##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington D.C. 20549




---

Form 10-Q

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|  
|   |  | For the quarter ended March 31,
    2004                                                    
|  
|or
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-14094

Meadowbrook Insurance Group, Inc.

(Exact name of registrant as specified in its
charter)


|                         |  |                                  
|------------------------ |  | ---------------------------------
|Michigan                 |  | 38-2626206                       
|(State of Incorporation) |  | (IRS Employer Identification No.)

26600 Telegraph Road, Southfield, Michigan
48034

(Address, zip code of principal executive
offices)


(248) 358-1100

(Registrants telephone number, including
area code)




---

Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.     Yes þ          No o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange
Act).     Yes þ          No o

The aggregate number of shares of the
Registrants Common Stock, $.01 par value, outstanding
on May 6, 2004 was 29,034,433.



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TABLE OF CONTENTS

|                                              |  |                                                                                           |    |      |       | 
|--------------------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | ----- | 
|                                              |  |                                                                                           |    | Page
|                                              |  |                                                                                           |    |     
|PART I 
    FINANCIAL INFORMATION           
|ITEM 1.                                       |  | FINANCIAL STATEMENTS                                                                      |    |      |       | 
|                                              |  | Consolidated Statements of
    Income (unaudited)                                         |    |      | 2     | 
|                                              |  | Consolidated Statements of
    Comprehensive Income (unaudited)                           |    |      | 3     | 
|                                              |  | Consolidated Balance Sheets
    (unaudited)                                               |    |      | 4     | 
|                                              |  | Consolidated Statement of
    Cash Flows (unaudited)                                      |    |      | 5     | 
|                                              |  | Notes to Consolidated
    Financial Statements (unaudited)                                |    |      | 6-15  | 
|                                              |  | Management Representation                                                                 |    |      | 16    | 
|ITEM 2.                                       |  | MANAGEMENTS DISCUSSION
    AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |    |      | 17-29 | 
|ITEM 3.                                       |  | QUANTITATIVE AND QUALITATIVE
    DISCLOSURES ABOUT MARKET RISK                            |    |      | 29    | 
|ITEM 4.                                       |  | CONTROLS AND PROCEDURES                                                                   |    |      | 29    | 
|PART II  OTHER
    INFORMATION              
|ITEM 1.                                       |  | LEGAL PROCEEDINGS                                                                         |    |      | 30    | 
|ITEM 2.                                       |  | CHANGES IN SECURITIES, USE
    OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES      |    |      | 30    | 
|ITEM 6.                                       |  | EXHIBITS AND REPORTS ON FORM
    8-K                                                      |    |      | 30    | 
|SIGNATURES                                    |  |                                                                                           | 31 |     
|Tri-Party Agreement, dated March 24, 2004    
|Fourth Amendment To Restated Credit Agreement
|Fifth Amendment To Restated Credit Agreement 
|Certification of Robert S. Cubbin, CEO       
|Certification of Karen M. Spaun, SVP and CFO 
|906 Certification of Chief Executive Officer 
|906 Certification of SVP and CFO             



1



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##### Table of Contents






PART 1  FINANCIAL
INFORMATION






|        |                     
|------- | --------------------
|ITEM 1. | Financial Statements

MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF INCOME


|                                             |                                                               |                            |       |            |         |   |       |            |         |  
|-------------------------------------------- | ------------------------------------------------------------- | -------------------------- | ----- | ---------- | ------- | - | ----- | ---------- | ------- | -
|                                             |                                                               |                           
|                                             |                                                               | For the Three Months Ended
|                                             |                                                               | March 31,                 
|                                             |                                                               |                           
|                                             |                                                               | 2004                       |       | 2003      
|                                             |                                                               |                            |       |           
|                                             |                                                               |                           
|                                             |                                                               | (Unaudited)               
|                                             |                                                               | (In thousands,            
|                                             |                                                               | except share data)        
|Revenues                                     |                                                               |                            |       |            |         |   |       |           
|                                             | Premiums earned                                               |                            |       |            |         |   |       |            |        
|                                             |                                                               | Gross                      |       | $          | 66,178  |   |       | $          | 45,313  |  
|                                             |                                                               | Ceded                      |       |            | (16,465 | ) |       |            | (17,929 | )
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             | Net earned                                                    |                            |       | 49,713     |         |   |       | 27,384     |        
|                                             | Net commissions and fees                                      |                            |       | 11,281     |         |   |       | 13,356     |        
|                                             | Net investment income                                         |                            |       | 3,597      |         |   |       | 3,353      |        
|                                             | Net realized (losses) gains on disposition
    of investments |                            |       | (120       | )       |   |       | 205        |        
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             |                                                               | Total revenues             |       |            | 64,471  |   |       |            | 44,298  |  
|                                             |                                                               |                            |       |            |         |   |       |           
|Expenses                                     |                                                               |                            |       |            |         |   |       |           
|                                             | Losses and loss adjustment expenses                           |                            |       | 51,414     |         |   |       | 27,323     |        
|                                             | Reinsurance recoveries                                        |                            |       | (18,905    | )       |   |       | (10,137    | )      
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             | Net losses and loss adjustment expenses                       |                            |       | 32,509     |         |   |       | 17,186     |        
|                                             | Salaries and employee benefits                                |                            |       | 12,808     |         |   |       | 11,932     |        
|                                             | Policy acquisition and other underwriting expenses            |                            |       | 7,562      |         |   |       | 3,756      |        
|                                             | Other administrative expenses                                 |                            |       | 6,628      |         |   |       | 7,084      |        
|                                             | Interest expense                                              |                            |       | 315        |         |   |       | 237        |        
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             |                                                               | Total expenses             |       |            | 59,822  |   |       |            | 40,195  |  
|                                             |                                                               |                            |       |            |         |   |       |           
|Income before taxes and equity earnings      |                                                               |                            | 4,649 |            |         |   | 4,103 |           
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             | Federal income tax expense                                    |                            |       | 1,440      |         |   |       | 1,347      |        
|                                             | Equity earnings of affiliates                                 |                            |       | 23         |         |   |       |           |        
|                                             |                                                               |                            |       |            |         |   |       |           
|Net income                                   |                                                               | $                          | 3,232 |            |         | $ | 2,756 |           
|                                             |                                                               |                            |       |            |         |   |       |           
|Earnings Per Share                           |                                                               |                            |       |            |         |   |       |           
|                                             | Basic                                                         |                            | $     | 0.11       |         |   | $     | 0.09       |        
|                                             | Diluted                                                       |                            | $     | 0.11       |         |   | $     | 0.09       |        
|Weighted average number of common
    shares |                                                               |                            |       |            |         |   |       |           
|                                             | Basic                                                         |                            |       | 29,025,509 |         |   |       | 29,503,567 |        
|                                             | Diluted                                                       |                            |       | 29,395,208 |         |   |       | 29,510,681 |        

The accompanying notes are an integral part of
the Consolidated Financial Statements.

2



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME


|           |                                         |                                                                                 |                                        |      |       |       |       |  |      |       | 
|---------- | --------------------------------------- | ------------------------------------------------------------------------------- | -------------------------------------- | ---- | ----- | ----- | ----- |  | ---- | ----- | 
|           |                                         |                                                                                
|           |                                         | For the Three                                                                  
|           |                                         | Months Ended                                                                   
|           |                                         | March 31,                                                                      
|           |                                         |                                                                                
|           |                                         | 2004                                                                            |                                        | 2003
|           |                                         |                                                                                 |                                        |     
|           |                                         |                                                                                
|           |                                         | (Unaudited)                                                                    
|           |                                         | (In thousands)                                                                 
|Net income |                                         | $                                                                               | 3,232                                  |      |       | $     | 2,756 | 
|           | Other comprehensive income, net of tax: |                                                                                 |                                        |      |       |       |       |  |     
|           |                                         | Unrealized gains on securities                                                  |                                        |      | 1,734 |       |       |  | 292  |      
|           |                                         | Less: reclassification adjustment for losses
    (gains) included in net income |                                        |      | 73    |       |       |  | (141 | )    
|           |                                         |                                                                                 |                                        |      |       |       |       | 
|           |                                         |                                                                                 | Other comprehensive income, net of tax |      |       | 1,807 |       |  |      | 151   | 
|           |                                         |                                                                                 |                                        |      |       |       |       | 
|           |                                         |                                                                                 | Comprehensive income                   |      | $     | 5,039 |       |  | $    | 2,907 | 
|           |                                         |                                                                                 |                                        |      |       |       |       | 

The accompanying notes are an integral part of
the Consolidated Financial Statements.

