##### Table of Contents









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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Form 10-Q

|  |  |                                                                                                                                                                                                                 |  | 
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF
    THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September 30, 2004                                                                |  | 
| 
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF
    THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period
    from                to                
    Commission File Number: 000-32057 |  | 

American Physicians Capital, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Michigan                                                           |  | 38-3543910                              
|(State or other jurisdiction of
    incorporation or organization) |  | (IRS employer
    identification number)

1301 North Hagadorn Road, East Lansing,
Michigan 48823

(Address of principal executive offices) (Zip
Code)


Registrants telephone number, including
area code: (517) 351-1150

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.

YESxNOo

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act)

YESxNOo

The number of shares outstanding of the
registrants common stock, no par value per share, as of
October 29, 2004 was 8,615,361.



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TABLE OF CONTENTS

|                                                                    |                                                                                                       |  |    |    | 
|------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------- |  | -- | -- | 
|PART I. FINANCIAL
    INFORMATION                                   |                                                                                                       |  |    |   
|                                                                    | Item 1. Financial
    Statements (Unaudited)                                                          |  |    |    | 
|                                                                    | Condensed
    Consolidated Balance Sheets                                                             |  |    | 3  | 
|                                                                    | Condensed
    Consolidated Statements of Income                                                       |  |    | 4  | 
|                                                                    | Condensed
    Consolidated Statements of Comprehensive Income                                         |  |    | 5  | 
|                                                                    | Condensed
    Consolidated Statements of Cash Flows                                                   |  |    | 6  | 
|                                                                    | Notes
    to Condensed Consolidated Financial Statements                                              |  |    | 7  | 
|                                                                    | Item 2. Managements
    Discussion and Analysis of Financial Condition and
    Results of Operations |  |    | 19 | 
|                                                                    | Item 3. Quantitative
    and Qualitative Disclosures About Market Risk                                |  |    | 34 | 
|                                                                    | Item 4. Controls
    and Procedures                                                                   |  |    | 35 | 
|PART II. OTHER
    INFORMATION                                      |                                                                                                       |  |    |   
|                                                                    | Item 4. Submission
    of Matters to a Vote of Security Holders                                       |  |    | 36 | 
|                                                                    | Item 5. Other
    Information                                                                         |  |    | 36 | 
|                                                                    | Item 6. Exhibits                                                                                      |  |    | 36 | 
|Signatures                                                          |                                                                                                       |  | 37 |   
|Exhibit Index                                                       |                                                                                                       |  | 38 |   
|Summary of 2004 Short-Term Incentive Plan                          
|Amendment dated, October 31, 2002                                  
|Amendment dated, September 15, 2004                                
|Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)
|Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)
|Certification of CEO and CFO Pursuant to Section 1350              
|Stock Purchase Agreement                                           



2



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##### Table of Contents






PART I. FINANCIAL INFORMATION

AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE
SHEETS





ITEM 1. Financial Statements

|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |           |         |         |         |           | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------ | --------------------------------- | ------------------------------------------ | ------- | ------------ | --------- | ------- | ------- | ------- | --------- | 
|                                                                                                                                                                       |                                                                                      | September 30,                     |                                            |         | December 31, |          
|                                                                                                                                                                       |                                                                                      | 2004                              |                                            |         | 2003         |          
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|                                                                                                                                                                       |                                                                                      | (Unaudited)                       |                                            |         |             
|                                                                                                                                                                       |                                                                                      |                                  
|                                                                                                                                                                       |                                                                                      | (In thousands, except share data) |                                           
|Assets                                                                                                                                                                 |                                                                                      |                                   |                                            |         |              |           |         |        
|Investments:                                                                                                                                                           |                                                                                      |                                   |                                            |         |              |           |         |        
|                                                                                                                                                                       | Fixed maturities, at fair value                                                      |                                   | $                                          | 621,132 |              |           | $       | 694,633 |        
|                                                                                                                                                                       | Equity securities, at fair value                                                     |                                   |                                            | 9,983   |              |           |         | 7,545   |        
|                                                                                                                                                                       | Other investments                                                                    |                                   |                                            | 8,078   |              |           |         | 29,776  |        
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|                                                                                                                                                                       |                                                                                      | Total investments                 |                                            |         | 639,193      |           |         |         | 731,954 |          
|Cash and cash equivalents                                                                                                                                              |                                                                                      |                                   | 198,069                                    |         |              |           | 102,051 |        
|Premiums receivable                                                                                                                                                    |                                                                                      |                                   | 61,610                                     |         |              |           | 65,362  |        
|Reinsurance recoverable                                                                                                                                                |                                                                                      |                                   | 104,138                                    |         |              |           | 103,652 |        
|Federal income tax recoverable                                                                                                                                         |                                                                                      |                                   | 1,654                                      |         |              |           | 973     |        
|Property and equipment, net of accumulated
    depreciation                                                                                                            |                                                                                      |                                   | 13,348                                     |         |              |           | 16,490  |        
|Intangible assets                                                                                                                                                      |                                                                                      |                                   | 854                                        |         |              |           | 1,539   |        
|Other assets                                                                                                                                                           |                                                                                      |                                   | 43,010                                     |         |              |           | 41,025  |        
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|                                                                                                                                                                       |                                                                                      |                                   | Total assets                               |         | $            | 1,061,876 |         |         | $       | 1,063,046 | 
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|Liabilities                                                                                                                                                            |                                                                                      |                                   |                                            |         |              |           |         |        
|Unpaid losses and loss adjustment expenses                                                                                                                             |                                                                                      | $                                 | 691,560                                    |         |              | $         | 673,605 |        
|Unearned premiums                                                                                                                                                      |                                                                                      |                                   | 102,123                                    |         |              |           | 103,806 |        
|Note payable, officer                                                                                                                                                  |                                                                                      |                                   |                                           |         |              |           | 6,000   |        
|Long-term debt                                                                                                                                                         |                                                                                      |                                   | 30,928                                     |         |              |           | 30,928  |        
|Other liabilities                                                                                                                                                      |                                                                                      |                                   | 34,375                                     |         |              |           | 44,698  |        
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|                                                                                                                                                                       |                                                                                      |                                   | Total liabilities                          |         |              | 858,986   |         |         |         | 859,037   | 
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|Commitments and Contingencies (Note
    6)                                                                                                                             |                                                                                      |                                   |                                            |         |              |           |         |        
|Minority Interest in Consolidated
    Subsidiary                                                                                                                       |                                                                                      |                                   | 2,181                                      |         |              |           | 2,201   |        
|Shareholders Equity                                                                                                                                                   |                                                                                      |                                   |                                            |         |              |           |         |        
|Common stock, no par value, 50,000,000 shares
    authorized: 8,527,677 and 8,445,807 shares outstanding at
    September 30, 2004 and December 31, 2003, respectively |                                                                                      |                                   |                                           |         |              |           |        |        
|Additional paid-in-capital                                                                                                                                             |                                                                                      |                                   | 86,577                                     |         |              |           | 85,137  |        
|Retained earnings                                                                                                                                                      |                                                                                      |                                   | 100,873                                    |         |              |           | 87,352  |        
|Unearned stock compensation                                                                                                                                            |                                                                                      |                                   | (501                                       | )       |              |           | (288    | )      
|Accumulated other comprehensive income:                                                                                                                                |                                                                                      |                                   |                                            |         |              |           |         |        
|                                                                                                                                                                       | Net unrealized appreciation on investments, net
    of deferred federal income taxes |                                   |                                            | 13,760  |              |           |         | 29,607  |        
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|                                                                                                                                                                       |                                                                                      |                                   | Total shareholders equity                 |         |              | 200,709   |         |         |         | 201,808   | 
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          
|                                                                                                                                                                       |                                                                                      |                                   | Total liabilities and shareholders equity |         | $            | 1,061,876 |         |         | $       | 1,063,046 | 
|                                                                                                                                                                       |                                                                                      |                                   |                                            |         |              |          

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

3



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |         |  |   |         |         |  
|------------------------------------------------------------ | ------------------------------------------------------------------- | ------------------------------------- | ------- | ------ | ----------------- | - | ------- | ------- | - | - | ------- | ------- |  | - | ------- | ------- | -
|                                                             |                                                                     |                                       |         |       
|                                                             |                                                                     | Three Months Ended                    |         |        | Nine Months Ended |  
|                                                             |                                                                     | September 30,                         |         |        | September 30,     |  
|                                                             |                                                                     |                                       |         |        |                   |  
|                                                             |                                                                     | 2004                                  |         |        | 2003              |   |         | 2004    |   |   | 2003    |        
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             |                                                                     |                                      
|                                                             |                                                                     | (In thousands, except per share data) |        
|Net premiums written                                         |                                                                     | $                                     | 63,723  |        |                   | $ | 79,371  |         |   | $ | 149,804 |         |  | $ | 179,202 |        
|Change in net unearned premiums                              |                                                                     |                                       | (14,968 | )      |                   |   | (22,783 | )       |   |   | 4,155   |         |  |   | (9,682  | )      
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             | Net premiums earned                                                 |                                       |         | 48,755 |                   |   |         | 56,588  |   |   |         | 153,959 |  |   |         | 169,520 |  
|Investment income                                            |                                                                     |                                       | 10,947  |        |                   |   | 11,400  |         |   |   | 36,451  |         |  |   | 32,209  |        
|Net realized (losses) gains                                  |                                                                     |                                       | (332    | )      |                   |   | 143     |         |   |   | 1,233   |         |  |   | 1,291   |        
|Other income                                                 |                                                                     |                                       | 156     |        |                   |   | 161     |         |   |   | 562     |         |  |   | 518     |        
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             | Total revenues and other income                                     |                                       |         | 59,526 |                   |   |         | 68,292  |   |   |         | 192,205 |  |   |         | 203,538 |  
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|Losses and loss adjustment expenses                          |                                                                     |                                       | 42,773  |        |                   |   | 96,721  |         |   |   | 137,700 |         |  |   | 203,733 |        
|Underwriting expenses                                        |                                                                     |                                       | 9,838   |        |                   |   | 11,721  |         |   |   | 33,986  |         |  |   | 36,828  |        
|Investment expenses                                          |                                                                     |                                       | 719     |        |                   |   | 934     |         |   |   | 2,264   |         |  |   | 2,083   |        
|Interest expense                                             |                                                                     |                                       | 428     |        |                   |   | 502     |         |   |   | 1,229   |         |  |   | 875     |        
|Amortization expense                                         |                                                                     |                                       | 274     |        |                   |   | 133     |         |   |   | 822     |         |  |   | 272     |        
|General and administrative expenses                          |                                                                     |                                       | 706     |        |                   |   | 715     |         |   |   | 2,912   |         |  |   | 1,993   |        
|Other expenses                                               |                                                                     |                                       | 15      |        |                   |   |        |         |   |   | 162     |         |  |   |        |        
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             | Total expenses                                                      |                                       |         | 54,753 |                   |   |         | 110,726 |   |   |         | 179,075 |  |   |         | 245,784 |  
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             | Income (loss) before federal income taxes
    and minority interest |                                       |         | 4,773  |                   |   |         | (42,434 | ) |   |         | 13,130  |  |   |         | (42,246 | )
|Federal income tax expense (benefit)                         |                                                                     |                                       | 226     |        |                   |   | 34,621  |         |   |   | (374    | )       |  |   | 34,687  |        
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             | Income (loss) before minority interest                              |                                       |         | 4,547  |                   |   |         | (77,055 | ) |   |         | 13,504  |  |   |         | (76,933 | )
|Minority interest in net loss of consolidated
    subsidiary |                                                                     |                                       | 2       |        |                   |   |        |         |   |   | 17      |         |  |   |        |        
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|                                                             | Net income (loss)                                                   |                                       | $       | 4,549  |                   |   | $       | (77,055 | ) |   | $       | 13,521  |  |   | $       | (76,933 | )
|                                                             |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |        
|Net income (loss)  per common share                         |                                                                     |                                       |         |        |                   |   |         |         |   |   |         |         |  |   |         |        
|                                                             | Basic                                                               |                                       | $       | 0.54   |                   |   | $       | (9.03   | ) |   | $       | 1.60    |  |   | $       | (8.97   | )
|                                                             | Diluted                                                             |                                       | $       | 0.52   |                   |   | $       | (9.03   | ) |   | $       | 1.57    |  |   | $       | (8.97   | )

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

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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME (UNAUDITED)


|                                   |                                                                                                                                                                                                                                                            |                                   |       |       |                   |   |         |        |         |   |        |        |         |   |         |       |         |  
|---------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------- | ----- | ----- | ----------------- | - | ------- | ------ | ------- | - | ------ | ------ | ------- | - | ------- | ----- | ------- | -
|                                   |                                                                                                                                                                                                                                                            |                                   |       |      
|                                   |                                                                                                                                                                                                                                                            | Three Months Ended                |       |       | Nine Months Ended |  
|                                   |                                                                                                                                                                                                                                                            | September 30,                     |       |       | September 30,     |  
|                                   |                                                                                                                                                                                                                                                            |                                   |       |       |                   |  
|                                   |                                                                                                                                                                                                                                                            | 2004                              |       |       | 2003              |   |         | 2004   |         |   | 2003   |       
|                                   |                                                                                                                                                                                                                                                            |                                   |       |       |                   |   |         |        |         |   |        |       
|                                   |                                                                                                                                                                                                                                                            |                                  
|                                   |                                                                                                                                                                                                                                                            | (In thousands)                    |      
|Net income (loss)                  |                                                                                                                                                                                                                                                            | $                                 | 4,549 |       |                   | $ | (77,055 | )      |         | $ | 13,521 |        |         | $ | (76,933 | )    
|Other comprehensive income (loss): |                                                                                                                                                                                                                                                            |                                   |       |       |                   |   |         |        |         |   |        |        |         |   |         |      
|                                   | Unrealized appreciation (depreciation) on
    investment securities arising during the period, net of deferred
    federal income tax expense (benefit) of $1,255 and
    $(3,519), respectively, in 2004 and $(559) and $4,527,
    respectively, in 2003 |                                   |       | 2,330 |                   |   |         | (1,038 | )       |   |        | (6,536 | )       |   |         | 8,407 |        
|                                   | Intra-period tax allocation of the effect of
    unrealized depreciation on the deferred tax valuation allowance                                                                                                                                           |                                   |       | 858   |                   |   |         |       |         |   |        | (5,548 | )       |   |         |      |        
|                                   | Reclassification adjustment for realized (gains)
    losses on investment securities included in net income (loss),
    net of income tax (expense) benefit of $(402) and $(2,026)
    respectively, in 2004 and $11 and $(391), respectively, in 2003     |                                   |       | (746  | )                 |   |         | 21     |         |   |        | (3,763 | )       |   |         | (725  | )      
|                                   |                                                                                                                                                                                                                                                            |                                   |       |       |                   |   |         |        |         |   |        |       
|                                   |                                                                                                                                                                                                                                                            | Other comprehensive income (loss) |       |       | 2,442             |   |         |        | (1,017  | ) |        |        | (15,847 | ) |         |       | 7,682   |  
|                                   |                                                                                                                                                                                                                                                            |                                   |       |       |                   |   |         |        |         |   |        |       
|                                   |                                                                                                                                                                                                                                                            | Comprehensive income (loss)       |       | $     | 6,991             |   |         | $      | (78,072 | ) |        | $      | (2,326  | ) |         | $     | (69,251 | )
|                                   |                                                                                                                                                                                                                                                            |                                   |       |       |                   |   |         |        |         |   |        |       

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

5



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS (UNAUDITED)


|                                     |                                                                                                 |                                                              |                                                          |        |          |         |   |         |          |         |  
|------------------------------------ | ----------------------------------------------------------------------------------------------- | ------------------------------------------------------------ | -------------------------------------------------------- | ------ | -------- | ------- | - | ------- | -------- | ------- | -
|                                     |                                                                                                 |                                                             
|                                     |                                                                                                 | Nine Months Ended                                            |                                                         
|                                     |                                                                                                 | September 30,                                                |                                                         
|                                     |                                                                                                 |                                                              |                                                         
|                                     |                                                                                                 | 2004                                                         |                                                          |        | 2003     |        
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|                                     |                                                                                                 |                                                             
|                                     |                                                                                                 | (In thousands)                                               |                                                         
|Cash flows from operating activities |                                                                                                 |                                                              |                                                          |        |          |         |   |        
|                                     | Net income (loss)                                                                               |                                                              | $                                                        | 13,521 |          |         | $ | (76,933 | )       
|                                     | Adjustments to reconcile net income to net cash
    provided by (used in) operating activities: |                                                              |                                                          |        |          |         |   |         |         
|                                     |                                                                                                 | Depreciation and amortization                                |                                                          |        | 6,198    |         |   |         | 4,790    |        
|                                     |                                                                                                 | Net realized gains                                           |                                                          |        | (1,233   | )       |   |         | (1,291   | )      
|                                     |                                                                                                 | Change in fair value of derivatives instruments              |                                                          |        | 619      |         |   |         | (465     | )      
|                                     |                                                                                                 | Change in deferred federal income taxes                      |                                                          |        |         |         |   |         | 38,285   |        
|                                     |                                                                                                 | Loss on equity method investees                              |                                                          |        |         |         |   |         | 272      |        
|                                     |                                                                                                 | Minority interest in net loss of consolidated
    subsidiary |                                                          |        | 17       |         |   |         |         |        
|                                     |                                                                                                 | Change in unpaid loss and loss adjustment expenses           |                                                          |        | 17,955   |         |   |         | 40,642   |        
|                                     |                                                                                                 | Change in unearned premiums                                  |                                                          |        | (1,683   | )       |   |         | 10,161   |        
|                                     |                                                                                                 | Changes in other assets and liabilities                      |                                                          |        | (9,723   | )       |   |         | (24,403  | )      
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|                                     |                                                                                                 |                                                              | Net cash provided by (used in) operating
    activities  |        |          | 25,671  |   |         |          | (8,942  | )
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|Cash flows from investing activities |                                                                                                 |                                                              |                                                          |        |          |         |   |        
|                                     | Purchases                                                                                       |                                                              |                                                          |        |          |         |   |         |         
|                                     |                                                                                                 | Available-for-sale  fixed maturities                        |                                                          |        | (165,005 | )       |   |         | (162,689 | )      
|                                     |                                                                                                 | Available-for-sale  equity securities                       |                                                          |        | (36,873  | )       |   |         | (10,561  | )      
|                                     |                                                                                                 | Leasehold improvements                                       |                                                          |        |         |         |   |         | (334     | )      
|                                     |                                                                                                 | Property and equipment                                       |                                                          |        | (904     | )       |   |         | (2,141   | )      
|                                     | Sales and maturities                                                                            |                                                              |                                                          |        |          |         |   |         |         
|                                     |                                                                                                 | Available-for-sale  fixed maturities                        |                                                          |        | 224,622  |         |   |         | 100,488  |        
|                                     |                                                                                                 | Available-for-sale  equity securities                       |                                                          |        | 34,751   |         |   |         | 2,153    |        
|                                     |                                                                                                 | Other invested assets                                        |                                                          |        | 18,815   |         |   |         |         |        
|                                     |                                                                                                 | Property and equipment                                       |                                                          |        | 17       |         |   |         |         |        
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|                                     |                                                                                                 |                                                              | Net cash provided by (used in) investing
    activities  |        |          | 75,423  |   |         |          | (73,084 | )
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|Cash flows from financing activities |                                                                                                 |                                                              |                                                          |        |          |         |   |        
|                                     | Principal payment on note payable                                                               |                                                              |                                                          | (6,000 | )        |         |   | (1,000  | )       
|                                     | Issuance of long-term debt                                                                      |                                                              |                                                          |       |          |         |   | 30,928  |         
|                                     | Common stock repurchased                                                                        |                                                              |                                                          |       |          |         |   | (7,068  | )       
|                                     | Proceeds from stock options exercised                                                           |                                                              |                                                          | 897    |          |         |   | 136     |         
|                                     | Other sources                                                                                   |                                                              |                                                          | 27     |          |         |   |        |         
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|                                     |                                                                                                 |                                                              | Net cash (used in) provided by financing
    activities  |        |          | (5,076  | ) |         |          | 22,996  |  
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|                                     |                                                                                                 |                                                              | Net increase (decrease) in cash and cash
    equivalents |        |          | 96,018  |   |         |          | (59,030 | )
|                                     |                                                                                                 |                                                              | Cash and cash equivalents, beginning of
    period       |        |          | 102,051 |   |         |          | 151,825 |  
|                                     |                                                                                                 |                                                              |                                                          |        |          |        
|                                     |                                                                                                 |                                                              | Cash and cash equivalents, end of
    period             |        | $        | 198,069 |   |         | $        | 92,795  |  
|                                     |                                                                                                 |                                                              |                                                          |        |          |        

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

6



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)


1.     Basis of
Presentation

The accompanying unaudited Condensed Consolidated
Financial Statements include the accounts of American Physicians
Capital, Inc. (APCapital), and its wholly owned
subsidiaries, Insurance Corporation of America
(ICA), APSpecialty Insurance Corporation
(APS), APConsulting LLC, APDirect Sales, LLC, Alpha
Advisors, Inc., APIndemnity (Bermuda) Ltd., APManagement Ltd.
and American Physicians Assurance Corporation (American
Physicians). In accordance with the guidance given in
Financial Accounting Standards Board (FASB)
Interpretation No. 46 (FIN No. 46), the
accounts of two wholly owned subsidiary trusts used to issue
mandatorily redeemable trust preferred securities have been
included on the equity method in the accompanying unaudited
Condensed Consolidated Financial Statements, and the accounts of
Physicians Insurance Company (PIC) have been
consolidated in the accompanying unaudited Condensed
Consolidated Financial Statements. APCapital and its
consolidated subsidiaries are sometimes referred to herein as
the Company. See Note 2 for further discussion
regarding the impact of FIN No. 46. All significant
intercompany accounts and transactions are eliminated in
consolidation.

