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  **SECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C. 20549****FORM 10-Q/A****Amendment No. 1**     **Quarterly Report pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934******for the Quarterly Period Ended September 30, 2005,******or**     **Transition report pursuant to Section 13 or 15(d) Of the Exchange Act******for the Transition Period from                      to                     ******No. 000-25425** **(Commission File Number)****MERCER INSURANCE GROUP, INC.**(Exact name of Registrant as specified in its charter)   PENNSYLVANIA 23-2934601   (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)   10 North Highway 31, P.O. Box 278, Pennington, NJ 08534   (Address of principal executive offices) (Zip Code)(609) 737-0426 (Registrant’s telephone number, including area code)    (Former name, former address and former fiscal year, if changed since last report)Indicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for suchshorter period that the Registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.    Yes þ No oIndicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 ofthe Exchange Act).   Yes þ No oIndicate by check mark whether the registrant is a shell company(as defined in Rule 12b-2 of the Exchange Act). Yes o No þIndicate the number of shares outstanding of each of the issuer’s classes of common stock, as ofthe latest practicable date.     Number of Shares Outstanding as of October 31,2005   COMMON STOCK (No Par Value) 6,556,670   (Title of Class) (Outstanding Shares)  
 

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**EXPLANATORY NOTE**    Theregistrant is filing this Amendment No. 1 to its Form 10-Q for the quarter ended September 30,2005, in response to a request by the SEC to remove narrative disclosure referring to overallor total underwriting profit or loss contained within Item 2, theManagement’s Discussion and Analysisof Financial Condition and Results of Operations. Other than the change referred to above,all other information included in the Mercer Insurance Group, Inc. Form 10-Q, as filed onNovember 9, 2005, remains unchanged. Items 1, 3 and 4 of Part I and all items of Part II ofthat filing have been omitted from this Amendment because they are unchanged. All informationcontained herein is as of September 30, 2005, and does not reflect any events that have occurredsubsequent to that date.
 

 
**TABLE OF CONTENTS**       **Page** PART I. FINANCIAL INFORMATION  4  Item 2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations 4 SIGNATURES 22 **Exhibits:**       Exhibit No. Title 3.1 Articles of Incorporation of Mercer Insurance Group, Inc.(incorporated by reference herein to the Company’sPre-effective Amendment No. 3 on Form S-1, SEC File No.333-104897.)   3.2 Bylaws of Mercer Insurance Group, Inc. (incorporated byreference herein to the Company’s Annual Report on Form 10-K,SEC File No. 000-25425, for the fiscal year ended December 31,2003.)   31.1 Certification of Chief Executive Officer in accordance withSection 302 of the Sarbanes-Oxley Act of 2002   31.2 Certification of Chief Financial Officer in accordance withSection 302 of the Sarbanes-Oxley Act of 2002   32.1 Certification of Chief Executive Officer in accordance withSection 906 of the Sarbanes-Oxley Act of 2002   32.2 Certification of Chief Financial Officer in accordance withSection 906 of the Sarbanes-Oxley Act of 2002 Certification of Chief Executive Officer Certification of Chief Financial Officer Certification of Chief Executive Officer in accordance with Section 906 Certification of Chief Financial Officer in accordance with Section 906(i)
 

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**Forward-looking Statements**     Mercer Insurance Group, Inc. (the “Company”) may from time to time make written or oral“forward-looking statements,” including statements contained in the Company’s filings with theSecurities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibitshereto and thereto), in its reports to shareholders and in other communications by the Company,which are made in good faith by the Company pursuant to the “safe harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995.     These forward-looking statements include statements with respect to the Company’s beliefs,plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subjectto significant risks and uncertainties, and are subject to change based on various factors (some ofwhich are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,”“anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended toidentify forward-looking statements. The following factors, among others, could cause the Company’sfinancial performance to differ materially from the plans, objectives, expectations, estimates andintentions expressed in such forward-looking statements: **•** future economic conditions in the regional and national markets in which theCompany competes which are less favorable than expected;  **•** the effects of weather-related and other catastrophic events;  **•** the geographic concentration of insured accounts;  **•** the effect of legislative, judicial, economic, demographic and regulatory eventsin the two states in which we do business as of September 30, 2005;  **•** the continuation of an A.M. Best rating in the Excellent category;  **•** the ability to enter new markets successfully and capitalize on growthopportunities either through acquisitions or the expansion of our producer network;  **•** the ability to obtain regulatory approval for an acquisition, to close thetransaction, and to successfully integrate an acquisition and its operations.  **•** financial market conditions, including, but not limited to, changes in interestrates and the stock markets causing a reduction of investment income or investmentgains, an acceleration of the amortization of deferred policy acquisition costs,reduction in the value of our investment portfolio or a reduction in the demand forour products;  **•** the impact of acts of terrorism and acts of war;  **•** the effects of terrorist related insurance legislation and laws;  **•** inflation;  **•** the cost, availability and collectibility of reinsurance;  **•** estimates and adequacy of loss reserves and trends in losses and loss adjustment expenses;  **•** heightened competition, including specifically the intensification of pricecompetition, the entry of new competitors and the development of new products by newand existing competitors;
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 **•** changes in the coverage terms selected by insurance customers, including higherdeductibles and lower limits;  **•** our inability to obtain regulatory approval of, or to implement, premium rateincreases;  **•** the potential impact on our reported net income that could result from theadoption of future accounting standards issued by the Financial Accounting StandardsBoard or other standard-setting bodies;  **•** inability to carry out marketing and sales plans, including, among others,development of new products or changes to existing products and acceptance of the newor revised products in the market;  **•** unanticipated changes in industry trends and ratings assigned by nationallyrecognized rating organizations;  **•** adverse litigation or arbitration results;  **•** the ability to carry out our business plans; or  **•** adverse changes in applicable laws, regulations or rules governing insuranceholding companies and insurance companies, and environmental, tax or accountingmatters including limitations on premium levels, increases in minimum capital andreserves, and other financial viability requirements, and changes that affect thecost of, or demand for our products.     The Company cautions that the foregoing list of important factors is not exclusive. Readersare also cautioned not to place undue reliance on these forward-looking statements, which reflectmanagement’s analysis only as of the date of this report. The Company does not undertake to updateany forward-looking statement, whether written or oral, that may be made from time to time by or onbehalf of the Company.
