##### 



UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-K Special Financial Report Pursuant to Section 15d-2 of the Securities Exchange Act of 1934
for the fiscal year ended December 31, 2004 Commission file number: 000-51127 NATIONAL ATLANTIC HOLDINGS CORPORATION  New Jersey
    
    22-3316586(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 4 Paragon Way
Freehold, NJ 07728
(732) 665-1100
(Address, including zip code, and telephone number, including area code,
of Registrants principal executive offices) Securities registered pursuant to Section 12(b) of the Act: None Securities Registered pursuant to Section 12(g) of the Act: Common Stock, no par value per share
    
    Nasdaq National Market(Title of Class)
    
    (Name of each exchange on
which registered)
 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.  Yes o     No þ (The Registrants only became subject to the Section 15(d) filing requirements on January 27, 2005
pursuant to the filing of a Registration Statement on Form S-1 (File No. 333-117804) that became
effective on that date.) Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
is not contained herein, and will not be contained, to the best of Registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.  þ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of
the Securities Exchange Act of 1934).  Yes o     No þ




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DOCUMENTS INCORPORATED BY REFERENCE None. This special financial report is being filed pursuant to Rule 15d-2 of the Securities Exchange Act
of 1934, as amended, and contains only certified financial statements as required by Rule 15d-2.
This special financial report is filed under cover of the facing sheet of the form appropriate for
annual reports of the Registrant as required by Rule 15d-2.




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##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES



TABLE OF CONTENTS


|                                                                        |                                                          |         |     |     | 
|----------------------------------------------------------------------- | -------------------------------------------------------- | ------- | --- | --- | 
|                                                                        |                                                          | Page(s)
|                                                                        |                                                          |        
|Consolidated Financial Statement:                                       |                                                          |         |     |    
|Report of Independent
    Registered Public Accounting Firm             |                                                          |         | F-2 |    
|Consolidated Balance
    Sheets:                                        |                                                          |         |     |    
|                                                                        | As of December 31, 2004 and 2003                         |         |     | F-3 | 
|Consolidated Statements of
    Income:                                  |                                                          |         |     |    
|                                                                        | For the years ended December 31, 2004, 2003
    and 2002 |         |     | F-4 | 
|Consolidated Statements of
    Comprehensive Income:                    |                                                          |         |     |    
|                                                                        | For the years ended December 31, 2004, 2003
    and 2002 |         |     | F-5 | 
|Consolidated Statements of
    Changes in Stockholders Equity:         |                                                          |         |     |    
|                                                                        | For the years ended December 31, 2004, 2003
    and 2002 |         |     | F-6 | 
|Consolidated Statements of
    Cash Flows:                              |                                                          |         |     |    
|                                                                        | For the years ended December 31, 2004, 2003
    and 2002 |         |     | F-7 | 
|Notes to Consolidated
    Financial Statements                          |                                                          |         | F-8 |    
|EXHIBIT 31.1                                                            |                                                          |         |     |    
|Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |                                                          |         |     |    
|EXHIBIT 31.2                                                            |                                                          |         |     |    
|Certification Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |                                                          |         |     |    
|EXHIBIT 32.1                                                            |                                                          |         |     |    
|Certification Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 |                                                          |         |     |    
|EXHIBIT 32.2                                                            |                                                          |         |     |    
|Certification Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 |                                                          |         |     |    

F-1



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##### 






REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM

To the Board of Directors,

National Atlantic Holdings Corporation and
Subsidiaries


We have audited the accompanying consolidated
balance sheets of National Atlantic Holdings Corporation and
subsidiaries (the Company) as of December 31,
2004 and 2003, and the related consolidated statements of
income, stockholders equity, and cash flows for each of
the three years in the period ended December 31, 2004.
These financial statements are the responsibility of the
Companys management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with
standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The
company is not required to have, nor were we engaged to perform,
an audit of its internal control over financial reporting. Our
audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys
internal control over financial reporting. Accordingly, we
express no such opinion. An audit also 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, as well as
evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our
opinion.

In our opinion, such consolidated financial
statements present fairly, in all material respects, the
financial position of National Atlantic Holdings Corporation and
subsidiaries at December 31, 2004 and 2003, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2004 in conformity
with accounting principles generally accepted in the United
States of America.

/s/ DELOITTE & TOUCHE LLP




Parsippany, New Jersey

March 17, 2005


F-2



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##### 






NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |         |         | 
|----------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                                                                                                                    |                                                                                                                                     |                           
|                                                                                                                                    |                                                                                                                                     | December 31,              
|                                                                                                                                    |                                                                                                                                     |                           
|                                                                                                                                    |                                                                                                                                     | 2004                       |         | 2003   
|                                                                                                                                    |                                                                                                                                     |                            |         |        
|Investments: (Note 2)                                                                                                               |                                                                                                                                     |                            |         |         |         |   |         |        
|                                                                                                                                    | Fixed maturities available-for-sale (amortized
    cost at December 31, 2004 and 2003 was $210,636, and
    $130,799, respectively) |                            | $       | 210,830 |         |   | $       | 130,410 |        
|                                                                                                                                    | Short-term investments (cost at December 31,
    2004 and 2003 was $13,820 and $31,569, respectively)                               |                            |         | 13,820  |         |   |         | 31,569  |        
|                                                                                                                                    | Equity securities (cost at December 31, 2004
    and 2003 was $12,979 and $8,117, respectively)                                     |                            |         | 12,801  |         |   |         | 8,593   |        
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|                                                                                                                                    |                                                                                                                                     | Total investments          |         |         | 237,451 |   |         |         | 170,572 | 
|Cash and cash equivalents                                                                                                           |                                                                                                                                     |                            | 15,542  |         |         |   | 9,124   |        
|Accrued investment income                                                                                                           |                                                                                                                                     |                            | 2,085   |         |         |   | 1,901   |        
|Premiums receivable                                                                                                                 |                                                                                                                                     |                            | 31,185  |         |         |   | 23,219  |        
|Reinsurance recoverable on paid and unpaid losses
    (Note 4)                                                                      |                                                                                                                                     |                            | 34,677  |         |         |   | 26,346  |        
|Reinsurance receivable (Note 4)                                                                                                     |                                                                                                                                     |                            |        |         |         |   | 10,050  |        
|Prepaid reinsurance                                                                                                                 |                                                                                                                                     |                            | 467     |         |         |   | 1,634   |        
|Receivable from Ohio Casualty, a related party
    (Note 3)                                                                         |                                                                                                                                     |                            | 4,350   |         |         |   | 6,820   |        
|Receivable from Sentry (Note 3)                                                                                                     |                                                                                                                                     |                            | 1,250   |         |         |   | 2,625   |        
|Deferred acquisition costs                                                                                                          |                                                                                                                                     |                            | 10,872  |         |         |   | 9,788   |        
|Property and equipment  Net
    (Note 7)                                                                                           |                                                                                                                                     |                            | 2,021   |         |         |   | 1,082   |        
|Federal income taxes recoverable                                                                                                    |                                                                                                                                     |                            |        |         |         |   | 2,168   |        
|Other assets                                                                                                                        |                                                                                                                                     |                            | 7,272   |         |         |   | 1,419   |        
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|Total assets                                                                                                                        |                                                                                                                                     | $                          | 347,172 |         |         | $ | 266,748 |        
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|                                                                                                                                   
|Liabilities and Stockholders
    Equity:                                                                                          
|Liabilities:                                                                                                                        |                                                                                                                                     |                            |         |         |         |   |         |        
|Unpaid losses and loss adjustment expenses
    (Note 5)                                                                             |                                                                                                                                     | $                          | 184,283 |         |         | $ | 134,201 |        
|Unearned premiums                                                                                                                   |                                                                                                                                     |                            | 64,170  |         |         |   | 51,813  |        
|Accounts payable and accrued expenses                                                                                               |                                                                                                                                     |                            | 2,900   |         |         |   | 2,290   |        
|Reinsurance payable                                                                                                                 |                                                                                                                                     |                            | 4,621   |         |         |   | 3,260   |        
|Deferred revenue from related party (Note 3)                                                                                        |                                                                                                                                     |                            |        |         |         |   | 9,530   |        
|Deferred revenue (Note 3)                                                                                                           |                                                                                                                                     |                            |        |         |         |   | 2,839   |        
|Deferred income taxes (Note 6)                                                                                                      |                                                                                                                                     |                            | 11,995  |         |         |   | 7,999   |        
|Federal income taxes payable                                                                                                        |                                                                                                                                     |                            | 1,512   |         |         |   |        |        
|State income taxes payable                                                                                                          |                                                                                                                                     |                            | 89      |         |         |   | 399     |        
|Other liabilities                                                                                                                   |                                                                                                                                     |                            | 9,763   |         |         |   | 4,630   |        
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|                                                                                                                                    |                                                                                                                                     | Total liabilities          |         |         | 279,333 |   |         |         | 216,961 | 
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|Stockholders equity:                                                                                                               |                                                                                                                                     |                            |         |         |         |   |         |        
|Common stock, Class A, no par value
    (4,300,000 shares authorized; 2,747,743 shares issued
    as of December 31, 2004 and 2003) |                                                                                                                                     |                            | 3,002   |         |         |   | 3,002   |        
|Common stock, Class B, no par value
    (4,300,000 shares authorized; 2,194,247 shares issued as of
    December 31, 2004 and 2003) |                                                                                                                                     |                            | 28,738  |         |         |   | 28,258  |        
|Retained earnings                                                                                                                   |                                                                                                                                     |                            | 35,917  |         |         |   | 18,470  |        
|Accumulated other comprehensive income                                                                                              |                                                                                                                                     |                            | 182     |         |         |   | 57      |        
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|                                                                                                                                    |                                                                                                                                     | Total stockholders equity |         |         | 67,839  |   |         |         | 49,787  | 
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        
|Total liabilities and stockholders equity                                                                                          |                                                                                                                                     | $                          | 347,172 |         |         | $ | 266,748 |        
|                                                                                                                                    |                                                                                                                                     |                            |         |         |         |   |         |        

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


F-3



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##### 






NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except earnings per share
data)


|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |        |        | 
|----------------------------------------------- | ------------------------------------------------ | -------------------------------- | ------ | ------- | ------- | ---- | ------ | ------- | ------- | - | ------ | ------ | ------ | 
|                                                |                                                  |                                 
|                                                |                                                  | For the Years Ended December 31,
|                                                |                                                  |                                 
|                                                |                                                  | 2004                             |        | 2003    |         | 2002
|                                                |                                                  |                                  |        |         |         |     
|Revenue:                                        |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|                                                | Net earned premiums                              |                                  | $      | 179,667 |         |      | $      | 143,156 |         |   | $      | 75,654 |       
|                                                | Net investment income                            |                                  |        | 7,061   |         |      |        | 4,258   |         |   |        | 1,593  |       
|                                                | Realized gains (losses) on
    investments  net |                                  |        | 1,931   |         |      |        | 1,373   |         |   |        | (55    | )     
|                                                | Replacement carrier revenue from related party   |                                  |        | 13,880  |         |      |        | 13,298  |         |   |        | 21,683 |       
|                                                | Replacement carrier revenue from unrelated party |                                  |        | 4,089   |         |      |        | 661     |         |   |        |       |       
|                                                | Other income                                     |                                  |        | 2,044   |         |      |        | 929     |         |   |        | 564    |       
|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|                                                |                                                  | Total revenue                    |        |         | 208,672 |      |        |         | 163,675 |   |        |        | 99,439 | 
|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|Costs and Expenses:                             |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|                                                | Loss and loss adjustment expenses incurred       |                                  |        | 134,987 |         |      |        | 108,123 |         |   |        | 69,491 |       
|                                                | Acquisition expenses                             |                                  |        | 39,586  |         |      |        | 25,547  |         |   |        | 14,887 |       
|                                                | Other operating and general expenses             |                                  |        | 7,765   |         |      |        | 992     |         |   |        | 3,605  |       
|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|                                                |                                                  | Total costs and expenses         |        |         | 182,338 |      |        |         | 134,662 |   |        |        | 87,983 | 
|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|Income before income taxes                      |                                                  |                                  | 26,334 |         |         |      | 29,013 |         |         |   | 11,456 |       
|Provision for income taxes                      |                                                  |                                  | 8,886  |         |         |      | 9,945  |         |         |   | 2,822  |       
|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|Net Income                                      |                                                  | $                                | 17,448 |         |         | $    | 19,068 |         |         | $ | 8,634  |       
|                                                |                                                  |                                  |        |         |         |      |        |         |         |   |        |       
|Net income per share Common Stock 
    Basic   |                                                  | $                                | 3.53   |         |         | $    | 4.29   |         |         | $ | 1.96   |       
|Net income per share Common Stock 
    Diluted |                                                  | $                                | 3.11   |         |         | $    | 3.77   |         |         | $ | 1.74   |       

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

F-4



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NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME

(in thousands)


|                                         |                                                                             |                                         |        |      |     |      |        |      |      |   |       |     |     | 
|---------------------------------------- | --------------------------------------------------------------------------- | --------------------------------------- | ------ | ---- | --- | ---- | ------ | ---- | ---- | - | ----- | --- | --- | 
|                                         |                                                                             |                                        
|                                         |                                                                             | For the Years Ended December 31,       
|                                         |                                                                             |                                        
|                                         |                                                                             | 2004                                    |        | 2003 |     | 2002
|                                         |                                                                             |                                         |        |      |     |     
|Net Income                               |                                                                             | $                                       | 17,448 |      |     | $    | 19,068 |      |      | $ | 8,634 |    
|Other comprehensive income  net of tax: |                                                                             |                                         |        |      |     |      |        |      |      |   |       |    
|                                         | Net holding gains arising during the year                                   |                                         |        | 451  |     |      |        | 63   |      |   |       | 441 |    
|                                         | Reclassification adjustment for realized (gains)
    included in net income |                                         |        | (326 | )   |      |        | (354 | )    |   |       | (43 | )  
|                                         |                                                                             |                                         |        |      |     |      |        |      |      |   |       |    
|                                         |                                                                             | Total other comprehensive (loss) income |        |      | 125 |      |        |      | (291 | ) |       |     | 398 | 
|                                         |                                                                             |                                         |        |      |     |      |        |      |      |   |       |    
|Comprehensive Income                     |                                                                             | $                                       | 17,573 |      |     | $    | 18,777 |      |      | $ | 9,032 |    
|                                         |                                                                             |                                         |        |      |     |      |        |      |      |   |       |    