3



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED BALANCE SHEETS


|                                         |                                                                                                                                 |                                            |   |              |         |  |   |         |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | - | ------------ | ------- |  | - | ------- | ------- | 
|                                         |                                                                                                                                 | March 31,                                  |   | December 31,
|                                         |                                                                                                                                 | 2004                                       |   | 2003        
|                                         |                                                                                                                                 |                                            |   |             
|                                         |                                                                                                                                 | (Unaudited)                                |   |             
|                                         |                                                                                                                                 |                                           
|                                         |                                                                                                                                 | (In thousands, except share               
|                                         |                                                                                                                                 | data)                                     
|ASSETS                                  
|Investments                              |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         | Debt securities available for sale, at fair value
    (amortized cost of $284,367 and $260,330)                                 |                                            | $ | 297,993      |         |  | $ | 271,217 |        
|                                         | Equity securities available for sale, at fair
    value (cost of $1,980 and $1,980)                                             |                                            |   | 2,393        |         |  |   | 2,371   |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total investments                          |   |              | 300,386 |  |   |         | 273,588 | 
|                                         | Cash and cash equivalents                                                                                                       |                                            |   | 37,522       |         |  |   | 50,647  |        
|                                         | Accrued investment income                                                                                                       |                                            |   | 3,473        |         |  |   | 3,441   |        
|                                         | Premiums and agent balances receivable, net                                                                                     |                                            |   | 88,699       |         |  |   | 77,554  |        
|                                         | Reinsurance recoverable on:                                                                                                     |                                            |   |              |         |  |   |         |        
|                                         |                                                                                                                                 | Paid losses                                |   |              | 16,746  |  |   |         | 17,566  | 
|                                         |                                                                                                                                 | Unpaid losses                              |   |              | 152,337 |  |   |         | 147,446 | 
|                                         | Prepaid reinsurance premiums                                                                                                    |                                            |   | 22,556       |         |  |   | 20,492  |        
|                                         | Deferred policy acquisition costs                                                                                               |                                            |   | 22,340       |         |  |   | 19,564  |        
|                                         | Deferred federal income taxes                                                                                                   |                                            |   | 14,324       |         |  |   | 15,201  |        
|                                         | Goodwill                                                                                                                        |                                            |   | 28,997       |         |  |   | 28,997  |        
|                                         | Other assets                                                                                                                    |                                            |   | 37,598       |         |  |   | 37,770  |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total assets                               |   | $            | 724,978 |  |   | $       | 692,266 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                        
|LIABILITIES AND SHAREHOLDERS
    EQUITY
|Liabilities                              |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         | Losses and loss adjustment expenses                                                                                             |                                            | $ | 349,801      |         |  | $ | 339,465 |        
|                                         | Unearned premiums                                                                                                               |                                            |   | 124,554      |         |  |   | 109,677 |        
|                                         | Debt                                                                                                                            |                                            |   | 17,692       |         |  |   | 17,506  |        
|                                         | Accounts payable and accrued expenses                                                                                           |                                            |   | 31,554       |         |  |   | 26,283  |        
|                                         | Reinsurance funds held and balances payable                                                                                     |                                            |   | 15,385       |         |  |   | 13,961  |        
|                                         | Junior subordinated debentures                                                                                                  |                                            |   | 10,310       |         |  |   | 10,310  |        
|                                         | Payable to insurance companies                                                                                                  |                                            |   | 3,833        |         |  |   | 7,853   |        
|                                         | Other liabilities                                                                                                               |                                            |   | 11,584       |         |  |   | 12,098  |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total liabilities                          |   |              | 564,713 |  |   |         | 537,153 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|Commitments and contingencies (Note 7)   |                                                                                                                                 |                                            |   |              |         |  |   |        
|Shareholders Equity                     |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         | Common stock, $0.01 stated value; authorized
    50,000,000 shares; 29,034,433 and 29,022,435 shares issued and
    outstanding |                                            |   | 290          |         |  |   | 290     |        
|                                         | Additional paid-in capital                                                                                                      |                                            |   | 125,243      |         |  |   | 125,181 |        
|                                         | Retained earnings                                                                                                               |                                            |   | 26,347       |         |  |   | 23,069  |        
|                                         | Note receivable from officer                                                                                                    |                                            |   | (881         | )       |  |   | (886    | )      
|                                         | Accumulated other comprehensive income                                                                                          |                                            |   | 9,266        |         |  |   | 7,459   |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total shareholders equity                 |   |              | 160,265 |  |   |         | 155,113 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total liabilities and shareholders equity |   | $            | 724,978 |  |   | $       | 692,266 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        

The accompanying notes are an integral part of
the Consolidated Financial Statements.

4



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF CASH
FLOWS


|                                     |                                                                                                 |                                                          |                   |         |         |        |   |         |         |        | 
|------------------------------------ | ----------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ----------------- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | For the Three Months                                    
|                                     |                                                                                                 | Ended March 31,                                         
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | 2004                                                     |                   | 2003   
|                                     |                                                                                                 |                                                          |                   |        
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | (Unaudited)                                             
|                                     |                                                                                                 | (In thousands)                                          
|Cash Flows From Operating Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Net income                                                                                      |                                                          | $                 | 3,232   |         |        | $ | 2,756   |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Adjustments to reconcile net income to net cash
    provided by (used in) operating activities: |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Amortization of goodwill and other intangible
    assets |                   |         | 99      |        |   |         | 70      |       
|                                     |                                                                                                 | Amortization of deferred debenture issuance costs        |                   |         | 11      |        |   |         |        |       
|                                     |                                                                                                 | Depreciation of furniture and equipment                  |                   |         | 275     |        |   |         | 380     |       
|                                     |                                                                                                 | Net accretion of discount and premiums on bonds          |                   |         | 318     |        |   |         | 470     |       
|                                     |                                                                                                 | Gain on sale of investments                              |                   |         | 110     |        |   |         | (214    | )     
|                                     |                                                                                                 | Stock-based employee compensation                        |                   |         | 27      |        |   |         | 86      |       
|                                     |                                                                                                 | Deferred income tax (benefit) expense                    |                   |         | (77     | )      |   |         | 1,347   |       
|                                     | Changes in operating assets and liabilities:                                                    |                                                          |                   |         |         |        |   |         |        
|                                     | Decrease (increase) in:                                                                         |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Premiums and agent balances receivable                   |                   |         | (10,882 | )      |   |         | (9,895  | )     
|                                     |                                                                                                 | Reinsurance recoverable on paid and unpaid losses        |                   |         | (2,459  | )      |   |         | 3,011   |       
|                                     |                                                                                                 | Prepaid reinsurance premiums                             |                   |         | (1,638  | )      |   |         | 942     |       
|                                     |                                                                                                 | Deferred policy acquisition costs                        |                   |         | (2,946  | )      |   |         | (3,762  | )     
|                                     |                                                                                                 | Other assets                                             |                   |         | 1,571   |        |   |         | (395    | )     
|                                     | Increase (decrease) in:                                                                         |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Losses and loss adjustment expenses                      |                   |         | 10,336  |        |   |         | (13,010 | )     
|                                     |                                                                                                 | Unearned premiums                                        |                   |         | 14,876  |        |   |         | 23,476  |       
|                                     |                                                                                                 | Payable to insurance companies                           |                   |         | (4,020  | )      |   |         | (888    | )     
|                                     |                                                                                                 | Reinsurance funds held and balances payable              |                   |         | 1,212   |        |   |         | 1,990   |       
|                                     |                                                                                                 | Other liabilities                                        |                   |         | 6,112   |        |   |         | 6,450   |       
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 |                                                          | Total adjustments |         |         | 12,925 |   |         |         | 10,058 | 
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash provided by operating activities                |                   |         | 16,157  |        |   |         | 12,814  |       
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|Cash Flows From Investing Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Purchase of debt securities available for sale                                                  |                                                          |                   | (38,582 | )       |        |   | (22,988 | )      
|                                     | Proceeds from sales and maturities of debt
    securities available for sale                    |                                                          |                   | 13,275  |         |        |   | 15,333  |        
|                                     | Capital expenditures                                                                            |                                                          |                   | (835    | )       |        |   | (215    | )      
|                                     | Purchase of books of business                                                                   |                                                          |                   | (187    | )       |        |   | (100    | )      
|                                     | Deconsolidation of subsidiary                                                                   |                                                          |                   | (4,218  | )       |        |   |        |        
|                                     | Other investing activities                                                                      |                                                          |                   | 1,496   |         |        |   | 267     |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash used in investing activities                    |                   |         | (29,051 | )      |   |         | (7,703  | )     
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|Cash Flows From Financing Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Proceeds from lines of credit                                                                   |                                                          |                   | 4,947   |         |        |   | 4,763   |        
|                                     | Payment of lines of credit                                                                      |                                                          |                   | (4,760  | )       |        |   | (16,225 | )      
|                                     | Book overdraft                                                                                  |                                                          |                   | (445    | )       |        |   | 1,831   |        
|                                     | Share issuance (repurchases)                                                                    |                                                          |                   | 22      |         |        |   | (546    | )      
|                                     | Other financing activities                                                                      |                                                          |                   | 5       |         |        |   | (9      | )      
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash used in by financing activities                 |                   |         | (231    | )      |   |         | (10,186 | )     
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Net decrease in cash and cash equivalents                                                       |                                                          |                   | (13,125 | )       |        |   | (5,075  | )      
|                                     | Cash and cash equivalents, beginning of period                                                  |                                                          |                   | 50,647  |         |        |   | 39,385  |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Cash and cash equivalents, end of period                                                        |                                                          | $                 | 37,522  |         |        | $ | 34,310  |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        