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**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**     The following presents management’s discussion and analysis of our financial condition andresults of operations as of the dates and for the periods indicated. You should read thisdiscussion in conjunction with the condensed consolidated financial statements and notes theretoincluded in this report. This discussion contains forward-looking information that involves risksand uncertainties. Actual results could differ significantly from these forward-looking statements.See “Forward-Looking Statements”.**Overview****THE CONVERSION TRANSACTION AND THE HOLDING COMPANY**     Mercer Insurance Group, Inc. (the “Company” or the “Holding Company”) is a holding companyowning all of the outstanding shares of Mercer Insurance Company, the company resulting from theconversion of Mercer Mutual Insurance Company from the mutual to the stock form of organization on December 15,2003 (the “Conversion”). Prior to the Conversion, and since 1844, Mercer Mutual Insurance Companywas engaged in the business of selling property and casualty insurance.**Our Business**     The Company and its subsidiaries underwrite property and casualty insurance in New Jersey andPennsylvania. Our consolidated operating insurance company subsidiaries are: **•** Mercer Insurance Company, a Pennsylvania property and casualty stock insurancecompany offering insurance coverage to businesses and individuals in New Jersey andPennsylvania,  **•** Mercer Insurance Company of New Jersey, Inc., a New Jersey property and casualtystock insurance company offering insurance coverage to businesses and individuals inNew Jersey; and  **•** Franklin Insurance Company, a property and casualty stock insurance companyoffering private passenger automobile and homeowners insurance to individuals locatedin Pennsylvania.     The Company is subject to regulation by the Pennsylvania Insurance Department and the NewJersey Department of Banking and Insurance as its primary regulators because it is the holdingcompany for Mercer Insurance Company, and, indirectly, Mercer Insurance Company of New Jersey, Inc.and Franklin Insurance Company.     Mercer Insurance Company has applied for a license to write property and casualty insurance inNew York. When licensed in that state, Mercer Insurance Company will initially write business whichsupports existing accounts, and may introduce in that state specialty programs for select religiousinstitutions and habitational risks. After October 1, 2005, through its new subsidiary FinancialPacific Insurance Company, the Company will be writing business in the California, Arizona, Nevadaand Oregon, and will be licensed in 15 additional states.     We manage our business and report our operating results in three operating segments:commercial lines insurance, personal lines insurance and the investment function. See Note 2 ofthe notes to our condensed consolidated financial statements included in this report. However,assets are not allocated to segments and are
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reviewed in the aggregate for decision-makingpurposes. Our commercial lines insurance business consists primarily of multi-peril and generalliability and related coverages. Our personal lines insurance business consists primarily ofhomeowners (in New Jersey and Pennsylvania) and private passenger automobile (in Pennsylvania only)insurance coverages. We market both the commercial and personal insurance lines throughindependent producers.     Our income is principally derived from written premiums received from insureds in thecommercial lines (businesses insured) and personal lines (individuals insured) segments, less thecosts of underwriting the insurance policies, the costs of settling and paying claims reported onthe policies, and from investment income reduced by investment expenses and gains or losses onholdings in our investment portfolio. Written premiums are the total amount of premiums billed tothe policyholder less the amount of premiums returned, generally as a result of cancellations,during a policy period. Written premiums become premiums earned as the policy ages. In the absenceof premium rate changes, if an insurance company writes the same number and mix of policies eachyear, written premiums and premiums earned will be equal, and the unearned premium reserve willremain constant. During periods of growth, the unearned premium reserve will increase, causingpremiums earned to be less than written premiums. Conversely, during periods of decline, theunearned premium reserve will decrease, causing premiums earned to be greater than writtenpremiums.     Variability in our income is caused by a variety of circumstances, some within the control ofour companies and some not within our control. Premium volume is affected by, among other things,the availability and regular flow to our insurance companies of quality, properly-priced risksbeing produced by our agents, the ability to retain on renewal existing good-performing accounts,competition from other insurance companies, regulatory rate approvals, our reputation, and otherlimitations created by the marketplace or regulators. Our underwriting costs are affected by,among other things, the amount of commission and profit-sharing commission we pay our agents toproduce the underwriting risks for which we receive premiums, the cost of issuing insurancepolicies and maintaining our customer and agent relationships, marketing costs, taxes we pay to thestates in which we operate on the amount of premium we collect, and other assessments and chargesimposed on our companies by the regulators in the states in which we do business. Our claim andclaim settlement costs are affected by, among other things, the quality of our accounts, severe orextreme weather in our operating region, the nature of the claim, the regulatory and legalenvironment in our territories, inflation in underlying medical and property repair costs, and theavailability and cost of reinsurance. Our investment income and realized gains and losses aredetermined by, among other things, market forces, the rates of interest and dividends paid on ourinvestment portfolio holdings, the credit or investment quality of the issuers and the success oftheir underlying businesses, the market perception of the issuers, and other factors such asratings by rating agencies and analysts.**Critical Accounting Policies**     *General.*The Company’s financial statements are prepared in conformity with U.S. generallyaccepted accounting principles (GAAP). We are required to make estimates and assumptions in certaincircumstances that affect amounts reported in our consolidated financial statements and relatedfootnotes. We evaluate these estimates and assumptions on an on-going basis based on historicaldevelopments, market conditions, industry trends and other information that we believe to bereasonable under the circumstances. There can be no assurance that actual results will conform toour estimates and assumptions, and that reported results of operations will not be materiallyadversely affected by the need to make accounting adjustments to reflect changes in these estimatesand assumptions from time to time. We believe the following policies are the most sensitive toestimates and judgments.     *Liabilities for Loss and Loss Adjustment Expenses.*The liability for losses and lossadjustment expenses represents estimates of the ultimate unpaid cost of all losses incurred,including losses for claims that have not yet been reported to our insurance companies. The amountof loss reserves for reported claims is based primarily upon
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a case-by-case evaluation of the typeof risk involved, knowledge of the circumstances surrounding each claim and the insurance policyprovisions relating to the type of loss. The amounts of loss reserves for unreported claims andloss adjustment expenses are determined using historical information by line of insurance asadjusted to current conditions. Inflation is implicitly provided for in the reserving functionthrough analysis of costs, trends and reviews of historical reserving results over multiple years.     Reserves are closely monitored and are recomputed periodically using the most recentinformation on reported claims and a variety of statistical techniques. Specifically, on aquarterly basis, we review, by line of business, existing reserves, new claims, changes to existingcase reserves, and paid losses with respect to the current and prior accident years. We usehistorical paid and incurred losses and accident year data to derive expected ultimate loss andloss adjustment expense ratios by line of business. We then apply these expected loss and lossadjustment expense ratios to in-force business to derive a reserve level for each line of business.This amount, together with reserves required by new reported claims and changes to existing casereserves, is compared to existing reserves to establish the adjustment to reserves that isrequired. In connection with the determination of the reserves, we also consider other specificfactors such as recent weather-related losses, trends in historical paid losses, and legal andjudicial trends with respect to theories of liability. Because of the nature of our business,which generally provides coverage for short-term risks, loss development is comparatively rapid andhistorical paid losses have been a reliable predictive measure of future losses.     