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

F-5



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##### 






NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

For the periods ended December 31, 2004,
2003 and 2002


(in thousands, except share data)


|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |        |  
|---------------------------- | ------------------------------------------------ | ------------ | --------- | ------------ | - | ------------ | ----- | ---------- | - | ------------- | --------- | ------------- |  | ------------- | ------ | ------ | - | - | ------ | ------ |  |  | ------- | ------ |  | - | --- | ---- | - | - | ------ | ------ | -
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |              
|                             |                                                  | Class A      |           | Class B      |   | Retained     |       | Receivable |   | Accumulated   |           |              
|                             |                                                  | Common Stock |           | Common Stock |   | Earnings     |       | for        |   | Other         |           | Total        
|                             |                                                  |              |           |              |   | (Accumulated |       | Securities |   | Comprehensive |           | Stockholders
|                             |                                                  | Shares       |           | Amount       |   | Shares       |       | Amount     |   | Deficit)      |           | Issued        |  | Income (Loss) |        | Equity
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |       
|Balance at December 31, 2001 |                                                  |              | 2,792,893 |              |   |              | 3,055 |            |   |               | 1,611,597 |               |  |               | 15,212 |        |   |   | (9,232 | )      |  |  | (13,000 | )      |  |   | (50 | )    |   |   | (4,015 | )     
|                             | Exchange of Class A for Class B Common
    Stock |              |           | (45,150      | ) |              |       | (53        | ) |               |           | 45,150        |  |               |        | 53     |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |        |  
|                             | Issuance of Class B Common Stock                 |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         | 13,000 |  |   |     |      |   |   |        | 13,000 |  
|                             | Issuance of stock options                        |              |           |              |   |              |       |            |   |               |           |               |  |               |        | 706    |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        | 706    |  
|                             | Unamortized deferred compensation                |              |           |              |   |              |       |            |   |               |           |               |  |               |        | (589   | ) |   |        |        |  |  |         |        |  |   |     |      |   |   |        | (589   | )
|                             | Net Income                                       |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        | 8,634  |  |  |         |        |  |   |     |      |   |   |        | 8,634  |  
|                             | Other comprehensive income                       |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     | 398  |   |   |        | 398    |  
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |       
|Balance at December 31, 2002 |                                                  |              | 2,747,743 |              |   |              | 3,002 |            |   |               | 1,656,747 |               |  |               | 15,382 |        |   |   | (598   | )      |  |  | 0       |        |  |   | 348 |      |   |   | 18,134 |       
|                             | Issuance of Class B Common Stock                 |              |           |              |   |              |       |            |   |               |           | 537,500       |  |               |        | 12,457 |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        | 12,457 |  
|                             | Issuance of Stock Options                        |              |           |              |   |              |       |            |   |               |           |               |  |               |        | 736    |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        | 736    |  
|                             | Unamortized deferred compensation                |              |           |              |   |              |       |            |   |               |           |               |  |               |        | (552   | ) |   |        |        |  |  |         |        |  |   |     |      |   |   |        | (552   | )
|                             | Amortization of 2002 options                     |              |           |              |   |              |       |            |   |               |           |               |  |               |        | 235    |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        | 235    |  
|                             | Net Income                                       |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        | 19,068 |  |  |         |        |  |   |     |      |   |   |        | 19,068 |  
|                             | Other comprehensive loss                         |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     | (291 | ) |   |        | (291   | )
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |       
|Balance at December 31, 2003 |                                                  |              | 2,747,743 |              |   |              | 3,002 |            |   |               | 2,194,247 |               |  |               | 28,258 |        |   |   | 18,470 |        |  |  | 0       |        |  |   | 57  |      |   |   | 49,787 |       
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |       
|                             | Amortization of 2002 and 2003 options            |              |           |              |   |              |       |            |   |               |           |               |  |               |        | 480    |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        | 480    |  
|                             | Net Income                                       |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        | 17,448 |  |  |         |        |  |   |     |      |   |   |        | 17,448 |  
|                             | Other comprehensive income                       |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     | 125  |   |   |        | 125    |  
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |       
|Balance at December 31, 2004 |                                                  |              | 2,747,743 |              |   | $            | 3,002 |            |   |               | 2,194,247 |               |  | $             | 28,738 |        |   | $ | 35,917 |        |  |  | 0       |        |  | $ | 182 |      |   | $ | 67,839 |       
|                             |                                                  |              |           |              |   |              |       |            |   |               |           |               |  |               |        |        |   |   |        |        |  |  |         |        |  |   |     |      |   |   |        |       

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

F-6



---



##### 






NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH
FLOWS

(in thousands)


|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |         |         |         |  
|------------------------------------------------------------------------------------------- | ------------------------------------------------ | ------------------------------------------ | ----------------------------------------- | -------- | ------ | ------- | ------ | -------- | ------- | ------- | ------ | ------- | ------- | ------- | -
|                                                                                            |                                                  |                                           
|                                                                                            |                                                  | For the Years Ended December 31,          
|                                                                                            |                                                  |                                           
|                                                                                            |                                                  | 2004                                       |                                           | 2003     |        | 2002   
|                                                                                            |                                                  |                                            |                                           |          |        |        
|CASH FLOWS FROM OPERATING
    ACTIVITIES:                                                   |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|Net income                                                                                  |                                                  | $                                          | 17,448                                    |          |        | $       | 19,068 |          |         | $       | 8,634  |        
|Adjustment to reconcile net income to net cash
    provided (used in) operating activities: |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            | Depreciation and amortization                    |                                            |                                           | 428      |        |         |        | 312      |         |         |        | 285     |        
|                                                                                            | Amortization of premium/discount on bonds        |                                            |                                           | 1,090    |        |         |        | 837      |         |         |        | 259     |        
|                                                                                            | Realized losses (gains) on investment sales      |                                            |                                           | (1,931   | )      |         |        | (1,373   | )       |         |        | 55      |        
|                                                                                            | Changes in:                                      |                                            |                                           |          |        |         |        |          |         |         |        |         |        
|                                                                                            |                                                  | Deferred income taxes                      |                                           |          | 3,932  |         |        |          | 9,487   |         |        |         | 2,823   |        
|                                                                                            |                                                  | Premiums receivable                        |                                           |          | (7,966 | )       |        |          | (1,364  | )       |        |         | (12,271 | )      
|                                                                                            |                                                  | Reinsurance recoverable                    |                                           |          | (8,331 | )       |        |          | (3,228  | )       |        |         | 5,998   |        
|                                                                                            |                                                  | Reinsurance receivable                     |                                           |          | 10,050 |         |        |          | (10,050 | )       |        |         |        |        
|                                                                                            |                                                  | Prepaid reinsurance                        |                                           |          | 1,167  |         |        |          | 321     |         |        |         | 7,230   |        
|                                                                                            |                                                  | Receivable from Ohio Casualty              |                                           |          | (2,470 | )       |        |          | (53     | )       |        |         | (6,767  | )      
|                                                                                            |                                                  | Receivable from Sentry                     |                                           |          | 1,375  |         |        |          | (2,625  | )       |        |         |        |        
|                                                                                            |                                                  | Guarantee fund receivable                  |                                           |          |       |         |        |          |        |         |        |         | 21      |        
|                                                                                            |                                                  | Deferred acquisition costs                 |                                           |          | (1,084 | )       |        |          | (1,010  | )       |        |         | (6,947  | )      
|                                                                                            |                                                  | Accrued interest income                    |                                           |          | (184   | )       |        |          | (1,051  | )       |        |         | (678    | )      
|                                                                                            |                                                  | Federal income taxes recoverable           |                                           |          | 2,168  |         |        |          | (2,168  | )       |        |         | 608     |        
|                                                                                            |                                                  | Other assets                               |                                           |          | (5,856 | )       |        |          | 1,171   |         |        |         | (2,449  | )      
|                                                                                            |                                                  | Unpaid losses and loss adjustment expenses |                                           |          | 50,082 |         |        |          | 48,729  |         |        |         | 28,740  |        
|                                                                                            |                                                  | Stock options                              |                                           |          | 480    |         |        |          | 419     |         |        |         | 117     |        
|                                                                                            |                                                  | Accounts payable                           |                                           |          | 610    |         |        |          | 745     |         |        |         | 1,364   |        
|                                                                                            |                                                  | Deferred revenue from related party        |                                           |          | (9,530 | )       |        |          | 3,614   |         |        |         | 5,917   |        
|                                                                                            |                                                  | Deferred revenue                           |                                           |          | (2,839 | )       |        |          | 2,839   |         |        |         |        |        
|                                                                                            |                                                  | Unearned premiums                          |                                           |          | 12,357 |         |        |          | 5,795   |         |        |         | 29,208  |        
|                                                                                            |                                                  | Reinsurance payable                        |                                           |          | 1,361  |         |        |          | 3,920   |         |        |         | (2,324  | )      
|                                                                                            |                                                  | Federal income taxes payable               |                                           |          | 1,512  |         |        |          |        |         |        |         |        |        
|                                                                                            |                                                  | State income taxes payable                 |                                           |          | (310   | )       |        |          | 394     |         |        |         |        |        
|                                                                                            |                                                  | Other liabilities                          |                                           |          | 5,132  |         |        |          | 532     |         |        |         | 2,892   |        
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            |                                                  |                                            | Net cash provided by operating activities |          |        | 73,631  |        |          |         | 75,266  |        |         |         | 62,715  |  
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|CASH FLOWS FROM INVESTING
    ACTIVITIES:                                                   |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            | Purchases of property and equipment              |                                            |                                           | (1,367   | )      |         |        | (474     | )       |         |        | (821    | )      
|                                                                                            | Purchases of fixed maturity investments          |                                            |                                           | (215,882 | )      |         |        | (131,225 | )       |         |        | (56,735 | )      
|                                                                                            | Sales and maturities of fixed income investments |                                            |                                           | 135,410  |        |         |        | 68,326   |         |         |        | 4,016   |        
|                                                                                            | Purchases of equity securities                   |                                            |                                           | (21,779  | )      |         |        | (14,282  | )       |         |        | (1,927  | )      
|                                                                                            | Sales of equity securities                       |                                            |                                           | 18,650   |        |         |        | 7,664    |         |         |        | 875     |        
|                                                                                            | Purchases of short-term investments 
    net    |                                            |                                           | 17,755   |        |         |        | (26,984  | )       |         |        | (556    | )      
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            |                                                  |                                            | Net cash (used in) investing activities   |          |        | (67,213 | )      |          |         | (96,975 | )      |         |         | (55,148 | )
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|CASH FLOWS FROM FINANCING
    ACTIVITIES:                                                   |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            | Change in notes payable                          |                                            |                                           |         |        |         |        |         |         |         |        | (5,683  | )      
|                                                                                            | Proceeds from issuance of common
    stock  net |                                            |                                           |         |        |         |        | 12,457   |         |         |        |        |        
|                                                                                            | Capital allocation to shareholder                |                                            |                                           |         |        |         |        |         |         |         |        | 13,000  |        
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|Net cash provided by financing activities                                                   |                                                  |                                            | 0                                         |          |        |         | 12,457 |          |         |         | 7,317  |        
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|Net increase (decrease) in cash                                                             |                                                  |                                            | 6,418                                     |          |        |         | (9,252 | )        |         |         | 14,884 |        
|Cash and cash equivalents at beginning of period                                            |                                                  |                                            | 9,124                                     |          |        |         | 18,376 |          |         |         | 3,492  |        
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|Cash and cash equivalents at end of period                                                  |                                                  | $                                          | 15,542                                    |          |        | $       | 9,124  |          |         | $       | 18,376 |        
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|Cash paid during the year for:                                                              |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            | Interest                                         |                                            | $                                         |         |        |         | $      | 3        |         |         | $      | 389     |        
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        
|                                                                                            | Income taxes paid (received)                     |                                            | $                                         | 1,692    |        |         | $      | 2,227    |         |         | $      | (608    | )      
|                                                                                            |                                                  |                                            |                                           |          |        |         |        |          |         |         |        |        

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

F-7



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


FOR THE YEARS ENDED DECEMBER 31, 2004,
2003 AND 2002




|   |                                                             
|-- | ------------------------------------------------------------
|1. | Nature of Operations and Significant
    Accounting Policies

National Atlantic Holdings Corporation
(NAHC) and Subsidiaries (the Company) was incorporated in
New Jersey, on July 29, 1994. The Company is a holding
company for Proformance Insurance Company (Proformance), its
wholly-owned subsidiary. Proformance is domiciled in the State
of New Jersey and writes property and casualty insurance,
primarily personal auto. NAHCs initial capitalization was
pursuant to private placement offerings. The initial
stockholders paid $1.16 per share for 2,812,200 shares
of Class A common stock.

On February 14, 1995 the Board of Directors
approved the offering of up to 645,000 shares at
$2.33 per share of nonvoting Class B common stock. At
the end of 1995, 283,112 shares were issued at
$2.33 per share to new agents and at 105% of the net book
value to the officers and directors under a one-time stock
purchase program. The average per share price for both issuances
of this Class B common stock was approximately
$2.05 per share. On April 7, 1995, the Certificate of
Incorporation was amended to authorize the issuance of up to
4,300,000 shares of nonvoting common stock.

NAHC also has a controlling interest
(80 percent) in Niagara Atlantic Holdings Corporation and
Subsidiaries (Niagara), which is a New York corporation. Niagara
was incorporated on December 29, 1995. The remaining
interest (20 percent) is owned by New York agents. Niagara
was established as a holding company in order to execute a
surplus debenture and service agreement with Capital Mutual
Insurance (CMI). As of June 5, 2000, CMI has gone into
liquidation and is under the control of the New York State
Insurance Department. CMI is no longer writing new business and
therefore neither is Niagara. Niagara had $0 equity value as of
December 31, 2004 and 2003. NAHC has no remaining
obligations as it relates to the agreement.

In addition, NAHC has another wholly owned
subsidiary, Riverview Professional Services, Inc., which was
established in 2002 for the purpose of providing case management
and medical cost containment services to Proformance and other
unaffiliated clients.

In December 2001, NAHC established National
Atlantic Financial Corporation (NAFC), to offer general
financing services to its agents and customers. In November
2003, NAFC established a wholly owned subsidiary, Mayfair
Reinsurance Company Limited, for the purpose of assuming
reinsurance business as a retrocessionaire from third party
reinsurers of Proformance and providing reinsurance services to
unaffiliated clients.

Another wholly owned subsidiary of NAHC is
National Atlantic Insurance Agency, Inc. (NAIA), which was
incorporated on April 5, 1995. The Company purchased all
1,000 shares of NAIAs authorized common stock at
$1 per share. NAIA obtained its license to operate as an
insurance agency in December 1995. The agency commenced
operations on March 20, 1996. The primary purpose of this
entity is to service any direct business written by Proformance
and to provide services to agents and policyholders acquired as
part of replacement carrier transactions.

The significant accounting policies followed by
the Company in the preparation of the accompanying consolidated
financial statements are as follows:

Basis of
Presentation The
accompanying financial statements have been prepared in
conformity with accounting principles generally accepted in the
United States of America (GAAP) which differ materially
from statutory accounting practices prescribed or permitted for
insurance companies by regulatory agencies. All significant
intercompany transactions and balances have been eliminated.

Segment
Disclosure We manage
and report our business as a single segment based upon several
factors. Our insurance subsidiary, Proformance Insurance
Company, has historically generated in excess of 90% of our
total consolidated revenues and reported profit or loss. In
addition, Proformance is our only subsidiary

F-8



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

which has assets in excess of 10% of the
consolidated assets of the Company. Therefore, only Proformance
meets any of the quantitative thresholds of a reportable
segment. In addition, although Proformance writes both personal
line and commercial line business, we consider those operating
segments as one operating segment due to the fact that the
nature of the products are similar, they share the same
distribution system, the nature of the regulatory environment
for each line is similar and they follow the same production
process in accordance with the requirements of segments that
share similar economic characteristics.

A summary of our consolidated revenues is as
follows:

|                                       |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  |  | 
|-------------------------------------- | ------------------------------------------------ | -------------------------------- | ----------- | ----------- |  | ---- | ----------- | ----------- |  | - | ---------- | ---------- |  |  |  |  | 
|                                       |                                                  |                                  |             |            
|                                       |                                                  | For the years ended December 31, |             |            
|                                       |                                                  |                                  |             |            
|                                       |                                                  | 2004                             |             | 2003        |  | 2002 |             |            
|                                       |                                                  |                                  |             |             |  |      |             |            
|Proformance                            |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|                                       | Personal lines insurance                         |                                  | $           | 165,681,991 |  |      | $           | 126,845,351 |  |   | $          | 66,264,731 |  |  |  |  | 
|                                       | Commercial lines insurance                       |                                  |             | 13,984,730  |  |      |             | 16,310,572  |  |   |            | 9,389,152  |  |  |  |  | 
|                                       | Replacement carrier revenue from related party   |                                  |             | 13,880,303  |  |      |             | 13,297,593  |  |   |            | 21,683,013 |  |  |  |  | 
|                                       | Replacement carrier revenue from unrelated party |                                  |             | 4,088,889   |  |      |             | 661,111     |  |   |            |           |  |  |  |  | 
|Riverview                              |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|                                       | Medical Case Management                          |                                  |             | 4,882,171   |  |      |             | 3,688,114   |  |   |            | 644,509    |  |  |  |  | 
|NAIA                                   |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|                                       | Insurance brokerage                              |                                  |             | 4,061,520   |  |      |             | 2,572,129   |  |   |            | 1,088,606  |  |  |  |  | 
|Mayfair                                |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|                                       | Reinsurance                                      |                                  |             |            |  |      |             |            |  |   |            |           |  |  |  |  | 
|NAHC                                   |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|Intercompany elimination entries       |                                                  |                                  | (8,417,604  | )           |  |      | (6,190,977  | )           |  |   | (1,716,642 | )          |  |  |  | 
|                                       |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|Subtotal                               |                                                  |                                  | 198,162,000 |             |  |      | 157,183,893 |             |  |   | 97,353,369 |            |  |  |  | 
|                                       |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|Investment Income                      |                                                  |                                  | 7,061,161   |             |  |      | 4,257,672   |             |  |   | 1,592,878  |            |  |  |  | 
|Net realized investment gains (losses) |                                                  |                                  | 1,931,258   |             |  |      | 1,372,557   |             |  |   | (55,219    | )          |  |  |  | 
|Other income                           |                                                  |                                  | 1,517,823   |             |  |      | 860,379     |             |  |   | 547,989    |            |  |  |  | 
|                                       |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 
|Total Revenue                          |                                                  | $                                | 208,672,242 |             |  | $    | 163,674,501 |             |  | $ | 99,439,017 |            |  |  |  | 
|                                       |                                                  |                                  |             |             |  |      |             |             |  |   |            |            |  |  |  | 

Use of
Estimates The
preparation of financial statements requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. The primary estimates made by management involve the
establishment of reserves for losses and loss adjustment
expenses. Actual results could differ from those estimates.