The accompanying notes are an integral part of
the Consolidated Financial Statements.

5



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##### Table of Contents






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(Unaudited)

Note 1  Summary of Significant
Accounting Policies



| |                      
| | ---------------------
| | Basis of Presentation

The consolidated financial statements include
accounts, after elimination of intercompany accounts and
transactions, of Meadowbrook Insurance Group, Inc. (the
Company), its wholly owned subsidiary Star Insurance
Company (Star), and Stars wholly owned
subsidiaries, Savers Property and Casualty Insurance Company,
Williamsburg National Insurance Company, and Ameritrust
Insurance Corporation (which are collectively referred to as the
Insurance Company Subsidiaries), and Preferred
Insurance Company, Ltd. The consolidated financial statements
also include Meadowbrook, Inc. and its subsidiaries, and Crest
Financial Corporation and its subsidiaries.

Effective January 1, 2004, the Company
deconsolidated its wholly-owned subsidiary, American Indemnity
Insurance Company, Ltd., (AIIC), due to the adoption
of Financial Accounting Standards Board Interpretation Number
(FIN) 46(R)  discussed further under
heading New Accounting Pronouncements.

These financial statements and the notes thereto
should be read in conjunction with the Companys audited
financial statements and accompanying notes included in its
Annual Report on Form 10-K for the year ended
December 31, 2003.

The consolidated financial statements reflect all
normal recurring adjustments, which were, in the opinion of
management, necessary to present a fair statement of the results
for the interim period. The results of operations for the three
months ended March 31, 2004, are not necessarily indicative
of the results expected for the full year.

Certain amounts in the 2003 financial statements
and notes to consolidated financial statements have been
reclassified to conform to the 2004 presentation.



| |                    
| | -------------------
| | Revenue Recognition

Premiums written are recognized as earned on a
pro rata basis over the life of the policy term. Unearned
premiums represent the portion of premiums written that are
applicable to the unexpired terms of policies in force.
Provisions for unearned premiums on reinsurance assumed from
others are made on the basis of ceding reports when received and
actuarial estimates. Certain premiums are subject to
retrospective premium adjustments. The estimated ultimate
premium is recognized over the term of the insurance contract.

Fee income, which includes risk management
consulting, loss control, and claims services, is recognized in
the period the services are provided. The claims processing fees
are recognized as revenue over the estimated life of the claims.
For those contracts that provide services beyond the
contractually defined termination date of the related contracts,
fees are deferred in an amount equal to managements
estimate of the Companys obligation to continue to provide
services.

Commission income, which includes reinsurance
brokerage, is recorded on the later of the effective date or the
billing date of the policies on which they were earned.
Commission income is reported net of sub-broker commission
expense. Commission and other adjustments are recorded when they
occur and the Company maintains an allowance for estimated
policy cancellations and commission returns.

The Company reviews, on an ongoing basis, the
collectibility of its receivables and establishes an allowance
for estimated uncollectible accounts.

Realized gains or losses on sale of investments
are determined on the basis of specific costs of the
investments. Dividend and interest income are recognized when
earned. Discount or premium on debt securities purchased at
other than par value is amortized using the constant yield
method. Investments with

6



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


other than temporary declines in fair value are
written down to their estimated net fair value and the related
realized losses are recognized in income.



| |                   
| | ------------------
| | Earnings Per Share

Basic earnings per share are based on the
weighted average number of common shares outstanding during the
period, while diluted earnings per share includes the weighted
average number of common shares and potential dilution from
shares issuable pursuant to stock options using the treasury
stock method.

Outstanding options of 1,036,796 and 2,685,223
for the periods ended March 31, 2004 and 2003,
respectively, have been excluded from the diluted earnings per
share, as they were anti-dilutive. Shares issuable pursuant to
stock options included in diluted earnings per share were
298,131 and 7,113 for the periods ended March 31, 2004 and
2003, respectively. In addition, shares issuable pursuant to
outstanding warrants included in diluted earnings per share were
71,568 for the period ended March 31, 2004. Outstanding
warrants of 300,000 for the period ended March 31, 2003,
have been excluded from the diluted earnings per share, as they
were anti-dilutive.



| |              
| | -------------
| | Stock Options

Effective January 1, 2003, the Company
adopted the requirements of Statement of Financial Accounting
Standards (SFAS) No. 148, Accounting for
Stock-Based Compensation  Transition and
Disclosure  an amendment of FASB Statement No.
123 utilizing the prospective method. Under the
prospective method, stock-based compensation expense is
recognized for awards granted after the beginning of the fiscal
year in which the change is made. Upon implementation of SFAS
No. 148 in 2003, the Company is recognizing stock-based
compensation expense for awards granted after January 1,
2003.

Prior to the adoption of SFAS No. 148, the
Company applied the intrinsic value-based provisions set forth
in APB Opinion No. 25. Under the intrinsic value method,
compensation expense is determined on the measurement date, that
is the first date on which both the number of shares the
employee is entitled to receive, and the exercise price are
known. Compensation expense, if any, resulting from stock
options granted by the Company is determined based on the
difference between the exercise price and the fair market value
of the underlying common stock at the date of grant. The
Companys Stock Option Plan requires the exercise price of
the grants to be at the current fair market value of the
underlying common stock.

The Company, through its 1995 and 2002 Stock
Option Plans (the Plans), may grant options to key
executives and other members of management of the Company and
its subsidiaries in amounts not to exceed 2,000,000 shares of
the Companys common stock allocated for each plan. The
Plans are administered by the Compensation Committee (the
Committee) of the Board of Directors. Option shares
may be exercised subject to the terms of the Plans and the terms
prescribed by the Committee at the time of grant. Currently, the
Plans options have either five or ten-year terms and are
exercisable and vest in equal increments over the option term.

