedule.
         All other exhibits are omitted because they are inapplicable.
</TABLE>
--------
*Denotes management contract or compensatory plan or arrangement.
 
b  Reports of Form 8-K.
 
   Anchor filed a Form 8-K dated April 26, 1996 in which it reported pursuant
to Items 4 and 7 thereof a change in its independent accountant, and attached
the following exhibits:
 
16 Letter from Ernst & Young LLP regarding change in certifying accountant.
 
                                      22
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED.
 
                                          Anchor Pacific Underwriters, Inc.
                                          (Registrant)
 
March 24, 1997                            By:  /s/ James R. Dunathan
                                             ---------------------------------- 
                                                    JAMES R. DUNATHAN
                                              PRESIDENT AND CHIEF EXECUTIVE
                                                         OFFICER
                                              (PRINCIPAL EXECUTIVE OFFICER)
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS ON
BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
<TABLE>
<CAPTION>
              SIGNATURE                            TITLE                    DATE
              ---------                            -----                    ----
 <S>                                   <C>                           <C>
        /s/ James R. Dunathan 
 ____________________________________  President, Chief Executive      March 24, 1997
          JAMES R. DUNATHAN              Officer and Director
    (PRINCIPAL EXECUTIVE OFFICER) 
   
          /s/ Earl Wiklund 
 ____________________________________  Chief Financial Officer,        March 24, 1997
             EARL WIKLUND               Secretary and Director
 (PRINCIPAL FINANCIAL AND ACCOUNTING   
               OFFICER)                
                                       
          /s/ Audie J. Dudum 
 ____________________________________  Chairman, Director              March 24, 1997
            AUDIE J. DUDUM

      /s/ Steven A. Gonsalves 
 ____________________________________  Director                        March 24, 1997
          STEVEN A. GONSALVES
 
       /s/ Lawrence A. Hayes 
____________________________________  Director                        March 24, 1997
          LAWRENCE A. HAYES

      /s/ R. William MacCullough
 ____________________________________  Director                        March 24, 1997
        R. WILLIAM MACCULLOUGH

        /s/ Donald B. Putnam
 ____________________________________  Director                        March 24, 1997
           DONALD B. PUTNAM

        /s/ Michael R. Sanford
 ____________________________________  Director                        March 24, 1997
          MICHAEL R. SANFORD

      /s/ Gordon M. Silverstein
 ____________________________________  Director                        March 24, 1997
        GORDON M. SILVERSTEIN

         /s/ James P. Wieking
 ____________________________________  Director                        March 24, 1997
           JAMES P. WIEKING
</TABLE>
 
                                      23
<PAGE>
 





              ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
              --------------------------------------------------

                       CONSOLIDATED FINANCIAL STATEMENTS
                       ---------------------------------

                      AND REPORT OF INDEPENDENT AUDITORS
                      ----------------------------------


                                   * * * * *


                               DECEMBER 31, 1996
<PAGE>
 
               ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                       CONSOLIDATED FINANCIAL STATEMENTS
 
                          YEAR ENDED DECEMBER 31, 1996
 
<TABLE>
<S>                                                                        <C>
Report of Independent Auditors .........................................   1
 
Audited Consolidated Financial Statements
 
Consolidated Balance Sheet .............................................   2
 
Consolidated Statement of Operations ...................................   3
 
Consolidated Statement of Shareholders' Equity .........................   4
 
Consolidated Statement of Cash Flows ...................................   5

Notes to Consolidated Financial Statements .............................   7
</TABLE>
 
<PAGE>

ODENBERG, ULLAKKO, MURANISHI & CO.
Accountancy Corporations                          351 CALIFORNIA STREET
                                           SAN FRANCISCO, CALIFORNIA  94104-2492
                                                   TELEPHONE 415 434-3744
                                                  TELECOPIER 415 788-2260

To the Board of Directors
 
 and Shareholders of
 
  Anchor Pacific Underwriters, Inc.
 
                        REPORT OF INDEPENDENT AUDITORS
 
  In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, shareholders' equity and cash flows
present fairly, in all material respects, the financial position of Anchor
Pacific Underwriters, Inc. and its subsidiaries at December 31, 1996, and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles. 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 audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for the
opinion expressed above. The consolidated financial statements of Anchor
Pacific Underwriters, Inc. and its subsidiaries for the years ended December
31, 1995 and 1994 were audited by other auditors whose report dated March 18,
1996 expressed an unqualified opinion on those statements.
 
/s/ Odenberg, Ullakko, Muranishi & Co.
--------------------------------------
Odenberg, Ullakko, Muranishi & Co.
 
March 19, 1997
San Francisco, California
 
<PAGE>
 
               ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                           CONSOLIDATED BALANCE SHEET
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31    
                                                    ---------------------------
                                                         1996         1995  
                                                     -----------  ------------- 
                       A S S E T S
<S>                                                 <C>           <C>
Current assets:
 Cash and cash equivalents--corporate funds........ $    151,765  $    904,781
 Cash and cash equivalents--brokerage fiduciary
  funds............................................      977,086     1,529,524
 Cash and cash equivalents--third party
  administration fiduciary funds...................    3,580,793     4,010,606
 Accounts receivable (less allowance for doubtful
  accounts of $32,438 and $49,560 in 1996 and 1995,
  respectively)....................................    1,309,921     1,255,335
 Prepaid expenses and other current assets.........      244,086       295,537
                                                    ------------  ------------
  Total current assets.............................    6,263,651     7,995,783
                                                    ------------  ------------
Property and equipment, less accumulated
 depreciation and amortization.....................      821,197     1,056,932
                                                    ------------  ------------
Other assets:
 Goodwill, net.....................................    1,903,729     2,128,452
 Intangible assets, net............................    1,139,467     1,128,740
 Deferred compensation.............................      257,784       361,344
 Other.............................................      125,611        61,182
                                                    ------------  ------------
                                                       3,426,591     3,679,718
                                                    ------------  ------------
                                                    $ 10,511,439  $ 12,732,433
                                                    ============  ============
 