Nevertheless, reserves are estimates because there are uncertainties inherent in thedetermination of ultimate losses. Court decisions, regulatory changes and economic conditions canaffect the ultimate cost of claims that occurred in the past as well as create uncertaintiesregarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and losssettlement expenses will likely differ from the amount recorded at September 30, 2005. Changes inestimates or differences between estimates and amounts ultimately paid are reflected in currentoperations. Loss reserving techniques and assumptions have been consistently applied during theperiods presented.     The table below summarizes the effect on net loss reserves and equity in the event ofreasonably likely changes in the variables considered in establishing loss and loss adjustmentexpense reserves. The range of reasonably likely changes was established based on a review ofchanges in accident year development by line of business and applied to loss reserves as a whole.The selected range of changes does not indicate what could be the potential best or worst case orlikely scenarios:                 **Adjustment** **Adjusted Loss and**      **Change in Loss and** **Loss Reserves Net of** **Percentage Change in** **Adjusted Loss and Loss** **Percentage Change****Loss Adjustment** **Reinsurance as of** **Stockholders’ Equity as** **Adjustment Reserves** **in Stockholders’****Reserves Net of** **September 30,** **of September 30,** **Net of Reinsurance as of** **Equity as of****Reinsurance** **2005** **2005(1)** **December 31, 2004** **December 31, 2004(1)****(Dollars in thousands)**(10.0)%  29,005   2.1%  29,669   2.2%(7.5)%  29,810   1.6%  30,493   1.6%(5.0)%  30,616   1.1%  31,317   1.1%(2.5)%  31,422   0.5%  32,141   0.5%Base  32,227   —   32,965   — 2.5%  33,033   (0.5)%  33,789   (0.5)%5.0%  33,839   (1.1)%  34,613   (1.1)%7.5%  34,644   (1.6)%  35,437   (1.6)%10.0%  35,450   (2.1)%  36,262   (2.2)% (1) Net of tax
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     The property and casualty industry has incurred substantial aggregate losses from claimsrelated to asbestos-related illnesses, environmental remediation, product and construction defectliability, mold, and other uncertain exposures. We have nothistorically experienced significant losses fromthese types of claims, although Financial Pacific Insurance Group,which the Company acquired on October 1, 2005, has a book ofContractors business which has resulted in construction defect claimsover the years.     The table below summarizes loss and loss adjustment reserves by major line of business:           September 30, 2005  December 31, 2004   (Dollars in thousands) Commercial lines:        Other Liability $9,908  $9,374 Commercial multi-peril  7,240   5,441 Workers’ compensation  5,451   4,627 Commercial automobile  947   1,456 Fire, allied, inland marine  701   781           24,247   21,679                 Personal lines:        Homeowners  8,147   10,095 Personal automobile  1,975   2,283 Other liability  1,076   1,596 Fire, allied, inland marine  262   338 Workers’ compensation  75   37           11,535   14,349        Total $35,782  $36,028             *Investments.*Unrealized investment gains or losses on investments carried at fair value,net of applicable income taxes, are reflected directly in stockholders’ equity as a component ofcomprehensive income and, accordingly, have no effect on net income. A decline in fair value of aninvestment below its cost that is deemed other than temporary is charged to earnings as a realizedloss. We monitor our investment portfolio and review investments that have experienced a declinein fair value below cost to evaluate whether the decline is other than temporary. Theseevaluations involve judgment and consider the magnitude and reasons for a decline and the prospectsfor the fair value to recover in the near term. Adverse investment market conditions, or pooroperating results of underlying investments, could result in impairment charges in the future.     The Company’s policy on impairment of value of investments is as follows: if a security has amarket value below cost it is considered impaired. For any such security a review of the financialcondition and prospects of the company will be performed by the Investment Committee to determineif the decline in market value is other than temporary. If it is determined that the decline inmarket value is “other than temporary”, the carrying value of the security will be written down to“realizable value” and the amount of the write down accounted for as a realized loss. “Realizablevalue” is defined for this purpose as the market price of the security. Write-down to a value otherthan the market price requires objective evidence in support of that value.     In evaluating the potential impairment of fixed income securities, the Investment Committeewill evaluate relevant factors, including but not limited to the following: the issuer’s currentfinancial condition and ability to make future scheduled principal and interest payments, relevantrating history, analysis and guidance provided by rating agencies and analysts, the degree to whichan issuer is current or in arrears in making principal and interest payments, and changes in pricerelative to the market.     In evaluating the potential impairment of equity securities, the Investment Committee willevaluate certain factors, including but not limited to the following: the relationship of marketprice per share versus carrying value per share at the date of acquisition and the date ofevaluation, the price-to-earnings ratio at the date of acquisition and the date of evaluation, anyrating agency announcements, the issuer’s financial condition and near-term
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prospects, includingany specific events that may influence the issuer’s operations, the independent auditor’s reporton the issuer’s financial statements; and any buy/sell/hold recommendations or price projectionsby outside investment advisors.     We have one significant non-traded equity security, a non-voting common stock in ExcessReinsurance Company, which is carried at $1.1 million. Its fair value is estimated at the statutorybook value as reported to the National Association of Insurance Commissioners (NAIC). Othernon-traded securities, which are not material in the aggregate, are carried at cost.     *Policy Acquisition Costs.*We defer policy acquisition costs, such as commissions, premiumtaxes and certain other underwriting expenses that vary with and are primarily related to theproduction of business. These costs are amortized over the effective period of the relatedinsurance policies. The method followed in computing deferred policy acquisition costs limits theamount of deferred costs to their estimated realizable value, which gives effect to the premium tobe earned, related investment income, loss and loss adjustment expenses, and certain other costsexpected to be incurred as the premium is earned. Future changes in estimates, the mostsignificant of which is expected loss and loss adjustment expenses, may require acceleration of theamortization of deferred policy acquisition costs.     *Reinsurance.*Amounts recoverable from property and casualty reinsurers are estimated in amanner consistent with the claim liability associated with the reinsured policy. Amounts paid forreinsurance contracts are expensed over the contract period during which insured events are coveredby the reinsurance contracts.     Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid loss and lossadjustment expenses are reported separately as assets, instead of being netted with the appropriateliabilities, because reinsurance does not relieve us of our legal liability to our policyholders.Reinsurance balances recoverable are subject to credit risk associated with the particularreinsurer. Additionally, the same uncertainties associated with estimating unpaid loss and lossadjustment expenses affect the estimates for the ceded portion of these liabilities.     We continually monitor the financial condition of our reinsurers.     *Income Taxes.*We use the asset and liability method of accounting for income taxes. Deferredincome taxes are provided and arise from the recognition of temporary differences between financialstatement carrying amounts and the tax bases of our assets and liabilities. A valuation allowanceis provided when it is more likely than not that some portion of the deferred tax asset will not berealized. The effect of a change in tax rates is recognized in the period of the enactment date.**Results of Operations**     Our results of operations are influenced by factors affecting the property and casualtyinsurance industry in general, which include potentially significant variations due to competition,weather, catastrophic events, regulation, the state of the reinsurance market, general economicconditions, judicial trends, fluctuations in interest rates and other changes in the investmentenvironment.     Our growth in premiums and underwriting results has been, and continue to be, influenced bymarket conditions. Pricing in the property and casualty insurance industry historically has beenand remains cyclical. During a soft market cycle, price competition is prevalent, which makes itdifficult to write and retain properly priced personal and commercial lines business. Our policyis to maintain disciplined underwriting and pricing standards during soft markets, decliningbusiness which is inadequately priced for its level of risk. The hard market