Cash and Cash
Equivalents For
purposes of the statements of cash flows, the Company considers
short-term investments with an initial maturity of three months
or less to be cash equivalents.

Property and
Equipment Property and
equipment are stated at cost. Depreciation and amortization is
provided under the straight-line method based upon the following
estimated useful lives:

|                                                |  |              |   | 
|----------------------------------------------- |  | ------------ | - | 
|                                                |  | Estimated   
|Description                                     |  | Life (Years)
|                                                |  |             
|Automobiles                                     |  |              | 5 | 
|Furniture and fixtures                          |  |              | 7 | 
|Computer software and electronic data equipment |  |              | 3 | 
|Leasehold improvements                          |  |              | * | 



---



|  |                                                                                    
|- | -----------------------------------------------------------------------------------
|* | Amortized over the remaining life of the lease
    from the date placed in service.

F-9



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Major replacements of, or improvements to,
property and equipment are capitalized. Minor replacements,
repairs and maintenance are charged to expense as incurred. Upon
retirement or sale, the cost of the assets disposed and the
related accumulated depreciation and amortization are removed
from the accounts and any resulting gain or loss is recorded in
operations. The recoverable value of property and equipment
assets are evaluated at least annually.

Investments
Fixed maturity investments which may be sold in response to,
among other things, changes in interest rates, prepayment risk,
income tax strategies or liquidity needs, are classified as
available-for-sale and are carried at market value. Equity
securities, which are classified as available for sale, are also
carried at market value. Changes in market value for fixed
maturity investments and equity securities are credited or
charged to stockholders equity as other comprehensive
income (loss). Short-term securities are carried at cost, which
approximates market value. Market values are based on quoted
market prices. For mortgage-backed securities for which there is
a prepayment risk, prepayment assumptions are evaluated and
revised as necessary. Any adjustments required due to the
resultant change in effective yields and maturities are
recognized on a prospective basis through yield adjustments.
Realized investment gains and losses are recorded on the
specific identification method. All security transactions are
recorded on a trade date basis.

The Company considers a number of factors in the
evaluation of whether a decline in value is other-than-temporary
including: (a) the financial condition and near term
prospects of the issuer; (b) the Companys ability and
intent to retain the investment for a period of time sufficient
to allow for an anticipated recovery in value; and (c) the
period and degree to which the market value has been below cost.
A fixed maturity security is other-than-temporarily impaired if
it is probable that the Company will not be able to collect all
the amounts due under the securitys contractual terms.
Equity investments are considered to be impaired when it becomes
apparent that the Company will not recover its cost after
considering the severity and duration of the unrealized loss,
compared with general market conditions. These adjustments are
recorded as realized investment losses.

Concentration of Credit
Risk Financial
instruments which potentially subject the Company to
concentrations of credit risk include cash balances and
marketable fixed maturity securities. The Company places its
temporary cash investments with creditworthy financial
institutions. The Company holds bonds and notes issued by the
United States government and corporations. By policy, these
investments are kept within limits designed to prevent risks
caused by concentration. Consequently, as of December 31,
2004, the Company does not believe it has significant
concentrations of credit risks. The Company is exposed to a
concentration of credit risk with respect to amounts due from
reinsurers.

Deferred Policy Acquisition
Costs Deferred
acquisition costs, which consist of commissions and other
underwriting expenses, are costs that vary with and are directly
related to the underwriting of new policies and are deferred and
amortized over the period in which the related premiums are
earned. Anticipated investment income is considered in the
determination of the recoverability of deferred acquisition
costs.

Amortization of deferred acquisition costs for
the years ended December 31, 2004, 2003 and 2002 were
$39,585,988, $25,547,188 and $14,887,237, respectively.

Insurance Liabilities/ Reserves for Losses
and Loss Adjustment
Expenses The provision
for unpaid losses and loss adjustment expenses includes
individual case estimates, principally on the basis of reports
received from claim adjusters engaged by the Company, for losses
reported prior to the close of the year and estimates with
respect to incurred but not reported (IBNR) losses and loss
adjustment expenses, net of anticipated salvage and subrogation.
The method of making such estimates and for establishing the
resulting reserves is continually reviewed and updated, and
adjustments resulting therefrom are reflected in current
operations. The estimates are determined by management and are
based upon industry data relating to loss and loss adjustment
expense ratios as well as the Companys historical data.
The unpaid losses and unpaid loss adjustment expenses presented
in these financial statements have not been discounted.

F-10



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

This liability is subject to the impact of
changes in claim severity, frequency and other factors which may
be outside of the Companys control. Despite the
variability inherent in such estimates, management believes that
the liability for unpaid losses and loss adjustment expenses is
adequate and represents its best estimate of the ultimate cost
of investigating, defending and settling claims. However, the
Companys actual future experience may not conform to the
assumptions inherent in the determination of this liability.
Accordingly, the ultimate settlement of these losses and the
related loss adjustment expenses may vary significantly from the
amounts included in the accompanying financial statements.

Recognition of Premium
Revenues Premiums
written or assumed are earned on a daily pro-rata basis over the
estimated life of the policy or reinsurance contract. Unearned
premiums are established and represent the portion of net
premiums which is applicable to the unexpired terms of policies
in force.

Allowance for Doubtful
Accounts The Company
creates a reserve for future premium receivables that may become
uncollectible. The amount of the reserve is based upon
managements assessment of collectibility in reviewing
aging experience.

Recognition of Replacement Carrier
Revenues Revenue from
replacement carrier contracts is recognized pro-rata over the
period as the Company completes the obligations under the terms
of the agreement, typically the renewal option period of the
policyholders ranging from six months to a year, as required
pursuant to the terms of the contract. Certain replacement
carrier contracts require additional consideration to be paid to
the Company based on an evaluation of premiums written to
surplus. The calculation is performed and related revenue is
recognized as earned annually pursuant to the terms of the
contract. See Note 3.

Accounting for
Reinsurance The
Company accounts for reinsurance in conformity with Statement of
Financial Accounting Standards No. 113, Accounting and
Reporting for Reinsurance of Short-Duration and Long-Duration
Contracts. This standard requires the Company to report
assets and liabilities relating to reinsured contracts gross of
the effects of reinsurance. The standard also establishes the
conditions required for a contract with a reinsurer to be
accounted for as reinsurance and prescribes accounting and
reporting standards for such contracts.

The Company contracts with insurance companies,
which assume portions of the risk undertaken. The Company
remains the primary obligor to the extent any reinsurer is
unable to meet its obligations under the existing reinsurance
agreements. The reinsurance contracts are accounted for on a
basis consistent with that used in the accounting of the direct
policies issued by the Company.

Income
Taxes The Company
files a consolidated federal tax return. Under the tax
allocation agreement, current federal income tax expense
(benefit) is computed on a separate return basis and provides
that members shall make payments (receive reimbursements) to the
extent that their income (losses and other credit) contributes
to (reduces) consolidated federal income tax expense. The
member companies are reimbursed for the tax attributes they have
generated when utilized in the consolidated return.

The Company recognizes taxes payable or
refundable for the current year, and deferred taxes for the
future tax consequences of differences between the financial
reporting and tax basis of assets and liabilities. Deferred tax
assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years the temporary
differences between the carrying amounts of assets and
liabilities for finance reporting purposes and the amounts used
for income tax purposes are expected to reverse.

Stock
Options The Company
adopted Statement of Financial Accounting Standards
No. 123, Accounting for Stock-Based Compensation(SFAS 123), in 1996. Under the provisions of
SFAS 123,

F-11



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

companies can elect to account for stock-based
compensation plans using a fair-value based method or continue
measuring compensation expenses for those plans using the
intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees(APB 25) and related interpretations. In December 2002,
the FASB issued SFAS No. 148 which amended the
disclosure requirements of SFAS No. 123 to require
prominent disclosures in financial statements about the method
of accounting for stock-based employee compensation and the
effect of the method on reported results. The Company has
elected to continue using the intrinsic value method (APB
No. 25) to account for stock based compensation plans.

The following table presents the Companys
pro forma net income (loss) for the years ended
December 31, 2004, 2003 and 2002, assuming the Company had
used the fair value method (SFAS No. 123) to recognize
compensation expense with respect to its options:

|                                                                                                                                              |                       |                          |            |      |  |      |            |      |  |   |           |      | 
|--------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | ------------------------ | ---------- | ---- |  | ---- | ---------- | ---- |  | - | --------- | ---- | 
|                                                                                                                                              |                       |                         
|                                                                                                                                              |                       | Years Ended December 31,
|                                                                                                                                              |                       |                         
|                                                                                                                                              |                       | 2004                     |            | 2003 |  | 2002
|                                                                                                                                              |                       |                          |            |      |  |     
|Net income  as reported                                                                                                                      |                       | $                        | 17,448,050 |      |  | $    | 19,067,575 |      |  | $ | 8,633,512 |     
|Plus: Compensation expense recorded against income                                                                                            |                       |                          | 480,773    |      |  |      | 419,000    |      |  |   | 118,000   |     
|Deduct: Total stock-based employee compensation
    expense determined under fair value method for all awards, net
    of related tax effects |                       |                          | (492,596   | )    |  |      | (418,559   | )    |  |   | (130,973  | )   
|                                                                                                                                              |                       |                          |            |      |  |      |            |      |  |   |           |     
|Pro forma net income                                                                                                                          |                       | $                        | 17,436,227 |      |  | $    | 19,068,016 |      |  | $ | 8,620,539 |     
|                                                                                                                                              |                       |                          |            |      |  |      |            |      |  |   |           |     
|Net income per weighted average shareholding                                                                                                  |                       |                          |            |      |  |      |            |      |  |   |           |     
|                                                                                                                                              | Basic  as reported   |                          | $          | 3.53 |  |      | $          | 4.29 |  |   | $         | 1.96 | 
|                                                                                                                                              | Basic  proforma      |                          | $          | 3.53 |  |      | $          | 4.29 |  |   | $         | 1.96 | 
|                                                                                                                                              | Diluted  as reported |                          | $          | 3.11 |  |      | $          | 3.77 |  |   | $         | 1.74 | 
|                                                                                                                                              | Diluted  proforma    |                          | $          | 3.11 |  |      | $          | 3.77 |  |   | $         | 1.74 | 

The above pro forma information has been
determined as if the Company had accounted for its
employees stock options under the fair value method. The
fair value of the options was estimated at the date of grant
using the Black-Scholes option-pricing model with a volatility
factor assumed to be zero percent and the following weighted
average assumptions:

|                         |  |      |          |      |  |      |          |  |  |  |          | 
|------------------------ |  | ---- | -------- | ---- |  | ---- | -------- |  |  |  | -------- | 
|                         |  | 2004 |          | 2003 |  | 2002
|                         |  |      |          |      |  |     
|Risk-free interest yield |  |      | 4.0%     |      |  |      | 4.0%     |  |  |  | 4.6%     | 
|Dividend yield           |  |      | 0.0%     |      |  |      | 0.0%     |  |  |  | 0.0%     | 
|Average life             |  |      | 3  Years |      |  |      | 3  Years |  |  |  | 3  Years | 

The weighted average fair value of options
granted whose exercise price was equal to the market price of
the stock on the date of grant was $0 for each of the years
ended December 31, 2004, 2003 and 2002.

The weighted average fair value of options
granted whose exercise price was less than the market price of
the stock on the date of grant for the years ended
December 31, 2004, 2003 and 2002 was $0, $823,049 and
$716,807, respectively. The weighted average exercise price of
options granted whose exercise price was less than market price
of the stock on the date of grant was $0, $6.14 and $0.60,
respectively.

Option pricing models require the input of highly
subjective assumptions. Because the Companys employee
stock has characteristics significantly different from those of
traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in
managements opinion, the existing models do not
necessarily provide a reliable single measure of the fair value
of its employee stock options.

F-12



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

On December 16, 2004, the FASB issued
Statement No. 123 (Revised 2004), Share-Based Payment.
This statement requires all entities to recognize compensation
expense in an amount equal to the fair value of share-based
payments (e.g., stock options and restricted stock)
granted to employees. This standard is effective for public
companies in interim or annual periods beginning after
June 15, 2005. We are currently in the process of assessing
the impact that the adoption of this standard will have on our
financial statements.

Retirement
Plans The Company has
a contributory savings plan for salaried employees meeting
certain service requirements, which qualifies under
Section 401(k) of the Internal Revenue Code of 1986.
Retirement plan expense for the years ended December 31,
2004, 2003 and 2002 amounted to $235,285, $149,760 and $127,730,
respectively.

Guaranty Fund
Assessments As more
fully described in Note 10, New Jersey law requires that
property and casualty insurers licensed to do business in New
Jersey participate in the New Jersey Property-Liability
Insurance Guaranty Association (which we refer to as NJPLIGA).
Proformance accounts for its participation in the NJPLIGA in
accordance with Statement of Position 97-3, the
Accounting Treatment For Insurance and Other Enterprises for
Insurance Related Assessments. In this regard, Proformance
records a liability when writing the premiums, as direct written
premiums are the basis for the state assessment and are
considered the obligating event that establishes the liability.
The percentage of written premium recorded as a liability is
equal to the surcharge percentage mandated by the state to be
charged to each policy holder. This surcharge percentage is
likewise determined based on the relationship between the
Companys direct written premium to that of the industry as
a whole as determined by the state. As such, Proformance also
records a corresponding receivable from policyholders in
recognition of the fact that New Jersey law allows for
Proformance to fully recoup amounts assessed through
policyholder surcharges. There is no income statement impact
because as SOP 97-3 outlines, policyholder surcharges that
are required as a pass through to the state regulatory body
should be accounted for in a manner such that amounts collected
or receivable are not recorded as revenues and amounts due or
paid are not expensed.

Also, as more fully described in Note 10,
the Company may be assigned business by the State of New Jersey
relating to the Personal Automobile Insurance Plan (PAIP) and
the Commercial Automobile Insurance Plan (CAIP). With regard to
PAIP, the State of New Jersey allows for the Company to enter
into Limited Assignment Distribution (LAD) arrangements whereby
for a fee, the Companys portion of PAIP business is
transferred to the LAD carrier such that Proformance has no
responsibility for the PAIP business. Proformance records its
CAIP liability assignment on its books as assumed business as
required by the State of New Jersey.

The New Jersey Automobile Insurance Risk
Exchange, or NJAIRE, is a plan designed to compensate member
companies for claims paid for non-economic losses and claims
adjustment expenses which would not have been incurred had the
tort limitation option provided under New Jersey insurance law
been elected by the injured party filing the claim for
non-economic losses. As a member company of NJAIRE, we submit
information with respect to the number of claims reported to us
that meet the criteria outlined above. NJAIRE compiles the
information submitted by all member companies and remits
assessments to each member company for this exposure. The
Company, since its inception, has never received compensation
from NJAIRE as a result of its participation in the plan. The
Companys participation in NJAIRE is mandated by the New
Jersey Department of Banking and Insurance. The assessments that
the Company has received required payment to NJAIRE for the
amounts assessed. The Company records the assessments received
as other operating and general expenses.