7



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


If compensation cost for stock option grants had
been determined based on a fair value method, net income and
earnings per share on a pro forma basis for the three months
ending March 31, 2004 and 2003 would be as follows (in
thousands):

|                                                                                                                                                     |                       |               |       |      |  |   |       |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | ------------- | ----- | ---- |  | - | ----- | ---- | 
|                                                                                                                                                     |                       |              
|                                                                                                                                                     |                       | For the Three
|                                                                                                                                                     |                       | Months Ended 
|                                                                                                                                                     |                       | March 31,    
|                                                                                                                                                     |                       |              
|                                                                                                                                                     |                       | 2004          |       | 2003
|                                                                                                                                                     |                       |               |       |     
|Net income, as reported                                                                                                                              |                       | $             | 3,232 |      |  | $ | 2,756 |     
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                           |                       |               | 18    |      |  |   | 57    |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value-based methods for all
    awards, net of related tax effects |                       |               | (134  | )    |  |   | (286  | )   
|                                                                                                                                                     |                       |               |       |      |  |   |       |     
|Pro forma net income                                                                                                                                 |                       | $             | 3,116 |      |  | $ | 2,527 |     
|                                                                                                                                                     |                       |               |       |      |  |   |       |     
|Earnings per share:                                                                                                                                  |                       |               |       |      |  |   |       |     
|                                                                                                                                                     | Basic  as reported   |               | $     | 0.11 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Basic  pro forma     |               | $     | 0.11 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Diluted  as reported |               | $     | 0.11 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Diluted  pro forma   |               | $     | 0.11 |  |   | $     | 0.09 | 

The Black-Scholes valuation model utilized the
following annualized assumptions for 2003: Risk-free interest
rate of 2.90%, no dividends were declared in 2003, the
volatility factor for the expected market price of the
Companys common stock is 0.586, and the weighted average
expected life of options is 5.0 for the 2003 grants. No options
were granted during the three months ended March 31, 2004.

Compensation expense of $26,725 and $86,000 has
been recorded in the three months ended March 31, 2004 and
2003, respectively, under SFAS 148.



| |                              
| | -----------------------------
| | New Accounting Pronouncements

On May 15, 2003, the Financial Accounting
Standards Board (FASB) issued SFAS No. 150
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity. The
statement requires issuers to classify as liabilities (or assets
in some circumstances) three classes of freestanding financial
instruments that embody obligations for the issuer. Generally,
the statement is effective for financial instruments entered
into or modified after May 31, 2003, and is otherwise
effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of this standard had no
effect on the Companys financial statements.

In November 2002, the FASB issued FIN
No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN No. 45 clarifies the
requirements of SFAS No. 5, Accounting for
Contingencies, relating to a guarantors accounting
for, and disclosure of, the issuance of certain types of
guarantees. For certain guarantees issued after
December 31, 2002, FIN No. 45 requires a guarantor to
recognize, upon issuance of a guarantee, a liability for the
fair value of the obligations it assumes under the guarantee.
Guarantees issued prior to January 1, 2003, are not subject
to liability recognition, but are subject to expanded disclosure
requirements. Refer to Note 4 and Note 7 for additional
information regarding the effect of the adoption of FIN
No. 45.

In January 2003, the FASB issued FIN No. 46,
Consolidation of Variable Interest Entities. The
primary objective of FIN No. 46 is to provide guidance on
the identification of, and financial reporting for, entities
over which control is achieved through means other than voting
rights; such entities are known as variable interest entities.
FIN No. 46 requires variable interest entities to be
consolidated by the primary beneficiary of the variable interest
entities and expands disclosure requirements for both variable
interest

8



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


entities that are consolidated as well as those
within which an enterprise holds a significant variable
interest. In accordance with FIN 46, the Company performed an
evaluation of its business relationships and determined that
Meadowbrook Capital Trust I (Trust) was a variable
interest entity; however, it was also determined that the Trust
did not meet the qualifications for consolidation as the Trust
equity was deemed to not be at risk. The adoption of FIN
No. 46 did not have a material impact on the Companys
consolidated balance sheet or its consolidated statement of
income. See Note 4 for additional information regarding the
Companys unconsolidated subsidiary trust.

In December 2003, FIN 46 was revised as FIN 46(R)
to address certain implementation issues and to defer full
adoption into financial statements for periods ending after
March 15, 2004, with earlier adoption permitted. In
accordance with FIN 46(R), the Company performed an evaluation
of its business relationships and determined that its
wholly-owned subsidiary, AIIC, did not meet the tests for
consolidation, as neither the Company, nor its subsidiary Star,
are the primary beneficiaries of AIIC. Therefore, effective
January 1, 2004, the Company deconsolidated AIIC on a
prospective basis in accordance with the provisions of FIN
46(R). The adoption of FIN 46(R) and the deconsolidation of AIIC
did not have a material impact on the Companys
consolidated balance sheet or consolidated statement of income.

Note 2  Reinsurance

The Insurance Company Subsidiaries cede insurance
to other insurers under pro-rata and excess-of-loss contracts.
These reinsurance arrangements diversify the Companys
business and minimize its exposure to large losses or from
hazards of an unusual nature. The ceding of insurance does not
discharge the original insurer from its primary liability to its
policyholder. In the event that all or any of the reinsuring
companies are unable to meet their obligations, the Insurance
Company Subsidiaries would be liable for such defaulted amounts.
Therefore, the Company is subject to a credit risk with respect
to the obligations of its reinsurers. In order to minimize its
exposure to significant losses from reinsurer insolvencies, the
Company evaluates the financial condition of its reinsurers and
monitors the economic characteristics of the reinsurers on an
ongoing basis. The Company also assumes insurance from other
insurers and reinsurers, both domestic and foreign, under
pro-rata and excess-of-loss contracts.

At March 31, 2004, the Company had
reinsurance recoverables for paid and unpaid losses of
$169.1 million. The Company customarily collateralizes
reinsurance balances due from non-admitted reinsurers through
funds withheld trusts or letters of credit. The largest
unsecured reinsurance recoverable is due from an admitted
reinsurer with an A A.M. Best rating and accounts
for 33.7% of the total recoverable for paid and unpaid losses.

The Company maintains an excess-of-loss
reinsurance program designed to protect against large or unusual
loss and loss adjustment expense activity. The Company
determines the appropriate amount of reinsurance based on the
Companys evaluation of the risks accepted and analysis
prepared by consultants and reinsurers and on market conditions
including the availability and pricing of reinsurance. To date,
there have been no material disputes with the Companys
excess-of-loss reinsurers. No assurance can be given, however,
regarding the future ability of any of the Companys
excess-of-loss reinsurers to meet their obligations.

Under the workers compensation reinsurance
program, the reinsurers are responsible for 100% of each loss in
excess of $300,000 up to $5.0 million for each claimant. In
addition, there is coverage for loss events involving more than
one claimant up to $50.0 million per occurrence.

Under the core liability reinsurance treaty, the
reinsurers are responsible for 100% of each loss in excess of
$350,000 up to $2.0 million per occurrence. The Company
also purchases an additional $3.0 million of reinsurance
clash coverage in excess of the $2.0 million to cover
amounts that may be in excess of the $2.0 million policy
limit, such as expenses associated with the settlement of claims
or awards in excess of policy limits. The Company has a separate
structure to cover liability specifically related to commercial
trucking, where reinsurers are responsible for 100% of each loss
in excess of $350,000, up to $1.0 million. In addition, the
Company purchases an additional $1.0 million of reinsurance
clash coverage.

9



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Under the property reinsurance program,
reinsurers are responsible for 100% of the amount of each loss
in excess of $500,000 up to $5.0 million per location for
an occurrence. In addition, there is coverage for loss events
involving multiple locations up to $20.0 million after the
Company has incurred $750,000 in loss.