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and related pricingpower of the early part of the current decade has given way to a much more competitive marketrecently, particularly in large commercial accounts, package policies and in the Pennsylvaniapersonal auto market. This has resulted in slower premium growth than the Company has achieved inrecent years.     The availability of reinsurance at reasonable pricing is an important part of our business.The recent surge in hurricane activity has placed reinsurers under greater financial pressures thanexperienced in recent years, and so it is difficult to predict what impact these events will haveon catastrophe reinsurance rates, and on reinsurance capacity in the market place as we approachthe renewal of our annual reinsurance contracts at the beginning of 2006, or whether reinsurers maymove to reduce occurrence limits included in reinsurance contracts to control catastropheexposures. Although our operating territories experienced only a minor impact from the residualeffects of the hurricanes that ravaged the Gulf coast, it is still yet to be determined how much ofan impact those events may have on the pricing of our reinsurance contracts on renewal.**Nine months and three months ended September 30, 2005 compared with nine months and three monthsended September 30, 2004.**     The components of income for 2005 and 2004, and the change and percentage change from year toyear, are shown in the charts below. The accompanying narrative refers to the statisticalinformation displayed in the chart(s) immediately above the narrative.                 **Nine months ended September 30,**               2005 vs. 2004 Income             % (Dollars in thousands) 2005  2004  Change  Change Commercial lines underwriting income $3,242  $5,384  $(2,142)  (39.8)%Personal lines underwriting loss  (1,121)  (4,591)  3,470   75.6%Total underwriting income  2,121   793   1,328   167.5%Net investment income  2,254   1,933   321   16.6%Realized investment gains  1,273   439   834   190.0%Other revenue  256   266   (10)  (3.8)%Income before income taxes  5,904   3,431   2,473   72.1%Income taxes  1,785   1,010   775   76.7%Net income $4,119  $2,421  $1,698   70.1%                 Loss / LAE ratio (GAAP)  47.6%  50.7%  (3.1)%    Underwriting expense ratio (GAAP)  47.7%  47.4%  0.3%    Combined ratio (GAAP)  95.3%  98.1%  (2.8)%                     Loss / LAE ratio (Statutory)  47.6%  50.7%  (3.1)%    Underwriting expense ratio (Statutory)  47.1%  45.8%  1.3%    Combined ratio (Statutory)  94.7%  96.5%  (1.8)%    
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                 **Three months ended September 30,**               2005 vs. 2004 Income             % (Dollars in thousands) 2005  2004  Change  Change Commercial lines underwriting income $1,599  $1,880  $(281)  (14.9)%Personal lines underwriting loss  (596)  (1,261)  665   52.7%Total underwriting income  1,003   619   384   62.0%Net investment income  770   639   131   20.5%Realized investment gains  1,175   340   835   245.6%Other revenue  84   86   (2)  (2.3)%Income before income taxes  3,032   1,684   1,348   80.0%Income taxes  971   563   408   72.5%Net income $2,061  $1,121  $940   83.9%                 Loss / LAE ratio (GAAP)  42.6%  44.0%  (1.4)%    Underwriting expense ratio (GAAP)  50.9%  51.6%  (0.7)%    Combined ratio (GAAP)  93.5%  95.6%  (2.1)%                     Loss / LAE ratio (Statutory)  42.6%  44.0%  (1.4)%    Underwriting expense ratio (Statutory)  51.4%  50.5%  0.9%    Combined ratio (Statutory)  94.0%  94.5%  (0.5)%         Charts and discussion relating to each of our reporting segments (commercial linesunderwriting, personal lines underwriting, and the investments segment) follow below.     Ourpersonal lines underwriting performance in the first nine months of 2005 is significantly better than theprior year. This improvedperformance has been driven by the absence in 2005 of the severe weather which occurred in ouroperating territories in the first quarter of 2004, during which the Company had a significantlyhigher number of claims in personal lines. This improvement in personal lines in 2005was offset by higher losses in the commercial lines segment, including a number of larger losses inthe second and third quarters, although through the nine months of 2005 the number of new claims continues tobe on the low side of the normal range of expectations, and more favorable than the prior year, andlarge losses in the aggregate are within the normal range of expectations. The Company’s statutorycombined ratio improved to 94.7% in 2005 from 96.5% in 2004. Net investment income increased 16.6%to $2.3 million, primarily as a result of increased yields on short-term investments held in thefixed-income investment portfolio. Realized investment gains amounted to $1.3 million in 2005,compared to a gain of $439,000 in 2004. The unusual level of realized gains in 2005 is attributableto the disposition of securities in anticipation of funding the acquisition of Financial PacificInsurance Group, Inc. on October 1, 2005, for $40.4 million in cash. Our other income, primarilyservice charges recorded on insurance premiums paid over the term of the policy instead of when thepolicy is issued, has declined modestly in 2005.     Inthe three months ended September 30, 2005, claims frequencyimproved on that of the 2004 quarter. Netinvestment income in the quarter improved by 20% over the prior year to $770,000, due principallyto the higher general level of interest rates on short-term holdings.
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                 **Nine months ended September 30,**            2005 vs. 2004 Revenue            (Dollars in thousands) 2005  2004  Change  % Change Direct premiums written $48,004  $46,883  $1,121   2.4%Net premiums written  44,112   42,193   1,919   4.5%Net premiums earned  45,378   41,617   3,761   9.0%Net investment income  2,254   1,933   321   16.6%Realized investment gains  1,273   439   834   190.0%Other Revenue  256   266   (10)  (3.8)%Total Revenue $49,161  $44,255  $4,906   11.1%                 **Three months ended September 30,**            2005 vs. 2004 Revenue            (Dollars in thousands) 2005  2004  Change  % Change Direct premiums written $15,270  $14,644  $626   4.3%Net premiums written  14,171   13,420   751   5.6%Net premiums earned  15,404   14,032   1,372   9.8%Net investment income  770   639   131   20.5%Realized investment gains  1,175   340   835   245.6%Other Revenue  84   86   (2)  (2.3)%Total Revenue $17,433  $15,097  $2,336   15.5%     Total revenues for the nine months of 2005 were up 11.1% over 2004 to $49.2 million. Thisincrease was due primarily to a $3.8 million, or 9.0%, increase in net premiums earned in 2005, a190% increase in realized investment gains to $1.3 million resulting from securities sales to fundthe Financial Pacific acquisition, and a 16.6% increase in net investment income to $2.3 millionresulting from higher short term interest rates in 2005 over 2004. In the third quarter of 2005, ascompared to the same period of 2004, total revenues were up 15.5%over 2004 to $17.4 million. Thisincrease was due primarily to a $1.4 million, or 9.8%, increase in net premiums earned in 2005, an245.6% increase in realized investment gains to $1.2 million resulting from securities sales to fundthe Financial Pacific acquisition, and a 20.5% increase in net investment income to $770,000resulting from higher short term interest rates in 2005 over 2004..     In the first nine months of 2005 direct premiums written increased only 2.4% to $48.0 million,reflecting more competitive pricing in the marketplace and the Company’s discipline to not acceptunderwriting risks which are priced inappropriately. In the third quarter of 2005, as compared tothe same quarter in the prior year, direct premiums written increased 4.3% to $15.3 million. Netpremiums written for the nine months and third quarter increased 4.5 % and 5.6%, respectively, to$44.1 million and $14.2 million, respectively. Net premiums earned for the nine months and thirdquarter increased 9.0% and 9.8%, respectively, to $45.4 million and $15.4 million, respectively.     Growth in Net Investment Income is discussed below.