The Company is principally engaged in the
business of providing medical professional liability insurance
throughout the United States with a concentration of writings in
the Midwest, and is currently in the process of exiting its
workers compensation and health insurance lines of
business.

The accompanying unaudited Condensed Consolidated
Financial Statements of the Company have been prepared in
conformity with accounting principles generally accepted in the
United States of America (GAAP) and with the
instructions for Form 10-Q and Rule 10-01 of
Regulation S-X as they apply to interim financial
information. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete
financial statements.

In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered
necessary for a fair presentation have been included. The
operating results for the three-month and nine-month periods
ended September 30, 2004 are not necessarily indicative of
the results to be expected for the year ending December 31,
2004. The accompanying unaudited Condensed Consolidated
Financial Statements should be read with the annual consolidated
financial statements and notes contained in the Companys
Annual Report on Form 10-K for the year ended
December 31, 2003.

The preparation of financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

The most significant estimates that are
susceptible to significant change in the near-term relate to the
determination of the liability for unpaid losses and loss
adjustment expenses, investments, income taxes, reinsurance, the
reserve for extended reporting period claims and deferred policy
acquisition costs. Although considerable variability is inherent
in these estimates, management believes that the current
estimates are reasonable in all material respects. The estimates
are reviewed regularly and adjusted as necessary. Such
adjustments are reflected in current operations.

Stock-based Compensation

The Company uses the intrinsic value-based method
to account for all stock-based employee compensation plans and
has adopted the disclosure alternative of Statement of Financial
Accounting Standard (SFAS) No. 123
Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure. In
accordance with SFAS No. 123, as amended by SFAS
No. 148, the Company is required to disclose the pro forma
effects on operating results as if the Company had elected the
fair value approach to account for its stock-based employee
compensation plans.

7



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

If compensation had been determined based on the
fair value at the grant date, consistent with the provisions of
SFAS No. 123, our net income (loss) and net income
(loss) per share would have been as follows for the three
and nine months ended September 30, 2004 and 2003:

|                                                                                                                                                                       |             |                                       |       |      |                   |   |         |       |   |   |        |      |  |   |         |       |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | ------------------------------------- | ----- | ---- | ----------------- | - | ------- | ----- | - | - | ------ | ---- |  | - | ------- | ----- | -
|                                                                                                                                                                       |             |                                       |       |     
|                                                                                                                                                                       |             | Three Months Ended                    |       |      | Nine Months Ended |  
|                                                                                                                                                                       |             | September 30,                         |       |      | September 30,     |  
|                                                                                                                                                                       |             |                                       |       |      |                   |  
|                                                                                                                                                                       |             | 2004                                  |       |      | 2003              |   |         | 2004  |   |   | 2003   |     
|                                                                                                                                                                       |             |                                       |       |      |                   |   |         |       |   |   |        |     
|                                                                                                                                                                       |             |                                      
|                                                                                                                                                                       |             | (In thousands, except per share data) |      
|Net income (loss), as reported                                                                                                                                         |             | $                                     | 4,549 |      |                   | $ | (77,055 | )     |   | $ | 13,521 |      |  | $ | (76,933 | )    
|Add: Stock-based employee compensation expense
    included in reported net income, net of related tax effects                                                         |             |                                       | 83    |      |                   |   | 75      |       |   |   | 214    |      |  |   | 225     |      
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards
    granted since 2000, net of related tax effects |             |                                       | (267  | )    |                   |   | (349    | )     |   |   | (726   | )    |  |   | (1,040  | )    
|                                                                                                                                                                       |             |                                       |       |      |                   |   |         |       |   |   |        |     
|Pro forma net income (loss)                                                                                                                                            |             | $                                     | 4,365 |      |                   | $ | (77,329 | )     |   | $ | 13,009 |      |  | $ | (77,748 | )    
|                                                                                                                                                                       |             |                                       |       |      |                   |   |         |       |   |   |        |     
|Basic income (loss) per share                                                                                                                                          |             |                                       |       |      |                   |   |         |       |   |   |        |      |  |   |         |      
|                                                                                                                                                                       | As reported |                                       | $     | 0.54 |                   |   | $       | (9.03 | ) |   | $      | 1.60 |  |   | $       | (8.97 | )
|                                                                                                                                                                       | Pro forma   |                                       | $     | 0.52 |                   |   | $       | (9.06 | ) |   | $      | 1.54 |  |   | $       | (9.07 | )
|Diluted income (loss) per share(1)                                                                                                                                     |             |                                       |       |      |                   |   |         |       |   |   |        |      |  |   |         |      
|                                                                                                                                                                       | As reported |                                       | $     | 0.52 |                   |   | $       | (9.03 | ) |   | $      | 1.57 |  |   | $       | (8.97 | )
|                                                                                                                                                                       | Pro forma   |                                       | $     | 0.50 |                   |   | $       | (9.06 | ) |   | $      | 1.51 |  |   | $       | (9.07 | )




|    |                                                                                                                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | As the Company was in a net loss position for the
    three months and nine months ended September 30, 2003, no
    effect of options or other stock awards was calculated, as the
    impact would have been anti-dilutive.

Such pro forma disclosures may not be
representative of future compensation costs as options may vest
over several years and additional grants may be made.

In March 2004, there were 100,000 options granted
with an exercise price of $21.54. At September 30, 2004,
there were 863,050 options outstanding with a weighted average
exercise price of $18.60. On January 14, 2004, the Company
issued 30,000 shares of restricted stock to certain employees
with a fair market value at the date of grant of $17.20 per
share. In addition, on August 11, 2004, the Company granted
1,000 shares of unrestricted stock to new directors with a
fair market value at the date of grant of $27.21.

Derivative Financial Instruments

The Company has purchased interest-only
certificates that may not allow for the recovery of
substantially all of its investment. These certificates pay a
variable rate of interest that is inversely related to the
London Interbank Offered Rate (LIBOR). The Company
has determined that these certificates contain an embedded
derivative instrument as defined by SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities.

All interest-only certificates with an inverse
floating rate of interest are carried on the balance sheet at
fair value as a fixed maturity security. These certificates are
not linked to specific assets or liabilities on the balance
sheet or to a forecasted transaction and, therefore, do not
qualify for hedge accounting. In addition, the Company is not
able to reliably identify and separately measure the embedded
derivative instrument. Accordingly, any changes in the fair
value of the entire interest-only certificates, based on quoted
market prices, are recorded in current period earnings as a
component of investment income.

8



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

At September 30, 2004, the Company had such
certificates with a fair value of approximately
$5.4 million. The fair value of these certificates
decreased approximately $912,000 and $619,000, respectively,
during the three-month and nine-month periods ended
September 30, 2004, and increased approximately $65,000 and
$465,000 during the three months and nine months ended September
30, 2003.

The Company uses these certificates as a part of
its overall interest rate risk-management strategy related to
its investment portfolio.

2.     Effects of New
Accounting Pronouncements

In January 2003, the FASB issued FIN No. 46,
which was revised in December 2003 by FASB FIN No. 46R.
These interpretations address consolidation by business
enterprises of variable interest entities and are effective
during the first interim or annual period ending after
December 15, 2003. The Company has evaluated certain
investments, as required by FIN No. 46, and has determined
that its investments in subsidiary trusts used to issue
mandatorily redeemable trust preferred securities should not be
consolidated. Accordingly, the Company has not consolidated the
trusts in the accompanying unaudited Condensed Consolidated
Financial Statements. Also, during 2003, the Company invested
$2,450,000 for 49% of the outstanding common stock of PIC, a
start-up insurance company in the state of Florida. The Company
has evaluated its investment in PIC, and based on the guidance
given in FIN No. 46, has determined that PIC should be
consolidated because, among other factors, the Company financed
a portion of the other investors capital contribution at
PICs inception. The amount financed was repaid in full
prior to December 31, 2003. Minority interest in the
accompanying unaudited Condensed Consolidated Statements of
Income and Condensed Consolidated Balance Sheets represents the
remaining 51% of the net loss and shareholders equity of
PIC.

PIC was formed in March of 2003 with the intent
of writing as much medical professional liability insurance as
PICs capital and surplus levels could reasonably support.
At September 30, 2004, PICs total assets were
approximately $13.4 million and direct premiums written by
PIC were approximately $6.1 million and $0 for the nine
months ended September 30, 2004 and 2003, respectively. The
Company has no future obligations with respect to its investment
in PIC, nor do creditors of PIC have any recourse to the general
credit of the Company. Accordingly, the maximum exposure to loss
as a result of the Companys involvement with PIC is
approximately $2.5 million, which represents the initial
pro-rata equity contribution of $2,450,000 plus the remaining
unamortized balance of an intangible asset of $72,000 related to
a covenant not to compete.

In May 2003, the FASB issued SFAS No. 150,
Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity (SFAS
No. 150). This statement, which is effective for
interim periods beginning after June 15, 2003, establishes
standards for how certain financial instruments with
characteristics of both liabilities and equity are classified in
a companys balance sheet. The adoption of SFAS
No. 150 did not have any effect on the Companys
reported results of operations or financial condition.

In 2003, the Emerging Issues Task Force
(EITF) issued EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. The guidance contained in EITF 03-1 has been
delayed by FASB Staff Position (FSP)
EITF 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. The final issuance of proposed FSP EITF
Issue 03-1-a, Implication Guidance for the
Application of Paragraph 16 of EITF Issue
No. 03-1 which was subject to comments through
October 29, 2004, will supersede the delay of the effective
date by FSP EITF 03-1-1.

The disclosures requirements of EITF 03-1
continue to be effective in annual financial statements for
fiscal years ending after December 15, 2003, for
investments accounted for under Statements 115 and 124. The
impact of FSP EITF 03-1-a on the Companys financial
position or results of operations cannot be

9



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

determined at this time. However, under the
proposed guidance, decreases in the market value of certain
investments could have a negative impact on the Companys
future results of operations.

3.     Income (Loss)
Per Share

Net income (loss) per common share is
computed by dividing net income or loss by the weighted average
number of shares of common stock and common stock equivalents
(e.g., stock options and stock awards) outstanding, calculated
on a daily basis. Basic weighted average shares outstanding for
the three and nine months ended September 30, 2004 were
8,443,267 and 8,427,211, respectively, and 8,533,929 and
8,575,742, respectively, for the three and nine months ended
September 30, 2003. Diluted weighted average shares
outstanding for the three and nine months ended
September 30, 2004 were 8,755,378 and 8,625,887,
respectively. As the Company was in a net loss position for the
three months and nine months ended September 30, 2003, no
effect of options or other stock awards was calculated as the
impact would have been anti-dilutive.

The following table sets forth the computation of
basic and diluted net income (loss) per common share:

|                                                                    |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |       |  |   |         |       | 
|------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ------------------------------------- | ----- | ----- | ----------------- | - | ------- | ----- |  | - | ------ | ----- |  | - | ------- | ----- | 
|                                                                    |                                                                                                    |                                       |       |      
|                                                                    |                                                                                                    | Three Months Ended                    |       |       | Nine Months Ended |  
|                                                                    |                                                                                                    | September 30,                         |       |       | September 30,     |  
|                                                                    |                                                                                                    |                                       |       |       |                   |  
|                                                                    |                                                                                                    | 2004                                  |       |       | 2003              |   |         | 2004  |  |   | 2003   |      
|                                                                    |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |      
|                                                                    |                                                                                                    |                                      
|                                                                    |                                                                                                    | (In thousands, except per share data) |      
|Numerator for basic and diluted income
    (loss) per common share: |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |       |  |   |         |      
|Net income (loss)                                                   |                                                                                                    | $                                     | 4,549 |       |                   | $ | (77,055 | )     |  | $ | 13,521 |       |  | $ | (76,933 | )    
|                                                                    |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |      
|Denominator:                                                        |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |       |  |   |         |      
|                                                                    | Denominator for basic income per common
    share  weighted average shares outstanding            |                                       |       | 8,443 |                   |   |         | 8,534 |  |   |        | 8,427 |  |   |         | 8,576 | 
|                                                                    | Effect of dilutive stock options and awards                                                        |                                       |       | 312   |                   |   |         |      |  |   |        | 199   |  |   |         |      | 
|                                                                    |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |      
|                                                                    | Denominator for diluted income per common
    share  adjusted weighted average shares outstanding |                                       |       | 8,755 |                   |   |         | 8,534 |  |   |        | 8,626 |  |   |         | 8,576 | 
|                                                                    |                                                                                                    |                                       |       |       |                   |   |         |       |  |   |        |      
|Net income (loss) per common
    share  basic                      |                                                                                                    | $                                     | 0.54  |       |                   | $ | (9.03   | )     |  | $ | 1.60   |       |  | $ | (8.97   | )    
|Net income (loss) per common
    share  diluted                    |                                                                                                    | $                                     | 0.52  |       |                   | $ | (9.03   | )     |  | $ | 1.57   |       |  | $ | (8.97   | )    

4.     Segment
Information

The Company is organized and operates principally
in the property and casualty insurance industry and has three
reportable segments  medical professional liability,
other insurance lines, and corporate and other in 2004. Prior to
2004, the Company had five reportable segments 
medical professional liability, workers compensation,
health, and personal and commercial insurance lines, as well as
a corporate and other segment. As the Company has implemented
its exit from the workers compensation and health
insurance lines, and exited the personal and commercial lines in
2001, managements emphasis on these lines, as well as
their financial significance has decreased. Accordingly, these
three previously separately reported segments have been
aggregated into the other insurance lines segment reported in
2004. Reported 2003 amounts have been reclassified to conform to
the current year presentation.

The accounting policies of the segments are
consistent with those described in the Notes to the Consolidated
Financial Statements included in the Companys most recent
Annual Report on Form 10-K. Expense allocations are based
primarily on loss and loss adjustment expenses by line of
business and certain other estimates for underwriting expenses.
Investment income, investment expense, amortization expense and
interest expense are allocated to the segments based on that
segments ownership percentage of the assets or

10



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

liabilities underlying the income or expense.
General and administrative expenses are attributed exclusively
to the holding company and are included in corporate and other.

The following tables show total assets and income
(loss) before income taxes and minority interests for each
of the Companys reportable segments:

|              |                    |                |   |         |           |  |   |           |  |  |              |         |  |              |   |          |   |  |   |           | 
|------------- | ------------------ | -------------- | - | ------- | --------- |  | - | --------- |  |  | ------------ | ------- |  | ------------ | - | -------- | - |  | - | --------- | 
|              |                    | Medical        |   |         | Other     |  |   |           |  |  |              |        
|              |                    | Professional   |   |         | Insurance |  |   | Corporate |  |  | Intersegment |         |  |             
|              |                    | Liability      |   |         | Lines     |  |   | and Other |  |  | Eliminations |         |  | Consolidated |  
|              |                    |                |   |         |           |  |   |           |  |  |              |         |  |              |  
|              |                    |               
|              |                    | (In thousands) |  
|Total assets: |                    |                |   |         |           |  |   |           |  |  |              |         |  |              |   |          |   |  |   |          
|              | September 30, 2004 |                | $ | 972,623 |           |  | $ | 80,761    |  |  | $            | 230,753 |  |              | $ | (222,261 | ) |  | $ | 1,061,876 | 
|              | December 31, 2003  |                | $ | 909,372 |           |  | $ | 123,064   |  |  | $            | 234,326 |  |              | $ | (203,716 | ) |  | $ | 1,063,046 | 

|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |   |      |      |   |       |        |        | 
|----------------------------------------------------------- | ----------------------------------- | --------------------------------------------- | ----- | ------ | --------- | - | ------ | --------- | ----- | - | ------------ | --- | ----- | ------------ | - | ---- | ---- | - | ----- | ------ | ------ | 
|                                                            |                                     |                                              
|                                                            |                                     | For the Three Months Ended September 30, 2004 |      
|                                                            |                                     |                                               |      
|                                                            |                                     | Medical                                       |       |        | Other     |   |        |          
|                                                            |                                     | Professional                                  |       |        | Insurance |   |        | Corporate |       |   | Intersegment |     |       |             
|                                                            |                                     | Liability                                     |       |        | Lines     |   |        | and Other |       |   | Eliminations |     |       | Consolidated |  
|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |  
|                                                            |                                     |                                              
|                                                            |                                     | (In thousands)                                |      
|Revenues:                                                   |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |   |      |      |   |       |       
|                                                            | Net premiums earned                 |                                               | $     | 44,169 |           |   | $      | 4,586     |       |   | $            |    |       |              | $ |     |      |   | $     | 48,755 |       
|                                                            | Investment income                   |                                               |       | 10,295 |           |   |        | 647       |       |   |              | 5   |       |              |   |     |      |   |       | 10,947 |       
|                                                            | Other revenue items                 |                                               |       | (156   | )         |   |        | (50       | )     |   |              | 187 |       |              |   | (157 | )    |   |       | (176   | )     
|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |  
|                                                            |                                     | Total revenues                                |       |        | 54,308    |   |        |           | 5,183 |   |              |     | 192   |              |   |      | (157 | ) |       |        | 59,526 | 
|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |  
|Expenses:                                                   |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |   |      |      |   |       |       
|                                                            | Loss and loss adjustment expenses   |                                               |       | 36,181 |           |   |        | 6,592     |       |   |              |    |       |              |   |     |      |   |       | 42,773 |       
|                                                            | Underwriting expenses               |                                               |       | 9,185  |           |   |        | 653       |       |   |              |    |       |              |   |     |      |   |       | 9,838  |       
|                                                            | General and administrative expenses |                                               |       |       |           |   |        |          |       |   |              | 706 |       |              |   |     |      |   |       | 706    |       
|                                                            | Other expense items                 |                                               |       | 839    |           |   |        | 81        |       |   |              | 673 |       |              |   | (157 | )    |   |       | 1,436  |       
|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |  
|                                                            |                                     | Total expenses                                |       |        | 46,205    |   |        |           | 7,326 |   |              |     | 1,379 |              |   |      | (157 | ) |       |        | 54,753 | 
|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |  
|Income (loss) before income taxes and
    minority interest |                                     | $                                             | 8,103 |        |           | $ | (2,143 | )         |       | $ | (1,187       | )   |       | $            |  |      |      | $ | 4,773 |       
|                                                            |                                     |                                               |       |        |           |   |        |           |       |   |              |     |       |              |  