F-13



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |            
|-- | -----------
|2. | Investments

The amortized cost and estimated market value of
the investment portfolio, classified by category, as of
December 31, 2004 are as follows:

|                       |                                                          |           |             |             |  |            |           |              |  |   |            |          |   |   |             |             | 
|---------------------- | -------------------------------------------------------- | --------- | ----------- | ----------- |  | ---------- | --------- | ------------ |  | - | ---------- | -------- | - | - | ----------- | ----------- | 
|                       |                                                          | Cost/     |             | Gross       |  | Gross      |           |             
|                       |                                                          | Amortized |             | Unrealized  |  | Unrealized |           | Estimated   
|                       |                                                          | Cost      |             | Gains       |  | (Losses)   |           | Market Value
|                       |                                                          |           |             |             |  |            |           |             
|Fixed maturities:      |                                                          |           |             |             |  |            |           |              |  |   |            |          |   |   |             |            
|                       | U.S. Government, government agencies and
    authorities |           | $           | 113,849,983 |  |            | $         | 167,336      |  |   | $          | (229,199 | ) |   | $           | 113,788,120 | 
|                       | State, local government and agencies                     |           |             | 47,447,514  |  |            |           | 471,383      |  |   |            | (151,091 | ) |   |             | 47,767,806  | 
|                       | Industrial and miscellaneous                             |           |             | 48,235,166  |  |            |           | 445,482      |  |   |            | (520,779 | ) |   |             | 48,159,869  | 
|                       | Mortgage-backed securities                               |           |             | 1,103,325   |  |            |           | 13,733       |  |   |            | (2,786   | ) |   |             | 1,114,272   | 
|                       |                                                          |           |             |             |  |            |           |              |  |   |            |          |   |   |             |            
|Total fixed maturities |                                                          |           | 210,635,988 |             |  |            | 1,097,934 |              |  |   | (903,855   | )        |   |   | 210,830,067 |            
|Other Investments:     |                                                          |           |             |             |  |            |           |              |  |   |            |          |   |   |             |            
|                       | Short-term investments                                   |           |             | 13,820,488  |  |            |           |             |  |   |            |         |   |   |             | 13,820,488  | 
|                       | Equity securities                                        |           |             | 12,718,656  |  |            |           | 178,670      |  |   |            | (96,790  | ) |   |             | 12,800,536  | 
|                       |                                                          |           |             |             |  |            |           |              |  |   |            |          |   |   |             |            
|Total Investments      |                                                          | $         | 237,175,132 |             |  | $          | 1,276,604 |              |  | $ | (1,000,645 | )        |   | $ | 237,451,091 |            
|                       |                                                          |           |             |             |  |            |           |              |  |   |            |          |   |   |             |            

The company has two non-redeemable preferred
stocks, issued by the Federal National Mortgage Association and
by ABN Amro. The Company currently as 29,800 shares of the
Federal National Mortgage Association preferred stock and 500
shares of the ABN Amro preferred stock. The fair market values
as of December 31, 2004 are $1,230,740 and $528,128,
respectively.

The amortized cost and estimated market value of
the investment portfolio, classified by category, as of
December 31, 2003 are as follows:

|                       |                                                          |           |             |            |  |            |         |              |  |   |          |          |   |   |             |            | 
|---------------------- | -------------------------------------------------------- | --------- | ----------- | ---------- |  | ---------- | ------- | ------------ |  | - | -------- | -------- | - | - | ----------- | ---------- | 
|                       |                                                          | Cost/     |             | Gross      |  | Gross      |         |             
|                       |                                                          | Amortized |             | Unrealized |  | Unrealized |         | Estimated   
|                       |                                                          | Cost      |             | Gains      |  | (Losses)   |         | Market Value
|                       |                                                          |           |             |            |  |            |         |             
|Fixed maturities:      |                                                          |           |             |            |  |            |         |              |  |   |          |          |   |   |             |           
|                       | U.S. Government, government agencies and
    authorities |           | $           | 39,633,926 |  |            | $       | 17,604       |  |   | $        | (338,138 | ) |   | $           | 39,313,392 | 
|                       | State, local government and agencies                     |           |             | 41,277,531 |  |            |         | 12,929       |  |   |          |         |   |   |             | 41,290,460 | 
|                       | Industrial and miscellaneous                             |           |             | 44,903,263 |  |            |         | 116,868      |  |   |          | (205,222 | ) |   |             | 44,814,909 | 
|                       | Mortgage-Backed securities                               |           |             | 4,984,097  |  |            |         | 6,604        |  |   |          |         |   |   |             | 4,990,701  | 
|                       |                                                          |           |             |            |  |            |         |              |  |   |          |          |   |   |             |           
|Total fixed maturities |                                                          |           | 130,798,817 |            |  |            | 154,005 |              |  |   | (543,360 | )        |   |   | 130,409,462 |           
|Other Investments:     |                                                          |           |             |            |  |            |         |              |  |   |          |          |   |   |             |           
|                       | Short-term investments                                   |           |             | 31,569,445 |  |            |         |             |  |   |          |         |   |   |             | 31,569,445 | 
|                       | Equity securities                                        |           |             | 8,117,385  |  |            |         | 763,737      |  |   |          | (288,038 | ) |   |             | 8,593,084  | 
|                       |                                                          |           |             |            |  |            |         |              |  |   |          |          |   |   |             |           
|Total Investments      |                                                          | $         | 170,485,647 |            |  | $          | 917,742 |              |  | $ | (831,398 | )        |   | $ | 170,571,991 |           
|                       |                                                          |           |             |            |  |            |         |              |  |   |          |          |   |   |             |           

F-14



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The fair values of available-for-sale securities
at December 31, 2004, by contractual maturity, are shown
below. Expected maturities of mortgaged-backed securities may
differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without
prepayment penalties.

|                                    |  |            |             | 
|----------------------------------- |  | ---------- | ----------- | 
|                                    |  | Estimated 
|                                    |  | Fair Value
|                                    |  |           
|Due in one year or less             |  | $          | 10,446,656  | 
|Due in one year through five years  |  |            | 64,609,795  | 
|Due in five years through ten years |  |            | 62,251,714  | 
|Due in ten through twenty years     |  |            | 71,127,928  | 
|Due in over twenty years            |  |            | 1,279,701   | 
|Mortgage-Backed securities          |  |            | 1,114,273   | 
|                                    |  |            |             | 
|Total                               |  | $          | 210,830,067 | 
|                                    |  |            |             | 

For the years ended December 31, 2004 and
2003, the Company held no investments that were below investment
grade or not rated by an independent rating agency.

The Company has placed securities on deposit
having a fair value of $200,000 and $208,724 at
December 31, 2004 and 2003, respectively, in order to
comply with New Jersey state insurance regulatory requirements.

Proceeds from sales of fixed maturity and equity
securities and gross realized gains and losses on sales as well
as other-than-temporary impairment charges for the years ended
December 31, 2004, 2003 and 2002 are shown below:

|                      |  |                                  |             |      |  |      |            |   |  |   |           |  
|--------------------- |  | -------------------------------- | ----------- | ---- |  | ---- | ---------- | - |  | - | --------- | -
|                      |  |                                 
|                      |  | For the Years Ended December 31,
|                      |  |                                 
|                      |  | 2004                             |             | 2003 |  | 2002
|                      |  |                                  |             |      |  |     
|Proceeds              |  | $                                | 154,060,505 |      |  | $    | 75,990,136 |   |  | $ | 4,890,603 |  
|Gross realized gains  |  |                                  | 2,605,208   |      |  |      | 1,802,770  |   |  |   | 23,174    |  
|Gross realized losses |  |                                  | (673,950    | )    |  |      | (430,213   | ) |  |   | (78,393   | )

There was one security of $260,515 that was
considered to be other-than-temporarily impaired as of December
31, 2004. No other-than-temporary impairments were recognized
for the years ended December 31, 2003 and 2002,
respectively.

The components of net investment income earned
were as follows:

|                      |                 |                                  |           |           |  |      |           |           |  |   |           |           | 
|--------------------- | --------------- | -------------------------------- | --------- | --------- |  | ---- | --------- | --------- |  | - | --------- | --------- | 
|                      |                 |                                 
|                      |                 | For the Years Ended December 31,
|                      |                 |                                 
|                      |                 | 2004                             |           | 2003      |  | 2002
|                      |                 |                                  |           |           |  |     
|Investment income:    |                 |                                  |           |           |  |      |           |           |  |   |           |          
|                      | Interest income |                                  | $         | 6,651,242 |  |      | $         | 4,199,917 |  |   | $         | 1,675,194 | 
|                      | Dividend income |                                  |           | 539,105   |  |      |           | 312,545   |  |   |           | 38,622    | 
|                      |                 |                                  |           |           |  |      |           |           |  |   |           |          
|Investment income     |                 |                                  | 7,190,347 |           |  |      | 4,512,462 |           |  |   | 1,713,816 |          
|Investment expenses   |                 |                                  | (129,187  | )         |  |      | (254,790  | )         |  |   | (120,938  | )        
|                      |                 |                                  |           |           |  |      |           |           |  |   |           |          
|Net investment income |                 | $                                | 7,061,160 |           |  | $    | 4,257,672 |           |  | $ | 1,592,878 |          
|                      |                 |                                  |           |           |  |      |           |           |  |   |           |          

Adoption of New Accounting
Pronouncements
Effective December 31, 2003, the Company adopted the
disclosure requirements of Emerging Issues Task Force
(EITF) Issue No. 03-01, The Meaning of
Other-Than-Temporary Impairment and Its Applications of Certain
Investments. Under the consensus, disclosures are required
for unrealized losses on fixed maturity and equity securities
accounted for under SFAS No. 115, Accounting for
Certain Investment in Debt and Equity Securities, which are
classified as either available-for-sale or held-to-maturity. The
disclosure requirements include quantitative information

F-15



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

regarding the aggregate amount of unrealized
losses and the associated fair value of the investments in an
unrealized loss position, segregated into time periods for which
the investments have been in an unrealized loss position. The
consensus also requires certain qualitative disclosures about
the holdings in an unrealized loss position in order to provide
additional information that the Company considered in concluding
that the unrealized losses were not other-than-temporary. In
September 2004, the Financial Accounting Standards Board, which
we refer to as FASB, issued FASB Staff Position Emerging Issues
Task Force Issue 03-1-1, Effective Date of Paragraphs 10-20
of EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments, which delays the effective date for the
recognition and measurement guidance in EITF Issue
No. 03-1. In addition, the FASB has issued a proposed FASB
Staff Position to consider whether further application guidance
is necessary for securities analyzed for impairment under
EITF 03-1. We continue to assess the potential impact that
the adoption of the proposed FASB Staff Position could have on
our financial statements.

There are two equity and preferred securities
having an unrealized loss of $47,799, a fair value of $436,220
and an amortized cost of $484,019 as of December 31, 2004
which have been in a continuous unrealized loss position for
less than six months.

There is one equity and preferred security having
an unrealized loss of $33,619, a fair value of $296,560 and an
amortized cost of $330,179 as of December 31, 2004 which
has been in a continuous unrealized loss position between six
and twelve months.

There is one preferred security having an
unrealized loss of $15,372, a fair value of $528,128 and an
amortized cost of $543,500 as of December 31, 2004 which
has been in a continuous unrealized loss position for greater
than twelve months.

There are 112 fixed maturity securities having an
unrealized loss of $310,972, a fair value of $74,296,481 and an
amortized cost of $74,607,453 as of December 31, 2004 which
have been in a continuous unrealized loss position for less than
six months.

There are 12 fixed maturity securities having an
unrealized loss of $17,363, a fair value of $2,180,861 and an
amortized cost of $2,198,224 as of December 31, 2004 which
have been in a continuous unrealized loss position between 6 and
12 months.

There are 19 fixed maturity securities having an
unrealized loss of $575,520, a fair value of $14,626,924 and an
amortized cost of $15,202,444 as of December 31, 2004 which
have been in a continuous unrealized loss position for greater
than 12 months.

The fixed income securities in an unrealized loss
position are above investment grade securities with extended
maturity dates, which have been adversely impacted by the
increase in interest rates after the purchase date. As part of
the ongoing security monitoring process by the Companys
investment manager and investment committee, it was concluded
that there was one security that was considered to be
other-than-temporarily impaired as of December 31, 2004. It
is managements position with the committees
confirmation that the securities that are temporarily impaired
are of quality and continue to pay in accordance with their
contractual terms with the expectation that they will continue
to do so.

The evaluation for other-than-temporary
impairments is a quantitative and qualitative process, which is
subject to risks and uncertainties in the determination of
whether declines in the fair value of investments are
other-than-temporary. The risks and uncertainties include
changes in general economic conditions, the issuers
financial condition or near term recovery prospects and the
effects of changes in interest rates.

F-16



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The changes in net unrealized investment gains
(losses) were as follows:

|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  
|-------------------------------------------------------- |  | ------------------------ | -------- | ---- |  | ---- | ---------- | - |  | - | -------- | -
|                                                         |  |                         
|                                                         |  | Years Ended December 31,
|                                                         |  |                         
|                                                         |  | 2004                     |          | 2003 |  | 2002
|                                                         |  |                          |          |      |  |     
|Fixed Maturities:                                        |  |                          |          |      |  |      |            |   |  |   |          |  
|Balance at January 1,                                    |  | $                        | (256,974 | )    |  | $    | 456,973    |   |  | $ | (7,207   | )
|Unrealized investment gains (losses) during the
    year |  |                          | 583,434  |      |  |      | (1,081,738 | ) |  |   | 703,303  |  
|Deferred income taxes                                    |  |                          | (198,368 | )    |  |      | 367,791    |   |  |   | (239,123 | )
|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  
|Balance at December 31,                                  |  |                          | 128,092  |      |  | $    | (256,974   | ) |  | $ | 456,973  |  
|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  
|Net change in unrealized investment gains (losses)       |  |                          | 385,066  |      |  | $    | (713,947   | ) |  | $ | 464,180  |  
|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  
|Equity Securities:                                       |  |                          |          |      |  |      |            |   |  |   |          |  
|Balance at January 1,                                    |  | $                        | 313,961  |      |  | $    | (109,109   | ) |  | $ | (42,437  | )
|Unrealized investment gains (losses) during the
    year |  |                          | (393,819 | )    |  |      | 641,015    |   |  |   | (99,988  | )
|Deferred income taxes                                    |  |                          | 133,898  |      |  |      | (217,945   | ) |  |   | 33,316   |  
|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  
|Balance at December 31,                                  |  |                          | 54,040   |      |  | $    | 313,961    |   |  | $ | (109,109 | )
|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  
|Net change in unrealized investment gains (losses)       |  |                          | (259,921 | )    |  | $    | 423,070    |   |  | $ | (66,672  | )
|                                                         |  |                          |          |      |  |      |            |   |  |   |          |  

Net realized gains (losses) were as follows:

|                  |  |                          |           |      |  |      |           |   |  |   |         |  
|----------------- |  | ------------------------ | --------- | ---- |  | ---- | --------- | - |  | - | ------- | -
|                  |  |                         
|                  |  | Years Ended December 31,
|                  |  |                         
|                  |  | 2004                     |           | 2003 |  | 2002
|                  |  |                          |           |      |  |     
|Fixed maturities  |  | $                        | 2,605,208 |      |  | $    | 1,546,459 |   |  | $ | 592     |  
|Equity Securities |  |                          | (673,950  | )    |  |      | (173,902  | ) |  |   | (55,811 | )
|                  |  |                          |           |      |  |      |           |   |  |   |         |  
|                  |  | $                        | 1,931,258 |      |  | $    | 1,372,557 |   |  | $ | (55,219 | )
|                  |  |                          |           |      |  |      |           |   |  |   |         |  



|   |                                 
|-- | --------------------------------
|3. | Replacement Carrier Transactions



| |              
| | -------------
| | Ohio Casualty

On December 18, 2001 the Company entered
into a replacement carrier agreement with Ohio Casualty
Insurance Company (OCIC) and Ohio Casualty of New Jersey,
Inc. (OCNJ) pursuant to which OCNJ would transfer to
Proformance the obligation to offer renewals for all of
OCNJs New Jersey private passenger automobile business,
effective March 18, 2002. In accordance with the agreement,
OCNJ ceased issuing private passenger automobile policies in the
State of New Jersey. As part of the withdrawal, Proformance
became the replacement carrier for OCNJ, providing OCNJs
policyholders with a guaranteed option to renew their policies
over a twelve month period. OCNJ retains all rights and
responsibilities related to policies issued by OCNJ and is
responsible to issue any endorsements in the ordinary course of
business prior to the renewal date. Under the terms of the
contract, the offers of renewal are processed over a twelve
month period. As part of the transaction, OCNJ paid Proformance
$41,100,000, of which $500,000 was paid at the contract date and
$40,600,000 was paid in twelve equal monthly installments of
$3,833,333, with the first payment due on March 18, 2002.

In connection with this transaction, OCIC
acquired a 19.71 percent interest (at the time of the
transaction) in the Company by purchasing 867,955 shares of
Class B nonvoting common stock. The Company valued the
stock issued as part of the transaction at $13,500,000, based on
a valuation performed for the Company as of January 1,
2002. The remaining $27,600,000 was earned evenly as replacement
carrier revenue over the twelve month period beginning on
March 18, 2002, consistent with the terms of the contract.