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                 **Nine months ended September 30**,            2005 vs. 2004 Investment income and            realized gains            (Dollars in thousands) 2005  2004  Change  % Change Fixed income securities $2,651  $2,471  $180   7.3%Dividends  303   303   0   0.0%Cash, cash equivalents & other  582   279   303   108.6%Gross investment income  3,536   3,053   483   15.8%Investment expenses  (1,282)  (1,120)  162   14.5%Net investment income $2,254  $1,933  $321   16.6%                 Realized losses on fixed income $(498) $(146) $(352) NM%Realized gains on equities  1,771   590   1,181  NM%Realized losses — other  —   (5)  5  NM%Net realized gains $1,273  $439  $834  NM% (N/M means “not meaningful”)     In the nine months ended September 30, net investment income increased $321,000, or 16.6%, dueprincipally to increased yields on the short-term portfolio holdings, driven by higher interestrates on the shorter end of the yield curve.     Effective January 1, 2004, the Company engaged a new investment management firmfor its fixed income securities portfolio, whose responsibilites included investing the proceeds ofthe Conversion. Given a difficult interest rate environment and fixed income securities market,this was not largely completed until the second quarter of 2004, and, consequently, a portion ofthe Conversion proceeds earned a short-term yield during much of the first six months of 2004 thatwas considerably lower than similar yields in 2005.     In implementing the investment policy guidelines and directions of the Investment Committee ofthe Board of Directors, the fixed income securities managers during 2004 changed the composition ofthe fixed income securities portfolio to be more heavily weighted in tax-exempt securities,industrial and miscellaneous fixed income securities, and mortgage-backed securities, and lessheavily weighted towards U.S government and government agencies fixed income securities, with agoal of increasing yields while continuing to maintain high credit qualities.     Net realized gains for the first nine months of 2005 were $1.3 million, as compared to$439,000 in the similar period in 2004. As noted above, these gains were taken as part of theprocess of funding the acquisition of Financial Pacific Insurance Group. In 2005, net realizedinvestment gains of $1.3 million included gains on securities sales of $2.3 million, offset bylosses on securities sales of $1.0 million. The losses from securities sales were comprised of$358,000 from the sale of fixed income securities, $203,000 from the sale of equities, and $402,000from the writedown in the second quarter of securities determined to be other-than-temporarilyimpaired. These securities were written down to our estimate of fair market value at the time ofthe write-down.     The following table summarizes the period of time that equity securities sold at a loss during2005 had been in a continuous unrealized loss position:           **Fair**    **PERIOD OF TIME IN AN** **Value on**  **Realized** **UNREALIZED LOSS POSITION** **Sale Date**  **Loss**   **(In thousands)** 0-6 months $1,746  $165 7-12 months  360   38 More than 12 months  —   —        Total $2,106  $203        
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     The equity securities sold at a loss had been expected to appreciate in value but afterre-evaluation were sold so that sale proceeds could be reinvested. Securities were sold due to adesire to reduce exposure to certain issuers and industries or in light of changing economicconditions.     The following table summarizes the length of time equity securities with unrealized losses atSeptember 30, 2005 have been in an unrealized loss position:                               **Length of Unrealized Loss**   **Fair**  **Unrealized**  **Less than**  **6 to 12**  **Over 12** **September 30, 2005** **Value**  **Losses**  **6 months**  **Months**  **Months**  **(In thousands)**Equity securities:                                    Preferred stocks $1,154  $51  $51  $0  $0                      The estimated fair value and unrealized loss for all fixed income and equity securities in atemporary unrealized loss position as of September 30, 2005 are as follows:                           Less than 12 Months 12 Months or Longer Total  Estimated Unrealized Estimated Unrealized Estimated Unrealized  Fair Value Losses Fair Value Losses Fair Value Losses  (In thousands)U.S. Treasury securities andobligations of U.S. governmentcorporations and agencies $5,661  $92  $6,761  $188  $12,422  $280                          Obligations of states andpolitical subdivisions  12,518   144   9,669   194   22,187   338                          Corporate securities  4,063   120   6,734   163   10,797   283                          Mortgage-backed securities  8,874   115   6,203   136   15,077   251    Total fixed maturities  31,116   471   29,367   681   60,482   1,152    Total equity securities  1,154   51   —   —   1,154   51    Total securities in a temporaryunrealized loss position $32,270  $522  $29,367  $681  $61,637  $1,203         The unrealized losses on fixed maturity investments were primarily due to changes in theinterest rate environment. The Company has 40 fixed maturity securities which have been in anunrealized loss position for more than twelve months. Of the 40 fixed maturity securities withunrealized losses for more than twelve months, all have fair values greater than 94% of cost, and36 of the 40 have fair values greater than 97% of cost. The Company has reviewed these securitiesand believes these declines are temporary.     There are 5 equity securities (all preferred stock) that are in an unrealized loss position onSeptember 30, 2005. All of these securities have been in an unrealized loss position for less thansix months. The Company has reviewed these securities and believes these declines are temporary.     Results of our Commercial Lines segment were as follows:
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                 **Nine months ended September 30,**        2005 vs. 2004 Commercial lines (CL)        (Dollars in thousands) 2005 2004 Change % ChangeCL Direct premiums written $30,832  $28,125  $2,707   9.6 %CL Net premiums written $28,005  $24,965  $3,040   12.2%CL Net premiums earned $28,517  $24,150  $4,367   18.1%                 CL Loss / LAE expense ratio (GAAP)  39.1%  28.3 %  10.8 %    CL Expense ratio (GAAP)  49.5%  49.4 %  0.1 %    CL Combined ratio (GAAP)  88.6%  77.7%  10.9 %                     **Three months ended September 30,**        2005 vs. 2004 Commercial lines (CL)        (Dollars in thousands) 2005 2004 Change % ChangeCL Direct premiums written $9,104  $8,048  $1,056   13.1 %CL Net premiums written $8,393  $7,343  $1,050   14.3 %CL Net premiums earned $9,860  $8,294  $1,566   18.9 %                 CL Loss / LAE expense ratio (GAAP)  33.0%  25.7%  7.3%    CL Expense ratio (GAAP)  50.8%  51.6%  (0.9)%    CL Combined ratio (GAAP)  83.8%  77.3 %  6.5 %         In the first nine months of 2005, our commercial lines direct premiums written increased by$2.7 million, or 9.6%, to $30.8 million, as compared to the same period in 2004. Commercial linesnet written premium increased $3.0 million, or 12.2%, to $28.0 million in the same period, and netpremiums earned increased $4.4 million, or 18.1%, to $28.5 million.     In the third quarter of 2005, our commercial lines direct premiums written increased by $1.1million, or 13.1%, to $9.1 million as compared to 2004. Commercial lines net written premiumincreased $1.1 million, or 14.3%, to $8.4 million in the same period, and net premiums earnedincreased $1.6 million, or 18.9%, to $9.9 million     Our premiums written growth reflects the Company’s focus on growing the commercial lines book,while working within our underwriting standards. Growth rates in our commercial lines directpremiums written have declined recently as compared to previous years, due to a more competitivemarketplace. Some of our classes of business, consisting generally of larger accounts, are moresensitive to competition than others. Competitive pressures tend to be more moderate for our smalleraccounts, with a higher retention rate and less pressure on the renewal premium. We continuallywork with our agents to target classes of business and accountscompatible with our underwriting appetite,which includes certain types of religious institution risks, small business risks and propertyrisks.     In the commercial lines segment for the first nine months of 2005, we had underwriting incomeof $3.2 million, a GAAP combined ratio of 88.6%, a GAAP loss and loss adjustment expense ratio of39.1% and a GAAP underwriting expense ratio of 49.5%, compared to an underwriting gain of $5.4million, a GAAP combined ratio of 77.7%, a GAAP loss and loss adjustment expense ratio of 28.3% andan underwriting expense ratio of 49.4% for