|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |   |      |      |   |         |        |         | 
|----------------------------------------------------------- | ----------------------------------- | --------------------------------------------- | ------- | ------ | --------- | - | --- | --------- | ------ | - | ------------ | --- | ----- | ------------ | - | ---- | ---- | - | ------- | ------ | ------- | 
|                                                            |                                     |                                              
|                                                            |                                     | For the Three Months Ended September 30, 2003 |        
|                                                            |                                     |                                               |        
|                                                            |                                     | Medical                                       |         |        | Other     |   |     |          
|                                                            |                                     | Professional                                  |         |        | Insurance |   |     | Corporate |        |   | Intersegment |     |       |             
|                                                            |                                     | Liability                                     |         |        | Lines     |   |     | and Other |        |   | Eliminations |     |       | Consolidated |  
|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |  
|                                                            |                                     |                                              
|                                                            |                                     | (In thousands)                                |        
|Revenues:                                                   |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |   |      |      |   |         |       
|                                                            | Net premiums earned                 |                                               | $       | 41,043 |           |   | $   | 15,545    |        |   | $            |    |       |              | $ |     |      |   | $       | 56,588 |        
|                                                            | Investment income                   |                                               |         | 9,697  |           |   |     | 1,589     |        |   |              | 114 |       |              |   |     |      |   |         | 11,400 |        
|                                                            | Other revenue items                 |                                               |         | 199    |           |   |     | 44        |        |   |              | 200 |       |              |   | (139 | )    |   |         | 304    |        
|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |  
|                                                            |                                     | Total revenues                                |         |        | 50,939    |   |     |           | 17,178 |   |              |     | 314   |              |   |      | (139 | ) |         |        | 68,292  | 
|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |  
|Expenses:                                                   |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |   |      |      |   |         |       
|                                                            | Loss and loss adjustment expenses   |                                               |         | 83,823 |           |   |     | 12,898    |        |   |              |    |       |              |   |     |      |   |         | 96,721 |        
|                                                            | Underwriting expenses               |                                               |         | 7,770  |           |   |     | 3,951     |        |   |              |    |       |              |   |     |      |   |         | 11,721 |        
|                                                            | General and administrative expenses |                                               |         |       |           |   |     |          |        |   |              | 715 |       |              |   |     |      |   |         | 715    |        
|                                                            | Other expense items                 |                                               |         | 937    |           |   |     | 179       |        |   |              | 592 |       |              |   | (139 | )    |   |         | 1,569  |        
|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |  
|                                                            |                                     | Total expenses                                |         |        | 92,530    |   |     |           | 17,028 |   |              |     | 1,307 |              |   |      | (139 | ) |         |        | 110,726 | 
|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |  
|Income (loss) before income taxes and
    minority interest |                                     | $                                             | (41,591 | )      |           | $ | 150 |           |        | $ | (993         | )   |       | $            |  |      |      | $ | (42,434 | )     
|                                                            |                                     |                                               |         |        |           |   |     |           |        |   |              |     |       |              |  

11



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |   |      |      |   |        |         |         | 
|----------------------------------------------------------- | ----------------------------------- | -------------------------------------------- | ------ | ------- | --------- | - | ------ | --------- | ------ | - | ------------ | ----- | ----- | ------------ | - | ---- | ---- | - | ------ | ------- | ------- | 
|                                                            |                                     |                                             
|                                                            |                                     | For the Nine Months Ended September 30, 2004 |       
|                                                            |                                     |                                              |       
|                                                            |                                     | Medical                                      |        |         | Other     |   |        |          
|                                                            |                                     | Professional                                 |        |         | Insurance |   |        | Corporate |        |   | Intersegment |       |       |             
|                                                            |                                     | Liability                                    |        |         | Lines     |   |        | and Other |        |   | Eliminations |       |       | Consolidated |  
|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |  
|                                                            |                                     |                                             
|                                                            |                                     | (In thousands)                               |       
|Revenues:                                                   |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |   |      |      |   |        |        
|                                                            | Net premiums earned                 |                                              | $      | 130,184 |           |   | $      | 23,775    |        |   | $            |      |       |              | $ |     |      |   | $      | 153,959 |        
|                                                            | Investment income                   |                                              |        | 33,152  |           |   |        | 3,264     |        |   |              | 35    |       |              |   |     |      |   |        | 36,451  |        
|                                                            | Other revenue items                 |                                              |        | 1,489   |           |   |        | 111       |        |   |              | 641   |       |              |   | (446 | )    |   |        | 1,795   |        
|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |  
|                                                            |                                     | Total revenues                               |        |         | 164,825   |   |        |           | 27,150 |   |              |       | 676   |              |   |      | (446 | ) |        |         | 192,205 | 
|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |  
|Expenses:                                                   |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |   |      |      |   |        |        
|                                                            | Loss and loss adjustment expenses   |                                              |        | 111,147 |           |   |        | 26,553    |        |   |              |      |       |              |   |     |      |   |        | 137,700 |        
|                                                            | Underwriting expenses               |                                              |        | 27,340  |           |   |        | 6,646     |        |   |              |      |       |              |   |     |      |   |        | 33,986  |        
|                                                            | General and administrative expenses |                                              |        |        |           |   |        |          |        |   |              | 2,912 |       |              |   |     |      |   |        | 2,912   |        
|                                                            | Other expense items                 |                                              |        | 2,464   |           |   |        | 411       |        |   |              | 2,048 |       |              |   | (446 | )    |   |        | 4,477   |        
|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |  
|                                                            |                                     | Total expenses                               |        |         | 140,951   |   |        |           | 33,610 |   |              |       | 4,960 |              |   |      | (446 | ) |        |         | 179,075 | 
|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |  
|Income (loss) before income taxes and
    minority interest |                                     | $                                            | 23,874 |         |           | $ | (6,460 | )         |        | $ | (4,284       | )     |       | $            |  |      |      | $ | 13,130 |        
|                                                            |                                     |                                              |        |         |           |   |        |           |        |   |              |       |       |              |  

|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |   |      |      |   |         |         |         | 
|----------------------------------------------------------- | ----------------------------------- | -------------------------------------------- | ------- | ------- | --------- | - | ---- | --------- | ------ | - | ------------ | ----- | ----- | ------------ | - | ---- | ---- | - | ------- | ------- | ------- | 
|                                                            |                                     |                                             
|                                                            |                                     | For the Nine Months Ended September 30, 2003 |        
|                                                            |                                     |                                              |        
|                                                            |                                     | Medical                                      |         |         | Other     |   |      |          
|                                                            |                                     | Professional                                 |         |         | Insurance |   |      | Corporate |        |   | Intersegment |       |       |             
|                                                            |                                     | Liability                                    |         |         | Lines     |   |      | and Other |        |   | Eliminations |       |       | Consolidated |  
|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |  
|                                                            |                                     |                                             
|                                                            |                                     | (In thousands)                               |        
|Revenues:                                                   |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |   |      |      |   |         |        
|                                                            | Net premiums earned                 |                                              | $       | 118,903 |           |   | $    | 50,617    |        |   | $            |      |       |              | $ |     |      |   | $       | 169,520 |        
|                                                            | Investment income                   |                                              |         | 27,133  |           |   |      | 4,802     |        |   |              | 274   |       |              |   |     |      |   |         | 32,209  |        
|                                                            | Other revenue items                 |                                              |         | 1,307   |           |   |      | 285       |        |   |              | 655   |       |              |   | (438 | )    |   |         | 1,809   |        
|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |  
|                                                            |                                     | Total revenues                               |         |         | 147,343   |   |      |           | 55,704 |   |              |       | 929   |              |   |      | (438 | ) |         |         | 203,538 | 
|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |  
|Expenses:                                                   |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |   |      |      |   |         |        
|                                                            | Loss and loss adjustment expenses   |                                              |         | 162,492 |           |   |      | 41,241    |        |   |              |      |       |              |   |     |      |   |         | 203,733 |        
|                                                            | Underwriting expenses               |                                              |         | 22,662  |           |   |      | 14,166    |        |   |              |      |       |              |   |     |      |   |         | 36,828  |        
|                                                            | General and administrative expenses |                                              |         |        |           |   |      |          |        |   |              | 1,993 |       |              |   |     |      |   |         | 1,993   |        
|                                                            | Other expense items                 |                                              |         | 2,122   |           |   |      | 432       |        |   |              | 1,114 |       |              |   | (438 | )    |   |         | 3,230   |        
|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |  
|                                                            |                                     | Total expenses                               |         |         | 187,276   |   |      |           | 55,839 |   |              |       | 3,107 |              |   |      | (438 | ) |         |         | 245,784 | 
|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |  
|Income (loss) before income taxes and
    minority interest |                                     | $                                            | (39,933 | )       |           | $ | (135 | )         |        | $ | (2,178       | )     |       | $            |  |      |      | $ | (42,246 | )      
|                                                            |                                     |                                              |         |         |           |   |      |           |        |   |              |       |       |              |  

In late 2003, management announced its intention
to exit both the workers compensation and health insurance
lines of business, both of which are included above in other
insurance lines. The Company began non-renewing workers
compensation policies in early 2004 and began non-renewing
health policies effective July 1, 2004.

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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

5.     Investments

The composition of the investment portfolio,
including unrealized gains and losses at September 30, 2004
and December 31, 2003 was as follows:

|                   |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |         |         | 
|------------------ | --------------------------------- | ------------------------ | - | ------- | ---------- |  | ----- | ---------- | ------ |  | ---------- | ------ | ------ | - | - | ------- | ------- | 
|                   |                                   |                         
|                   |                                   | September 30, 2004       |  
|                   |                                   |                          |  
|                   |                                   |                          |   | Gross   |            |  | Gross |            |        | 
|                   |                                   | Amortized                |   |         | Unrealized |  |       | Unrealized |        |  | Estimated  |       
|                   |                                   | Cost/Cost                |   |         | Gains      |  |       | Losses     |        |  | Fair Value |       
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   |                         
|                   |                                   | (In thousands)           |  
|Available-for-sale |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |        
|                   | U.S. government obligations       |                          | $ | 74,619  |            |  | $     | 1,467      |        |  | $          | (11    | )      |   | $ | 76,075  |        
|                   | States and political subdivisions |                          |   | 21,532  |            |  |       | 806        |        |  |            |       |        |   |   | 22,338  |        
|                   | Corporate securities              |                          |   | 330,985 |            |  |       | 23,926     |        |  |            | (15    | )      |   |   | 354,896 |        
|                   | Mortgage-backed securities        |                          |   | 138,737 |            |  |       | 3,722      |        |  |            | (1,987 | )      |   |   | 140,472 |        
|                   | Other debt securities             |                          |   | 25,748  |            |  |       | 1,603      |        |  |            |       |        |   |   | 27,351  |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   | Fixed maturities         |   |         | 591,621    |  |       |            | 31,524 |  |            |        | (2,013 | ) |   |         | 621,132 | 
|                   | Equity securities                 |                          |   | 9,982   |            |  |       | 583        |        |  |            | (582   | )      |   |   | 9,983   |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   | Total available-for-sale |   | $       | 601,603    |  |       | $          | 32,107 |  |            | $      | (2,595 | ) |   | $       | 631,115 | 
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       

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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

|                   |                                   |                          |   |         |            |  |       |            |        |  |            |      |      |   |   |         |         | 
|------------------ | --------------------------------- | ------------------------ | - | ------- | ---------- |  | ----- | ---------- | ------ |  | ---------- | ---- | ---- | - | - | ------- | ------- | 
|                   |                                   |                         
|                   |                                   | December 31, 2003        |  
|                   |                                   |                          |  
|                   |                                   |                          |   | Gross   |            |  | Gross |            |        | 
|                   |                                   | Amortized                |   |         | Unrealized |  |       | Unrealized |        |  | Estimated  |     
|                   |                                   | Cost/Cost                |   |         | Gains      |  |       | Losses     |        |  | Fair Value |     
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     
|                   |                                   |                         
|                   |                                   | (In thousands)           |  
|Available-for-sale |                                   |                          |   |         |            |  |       |            |        |  |            |      |      |   |   |        
|                   | U.S. government obligations       |                          | $ | 54,168  |            |  | $     | 1,927      |        |  | $          | (4   | )    |   | $ | 56,091  |        
|                   | States and political subdivisions |                          |   | 32,932  |            |  |       | 1,404      |        |  |            | (18  | )    |   |   | 34,318  |        
|                   | Corporate securities              |                          |   | 475,866 |            |  |       | 37,896     |        |  |            | (75  | )    |   |   | 513,687 |        
|                   | Mortgage-backed securities        |                          |   | 60,440  |            |  |       | 2,546      |        |  |            | (557 | )    |   |   | 62,429  |        
|                   | Other debt securities             |                          |   | 25,706  |            |  |       | 2,402      |        |  |            |     |      |   |   | 28,108  |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     
|                   |                                   | Fixed maturities         |   |         | 649,112    |  |       |            | 46,175 |  |            |      | (654 | ) |   |         | 694,633 | 
|                   | Equity securities                 |                          |   | 7,085   |            |  |       | 567        |        |  |            | (107 | )    |   |   | 7,545   |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     
|                   |                                   | Total available-for-sale |   | $       | 656,197    |  |       | $          | 46,742 |  |            | $    | (761 | ) |   | $       | 702,178 | 
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     

Unrealized gains at September 30, 2004 and
December 31, 2003 include $(186,000) and $432,000,
respectively, of net (losses) gains that relate to
securities that contain an embedded derivative instrument. These
(losses) gains have been included in investment income for the
period in accordance with SFAS No. 133. See Note 1 for
further discussion of these securities and the embedded
derivative instruments.

6.     Commitments
and Contingencies

On December 30, 2003 and February 20,
2004, separate putative shareholder class action complaints were
filed in United States District Court for the Western District
of Michigan against the Company, its former President and Chief
Executive Officer, and its Chief Financial Officer. The
complaints allege violations of federal securities laws for
certain disclosures made by the Company between
February 13, 2003 and November 6, 2003, regarding its
operating results and the adequacy of its reserves, and each
seeks monetary damages in an unspecified amount. The Company
denies the allegations and intends to vigorously defend the
lawsuits. On March 23, 2004, the Court dismissed the first
case and entered an Order approving a lead plaintiff in the
second case. A consolidated amended complaint was filed by the
lead plaintiff on May 7, 2004. On June 28, 2004, the
Company and the individual defendants filed a motion to dismiss
the complaint. While management believes that meritorious
defenses to the allegations exist, the ultimate disposition of
this litigation could have a material adverse impact on the
Companys financial position, liquidity and results of
operations.

As of September 17, 2004, the Companys
subsidiary, American Physicians Assurance Corporation
(American Physicians), entered into a stock purchase
agreement with various shareholders of Physicians Insurance
Company of Wisconsin, Inc. (PICW) to acquire a
substantial minority interest in PICW. The stock purchase
agreement states that American Physicians will purchase
4,450 shares of PICW common stock at a purchase price of
$3,800 per share in cash, or approximately $17 million. The
closing of the purchase is subject to various conditions,
including the receipt of approval from Wisconsins Office
of the Commissioner of Insurance.

7.     Related Party
Transactions

On January 2, 2004, the $6.0 million
obligation to the Companys former President and Chief
Executive Officer (CEO) was repaid in its entirety
in connection with his retirement.

At December 31, 2003, the Company had a
$286,000 non-interest bearing note receivable from SCW Agency
Group, Inc. (SCW), an insurance agency that is
principally owned by the Companys former President and
CEO. At December 31, 2003, the Company had established an
allowance in the amount of

14



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

$286,000 related to the note receivable. As part
of a new master agency agreement between American Physicians, a
wholly owned subsidiary of APCapital, and SCW, which was
effective January 1, 2004, this note receivable was
forgiven in exchange for certain more favorable contract terms.
Accordingly, the note receivable and the allowance were written
off during 2004, which did not result in a charge to income.

8.     Restructuring
Charges

In the fourth quarter of 2003, the Company began
to exit its workers compensation and health lines of
business. In connection with the exit of these lines, the
Company expects to incur a total of approximately
$1.1 million of restructuring charges for one-time employee
termination benefits and employee stay bonuses. During the three
and nine months ended September 30, 2004, $15,000 and
$162,000, respectively, of additional restructuring costs were
incurred, bringing the total amount incurred through
September 30, 2004, to $971,000. The costs are included on
the accompanying unaudited Condensed Consolidated Statements of
Income in the other expenses line item.

The activity in the liability for restructuring
charges for the nine months ended September 30, 2004 was as
follows (in thousands):

|                      |  |      |      |  
|--------------------- |  | ---- | ---- | -
|                      |  | 2004 |     
|                      |  |      |     
|Balance, January 1    |  | $    | 727  |  
|Employee separations  |  |      | 162  |  
|Payments              |  |      | (747 | )
|                      |  |      |     
|Balance, September 30 |  | $    | 142  |  
|                      |  |      |     

Certain employees related to the workers
compensation line of business have been retained to manage the
run-off of this line through June 30, 2005. The employee
separation costs related to these individuals will be recognized
prospectively over the future service period. At
September 30, 2004, total future employee separation costs
are estimated to be approximately $100,000.