                      LIABILITIES AND SHAREHOLDERS' EQUITY
 
Current liabilities:
 Cash and cash equivalents--third party
  administration fiduciary funds................... $  3,580,793  $  4,010,606
 Net premiums payable--insurance companies.........    2,037,749     2,510,983
 Accounts payable and accrued expenses.............      438,208       404,801
 Short-term borrowings.............................    1,395,000     1,175,000
 Current portion of long-term debt.................      425,110       156,622
 Current portion of long-term liabilities..........      604,398       498,537
                                                    ------------  ------------
  Total current liabilities........................    8,481,258     8,756,549
                                                    ------------  ------------
Long-term liabilities..............................      773,930     1,034,895
                                                    ------------  ------------
Long-term debt, including $220,000 in 1996 and
 $790,000 in 1995, owed to related parties, net of
 current portion...................................      149,020     1,266,635
                                                    ------------  ------------
Deferred income taxes..............................           --       111,322
                                                    ------------  ------------
Shareholders' equity:
 Preferred stock--$.02 par value; 500,000 shares
  authorized; none issued and outstanding
 Common stock--$.02 par value; 8,000,000 shares
  authorized; 4,362,837 and 3,674,501 shares issued
  and outstanding December 31, 1996 and 1995,
  respectively.....................................       87,256        73,490
 Additional paid-in capital........................    3,925,508     2,989,275
 Accumulated deficit...............................   (2,905,533)   (1,499,733)
                                                    ------------  ------------
                                                       1,107,231     1,563,032
                                                    ------------  ------------
Commitments and contingencies (Notes 1, 8, 12, and
 13)............................................... $ 10,511,439  $ 12,732,433
                                                    ============  ============
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       2
<PAGE>
 
               ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                      CONSOLIDATED STATEMENT OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31
                                           -----------------------------------
                                              1996         1995        1994
                                           -----------  ----------  ----------
<S>                                        <C>          <C>         <C>
Revenues:
 Commissions, fees and other income....... $ 7,882,828  $8,616,122  $5,978,754
 Interest income..........................     111,656     145,156     112,411
                                           -----------  ----------  ----------
                                             7,994,484   8,761,278   6,091,165
                                           -----------  ----------  ----------
Operating expenses:
 Salaries, commissions and employee
  benefits................................   5,534,549   5,949,035   3,921,242
 Selling, general and administrative
  expenses................................   3,163,631   3,048,242   2,106,574
                                           -----------  ----------  ----------
                                             8,698,180   8,997,277   6,027,816
                                           -----------  ----------  ----------
                                             (703,696)    (235,999)     63,349
                                           -----------  ----------  ----------
Other income (expense):
 Amortization of goodwill and intangible
  assets..................................    (380,832)   (409,908)   (256,149)
 Interest.................................    (379,071)   (161,769)    (35,925)
 Other....................................      64,629     166,667      45,637
 Nonrecurring merger expenses.............          --    (221,220)   (462,601)
                                           -----------  ----------  ----------
                                             (695,274)    (626,230)   (709,038)
                                           -----------  ----------  ----------
Loss before income taxes..................  (1,398,970)   (862,229)   (645,689)
Provision for income taxes................       6,830       4,800       4,800
                                           -----------  ----------  ----------
Net loss.................................. $(1,405,800) $ (867,029) $ (650,489)
                                           ===========  ==========  ==========
Primary loss per common share............. $     (0.37) $    (0.23) $    (0.22)
                                           ===========  ==========  ==========
Weighted average number of common shares
 outstanding..............................   3,759,275   3,819,605   3,022,658
                                           ===========  ==========  ==========
Fully diluted loss per common share (Note
 2)....................................... $      (.30) $       --  $       --
                                           ===========  ==========  ==========
Weighted average number of common shares
 outstanding and shares issued upon
 conversion of debentures, assuming the
 conversion occurred at the beginning of
 the period...............................   4,339,830          --          --
                                           ===========  ==========  ==========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       3
<PAGE>
 
               ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                 CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                           COMMON STOCK      ADDITIONAL  ACCUMULATED
                         ------------------   PAID-IN     EARNINGS
                          SHARES    AMOUNT    CAPITAL     (DEFICIT)     TOTAL
                         ---------  -------  ----------  -----------  ----------  ---
<S>                      <C>        <C>      <C>         <C>          <C>         <C>
Balance at December 31,
1993.................... 2,722,488  $54,450  $1,817,752  $    17,785  $1,889,987
 Shares issued for
  acquisitions.......... 1,200,770   24,015   1,476,950           --   1,500,965
 Net loss...............        --       --          --     (650,489)   (650,489)
                         ---------  -------  ----------  -----------  ----------
Balance at December 31,
 1994................... 3,923,258   78,465   3,294,702     (632,704)  2,740,463
 Shares issued for
  warrants exercised....       163        3         486           --         489
 Canceled stock:
  Acquisition related
   adjustment...........  (248,710)  (4,974)   (305,917)          --    (310,891)
  Fractional shares.....      (210)      (4)          4           --          --
 Net loss...............        --       --          --     (867,029)   (867,029)
                         ---------  -------  ----------  -----------  ----------
Balance at December 31,
 1995................... 3,674,501   73,490   2,989,275   (1,499,733)  1,563,032
 Shares issued for
  warrants exercised....        36        1         107           --         108
 Debentures exchanged
  for stock.............   644,444   12,889     857,111           --     870,000
 Shares issued for
  acquisitions..........    43,928      879      79,120           --      79,999
 Canceled stock:
  Fractional shares.....       (72)      (3)       (105)          --        (108)
 Net loss...............        --       --          --   (1,405,800) (1,405,800)
                         ---------  -------  ----------  -----------  ----------
Balance at December 31,
 1996................... 4,362,837  $87,256  $3,925,508  $(2,905,533) $1,107,231
                         =========  =======  ==========  ===========  ==========
</TABLE>
 
 
          See accompanying notes to consolidated financial statements.
 