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the same period in 2004. Our commercial lines loss ratiofor 2005 has been adversely affected by a modestly higher amount of large property and casualtylosses as compared to the same period in 2004, however the volume of new claims in 2005 isgenerally favorable.     In the commercial lines segment for the third quarter of 2005, we had underwriting income of$1.6 million, a GAAP combined ratio of 83.8%, a GAAP loss and loss adjustment expense ratio of33.0% and a GAAP underwriting expense ratio of 50.8%, compared to an underwriting gain of $1.9million, a GAAP combined ratio of 77.3%, a GAAP loss and lossadjustment expense ratio of 25.7% andan underwriting expense ratio of 51.6% for the same period in 2004     Results of our Personal Lines segment were as follows:                 **Nine months ended September 30,**        2005 vs. 2004 Personal lines (PL)        (Dollars in thousands) 2005 2004 Change % ChangePL Direct premiums written $17,172  $18,758  $(1,586)  (8.5) %PL Net premiums written $16,107  $17,229  $(1,122)  (6.5) %PL Net premiums earned $16,861  $17,467  $(606)  (3.5) %                 PL Loss / LAE expense ratio (GAAP)  61.9 %  81.7%  (19.8) %    PL Expense ratio (GAAP)  44.7 %  44.6%  0.1  %    PL Combined ratio (GAAP)  106.6 %  126.3%  (19.7) %                     **Three months ended September 30,**        2005 vs. 2004 Personal lines (PL)        (Dollars in thousands) 2005 2004 Change % ChangePL Direct premiums written $6,166  $6,596  $(430)  (6.5)%PL Net premiums written $5,778  $6,077  $(299)  (4.9)%PL Net premiums earned $5,543  $5,737  $(194)  (3.4)%                 PL Loss / LAE expense ratio (GAAP)  59.7 %  70.5 %  (10.8)%    PL Expense ratio (GAAP)  51.0 %  51.5 %  (0.5)%    PL Combined ratio (GAAP)  110.7 %  122.0 %  (11.3)%         In the personal lines segment for the first nine months of 2005, we had an underwriting lossof $1.1 million, a GAAP combined ratio of 106.6%, a GAAP loss and loss adjustment expense ratio of61.9% and a GAAP underwriting expense ratio of 44.7%, compared to an underwriting loss of $4.6million, a GAAP combined ratio of 126.3%, a GAAP loss and loss adjustment expense ratio of 81.7%and an underwriting expense ratio of 44.6% for the same period in 2004.     In the personal lines segment for the third quarter of 2005, we had an underwriting loss of$596,000, a GAAP combined ratio of 110.7%, a GAAP loss and loss adjustment expense ratio of 59.7%and a GAAP underwriting expense ratio of 51.0%, compared to an underwriting loss of $1.3 million, aGAAP combined ratio of 122.0%, a GAAP loss and loss adjustment expense ratio of 70.5% and anunderwriting expense ratio of 51.5% for the same period in 2004.
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     The personal lines performance in the first nine months of 2005 was affected by asignificantly lower frequency of losses and by a lower severity of losses as compared to the firstnine months of 2004. The 2004 losses were significantly higher than usual, and were attributable toharsh weather conditions which resulted in a high number of losses from frozen pipes, structuralcollapses, more frequent automobile losses and accidents, and other losses of the type caused by anextended period of harsh weather.     Besides the improved loss frequency resulting from the more moderate weather in the first ninemonths of 2005, the personal lines book benefited from the underwriting initiatives undertaken inboth the homeowners and Pennsylvania personal automobile lines in the last two years. Theseinitiatives included the reclassification of certain homeowners risks from our preferred program toour standard program, resulting in a higher premium, as well as modified underwriting standardsrelating to the types of Pennsylvania personal automobile risks the Company will write. The Companyimplemented a rate increase for the homeowners line in New Jersey on July 1, 2005, and anticipatesan overall average rate increase of approximately 5.7%. The impact of the Company’s underwritinginitiatives in its Pennsylvania personal automobile line has resulted in lower direct premiumwritten, as contraction in the number of policies in certain tiers has occurred more quickly thanpremium expansion in the targeted tiers. The direct loss ratio for our Pennsylvania personalautomobile book has improved, however, as our targeted tiers have become a proportionately largerpart of our book.     Although the Company expects to continue growing its personal lines book, it will continue todevote greater focus to growth in the commercial lines book.     The Company’s operating expenses were as follows:                 **Nine months ended September 30,**        2005 vs. 2004 Expenses and expense ratio        (Dollars in thousands) 2005 2004 Change % ChangeAmortization of DAC $11,936  $11,509  $427   3.7 %As a % of net premiums earned  26.3 %  27.7 %  (1.4) %    Other underwriting expenses  9,725   8,212   1,513   18.4%Total expenses excluding losses/LAE $21,661  $19,721  $1,940   9.8 %                 Underwriting expense ratio  47.7 %  47.4 %  0.3 %  N/M (N/M means “not meaningful”)                     Underwriting expenses increased by $1.9 million, or 9.8%, to $21.6 million for the nine monthsof 2005, as compared to the same period in 2004. This increase was principally attributable to anincrease in other underwriting expenses, growth in commissions resulting from higher earned premiumvolume, and increased charges relating to corporate expenses and compensation expenses, includingbonuses and agents profit-sharing, which were at higher levels than the first nine months of 2004.In 2005, the Company had pre-tax external expense associated with Sarbanes – Oxley compliance of$546,000, and pre-tax expense of $506,000 associated with grants of restricted stock, for whichexpenses were $150,000 and $206,000, respectively, in the first nine months of 2004.     The Company maintains an Agency Profit Sharing plan, which, in addition to base commissions,annually rewards agents for the growth and profitability of the business they produce whilerepresenting the Company. The additional commission is computed only on the aggregate growth andprofitability of the book of business the agent
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produces each year. The Company does not have anymarketing services agreements, placement services agreements, or similar arrangements.     We are currently in the process of converting our information system, which is targeted forcompletion in the latter half of 2006. When completed, we expect some costs to moderate asimplementation costs and costs associated with operating dual systems end. These reduced costs willbe offset by some higher staffing costs, but we also should be positioned to expand premium volumein the near term without material incremental expense because of increased processing capacity.     In the first nine months of 2004, a disputed retaliatory tax assessment was paid, leaving anunneeded accrual of $300,000 which was then reversed and served to reduce premium tax expenseaccordingly.     In the third quarter of 2004, we began renewing most of our New Jersey policies in our MercerInsurance Company of New Jersey, Inc. subsidiary, thus eliminating the Company’s liability forretaliatory premium taxes. Accordingly, the results for the first nine months of 2005 do notreflect any expense for retaliatory taxes, while the first nine months of 2004 included a pre-taxexpense for this item of approximately $200,000. See the Liquidity and Capital Resources sectionfor additional information regarding retaliatory tax and the Company’s claim to recover previouslypaid retaliatory tax.     The Company’s tax provision is as follows:                 **Nine months ended September 30,**        2005 vs. 2004 Income taxes        (Dollars in thousands) 2005 2004 Change % ChangeIncome before income taxes $5,904  $3,431  $2,473   72.1 %Income taxes  1,785   1,010   775   76.7 %Net income $4,119  $2,421  $1,698   70.1%Effective tax rate  30.2%  29.4 %  0.8 %     (N/M means “not meaningful”)Federal income tax expense was $1.8 million for the first nine months of 2005, an effective rate of30.2%, compared to $1.0 million, or an effective rate of 29.4%, for the same period in 2004. Theincrease in the effective tax rate in 2005 is primarily attributable to the fact that tax-exemptinvestment income and dividend income (which reduce the effective tax rate) represented a smallerpercentage of net income in 2005 than in 2004.**LIQUIDITY AND CAPITAL RESOURCES**     Our insurance companies generate sufficient funds from their operations to meet theirobligations and to maintain a high degree of liquidity in their investment portfolios. The primarysource of funds to meet the demands of claim settlements and operating expenses are premiumcollections, investment earnings and maturing investments. Mercer Insurance Company in 2004completed an expansion of its facilities in Pennington, New Jersey, at a cost of at $2.9 million.These improvements are fully paid for and will not require any further use of operating cash flow.     We are also in the process of building an information system platform that will allow ourproducers to conduct their business through the Internet. As of September 30, 2005, we have spent$3.6 million on the development of this platform, which includes license fees for software used inthe platform. It is anticipated to be completed in the