9.     Income
Taxes

The provision for income taxes for the three and
nine months ended September 30, 2004 and 2003 consists of
the following:

|                                 |                         |                    |        |     |                   |   |         |        |  |   |        |      |   |   |         |        | 
|-------------------------------- | ----------------------- | ------------------ | ------ | --- | ----------------- | - | ------- | ------ |  | - | ------ | ---- | - | - | ------- | ------ | 
|                                 |                         |                    |        |    
|                                 |                         | Three Months Ended |        |     | Nine Months Ended |  
|                                 |                         | September 30,      |        |     | September 30,     |  
|                                 |                         |                    |        |     |                   |  
|                                 |                         | 2004               |        |     | 2003              |   |         | 2004   |  |   | 2003   |     
|                                 |                         |                    |        |     |                   |   |         |        |  |   |        |     
|                                 |                         |                   
|                                 |                         | (In thousands)     |       
|Current expense (benefit)        |                         | $                  | 226    |     |                   | $ | (12,355 | )      |  | $ | (374   | )    |   | $ | (13,339 | )     
|Deferred expense (benefit)       |                         |                    | 1,357  |     |                   |   | (2,971  | )      |  |   | 4,145  |      |   |   | (1,921  | )     
|Deferred tax valuation allowance |                         |                    | (1,357 | )   |                   |   | 49,947  |        |  |   | (4,145 | )    |   |   | 49,947  |       
|                                 |                         |                    |        |     |                   |   |         |        |  |   |        |     
|                                 | Total expense (benefit) |                    | $      | 226 |                   |   | $       | 34,621 |  |   | $      | (374 | ) |   | $       | 34,687 | 
|                                 |                         |                    |        |     |                   |   |         |        |  |   |        |     

15



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

Income taxes incurred do not bear the usual
relationship to income before federal income taxes for the three
and nine months ended September 30, 2004 and 2003 due to
the following:

|                                                                    |                     |                                  |       |        |                                 |  |      |       |     |   |         |        |        |  |      |        |       |   |        |        |      |   |      |       |      |   |         |        |        |  |      |        |       |  
|------------------------------------------------------------------- | ------------------- | -------------------------------- | ----- | ------ | ------------------------------- |  | ---- | ----- | --- | - | ------- | ------ | ------ |  | ---- | ------ | ----- | - | ------ | ------ | ---- | - | ---- | ----- | ---- | - | ------- | ------ | ------ |  | ---- | ------ | ----- | -
|                                                                    |                     |                                  |       |       
|                                                                    |                     | Three Months Ended September 30, |       |        | Nine Months Ended September 30, | 
|                                                                    |                     |                                  |       |        |                                 | 
|                                                                    |                     |                                  |       |        |                                 |  |      |      
|                                                                    |                     | 2004                             |       |        | 2003                            |  |      | 2004  |     |   | 2003    |       
|                                                                    |                     |                                  |       |        |                                 |  |      |       |     |   |         |       
|                                                                    |                     |                                  |       |        |                                 |  |      |       |     |   |         |        |        |  |      |       
|                                                                    |                     |                                 
|                                                                    |                     | (In thousands)                   |      
|Income (loss) before federal income taxes
    and minority interest |                     | $                                | 4,773 |        |                                 |  |      |       |     | $ | (42,434 | )      |        |  |      |        |       | $ | 13,130 |        |      |   |      |       |      | $ | (42,246 | )      |        |  |      |       
|                                                                    |                     |                                  |       |        |                                 |  |      |       |     |   |         |        |        |  |      |        |       |   |        |        |      |   |      |      
|Tax at statutory rate                                               |                     | $                                | 1,671 |        |                                 |  | 35.0 | %     |     | $ | (14,852 | )      |        |  | 35.0 | %      |       | $ | 4,596  |        |      |   | 35.0 | %     |      | $ | (14,786 | )      |        |  | 35.0 | %     
|Tax effect of:                                                      |                     |                                  |       |        |                                 |  |      |       |     |   |         |        |        |  |      |        |       |   |        |        |      |   |      |       |      |   |         |        |        |  |      |       
|                                                                    | Tax exempt interest |                                  |       | (88    | )                               |  |      | -1.8  | %   |   |         | (124   | )      |  |      | 0.3    | %     |   |        | (285   | )    |   |      | -2.2  | %    |   |         | (372   | )      |  |      | 0.9    | %    
|                                                                    | Cushion adjustment  |                                  |       |       |                                 |  |      | 0.0   | %   |   |         |       |        |  |      | 0.0    | %     |   |        | (600   | )    |   |      | -4.6  | %    |   |         |       |        |  |      | 0.0    | %    
|                                                                    | Other items, net    |                                  |       |       |                                 |  |      | 0.0   | %   |   |         | (350   | )      |  |      | 0.8    | %     |   |        | 60     |      |   |      | 0.5   | %    |   |         | (102   | )      |  |      | 0.2    | %    
|                                                                    | Valuation allowance |                                  |       | (1,357 | )                               |  |      | -28.3 | %   |   |         | 49,947 |        |  |      | -117.7 | %     |   |        | (4,145 | )    |   |      | -31.5 | %    |   |         | 49,947 |        |  |      | -118.2 | %    
|                                                                    |                     |                                  |       |        |                                 |  |      |       |     |   |         |        |        |  |      |        |       |   |        |        |      |   |      |      
|                                                                    |                     | Total expense (benefit)          |       | $      | 226                             |  |      |       | 4.7 | % |         | $      | 34,621 |  |      |        | -81.6 | % |        | $      | (374 | ) |      |       | -2.8 | % |         | $      | 34,687 |  |      |        | -82.1 | %
|                                                                    |                     |                                  |       |        |                                 |  |      |       |     |   |         |        |        |  |      |        |       |   |        |        |      |   |      |      

The federal income tax benefit recorded for the
nine months ended September 30, 2004 represents the
reversal of a tax cushion that had been maintained
in connection with an amended return filed for tax year 2000.
Although the Company has not yet received the refund related to
the 2000 amended return, dialogue with the Internal Revenue
Service has indicated that the refund is being processed as
requested, and the cushion is therefore no longer needed. This
benefit is partially offset by an alternative minimum tax
(AMT) liability, which results due to a limitation
on AMT net operating loss carryforwards.

Deferred federal income tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to the differences between financial
statement carrying amounts of existing assets and liabilities,
and their respective tax bases. The Company has reviewed its
deferred federal income tax assets for recoverability based on
the availability of future taxable income when the deductible
temporary differences are expected to reverse, and has
determined, based on its recent loss experience, that sufficient
taxable income may not exist in the periods of reversal.
Accordingly, the Company has recorded a deferred tax asset
valuation allowance for the entire net deferred tax asset. Once
the Company has re-established a pattern of profitability, the
deferred tax asset valuation allowance may be reduced upon
evaluation of the availability of future taxable income.

16



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

At September 30, 2004 and December 31,
2003, the components of the net deferred federal income tax
asset were as follows:

|                                      |                                     |                                                   |   |        |              |   |   |        |         |  
|------------------------------------- | ----------------------------------- | ------------------------------------------------- | - | ------ | ------------ | - | - | ------ | ------- | -
|                                      |                                     | September 30,                                     |   |        | December 31, |  
|                                      |                                     | 2004                                              |   |        | 2003         |  
|                                      |                                     |                                                   |   |        |              |  
|                                      |                                     |                                                  
|                                      |                                     | (In thousands)                                    |  
|Deferred tax assets arising from      |                                     |                                                   |   |        |              |   |   |       
|                                      | Losses and loss adjustment expenses |                                                   | $ | 27,639 |              |   | $ | 29,385 |        
|                                      | Net operating loss carryforwards    |                                                   |   | 14,188 |              |   |   | 15,658 |        
|                                      | Unearned and audit premiums         |                                                   |   | 7,316  |              |   |   | 7,732  |        
|                                      | Minimum tax credits                 |                                                   |   | 8,470  |              |   |   | 8,242  |        
|                                      | Realized losses on investments      |                                                   |   | 1,674  |              |   |   | 4,257  |        
|                                      | Goodwill                            |                                                   |   | 4,588  |              |   |   | 4,827  |        
|                                      | Other                               |                                                   |   | 3,637  |              |   |   | 2,604  |        
|                                      |                                     |                                                   |   |        |              |  
|                                      |                                     | Total deferred tax assets                         |   |        | 67,512       |   |   |        | 72,705  |  
|                                      |                                     |                                                   |   |        |              |  
|Deferred tax liabilities arising from |                                     |                                                   |   |        |              |   |   |       
|                                      | Deferred policy acquisition costs   |                                                   |   | 3,208  |              |   |   | 3,656  |        
|                                      | Net unrealized gains on securities  |                                                   |   | 10,394 |              |   |   | 15,942 |        
|                                      | Other                               |                                                   |   | 1,744  |              |   |   | 2,435  |        
|                                      |                                     |                                                   |   |        |              |  
|                                      |                                     | Total deferred tax liabilities                    |   |        | 15,346       |   |   |        | 22,033  |  
|                                      |                                     |                                                   |   |        |              |  
|                                      |                                     | Net deferred tax asset before valuation allowance |   |        | 52,166       |   |   |        | 50,672  |  
|                                      |                                     | Valuation allowance                               |   |        | (52,166      | ) |   |        | (50,672 | )
|                                      |                                     |                                                   |   |        |              |  
|                                      | Net deferred tax asset              |                                                   | $ |       |              |   | $ |       |        
|                                      |                                     |                                                   |   |        |              |  

As the Companys deferred tax assets and
liabilities change, the valuation allowance also changes. Any
change in the valuation allowance related to the tax effect of
items that are included in continuing operations is recorded as
federal income tax expense (benefit) from continuing
operations in the period of change. In periods of reported net
income, the change in the deferred tax valuation allowance that
pertains to items that are not related to continuing operations,
such as unrealized appreciation or depreciation on investment
securities, is reported as a component of that measure of income
to which those items pertain. Accordingly, the Company has
recorded the effect of the change in the valuation allowance
related to unrealized appreciation or depreciation on investment
securities, as well as expenses from employee stock options that
have different book and tax treatments, directly to either
comprehensive income or shareholders equity in 2004.

The following table shows the intraperiod
allocation of the change in the deferred tax valuation allowance
for the nine months ended September 30, 2004 and 2003.

|                                          |                                             |                                                                                              |         |   |        |   |         |   |         |  
|----------------------------------------- | ------------------------------------------- | -------------------------------------------------------------------------------------------- | ------- | - | ------ | - | ------- | - | ------- | -
|                                          |                                             |                                                                                             
|                                          |                                             | For the Nine Months Ended                                                                    |        
|                                          |                                             | September 30,                                                                                |        
|                                          |                                             |                                                                                              |        
|                                          |                                             | 2004                                                                                         |         |   | 2003   |  
|                                          |                                             |                                                                                              |         |   |        |  
|                                          |                                             |                                                                                             
|                                          |                                             | (In thousands)                                                                               |        
|Valuation allowance balance, January 1    |                                             | $                                                                                            | (50,672 | ) |        | $ |        |  
|                                          | Change in valuation allowance allocated to: |                                                                                              |         |   |        |   |         |   |        
|                                          |                                             | Federal income tax benefit (expense) from
    continuing operations                          |         |   | 4,145  |   |         |   | (49,947 | )
|                                          |                                             | Unrealized depreciation on investment securities
    allocated to other comprehensive income |         |   | (5,548 | ) |         |   |        |  
|                                          |                                             | Other items allocated to shareholders equity                                                |         |   | (91    | ) |         |   |        |  
|                                          |                                             |                                                                                              |         |   |        |  
|Valuation allowance balance, September 30 |                                             | $                                                                                            | (52,166 | ) |        | $ | (49,947 | )
|                                          |                                             |                                                                                              |         |   |        |  

17



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (UNAUDITED)  (Continued)

At September 30, 2004, the Company had the
following net operating loss carryforwards:

|                                                             |  |                |        |        |            |   |         |            |  |  |      | 
|------------------------------------------------------------ |  | -------------- | ------ | ------ | ---------- | - | ------- | ---------- |  |  | ---- | 
|                                                             |  |                |        | Annual |            |   | Year of |           
|                                                             |  | Amount         |        |        | Limitation |   |         | Expiration | 
|                                                             |  |                |        |        |            |   |         |            | 
|                                                             |  |                |        |       
|                                                             |  | (in thousands) |        |        |           
|New Mexico Physicians Mutual Liability Company
    merger(2) |  | $              | 3,421  |        |            | $ | 575     |            |  |  | 2010 | 
|State Mutual Insurance Company merger(2)                     |  | $              | 2,376  |        |            | $ | 340     |            |  |  | 2012 | 
|2003 net operating loss(1)                                   |  | $              | 34,740 |        |            |   |        |            |  |  | 2018 | 



---



|    |                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------
|(1) | There are no limitations on the annual use of net
    operating losses related to the year ended December 31,
    2003.           
|   
|(2) | American Physicians merged with New Mexico
    Physicians Mutual Liability Company and State Mutual Insurance
    Company in 1997.

In addition to the net operating loss
carryforwards above, at September 30, 2004, the Company had
approximately $8.5 million of AMT credits, which can be
carried forward indefinitely.

10.     Reinsurance

The Company commuted its ceded reinsurance
treaties with Gerling Global Reinsurance Corporation
(Gerling) in May 2004. The Company recognized the
$13.5 million received from Gerling as reduction of losses
and loss adjustment expenses paid (thereby reducing losses and
loss adjustment expenses incurred) in the current year. The
Company also reduced its reinsurance recoverable from Gerling
(thereby increasing losses and loss adjustment expenses
incurred) to recognize the effect of releasing Gerling from its
obligations under the treaties. The net effect of the
commutation was an increase in losses and loss adjustment
expenses of $4.4 million, partially offset by an $837,000
increase in net premiums earned.

11.     Subsequent
Events

Subsequent to September 30, 2004, the
Company sold one of its real estate limited partnership
interests to the other members of the partnership for $650,000.
Under the terms of the agreement, the Company received $65,000
in cash and a note receivable for the balance of the purchase
price. The note is repayable in quarterly installments beginning
on April 1, 2005, with any remaining principal and interest
outstanding due and payable in full on December 31, 2005.
Under equity method accounting, the Companys recorded
investment in this limited partnership was zero, and a pre-tax
realized gain of $650,000 will be recognized on the sale in the
fourth quarter of 2004.

18



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##### Table of Contents








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|ITEM 2. | Managements Discussion and Analysis of
    Financial Condition and Results of Operations

The following discussion and analysis should be
read in conjunction with the unaudited Condensed Consolidated
Financial Statements and the Notes thereto included elsewhere in
this report and our Annual Report on Form 10-K for the year
ended December 31, 2003, particularly
Item 7  Managements Discussion and
Analysis of Financial Condition and Results of Operations
in the Annual Report.

The following discussion of our financial
condition and results of operations contains certain
forward-looking statements related to our anticipated future
financial condition and operating results and our current
business plans. When we use words such as will,
should, likely, believe,
expect, anticipate, estimate
or similar expressions, we are making forward-looking
statements. These forward-looking statements represent our
outlook only as of the date of this report.

We claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995 for all of our forward-looking
statements. While we believe that our forward-looking statements
are reasonable, you should not place undue reliance on any such
forward-looking statements, which speak only as of the date
made. Because these forward-looking statements are based on
estimates and assumptions that are subject to significant
business, economic and competitive uncertainties, many of which
are beyond our control or are subject to change, actual results
could be materially different. Factors that might cause such a
difference include the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The process of estimating the reserves for unpaid
    losses and loss adjustment expenses involves significant
    judgment and is complex and imprecise due to the number of
    variables and assumptions inherent in the estimation process.
    These variables include the effects on ultimate loss payments of
    internal factors such as changes in claims handling practices
    and changes in the mix of our products, as well as external
    factors such as changes in loss severity trends, economic
    inflation, judicial trends and legislative and regulatory
    changes. In addition, medical professional liability claims may
    take several years to resolve due to typical delays in reporting
    claims to us, the often lengthy discovery process, and the time
    necessary to defend the claim. In addition, claims with similar
    characteristics may result in very different ultimate losses
    depending on the state or region where the claim occurred. All
    of these factors contribute to the variability in estimating
    ultimate loss payments, especially since the effects of many of
    these variables cannot be directly quantified, particularly on a
    prospective basis. The assumptions and methodologies used in
    estimating and establishing the reserve for unpaid losses and
    loss adjustment expenses are continually reviewed and any
    adjustments are reflected as income or expense in the period in
    which the adjustment is made. Historically, such adjustments
    have not exceeded plus or minus 8% of our recorded net reserves
    as of the beginning of the period, but can materially and
    adversely affect our results of operations when an adjustment is
    made. Due to the current volatility of losses in the medical
    professional liability and workers compensation
    industries, adjustments have occurred in each of the last
    several years, and additional adjustment may occur in the future.
|
| |  | A deterioration in the current accident year
    experience could result in a portion or all of our deferred
    policy acquisition costs not being recoverable, which would
    result in a charge to income.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | Our exit from various markets and lines of
    business, including without limitation our exit from the
    workers compensation, health and personal and commercial
    lines of business, as well as various geographic markets, could
    result in material future charges to income due to unforeseen
    costs or the need for additional reserve enhancements.
    Additional reserve enhancements may be necessary due to the
    volatility of loss reserves on these run-off lines. Run-off
    lines are typically more volatile as reported and paid claim
    trends often emerge differently than those that have been
    historically indicated, thus increasing the uncertainty inherent
    in reserve estimates, especially on longer-tailed lines such as
    workers compensation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | An adverse outcome in the putative shareholder
    class action lawsuit against us may result in a charge to income
    that could have a material adverse effect on our financial
    condition, liquidity and results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

19



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##### Table of Contents





| |   |                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Substantial jury awards against our insureds
    could impose liability on us exceeding our policy limits or the
    funds we have reserved for the payment of claims.                                                                                                                                                                                     
|
| |  | If the marketplace puts pressure on pricing
    increases, we may not be able to obtain expected rate increases.                                                                                                                                                                                                                                           
|
| |  | If competitive or other conditions change, our
    revenues may decrease or our expenses may increase.                                                                                                                                                                                                                                                     
|
| |  | If we experience substantial increases in claims
    frequency or severity patterns, our profitability may decline.                                                                                                                                                                                                                                        
|
| |  | We may be unable to collect the full amount of
    reinsurance recoverable from PMA Capital Insurance Company
    and/or Converium Reinsurance (NA), Inc. if their cash flow or
    surplus levels are inadequate to make claim payments, which
    could result in a future charge to income.                                                             
|
| |  | If reinsurance rates rise significantly or
    reinsurance becomes unavailable or reinsurers are unable to pay
    our claims, our results of operations and financial condition
    may be adversely affected.                                                                                                                                            
|
| |  | The concentration of our business in Michigan,
    Illinois and Ohio leaves us vulnerable to various factors
    specific to those states.                                                                                                                                                                                                                 
|
| |  | If our current relationship with medical
    associations and physicians does not continue, our ability to
    market our products and compete successfully may be harmed.                                                                                                                                                                                 
|
| |  | An interruption or change in our relationship
    with SCW Agency Group, an insurance sales agency that is
    principally owned by our former President and CEO, could reduce
    our insurance premiums and net income. This agency accounts for
    substantially more of our medical professional liability
    premiums written than any other agency.
|
| |  | If any of the member companies in the various
    guaranty associations in which we participate were to become
    insolvent, we could be assessed by the relevant association in
    an amount that could materially affect our financial condition
    or results of operations.                                                                         
|
| |  | We may not be able to obtain regulatory approval
    for rate increases, which may negatively affect our
    profitability.                                                                                                                                                                                                                                
|
| |  | If we fail to comply with insurance industry
    regulations, or if those regulations become more burdensome to
    us, we may not be able to operate profitably.                                                                                                                                                                                          
|
| |  | A further reduction in our A.M. Best Company or
    Standard & Poors rating could make it more difficult
    for us to sell our products.                                                                                                                                                                                                                 
|
| |  | Changes in prevailing interest rates and other
    negative changes in financial market conditions may reduce our
    revenues, cash flows or assets, including the amount of
    unrealized gains on investments shown on our balance sheet.                                                                                                              
|
| |  | An increase in short-term interest rates will
    increase our debt service costs related to our variable rate
    long-term debt.                                                                                                                                                                                                                         
|
| |  | Changes in current market conditions may
    adversely impact the property value of real estate investments
    that we currently hold.                                                                                                                                                                                                                    
|
| |  | A downturn in general economic conditions or
    significant increase in inflation in the markets in which we
    compete could negatively affect our profitability.                                                                                                                                                                                       

Other factors not currently anticipated by
management may also materially and adversely affect the
Companys financial position and results of operations. The
Company does not undertake, and expressly disclaims any
obligation, to update or alter its statements, whether as a
result of new information, future events or otherwise, except as
required by applicable law.

20



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##### Table of Contents



Overview of APCapitals
Operations

We are a leading provider of medical professional
liability insurance. Medical professional liability insurance
coverage protects physicians and other health providers from
claims filed against them for alleged acts of medical
malpractice. In addition to medical professional liability
insurance, we have historically also offered workers
compensation insurance and health insurance products. However,
in late 2003, we announced our intention to exit the
workers compensation and health insurance markets. We
began non-renewing workers compensation policies in the
first quarter of 2004 and began non-renewing health policies
effective July 1, 2004.

Significant Accounting Policies

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires us to make estimates and
assumptions that affect amounts reported in the accompanying
consolidated financial statements and related footnotes. These
estimates and assumptions are evaluated on an on-going basis
based on historical developments, market conditions, industry
trends and other information we believe to be reasonable under
the circumstances. There can be no assurance that actual results
will conform to our estimates and assumptions, or that reported
results of operations will not be materially adversely affected
by the need to make accounting adjustments to reflect changes in
these estimates and assumptions from time to time. Adjustments
related to changes in estimates are reflected in the
Companys results of operations in the period in which
those estimates changed.

The policies relating to unpaid loss and loss
adjustment expenses, investments, income taxes, reinsurance, the
reserve for extended reporting period claims and deferred policy
acquisition costs are those we believe to be most sensitive to
estimates and judgments. These policies are more fully described
in Item 7  Managements Discussion
and Analysis of Financial Condition and Results of Operations,
Significant Accounting Policies of our Annual Report on
Form 10-K for the year ended December 31, 2003, and in
Note 1 to our Consolidated Financial Statements contained
in that report. There have been no material changes to these
policies during the most recent quarter.