F-17



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In addition, as part of the agreement, there is
also a provisional amount due to the Company pursuant to which
OCNJ will pay to the Company up to $15,600,000 of additional
consideration as necessary to reduce the premium-to-surplus
ratio to 2.5 to 1 on the renewal business for a three year
period based on calculations performed at each calendar
year-end. As the additional consideration depends on factors
that do not exist or are not measurable at the inception of the
agreement they are considered contingent and the additional
consideration is recognized as actual results reflect a
premium-to-surplus ratio of greater than 2.5 to 1.

With respect to our replacement carrier
transaction with OCIC and OCNJ, on February 22, 2005
Proformance notified OCNJ that OCNJ owed Proformance $7,762,000
for the 2004 year in connection with the requirement that a
premium-to-surplus ratio of 2.5 to 1 be maintained on the OCNJ
renewal business. Pursuant to our agreement, OCNJ has until
May 15, 2005 to make payment to us. Subsequent to the
notification provided to OCIC and OCNJ, we have had several
discussions with OCIC relating to certain components to the
underlying calculation which supports the amount owed to
Proformance for the 2004 year. As part of these
discussions, which are ongoing as of the date of this
prospectus, OCIC has requested additional supporting
documentation, and has initially raised issues with respect to
approximately $2 million of loss adjustment expense,
approximately $800,000 of commission expense, and approximately
$600,000 of NJAIRE assessments, or a total of $3,412,000,
allocated to OCNJ. We have recorded $4,350,000 (the difference
between the $7,762,000 we notified OCNJ they owed us, and the
$3,412,000 currently under discussion with OCIC) as replacement
carrier revenue from related party in our consolidated statement
of income for the year ended December 31, 2004 with respect
to the OCIC replacement carrier transaction. We recorded
$4,350,000 because that is managements best estimate of
the amount for which we believe collectibility is reasonably
assured based on several factors. First, the calculation to
determine the amount owed by OCIC to us is complex and certain
elements of the calculation are significantly dependent on
managements estimates and judgment and thus more
susceptible to challenge by OCIC. In addition, management cannot
be certain that OCIC will not raise any additional issues beyond
those of which we are presently aware and have itemized herein.
OCNJ has until May 15, 2005 to make payment to us and may
prior to that date raise additional issues and dispute other
amounts. We also note our experience in the past in negotiating
these issues with OCIC. For example, in 2003 we notified OCNJ
that OCNJ owed Proformance approximately $10,100,000 for 2003.
After negotiations we ultimately received $6,820,000.
Accordingly, because of the nature of the calculation, the
inherent subjectivity in establishing certain estimates upon
which the calculation is based, and the fact that we have not
yet reached final agreement with OCIC and OCNJ and they may
raise additional issues until May 15, 2005, and our
experience from 2003, managements best estimate of the
amount for 2004 for which we believe collectibility from OCIC is
reasonably assured is $4,350,000.

For the years ended December 31, 2004, 2003
and 2002, the Company recognized additional consideration of
$4,350,000, $6,820,000 and $0, respectively, as replacement
carrier revenue in accordance with the terms of the contract.

As of December 31, 2004 and 2003, amounts
due from OCNJ relating to the transaction amounted to $4,350,000
and $6,820,000, respectively. Deferred revenue relating to the
contract was $0 as of each of December 31, 2004 and 2003.

Metropolitan Property and Casualty Insurance
Company

On September 2, 2003, the Company entered
into a replacement carrier agreement with Metropolitan Property
and Casualty Insurance Company (Met) pursuant to which Met would
transfer to Proformance the obligation to offer renewals for all
of Mets New Jersey personal lines business, effective
December 22,

F-18



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2003. In accordance with the agreement, Met
ceased issuing new personal lines policies in the State of New
Jersey. As part of the withdrawal, Proformance became the
replacement carrier for Met, providing Mets policyholders
with a guaranteed option to renew their policies over a six
month period. As part of the transaction, Met was required to
pay Proformance consideration of $10,090,909 and purchase
430,000 shares of class B nonvoting stock for
$10,000,000, which represented a 9% interest at the time of the
transaction, based upon the Companys valuation. The
Company recognized $560,606 as replacement carrier revenue from
a related party for the year ended December 31, 2003. The
remaining $9,530,303 was recorded as deferred revenue at
December 31, 2003 and was fully earned during the year
ended December 31, 2004.

Sentry Insurance Company

The Company entered into a replacement carrier
agreement on March 14, 2003 with Sentry Insurance Mutual
Company (Sentry) pursuant to which Sentry would transfer to
Proformance the obligation to offer renewals for all of
Sentrys New Jersey personal lines business, effective
October 24, 2003. In accordance with the agreement, Sentry
ceased issuing new personal lines policies in the State of New
Jersey. As part of the withdrawal, Proformance became the
replacement carrier for Sentry, providing Sentrys
policyholders with a guaranteed option to renew their policies
over a twelve month period. As part of the transaction, Sentry
was required to pay the Company $3,500,000 in four equal
quarterly installments of $875,000 with the first payment on
October 24, 2003. At December 31, 2003 amounts due
from Sentry relating to the transaction amounted to $2,625,000.
The Company recognized $661,111 in replacement carrier revenue
for the year ended December 31, 2003. In addition, deferred
revenue relating to the contract amounted to $2,838,889 at
December 31, 2003.

In addition, as part of the agreement, there is
also a provisional amount due to the Company pursuant to which
Sentry will pay to the Company up to $1,250,000 of additional
consideration as necessary to reduce the premium-to-surplus
ratio to 2.5 to 1 on the renewal business for a three
year period based on calculations preformed at each calendar
year-end. As the additional consideration depends on factors
that do not exist or are not measurable at the inception of the
agreement they are considered contingent and the additional
consideration is recognized as actual results reflect a
premium-to-surplus ratio of greater than 2.5 to 1. For the
years ended December 31, 2004 and 2003, the Company
recognized additional consideration of $1,250,000 and $0,
respectively, as replacement carrier revenue in accordance with
the terms of the contract. At December 31, 2004 the amount
due from Sentry relating to the transaction was $1,250,000. On
February 22, 2005 Proformance notified Sentry that Sentry
owed Proformance $1,250,000 for the 2004 year in connection
with the requirements that a premium-to-surplus ratio of
2.5 to 1 be maintained on the Sentry Renewal business,
as discussed more fully in Business  Recent
Transactions  Sentry Insurance Replacement Carrier
Transaction. Pursuant to our agreement Sentry has until
May 15, 2005 to make payment to us. Managements best
estimate of the amount owed to Proformance is $1,250,000 for the
2004 year and as such we have recorded $1,250,000 of
Replacement Carrier Revenue from unrelated party in our
consolidated statement of income for the year ended
December 31, 2004. The Company recognized $4,088,889 in
replacement carrier revenue for the year ended December 31,
2004. Deferred revenue relating to the contract was $0 at
December 31, 2004.



|   |                     
|-- | --------------------
|4. | Reinsurance Activity

In the ordinary course of business, the Company
reinsures certain risks with other companies. Such arrangements
serve to limit the Companys maximum loss from
catastrophes, large risks and unusually hazardous risks. To the
extent that any reinsuring company is unable to meet its
obligations, the Company would be liable for its respective
participation in such defaulted amounts. The Company does not
require or hold any collateral to secure the amounts
recoverable. In addition the Company does not have any
reinsurance treaties with retroactive adjustments or contingent
commissions.

F-19



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

For the years ended December 31, 2004, 2003
and 2002, the Company reinsured its business through various
excess of loss reinsurance agreements and catastrophe
reinsurance agreements. The various excess of loss agreements
provide protection for losses and loss adjustment expenses in
excess of $250,000 per occurrence. Effective on
July 1, 2003, the Company entered into a Multiple Line Loss
Ratio Excess of Loss treaty. Under the terms of the treaty the
Company retained the risk up to an ultimate net loss ratio of
80 percent of subject written premiums in force for the one
six month term of the contract. The reinsurer assumes the risk
for 11 percent of subject premiums in excess of
80 percent up to a maximum of $15,000,000. Any losses
exceeding the reinsurers liability remains the liability of the
company.

Under the terms of the contract, the Company was
entitled to an experience rating adjustment based on reinsurance
premiums paid net of ceding commissions and reinsurers margin,
determined by a specific formula outline in the contract. The
ceding enterprise should recognize an asset and the assuming
enterprise should recognize a liability to the extent that any
cash (or other consideration) would be payable from the assuming
enterprise to the ceding enterprise based on experience to date
under the contract. The Company commuted the contract effective
December 31, 2003. In connection with the terms of the
contract, which contained specific provisions to calculate
amounts due to the ceding carrier, if any, upon commutation of
the contract, the Company determined the reinsurer owed the
Company $10,050,000 as of the date of the commutation.
Accordingly, as of December 31, 2003, the Company accrued
for a reinsurance receivable which was received on May 28,
2004 in the amount of $10,050,000 which represented a return of
the premium ceded pursuant to this contract. The Company
recorded this amount as a reinsurance receivable to accommodate
this specific transaction and distinguish it from reinsurance
recoverables that the Company uses to record reinsurance
transactions, as part of its ongoing reinsurance activities. In
connection with this commutation, the Company recognized the
amounts received as a decrease in ceded written premium of
$10,050,000.

A summary of reinsurance transactions is as
follows:

|        |       |                                  |             |             |  |         |             |             |  |         |             |             |  |   |             |             |  |   |             |             |  |   |             |            | 
|------- | ----- | -------------------------------- | ----------- | ----------- |  | ------- | ----------- | ----------- |  | ------- | ----------- | ----------- |  | - | ----------- | ----------- |  | - | ----------- | ----------- |  | - | ----------- | ---------- | 
|        |       |                                 
|        |       | For the years ended December 31,
|        |       |                                 
|        |       |                                  |             |             |  |        
|        |       | 2004                             |             | 2003        |  | 2002   
|        |       |                                  |             |             |  |        
|        |       | Written                          |             | Earned      |  | Written |             | Earned      |  | Written |             | Earned     
|        |       |                                  |             |             |  |         |             |             |  |         |             |            
|Direct  |       | $                                | 207,320,350 |             |  | $       | 195,070,774 |             |  | $       | 163,178,887 |             |  | $ | 158,409,998 |             |  | $ | 114,624,256 |             |  | $ | 85,418,626  |           
|Assumed |       |                                  | 3,375,295   |             |  |         | 3,266,956   |             |  |         | 2,719,644   |             |  |   | 1,693,591   |             |  |   | 2,546,694   |             |  |   | 2,544,625   |           
|        |       |                                  |             |             |  |         |             |             |  |         |             |             |  |   |             |             |  |   |             |             |  |   |             |           
|        | Gross |                                  |             | 210,695,645 |  |         |             | 198,337,730 |  |         |             | 165,898,531 |  |   |             | 160,103,589 |  |   |             | 117,170,950 |  |   |             | 87,963,251 | 
|Ceded   |       |                                  | (17,503,411 | )           |  |         | (18,671,009 | )           |  |         | (18,853,811 | )           |  |   | (16,947,666 | )           |  |   | (6,545,149  | )           |  |   | (12,309,368 | )         
|        |       |                                  |             |             |  |         |             |             |  |         |             |             |  |   |             |             |  |   |             |             |  |   |             |           
|Net     |       | $                                | 193,192,234 |             |  | $       | 179,666,721 |             |  | $       | 147,044,720 |             |  | $ | 143,155,923 |             |  | $ | 110,625,801 |             |  | $ | 75,653,883  |           
|        |       |                                  |             |             |  |         |             |             |  |         |             |             |  |   |             |             |  |   |             |             |  |   |             |           

Reinsurance assumed relates to mandated premiums
from the New Jersey Commercial Automobile Insurance Plan which
we refer to as CAIP.

The Company reported reinsurance recoverables on
paid losses and loss adjustment expenses of $9,740,821,
$5,016,795 and $3,687,466 at December 31, 2004, 2003 and
2002, respectively.

The Company also reported reinsurance
recoverables on unpaid losses and loss adjustment expenses of
approximately $24,936,000, $21,329,000 and $19,430,695 at
December 31, 2004, 2003 and 2002, respectively.

Incurred losses and loss adjustment expenses
ceded to reinsurers totaled $14,549,000, $16,822,000 and
$16,172,000 at December 31, 2004, 2003 and 2002,
respectively.

F-20



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Reinsurance recoverables on ceded paid and unpaid
losses, loss adjustment expenses and ceded unearned premiums and
reinsurance receivable from individual reinsurers in excess of
3 percent of the Companys equity were as follows (in
thousands):

|                                            |  |              |       |              |  |              |        |  |  |   |        | 
|------------------------------------------- |  | ------------ | ----- | ------------ |  | ------------ | ------ |  |  | - | ------ | 
|                                            |  | For the      |       | For the      |  | For the     
|                                            |  | Year Ended   |       | Year Ended   |  | Year Ended  
|                                            |  | December 31, |       | December 31, |  | December 31,
|                                            |  | 2004         |       | 2003         |  | 2002        
|                                            |  |              |       |              |  |             
|Gerling Global Reinsurance Corp. of America |  | $            |      |              |  | $            |       |  |  | $ | 7,087  | 
|Scor Reinsurance Company                    |  |              | 9,595 |              |  |              | 8,176  |  |  |   | 5,600  | 
|American Reinsurance                        |  |              | 3,989 |              |  |              | 9,169  |  |  |   | 4,772  | 
|Odyssey America Reinsurance                 |  |              | 7,886 |              |  |              | 14,772 |  |  |   | 11,652 | 

In 2002, the Company commuted an aggregate stop
loss treaty with Odyssey American Reinsurance. The commutation
was initiated and accrued for in December 2002 and the return
premium was received on March 7, 2003 in the amount of
$3,379,500. The commutation was recognized as a decrease in
ceded premium. The Company recorded a net loss of $518,000 in
connection with this transaction.

In 2003, the Company commuted all treaties held
with Gerling Global Reinsurance Corporation (Gerling), due to
credit downgrades and the financial deterioration of Gerling. In
March 2003, The Company received $6,200,000 from Gerling in full
settlement of their liability. The Company recognized the amount
received as a reduction of reinsurance recoverables, ceded loss
and loss adjustment expense reserves in the amount of
$2,047,612, $3,805,535 and $346,853, respectively (thereby
increasing net losses and loss adjustment expenses incurred) in
the current year. The Company also decreased its net loss and
loss adjustment expenses paid (thereby increasing net losses and
loss adjustment expenses incurred) to recognize the effect of
releasing Gerling from its obligations under the treaties. The
Company recorded a net loss of $235,999 on the transaction.

On January 1, 2004, Proformance entered into
a Commercial and Personal Excess Liability Excess of Loss
Reinsurance Contract with Odyssey America Reinsurance
Corporation (OdysseyRe). Under the terms of this
contract, Proformance ceded $5,555,556 of written premiums to
OdysseyRe as of December 31, 2004. On January 1, 2004,
Mayfair entered into a reinsurance agreement with OdysseyRe
whereby Mayfair would accept 100% of OdysseyRes share in
the interests and liabilities under the contract issued to
Proformance. Total assumed written premiums under this contract
was $5,000,000 as of December 31, 2004.

On December 31, 2004, Proformance commuted
the Commercial and Personal Excess Liability Excess of Loss
Reinsurance Contract with OdysseyRe. The commutation was
initiated and accrued for in December 2004 and the return
premium was received on January 21, 2005 in the amount of
$4,750,000. The transaction was recorded as a decrease in ceded
written premiums in the amount of $5,555,556 and a decrease in
ceded commissions of $555,556. Proformance recognized a loss of
$250,000 in connection with this transaction. On
December 31, 2004, the reinsurance agreement between
OdysseyRe and Mayfair was commuted. The transaction was recorded
as a decrease in assumed written premiums in the amount of
$5,000,000.