                                       4
<PAGE>
 
               ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                      CONSOLIDATED STATEMENT OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31
                                             ---------------------------------
                                                1996        1995       1994
                                             -----------  ---------  ---------
<S>                                          <C>          <C>        <C>
Operations:
 Net loss................................... $(1,405,800) $(867,029) $(650,489)
 Adjustments to reconcile net loss to net
  cash provided by (used in) operating
  activities:
  Depreciation and amortization.............     319,770    295,410    208,751
  Amortization of goodwill, other
   intangibles and organization expenses....     380,832    409,908    257,309
  Changes in operating assets and
   liabilities, net of effect of purchases
   of subsidiaries:
   Cash and cash equivalents--brokerage
    fiduciary funds.........................     552,438   (206,152)   322,950
   Accounts receivable......................     (54,586)    51,292   (133,818)
   Prepaid expenses and other current
    assets..................................      51,451     87,268    579,932
   Other assets.............................     (65,589)    83,626    (66,928)
   Deferred compensation....................     103,560    205,560   (566,904)
   Net premiums payable--insurance
    companies...............................    (473,234)   254,670   (254,236)
   Accounts payable and accrued expenses....      33,407     39,712    (78,931)
   Other liabilities........................    (229,220)  (180,925)  (152,000)
                                             -----------  ---------  ---------
Net cash (used in) provided by operating
 activities.................................    (786,971)   173,340   (534,364)
                                             -----------  ---------  ---------
Investing activities:
 Purchases of property and equipment........     (84,035)  (394,291)  (394,916)
 Purchases of customer lists................    (100,000)   (63,368)        --
 Purchases of subsidiaries, net of cash
  acquired..................................          --         --    (28,534)
                                             -----------  ---------  ---------
Net cash used in investing activities.......    (184,035)  (457,659)  (423,450)
                                             -----------  ---------  ---------
</TABLE>
 
 
          See accompanying notes to consolidated financial statements.
 
                                       5
<PAGE>
 
               ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENT OF CASH FLOWS--CONTINUED
 
<TABLE>
<CAPTION>
                                                   YEAR ENDED DECEMBER 31
                                                 -----------------------------
                                                   1996      1995       1994
                                                 --------  ---------  --------
<S>                                              <C>       <C>        <C>
Financing activities:
 Short-term borrowings, net.....................  220,000    325,000   600,000
 Borrowings on long-term debt...................  225,000  1,482,583        --
 Repayment of long-term debt.................... (204,127)  (494,997)       --
 Payments on long term liabilities..............  (22,883)  (461,467) (190,245)
 Repayment of capital lease obligations.........       --    (46,610)  (10,969)
 Common stock--warrants exercised...............       --        489        --
                                                 --------  ---------  --------
Net cash provided by financing activities.......  217,990    804,998   398,786
                                                 --------  ---------  --------
Net (decrease) increase in cash and cash
 equivalents.................................... (753,016)   520,679  (559,028)
Cash and cash equivalents--corporate funds:
 Beginning of period............................  904,781    384,102   943,130
                                                 --------  ---------  --------
 End of period.................................. $151,765  $ 904,781  $384,102
                                                 ========  =========  ========
Supplemental cash flow information:
 Cash paid during the period for:
  Interest...................................... $379,071  $ 161,769  $ 35,925
                                                 ========  =========  ========
  Income taxes.................................. $  6,830  $   5,600  $ 93,042
                                                 ========  =========  ========
Supplemental schedule of noncash investing and
 financing activities:
 Common stock--convertible debentures exercised. $870,000  $      --  $     --
                                                 ========  =========  ========
 Increase in intangible assets and common stock
  related to purchase of customer lists......... $176,999  $      --  $     --
                                                 ========  =========  ========
 Decrease in goodwill and intangible assets
  related to adjustment in deferred taxes....... $111,322  $      --  $     --
                                                 ========  =========  ========
 Increase in goodwill related to adjustment of
  sublease liability............................ $     --  $ 104,542  $     --
                                                 ========  =========  ========
 Decrease in goodwill related to cancellation of
  stock issued in conjunction with PKW merger... $     --  $ 310,890  $     --
                                                 ========  =========  ========
 Increase in intangible assets and note payable
  related to the purchase of customer lists..... $     --  $ 140,395  $     --
                                                 ========  =========  ========
 Decrease in goodwill and notes payable related
  to reevaluation of customer list.............. $     --  $      --  $ 50,000
                                                 ========  =========  ========
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       6
<PAGE>
 
              ANCHOR PACIFIC UNDERWRITERS, INC. AND SUBSIDIARIES
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS
 
ORGANIZATION
 
  Anchor Pacific Underwriters, Inc. ("Anchor") is a holding company that
provides insurance administration and property and casualty brokerage services
through its five direct and indirect subsidiaries. Administration services are
provided to employer groups of varying sizes, primarily located in California
and Arizona. Anchor also operates a property and casualty insurance agency
which services customers located primarily in the greater San Francisco Bay
Area.
 
  The consolidated financial statements include the accounts of Anchor and its
wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
 
BASIS OF PRESENTATION
 
  The financial statements have been prepared on the going concern basis. The
Company has reported a net loss during the past three years. The increase in
net loss from 1995 to 1996 relates primarily to business lost due to new
underwriting requirements imposed by a new insurance carrier. In addition, one
of the Company's lenders has not renewed its line of credit and the Company is
working to replace the credit facility with another interested bank or to
repay the loan (see Note 6). The Company's business is not capital intensive
and the Company historically has had sufficient capital to meet its operating
needs. However, Anchor is currently seeking to raise an additional $500,000 in
equity from the members of the Board of Directors and other qualified
investors to supplement working capital. As of March 19, 1997, the Company has
raised $150,000 (from certain members of Anchor's Board of Directors), and has
oral commitments for an additional $200,000 in equity financing under which it
will issue common stock at $.90 per share and a five year warrant to purchase
stock at $.90 per share.
 
  Additionally, to further supplement current funding sources, Anchor is
presently seeking alternative bank lines and is seeking to raise additional
funds from institutional investors. Anchor also entered into an Financial
Advisory Agreement with The Private Financing Group ("TPFG"), to assist in
planning, balance sheet analysis, locating investors, joint ventures, merger
partners or funding sources, and to review the overall business needs and
promotion of the internal and external business goals of Anchor.
 
 
                                       7
<PAGE>
 
  Management's plan to achieve profitability includes a strategy to strengthen
its core health insurance and property and casualty insurance business by: a)
continuing to develop specialized affiliated business units that target
selected insurance market segments defined by industry type, geographic
location and consumer demographics; b) establishing new products and services;
c) strengthening management, sales and marketing staff; and d) seeking to
acquire and integrate compatible insurance brokerage and administration
businesses in the Western United States. In conjunction with such acquisition
strategies, management intends to realize efficiencies and reduce expenses
through the integration and centralization of certain services with its
existing infrastructure.
 