Description of Ratios Analyzed

In the analysis of our operating results that
follows, we refer to various financial ratios and other measures
that management uses to analyze and compare the underwriting
results of our insurance operations.



| |                                                  
| | -------------------------------------------------
| | GAAP Ratios and Other GAAP Financial
    Measures

We calculate loss ratio, underwriting expense
ratio and combined ratio on a GAAP basis. There have been no
material changes to the calculation and use of these ratios
during the most recent quarter. The Company also calculates
underwriting gain (loss) on a GAAP basis. This measure
equals the net premiums earned less loss and loss adjustment
expenses as well as underwriting expenses. It is another measure
used by management and insurance regulators to evaluate the
underwriting performance of our insurance operations.



| |                         
| | ------------------------
| | Accident Year Loss Ratio

In addition to our reported GAAP loss ratios, we
also report accident year loss ratios. The accident year loss
ratio excludes the effect of development on prior year loss
reserves. We believe this ratio is useful in evaluating our
current underwriting performance, as it focuses on the
relationships between current premiums earned and losses
incurred related to the current year. Considerable variability
is inherent in the establishment of loss reserves related to the
current accident year. While management believes that its
estimate is reasonable, there can be no assurance that these
loss reserves will develop as expected. Our method of
calculating accident year loss ratios may differ from those used
by other companies and, therefore, comparability may be limited.

21



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##### Table of Contents



Results of Operations  Three and
Nine Months Ended September 30, 2004 Compared to Three and
Nine Months Ended September 30, 2003



| |                                       
| | --------------------------------------
| | Consolidated Results of
    Operations

The following table sets forth our results of
operations for the three-month and nine-month periods ended
September 30, 2004 and 2003, on a consolidated basis. The
discussion that follows should be read in connection with the
unaudited Condensed Consolidated Financial Statements, and Notes
thereto, included elsewhere in this report.

|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |         |         |   |         |         |         |   |         |        |         | 
|----------------------------------------- | ------------------------------ | ------------------------------------------------------------------- | ------ | ---------- | --------------------------------------- |  | ------ | ------ | ---------- | - | ------- | ------- | ------- | ---- | ------- | ------ | ------- |  | ------- | ------- | ------- |  | ------- | ------- | ------- | - | ------- | ------- | ------- | - | ------- | ------ | ------- | 
|                                          |                                |                                                                     |        |           
|                                          |                                | For the Three Months Ended September 30,                            |        |            | For the Nine Months Ended September 30, | 
|                                          |                                |                                                                     |        |            |                                         | 
|                                          |                                |                                                                     |        | Percentage |                                         |  |        |        | Percentage |  
|                                          |                                | 2004                                                                |        |            | 2003                                    |  |        | Change |            |   | Change  |         |         | 2004 |         |        | 2003    |  |         | Change  |         |  | Change  |        
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                |                                                                    
|                                          |                                | (dollars in thousands)                                              |       
|Net premiums earned by insurance segment: |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |         |         |   |         |         |         |   |         |       
|                                          | Medical professional liability |                                                                     | $      | 44,169     |                                         |  | $      | 41,043 |            |   | $       | 3,126   |         |      |         | 7.6%   |         |  | $       | 130,184 |         |  | $       | 118,903 |         |   | $       | 11,281  |         |   |         | 9.5%   |        
|                                          | Other insurance lines          |                                                                     |        | 4,586      |                                         |  |        | 15,545 |            |   |         | (10,959 | )       |      |         | -70.5% |         |  |         | 23,775  |         |  |         | 50,617  |         |   |         | (26,842 | )       |   |         | -53.0% |        
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                | Total net premiums earned                                           |        |            | 48,755                                  |  |        |        | 56,588     |   |         |         | (7,833  | )    |         |        | -13.8%  |  |         |         | 153,959 |  |         |         | 169,520 |   |         |         | (15,561 | ) |         |        | -9.2%   | 
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|Investment income                         |                                |                                                                     | 10,947 |            |                                         |  | 11,400 |        |            |   | (453    | )       |         |      | -4.0%   |        |         |  | 36,451  |         |         |  | 32,209  |         |         |   | 4,242   |         |         |   | 13.2%   |       
|Net realized (losses) gains               |                                |                                                                     | (332   | )          |                                         |  | 143    |        |            |   | (475    | )       |         |      | -332.2% |        |         |  | 1,233   |         |         |  | 1,291   |         |         |   | (58     | )       |         |   | -4.5%   |       
|Other income                              |                                |                                                                     | 156    |            |                                         |  | 161    |        |            |   | (5      | )       |         |      | -3.1%   |        |         |  | 562     |         |         |  | 518     |         |         |   | 44      |         |         |   | 8.5%    |       
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                | Total revenues and other income                                     |        |            | 59,526                                  |  |        |        | 68,292     |   |         |         | (8,766  | )    |         |        | -12.8%  |  |         |         | 192,205 |  |         |         | 203,538 |   |         |         | (11,333 | ) |         |        | -5.6%   | 
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|Losses and loss adjustment expenses       |                                |                                                                     | 42,773 |            |                                         |  | 96,721 |        |            |   | (53,948 | )       |         |      | -55.8%  |        |         |  | 137,700 |         |         |  | 203,733 |         |         |   | (66,033 | )       |         |   | -32.4%  |       
|Underwriting expenses                     |                                |                                                                     | 9,838  |            |                                         |  | 11,721 |        |            |   | (1,883  | )       |         |      | -16.1%  |        |         |  | 33,986  |         |         |  | 36,828  |         |         |   | (2,842  | )       |         |   | -7.7%   |       
|Investment expenses                       |                                |                                                                     | 719    |            |                                         |  | 934    |        |            |   | (215    | )       |         |      | -23.0%  |        |         |  | 2,264   |         |         |  | 2,083   |         |         |   | 181     |         |         |   | 8.7%    |       
|Interest expense                          |                                |                                                                     | 428    |            |                                         |  | 502    |        |            |   | (74     | )       |         |      | -14.7%  |        |         |  | 1,229   |         |         |  | 875     |         |         |   | 354     |         |         |   | 40.5%   |       
|Amortization expense                      |                                |                                                                     | 274    |            |                                         |  | 133    |        |            |   | 141     |         |         |      | 106.0%  |        |         |  | 822     |         |         |  | 272     |         |         |   | 550     |         |         |   | 202.2%  |       
|General and administrative expenses       |                                |                                                                     | 706    |            |                                         |  | 715    |        |            |   | (9      | )       |         |      | -1.3%   |        |         |  | 2,912   |         |         |  | 1,993   |         |         |   | 919     |         |         |   | 46.1%   |       
|Other expense                             |                                |                                                                     | 15     |            |                                         |  |       |        |            |   | 15      |         |         |      |         |        |         |  | 162     |         |         |  |        |         |         |   | 162     |         |         |   |         |       
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                | Total expenses                                                      |        |            | 54,753                                  |  |        |        | 110,726    |   |         |         | (55,973 | )    |         |        | -50.6%  |  |         |         | 179,075 |  |         |         | 245,784 |   |         |         | (66,709 | ) |         |        | -27.1%  | 
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                | Income (loss) before federal income taxes and
    minority interest |        |            | 4,773                                   |  |        |        | (42,434    | ) |         |         | 47,207  |      |         |        | -111.2% |  |         |         | 13,130  |  |         |         | (42,246 | ) |         |         | 55,376  |   |         |        | -131.1% | 
|Federal income tax expense (benefit)      |                                |                                                                     | 226    |            |                                         |  | 34,621 |        |            |   | (34,395 | )       |         |      | -99.3%  |        |         |  | (374    | )       |         |  | 34,687  |         |         |   | (35,061 | )       |         |   | -101.1% |       
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                | Income (loss) before minority interest                              |        |            | 4,547                                   |  |        |        | (77,055    | ) |         |         | 81,602  |      |         |        | -105.9% |  |         |         | 13,504  |  |         |         | (76,933 | ) |         |         | 90,437  |   |         |        | -117.6% | 
|Minority interest                         |                                |                                                                     | 2      |            |                                         |  |       |        |            |   | 2       |         |         |      |         |        |         |  | 17      |         |         |  |        |         |         |   | 17      |         |         |   |         |       
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|                                          |                                | Net income (loss)                                                   |        | $          | 4,549                                   |  |        | $      | (77,055    | ) |         | $       | 81,604  |      |         |        | -105.9% |  |         | $       | 13,521  |  |         | $       | (76,933 | ) |         | $       | 90,454  |   |         |        | -117.6% | 
|                                          |                                |                                                                     |        |            |                                         |  |        |        |            |   |         |         |         |      |         |        |         |  |         |         |         |  |         |        
|Loss ratio                                |                                |                                                                     | 87.7%  |            |                                         |  | 170.9% |        |            |   | -83.2%  |         |         |      |         |        |         |  | 89.4%   |         |         |  | 120.2%  |         |         |   | -30.8%  |         |         |   |         |       
|Underwriting ratio                        |                                |                                                                     | 20.2%  |            |                                         |  | 20.7%  |        |            |   | -0.5%   |         |         |      |         |        |         |  | 22.1%   |         |         |  | 21.7%   |         |         |   | 0.4%    |         |         |   |         |       
|Combined ratio                            |                                |                                                                     | 107.9% |            |                                         |  | 191.6% |        |            |   | -83.7%  |         |         |      |         |        |         |  | 111.5%  |         |         |  | 141.9%  |         |         |   | -30.4%  |         |         |   |         |       

We reported net income for the three-month and
nine-month periods ended September 30, 2004, compared to
net losses for the same periods of 2003, primarily due to a
$43 million increase in prior year medical professional
liability loss reserves and the establishment of a deferred tax
valuation allowance, both of which occurred during the third
quarter of 2003. Our 2004 results also benefited from the
continued improvements in the underwriting performance (i.e.,
underwriting gain or loss) of our medical professional liability
segment, which is discussed more fully in the section regarding
that segments results of operations. In addition,
increases in year-to-date investment income also contributed to
the increases in year-to-date net income. Partially offsetting
these positive factors were increases in the underwriting losses
generated by our other insurance lines segment, which is
primarily attributable to the run-off of our workers
compensation and health lines of insurance, increases in general
and administrative expenses, and a $2.5 million charge
related to the write-off of software in the second quarter of
2004.

The decreases in net premiums earned were
primarily attributable to our exit from the workers
compensation and health insurance lines of business, which we
announced in the fourth quarter of 2003, partially offset by
premium rate increases on our medical professional liability
line and an $837,000 increase in net premiums earned related to
the commutation of our reinsurance treaties with Gerling Global
Reinsurance Corporation (Gerling). We anticipate
that net premiums earned will continue to remain at lower levels
than

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in previous periods for the near future as we
complete our exit from these lines. However, we believe that
rate increases related to our medical professional liability
line will eventually offset the decrease in net premiums earned
from the exit of our workers compensation and health lines.


Investment income for the three months ended
September 30, 2004 was $10.9 million, a decrease of
$453,000 compared to the same period in 2003. This decrease was
primarily the result of the sale of our high-yield bond
portfolio, described below, as well as a $912,000 charge in the
third quarter of 2004 related to the change in fair value of
certain investment securities that management has determined
contain embedded derivative financial instruments. These
securities, and their impact on reported earnings, are described
more fully in Note 1 of the accompanying unaudited
Condensed Consolidated Financial Statements. The increase in our
cash position during the third quarter of 2004 also contributed
to the decrease in investment income for the period. Our cash
position has increased throughout 2004 as we have not reinvested
some of the proceeds from maturities and sales during the year
due to the low interest rate environment. In the fourth quarter
of 2004 management intends to implement a plan to redeploy some
of our cash resources into longer-term, higher yielding
fixed-income securities. Investment income for the nine months
ended September 30, 2004 was $36.5 million, a
$4.2 million increase compared to the same period in 2003.
The increase in investment income for the nine months ended
September 30, 2004 was the result of strong returns on our
collateralized-mortgage obligations and high-yield bond
portfolios during the first part of the year and one-time call
premiums of $1.5 million. Overall, the yield on our
investment portfolio increased to 6.05% for the nine months
ended September 30, 2004 compared to 5.54% for the nine
months ended September 30, 2003.

Near the end of the first quarter of 2004 we
began to liquidate our $50 million investment in high-yield
bonds. During the nine-months ended September 30, 2004 we
realized a pre-tax gain of $1.6 million on the sale of
these securities. In addition, we liquidated the majority of our
other non-investment grade securities for a pre-tax gain of
$2.6 million. The liquidation of our high-yield and other
non-investment grade securities has reduced the overall risk
level associated with our investment portfolio, but is likely to
decrease future investment income as we reinvest in lower-risk,
lower-yielding securities.

Offsetting the gains realized on the liquidation
of our high-yield bonds and other non-investment grade
securities, was a $2.5 million charge, in the second
quarter of 2004, for the write-off of capitalized software costs
associated with an information system project involving a
computer system to administer medical professional liability
policies and claims. This project, which began in the fall of
2002, was not producing the anticipated results and therefore,
management decided to discontinue the project.

In an effort to simplify the Companys
investment portfolio, management has accelerated its plans to
divest its investment real estate properties. During the third
quarter of 2004, we sold investment real estate with a book
value of approximately $17.1 million, which resulted in a
pre-tax realized loss of approximately $1.6 million. In
addition, during the nine-months ended September 30, 2004,
we have recorded a $250,000 impairment charge related to other
investment real estate properties.

The loss ratios for the three months and nine
months ended September 30, 2004 were 87.7% and 89.4%,
respectively. The loss ratios for the same periods of 2003 were
170.9% and 120.2%, respectively. The decreases in the loss
ratios from 2003 to 2004 were primarily the result of the
$43 million increase in prior year medical professional
liability loss reserves, recorded in the third quarter of 2003,
as well as underwriting changes and rate increases related to
our medical professional liability segment that have been
implemented over the last two years. Partially offsetting these
positive factors in 2004 was a $4.4 million increase in incurred
losses from the commutation of our reinsurance treaties with
Gerling in the second quarter of 2004. The Gerling commutation
is more fully described in Note 10 of the accompanying unaudited
Condensed Consolidated Financial Statements.

The underwriting expense ratios for the three
months and nine months ended September 30, 2004 were 20.2%
and 22.1%, respectively, compared to 20.7% and 21.7%,
respectively, for the same periods of 2003. The increase in the
underwriting expense ratio for the nine months ended
September 30, 2004, compared to the same period of 2003 was
primarily the result of severance costs incurred in connection
with the downsizing of non-operational support staff in our home
office during the first half of 2004. In total, we have
eliminated approximately 20 positions with severances
totaling approximately $1.5 million during the nine months
ended

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##### Table of Contents



September 30, 2004. These 20 positions
represent annual salary and employee benefit costs of
approximately $1.4 million. In addition to severance costs
recorded in the nine months of 2004, approximately $525,000 of
incremental professional service fees have been incurred during
2004 in connection with documentation of internal controls
related to the insurance companies operations necessary to
comply with the Sarbanes-Oxley Act and related SEC requirements,
and other corporate initiatives. While compliance with the
provisions of Sarbanes-Oxley will be an ongoing matter, we
anticipate that costs incurred in 2004 will be more significant
than in subsequent years. The decrease in the underwriting
expense ratio for the three months ended September 30,
2004, compared to the three months ended September 30, 2003, was
primarily attributable to a decrease in salary costs as a result
of the elimination of the positions described above.


With the liquidation of our high-yield bond
portfolio during the first half of 2004 and the sale of some of
our investment real estate in the third quarter of 2004, we have
seen a decrease in investment expenses for the three months
ended September 30, 2004, compared to the same period of
2003. However, investment expenses for the nine months ended
September 30, 2004 continue to be higher than those
reported for the same period of 2003, primarily as a result of
an increase in fees related to our equity security portfolio,
which we did not begin to acquire until late in the second
quarter of 2003. We expect to see a decrease in investment
expenses in future periods related to the disposal of our
investment real estate properties; however, these decreases
could be at least partially offset if our unaffiliated equity
security portfolio grows.

The increase in interest expense for the nine
months ended September 30, 2004 is related to the issuance
of approximately $30.9 million of long-term debt in
connection with the issuance of mandatorily redeemable trust
preferred securities in May 2003. The increase in interest
expense related to this long-term debt was partially offset by
the elimination of interest associated with an obligation to the
Companys former President and Chief Executive Officer.
This obligation was fully repaid in January 2004 in connection
with his retirement. The elimination of interest on this
obligation accounts for the decrease in interest expense for the
three months ended September 30, 2004 compared to the same
period of 2003. The long-term debt and the transactions that
gave rise to its issuance are more fully described in
Item 8  Notes to Consolidated Financial
Statements included in our Annual Report on Form 10-K
for the year ended December 31, 2003.

The increases in amortization expense were
primarily related to an intangible asset arising from a two-year
covenant not to compete with the Companys former CEO and
President upon his retirement effective December 31, 2003.

The increase in general and administrative
expenses for the nine months ended September 30, 2004
compared to 2003 was primarily the result of increased legal,
audit and other professional fees incurred as a result of
actions taken to comply with the Sarbanes-Oxley Act and related
SEC requirements and the exploration of strategic alternatives
by the Board of Directors. The Board of Directors completed its
review of alternatives in late June 2004. General and
administrative expenses for the three months ended
September 30, 2004 were essentially the same as those
incurred during the same period of 2003. Partially offsetting
the increased expenses in the third quarter of 2004 due to
Sarbanes-Oxley compliance, was an increase in the allocation of
costs to the insurance companies, and recorded primarily as
underwriting expenses, compared with the third quarter of 2003.
We anticipate general and administrative expenses to remain at
levels below those experienced in the first six months of 2004
but probably not as low as previously experienced as the Company
will continue to incur costs associated with ongoing
Sarbanes-Oxley compliance.

Other expenses represent the accrual of stay
bonuses and termination benefits associated with our exit from
the workers compensation line of business. The impact of
employee separation costs related to the exit from our
workers compensation line of business is more fully
described in Note 8 to the unaudited Condensed Consolidated
Financial Statements, included elsewhere in this report.