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latter part of 2006, at an additional costof approximately $1.0 million. Mercer Insurance Company possesses sufficient resources for thesefuture expenditures without incurring any debt.     Our insurance companies maintain investment and reinsurance programs that are intended toprovide sufficient funds to meet their obligations without forced sales of investments. Thisrequires them to ladder the maturity of their portfolios and thereby maintain a portion of theirinvestment portfolio in relatively short-term and highly liquid assets to ensure the availabilityof funds.     The principal source of liquidity for Mercer Insurance Group, Inc. (which has very fewexpenses and does not currently need a significant regular source of cash flow to cover theseexpenses for the forseeable future) has up to now been the net proceeds it retained from theConversion stock offering, as well as dividend payments and other fees received from MercerInsurance Company or other subsidiaries, and payments it receives on the 10-year note it receivedfrom the ESOP (see below) when the ESOP purchased shares at the time of the Conversion. For aperiod of three years after the Conversion (which took place on December 15, 2003), MercerInsurance Company may not declare or pay any dividend to Mercer Insurance Group without theapproval of the Pennsylvania Insurance Department. After this three-year period, Mercer InsuranceCompany will be limited by the insurance laws of Pennsylvania as to the amount of dividends orother distributions it may pay to its holding company. UnderPennsylvania law, there is a maximum amount that may be paid by Mercer Insurance Companyduring any twelve-month period after notice to, but without prior approval of, the PennsylvaniaInsurance Department. This limit is the greater of 10% of Mercer Insurance Company’s statutorysurplus as reported on its most recent annual statement filed with the Pennsylvania InsuranceDepartment, or the net income of Mercer Insurance Company for the period covered by such annualstatement.     If the dividend restrictions imposed on Mercer Insurance Company related to the Conversionwere not in effect, then as of December 31, 2004, the amounts available for payment of dividendsfrom Mercer Insurance Company in 2005, without the prior approval of the Pennsylvania InsuranceDepartment would have been approximately $6.2 million. Similar restrictions apply to the insurancesubsidiaries of Mercer Insurance Company and their ability to pay dividends upstream to it.     In connection with the acquisition of Financial Pacific Insurance Group for approximately$40.4 million in cash on October 1, 2005, all of the securities of Mercer Insurance Group, Inc.(which were purchased with proceeds of the Conversion) were converted into cash, with all butapproximately $300,000 of this balance used to fund the acquisition. The remaining liquid assets inMercer Insurance Group, as well as its other sources of revenue, are adequate to fund its currentexpenses for the foreseeable future.     As part of the funding of the acquisition, Mercer Insurance Company, with the approval of thePennsylvania Department of Insurance, paid an extraordinary dividend of $10 million on September30, 2005, to Mercer Insurance Group, Inc. Mercer Insurance Companyalso entered into a loan agreement with Mercer Insurance Group, Inc., by whichit advanced on September 30, 2005, a loan of $10 millionwith a 20-year note and a fixed interest rate of 4.75%, repayable in20 equal annual installments. After the acquisition, Mercer Insurance Group has no special limitations on its ability totake periodic dividends from Financial Pacific Insurance Group, but Financial Pacific InsuranceGroup will be subject to normal dividend restrictions administered by the California Department ofInsurance similar to those described above for Mercer Insurance Company. The Company believes thatthe resourcesavailable to Mercer Insurance Group, Inc., will be adequate for it to meets its obligation under the noteto Mercer Insurance Company and its other expenses.     Total assets decreased by 1.8%, or $3.2 million, to $178.3 million, at September 30, 2005 fromDecember 31, 2004. Cash balances were increased by $31.6 million from December 31, 2004 amounts,to $47.8 million in preparation for the funding of the cash acquisition of Financial PacificInsurance Group on October 1, 2005 for
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$40.4 million. Premium receivables decreased by $1.5million, or 13.7%, reflecting the timing of a large account written by the Company in December2004, as well as the seasonality of renewals. Reinsurance receivables increased $1.2 million, or46.9%, due principally to increased recoverables on large losses. Other assets increased by $1.1million, or 80.4%, from December 31, 2004, primarily due to funds paid in advance to a stateguaranty association that will be recouped by the Company through policyholder surcharge over thenext year.     Total liabilities decreased by $3.4 million, or 4.2%, in the nine months ended September 30,2005, to $77.7 million. Loss and loss adjustment expense reserves were relatively unchanged whileunearned premium reserves decreased by $1.4 million, or 4.2%, reflecting renewal seasonality andthe more competitive marketplace.     Total stockholders’ equity increased marginally by $200,000, or less than 1%, to $100.6million from December 31, 2004. Changes to stockholders’ equity for the nine months endedSeptember 30, 2005 principally included net income of $4.1 million, the purchase of treasury stockfor $3.2 million and unrealized investment losses (after tax) of $1.8 million.     The Company maintains an ESOP, which purchased 626,111 shares from the Company at the time ofthe Conversion in return for a note bearing interest at 4% on the principal amount of $6,261,110.Mercer InsuranceCompany makes annual contributions to the ESOP sufficient for it to make its required annualpayment under the terms of the loan to the Company. It is anticipated that approximately 10% ofthe original ESOP shares will be allocated annually to employee participants of the ESOP. Anexpense charge is booked ratably during each year for the shares committed to be allocated toparticipants that year, determined with reference to the fair market value of the Company’s stockat the time the commitment to allocate the shares is accrued and recognized. The issuance of theshares to the ESOP was fully recognized in the Additional Paid-in Capital account at Conversion,with a contra account entitled Unearned ESOP Shares established in the Stockholders’ Equity sectionof the balance sheet for the unallocated shares at an amount equal to their original per-sharepurchase price.     Mercer Insurance Group, Inc. adopted a stock-based incentive plan at its 2004 annual meetingof shareholders. Pursuant to that plan, Mercer Insurance Group may issue a total of 876,555shares, which amount will increase automatically each year by 1% of the number of sharesoutstanding at the end of the preceding year. At June 30, 2005, the shares authorized under theplan has been increased under this provision to 944,597 shares. The fair market value of any commonstock used for restricted stock awards will initially represent unearned compensation, and will beamortized ratably against earnings. As Mercer Insurance Group accrues compensation expense toreflect the vesting of such shares, unearned compensation will be reduced accordingly. Thiscompensation expense will be deductible for federal income tax purposes upon vesting under currentlaw. During 2004, the Company made grants of 215,000 shares of restricted stock, grants of 173,000Incentive Stock Options, and grants of 364,700 non-qualified stock options. As of September 30,2005, 7,500 shares of restricted stock and 18,500 stock options were forfeited, and 5,000 shares ofrestricted stock and 15,000 Incentive Stock options were granted. Additional grants of 10,000 sharesof restricted stock, 97,575 Incentive Stock options, and 27,425 non-qualified options were madeafter September 30, 2005 to individuals employed by Financial Pacific Insurance Group in connectionwith its acquisition on October 1, 2005 by Mercer Insurance Group.     On October 20, 2004, the Company’s Board of Directors authorized the repurchase of up to250,000 additional shares of its common stock (in addition to the 250,000 share repurchaseauthorized June 16, 2004 and previously completed). The repurchase of the additional 250,000 shareswas completed on March 2, 2005. The repurchased shares will be held as treasury shares availablefor issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. In theaggregate, 500,000 shares have been repurchased since the Conversion, at an aggregate cost of $6.3million, or $12.53 per share, with 2005 purchases totaling $3.2 million, or $13.18 per share. Inaddition, 1,563 shares of stock were repurchased from employees in order to pay the required taxwithholdings on the first vesting of restricted stock under the stock incentive plan.