RECAPITALIZATION AND RESTATEMENT
 
  On January 6, 1995, Anchor merged with System Industries, Inc. ("System"),
previously a dormant, publicly traded shell corporation. As a result of the
merger, Anchor became a public company. For accounting purposes, the merger
has been treated as a recapitalization of Anchor with Anchor as the acquirer.
The historical financial statements prior to January 6, 1995 are those of
Anchor. These historical financial statements have been restated to give
effect to this recapitalization. Upon consummation of this merger,
shareholders and certain creditors of System each received one share of Anchor
common stock and one warrant to purchase one share of Anchor common stock at a
price of $3.00 for every 42.3291 shares of issued and outstanding System common
stock. Warrants to purchase 195,453 shares of common stock expired January 6,
1997, and unissued warrants to purchase 195,789 shares of common stock will
expire one year after their issuance.
 
  Costs incurred in conjunction with the merger, totaling $221,220 and
$462,601 in 1995 and 1994, respectively, have been expensed. There were no
merger related costs incurred in 1996.
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
USE OF ESTIMATES
 
  The preparation of financial statements requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
 
REVENUE RECOGNITION
 
  The majority of revenue from third party administration services consists of
fees charged for the administration of fully insured and self-insured group
health plans. Fee income is recognized at the time employers remit monthly
premiums and when services are rendered. Anchor derived 57%, 59%, and 72% of
its revenues in 1996, 1995, and 1994, respectively, from its third-party
activities.
 
                                       8
<PAGE>
 
  Insurance brokerage revenue consists principally of insurance commissions
(net of split or shared commissions), fees in lieu of commissions for
insurance placement services and interest income on fiduciary and corporate
funds. Insurance commissions and fees in lieu of commissions for insurance
placement services are recognized when coverage becomes effective, the premium
due under the policy is known or can be reasonably estimated, and
substantially all required services related to placing the insurance have been
provided.
 
  Broker commission adjustments and commissions on premiums billed directly by
underwriters are recognized principally when such amounts can be reasonably
estimated.
 
  In addition, Anchor receives annual contingency commissions from various
property and casualty insurance carriers. The commissions are based upon the
carrier's loss experience as well as the number of policies placed. Revenue
from contingency commissions is recognized when received. Fee income for
services other than placement of insurance coverages is recognized as those
services are provided. Anchor derived 43%, 40%, and 27% of its revenues in
1996, 1995, and 1994, respectively, from its insurance brokerage activities.
 
EXPENSE RECOGNITION
 
  All costs are expensed as incurred.
 
CASH AND CASH EQUIVALENTS
 
  Anchor considers all highly liquid investments with a maturity of three
months or less at the date of acquisition to be cash equivalents.
 
FIDUCIARY FUNDS AND LIABILITIES
 
  Funds held for self-funded employers, fully insured programs and unremitted
insurance premiums are held in a fiduciary capacity.
 
  Interest earned on certain fiduciary funds is included in Anchor's earnings.
Interest income on fiduciary funds amounted to $94,591, $138,051, and $64,139,
in 1996, 1995, and 1994, respectively.

CONCENTRATION OF CREDIT RISK

  Cash and cash equivalents are on deposit in approximately 115 separate
accounts with certain accounts exceeding $100,000. The FDIC insures accounts
up to $100,000 each. If several accounts are maintained for the same entity at
the same bank, the FDIC applies the $100,000 limit to the combined group. The
accounts are maintained in well-established local commercial banks. These
banks have satisfied the FDIC's more stringent capitalization requirements,
qualifying them to accept broker deposits. The banks have received high
ratings from bank rating services. As a result, credit risk is deemed to be
minimal.
 
                                       9
<PAGE>
 
ACCOUNTS RECEIVABLE
 
  Anchor provides for future estimated credit losses based on an evaluation of
a current aging of the accounts, current economic conditions and other factors
necessary to provide for losses that can be reasonably anticipated.
 
FAIR VALUE OF FINANCIAL INSTRUMENTS
 
  The carrying values of financial instruments such as cash and cash
equivalents, fiduciary funds, and debt obligations approximate their fair
market value.
 
  The following methods and assumptions were used by the company in estimating
its fair value disclosures for financial instruments:
 
  Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and short-term instruments approximate those assets' fair
values.
 
  Short-term borrowings: The carrying amounts on the lines of credits and
other short-term borrowings approximate their fair value.
 
  Long-term borrowings: The fair values of Anchor's long-term borrowings are
estimated using discounted cash flow analyses, based on the current
incremental borrowing rates for similar types of borrowing arrangements.
 
PROPERTY AND EQUIPMENT
 
  Property and equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
assets, which range from three to ten years.
 
  Software costs relating to the upgrading and enhancing of existing programs
are capitalized and amortized over a period of five years.
 
GOODWILL AND INTANGIBLE ASSETS
 
  Goodwill represents the excess of the cost of acquisitions over the fair
value of net assets acquired. Intangible assets relate to covenants not to
compete, customer lists and other contractual rights acquired in acquisitions.
Goodwill is amortized on the straight-line basis over 10 to 25 years.
Covenants not to compete and customer lists are amortized on the straight-line
basis over 5 to 13 years.
 
  Impairment of goodwill and intangible assets is measured on the basis of
anticipated undiscounted cash flows for each asset. Based upon the Company's
analysis, no impairment of such assets was indicated for the years ended
December 31, 1996, 1995, or 1994.

                                      10
<PAGE>
 
INCOME TAXES
 
  Anchor and its subsidiaries file a consolidated federal income tax return
and combined returns for state franchise tax purposes.
 
LOSS PER SHARE
 
  Primary loss per common share is based on the weighted average number of
common shares outstanding during the period. Fully diluted loss per common
share in 1996 is computed by dividing net loss, after subtracting interest on
debentures converted to stock, by the weighted average number of common shares
outstanding during the period and shares issued upon conversion of the
debentures, assuming the conversion occurred at the beginning of the period.
Fully diluted loss per common share was not reported in 1995 and 1994 because
they were antidilutive.
 
  In February 1997, the FASB issued Statement of Financial Accounting Standard
No. 128, "Earnings Per Share" ("EPS"), which establishes new standards for
computing and presenting earnings per share. The statement is effective for
financial statements issued for periods ending after December 15, 1997,
including interim periods, and requires restatement of all prior-period EPS
data presented. The impact of this statement on reported EPS in the
accompanying consolidated financial statements for the years ended December
31, 1996, 1995, and 1994 has not been determined.
 