The effective tax rates for the three months and
nine months ended September 30, 2004 were 4.7% and (2.8)%,
respectively, compared to (81.6)% and (82.1)% for the three
months and nine months ended September 30, 2003,
respectively. The maintenance of a 100% deferred tax valuation
allowance, in periods where we are either generating or
utilizing net operating loss carryforwards, essentially
eliminates any income tax benefit or expense. The effective tax
rates noted for the three-month and nine-month periods in 2004
were the result of the release of approximately $600,000 of tax
cushion in the second quarter of 2004, partially

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offset by an alternative minimum tax liability
recognized in the third quarter of 2004. The unusual effective
tax rates for the three months and nine months ended
September 30, 2003 were the result of the establishment of
the deferred tax valuation allowance in the third quarter of
2003. See Note 9 of the unaudited Condensed Consolidated
Financial Statements for further information regarding federal
income taxes.




| |                                                         
| | --------------------------------------------------------
| | Medical Professional Liability Results of
    Operations

The following table sets forth the results of
operations of our medical professional liability insurance
segment for the three months and nine months ended
September 30, 2004 and 2003.

|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |         |         |   |        |         |         |   |         |         |        | 
|------------------------------------------------------------------- | --------------------------------------- | -------------------------------- | ------ | ---------- | ------------------------------- | - | ------- | ------ | ---------- | - | ------- | ------- | ------- | ---- | ------- | ------- | ------ | - | ------- | ------- | ------- | - | ------- | ------- | ------- | - | ------ | ------- | ------- | - | ------- | ------- | ------ | 
|                                                                    |                                         |                                  |        |           
|                                                                    |                                         | Three Months Ended September 30, |        |            | Nine Months Ended September 30, |  
|                                                                    |                                         |                                  |        |            |                                 |  
|                                                                    |                                         |                                  |        | Percentage |                                 |   |         |        | Percentage |  
|                                                                    |                                         | 2004                             |        |            | 2003                            |   |         | Change |            |   | Change  |         |         | 2004 |         |         | 2003   |   |         | Change  |         |   | Change  |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|                                                                    |                                         |                                 
|                                                                    |                                         | (dollars in thousands)           |       
|Direct premiums written:                                            |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |         |         |   |        |         |         |   |         |        
|                                                                    | Illinois                                |                                  | $      | 24,179     |                                 |   | $       | 25,888 |            |   | $       | (1,709  | )       |      |         | -6.6%   |        |   | $       | 48,397  |         |   | $       | 46,726  |         |   | $      | 1,671   |         |   |         | 3.6%    |       
|                                                                    | Michigan                                |                                  |        | 20,026     |                                 |   |         | 20,764 |            |   |         | (738    | )       |      |         | -3.6%   |        |   |         | 43,165  |         |   |         | 36,545  |         |   |        | 6,620   |         |   |         | 18.1%   |       
|                                                                    | Ohio                                    |                                  |        | 10,976     |                                 |   |         | 13,000 |            |   |         | (2,024  | )       |      |         | -15.6%  |        |   |         | 29,261  |         |   |         | 29,228  |         |   |        | 33      |         |   |         | 0.1%    |       
|                                                                    | New Mexico                              |                                  |        | 6,891      |                                 |   |         | 5,132  |            |   |         | 1,759   |         |      |         | 34.3%   |        |   |         | 16,111  |         |   |         | 12,157  |         |   |        | 3,954   |         |   |         | 32.5%   |       
|                                                                    | Kentucky                                |                                  |        | 3,047      |                                 |   |         | 2,686  |            |   |         | 361     |         |      |         | 13.4%   |        |   |         | 12,095  |         |   |         | 12,699  |         |   |        | (604    | )       |   |         | -4.8%   |       
|                                                                    | Florida  PIC                           |                                  |        | 2,828      |                                 |   |         |       |            |   |         | 2,828   |         |      |         |         |        |   |         | 6,136   |         |   |         |        |         |   |        | 6,136   |         |   |         |         |       
|                                                                    | Other                                   |                                  |        | 1,443      |                                 |   |         | 1,252  |            |   |         | 191     |         |      |         | 15.3%   |        |   |         | 4,448   |         |   |         | 3,245   |         |   |        | 1,203   |         |   |         | 37.1%   |       
|                                                                    | Nevada                                  |                                  |        | 975        |                                 |   |         | 1,661  |            |   |         | (686    | )       |      |         | -41.3%  |        |   |         | 3,416   |         |   |         | 4,079   |         |   |        | (663    | )       |   |         | -16.3%  |       
|                                                                    | Florida                                 |                                  |        | 419        |                                 |   |         | 1,638  |            |   |         | (1,219  | )       |      |         | -74.4%  |        |   |         | 812     |         |   |         | 6,014   |         |   |        | (5,202  | )       |   |         | -86.5%  |       
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|                                                                    |                                         | Total                            |        | $          | 70,784                          |   |         | $      | 72,021     |   |         | $       | (1,237  | )    |         |         | -1.7%  |   |         | $       | 163,841 |   |         | $       | 150,693 |   |        | $       | 13,148  |   |         |         | 8.7%   | 
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|Net premiums written                                                |                                         | $                                | 61,149 |            |                                 | $ | 61,661  |        |            | $ | (512    | )       |         |      | -0.8%   |         |        | $ | 141,088 |         |         | $ | 128,395 |         |         | $ | 12,693 |         |         |   | 9.9%    |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|Net premiums earned:                                                |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |         |         |   |        |         |         |   |         |        
|                                                                    | Excluding Gerling                       |                                  | $      | 44,169     |                                 |   | $       | 41,043 |            |   | $       | 3,126   |         |      |         | 7.6%    |        |   | $       | 129,347 |         |   | $       | 118,903 |         |   | $      | 10,444  |         |   |         | 8.8%    |       
|                                                                    | Impact of Gerling commutation           |                                  |        |           |                                 |   |         |       |            |   |         |        |         |      |         |         |        |   |         | 837     |         |   |         |        |         |   |        | 837     |         |   |         |         |       
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|                                                                    |                                         | Total                            |        |            | 44,169                          |   |         |        | 41,043     |   |         |         | 3,126   |      |         |         | 7.6%   |   |         |         | 130,184 |   |         |         | 118,903 |   |        |         | 11,281  |   |         |         | 9.5%   | 
|Incurred loss and loss adjustment expenses:                         |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |         |         |   |        |         |         |   |         |        
|                                                                    | Current accident year losses            |                                  |        | 36,881     |                                 |   |         | 40,823 |            |   |         | (3,942  | )       |      |         | -9.7%   |        |   |         | 112,557 |         |   |         | 118,242 |         |   |        | (5,685  | )       |   |         | -4.8%   |       
|                                                                    | Prior year losses  Gerling commutation |                                  |        |           |                                 |   |         |       |            |   |         |        |         |      |         |         |        |   |         | 4,139   |         |   |         |        |         |   |        | 4,139   |         |   |         |         |       
|                                                                    | Prior year losses, excluding Gerling    |                                  |        | (700       | )                               |   |         | 43,000 |            |   |         | (43,700 | )       |      |         | -101.6% |        |   |         | (5,549  | )       |   |         | 44,250  |         |   |        | (49,799 | )       |   |         | -112.5% |       
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|                                                                    |                                         | Total                            |        |            | 36,181                          |   |         |        | 83,823     |   |         |         | (47,642 | )    |         |         | -56.8% |   |         |         | 111,147 |   |         |         | 162,492 |   |        |         | (51,345 | ) |         |         | -31.6% | 
|Underwriting expenses                                               |                                         |                                  | 9,185  |            |                                 |   | 7,770   |        |            |   | 1,415   |         |         |      | 18.2%   |         |        |   | 27,340  |         |         |   | 22,662  |         |         |   | 4,678  |         |         |   | 20.6%   |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|Underwriting loss                                                   |                                         | $                                | (1,197 | )          |                                 | $ | (50,550 | )      |            | $ | 49,353  |         |         |      | 97.6%   |         |        | $ | (8,303  | )       |         | $ | (66,251 | )       |         | $ | 57,948 |         |         |   | 87.5%   |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|Income (loss) before federal income taxes
    and minority interest |                                         | $                                | 8,103  |            |                                 | $ | (41,591 | )      |            | $ | 49,694  |         |         |      | -119.5% |         |        | $ | 23,874  |         |         | $ | (39,933 | )       |         | $ | 63,807 |         |         |   | -159.8% |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|Loss ratio:                                                         |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |         |         |   |        |         |         |   |         |        
|                                                                    | Accident year                           |                                  |        | 83.5%      |                                 |   |         | 99.5%  |            |   |         | -16.0%  |         |      |         |         |        |   |         | 86.5%   |         |   |         | 99.4%   |         |   |        | -12.9%  |         |   |         |         |       
|                                                                    | Prior years                             |                                  |        | -1.6%      |                                 |   |         | 104.8% |            |   |         | -106.4% |         |      |         |         |        |   |         | -1.1%   |         |   |         | 37.2%   |         |   |        | -38.3%  |         |   |         |         |       
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|                                                                    | Calendar year                           |                                  |        | 81.9%      |                                 |   |         | 204.3% |            |   |         | -122.4% |         |      |         |         |        |   |         | 85.4%   |         |   |         | 136.6%  |         |   |        | -51.2%  |         |   |         |         |       
|Underwriting expense ratio                                          |                                         |                                  | 20.8%  |            |                                 |   | 18.9%   |        |            |   | 1.9%    |         |         |      |         |         |        |   | 21.0%   |         |         |   | 19.1%   |         |         |   | 1.9%   |         |         |   |         |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        
|Combined ratio                                                      |                                         |                                  | 102.7% |            |                                 |   | 223.2%  |        |            |   | -120.5% |         |         |      |         |         |        |   | 106.4%  |         |         |   | 155.7%  |         |         |   | -49.3% |         |         |   |         |        
|                                                                    |                                         |                                  |        |            |                                 |   |         |        |            |   |         |         |         |      |         |         |        |   |         |         |         |   |         |        

Direct premiums written for the nine months ended
September 30, 2004 increased $13.1 million compared to
the same period in 2003. This increase was primarily the result
of rate increases, particularly in the states of Michigan,
Illinois and Ohio. The Michigan and Illinois rate increase took
effect April 1, 2004. These increases were partially offset by
reduced physician counts in Kentucky and Ohio, where we have
discontinued writing occurrence-based policies and other
high-risk specialties, Florida, which we began to exit in late
2002, and Illinois, where our historic retention rates have
dropped since the rate increase took effect April 1, 2004.
At September 30, 2004, our insured physician count totaled
approximately 9,750, down 6.6% from December 31, 2003 and
7.6% from September 30, 2003. The majority of the direct
premiums written in the state of Florida during 2004 were from
our consolidated subsidiary, Physicians Insurance Company
(PIC). See Note 2 of the Notes to unaudited
Condensed Consolidated Financial Statements, included elsewhere
in this report, for further information regarding PIC. We are
currently exploring various options to sell our investment in
PIC to PICs other investor. We anticipate that direct
premiums written in this segment will continue to increase in
the near-term, as we implement additional rate increases.
However, direct

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premiums written may not increase in the future
if the marketplace puts pressure on pricing increases, which may
result in a decrease in our market share in certain geographic
regions as we remain committed to our strategy of strict
underwriting and adequate pricing.


The decrease in direct premiums written for the
three months ended September 30, 2004 compared to the three
months ended September 30, 2003 was primarily the result of
decreased physician counts described above, particularly in the
Ohio and Illinois markets, partially offset by the rate
increases described above and an increase in insured physicians
in our New Mexico market.

As a percentage of direct premiums written, net
premiums written were 86.4% and 86.1% for the three months and
nine months ended September 30, 2004, respectively,
compared to 85.6% and 85.2%, respectively, for the same periods
of 2003. These slight increases are attributable to the
retention of a 30% participation in our primary medical
professional liability excess of loss contract, which reinsures
the first $500,000 of a loss in excess of $500,000. We began
retaining this 30% participation effective January 1, 2004.
Partially offsetting this increase in retention was an increase
in the overall cost of our reinsurance program. In addition, we
anticipate that the retention of the additional participation
will result in an increase in net incurred losses. However, we
expect the effect of the increase in net premiums written and
earned will most likely offset the anticipated increase in net
incurred losses.

Net premiums earned increased for the three
months and nine months ended September 30, 2004, compared
to the three and nine months ended September 30, 2003, as
we continue to earn in rate increases taken over the
last year. Most policies are written with a one-year policy
term. Therefore, it may take a full year before the rate
increases fully impact net premiums earned.

Incurred loss and loss adjustment expenses
decreased primarily as a result of a $43.0 million increase
in prior year loss reserves in the third quarter of 2004. To a
lesser extent, the decreases were a result of decreases in
reported claims and net paid losses. On an accident year basis,
the loss ratio for the three months and nine months ended
September 30, 2004 was 83.5% and 86.5%, respectively. This
compares to accident year loss ratios of 99.5% and 99.4% for the
same periods of 2003. The decreases in the accident year loss
ratio were primarily attributable to higher premium rates,
decreases in net paid losses and lower reported claim counts.

The commutation of our reinsurance treaties with
Gerling in the second quarter of 2004 had the effect of
increasing medical professional liability losses incurred during
the nine months ended September 30, 2004 by approximately
$4.1 million. The losses covered under the Gerling treaties
all related to prior accident years. Excluding the effect of the
Gerling commutation, prior year reserves developed favorably by
$700,000 in the third quarter of 2004 and $5.5 million for
the nine months ended September 30, 2004. This favorable
development is the result of claims settling for amounts less
than originally projected by actuarial estimates and reported
loss frequency developing more favorably than anticipated at
December 31, 2003, especially in our Michigan and Ohio
markets. The improved 2004 accident year loss ratios combined
with the Gerling commutation and other prior year development
resulted in a decrease of the calendar year loss ratios to 81.9%
and 85.4% for the three months and nine months ended
September 30, 2004, respectively.

The following table shows reported claim counts,
claims closed with a loss or loss adjustment expense payment,
net paid loss and loss adjustment expenses, and the average net
paid loss and loss adjustment expense per claim closed with a
payment.

|               |  |                 |       |               |              |  |                     |                        |  |                         |                           |  |  |      |       |  |      |   |        |      |  |   |         |  |  |   |        |  |  |   |        | 
|-------------- |  | --------------- | ----- | ------------- | ------------ |  | ------------------- | ---------------------- |  | ----------------------- | ------------------------- |  |  | ---- | ----- |  | ---- | - | ------ | ---- |  | - | ------- |  |  | - | ------ |  |  | - | ------ | 
|               |  |                 |       |               |              |  |                     |                        |  |                         |                           | 
|               |  |                 |       |               |              |  |                     | Net Paid Loss and Loss |  |                         | Average Net Paid Loss and | 
|               |  |                 |       | Claims Closed |              |  | Adjustment Expenses |                        |  | Loss adjustment Expense |                          
|               |  | Reported Claims |       |               | with Payment |  |                     | (In thousands)         |  |                         | per Closed Claim          | 
|               |  |                 |       |               |              |  |                     |                        |  |                         |                           | 
|               |  | 2004            |       |               | 2003         |  |                     | 2004                   |  |                         | 2003                      |  |  | 2004 |       |  | 2003 |   |        | 2004 |  |   | 2003    | 
|               |  |                 |       |               |              |  |                     |                        |  |                         |                           |  |  |      |       |  |      |   |        |      |  |   |         | 
|First quarter  |  |                 | 525   |               |              |  | 803                 |                        |  |                         | 575                       |  |  |      | 547   |  |      | $ | 31,885 |      |  | $ | 39,117  |  |  | $ | 55,452 |  |  | $ | 71,512 | 
|Second quarter |  |                 | 459   |               |              |  | 694                 |                        |  |                         | 565                       |  |  |      | 606   |  |      |   | 32,113 |      |  |   | 36,562  |  |  |   | 56,837 |  |  |   | 60,333 | 
|               |  |                 |       |               |              |  |                     |                        |  |                         |                           |  |  |      |       |  |      |   |        |      |  |   |         | 
|Year to date   |  |                 | 984   |               |              |  | 1,497               |                        |  |                         | 1,140                     |  |  |      | 1,153 |  |      |   | 63,998 |      |  |   | 75,679  |  |  |   | 56,139 |  |  |   | 65,637 | 
|Third quarter  |  |                 | 431   |               |              |  | 631                 |                        |  |                         | 379                       |  |  |      | 481   |  |      |   | 31,299 |      |  |   | 39,517  |  |  |   | 82,583 |  |  |   | 82,156 | 
|               |  |                 |       |               |              |  |                     |                        |  |                         |                           |  |  |      |       |  |      |   |        |      |  |   |         | 
|Year to date   |  |                 | 1,415 |               |              |  | 2,128               |                        |  |                         | 1,519                     |  |  |      | 1,634 |  |      |   | 95,297 |      |  |   | 115,196 |  |  |   | 62,737 |  |  |   | 70,499 | 
|               |  |                 |       |               |              |  |                     |                        |  |                         |                           |  |  |      |       |  |      |   |        |      |  |   |         | 

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The table above does not include claim counts or
net paid loss and loss adjustment expenses for PIC, as the claim
count information was not available to us. Net paid loss and
loss adjustment expenses for PIC excluded from the table above
were $153,000, $107,000 and $80,000 for the first, second and
third quarters of 2004, respectively. Also excluded from the
table above were approximately $12.5 million of ceded paid
loss and loss adjustment expenses in the second quarter of 2004
and year to date 2004 amounts related to the Gerling
commutation. The inclusion of these ceded paid loss and loss
adjustment expense amounts would have decreased net paid loss
and loss adjustment expenses by approximately
$12.5 million, and would have resulted in amounts that were
not meaningful for purposes of the analysis, nor accurately
reflect the paid activity for the periods. Had the Gerling ceded
paid losses been included, net paid loss and loss adjustment
expenses for the second quarter of 2004, the second quarter
2004 year to date, and the third quarter 2004 year to date
would have been $19.7 million, $51.5 million and
$82.8 million, respectively, and the average net paid loss
and loss adjustment expense per closed claim for the same
periods would have been $34,791, $45,212 and $54,537,
respectively.

We believe that the decreases in our paid losses
and reported claim counts are the result of stricter
underwriting standards that we have worked to implement over the
past few years.

The increase in underwriting expenses is
attributable to the payment of severance costs relating to a
reduction in headcount and an increase in professional service
costs relating to our initial internal controls audit required
by the Sarbanes Oxley Act and related SEC rules, as discussed
under  Consolidated Results of Operations.



| |                                                
| | -----------------------------------------------
| | Other Insurance Lines Results of
    Operations

The following table sets forth the results of
operations of our other insurance lines segment for the
three months and nine months ended September 30,
2004 and 2003. The other insurance lines segment consists of the
run-off operations of our workers compensation, health and
personal and commercial lines of business.

|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |        |        |   |         |         |         |   |          |         |        | 
|------------------------------------------------------------ | --------------------------------------- | -------------------------------- | ------ | ---------- | ------------------------------- | - | ------ | ------ | ---------- | - | ------- | ------- | ------- | ---- | -------- | ------- | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------- | ------- | ------- | - | -------- | ------- | ------ | 
|                                                             |                                         |                                  |        |           
|                                                             |                                         | Three Months Ended September 30, |        |            | Nine Months Ended September 30, |  
|                                                             |                                         |                                  |        |            |                                 |  
|                                                             |                                         |                                  |        | Percentage |                                 |   |        |        | Percentage |  
|                                                             |                                         | 2004                             |        |            | 2003                            |   |        | Change |            |   | Change  |         |         | 2004 |          |         | 2003   |   |        | Change |        |   | Change |       
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|                                                             |                                         |                                 
|                                                             |                                         | (dollars in thousands)           |       
|Direct premiums written:                                     |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |        |        |   |         |         |         |   |          |        
|                                                             | Workers compensation                    |                                  | $      | (37        | )                               |   | $      | 12,426 |            |   | $       | (12,463 | )       |      |          | -100.3% |        |   | $      | (10    | )      |   | $      | 32,594 |        |   | $       | (32,604 | )       |   |          | -100.0% |       
|                                                             | Health                                  |                                  |        | 2,343      |                                 |   |        | 5,513  |            |   |         | (3,170  | )       |      |          | -57.5%  |        |   |        | 8,948  |        |   |        | 18,095 |        |   |         | (9,147  | )       |   |          | -50.5%  |       
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|                                                             |                                         | Total                            |        | $          | 2,306                           |   |        | $      | 17,939     |   |         | $       | (15,633 | )    |          |         | -87.1% |   |        | $      | 8,938  |   |        | $      | 50,689 |   |         | $       | (41,751 | ) |          |         | -82.4% | 
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|Net premiums written                                         |                                         | $                                | 2,574  |            |                                 | $ | 17,710 |        |            | $ | (15,136 | )       |         |      | -85.5%   |         |        | $ | 8,716  |        |        | $ | 50,807 |        |        | $ | (42,091 | )       |         |   | -82.8%   |        
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|Net premiums earned                                          |                                         | $                                | 4,586  |            |                                 | $ | 15,545 |        |            | $ | (10,959 | )       |         |      | -70.5%   |         |        | $ | 23,775 |        |        | $ | 50,617 |        |        | $ | (26,842 | )       |         |   | -53.0%   |        
|Incurred loss and loss adjustment expenses:                  |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |        |        |   |         |         |         |   |          |        
|                                                             | Current accident year losses            |                                  |        | 4,706      |                                 |   |        | 12,517 |            |   |         | (7,811  | )       |      |          | -62.4%  |        |   |        | 21,088 |        |   |        | 42,177 |        |   |         | (21,089 | )       |   |          | -50.0%  |       
|                                                             | Prior year losses  Gerling commutation |                                  |        |           |                                 |   |        |       |            |   |         |        |         |      |          |         |        |   |        | 271    |        |   |        |       |        |   |         | 271     |         |   |          |         |       
|                                                             | Prior year losses, excluding Gerling    |                                  |        | 1,886      |                                 |   |        | 381    |            |   |         | 1,505   |         |      |          | -395.0% |        |   |        | 5,194  |        |   |        | (936   | )      |   |         | 6,130   |         |   |          | 654.9%  |       
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|                                                             |                                         | Total                            |        |            | 6,592                           |   |        |        | 12,898     |   |         |         | (6,306  | )    |          |         | -48.9% |   |        |        | 26,553 |   |        |        | 41,241 |   |         |         | (14,688 | ) |          |         | -35.6% | 
|Underwriting expenses                                        |                                         |                                  | 653    |            |                                 |   | 3,951  |        |            |   | (3,298  | )       |         |      | -83.5%   |         |        |   | 6,646  |        |        |   | 14,166 |        |        |   | (7,520  | )       |         |   | -53.1%   |        
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|Underwriting loss                                            |                                         | $                                | (2,659 | )          |                                 | $ | (1,304 | )      |            | $ | (1,355  | )       |         |      | -103.9%  |         |        | $ | (9,424 | )      |        | $ | (4,790 | )      |        | $ | (4,634  | )       |         |   | -96.7%   |        
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|Income before federal income taxes and minority
    interest |                                         | $                                | (2,143 | )          |                                 | $ | 150    |        |            | $ | (2,293  | )       |         |      | -1528.7% |         |        | $ | (6,460 | )      |        | $ | (135   | )      |        | $ | (6,325  | )       |         |   | -4685.2% |        
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|Loss ratio:                                                  |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |        |        |   |         |         |         |   |          |        
|                                                             | Accident year                           |                                  |        | 102.6%     |                                 |   |        | 80.5%  |            |   |         | 22.1%   |         |      |          |         |        |   |        | 88.7%  |        |   |        | 83.3%  |        |   |         | 5.4%    |         |   |          |         |       
|                                                             | Prior years                             |                                  |        | 41.1%      |                                 |   |        | 2.5%   |            |   |         | 38.6%   |         |      |          |         |        |   |        | 23.0%  |        |   |        | -1.8%  |        |   |         | 24.8%   |         |   |          |         |       
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|                                                             | Calendar year                           |                                  |        | 143.7%     |                                 |   |        | 83.0%  |            |   |         | 60.7%   |         |      |          |         |        |   |        | 111.7% |        |   |        | 81.5%  |        |   |         | 30.2%   |         |   |          |         |       
|Underwriting expense ratio                                   |                                         |                                  | 14.2%  |            |                                 |   | 25.4%  |        |            |   | -11.2%  |         |         |      |          |         |        |   | 28.0%  |        |        |   | 28.0%  |        |        |   | 0.0%    |         |         |   |          |        
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       
|Combined ratio                                               |                                         |                                  | 157.9% |            |                                 |   | 108.4% |        |            |   | 49.5%   |         |         |      |          |         |        |   | 139.7% |        |        |   | 109.5% |        |        |   | 30.2%   |         |         |   |          |        
|                                                             |                                         |                                  |        |            |                                 |   |        |        |            |   |         |         |         |      |          |         |        |   |        |        |        |   |        |       

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The decreases in direct premiums written were the
result of our continued exit from the workers compensation
and health lines of business. In the first quarter of 2004, we
began the process of non-renewing all workers compensation
policies. In addition, as is often the case when a company
announces its exit from a certain line of business, a number of
our policyholders with policies currently in-force cancelled
their coverage. As a result, we have reported negative
workers compensation direct premiums written for both the
three months and nine months ended September 30, 2004.