F-21



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                     
|-- | ----------------------------------------------------
|5. | Reserves for Losses and Loss Adjustment
    Expenses

The changes in unpaid losses and loss adjustment
expenses are summarized as follows (000s omitted):

|                                              |                |                                  |         |         |   |      |         |         |  |   |         |        | 
|--------------------------------------------- | -------------- | -------------------------------- | ------- | ------- | - | ---- | ------- | ------- |  | - | ------- | ------ | 
|                                              |                |                                 
|                                              |                | For the Years Ended December 31,
|                                              |                |                                 
|                                              |                | 2004                             |         | 2003    |   | 2002
|                                              |                |                                  |         |         |   |     
|Balance as of beginning of period             |                | $                                | 134,201 |         |   | $    | 85,472  |         |  | $ | 56,732  |       
|Less reinsurance recoverable on unpaid losses |                |                                  | (21,329 | )       |   |      | (19,431 | )       |  |   | (26,718 | )     
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Net balance as of beginning of period         |                |                                  | 112,872 |         |   |      | 66,041  |         |  |   | 30,014  |       
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Incurred related to:                          |                |                                  |         |         |   |      |         |         |  |   |         |       
|                                              | Current period |                                  |         | 135,659 |   |      |         | 108,047 |  |   |         | 60,861 | 
|                                              | Prior period   |                                  |         | (672    | ) |      |         | 76      |  |   |         | 8,630  | 
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Total incurred                                |                |                                  | 134,987 |         |   |      | 108,123 |         |  |   | 69,491  |       
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Paid related to:                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|                                              | Current period |                                  |         | 44,899  |   |      |         | 37,594  |  |   |         | 20,114 | 
|                                              | Prior period   |                                  |         | 43,613  |   |      |         | 23,698  |  |   |         | 13,350 | 
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Total paid                                    |                |                                  | 88,512  |         |   |      | 61,292  |         |  |   | 33,464  |       
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Net balance as of end of period               |                |                                  | 159,347 |         |   |      | 112,872 |         |  |   | 66,041  |       
|Plus reinsurance recoverable on unpaid losses |                |                                  | 24,936  |         |   |      | 21,329  |         |  |   | 19,431  |       
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       
|Balance as of end of period                   |                | $                                | 184,283 |         |   | $    | 134,201 |         |  | $ | 85,472  |       
|                                              |                |                                  |         |         |   |      |         |         |  |   |         |       

As a result of changes in estimates of insured
events in prior years, incurred losses in prior years increased
by approximately $76,000 in 2003 and $8,630,000 in 2002 because
of higher than anticipated losses on the private passenger
automobile, automobile physical damage and commercial automobile
liability, as well as reserve strengthening during 2002 and
2001. The incurred losses related to prior years of $76,000 in
2003 included the previously discussed, Gerling commutation loss
of $235,999 which was offset by favorable loss development on
prior accident year reserves. For the year ended
December 31, 2004, we reduced reserves for prior years by
$672,000 due to the fact that the actual loss experience
observed during the period, especially during the fourth quarter
of 2004, was slightly lower than expected due to a reduction in
the frequency of claims reported during the fourth quarter of
2004.

Environmental
Reserves The
Companys exposure to environmental claims arises solely
from the sale of Homeowners policies. The exposure to
environmental claims which may also be referred to as
pollution, hazardous waste, or
environmental impairment liability was due to
leakage of underground fuel storage tanks, which contaminated
the surrounding soil and ground water.

The Company establishes full case reserves for
all reported environmental claims. Reserves for losses incurred
but not reported (IBNR) include a provision for development
of reserves on reported losses. The Companys IBNR reserves
are established based on a review of a number of actuarial
analyses.

F-22



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The table balance represents the loss activity
related to environmental exposures for the periods ended
December 31, 2004, 2003 and 2002 (000s omitted):

|                                    |                                                                 |      |   |      |  |      |   |     |  |  |   |     | 
|----------------------------------- | --------------------------------------------------------------- | ---- | - | ---- |  | ---- | - | --- |  |  | - | --- | 
|                                    |                                                                 | 2004 |   | 2003 |  | 2002
|                                    |                                                                 |      |   |      |  |     
|Environmental, Gross of Reinsurance |                                                                 |      |   |      |  |      |   |     |  |  |   |    
|                                    | Beginning Reserves  including case,
    bulk and IBNR, and LAE |      | $ | 743  |  |      | $ | 650 |  |  | $ | 471 | 
|                                    | Losses and LAE incurred                                         |      |   | 888  |  |      |   | 186 |  |  |   | 699 | 
|                                    | Calendar year payments for losses and LAE                       |      |   | 739  |  |      |   | 93  |  |  |   | 520 | 
|                                    | Ending reserves  including case, bulk
    and IBNR, and LAE    |      |   | 892  |  |      |   | 743 |  |  |   | 650 | 
|Environmental, net of reinsurance   |                                                                 |      |   |      |  |      |   |     |  |  |   |    
|                                    | Beginning Reserves  including case,
    bulk and IBNR, and LAE |      | $ | 454  |  |      | $ | 381 |  |  | $ | 114 | 
|                                    | Losses and LAE incurred                                         |      |   | 705  |  |      |   | 146 |  |  |   | 439 | 
|                                    | Calendar year payments for losses and LAE                       |      |   | 525  |  |      |   | 73  |  |  |   | 171 | 
|                                    | Ending reserves  including case, bulk
    and IBNR, and LAE    |      |   | 634  |  |      |   | 454 |  |  |   | 381 | 



|   |             
|-- | ------------
|6. | Income Taxes

The Company and its subsidiaries file a
consolidated Federal income tax return.

The components of the provision (benefit) for
income taxes on income for the years ended December 31,
2004, 2003 and 2002 are as follows:

|                                     |                |                                  |           |           |  |      |           |           |  |   |           |           | 
|------------------------------------ | -------------- | -------------------------------- | --------- | --------- |  | ---- | --------- | --------- |  | - | --------- | --------- | 
|                                     |                |                                 
|                                     |                | For the Years Ended December 31,
|                                     |                |                                 
|                                     |                | 2004                             |           | 2003      |  | 2002
|                                     |                |                                  |           |           |  |     
|Taxes on income before income taxes: |                |                                  |           |           |  |      |           |           |  |   |           |          
|                                     | Current taxes  |                                  | $         | 4,953,669 |  |      | $         | 457,640   |  |   | $         |          | 
|                                     | Deferred taxes |                                  |           | 3,932,128 |  |      |           | 9,487,562 |  |   |           | 2,822,353 | 
|                                     |                |                                  |           |           |  |      |           |           |  |   |           |          
|Total                                |                | $                                | 8,885,797 |           |  | $    | 9,945,202 |           |  | $ | 2,822,353 |          
|                                     |                |                                  |           |           |  |      |           |           |  |   |           |          

The components of deferred tax assets and
deferred tax liabilities are as follows as of December 31,
2004 and 2003:

|                        |                            |                                  |            |            |  |  |            |            | 
|----------------------- | -------------------------- | -------------------------------- | ---------- | ---------- |  |  | ---------- | ---------- | 
|                        |                            |                                 
|                        |                            | For the Years Ended December 31,
|                        |                            |                                 
|                        |                            | 2004                             |            | 2003      
|                        |                            |                                  |            |           
|Deferred tax assets:    |                            |                                  |            |            |  |  |            |           
|                        | 20% UPR adjustment         |                                  | $          | 4,340,295  |  |  | $          | 3,160,948  | 
|                        | Loss reserve discount      |                                  |            | 5,273,257  |  |  |            | 3,424,851  | 
|                        | Bad debt reserve           |                                  |            | 279,344    |  |  |            | 169,995    | 
|                        | Unrealized losses          |                                  |            |            |  |  |            | 282,675    | 
|                        | Incentive stock options    |                                  |            | 453,334    |  |  |            | 289,871    | 
|                        | GAAP reserve differentials |                                  |            |           |  |  |            | 3,400,000  | 
|                        | Prepaid reinsurance        |                                  |            |           |  |  |            | 1,255,842  | 
|                        |                            |                                  |            |            |  |  |            |           
|Deferred tax assets     |                            |                                  | 10,346,230 |            |  |  | 11,984,182 |           
|Deferred tax liability: |                            |                                  |            |            |  |  |            |           
|                        | Deferred acquisition costs |                                  |            | 3,696,439  |  |  |            | 3,328,304  | 
|                        | Accrual of bond discount   |                                  |            | 31,358     |  |  |            | 8,351      | 
|                        | Deferred revenues         |                                  |            | 18,227,709 |  |  |            | 12,118,184 | 

F-23



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                             |                                        |                                  |             |         |  |   |            |           | 
|---------------------------- | -------------------------------------- | -------------------------------- | ----------- | ------- |  | - | ---------- | --------- | 
|                             |                                        |                                 
|                             |                                        | For the Years Ended December 31,
|                             |                                        |                                 
|                             |                                        | 2004                             |             | 2003   
|                             |                                        |                                  |             |        
|                             | Prepaid expenses                       |                                  |             | 97,287  |  |   |            |          | 
|                             | Unrealized gains                       |                                  |             | 93,826  |  |   |            | 312,032   | 
|                             | Due & Accrued dividends                |                                  |             | 11,863  |  |   |            | 17,487    | 
|                             | Depreciation                           |                                  |             | 183,088 |  |   |            | 143,714   | 
|                             | Accrued income reinsurance recoverable |                                  |             |        |  |   |            | 3,817,000 | 
|                             | Reinsurance payable                    |                                  |             |        |  |   |            | 237,853   | 
|                             |                                        |                                  |             |         |  |   |            |          
|Deferred tax liabilities     |                                        |                                  | 22,341,570  |         |  |   | 19,982,925 |          
|                             |                                        |                                  |             |         |  |   |            |          
|Net deferred tax liabilities |                                        | $                                | (11,995,340 | )       |  | $ | (7,998,743 | )        
|                             |                                        |                                  |             |         |  |   |            |          

The income tax rate reconciliation for the years
ended December 31, 2004, 2003 and 2002 is as follows
(000s omitted):

|                               |  |                                  |        |      |  |      |       |    |  |   |        |   |  |  |       |    |  |   |        |   |  |  |        |   
|------------------------------ |  | -------------------------------- | ------ | ---- |  | ---- | ----- | -- |  | - | ------ | - |  |  | ----- | -- |  | - | ------ | - |  |  | ------ | --
|                               |  |                                 
|                               |  | For the Years Ended December 31,
|                               |  |                                 
|                               |  |                                  |        |      |  |      |       |    |  |   |        |  
|                               |  |                                  |        |      |  |      |       |    |  |   |        |  
|                               |  |                                  |        |      |  |     
|                               |  | 2004                             |        | 2003 |  | 2002
|                               |  |                                  |        |      |  |     
|Pre Tax Net Income             |  | $                                | 26,334 |      |  |      |       |    |  | $ | 29,013 |   |  |  |       |    |  | $ | 11,456 |   |  |  |        |   
|Income Tax Statutory Rate      |  |                                  | 8,954  |      |  |      | 34.00 | %  |  |   | 9,864  |   |  |  | 34.00 | %  |  |   | 3,895  |   |  |  | 34.00  | % 
|Tax Exempt Interest            |  |                                  | (596   | )    |  |      | (2.26 | )% |  |   | (230   | ) |  |  | (0.79 | )% |  |   | (11    | ) |  |  | (0.10  | )%
|DRD                            |  |                                  | (33    | )    |  |      | (0.13 | )% |  |   | (54    | ) |  |  | (0.19 | )% |  |   | (8     | ) |  |  | (0.07  | )%
|Proration                      |  |                                  | 94     |      |  |      | 0.36  | %  |  |   | 43     |   |  |  | 0.15  | %  |  |   | 3      |   |  |  | 0.03   | % 
|Life insurance expense         |  |                                  | 27     |      |  |      | 0.10  | %  |  |   | 27     |   |  |  | 0.09  | %  |  |   |       |   |  |  | 0.00   | % 
|State taxes                    |  |                                  | 434    |      |  |      | 1.65  | %  |  |   | 399    |   |  |  | 1.38  | %  |  |   |       |   |  |  | 0.00   | % 
|Release of valuation allowance |  |                                  |       |      |  |      | 0.00  | %  |  |   |       |   |  |  | 0.00  | %  |  |   | (1,161 | ) |  |  | (10.13 | )%
|Other                          |  |                                  | 6      |      |  |      | 0.02  | %  |  |   | (104   | ) |  |  | (0.36 | )% |  |   | 104    |   |  |  | 0.91   | % 
|                               |  |                                  |        |      |  |      |       |    |  |   |        |   |  |  |       |    |  |   |        |   |  |  |        |   
|Total income tax expense       |  | $                                | 8,886  |      |  |      | 33.74 | %  |  | $ | 9,945  |   |  |  | 34.28 | %  |  | $ | 2,822  |   |  |  | 24.63  | % 
|                               |  |                                  |        |      |  |      |       |    |  |   |        |   |  |  |       |    |  |   |        |   |  |  |        |   

Income tax provision in 2002 was less than the
amount of tax computed using the statutory tax rate primarily
due to the reduction in the valuation allowance for deferred tax
assets. The valuation allowance of $1,161,000 was originally
recorded in 2000 and related to net operating losses arising
from the Niagara subsidiary. Due to Niagaras history of
losses it was determined that it was more likely than not that
the asset would not be recovered. However, due to the tax law
changes enacted in 2002 that allowed for a 5 year
carry-back of the net operating losses generated in 2001, the
Niagara net operating loss was fully utilized in 2002.

F-24



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                       
|-- | ----------------------
|7. | Property and Equipment

A summary of property and equipment is as follows:

|                               |  |                     |           |      |  |   |           | 
|------------------------------ |  | ------------------- | --------- | ---- |  | - | --------- | 
|                               |  |                    
|                               |  | For the Years Ended
|                               |  | December 31,       
|                               |  |                    
|                               |  | 2004                |           | 2003
|                               |  |                     |           |     
|Automobiles                    |  | $                   | 463,656   |      |  | $ | 264,682   | 
|Computer Software              |  |                     | 822,545   |      |  |   | 44,374    | 
|Furniture & fixtures           |  |                     | 617,790   |      |  |   | 560,972   | 
|Leasehold improvements         |  |                     | 143,966   |      |  |   | 117,480   | 
|Electronic data equipment      |  |                     | 1,936,350 |      |  |   | 1,629,335 | 
|                               |  |                     |           |      |  |   |           | 
|                               |  |                     | 3,984,307 |      |  |   | 2,616,843 | 
|Less: Accumulated depreciation |  |                     | 1,962,873 |      |  |   | 1,534,951 | 
|                               |  |                     |           |      |  |   |           | 
|Net property and equipment     |  | $                   | 2,021,434 |      |  | $ | 1,081,892 | 
|                               |  |                     |           |      |  |   |           | 

Depreciation and amortization expense amounted to
$427,922, $312,351 and $285,250 for the years ended
December 31, 2004, 2003 and 2002, respectively.



|   |                     
|-- | --------------------
|8. | Capital Transactions

As discussed in Note 3, on December 8,
2003, the Company issued 430,000 shares of Class B
Non-voting Common Stock to Met for $10,000,000.

On August 1, 2003 the company made a private
offering to certain former personal lines agents of OCNJ. The
offering was of up to 215,000 shares at $23.26 per
share of nonvoting Class B common stock. At the end of
2003, 107,500 shares were issued at $23.26 per share
to the former agents of OCNJ.

During 2002, the Company cancelled
45,150 shares of Class A Voting Common Stock and
reissued 45,150 shares of Class B Non-voting Common
Stock.

As discussed further in Note 3, the company
sold 867,955 shares of Class B Non-voting Common
shares to OCIC which was valued by the Company at $13,500,000 at
the time of the transaction. This represented 19.71 percent
of the outstanding shares of the Company at December 18,
2001.

Pursuant to an investor rights agreement entered
into between OCIC and NAHC on December 18, 2001, OCIC had a
right to require NAHC to redeem all equity securities of NAHC
owned by OCIC for fair market value at any time (i) on or
after December 18, 2006 or (ii) prior to
December 18, 2006 if NAHC delivers notice of a change in
control event as defined in the agreement. On July 10,
2004, OCIC and NAHC entered into an agreement which would
facilitate the sale by OCIC of shares of common stock of NAHC
owned by OCIC that have an aggregate value of equal to at least
10% of the aggregate value of all shares of common stock sold by
NAHC as part of an initial public offering. In exchange for the
foregoing, OCIC agreed to waive its redemption right. As such,
the related common stock is considered capital.



|   |              
|-- | -------------
|9. | Stock Options

During 1995, the Company developed a stock option
plan for key management employees and directors. Options are
exercisable when the earliest of the following events occur:
three years from date of issuance, date of retirement or
expiration of the Directors term, date of change of
control, or the date of an offering of its shares through an
initial public offering. The options expire 10 years after
the date of grant. The options are also nontransferable and
contain further restrictions imposed after the options have

F-25



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

vested. If options are exercised then the
shareholders cannot transfer their shares unless the transfer is
permitted by the Company and the Company has first right to
purchase all or any of the shares offered for sale. These
restrictions have been taken into account when determining the
fair value of the stock.