RECLASSIFICATIONS
 
  Certain prior years' balances have been reclassified to conform with the
current year presentation.
 
NOTE 3 - ACQUISITIONS
 
  On August 1, 1994, Harden & Company, a subsidiary of Anchor, purchased
common stock of Benefit Resources Inc. (BRI), a third-party administrator
located in Scottsdale, Arizona. The purchase price consisted of $300,000 cash
and certain other acquisition expenses. The preliminary purchase price has
been allocated to assets and liabilities of BRI based upon their estimated
respective fair value. The preliminary purchase price exceeded the fair value
of BRI's net assets by approximately $212,000, which has been allocated to
intangible assets. In addition, Harden entered into a consulting contract
pursuant to which it agreed to pay $940,000 over a fifty-month period to an
entity affiliated with the former shareholders of BRI. At the end of the
fifty-month term, a final bonus payment will be calculated, if any, that would
be paid out from the fifty-first through the ninety-eighth month.
 
                                      11
<PAGE>
 
  On October 1, 1994, Anchor acquired Putnam, Knudsen & Wieking, Inc. (PKW), a
property and casualty insurance brokerage firm for an initial purchase price
of approximately $2,895,500 subject to certain future contingent payments or
adjustments. The purchase price consisted of the issuance of 1,200,770 shares
of newly issued Anchor stock at a value determined to be $1.25 per share plus
the assumption of approximately $710,000 in relocation liabilities relating to
PKW's former office facilities. The purchase price also consisted of certain
other acquisition expenses. The preliminary purchase price exceeded the fair
value of PKW's net assets by approximately $2,895,000. The excess of
$2,210,000 and $685,000 has been allocated to goodwill and other intangible
assets, respectively.
 
  During 1995, subsequent to the PKW acquisition certain contingencies
regarding PKW's operations caused Anchor to negotiate and secure an adjustment
to the purchase price paid for PKW. As a result, 248,710 shares of Anchor's
common stock, that were issued in connection with the acquisition, were
returned to Anchor. The returned shares resulted in a decrease of $310,891 in
goodwill and shareholders' equity and a decrease in the number of outstanding
shares of Anchor's common stock by 248,710. The decrease in goodwill was
partially offset by a $104,540 purchase price adjustment recorded during 1995 to
increase the estimate of liabilities assumed in the acquisition of PKW.
 
  The results of operations of BRI and PKW are included in the consolidated
results of operations of Anchor from their respective dates of acquisition,
August 1, 1994 and October 1, 1994. The unaudited pro forma consolidated
results of operations for the year ended December 31, 1994, assuming the
acquisitions of BRI and PKW occurred as of the beginning of 1994, are as
follows: Revenues--$10,037,190; Net loss--$(1,183,484); and Primary loss per
common share--$(.45).
 
NOTE 4 - PROPERTY AND EQUIPMENT
 
  Property and equipment consist of the following:
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31
                                                          ---------------------
                                                            1996       1995
                                                          --------- -----------
<S>                                                       <C>       <C>
  Leasehold improvements................................. $  47,376 $    47,376
  Furniture and equipment................................   818,800     806,712
  Office equipment.......................................   694,865     694,864
  Computer equipment.....................................   539,607     515,661
  Computer software......................................   875,849     827,849
                                                          --------- -----------
                                                          2,976,497   2,892,462
  Less--accumulated depreciation and amortization........ 2,155,300   1,835,530
                                                          --------- -----------
                                                          $ 821,197 $ 1,056,932
                                                          ========= ===========
</TABLE>
 
  The foregoing assets are pledged as security for certain indebtedness (see
Notes 6 and 8).
 
                                      12
<PAGE>
 
NOTE 5 - GOODWILL AND INTANGIBLE ASSETS
 
  Goodwill and intangible assets consist of the following:
 
<TABLE>
<CAPTION>
                                                DECEMBER 31
                                          -----------------------
                                                                  AMORTIZATION
                                             1996        1995        PERIOD
                                          ----------- ----------- -------------
<S>                                       <C>         <C>         <C>
Goodwill................................. $ 3,052,828 $ 3,087,646 10 - 25 years
Less - accumulated amortization..........   1,149,099     959,194
                                          ----------- -----------
                                          $ 1,903,729 $ 2,128,452
                                          =========== ===========
Covenants not to compete................. $   285,100 $   240,700  5 - 7  years
Customer lists...........................   2,121,730   1,965,636  5 - 13 years
                                          ----------- -----------
                                            2,406,830   2,206,336
Less - accumulated amortization..........   1,267,363   1,077,596
                                          ----------- -----------
                                          $ 1,139,467 $ 1,128,740
                                          =========== ===========
</TABLE>
 
  The foregoing assets are pledged as security for certain indebtedness (see
Notes 6 and 8).
 
NOTE 6 - SHORT-TERM BORROWINGS
 
  Anchor has a $1,000,000 revolving line of credit agreement with its
principal bank which expired on January 7, 1997. Interest is paid monthly, at
the bank's prime rate, as adjusted (8.25% and 8.75% at December 31, 1996 and
1995). Borrowings on the line are collateralized by accounts receivable,
equipment and general intangibles. The line of credit agreement contains
certain restrictive covenants which, among other things, require Anchor to
maintain a net worth (as defined) of at least $800,000. The outstanding
borrowings against the line of credit at December 31, 1996 and 1995 were
$975,000 each year. The weighted average interest rate on this loan was 8.28%
and 8.83% during 1996 and 1995, respectively.
 
  Although Anchor was within the covenants of the loan at the renewal date and
is current with all interest payments, the bank has notified Anchor that it is
no longer willing to continue to extend credit to Anchor because Anchor's
performance has not met the bank's expectations. The bank has given Anchor an
opportunity to make arrangements to replace the credit facility. Anchor is
currently working with the bank to move the credit facility to another
interested bank or to use proceeds from potential investors to satisfy the
obligation.
 