Due to certain contractual obligations with a
third-party who administers a substantial portion of our health
insurance business we were not able to begin non-renewing health
policies until July 1, 2004. However, during the first six
months of 2004, we implemented very strict underwriting and
pricing guidelines that resulted in a reduction in the number of
covered lives to 4,258 at June 30, 2004, a decrease of
35.0% from December 31, 2003. The number of covered lives
has continued to decrease to 3,274 at September 30, 2004.
This represents a 23.1% decrease from June 30, 2004, a
50.0% decrease from December 31, 2003, and a 59.4% decrease
from September 30, 2003. As a result of the decrease in the
number of covered lives, health direct premiums written for the
three months and nine months ended September 30, 2004
decreased $3.2 million and $9.1 million, respectively,
compared to the same periods of 2003.

The decreases in net premiums written were
relatively consistent with the decreases in direct premiums
written. Net premiums earned, however, did not decrease as much
as direct and net premiums written as premiums associated with
workers compensation policies written in 2003 continue to
be earned in 2004. As of September 30, 2004, there remained
approximately $1.4 million of net unearned premiums related
to our workers compensation line. We anticipate that the
majority of these premiums will be earned during the remainder
of 2004. In addition, we anticipate that direct and net premiums
written as well as net premiums earned related to our other
insurance lines will continue to decrease as we continue the
process of non-renewing policies during our exit from these
lines.

Incurred loss and loss adjustment expenses
decreased primarily as a result of the decrease in exposure
associated with the reduced number of covered lives in our
health line, and the number of policies in-force for
workers compensation. Prior year workers
compensation reserves developed unfavorably during the quarter
by $2.0 million and year-to-date by $5.8 million. The
unfavorable development on prior accident years for the nine
months ended September 30, 2004 includes $271,000 related
to the Gerling commutation. The unfavorable development on prior
accident year reserves for workers compensation is
primarily the result of increasing reserve estimates due to
higher paid losses than those originally projected in the
estimation of the year-end 2003 reserves. In addition, with the
centralization of workers compensation claims processing
in our Louisville, Kentucky office, and in an effort to expedite
the run-off process, we have reviewed all claim files and
attempted to settle claims as quickly as possible. This
increased effort has resulted in higher reported losses than
those originally projected in the December 31, 2003 reserve
estimates. As we continue the run-off of workers
compensation claims, we anticipate that loss reserves will
continue to be volatile and additional adverse development on
prior year losses may occur.

The decrease in underwriting expenses is
primarily the result of reduced salary and employee benefit
costs as a result of the departure of the workers
compensation management team in the last nine months of 2003.
Also, as a result of the decreased premium volume, there was a
decrease in corporate and shared services salary, employee
benefit and other costs allocated to the other insurance lines
segment. As we continue our exit from these lines, these
underwriting expenses should continue to decrease.

Offsetting the decrease in underwriting expenses
as a result of the aforementioned items was a charge of
approximately $300,000 to write off the remaining deferred
policy acquisition cost asset related to workers
compensation. Managements assessment, based on the current
workers compensation accident year loss ratio and
estimates for ongoing policy maintenance expenses, after taking
into consideration future investment earnings, did not support
the recoverability of the deferred policy acquisition costs. The
assessment, however, did not indicate the need for a premium
deficiency reserve, and none has been recorded.

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| |                    
| | -------------------
| | Corporate and Other

Loss before federal income taxes and minority
interests for this segment was $1.2 million for the three
months ended September 30, 2004 compared to a loss of
$1.0 million for the three months ended September 30,
2003. For the nine months ended September 30, 2004, this
segment incurred a loss before federal income taxes and minority
interest of $4.3 million compared to a $2.2 million
loss for the same period of 2003. The increases in the loss were
attributable to increases in general and administrative expenses
and interest expense, which are described more fully in
 Consolidated Results of Operations.

Liquidity and Capital Resources

The primary sources of our liquidity, on both a
short- and long-term basis, are funds provided by insurance
premiums collected, net investment income, recoveries from
reinsurers and proceeds from the maturity or sale of invested
assets. We also enter into financing transactions from time to
time to acquire additional capital, such as the issuance of
trust preferred securities and related 30 year debentures
in May 2003, which resulted in the incurrence of
$30.9 million in long-term debt, as described in
Note 9 of the Notes to Consolidated Financial Statements
included in our Annual Report on Form 10-K for the year
ended December 31, 2003. The primary uses of cash, on both
a short- and long-term basis, are losses, loss adjustment
expenses, operating expenses, the acquisition of invested assets
and fixed assets, reinsurance premiums, interest payments, and
taxes.

Our holding companys only material assets
are the capital stock of American Physicians and its other
subsidiaries, and cash. APCapitals cash flow consists
primarily of dividends and other permissible payments from its
subsidiaries and investment earnings on funds held. The payment
of dividends to APCapital by its insurance subsidiaries is
subject to limitations imposed by applicable law. Currently,
approximately $14.8 million of dividends could be paid to
APCapital without prior approval by the State of Michigan Office
of Financial and Insurance Services. APCapitals primary
uses of cash, on both a short- and long-term basis, include
periodic interest payments, operating expenses and the repayment
of the debentures. In January 2004, APCapital made a
$25 million surplus contribution to its American Physicians
subsidiary, and in May 2004, APCapital contributed all of the
outstanding common stock of APSpecialty Insurance Corporation
(APSpecialty) to American Physicians. The purpose of
the contributions was to increase American Physicians
statutory capital and surplus, which is a critical factor in the
financial stability rating process by insurance rating agencies
such as A.M. Best. At September 30, 2004,
APCapitals cash and cash equivalent resources totaled
approximately $2.0 million, which will be held at the
holding company for future debt service and other operating
costs. In addition, APCapital is exploring the possibility of
raising additional capital that could then be maintained at the
holding company level for future debt service and other
operating costs, as well as contributed downstream as surplus to
the various insurance subsidiaries.

American Physicians entered into a stock purchase
agreement on September 17, 2004, with various shareholders
of Physicians Insurance Company of Wisconsin, Inc.
(PICW) to acquire a substantial minority interest in
PICW. The stock purchase agreement states that American
Physicians will purchase 4,450 shares of PICW common stock
at a purchase price of $3,800 per share in cash, or
approximately $17 million. The closing of the purchase is
subject to various conditions, including the receipt of approval
from Wisconsins Office of the Commissioner of Insurance.
Subsequent to the signing of the original stock purchase
agreement, American Physicians is negotiating an amendment to
the prior stock purchase agreement to purchase another 332
shares of PICW stock at the same price. American Physicians may
make additional purchases from other PICW shareholders. Other
than the investment in PICW stock, pending regulatory approval,
we have no material planned expenditures for the acquisition of
assets, or other expenditures, other than expenses incurred in
the normal course of operations.

The Board of Directors has authorized the Company
to purchase shares of its outstanding common stock from time to
time, most recently in September 2003. There were no shares
repurchased during the three or nine months ended
September 30, 2004. The total number of shares purchased
pursuant to these authorizations as of September 30, 2004
and December 31, 2003 was 3,197,070, at a total cost of
$60,382,000, or an average price per share of $18.89. The
Companys repurchase of any of its shares is subject to
limitations that

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may be imposed by applicable laws and regulations
and the rules of the Nasdaq Stock Market. The timing of the
purchases and the number of shares to be bought at any one time
depend on market conditions and the Companys capital
requirements. As of September 30, 2004, the Company has
418,369 shares of its September, 2003 stock repurchase program
remaining to be purchased. The Company does not anticipate
repurchasing any of its shares in the near future, as it plans
to conserve capital to support future premium growth.


Our net cash flow provided by operations was
$25.7 million for the nine months ended September 30,
2004, compared to $8.9 million used in operations for the
same period of 2003. The increase in cash flow from operations
was primarily the result of a $50.4 million decrease in net
paid losses (including the $13.5 million received from
Gerling) for the nine months ended September 30, 2004
compared to 2003. The increase in cash provided was partially
offset by an $11.0 million payment for ceded reinsurance
premiums in February 2004 related to our swing-rated
reinsurance treaties and by a $3.0 million decrease in cash
relating to pending security transactions.

At September 30, 2004, the Company had
$198.1 million of cash and cash equivalents available and
an investment portfolio of $639.2 million. The portfolio
includes $79.9 million of bonds maturing in the next year
to meet short-term cash flow needs. On a long-term basis, fixed
income securities are purchased on a basis intended to provide
adequate cash flows from future maturities to meet future
policyholder obligations and ongoing cash needs to fund
operations. As of September 30, 2004, our fixed maturity
portfolio included $237.4 million of bonds that mature in
the next one to five years and $90.5 million that mature in
the next five to ten years. In addition, at September 30,
2004, we have $140.5 million of mortgage-backed securities
that provide periodic principal repayments.

Except as set forth elsewhere in this section,
based on historical trends, market conditions and our business
plans, we believe that our existing resources and sources of
funds, including possible dividend payments from our insurance
subsidiaries to our holding company, will be sufficient to meet
our short- and long-term liquidity needs. However, economic,
market and regulatory conditions may change, and there can be no
assurance that our funds will be sufficient to meet these
liquidity needs.

Financial Condition

In evaluating our financial condition, two
factors are the most critical: (1) the availability of
adequate statutory capital and surplus to satisfy state
regulatory requirements and our current A.M. Best Company
rating, and (2) the adequacy of our reserves for unpaid
loss and loss adjustment expenses.



| |                              
| | -----------------------------
| | Statutory Capital and Surplus

Our statutory capital and surplus (collectively
referred to herein as surplus) at September 30,
2004 was approximately $204.4 million, after eliminating
the stacking effect of APSpecialtys surplus, which is also
included in American Physicians due to the two companies
parent-subsidiary relationship. The $204.4 million of
surplus results in a net premiums written to surplus ratio of
0.94:1. Surplus at December 31, 2003 was approximately
$150.3 million, yielding a net premiums written to surplus
ratio of 1.49:1. The decrease in our ratio of net premiums
written to surplus was primarily the result of the
$25 million cash capital contribution, the reported
statutory net income of the insurance subsidiaries, and a
$42.3 million decrease in workers compensation and
health net premiums written due to our exit of these lines. The
continued exit from the workers compensation and health
insurance lines of business in 2004 is expected to make
additional surplus available to support future medical
professional liability premiums. However, due to the adverse
development on prior years workers compensation
reserves recorded through September 30, 2004, and the
continued volatility of workers compensation loss
reserves, management is considering the possibility of a surplus
contribution to the Companys Insurance Corporation of
America insurance subsidiary. Management intends to make a full
assessment of each insurance companys surplus needs prior
to December 31, 2004, and may transfer surplus among the
various insurance subsidiaries, or if additional capital is
raised at the holding company level, some of that capital may be
downstreamed to increase insurance subsidiary surplus levels.

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| |                                                            
| | -----------------------------------------------------------
| | Reserves for Unpaid Losses and Loss
    Adjustment Expenses

For the nine months ended September 30,
2004, we recorded an increase in ultimate loss estimates, net of
reinsurance, for accident years 2003 and prior of
$4.1 million, or 0.7% of $574.6 million of net loss
and loss adjustment expense reserves as of December 31,
2003. This result includes $5.5 million of favorable
development attributable to our medical professional liability
segment, offset by $5.2 million of unfavorable development
on our other insurance lines segment, primarily workers
compensation, and $4.4 million of unfavorable development
on prior year reserves attributable to the commutation of our
reinsurance treaties with Gerling. The unfavorable development
on prior accident year reserves for workers compensation
is primarily the result of increasing reserve estimates due to
higher paid losses than those originally projected in the
estimation of the year-end 2003 reserves. In addition, with the
centralization of workers compensation claims processing
in our Louisville, Kentucky office, and in an effort to expedite
the run-off process, we have reviewed all claim files and
attempted to settle claims as quickly as possible. This
increased effort has resulted in higher reported losses than
those originally projected in the December 31, 2003 reserve
estimates. Historical results have shown that ultimate losses
have varied from our initial estimates in a range of plus or
minus 8%.

The following table shows net case reserves, net
incurred but not reported (IBNR) claims reserves,
total net reserves, open claim counts, and average net case
reserve per open claim for our medical professional liability
segment at September 30, 2004 and December 31, 2003.
Amounts included in the table exclude claim counts, case and
IBNR reserves of PIC. Although PIC is a consolidated entity, we
do not control or manage it and we are currently exploring
various options to divest our investment in PIC. PIC net case
reserves were $732,000 and $82,000 at September 30, 2004
and December 31, 2003, respectively, while its net IBNR
reserves were $720,000 and $284,000, respectively, at the same
dates.

|                   |  |                                                                                 |         |  |          |   |         |           |  |   |             |  |  |                |       |   |  |   |         |  
|------------------ |  | ------------------------------------------------------------------------------- | ------- |  | -------- | - | ------- | --------- |  | - | ----------- |  |  | -------------- | ----- | - |  | - | ------- | -
|                   |  |                                                                                 |         |  |          |   |         | Number of |  |   | Average Net | 
|                   |  | Net Case                                                                        |         |  | Net IBNR |   |         | Total Net |  |   | Open        |  |  | Case Reserve   |      
|                   |  | Reserves                                                                        |         |  | Reserves |   |         | Reserves  |  |   | Claims      |  |  | Per Open Claim |      
|                   |  |                                                                                 |         |  |          |   |         |           |  |   |             |  |  |                |      
|                   |  |                                                                                
|                   |  | (In thousands, except claim counts and average net case reserve per open claim) |        
|December 31, 2003  |  | $                                                                               | 389,439 |  |          | $ | 117,522 |           |  | $ | 506,961     |  |  |                | 4,447 |   |  | $ | 87,573  |  
|Change             |  |                                                                                 | 3,463   |  |          |   | 23,418  |           |  |   | 26,881      |  |  |                | (644  | ) |  |   | (5,377  | )
|                   |  |                                                                                 |         |  |          |   |         |           |  |   |             |  |  |                |      
|September 30, 2004 |  | $                                                                               | 392,902 |  |          | $ | 140,940 |           |  | $ | 533,842     |  |  |                | 3,803 |   |  | $ | 103,314 |  
|                   |  |                                                                                 |         |  |          |   |         |           |  |   |             |  |  |                |      

Net IBNR reserves have increased approximately
$23.4 million from December 31, 2003 in part due to
the commutation of the Gerling reinsurance treaties, which
resulted in an increase of approximately $5.1 million. In
addition, our efforts to standardize our claims handling and
processing across our various regional offices resulted in a
decrease in net case reserves and an increase in net IBNR
related to our New Mexico business of approximately
$5 million. The remaining $13.3 million increase in
IBNR was the result of the favorable reported loss development
during the first nine months of 2004 having a less significant
impact on the actuarial estimate of ultimate losses than it did
on recorded case reserves. Quarterly reported loss volatility
can have a significant impact on changes in IBNR because the
reported loss development in a single quarter, while directly
impacting our net case reserves, does not always represent
enough data to significantly change the trends used by actuaries
to estimate ultimate losses that form the basis for our
determination of total net reserves.