The following table summarizes information with
respect to stock options outstanding as of December 31,
2004:

|                                         |           |           |         |                |  |   |      |      | 
|---------------------------------------- | --------- | --------- | ------- | -------------- |  | - | ---- | ---- | 
|                                         |           |           |         | Weighted      
|                                         |           | Number of |         | Average       
|                                         |           | Options   |         | Exercise Price
|                                         |           |           |         |               
|Balance Outstanding at January 1, 2002   |           |           | 582,650 |                |  | $ | 1.88 |     
|                                         | Granted   |           |         | 47,300         |  |   |      | 0.60 | 
|                                         | Exercised |           |         |               |  |   |      |     | 
|                                         | Forfeited |           |         |               |  |   |      |     | 
|                                         |           |           |         |                |  |   |      |     
|Balance Outstanding at December 31, 2002 |           |           | 629,950 |                |  |   | 1.79 |     
|                                         | Granted   |           |         | 43,000         |  |   |      | 6.14 | 
|                                         | Exercised |           |         |               |  |   |      |     | 
|                                         | Forfeited |           |         |               |  |   |      |     | 
|                                         |           |           |         |                |  |   |      |     
|Balance Outstanding at December 31, 2003 |           |           | 672,950 |                |  |   | 2.06 |     
|                                         | Granted   |           |         |               |  |   |      |     | 
|                                         | Exercised |           |         |               |  |   |      |     | 
|                                         | Forfeited |           |         |               |  |   |      |     | 
|                                         |           |           |         |                |  |   |      |     
|Balance Outstanding at December 31, 2004 |           |           | 672,950 |                |  | $ | 2.06 |     
|                                         |           |           |         |                |  |   |      |     

|                                                                |  |                          |      |      |  |      |       |  |  |   |       | 
|--------------------------------------------------------------- |  | ------------------------ | ---- | ---- |  | ---- | ----- |  |  | - | ----- | 
|                                                                |  |                         
|                                                                |  | Years Ended December 31,
|                                                                |  |                         
|                                                                |  | 2004                     |      | 2003 |  | 2002
|                                                                |  |                          |      |      |  |     
|Weighted average fair value of options granted
    (per option) |  | $                        | 0.00 |      |  | $    | 19.14 |  |  | $ | 15.13 | 
|                                                                |  |                          |      |      |  |      |       |  |  |   |       | 

The following table summarizes information about
stock options outstanding at December 31, 2004:

|                    |  |                     |         |             |  |          |      |           |  |          |      |  |  |  |         |  |  |   |      | 
|------------------- |  | ------------------- | ------- | ----------- |  | -------- | ---- | --------- |  | -------- | ---- |  |  |  | ------- |  |  | - | ---- | 
|                    |  |                    
|Options Outstanding |  | Options Exercisable
|                    |  |                    
|                    |  | Weighted            |         |             |  |         
|                    |  | Average             |         | Weighted    |  |          |      | Weighted 
|Range of            |  | Number of           |         | Contractual |  | Average  |      | Number of |  | Average 
|Exercise            |  | Stock               |         | Life        |  | Exercise |      | Stock     |  | Exercise
|Prices              |  | Options             |         | (in years)  |  | Price    |      | Options   |  | Price   
|                    |  |                     |         |             |  |          |      |           |  |         
|$0.60               |  |                     | 47,300  |             |  |          | 7.44 |           |  | $        | 0.60 |  |  |  | 47,300  |  |  | $ | 0.60 | 
|0.98 - 1.29         |  |                     | 303,150 |             |  |          | 2.09 |           |  |          | 1.20 |  |  |  | 303,150 |  |  |   | 1.20 | 
|2.50 - 2.89         |  |                     | 279,500 |             |  |          | 3.23 |           |  |          | 2.62 |  |  |  | 279,500 |  |  |   | 2.62 | 
|6.14                |  |                     | 43,000  |             |  |          | 8.28 |           |  |          | 6.14 |  |  |  |        |  |  |   |     | 
|                    |  |                     |         |             |  |          |      |           |  |          |      |  |  |  |         |  |  |   |      | 
|                    |  |                     | 672,950 |             |  |          | 3.34 |           |  | $        | 2.06 |  |  |  | 629,950 |  |  | $ | 1.79 | 
|                    |  |                     |         |             |  |          |      |           |  |          |      |  |  |  |         |  |  |   |      | 

F-26



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes information about
stock options outstanding at December 31, 2003:

|                    |  |                     |         |             |  |          |      |          |  |          |      |  |  |  |         |  |  |   |      | 
|------------------- |  | ------------------- | ------- | ----------- |  | -------- | ---- | -------- |  | -------- | ---- |  |  |  | ------- |  |  | - | ---- | 
|                    |  |                    
|Options Outstanding |  | Options Exercisable
|                    |  |                    
|                    |  | Weighted            |         |             |  |         
|                    |  | Average             |         | Weighted    |  |          |      | Weighted
|Range of            |  | Number              |         | Contractual |  | Average  |      | Number   |  | Average 
|Exercise            |  | of Stock            |         | Life        |  | Exercise |      | of Stock |  | Exercise
|Prices              |  | Options             |         | (in years)  |  | Price    |      | Options  |  | Price   
|                    |  |                     |         |             |  |          |      |          |  |         
|$0.60               |  |                     | 47,300  |             |  |          | 8.45 |          |  | $        | 0.60 |  |  |  |        |  |  | $ |     | 
|0.98 - 1.29         |  |                     | 303,150 |             |  |          | 3.10 |          |  |          | 1.20 |  |  |  | 240,800 |  |  |   | 1.25 | 
|2.50 - 2.89         |  |                     | 279,500 |             |  |          | 4.23 |          |  |          | 2.62 |  |  |  | 279,500 |  |  |   | 2.62 | 
|6.14                |  |                     | 43,000  |             |  |          | 9.28 |          |  |          | 6.14 |  |  |  |        |  |  |   |     | 
|                    |  |                     |         |             |  |          |      |          |  |          |      |  |  |  |         |  |  |   |      | 
|                    |  |                     | 672,950 |             |  |          | 4.34 |          |  | $        | 2.06 |  |  |  | 520,300 |  |  | $ | 1.99 | 
|                    |  |                     |         |             |  |          |      |          |  |          |      |  |  |  |         |  |  |   |      | 

The number of exercisable stock options
outstanding at December 31, 2004, 2003 and 2002 were
629,950, 520,300 and 520,300 respectively. The weighted average
exercise price of exercisable stock options outstanding at
December 31, 2004, 2003 and 2002 was $1.79, $1.99 and
$1.99, respectively.

Compensation expense recorded in connection with
the options issued during 2003 was $245,340 and $184,005 for the
years ended December 31, 2004 and 2003, respectively. The
unamortized deferred compensation in connection with these
options was $306,675 and $552,015 as of December 31, 2004
and 2003, respectively.

Compensation expense recorded in connection with
the options issued during 2002 was $235,433, $235,432 and
$117,717 for the years ended December 31, 2004, 2003 and
2002, respectively. The unamortized deferred compensation in
connection with these options was $117,717, $353,150 and 588,582
as of December 31, 2004, 2003 and 2002, respectively.

The company is not authorized to grant additional
options as of December 18, 2004.



|    |                              
|--- | -----------------------------
|10. | Contingencies and Commitments

Litigation
The Company is subject to legal proceedings and claims which
arise in the ordinary course of its business. The Company
accounts for such activity through the establishment of unpaid
claims and claim adjustment expense reserves. Management does
not believe that the outcome of any of those matters will have a
material adverse effect on the Companys financial
position, operating results or cash flows.

Operating
Leases The Company has
entered into a seven-year lease agreement for the use of office
space and equipment. The most significant obligations under the
lease terms other than the base rent are the reimbursement of
the Companys share of the operating expenses of the
premises, which include real estate taxes, repairs and
maintenance, utilities, and insurance. Net rent expense for
2004, 2003 and 2002 was $919,058, $743,200 and $475,710,
respectively.

The Company entered into a four-year lease
agreement for the use of additional office space and equipment
commencing on September 11, 2004. Rent expense for the
period from September 11, 2004 through December 31,
2004 was $70,800.

F-27



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Aggregate minimum rental commitments of the
Company as of December 31, 2004 are as follows:

|                    |  |        |           | 
|------------------- |  | ------ | --------- | 
|Year                |  | Amount
|                    |  |       
|2005                |  |        | 898,383   | 
|2006                |  |        | 906,775   | 
|2007                |  |        | 914,467   | 
|2008                |  |        | 845,240   | 
|2009 and thereafter |  |        | 578,499   | 
|                    |  |        |           | 
|Total               |  | $      | 4,143,364 | 
|                    |  |        |           | 

In connection with the lease agreement, the
Company executed a letter of credit in the amount of $300,000 as
security for payment of the base rent.

Guaranty Fund and
Assessment The Company
is subject to guaranty fund and other assessments by the State
of New Jersey. The Company is also assigned private passenger
automobile and commercial automobile risks by the State of
New Jersey for those who cannot obtain insurance in the
primary market.

New Jersey law requires that property and
casualty insurers licensed to do business in New Jersey
participate in the New Jersey Property-Liability Insurance
Guaranty Association (which we refer to as NJPLIGA). Members of
NJPLIGA are assessed the amount NJPLIGA deems necessary to pay
its obligations and its expenses in connection with handling
covered claims. Assessments are made in the proportion that each
members direct written property and casualty premiums for
the prior calendar year compared to the corresponding direct
written premiums for NJPLIGA members for the same period.
NJPLIGA notifies the insurer of the surcharge to the
policyholders, which is used to fund the assessment as a
percentage of premiums on an annual basis. The Company collects
these amounts on behalf of the NJPLIGA and there is no income
statement impact. Historically, requests for remittance of the
assessments are levied 12-14 months after the end of a policy
year. The Company remits the amount to NJPLIGA within
45 days of the assessment request.

For the years ended December 31, 2004 and
2003, Proformance was assessed $1,828,285 and $407,947,
respectively, as its portion of the losses due to insolvencies
of certain insurers. We anticipate that there will be additional
assessments from time to time relating to insolvencies of
various insurance companies. We are allowed to re-coup these
assessments from our policyholders over time until we have
recovered all such payments. In the event that the required
assessment is greater than the amount accrued for via
surcharges, the Company has the ability to increase its
surcharge percentage to re-coup that amount.

A summary of NJPLIGA balances and amounts is as
follows:

|        |  |                    |           |      |  |      |         |  |  |   |         | 
|------- |  | ------------------ | --------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|        |  |                   
|        |  | As of December 31,
|        |  |                   
|        |  | 2004               |           | 2003 |  | 2002
|        |  |                    |           |      |  |     
|Payable |  | $                  | 2,283,093 |      |  | $    | 486,548 |  |  | $ | 382,369 | 
|Paid    |  |                    | 2,370,085 |      |  |      |        |  |  | $ | 124,394 | 

The Personal Automobile Insurance Plan, or PAIP,
is a plan designed to provide personal automobile coverage to
drivers unable to obtain private passenger auto insurance in the
voluntary market and to provide for the equitable assignment of
PAIP liabilities to all licensed insurers writing personal
automobile insurance in New Jersey. We may be assigned PAIP
business by the state in an amount equal to the proportion that
our net direct written premiums on personal auto business for
the prior calendar year compares to the corresponding net direct
written premiums for all personal auto business written in New
Jersey for such year.

The State of New Jersey allows property and
casualty companies to enter into Limited Assignment Distribution
(LAD) agreements to transfer PAIP assignments to another
insurance carrier approved by the State of New Jersey to handle
this type of transaction. The LAD carrier is responsible for
handling all of

F-28



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the premium and loss transactions arising from
PAIP assignments. In turn, the buy-out company pays the LAD
carrier a fee based on a percentage of the buy-out
companys premium quota for a specific year. This
transaction is not treated as a reinsurance transaction on the
buy-out companys book but as an expense. In the event the
LAD carrier does not perform its responsibilities, the Company
will not have any liability associated with the assignments.

We have entered into a LAD agreement pursuant to
which the PAIP business assigned to us by the state are
transferred to Clarendon National Insurance Company and Auto One
Insurance Company which writes and services the business in
exchange for an agreed upon fee. Upon the transfer, we have no
liabilities with respect to such PAIP business. For the years
ended December 31, 2003 and 2002 the Company was assessed
LAD fees of $1,189,068 and $353,832, respectively, in connection
with payments to Clarendon National Insurance Company under the
LAD agreement. For the year ended December 31, 2004, the
Company was assessed LAD fees of $653,993 and $171,063 in
connection with payments made to Clarendon National Insurance
Company and Auto One Insurance Company, respectively, under
separate LAD Agreements. For the years ended December 31,
2004, 2003 and 2002, the Company would have been assigned
$9,348,729, $8,977,000 and $2,200,000 of premium respectively,
by the State of New Jersey under PAIP, if not for the LAD
agreements that were in place. These amounts served as the basis
for the fees to be paid to the LAD carriers.

The Commercial Automobile Insurance Plan, or
CAIP, is a plan similar to PAIP, but involving commercial auto
insurance rather than private passenger auto insurance. Private
passenger vehicles cannot be insured by CAIP if they are
eligible for coverage under PAIP or if they are owned by an
eligible person as defined under New Jersey law. We
are assessed an amount in respect of CAIP liabilities equal to
the proportion that our net direct written premiums on
commercial auto business for the prior calendar year compares to
the corresponding direct written premiums for commercial auto
business written in New Jersey for such year.

Proformance records its CAIP assignment on its
books as assumed business as required by the State of New
Jersey. For the years ended December 31, 2004, 2003 and
2002, the Company has been assigned $2,492,048, $2,041,173 and
$3,113,098 of premiums, and $1,238,971, $810,092 and $1,355,445
of losses, respectively, by the State of New Jersey under the
CAIP. On a quarterly basis, the State of New Jersey remits a
member participation report and cash settlement report. The net
result of premiums assigned less paid losses, losses and loss
adjustment expenses and other expenses plus investment income
results in a net cash settlement due to or from the
participating member. The reserving related to these assignments
is calculated by the State of New Jersey with corresponding
entries recorded on the Companys Financial Statements.

New Jersey Automobile Insurance Risk
Exchange

The New Jersey Automobile Insurance Risk
Exchange, or NJAIRE, is a plan designed to compensate member
companies for claims paid for non-economic losses and claims
adjustment expenses which would not have been incurred had the
tort limitation option provided under New Jersey insurance law
been elected by the injured party filing the claim for
non-economic losses. As a member company of NJAIRE, we submit
information with respect to the number of claims reported to us
that meet the criteria outlined above. NJAIRE compiles the
information submitted by all member companies and remits
assessments to each member company for this exposure. The
Company, since its inception, has never received compensation
from NJAIRE as a result of its participation in the plan. The
Companys participation in NJAIRE is mandated by the New
Jersey Department of Banking and Insurance. The assessments that
the Company has received required payment to NJAIRE for the
amounts assessed. The Company records the assessments received
as other operating and general expenses. For the years ended
December 31, 2004, 2003 and 2002, we have been assessed
$3,244,518, $518,018, and $380,635, respectively, by NJAIRE.