  On July 30, 1995, Anchor entered into an unsecured revolving line of credit
agreement with another bank which provides for a line of credit of $500,000
and expired on July 30, 1996. The credit line has been renewed with the bank
in the amount of $450,000 for twelve months and matures on October 20, 1997,
at which time all unpaid principal and interest is due. Amounts advanced
against the line bear interest at the bank's prime rate plus 1.5%, previously
the prime rate plus 1.25% (9.75% and 10% at December 31, 1996 and 1995). The
line of credit agreement contains certain restrictive covenants which, among
other things, require Anchor to maintain a net worth (as defined) of at least
$650,000. The outstanding borrowings against the line of credit were $420,000
and $200,000 at December 31, 1996 and 1995, respectively. The weighted average
interest rate on this loan was 9.58% and 10% during 1996 and 1995,
respectively.
 
                                      13
<PAGE>
 
NOTE 7 - OTHER LONG-TERM LIABILITIES
 
  Other long-term liabilities primarily consist of future contingent payments
relating to contractual agreements negotiated with the previous owners of
businesses acquired, deferred rent and other liabilities. The future
contingent payments are generally based upon the amount of net commission
income generated from the books of business acquired.
 
  At December 31, 1996, future payments of these liabilities are as follows:
 
<TABLE>
<CAPTION>
  YEAR
  ----
<S>                                                                    <C>
  1997                                                                 $ 604,398
  1998                                                                   292,862
  1999                                                                   119,903
  2000                                                                    90,691
  2001                                                                    74,867
  Thereafter..........................................................   195,607
                                                                       ---------
                                                                       1,378,328
  Less - current portion..............................................   604,398
                                                                       ---------
                                                                       $ 773,930
                                                                       =========
</TABLE>

NOTE 8 - LONG TERM DEBT
 
  At December 31, 1995, long-term included 10% convertible subordinated
debentures totaling $970,000. During 1996, debentures totaling $870,000 were
converted into 644,444 shares of Anchor's common stock at $1.35 per share. The
remaining $100,000 of the debentures may be converted into Anchor's common
stock at $1.65 per share. The debentures have varying maturity dates in 1997
and are included under the current portion of long-term debt.
 
  Also included under the current portion of long-term debt is $225,000 Anchor
raised during the third and fourth quarters of 1996 from members of the Board
of Directors and other qualified investors to supplement its working capital
and capital expenditure requirements through the issuance of 10% subordinated
bridge notes ("Bridge Notes") with a warrant to purchase shares of Anchor
common stock. The basic terms of the Bridge Notes were: a) 10% interest per
annum, paid in arrears; b) one year maturity; and c) for every $10,000
principal amount invested, the purchaser received a five year warrant to
acquire 1,000 shares of Anchor common stock at a purchase price of $1.75 per
share.
 
  In February 1997, Anchor offered the purchasers of the Bridge Notes an
opportunity to either change the terms of the warrants underlying the Bridge
Notes or to participate in Anchor's new financing. The basic terms of these
two alternatives are: a) in lieu of receiving 1,000 warrants to purchase 1,000
shares of Anchor common stock at a purchase price of $1.75 per share, the
purchaser would receive 2,000 warrants to purchase 2,000 shares of Anchor
common stock at a purchase price of $1. 35 per share; or b) exchange the
Bridge Notes and receive in return i) interest at the rate of 10% per annum up
to the date of conversion; ii) Anchor common stock in place of the Bridge
Notes at a price equal to $.90 per share; and iii) five year warrants, equal
to the number of shares issued in place of the Bridge Notes with the right to
purchase Anchor's common stock at a purchase price of $.90 per share.
 
                                      14
<PAGE>
 
  Long-term debt also includes four loans totaling $249,030 at December 31,
1996. The loans provide for monthly installments of principal and interest
(with interest rates ranging from 8.25% to 10% per annum) through February
2000. Certain of the loans are secured by furniture and equipment and
intangible assets.
 
  Principal payments due on long-term debt after December 31, 1996 are as
follows:
 
<TABLE>
<S>                                                                     <C>
  YEAR
  ----
  1997................................................................. $425,110
  1998.................................................................   70,212
  1999.................................................................   65,268
  2000.................................................................   13,540
                                                                        --------
                                                                         574,130
  Less - current portion...............................................  425,110
                                                                        --------
                                                                        $149,020
                                                                        ========
</TABLE>
 
NOTE 9 - INCOME TAXES
 
<TABLE>
<S>                                                      <C>     <C>    <C>
The provision for income taxes is as follows:
<CAPTION>
                                                         YEAR ENDED DECEMBER 31
                                                         ----------------------
                                                          1996    1995   1994
                                                         ------- ------ -------
<S>                                                      <C>     <C>    <C>
Current tax expense:
   Federal.............................................. $    -- $   -- $28,386
   State and local......................................   6,830  4,800   9,809
                                                         ------- ------ -------
                                                           6,830  4,800  38,195
                                                         ------- ------ -------
  Deferred tax benefit:
   Federal..............................................      --     -- (28,386)
   State and local......................................      --     --  (5,009)
                                                         ------- ------ -------
                                                              --     -- (33,395)
                                                         ------- ------ -------
                                                         $ 6,830 $4,800 $ 4,800
                                                         ======= ====== =======
</TABLE>
 
  Deferred income taxes are provided for the temporary differences between the
financial reporting and tax bases of Anchor's assets and liabilities. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized.
 
                                      15
<PAGE>
 
  Deferred tax liabilities and assets are comprised of the following:
 
<TABLE>
<CAPTION>
                                                               DECEMBER 31
                                                           --------------------
                                                              1996       1995
                                                           ----------  --------
<S>                                                        <C>         <C>
  Deferred tax liabilities:
   Depreciation and amortization.......................... $  210,416  $111,322
   Rent...................................................      8,088     6,188
                                                           ----------  --------
                                                              218,504   117,510
                                                           ----------  --------
  Deferred tax assets:
   Depreciation and amortization..........................         --    89,010
   Vacation pay...........................................     67,525    38,968
   Sublease liability.....................................    160,469        --
   Tax credits............................................     41,188    42,977
   Others.................................................     69,300    19,824
   Net operating loss carryforward........................    989,556   647,492
                                                           ----------  --------
                                                            1,328,038   838,271
  Valuation allowance for deferred tax assets............. (1,109,534) (832,083)
                                                           ----------  --------
  Net deferred tax asset..................................    218,504     6,188
                                                           ----------  --------
  Net deferred tax liabilities............................ $       --  $111,322
                                                           ==========  ========
</TABLE>
 
  At December 31, 1996 and 1995, deferred tax liabilities are noncurrent. At
December 31, 1996 and 1995, deferred tax assets are comprised of $34,316 and
$6,188 which are current and $184,188 and $0, which are noncurrent,
respectively. The decrease in deferred tax liabilities of $111,322 in 1996 was
recorded as a reduction of goodwill and intangible assets.
 