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Activity in the liability for unpaid loss and
loss adjustment expenses by insurance segment for the nine
months ended September 30, 2004 was as follows:

|                                                         |                                |                |         |         |           |   |        |              |        |   |         |         |         | 
|-------------------------------------------------------- | ------------------------------ | -------------- | ------- | ------- | --------- | - | ------ | ------------ | ------ | - | ------- | ------- | ------- | 
|                                                         |                                | Medical        |         |         | Other     |   |        |             
|                                                         |                                | Professional   |         |         | Insurance |   |        |             
|                                                         |                                | Liability      |         |         | Lines     |   |        | Consolidated |       
|                                                         |                                |                |         |         |           |   |        |              |       
|                                                         |                                |               
|                                                         |                                | (In thousands) |        
|Balance, December 31, 2003                               |                                | $              | 598,329 |         |           | $ | 75,276 |              |        | $ | 673,605 |        
|                                                         | Less, reinsurance recoverables |                |         | 91,002  |           |   |        | 7,956        |        |   |         | 98,958  |        
|                                                         |                                |                |         |         |           |   |        |              |       
|Net reserves, December 31, 2003                          |                                |                | 507,327 |         |           |   | 67,320 |              |        |   | 574,647 |        
|Incurred related to                                      |                                |                |         |         |           |   |        |              |        |   |         |        
|                                                         | Current year                   |                |         | 112,557 |           |   |        | 21,088       |        |   |         | 133,645 |        
|                                                         | Prior years                    |                |         | (1,410  | )         |   |        | 5,465        |        |   |         | 4,055   |        
|                                                         |                                |                |         |         |           |   |        |              |       
|                                                         |                                | Total          |         |         | 111,147   |   |        |              | 26,553 |   |         |         | 137,700 | 
|                                                         |                                |                |         |         |           |   |        |              |       
|Paid related to                                          |                                |                |         |         |           |   |        |              |        |   |         |        
|                                                         | Current year                   |                |         | 2,158   |           |   |        | 10,213       |        |   |         | 12,371  |        
|                                                         | Prior years                    |                |         | 81,023  |           |   |        | 26,128       |        |   |         | 107,151 |        
|                                                         |                                |                |         |         |           |   |        |              |       
|                                                         |                                | Total          |         |         | 83,181    |   |        |              | 36,341 |   |         |         | 119,522 | 
|                                                         |                                |                |         |         |           |   |        |              |       
|Net reserves, September 30, 2004                         |                                |                | 535,293 |         |           |   | 57,532 |              |        |   | 592,825 |        
|                                                         | Plus, reinsurance recoverables |                |         | 94,775  |           |   |        | 3,960        |        |   |         | 98,735  |        
|                                                         |                                |                |         |         |           |   |        |              |       
|Balance, September 30, 2004                              |                                | $              | 630,068 |         |           | $ | 61,492 |              |        | $ | 691,560 |        
|                                                         |                                |                |         |         |           |   |        |              |       
|Development as a % of December 31, 2003 net
    reserves |                                |                | -0.3%   |         |           |   | 8.1%   |              |        |   | 0.7%    |        
|                                                         |                                |                |         |         |           |   |        |              |       



| |                                          
| | -----------------------------------------
| | Other Significant Balance Sheet
    Items

Our invested assets consist primarily of fixed
maturity and equity securities, which are carried in the
unaudited Condensed Consolidated Balance Sheets, included
elsewhere in this report, at their estimated fair value, as well
as investment real estate, and investment real estate limited
partnerships. At September 30, 2004, our investment
portfolio included net unrealized gains of approximately
$29.7 million, a decrease of $15.9 million compared to
December 31, 2003. Net unrealized gains are reported net of
tax and the intra-period tax allocation related to the change in
the deferred tax valuation allowance associated with unrealized
gains, in the shareholders equity section of the unaudited
Condensed Consolidated Balance Sheets, and represented
approximately 6.9% and 14.7% of consolidated shareholders
equity at September 30, 2004 and December 31, 2003,
respectively. The decrease in unrealized gains was the result of
an increase in interest rates primarily in the second quarter of
2004, combined with the realization of approximately
$3.8 million, net of tax, of gains on the sale of
investment securities held at December 31, 2003. Generally,
the estimated fair value of our fixed maturity securities is
inversely related to current interest rates. Therefore, as
interest rates rise or fall, our net unrealized gains should
change accordingly. See Item 3 
Quantitative and Qualitative Disclosure About Market Risk,
for further information regarding the potential impact of
changes in prevailing interest rates on the fair value of our
fixed maturity portfolio. The cross-referenced information is
incorporated herein by reference.

Premiums receivable decreased $3.8 million,
or 5.8%, to $61.6 million at September 30, 2004. The
decrease in the premiums receivable balance was primarily the
result of the collection of workers compensation premiums
written in 2003, partially offset by the increase in medical
professional liability direct premiums written in the third
quarter of 2004 as compared to the fourth quarter of 2003.

Reinsurance recoverables increased $486,000 to
$104.1 million at September 30, 2004, from
$103.7 million at December 31, 2003. The increase was
primarily the result an increase in ceded case reserves, as
several claims have been recently reserved at levels above our
retention of $500,000 and an increase in ceded IBNR, partially
offset by the Gerling Commutation, which resulted in a decrease
of $17.9 million. At September 30, 2004, we had a
$3.3 million reinsurance recoverable from PMA Capital
Insurance Company (PMACIC). On July 29, 2004,
PMA Capital, PMACICs parent company, announced that it had
revised the companys corporate structure and had separated
its ongoing operations from its run-off operations, which
include PMACIC. This action may have a negative impact on
PMACICs future cash flows and surplus

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levels, and we continue to monitor PMACICs
capital and surplus, as well as its cash flows, closely. In
addition, in the third quarter and early fourth quarter of 2004,
the financial strength rating of Converium Reinsurance
(NA), Inc. (Converium), was downgraded by
A.M. Best Company (A.M. Best) from
A (Excellent) to B- (Fair). At
September 30, 2004, we had a $1.9 million recoverable
from Converium. We have not experienced any delays in payments
from PMACIC or Converium and we are closely monitoring the
financial condition and cash flows of these two reinsurance
companies.


At September 30, 2004 and December 31,
2003, we have no recorded deferred federal income tax assets due
to the establishment of a valuation allowance during 2003. The
valuation allowance was established in the third quarter of 2003
as the Companys recent loss experience increased the
uncertainty with respect to the generation of sufficient taxable
income in the periods when the deductible temporary differences
that gave rise to the deferred tax assets are expected to
reverse. Once the Company has re-established a pattern of
profitability, the deferred tax asset valuation allowance may be
reduced in whole or in part upon evaluation of the availability
of future taxable income.

Other assets increased $2.0 million from
$41.0 million at December 31, 2003 to
$43.0 million at September 30, 2004. This increase was
a result of a $3.4 million increase in receivables for
pending securities transactions, partially offset by the
amortization and write-off of deferred policy acquisition costs
as we continue to run-off our workers compensation line of
business, and the $2.5 million write-off of the
professional liability policy administration computer system
described in  Consolidated Results of
Operations. A pending security transaction liability
results when we purchase securities near the end of the period,
but those security transactions did not settle until after the
end of the period.

Unearned premiums decreased $1.7 million
from $103.8 million at December 31, 2003 to
$102.1 million at September 30, 2004. This decrease
was primarily the result of our exit from the workers
compensation line of business, which continues to earn premiums
written in 2003, partially offset by the increase in medical
professional liability direct premiums written during the third
quarter of 2004 compared to the fourth quarter of 2003. As of
September 30, 2004, workers compensation unearned
premiums were $1.4 million, a decrease of
$15.1 million compared to $16.5 million at
December 31, 2003.

The $6.0 million obligation to our former
President and CEO recorded at December 31, 2003 was paid in
its entirety in January 2004 in connection with his retirement.

Other liabilities decreased $10.3 million
from $44.7 million at December 31, 2003 to
$34.4 million at September 30, 2004. In addition to
accounts payable and other accruals, other liabilities includes
ceded reinsurance premium payable, advanced premiums and a
liability account for pending security transactions. The
$10.3 million decrease is primarily the result of a
decrease in the ceded reinsurance premiums payable of
$6.2 million during the period as a result of an
$11.0 million payment made in February related to our
swing rated medical professional liability
reinsurance treaty, a $1.8 million decrease in premiums
received in advance of the policys effective date, and a
decrease in accounts payable and other accruals of approximately
$2.7 million. The decrease in accounts payable and other
accruals was the result of payments made to the State of
Minnesota for assessments related to workers compensation
business written in 2002 and 2003.

Shareholders equity at September 30,
2004 was $200.7 million, a decrease of $1.1 million
from $201.8 million at December 31, 2003. The decrease
was primarily attributable to the unrealized depreciation on
investment securities, which, net of tax, totaled
$15.8 million for the period. The decrease was partially
offset by reported net income of $13.5 million for the nine
months ended September 30, 2004 and an increase of
additional paid in capital of $1.4 million related to stock
options exercised and other stock-based compensation awards. The
Companys book value per common share outstanding at
September 30, 2004 was $23.54 per share, based on
8,527,677 shares outstanding, compared to $23.89 per common
share outstanding at December 31, 2003. Total shares
outstanding at December 31, 2003 were 8,445,807.

Contractual Obligations and Off-Balance Sheet
Arrangements

Our contractual obligations and off-balance sheet
arrangements are described in Item 7 
Managements Discussion and Analysis of Financial Condition
and Results of Operations contained in our Annual

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Report on Form 10-K for the year ended
December 31, 2003. Except as described elsewhere in this
report on Form 10-Q (including American Physicians
obligation to purchase PICW shares subject to regulatory
approval), there have been no material changes to those
obligations or arrangements outside of the ordinary course of
business during the most recent quarter.


Effects of New Accounting
Pronouncements

The effects of new accounting pronouncements are
described in Note 2 to the unaudited Condensed Consolidated
Financial Statements included elsewhere in this report.





|        |                                                               
|------- | --------------------------------------------------------------
|ITEM 3. | Quantitative and Qualitative Disclosures About
    Market Risk

General

Market risk is the risk of loss due to adverse
changes in market rates and prices. We invest primarily in fixed
maturity securities, which are interest-sensitive assets.
Accordingly, our primary market risk is exposure to changes in
interest rates.

As of September 30, 2004, the majority of
our investment portfolio was invested in fixed maturity
securities and short-term investments. The fixed maturity
securities primarily consisted of U.S. government and
agency bonds, high-quality corporate bonds, mortgage-backed
securities and tax-exempt U.S. municipal bonds.

Qualitative Information About Market
Risk

Investments in our portfolio have varying degrees
of risk. The primary market risk exposure to the fixed maturity
portfolio is interest rate risk, which is limited somewhat by
our management of duration. The distribution of maturities and
sector concentrations are monitored on a regular basis.

Equity securities are carried at quoted market
values. The fair value of publicly traded fixed maturity
securities is based upon independent market quotations. The fair
value of non-publicly traded securities is based on independent
third party pricing sources that use valuation models. The
valuation models used by the independent third party pricing
sources use indicative information such as ratings, industry,
coupon, and maturity along with publicly traded bond prices to
determine security specific spreads, and the ultimate fair value
of the non-publicly traded fixed maturity securities. Realized
gains or losses on sales or maturities of investments are
determined on a specific identification basis and are credited
or charged to income.

At September 30, 2004, all of our fixed
maturity portfolio (excluding approximately $13.8 million
of private placement issues) was considered investment grade. We
define investment grade securities as those that have a
Standard & Poors credit rating of BBB and above.
Non-investment grade securities typically bear more credit risk
than those of investment grade quality. Credit risk is the risk
that amounts due the Company by creditors may not ultimately be
collected. We periodically review our investment portfolio for
any potential credit quality or collection issues and for any
securities with respect to which we consider any decline in
market value to be other than temporary.

The Companys fixed maturity portfolio
includes the interest-only portion of several mortgage-backed
securities. Unlike traditional fixed maturity securities, the
fair value of these investments is not inversely related to
interest rates, but rather, moves in the same direction as
interest rates as the underlying financial instruments are
mortgage-backed securities. In addition, with mortgage-backed
securities, as interest rates rise, prepayments will decrease,
which means that the interest-only certificates will generally
generate interest for a longer period of time than originally
anticipated, which in turn will increase the fair value of these
investments. At September 30, 2004, the Company had
interest-only mortgage-backed securities with an estimated fair
value of $8.1 million.

Approximately $5.4 million of these
interest-only certificates have an inverse floating rate of
interest tied to LIBOR. The Company has determined that these
inverse floating interest-only certificates contain
an embedded derivative as defined by SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities. Because the Company cannot readily segregate
the fair value of the embedded derivative from the host debt
instrument, the entire change in the fair value of these inverse
floating interest-only certificates is

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reported in earnings as investment income. For
the three and nine months ended September 30, 2004, a loss
of approximately $912,000 and $619,000, respectively, was
included in investment income for the change in fair value of
the inverse floating interest-only certificates, compared with a
gain of $65,000 and $465,000, respectively, for the same periods
of 2003.


Quantitative Information About Market
Risk

At September 30, 2004, our fixed income
security portfolio was valued at $621.1 million and had an
average modified duration of 2.40 years, compared to a
portfolio valued at $694.6 million with an average modified
duration of 2.89 years at December 31, 2003. Of the
$621.1 million at September 30, 2004,
$8.1 million were interest-only certificates that had a
modified duration of 1.00 year. The following tables show the
effects of a change in interest rates on the fair value and
duration of our entire fixed maturity portfolio at
September 30, 2004 and December 31, 2003, and then
separately for our interest-only certificates. We have assumed
an immediate increase or decrease of 1% or 2% in interest rate
for illustrative purposes. You should not consider this
assumption or the values shown in the table to be a prediction
of actual future results.

Entire Fixed Maturity Portfolio (Including
Interest-Only Certificates)

|                |  |                        |         |  |                        |   |         |          |  |  |           |  |  |           |         |  |          |   |         |   |  |  |      | 
|--------------- |  | ---------------------- | ------- |  | ---------------------- | - | ------- | -------- |  |  | --------- |  |  | --------- | ------- |  | -------- | - | ------- | - |  |  | ---- | 
|                |  |                        |         | 
|                |  | September 30, 2004     |         |  | December 31, 2003      |  
|                |  |                        |         |  |                        |  
|                |  | Portfolio              |         |  | Change in              |   |         | Modified |  |  | Portfolio |  |  | Change in |         |  | Modified |  
|Change in Rates |  | Value                  |         |  | Value                  |   |         | Duration |  |  | Value     |  |  | Value     |         |  | Duration |  
|                |  |                        |         |  |                        |   |         |          |  |  |           |  |  |           |         |  |          |  
|                |  |                        |         | 
|                |  | (dollars in thousands) |         |  | (dollars in thousands) |  
|+2%             |  | $                      | 588,677 |  |                        | $ | (32,455 | )        |  |  | 3.02      |  |  | $         | 664,072 |  |          | $ | (30,561 | ) |  |  | 3.07 | 
|+1%             |  |                        | 608,519 |  |                        |   | (12,613 | )        |  |  | 2.53      |  |  |           | 680,389 |  |          |   | (14,244 | ) |  |  | 2.81 | 
|0               |  |                        | 621,132 |  |                        |   |         |          |  |  | 2.40      |  |  |           | 694,633 |  |          |   |         |   |  |  | 2.89 | 
|-1%             |  |                        | 628,969 |  |                        |   | 7,837   |          |  |  | 2.11      |  |  |           | 708,257 |  |          |   | 13,624  |   |  |  | 2.80 | 
|-2%             |  |                        | 640,923 |  |                        |   | 19,791  |          |  |  | 2.17      |  |  |           | 726,316 |  |          |   | 31,683  |   |  |  | 2.87 | 

Interest-Only Certificates

|                |  |                        |        |  |                        |   |        |          |  |  |           |  |  |           |        |  |          |   |        |   |  |  |      | 
|--------------- |  | ---------------------- | ------ |  | ---------------------- | - | ------ | -------- |  |  | --------- |  |  | --------- | ------ |  | -------- | - | ------ | - |  |  | ---- | 
|                |  |                        |        | 
|                |  | September 30, 2004     |        |  | December 31, 2003      |  
|                |  |                        |        |  |                        |  
|                |  | Portfolio              |        |  | Change in              |   |        | Modified |  |  | Portfolio |  |  | Change in |        |  | Modified |  
|Change in Rates |  | Value                  |        |  | Value                  |   |        | Duration |  |  | Value     |  |  | Value     |        |  | Duration |  
|                |  |                        |        |  |                        |   |        |          |  |  |           |  |  |           |        |  |          |  
|                |  |                        |        | 
|                |  | (dollars in thousands) |        |  | (dollars in thousands) |  
|+2%             |  | $                      | 13,583 |  |                        | $ | 5,518  |          |  |  | 1.76      |  |  | $         | 19,217 |  |          | $ | 5,751  |   |  |  | 1.57 | 
|+1%             |  |                        | 12,298 |  |                        |   | 4,233  |          |  |  | 1.59      |  |  |           | 17,792 |  |          |   | 4,326  |   |  |  | 1.44 | 
|0               |  |                        | 8,065  |  |                        |   |        |          |  |  | 1.00      |  |  |           | 13,466 |  |          |   |        |   |  |  | 1.02 | 
|-1%             |  |                        | 3,304  |  |                        |   | (4,761 | )        |  |  | 0.37      |  |  |           | 7,136  |  |          |   | (6,330 | ) |  |  | 1.03 | 
|-2%             |  |                        | 2,252  |  |                        |   | (5,813 | )        |  |  | 0.30      |  |  |           | 5,536  |  |          |   | (7,930 | ) |  |  | 0.42 | 





|        |                        
|------- | -----------------------
|ITEM 4. | Controls and Procedures

As of the end of the period covered by this
report, the Company carried out an evaluation, under the
supervision and with the participation of the Companys
management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities
Exchange Act of 1934. Based upon that evaluation, the
Companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls
and procedures are effective to cause the material information
required to be disclosed by the Company in the reports that it
files or submits under the Securities Exchange Act of 1934 to be
recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms. There have
been no changes in the Companys internal controls over
financial reporting during the quarter ended September 30,
2004 that have materially affected, or are reasonably likely to
materially affect the Companys internal controls over
financial reporting.

35



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##### Table of Contents






PART II. OTHER INFORMATION




ITEM 4.     Submission
of Matters to a Vote of a Security Holders

The Company held its Annual Meeting of
Shareholders on August 4, 2004, at which the shareholders
elected four directors. Dr. Berglund was an incumbent,
while the other three nominees were nominated for their first
term. All nominees were elected. The following table sets forth
the number of shares voted for and withheld with respect to each
nominee.

|                         |  |       |           |  |          |  |        | 
|------------------------ |  | ----- | --------- |  | -------- |  | ------ | 
|                         |  | Votes |           |  | Votes    | 
|Nominee                  |  | For   |           |  | Withheld | 
|                         |  |       |           |  |          | 
|R. Kevin Clinton         |  |       | 7,974,425 |  |          |  | 13,641 | 
|Thomas R. Berglund, M.D. |  |       | 7,986,725 |  |          |  | 1,341  | 
|Daniel L. Gorman         |  |       | 7,986,725 |  |          |  | 1,341  | 
|D. Joseph Olson, J.D.    |  |       | 7,986,315 |  |          |  | 1,751  | 




ITEM 5.     Other
Information.

(a) As of September 15, 2004, the
Company entered into an amendment to the Standstill Agreement,
dated as of February 20, 2002, as amended, with Joseph
Stilwell, certain affiliates of Mr. Stilwell and Spencer
Schneider, a director of the Company (the Stilwell
Group). The amendment increased the limit on the shares of
the Companys common stock that could be owned by the
Stilwell Group from 5% to 9.9% and added two additional
affiliates of Mr. Stilwell to the Stilwell Group.




ITEM 6. Exhibits

Exhibits.

The Exhibits included as part of this report are
listed in the attached Exhibit Index, which is incorporated
herein by reference.

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##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned thereunto duly
authorized.

Date: November 9, 2004



| |                                  
| | ---------------------------------
| | AMERICAN PHYSICIANS CAPITAL, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ R. KEVIN CLINTON

| |                                           
| | ------------------------------------------
| |                                           
| | R. Kevin Clinton                          
| | Its: President and Chief Executive Officer



| |     |                    
| | --- | -------------------
| | By: | /s/ FRANK H. FREUND

| |                                          
| | -----------------------------------------
| |                                          
| | Frank H. Freund                          
| | Its: Executive Vice President, Treasurer,
| | Chief Financial Officer and              
| | principal accounting officer             

37



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##### Table of Contents






EXHIBIT INDEX

|            |      |   |                     |                                                                                                                                                                                                                       
|----------- | ---- | - | ------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |      |   | Exhibit Description
|            |      |   |                    
|            | 10.3 | 8 |                     | Summary of 2004 Short-Term Incentive Plan                                                                                                                                                                             
|            | 10.3 | 9 |                     | Amendment dated, October 31, 2002, to the
    Standstill Agreement, dated February 20, 2002                                                                                                                           
|            | 10.4 | 0 |                     | Amendment dated, September 15, 2004, to the
    Standstill Agreement dated, dated February 20, 2002, as
    amended by Amendment No. 1 dated October 31, 2002                                                         
|            | 31.1 |   |                     | Certification of Chief Executive Officer pursuant
    to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                                                    
|            | 31.2 |   |                     | Certification of Chief Financial Officer pursuant
    to Rule 13a-14(a) under the Securities Exchange Act of 1934.                                                                                                    
|            | 32   |   |                     | Certification of Chief Executive Officer and
    Chief Financial Officer pursuant to 18 U.S.C.
    Section 1350 and Rule 13a-14(b) under the Securities
    Exchange Act of 1934.                                     
|            | 99.1 |   |                     | Stock Purchase Agreement with Exhibits, dated as
    of September 17, 2004, by and among American Physicians
    Assurance Corporation and certain shareholders of Physicians
    Insurance Company of Wisconsin, Inc.

38