F-29



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

These assessments represent amounts to be paid to
NJAIRE as it relates to the Companys participation in its
plan.



|    |                                  
|--- | ---------------------------------
|11. | Other Comprehensive Income (Loss)

The tax effect of other comprehensive income is
as follows:

|                                                                                   |  |                  |      |        |  |            |      |   |  |   |      |  
|---------------------------------------------------------------------------------- |  | ---------------- | ---- | ------ |  | ---------- | ---- | - |  | - | ---- | -
|                                                                                   |  |                 
|                                                                                   |  | ($ in thousands)
|                                                                                   |  | Before Tax       |      | Tax    |  | Net of Tax
|For the Period Ended December 31, 2004                                             |  | Amount           |      | Effect |  | Amount    
|                                                                                   |  |                  |      |        |  |           
|Net holding gains arising during the year                                          |  | $                | 683  |        |  | $          | (232 | ) |  | $ | 451  |  
|Less reclassification adjustment for net realized
    gains included in net income |  |                  | (494 | )      |  |            | 168  |   |  |   | (326 | )
|                                                                                   |  |                  |      |        |  |            |      |   |  |   |      |  
|Other comprehensive income                                                         |  | $                | 189  |        |  | $          | (64  | ) |  | $ | 125  |  
|                                                                                   |  |                  |      |        |  |            |      |   |  |   |      |  

|                                                                                   |  |                  |      |        |  |            |     |   |  |   |      |  
|---------------------------------------------------------------------------------- |  | ---------------- | ---- | ------ |  | ---------- | --- | - |  | - | ---- | -
|                                                                                   |  |                 
|                                                                                   |  | ($ in thousands)
|                                                                                   |  | Before Tax       |      | Tax    |  | Net of Tax
|For the Year Ended December 31, 2003                                               |  | Amount           |      | Effect |  | Amount    
|                                                                                   |  |                  |      |        |  |           
|Net holding gains arising during the year                                          |  | $                | 95   |        |  | $          | (32 | ) |  | $ | 63   |  
|Less reclassification adjustment for net realized
    gains included in net income |  |                  | (536 | )      |  |            | 182 |   |  |   | (354 | )
|                                                                                   |  |                  |      |        |  |            |     |   |  |   |      |  
|Other comprehensive loss                                                           |  | $                | (441 | )      |  | $          | 150 |   |  | $ | (291 | )
|                                                                                   |  |                  |      |        |  |            |     |   |  |   |      |  

|                                                                                   |  |                  |     |        |  |            |      |   |  |   |     |  
|---------------------------------------------------------------------------------- |  | ---------------- | --- | ------ |  | ---------- | ---- | - |  | - | --- | -
|                                                                                   |  |                 
|                                                                                   |  | ($ in thousands)
|                                                                                   |  | Before Tax       |     | Tax    |  | Net of Tax
|For the Year Ended December 31, 2002                                               |  | Amount           |     | Effect |  | Amount    
|                                                                                   |  |                  |     |        |  |           
|Net holding gains arising during the year                                          |  | $                | 671 |        |  | $          | (230 | ) |  | $ | 441 |  
|Less reclassification adjustment for net realized
    gains included in net income |  |                  | (68 | )      |  |            | 25   |   |  |   | (43 | )
|                                                                                   |  |                  |     |        |  |            |      |   |  |   |     |  
|Other comprehensive income                                                         |  | $                | 603 |        |  | $          | (205 | ) |  | $ | 398 |  
|                                                                                   |  |                  |     |        |  |            |      |   |  |   |     |  



|    |                  
|--- | -----------------
|12. | Statutory Surplus

Proformance, which is domiciled in New Jersey,
prepares its statutory financial statements in accordance with
accounting principles and practices prescribed or permitted by
the New Jersey Department of Banking and Insurance, the
recognized authority for determining solvency under the New
Jersey insurance law. The commissioner of the New Jersey
Department of Banking and Insurance has the right to permit
other practices that may deviate from prescribed practices.
Prescribed statutory accounting practices are those practices
that are incorporated directly or by reference in state laws,
regulations, and general administrative rules applicable to all
insurance enterprises domiciled in New Jersey. Permitted
statutory accounting practices that are not prescribed may
differ from company to company within a state, and may change in
the future.

Generally accepted accounting principles differ
in certain respects from the accounting practices prescribed or
permitted by insurance regulatory authorities (statutory basis).
Based on amounts included in the original filings of the annual
statements for the respective years, statutory surplus including
the effects of the prescribed and permitted practices, was
$61,931,452, $58,245,092 and $37,106,900 at December 31,
2004, 2003 and 2002, respectively.

Subsequent to the original filings of the 2003
and 2002 annual statements, management identified certain
adjustments related to loss reserves, salary accruals and
contingent commissions which, if recorded

F-30



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

at the proper time, would have impacted the
amounts as filed. Such amounts would have reduced statutory
surplus by $1,174,351 and $12,279,375 at December 31, 2003
and 2002, respectively. As a result of these adjustments, there
were no regulatory actions taken or penalties assessed to the
Company.

The Companys statutory financial statements
are presented on the basis of accounting practices prescribed or
permitted by the New Jersey Department of Banking and Insurance.
New Jersey has adopted the National Association of Insurance
Commissioners statutory accounting practices as its
statutory accounting practices, except that it has retained the
prescribed practice of writing off goodwill immediately to
statutory surplus in the year of acquisition. In addition, the
commissioner of the New Jersey Department of Banking and
Insurance has the right to permit other specific practices that
may deviate from prescribed practices.



|    |                            
|--- | ---------------------------
|13. | Dividends from Subsidiaries

The funding of the cash requirements of National
Atlantic Holdings Corporation is primarily provided by cash
dividends from its subsidiaries. Dividends paid by Proformance
are restricted by regulatory requirements of the State of New
Jersey. Generally, the maximum dividend that may be paid without
prior regulatory approval is limited to the greater of
10 percent of statutory surplus (shareholders equity
on a statutory basis) or 100 percent of net income
(excluding realized capital gains) for the prior year. Dividends
exceeding these limitations can be made subject to approval by
state insurance departments. In addition, dividends must be paid
from unassigned funds which must not reflect a deficit.
Proformance is not permitted to pay any dividends without the
approval of the Commissioner as it has negative unassigned
surplus as a result of historical underwriting losses. No
dividends from Proformance were paid for the years ended
December 31, 2004, 2003 and 2002 as the unassigned funds
were $(24,471,562), $(20,935,121) and $(24,991,243),
respectively. In addition, Bermuda legislation imposes
limitations on the dividends Mayfair is permitted to pay, based
on minimum capital and solvency requirements. In connection with
these limitations, Mayfair did not pay any dividends for the
year ended December 31, 2004. The non-insurance
subsidiaries paid cash dividends to National Atlantic Holdings
Corporation of $2,650,000, $1,667,937 and $500,000 in 2004, 2003
and 2002, respectively.



|    |                                    
|--- | -----------------------------------
|14. | Fair Value of Financial Instruments

SFAS No. 107, Disclosure About Fair
Value of Financial Instruments, requires the Company to
disclose the estimated fair value of financial instruments, both
assets and liabilities, recognized and not recognized in the
consolidated balance sheets for which it is practical to
estimate fair value.

The following methods and assumptions were used
to estimate the fair value of each class of financial
instruments for which it is practicable to estimate that value:

Cash and Short Term Investments.For short-term instruments, the
carrying amount is a reasonable estimate of fair value.

Investment in Securities.For investments in securities,
fair values are based on quoted market prices or dealer quotes,
if available. If a quoted market price is not available, fair
value is estimated using quoted market prices for similar
securities.

F-31



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The statement value and estimated fair value of
financial instruments are as follows:

|                       |  |                    |             |            |  |           |             |            |  |   |             |  |  |   |             | 
|---------------------- |  | ------------------ | ----------- | ---------- |  | --------- | ----------- | ---------- |  | - | ----------- |  |  | - | ----------- | 
|                       |  |                   
|                       |  | As of December 31,
|                       |  |                   
|                       |  |                    |             |           
|                       |  | 2004               |             | 2003      
|                       |  |                    |             |           
|                       |  | Statement          |             | Estimated  |  | Statement |             | Estimated 
|                       |  | Value              |             | Fair Value |  | Value     |             | Fair Value
|                       |  |                    |             |            |  |           |             |           
|Fixed maturities       |  | $                  | 210,830,067 |            |  | $         | 210,830,067 |            |  | $ | 130,409,462 |  |  | $ | 130,409,462 | 
|Short-term investments |  |                    | 13,820,488  |            |  |           | 13,820,488  |            |  |   | 31,569,445  |  |  |   | 31,569,445  | 
|Equity Securities      |  |                    | 12,800,535  |            |  |           | 12,800,535  |            |  |   | 8,593,084   |  |  |   | 8,593,084   | 



|    |                       
|--- | ----------------------
|15. | Net Earnings Per Share

Basic net income per share is computed based on
the weighted average number of shares outstanding during the
year. Diluted net income per share includes the dilutive effect
of outstanding share options, using the treasury stock method.
Under the treasury stock method, exercise of options is assumed
with the proceeds used to purchase common stock at the average
price for the period. The difference between the number of
shares issued and the number of shares purchased represents the
dilutive shares.

The following table sets forth the computation of
basic and diluted earnings per share:

|                                             |                                        |                                 |           |           |         |      |           |           |         |   |           |           |         | 
|-------------------------------------------- | -------------------------------------- | ------------------------------- | --------- | --------- | ------- | ---- | --------- | --------- | ------- | - | --------- | --------- | ------- | 
|                                             |                                        |                                
|                                             |                                        | Years Ended December 31,       
|                                             |                                        |                                
|                                             |                                        | 2004                            |           | 2003      |         | 2002
|                                             |                                        |                                 |           |           |         |     
|                                             |                                        |                                
|                                             |                                        | (in thousands, except for share
|                                             |                                        | and per share data)            
|Net income applicable to common stockholders |                                        | $                               | 17,448    |           |         | $    | 19,068    |           |         | $ | 8,634     |          
|                                             | Weighted average common shares  basic |                                 |           | 4,941,990 |         |      |           | 4,448,684 |         |   |           | 4,404,490 |        
|                                             | Effect of dilutive securities:         |                                 |           |           |         |      |           |           |         |   |           |           |        
|                                             |                                        | Options                         |           |           | 672,950 |      |           |           | 613,235 |   |           |           | 557,549 | 
|                                             |                                        |                                 |           |           |         |      |           |           |         |   |           |          
|Weighted average common shares  diluted     |                                        |                                 | 5,614,940 |           |         |      | 5,061,919 |           |         |   | 4,962,039 |          
|                                             |                                        |                                 |           |           |         |      |           |           |         |   |           |          
|Basic earnings per share                     |                                        | $                               | 3.53      |           |         | $    | 4.29      |           |         | $ | 1.96      |          
|                                             |                                        |                                 |           |           |         |      |           |           |         |   |           |          
|Diluted earnings per share                   |                                        | $                               | 3.11      |           |         | $    | 3.77      |           |         | $ | 1.74      |          
|                                             |                                        |                                 |           |           |         |      |           |           |         |   |           |          

For the year ended December 31, 2004, the
amount of Effect of dilutive securities: Options
above represents the total amount of options outstanding without
using the treasury stock method.



|    |              
|--- | -------------
|16. | Notes Payable

On December 4, 1997, the Company entered
into a loan agreement with Gerling Global Reinsurance Company of
America (Gerling). The amount of the indebtedness was $3,000,000
and was written at a variable interest rate. The Base Rate was
the six month LIBOR rate plus an applicable margin of 7%. The
term of the obligation required repayment in full within
six years with semi-annual payments of interest only. The
following principal payments were required on December 4 of
each year starting in 2000; $600,000, $720,000, $840,000 and
$840,000. At December 31, 2000, the Company was unable to
make the scheduled principal repayment. On January 11,
2001, Gerling agreed to modify the loan agreement, delaying the
principal repayments for one year. In return for that
forbearance, the Company agreed to increase the interest rate by
2 percentage points. In addition, Gerling agreed to allow
the Company to postpone the initial principal payment scheduled
for December 2001 until January 2002, when payment was made.

The outstanding principal balance of this
obligation as of December 31, 2001 was $3,000,000; the loan
was paid in full in December of 2002.

F-32



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

On December 30, 1997, the Company entered
into a loan agreement with the National Cooperative Bank (NCB).
The amount of the indebtedness was $3,000,000 and the interest
rate was fixed at closing based on the 5 year US Treasury
index plus 400 basis points for the first (5) years,
and then the 5 year treasury index plus 390 basis
points for the balance of the term. The term of the loan was
11 years with interest only paid quarterly for the first
year. Quarterly principal reductions of $210,000 were to
commence January of 2000 and continue to and including January
of 2008 with a final principal payment of $1,110,000 plus all
accrued interest on January 1, 2009. As of
December 31, 2001, the outstanding principal balance of
this obligation was $2,392,782; the loan was paid in full in
March of 2002.

Interest expense related to these obligations was
$338,725 in 2002.



|    |                         
|--- | ------------------------
|17. | Related Party Disclosure

The Company has entered into material
transactions with related parties. These transactions are
comprised of share repurchase agreements with Met and James V.
Gorman, Chairman and CEO of NAHC and Proformance, Investor
Rights Agreements with OCIC and James V. Gorman, Non-Compete
agreements with Ohio Casualty Insurance Company and payments to
insurance agencies affiliated with members of NAHCs
directors.

The share repurchase agreement with Met restricts
Met from transferring shares for a period of two years from the
date of the repurchase agreement without NAHCs prior
consent. After the two year period but prior to an Initial
Public Offering, NAHC has the right to purchase all shares from
Met pursuant to the price and terms per the agreement. Prior to
a public offering, Met also has a co-sale right, to have its
pro-rata portion of common stock sold should Mr. Gorman
elect to sell common stock. This co-sale right and NAHCs
right of first offer will both terminate upon completion of an
Initial Public Offering. If prior to December 8, 2008, NAHC
shall issue or sell shares of common stock for consideration
less than the purchase price paid by Met, then Met shall have
the right to purchase additional shares for the same
consideration paid by the third party, in order to maintain
their ownership percentage immediately prior to the issuance or
sale of common stock.

In connection with the Ohio Casualty replacement
carrier transaction, Proformance entered into a non-competition
agreement with OCIC which prohibits Proformance from writing
commercial lines insurance policies until December 31, 2004
where the expiring policy was issued by Ohio Casualty Group.

NAHC, OCIC and James Gorman also have an investor
rights agreement which provides the other with the right of
first offer should NAHC issue securities or OCIC desire to
transfer their equity securities. OCIC also has the right of
co-sale within certain parameters should James Gorman sell
equity securities. This is not effective for certain qualified
public offerings such as an Initial Public Offering.

The Company has also made payments to insurance
agencies affiliated with certain of the Companys directors.

For the years ended December 31, 2004, 2003
and 2002, Proformance paid to Connelly-Campion-Wright Insurance
Agency commissions of $406,465, $287,986 and $138,317,
respectively. Mr. Campion, served as Vice-Chairman of our
board of directors, and as Chief Executive Officer of
Connelly-Campion-Wright Insurance Agency during each of these
years.

For the years ended December 31, 2004, 2003
and 2002, Proformance paid to Liberty Insurance Associates, Inc.
commissions of $197,433, $220,605 and $160,414, respectively.
Mr. Harris, a member of our board of directors, is Chief
Executive Officer of Liberty Insurance Associates.

For the years ended December 31, 2004, 2003
and 2002, Proformance paid to Fleet Insurance Services
commissions of $104,521, $104,941 and $116,434, respectively.
Mr. Sharkey, a member of our board of directors, is
Chairman of Fleet Insurance Services.

F-33



---



##### 



NATIONAL ATLANTIC HOLDINGS CORPORATION AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

In connection with the Commercial and Personal
Excess Liability Excess of Loss Reinsurance Contract between
Proformance and OdysseyRe and the reinsurance agreement between
OdysseyRe and Mayfair as outlined in Note 4, these
transactions are eliminated for GAAP reporting purposes as part
of the Companys consolidated financial results.



|    |                                            
|--- | -------------------------------------------
|18. | Initial Public Offering and Stock
    Split

Management announced plans for the sale of the
Companys common shares in a proposed initial public
offering (the IPO) in 2005. In conjunction with the
IPO, the Board of Directors of the Company declared a 43-for-1
common share split which became effective on January 14,
2005 immediately after the time the Company filed its amended
and restated articles of incorporation. All earnings per share
and other share amounts for the periods presented in the
consolidated financial statements have been adjusted
retroactively for the share split.

F-34



---



##### 



SIGNATURES Pursuant to the Requirements of Section 13 or 15(d) of Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized. NATIONAL ATLANTIC HOLDINGS CORPORATIONBy:

/s/
James V. GormanJames V. GormanChairman of the Board of Directors
and Chief Executive Officer Dated: April 27, 2005 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities and on the dates
indicated. Signature
    
    Title
    
    Date/s/ James
V. Gorman
James
V. Gorman
    
    Chairman of the Board
of Directors and
Chief Executive
Officer (Principle
Executive Officer)
    
    April 27, 2005/s/ Frank
J. Prudente
Frank
J. Prudente
    
    Executive Vice
President  Corporate
Finance (Principal
Financial and
Accounting Officer)
    
    April 27, 2005/s/ Peter
A. Cappello, Jr.
Peter
A. Cappello, Jr.
    
    Director
    
    April 27, 2005/s/ Andrew
C. Harris

Andrew
C. Harris
    
    Director
    
    April 27, 2005/s/ Thomas
J. Sharkey, Sr.

Thomas
J. Sharkey, Sr.
    
    Director
    
    April 27, 2005/s/ Steven
V. Stallone
 
Steven
V. Stallone
    
    Director
    
    April 27, 2005/s/ Thomas
M. Mulhare

Thomas
M. Mulhare
    
    Director
    
    April 27, 2005/s/ Candace
L. Straight

Candace
L. Straight
    
    Director
    
    April 27, 2005