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In connection with a continuing retaliatory tax controversy, in 2003 and 2004 the Company paid anaggregate of $3.2 million, plus interest, to the New Jersey Division of Taxation (the “Division”)in retaliatory tax. The retaliatory tax generally is imposed on foreign insurers when the foreigncompany’s home state (i.e., its state of incorporation or domicile) has a higher rate of premiumtax than the state imposing the tax, in this case New Jersey. The payments were made in responseto notices of deficiency issued by the Division to the Company.In conjunction with making such payments, the Company filed notices of protest with the Divisionwith respect to the retaliatory tax imposed. The basis for the protests was that the Division’simposition of the retaliatory tax was unconstitutional and based on an incorrect interpretation ofthe law which denied the Company the ability to take advantage of New Jersey’s premium tax cap,which limits the premiums tax to the lesser of the Company’s New Jersey premiums or 12.5 percent ofthe Company’s total premiums received from both New Jersey and out-of-state policyholders. Theprotests currently are pending with the Division’s Conferences and Appeals branch.Concurrent with the processing of the Company’s protests of the retaliatory tax, other foreigninsurers have been litigating virtually identical issues in New Jersey courts. On March 9, 2005,the Appellate Division of the New Jersey Superior Court reversed a decision of the New Jersey TaxCourt that had sustained the Division’s impositionof the retaliatory tax against a foreign insurer. The Division has since appealed the decision ofthe Appellate Division to the New Jersey Supreme Court, which has agreed to hear the case. TheCompany expects that the Division’s ruling on the Company’s protest will be based on the ultimateresolution of the case now being appealed to the New Jersey Supreme Court. It is not known how theNew Jersey Supreme Court will address this case, and therefore the Company is unable to determinewhether all, or any portion, of the retaliatory tax will be refunded. Any such refund would bereduced by related Federal Income Tax. Due to the contingencies involved, the Company has notaccrued any refund of the retaliatory tax.**SUBSEQUENT EVENT — ACQUISITIONS**On October 1, 2005, the Company acquired all the outstanding stock of Financial Pacific InsuranceGroup, Inc. for approximately $40.4 million in cash (the press release was filed on a Form 8-K onOctober 4, 2005). The transaction was effected through a merger of a wholly owned subsidiary ofMercer into Financial Pacific.The acquisition was made using the excess funds held by the holding company (Mercer InsuranceGroup, Inc.), as well as funds advanced to the holding company from Mercer Insurance Company in theform of both an extraordinary dividend as well as an intercompany loan. The majority of the cashbalance carried on the Company’s balance sheet at September 30, 2005, was used to consummate thetransaction shortly after the end of the quarter. The Pennsylvania Insurance Department previouslyapproved the extraordinary dividend and the intercompany loan arrangement.The acquisition will allow the Company to continue growing its commercial lines segment, to achieveproduct and geographic diversification, and to achieve greater scale over time in connection withinfrastructure costs such as information technology. It is expected that the acquisition ofFinancial Pacific will be immediately accretive to the earnings of the Company. Financial Pacificcurrently focuses on four western states and is licensed in another fifteen states outside theCompany’s present focus areas.As of and for the year ended December 31, 2004, Financial Pacific reported GAAP stockholders’equity of $35.4 million, operating income of $4.6 million and net income of $5.9 million. In 2004,Financial Pacific generated approximately $107 million of direct premiums primarily in California,Nevada, Oregon and Arizona through approximately 300 independent agents.
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**IMPACT OF INFLATION**     Inflation increases an insured’s need for property and casualty insurance coverage. Inflationalso increases the cost of claims incurred by property and casualty insurers as property repairs,replacements and medical expenses increase. These cost increases reduce profit margins to theextent that rate increases are not implemented on an adequate and timely basis. We establishproperty and casualty insurance premiums levels before the amount of losses and loss expenses, orthe extent to which inflation may affect these expenses, are known. Therefore, our insurancecompanies attempt to anticipate the potential impact of inflation when establishing rates, and ifinflation is not adequately factored into rates, the rate increases will lag behind increases inloss costs resulting from inflation. Because inflation has remained relatively low in recentyears, financial results have not been significantly affected by inflation.     Inflation also often results in increases in the general level of interest rates, and,consequently, generally results in increased levels of investment income derived from ourinvestments portfolio, although increases in investment income will generally lag behind increasesin loss costs caused by inflation.**OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS**     The Company was not a party to any unconsolidated arrangement or financial instrument withspecial purpose entities or other vehicles at September 30, 2005 which would give rise topreviously undisclosed market, credit or financing risk.     The Company and its subsidiaries have no significant contractual obligations at September 30,2005, other than its insurance obligations under its policies of insurance. Projected cashdisbursements pertaining to these insurance obligations have not materially changed since December31, 2004, and the Company expects to have the cash to pay these obligations as they come due.
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**Item 6. Exhibits****Exhibits**   Exhibit No. Title3.1 Articles of Incorporation of Mercer Insurance Group, Inc.(incorporated by reference herein to the Company’sPre-effective Amendment No. 3 on Form S-1, SEC File No.333-104897.)   3.2 Bylaws of Mercer Insurance Group, Inc. (incorporated byreference herein to the Company’s Annual Report on Form 10-K,SEC File No. 000-25425, for the fiscal year ended December 31,2003.)   31.1 Certification of Chief Executive Officer in accordance withSection 302 of the Sarbanes-Oxley Act of 2002 (filedherewith)   31.2 Certification of Chief Financial Officer in accordance withSection 302 of the Sarbanes-Oxley Act of 2002 (filedherewith)   32.1 Certification of Chief Executive Officer in accordance withSection 906 of the Sarbanes-Oxley Act of 2002 (filedherewith)   32.2 Certification of Chief Financial Officer in accordance withSection 906 of the Sarbanes-Oxley Act of 2002 (filedherewith)**SIGNATURES**          Inaccordance with the requirements of the Exchange Act, the Registrantcaused this amendment tobe signed on its behalf by the undersigned, thereunto duly authorized.      MERCER INSURANCE GROUP, INC. (Registrant)