Effective August 1, 2003, the Company
entered into a reinsurance agreement for reinsurance coverage of
$4,500,000 in excess of $500,000 for each occurrence for
policies covering losses in excess of the self-insured retention
level for public entities. The reinsurance charge for this
coverage is a minimum of 11% of subject premium plus 110% of
losses ceded under this agreement; however, the adjusted premium
cannot exceed 54%, the maximum rate under the agreement, or be
less than the 11% minimum. Based upon an actuarial study, the
probability of a loss to reinsurers under this treaty is less
than 15% and does not transfer significant timing or
underwriting risk, therefore under the provisions of SFAS
No. 113 Accounting and Reporting for Reinsurance of
Short-Duration and Long-Duration Contracts and Statement
of Position 98-7 Deposit Accounting: Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer
Insurance Risk, the transactions under this treaty are
accounted for using the interest method of deposit accounting.
At March 31, 2004, for transactions under this contract,
the Company carried a prepaid asset of $1.6 million and a
deposit liability of $1.3 million. For the quarter ended
March 31, 2004, the Company recorded an operating expense
of $726,000 for the subject premium described above.

In addition, the Company purchases
$10.0 million in excess of $5.0 million for each
occurrence which is layered on top of the underlying
$5.0 million of coverage for a specific program. Under this
agreement, reinsurers are responsible for 100% of each loss in
excess of $5.0 million for all lines except workers
compensation, which is covered by the Companys core
catastrophic workers compensation structure up to
$50.0 million per occurrence.

Additionally, several small programs have
separate reinsurance treaties in place, which limit the
Companys exposure to $250,000 or less.

Facultative reinsurance treaty is purchased for
property values in excess of $5.0 million and casualty
limits excess of $2.0 million or for coverage not protected
by the treaty.

In its risk-sharing programs, the Company is also
subject to credit risk with respect to the payment of claims by
its clients captive, rent-a-captive, large deductible
programs, indemnification agreements, and on the portion of risk
exposure either ceded to the captives, or retained by the
clients. The capitalization and credit worthiness of prospective
risk-sharing partners is one of the factors considered by the
Company in entering into and renewing risk-sharing programs. The
Company collateralizes balances due from its risk-sharing
partners through funds withheld trusts or letters of credit. At
March 31, 2004, the Company had risk exposure in excess of
collateral in the amount of $10.4 million, on these
programs, of which the Company has an allowance of
$7.2 million, related to these exposures. The Company has
historically maintained an allowance for the potential
uncollectibility of certain reinsurance balances due from some
risk-sharing partners, some of which are in litigation with the
Company. At the end of each quarter, an analysis of these
exposures is conducted to determine the potential exposure to
uncollectibility. As of March 31, 2004, management believes
that this allowance is adequate. To date, the Company has not,
in the aggregate, experienced material difficulties in
collecting balances from its risk-sharing partners. No assurance
can be given, however, regarding the future ability of any of
the Companys risk-sharing partners to meet their
obligations. At March 31, 2004, the exposure amount in
litigation with former risk-sharing partners which is not
reserved or collateralized is $1.2 million.

Note 3  Debt

The Company has a credit agreement that includes
a term loan and a revolving line of credit. This credit
agreement consists of a $20.0 million term loan and a
revolving line of credit for up to $8.0 million. The
Company uses the revolving line of credit to meet short-term
working capital needs. At March 31, 2004, the Companys
term loan had an outstanding balance of $12.8 million. The
Company had no outstanding balance on the revolving line of
credit at March 31, 2004. At December 31, 2003, the
outstanding balance on the term

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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


loan was $14.0 million. The Company had no
outstanding balance on the revolving line of credit at
December 31, 2003. The term loan calls for quarterly
amortization through July 1, 2006, at which time the term
loan will be paid in full. The quarterly amortization requires
payments of $1.25 million in 2004, 2005 and 2006, with a final
payment of $1.5 million on July 1, 2006. The revolving
line of credit will expire on July 1, 2004, and is
thereafter renewable on an annual basis. As part of the loan
agreement, certain of the Companys non-regulated
subsidiaries guaranteed repayment of the credit facility and the
Company pledged the stock of its non-regulated subsidiaries as
collateral. The eurocurrency based rate as of March 31,
2004, for the term loan was 3.3%.

Both the term loan and revolving line of credit
provide for interest at a variable rate based, at the
Companys option, upon either the prime rate or
eurocurrency based rate. The applicable margin, which ranges
from 200 to 300 basis points above eurocurrency based rates, is
determined by the level of the fixed charge coverage ratio. Of
all the covenants, the most restrictive covenant is the fixed
charge coverage ratio. The fixed charge coverage ratio, as
defined by the credit facility, is the ratio of the
non-regulated earnings before interest and taxes for the four
preceding fiscal quarters to the sum of fixed charges which
include interest expense, principal payments payable, stock
repurchases, and dividends declared during the period. Any
unused portion of the revolving credit as of the date of
determination reduces the sum of these fixed charges. At
March 31, 2004, this ratio was 6.9 to 1.0, compared to the
covenant minimum of 1.2 to 1.0.

The Company was in compliance with all of its
debt covenants, with the exception of one. The Insurance Company
Subsidiaries are subject to two covenants which limit the gross
written premium to surplus and net written premium to surplus
ratios. Williamsburg National Insurance Company
(Williamsburg) was in violation of the gross written
premium to surplus ratio. This ratio was 3.3 to 1.0, compared to
the covenant maximum of 3.0 to 1.0. Williamsburg was well within
the net written premium to surplus ratio. This ratio was 0.3 to
1.0, compared to the covenant maximum of 2.5 to 1.0. The Company
has obtained a waiver from its lender for the violation. Because
Williamsburg has an intercompany reinsurance agreement with the
Companys leading insurance company subsidiary, Star, the
relevancy of the gross written premium ratio on a subsidiary
basis is minimal. The majority of Williamsburgs gross
written premiums are ceded to Star. Stars gross and net
written premium ratios were 1.3 to 1.0 and 1.5 to 1.0,
respectively.

In addition, a non-insurance premium finance
subsidiary of the Company maintains a line of credit with a
bank, which permits borrowings up to 80% of the accounts
receivable, which collateralize the line of credit. At
March 31, 2004, this line of credit had an outstanding
balance of $4.9 million. The line bears interest at the
Prime Rate, which was 4.0% at March 31, 2004.

Note 4  Junior Subordinated
Debentures

On September 30, 2003, an unconsolidated
subsidiary trust (the Trust) of the Company issued
$10.0 million of mandatorily redeemable trust preferred
securities (TPS) to a trust formed by an
institutional investor. The Companys trust received a
total of $9.7 million in net proceeds, after the deduction
of approximately $300,000 of commissions paid to the placement
agents in the transaction.

The gross proceeds from the issuance of the TPS
were used to purchase floating rate junior subordinated
deferrable interest debentures (the Debentures)
issued by the Company. The Debentures have financial terms
similar to those of the TPS, which includes the deferral of
interest payments at any time or from time to time for a period
not exceeding five years, provided there is no event of default.
The Debentures mature in 30 years and provide for interest
at the three-month LIBOR, plus 4.05%, which started in December
2003. The Debentures are callable by the Company at par
beginning in October 2008. Associated with the Debentures, the
Company incurred $300,000 of issuance costs, which have been
capitalized and are included in other assets on the balance
sheet. Issuance costs will be amortized over seven years as a
component of interest expense. The Company estimates that the
fair value of the Debentures issued approximates the gross
proceeds of cash received at the time of issuance.

11



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The Debentures are unsecured obligations of the
Company and are junior to the right of payment to all future
senior indebtedness of the Company. The Company has guaranteed
that the payments made to the Trust will be distributed by the
Trust to the holders of the TPS.

The Company contributed $6.3 million of the
proceeds from the issuance of the Debentures to its Insurance
Company Subsidiaries and the remaining balance was used for
general corporate purposes.