  The change in the valuation allowance is comprised of the following items:
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED DECEMBER 31
                                                       ------------------------
                                                          1996         1995
                                                       -----------  -----------
   <S>                                                 <C>          <C>
     Increase due to net operating losses............  $   472,654  $   493,936
     Change in estimate of temporary differences for
      fixed and intangible assets, sublease
      liability, deferred rent, vacation pay and
      other..........................................     (195,203)     256,644
                                                       -----------  -----------
     Net increase....................................  $   277,451  $   750,580
                                                       ===========  ===========
</TABLE>
 
  At December 31, 1996, $151,000 of the valuation allowance related to
acquisitions. When realized, the tax benefit will be accounted for as a
reduction of goodwill.
 
                                      16
<PAGE>
 
  A reconciliation of income tax computed at the federal statutory corporate
tax rate to the provision for income taxes follows:
 
<TABLE>
<CAPTION>
                                        YEAR ENDED DECEMBER 31
                         ----------------------------------------------------------
                               1996                1995                1994
                         ------------------  ------------------  ------------------
                          AMOUNT    PERCENT   AMOUNT    PERCENT   AMOUNT    PERCENT
                         ---------  -------  ---------  -------  ---------  -------
<S>                      <C>        <C>      <C>        <C>      <C>        <C>
  Income taxes at fed-
   eral statutory rate.. $(477,972)  (34.0)% $(294,790)  (34.0)% $(219,534)  (34.0)%
  Increase (decrease) in
   income taxes
   resulting from:
   State and local in-
    come taxes, net
    of federal tax bene-
    fit.................   (84,348)   (6.0)    (51,559)   (6.0)    (38,741)   (6.0)
   Amortization of good-
    will and
    other intangibles...    79,949     5.7     100,817    11.6      21,594     3.3
   Employee benefits....     9,717     0.7      11,388     1.3      10,358     1.6
   Purchase accounting..        --      --    (259,792)  (30.0)         --      --
   Nonrecurring merger
    expenses............        --      --          --      --     192,927    30.0
   State minimum tax....     6,830     0.5       4,800     0.6       4,800     0.7
   Net operating loss...   472,654    33.6     493,936    57.1      33,396     5.1
                         ---------   -----   ---------   -----   ---------   -----
                         $   6,830     0.5%  $   4,800     0.6%  $   4,800     0.7%
                         =========   =====   =========   =====   =========   =====
</TABLE>
 
  At December 31, 1996, Anchor had federal and state net operating loss
carryforwards of approximately $2,767,000 and $1,347,000, respectively. The
net operating losses will begin to expire in the year ending December 31,
1998.
 
  At December 31, 1996, Anchor had federal general business credits of
$25,104. The general business credits expire in the years ending December 31,
1996 to December 31, 2000. At December 31, 1996, Anchor had state tax credits
of $16,084. The state tax credits may be carried forward indefinitely.
 
  As discussed in Note 1, Anchor consummated a merger with System Industries,
Inc., resulting in shares of Anchor being issued. Federal and state tax law
impose limitations on the use of the net operating losses and tax credits
following certain changes in ownership. If such an ownership change has
occurred, the limitation could reduce the amount of the benefit of the net
operating losses and general business credits that would be available to
offset future taxable income starting in the year of the ownership change.
 
NOTE 10 - RETIREMENT AND EMPLOYEE BENEFIT PLANS
 
  Anchor has a 401(k) profit sharing plan to which eligible employees may
contribute up to 15% of their salaries, or a maximum of $9,500 as deferred
compensation. The plan also provides for voluntary employer contributions
whereby Anchor may match 50% of the employee contribution up to a maximum of
3% of the employees' gross salary. Anchor made no contributions to the plan
during the years ended December 31, 1996, 1995, and 1994.
 
  In addition, Anchor offers active eligible employees certain life, health,
vision and dental benefits. There are several plans which differ in amounts of
coverage and deductibles. Anchor does not extend such benefits to retirees.
 
                                      17
<PAGE>
 
NOTE 11 - STOCK OPTION PLAN
 
  On December 5, 1994, the Board of Directors of Anchor adopted the Anchor
Pacific Underwriters, Inc. 1994 Stock Option Plan (the "1994 Plan"). The
aggregate number of shares that are available for issuance pursuant to the
exercise of options granted under the 1994 Plan may not exceed 700,000 shares
of common stock. Options granted to members of the Board of Directors in 1995
vested immediately upon grant. Other options granted in 1995 generally vested
after one year. Options granted in 1996 generally vested over a four-year
period, with 25 percent vesting each year. The options are priced at fair
market value of the stock at the date of grant, except for shareholders of
more than 10% of Anchor, in which case the options are priced at 110% of the
market price at the date of grant. Options generally have a ten-year life.
 
  Anchor applies the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") for its stock option
plan. Accordingly, no compensation cost has been recognized for the plan for
the years ended December 31, 1996, 1995 and 1994.
 
  Had Anchor adopted Financial Accounting Standards Board Statement No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"), the net loss of
$1,405,800 as reported for the year ended December 31, 1996 would compare to a
pro forma net loss of $1,441,189, and the net loss of $867,029 as reported for
the year ended December 31, 1995 would compare to a pro forma loss of
$1,125,240. The charge on a pro forma basis for the year ended December 31,
1995 was primarily the result of options granted to members of the Board of
Directors in 1995 which vested immediately. The options were granted to
members of the Board of Directors in conjunction with the merger of Anchor and
System Industries, Inc. (see Note 1). Primary loss per share of $(.37) as
reported for the year ended December 31, 1996 would compare to a pro forma
primary loss per share of $(.38), and for the year ended December 31, 1995,
the reported primary loss per share of $(.23) would compare to a pro forma
primary loss per share of $(.29). Fully diluted loss per share of $(.30) as
reported for the year ended December 31, 1996 would compare to a pro forma
fully diluted loss per share of $(.31).
 