Note 5  Shareholders
Equity

At March 31, 2004, shareholders equity
was $160.3 million, or a book value of $5.52 per common
share, compared to $155.1 million, or a book value of $5.34
per common share, at December 31, 2003.

On September 17, 2002, the Companys
Board of Directors authorized management to repurchase up to
1,000,000 shares of the Companys common stock in market
transactions for a period not to exceed twenty-four months. On
August 6, 2003, the Companys Board of Directors
authorized management to repurchase up to an additional
1,000,000 shares of the Companys common stock under the
existing share repurchase plan. Unless terminated earlier by
resolution of the Companys Board of Directors, the share
repurchase plan will expire on the earlier of such expiration
date or when the Company has repurchased all shares authorized
for repurchase. As of March 31, 2004, the cumulative amount
the Company repurchased and retired was 764,800 shares of common
stock for a total cost of approximately $2.0 million. The
Company did not repurchase any common stock during the quarter
ended March 31, 2004. As of March 31, 2004, the
Company has 1,235,200 shares remaining to be purchased.

Note 6  Regulatory Matters and
Rating Agencies

A significant portion of the Companys
consolidated assets represent assets of the Insurance Company
Subsidiaries that at this time, without prior approval of the
State of Michigan Office of Financial and Insurance Services
(OFIS), cannot be transferred to the holding company
in the form of dividends, loans or advances. The restriction on
the transferability to the holding company from its Insurance
Company Subsidiaries is dictated by Michigan insurance
regulatory guidelines which, in general, are as follows: the
maximum discretionary dividend that may be declared, based on
data from the preceding calendar year, is the greater of each
insurance companys net income (excluding realized capital
gains) or ten percent of the insurance companys surplus
(excluding unrealized gains). These dividends are further
limited by a clause in the Michigan law that prohibits an
insurer from declaring dividends, except from surplus earnings
of the company. Earned surplus balances are calculated on a
quarterly basis. Since Star is the parent insurance company, its
maximum dividend calculation represents the combined Insurance
Company Subsidiaries surplus. Based upon the 2003
statutory financial statements, Star may only pay dividends to
the Company during 2004 with the prior approval of OFIS.
Stars earned surplus position at December 31, 2003
was negative $24.6 million. At March 31, 2004, earned
surplus was negative $26.0 million. No statutory dividends
were paid in 2003.

Insurance operations are subject to various
leverage tests (e.g. premium to statutory surplus ratios), which
are evaluated by regulators and rating agencies. The
Companys targets for gross and net written premium to
statutory surplus are 3.0 to 1.0 and 2.0 to 1.0, respectively.
As of March 31, 2004, on a statutory consolidated basis,
the gross and net premium leverage ratios were 2.7 to 1.0 and
2.0 to 1.0, respectively.

The National Association of Insurance
Commissioners (NAIC) has adopted a risk-based
capital (RBC) formula to be applied to all property
and casualty insurance companies. The formula measures required
capital and surplus based on an insurance companys
products and investment portfolio and is used as a tool to
evaluate the capital of regulated companies. The RBC formula is
used by state insurance regulators to monitor trends in
statutory capital and surplus for the purpose of initiating
regulatory action. In general, an insurance company must submit
a calculation of its RBC formula to the insurance department of
its state of domicile as of the end of the previous calendar
year. These laws require increasing degrees of regulatory
oversight and intervention as an insurance companys RBC
declines. The level of regulatory oversight ranges

12



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


from requiring the insurance company to inform
and obtain approval from the domiciliary insurance commissioner
of a comprehensive financial plan for increasing its RBC to
mandatory regulatory intervention requiring an insurance company
to be placed under regulatory control in a rehabilitation or
liquidation proceeding.

At December 31, 2003, all of the Insurance
Company Subsidiaries were in compliance with RBC requirements.
Star reported statutory surplus of $99.9 million at
December 31, 2003, compared to the threshold requiring the
minimum regulatory involvement of $45.7 million in 2003. At
March 31, 2004, Stars statutory surplus was
$98.4 million.

The Insurance Company Subsidiaries A.M.
Best financial strength rating is a B+ (Very Good)
with a positive outlook. A positive outlook is placed on a
companys rating if its financial and market trends are
favorable, relative to its current rating level.

Note 7  Commitments and
Contingencies

On December 3, 2003, the Company entered
into a Development Agreement with an unaffiliated third party
for the construction of an office building on land currently
owned by the Company for a contract price of $11.0 million.
The office building will serve as the new location for the
Companys corporate offices.

On June 6, 2003, the Company entered into a
Guaranty Agreement with a bank. The Company is guaranteeing
payment of a $1.5 million term loan issued by the bank to
an unaffiliated insurance agency. In the event of default on the
term loan by the insurance agency, the Company is obligated to
pay any outstanding principal (up to a maximum of
$1.5 million), as well as any accrued interest on the loan,
and any costs incurred by the bank in the collection process. In
exchange for the Companys guaranty, the president and
member of the insurance agency pledged 100% of the common shares
of two other insurance agencies that he wholly owns. In the
event of default on the term loan by the insurance agency, the
Company has the right to sell any or all of the pledged
insurance agencies common shares and use the proceeds from
the sale to recover any amounts paid under the guaranty
agreement. Any excess proceeds would be paid to the shareholder.
As of March 31, 2004, no liability has been recorded with
respect to the Companys obligations under the guaranty
agreement, since the collateral is in excess of the guaranteed
amount.

The Company, and its subsidiaries, are subject at
times to various claims, lawsuits and proceedings relating
principally to alleged errors or omissions in the placement of
insurance, claims administration, consulting services and other
business transactions arising in the ordinary course of
business. Where appropriate, the Company vigorously defends such
claims, lawsuits and proceedings. Some of these claims, lawsuits
and proceedings seek damages, including consequential, exemplary
or punitive damages, in amounts that could, if awarded, be
significant. Most of the claims, lawsuits and proceedings
arising in the ordinary course of business are covered by errors
and omissions insurance or other appropriate insurance. In terms
of deductibles associated with such insurance, the Company has
established provisions against these items, which are believed
to be adequate in light of current information and legal advice.
In accordance with SFAS No. 5, Accounting for
Contingencies, if it is probable that an asset has been
impaired or liability has been incurred as of the date financial
statements and the amount of loss is estimable, an accrual for
the costs to resolve these claims is recorded by the Company in
its consolidated balance sheets. Period expenses related to the
defense of such claims are included in other operating expenses
in the accompanying consolidated statements of income.
Management, with the assistance of outside counsel, adjusts such
provisions from time-to-time according to new developments or
changes in the strategy in dealing with such matters. On the
basis of current information, the Company does not expect the
outcome of the claims, lawsuits and proceedings to which the
Company is subject to, either individually, or in the aggregate,
will have a material adverse effect on the Companys
financial condition. However, it is possible that future results
of operations or cash flows for any particular quarter or annual
period could be materially affected by an unfavorable resolution
of any such matters.

13



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 8  Segment
Information

The Company defines its operations as specialty
risk management operations and agency operations based upon
differences in products and services. The separate financial
information of these segments is consistent with the way results
are regularly evaluated by management in deciding how to
allocate resources and in assessing performance. Intersegment
revenue is eliminated in consolidation. It would be
impracticable for the Company to determine the allocation of
assets between the two segments.



| |                                         
| | ----------------------------------------
| | Specialty Risk Management
    Operations

The specialty risk management operations segment
focuses on specialty or niche insurance business in which it
provides various services and coverages that are tailored to
meet specific requirements of defined client groups and their
members. This includes, but is not limited to, providing
services, such as risk management consulting, claims
administration and handling, loss control, and reinsurance
brokering, along with various types of property and casualty
insurance coverage, including workers compensation,
commercial multiple peril, general liability, commercial auto
liability, and inland marine. Insurance coverage is provided
primarily to associations or similar groups of members and to
specified classes of business of the Companys
agent-partners. The Company recognizes revenue related to the
services and coverages the specialty risk management operations
provides within seven categories: net earned premiums,
management fees, claims fees, loss control fees, reinsurance
brokerage, investment income, and net realized gain
(loss) on investments.



| |                  
| | -----------------
| | Agency Operations

The Company earns commissions through the
operation of its retail property and casualty insurance agency,
which was formed in 1955. The agency has grown to be one of the
largest agencies in Michigan and, with acquisitions, has
expanded into California. The agency operations primarily
produce commercial insurance, as well as personal property,
casualty, life and accident and health insurance, with more than
fifty insurance carriers.