  The effects of applying SFAS No. 123 in the preceding pro forma disclosure
are not indicative of the effect on reported net income for future years. SFAS
No. 123 does not apply to awards granted prior to 1995.
 
  The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1995, respectively: expected
volatility of 25% for both years, risk-free interest rates of 6.5 and 6.0
percent, and expected lives of 5.8 and 6.4 years. No dividend yield was used
as Anchor has not paid dividends in the past and does not anticipate paying
dividends in the future. As Anchor's common stock does not have an adequate
length of time of being publicly traded, a public entity with similar lines of
business was used to estimate expected volatility.
 
  A summary of the status of Anchor's stock option plan as of December 31,
1996 and 1995, and changes during the years then ended is presented below:
 
                                      18
<PAGE>
 
<TABLE>
<CAPTION>
                                                  1996              1995
                                            ----------------- -----------------
                                                     WEIGHTED          WEIGHTED
                                            NUMBER   AVERAGE  NUMBER   AVERAGE
                                              OF     EXERCISE   OF     EXERCISE
                                            SHARES    PRICE   SHARES    PRICE
                                            -------  -------- -------  --------
<S>                                         <C>      <C>      <C>      <C>
Outstanding at beginning of year........... 505,250   $1.52      None      --
Granted....................................  62,200   $1.54   512,250   $1.52
Canceled or expired........................ (10,100)  $1.50    (7,000)  $1.50
                                            -------           -------
Outstanding at end of year................. 557,350   $1.52   505,250   $1.52
                                            =======           =======
Options exercisable at year end............ 494,400           374,350
Weighted average grant-date fair value of
options granted during the year whose 
exercise price equaled market price on date 
of grant...................................           $ .58             $ .60
Weighted average grant-date fair value of
options granted during the year whose 
exercise price exceeded market price on date 
of grant...................................           $ .59             $ .58
</TABLE>
 
  The following table summarizes information about stock options outstanding
at December 31, 1996:
 
<TABLE>
<CAPTION>
               OPTIONS OUTSTANDING                     OPTIONS EXERCISABLE
---------------------------------------------------   -----------------------
                              WEIGHTED
    RANGE                      AVERAGE     WEIGHTED                 WEIGHTED
     OF                       REMAINING    AVERAGE                  AVERAGE
  EXERCISE       NUMBER      CONTRACTUAL   EXERCISE     NUMBER      EXERCISE
   PRICES      OUTSTANDING      LIFE        PRICE     EXERCISABLE    PRICE
  --------     -----------   -----------   --------   -----------   --------
<S>            <C>           <C>           <C>        <C>           <C>
  $1.45-$1.65    556,350      8.6 years     $1.52       494,150      $1.52
  $2.19            1,000      8.6 years     $2.19           250      $2.19
  -----------    -------      ---------     -----       -------      -----
  $1.45-$2.19    557,350      8.6 years     $1.52       494,400      $1.52
  ===========    =======      =========     =====       =======      =====
</TABLE>
 
NOTE 12 - LEASES
 
  Anchor rents its Concord, California facilities under an operating lease
which expires in 2004. The terms of the lease include a 12-month rent deferral
and fixed rental escalation. The total rent for the lease term which reflects
the 12-month deferral and the escalation is being amortized on the straight-
line basis over the full term of the lease, resulting in deferred rent
liability of approximately $286,000 and $265,000 at December 31, 1996 and
1995, respectively. The deferred rent liability is included in long-term
liabilities on the accompanying balance sheet.
 
  A subsidiary located in Scottsdale, Arizona leases offices under an
operating lease which expires in 2002. In addition, in connection with the
acquisition of PKW in October 1994, 

                                      19

<PAGE>
 
Anchor assumed the lease obligation of certain facilities in Oakland,
California. During 1995, Anchor subleased 92% of the Oakland facility to two
separate tenants. The subleases expire in 1999.
 
  The consolidated statement of operations includes rent expense of $683,591,
$623,563, and $424,597 reflected in selling, general and administrative
expenses for the years ended December 31, 1996, 1995, and 1994, respectively. 
  Future minimum annual lease payments under operating leases as of December
31, 1996, exclusive of net amounts owed under the Oakland lease which are
disclosed in the schedule of payments under long-term liabilities in Note 7,
are as follows:
 
<TABLE>
<CAPTION>
   YEAR
   ----
   <S>                                                               <C>
   1997............................................................  $   595,050
   1998............................................................      609,183
   1999............................................................      631,656
   2000............................................................      746,909
   2001............................................................      748,716
   Thereafter......................................................    1,941,081
                                                                     -----------
                                                                     $ 5,272,595
                                                                     ===========
</TABLE>
 
NOTE 13 - COMMITMENTS AND CONTINGENCIES
 
  Anchor is subject to certain legal proceedings and claims arising in
connection with the normal course of its business. It is management's opinion
that the resolution of these claims will not have a material effect on
Anchor's consolidated financial position.
 
  As of March 19, 1997, Anchor had a total of 374,120 warrants outstanding to
purchase its common stock at prices ranging from $.90 to $3.00 per share (see
Notes 1 and 8).
 
NOTE 14 - RELATED PARTY TRANSACTIONS
 
  Anchor is contingently liable on certain bank loans made to three of its
shareholders. The amounts outstanding on these loans total approximately
$116,201 at December 31, 1996 and the loans mature at various dates from May
1997 to November 1998.
 
  In 1995, 10% convertible subordinated debentures, totaling $190,000 were
sold to seven members of the Board of Directors and two shareholders. An
additional $600,000 was raised by selling a second 10% convertible
subordinated debenture--series A to Guarantee Life Insurance Company (a
current shareholder). Total interest incurred and accrued under the debentures
was $95,279 and $8,750 for the years ended December 31, 1996 and 1995,
respectively. As of December 31, 1996, one shareholder and one Board member
had not converted their debentures (which total $50,000) to equity. This
liability is classified under the current portion of long-term debt. All other
Board members and shareholders have converted their debentures, including the
series A debenture, to equity (see Note 8).
 
  In 1996, 10% subordinated bridge notes totaling $170,000 were sold to five
members of the Board of Directors and two shareholders (see Note 8). Total
interest incurred 

                                      20
<PAGE>
 
and accrued for the bridge notes was $6,000 for the year ending December 31,
1996. This liability is classified under accounts payable and accrued expenses.

                                      21