14



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


The following table sets forth the segment
results (in thousands):

|                |                                            |                             |   |        |        |  |   |        |        | 
|--------------- | ------------------------------------------ | --------------------------- | - | ------ | ------ |  | - | ------ | ------ | 
|                |                                            |                            
|                |                                            | For the Three Months       
|                |                                            | Ended March 31,            
|                |                                            |                            
|                |                                            | 2004                        |   | 2003  
|                |                                            |                             |   |       
|Revenues        |                                            |                             |   |        |        |  |   |       
|                | Net earned premiums                        |                             | $ | 49,713 |        |  | $ | 27,384 |       
|                | Management fees                            |                             |   | 4,711  |        |  |   | 5,348  |       
|                | Claims fees                                |                             |   | 2,701  |        |  |   | 4,382  |       
|                | Loss control fees                          |                             |   | 545    |        |  |   | 577    |       
|                | Reinsurance brokerage                      |                             |   | 147    |        |  |   | 55     |       
|                | Investment income                          |                             |   | 3,591  |        |  |   | 3,340  |       
|                | Net realized (losses) gains on investments |                             |   | (120   | )      |  |   | 205    |       
|                |                                            |                             |   |        |        |  |   |       
|                |                                            | Specialty risk management   |   |        | 61,288 |  |   |        | 41,291 | 
|                | Agency operations                          |                             |   | 4,779  |        |  |   | 4,147  |       
|                | Reconciling items                          |                             |   | 6      |        |  |   | 13     |       
|                | Intersegment revenue                       |                             |   | (1,602 | )      |  |   | (1,153 | )     
|                |                                            |                             |   |        |        |  |   |       
|                |                                            | Consolidated revenue        |   | $      | 64,471 |  |   | $      | 44,298 | 
|                |                                            |                             |   |        |        |  |   |       
|Pre-tax income: |                                            |                             |   |        |        |  |   |       
|                | Specialty risk management                  |                             | $ | 3,096  |        |  | $ | 2,636  |       
|                | Agency operations*                         |                             |   | 2,496  |        |  |   | 2,052  |       
|                | Reconciling items                          |                             |   | (943   | )      |  |   | (585   | )     
|                |                                            |                             |   |        |        |  |   |       
|                |                                            | Consolidated pre-tax income |   | $      | 4,649  |  |   | $      | 4,103  | 
|                |                                            |                             |   |        |        |  |   |       



---



|  |                                                
|- | -----------------------------------------------
|* | Excluding the allocation of corporate overhead.

The reconciling item included in the revenue
relates to interest income in the holding company. The following
table sets forth the pre-tax income reconciling items:

|                         |  |                      |      |      |  |   |      |  
|------------------------ |  | -------------------- | ---- | ---- |  | - | ---- | -
|                         |  |                     
|                         |  | For the Three Months
|                         |  | Ended March 31,     
|                         |  |                     
|                         |  | 2004                 |      | 2003
|                         |  |                      |      |     
|Holding company expenses |  | $                    | (529 | )    |  | $ | (278 | )
|Amortization             |  |                      | (99  | )    |  |   | (70  | )
|Interest expense         |  |                      | (315 | )    |  |   | (237 | )
|                         |  |                      |      |      |  |   |      |  
|                         |  | $                    | (943 | )    |  | $ | (585 | )
|                         |  |                      |      |      |  |   |      |  



|         |                  
|-------- | -----------------
|Note 9  | Subsequent Events

On April 29, 2004, the Company issued a
senior note (Note) in the amount of
$13.0 million. The Note matures in 30 years and
provides for interest at the three-month LIBOR, plus 4.0%, which
is non-deferrable. The Note is callable by the Company at par
beginning in May 2009. Associated with the Note the Company
incurred $390,000 of commissions paid to the placement agents in
the transaction. The proceeds from the issuance of the Note will
be used to support future premium growth through contributions
to its Insurance Company Subsidiaries and general corporate
purposes.

15



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##### Table of Contents



PART I  FINANCIAL
INFORMATION

Management Representation

In the opinion of management, the financial
statements reflect all adjustments of a normal recurring nature
necessary for a fair presentation of the interim periods.
Preparation of financial statements under GAAP requires
management to make estimates. Actual results could differ from
those estimates. Interim results are not necessarily indicative
of results expected for the entire year. These financial
statements should be read in conjunction with the Companys
2003 Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission.

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##### Table of Contents






ITEM 2

MANAGEMENTS DISCUSSION AND ANALYSIS
OF


FINANCIAL CONDITION AND RESULTS OF
OPERATIONS


For the Quarters ended March 31, 2004 and
2003


Meadowbrook Insurance Group, Inc. (the
Company) is a publicly traded specialty risk
management company, specializing in alternative market insurance
and risk management solutions for agents, brokers, professional
and trade associations, and insureds of all sizes. The
alternative market includes a wide range of approaches to
financing and managing risk exposures, such as captives, risk
retention and risk purchasing groups, governmental pools and
trusts, and self-insurance plans. The alternative market
developed as a result of the historical volatility in the cost
and availability of traditional commercial insurance coverages,
and usually involves some form of self-insurance or risk-sharing
on the part of the client. The Company develops and manages
alternative risk management programs for defined groups and
their members. The Company also operates as an insurance agency
representing policyholders in placing their insurance coverages
with unaffiliated insurance companies. Management defines its
business segments as specialty risk management operations and
agency operations.

Results of Operations for the Nine Months
Ended March 31, 2004 and 2003



| |         
| | --------
| | Overview

Net income for the three months ended
March 31, 2004 was $3.2 million, or $0.11 per dilutive
share, compared to net income of $2.8 million, or $0.09 per
dilutive share, for the comparable period of 2003. This
improvement reflects the earning pattern of controlled growth of
premium in profitable programs which were written in 2003,
continued rate increases, growth in agency commission, control
over expenses, including lower producer commission expense, and
leveraging of fixed costs.

Revenues for the three months ended
March 31, 2004 increased $20.2 million, or 45.5%, to
$64.5 million from $44.3 million for the comparable
period in 2003. This increase reflects a $22.3 million, or
81.5%, increase in net earned premium. The growth in net earned
premium reflects the earning pattern of programs written in
2003. These programs include the conversion of an existing
west-coast commercial transportation program to the
Companys insurance subsidiaries, the impact of a renewal
rights contract for a select group of association-endorsed
workers compensation programs which had decades of
profitable underwriting experience, the implementation of an
excess liability program for public entities with a
statistically proven twenty-year track record, the return of
profitable programs, and the impact of an overall 13.6% rate
increase achieved in 2003. This increase was partially offset by
the anticipated reduction in managed fee revenue from two
limited duration or closed end administrative services and
claims contracts in the State of Missouri.

17



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##### Table of Contents





| |                                     
| | ------------------------------------
| | Specialty Risk Management Operations

The following table sets forth the revenues and
results from operations for specialty risk management operations
(in thousands):

|               |                                            |                      |   |        |   |  |   |        | 
|-------------- | ------------------------------------------ | -------------------- | - | ------ | - |  | - | ------ | 
|               |                                            |                     
|               |                                            | For the Three Months
|               |                                            | Ended March 31,     
|               |                                            |                     
|               |                                            | 2004                 |   | 2003  
|               |                                            |                      |   |       
|Revenue:       |                                            |                      |   |        |   |  |   |       
|               | Net earned premiums                        |                      | $ | 49,713 |   |  | $ | 27,384 | 
|               | Management fees                            |                      |   | 4,711  |   |  |   | 5,348  | 
|               | Claims fees                                |                      |   | 2,701  |   |  |   | 4,382  | 
|               | Loss control fees                          |                      |   | 545    |   |  |   | 577    | 
|               | Reinsurance brokerage                      |                      |   | 147    |   |  |   | 55     | 
|               | Investment income                          |                      |   | 3,591  |   |  |   | 3,340  | 
|               | Net realized (losses) gains on investments |                      |   | (120   | ) |  |   | 205    | 
|               |                                            |                      |   |        |   |  |   |       
|               | Total revenue                              |                      | $ | 61,288 |   |  | $ | 41,291 | 
|               |                                            |                      |   |        |   |  |   |       
|Pre-tax income |                                            |                      |   |        |   |  |   |       
|               | Specialty risk management operations       |                      | $ | 3,096  |   |  | $ | 2,636  | 

Revenues from specialty risk management
operations increased $20.0 million, or 48.4 %, to
$61.3 million for the three months ended March 31,
2004, from $41.3 million for the comparable period in 2003.

Net earned premium increased $22.3 million,
or 81.5%, to $49.7 million in the three months ended
March 31, 2004, from $27.4 million in the comparable
period in 2003. As previously mentioned, this increase is the
result of increased written premium in the last three quarters
of 2003 that are recognized as earned premium in 2004.

Management fees decreased $637,000, or 11.9%, to
$4.7 million for the three months ended March 31,
2004, from $5.3 million for the comparable period in 2003.
The decrease in management fees reflects a shift in
fee-for-service revenue previously generated from a third-party
contract to internally generated fee revenue that is eliminated
upon consolidation. The transition of such fees is directly
related to the Companys previously mentioned renewal
rights contract. All other management fee revenue remained
relatively consistent in comparison to 2003.

Claim fees decreased $1.7 million, or 38.4%,
to $2.7 million, from $4.4 million for the comparable
period in 2003. The decrease in claim fees reflects a similar
shifting of revenue previously generated from third-party
contracts to internally generated fee revenue that is eliminated
upon consolidation. The transition of such fees is directly
related to the Companys renewal rights contract. All other
claim fee revenue remained relatively consistent in comparison
to 2003.

Net investment income increased $251,000, or
7.5%, to $3.6 million in 2004, from $3.3 million in
2003. Average invested assets increased $41.4 million, or
14.3%, to $331.1 million in 2004, from $289.6 million
in 2003. The increase in average invested assets reflects cash
flows from underwriting activities and growth in gross written
premiums during 2003 and 2004. The average investment yield for
March 31, 2004 was 4.4%, compared to 4.6% for the
comparable period in 2003. The current pre-tax book yield is
4.2% and current after-tax book yield is 3.0%. The decline in
investment yield reflects the accelerated prepayment speeds in
mortgage-backed securities, and reinvestment of cash flows in
municipal bonds and other securities in an interest rate
environment where macro rates are relatively low and declining
during the period.

Specialty risk management operations generated
pre-tax income of $3.1 million for the three months ended
March 31, 2004, compared to pre-tax income of
$2.6 million for the comparable period in 2003. This
increase in pre-tax income demonstrates the improvement in
underwriting results and the further leveraging of fixed costs
as the Company continues to experience controlled growth of
premium volume. The generally

18



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##### Table of Contents



accepted accounting principles (GAAP)
combined ratio was 102.0% for the three months ended
March 31, 2004, compared to 105.5% for the same period
in 2003.


Net loss and loss adjustment expenses
(LAE) increased $15.3 million, or 89.2%, to
$32.5 million for the three months ended March 31,
2004, from $17.2 million for the same period in 2003. The
Companys loss and LAE ratio increased by
1.2 percentage points to 70.2% for the three months ended
March 31, 2004, from 69.0% for the same period in 2003.
This ratio is the unconsolidated net loss and LAE in relation to
net earned premium. The increase in the loss and LAE ratio
reflects the impact of a $1.8 million, or
3.6 percentage points, increase in net ultimate loss
estimates for prior accident years in 2004 compared to $331,000,
or 1.2 percentage points, for the comparable period of
2003. The change in net ultimate loss estimates in 2004 is
described in the reserve section below. This increase is
partially offset by an improvement in the current accident year
loss ratio which reflects rate increases achieved during 2004
and the addition of earned premium from profitable programs.

The Companys expense ratio improved
4.7 percentage points to 31.8% for the three months ended
March 31, 2004, from 36.5% for the same period in 2003.
This ratio is the unconsolidated policy acquisition and other
underwriting expenses in relation to net earned premium. This
improvement reflects an overall improvement in gross commissions
in relation to an increased net earned premium basis. In
addition, this improvement reflects the ability to leverage
fixed costs and a decrease in insurance related assessments.



| |                  
| | -----------------
| | Agency Operations

The following table sets forth the revenues and
results from operations for agency operations (in thousands):

|                |  |               |       |      |  |   |       | 
|--------------- |  | ------------- | ----- | ---- |  | - | ----- | 
|                |  |              
|                |  | For the Three
|                |  | Months Ended 
|                |  | March 31,    
|                |  |              
|                |  | 2004          |       | 2003
|                |  |               |       |     
|Net commission  |  | $             | 4,779 |      |  | $ | 4,147 | 
|Pre-tax income* |  | $             | 2,496 |      |  | $ | 2,052 | 



---



|  |                                               
|- | ----------------------------------------------
|* | Excluding the allocation of corporate overhead

Revenue from agency operations, which consists
primarily of agency commission revenue, increased $632,000, or
15.2%, to $4.8 million for the three months ended
March 31, 2004, from $4.1 million for the comparable
period in 2003. This increase is primarily the result of rate
increases and increases in new business and contingent
commissions.

Agency operations generated pre-tax income,
before corporate overhead, of $2.5 million for the three months
ended March 31, 2004, compared to $2.1 million for the
comparable period in 2003. The improvement in the pre-tax margin
is primarily attributable to the overall increase in revenue.

19



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##### Table of Contents



Other Items



| |         
| | --------
| | Reserves

At March 31, 2004, managements best
estimate for the ultimate liability for loss and LAE reserves,
net of reinsurance recoverables, was $197.5 million.
Management established a reasonable range of reserves of
approximately $183.9 million to $211.9 million. This
range was established primarily by considering the various
indications derived from standard actuarial techniques and other
appropriate reserve considerations. The following table sets
forth this range by line of business (in thousands):

|                                            |  |         |         |         |  |          |         |  |  |   |         | 
|------------------------------------------- |  | ------- | ------- | ------- |  | -------- | ------- |  |  | - | ------- | 
|                                            |  | Minimum |         | Maximum |  |         
|                                            |  | Reserve |         | Reserve |  | Selected
|Line of Business                            |  | Range   |         | Range   |  | Reserves
|                                            |  |         |         |         |  |         
|Workers Compensation(1)                    |  | $       | 104,070 |         |  | $        | 116,807 |  |  | $ | 110,770 | 
|Commercial Multiple Peril/General Liability |  |         | 37,962  |         |  |          | 46,848  |  |  |   | 41,595  | 
|Commercial Automobile                       |  |         | 26,712  |         |  |          | 30,090  |  |  |   | 28,432  | 
|Other                                       |  |         | 15,132  |         |  |          | 18,147  |  |  |   | 16,667  | 
|                                            |  |         |         |         |  |          |         |  |  |   |         | 
|Net Reserves                                |  | $       | 183,876 |         |  | $        | 211,892 |  |  | $ | 197,464 | 
|                                            |  |         |         |         |  |          |         |  |  |   |         | 



---



|    |                          
|--- | -------------------------
|(1) | Includes Residual Markets

Reserves are reviewed by internal and independent
actuaries for adequacy on a quarterly basis. When reviewing
reserves, the Company analyzes historical data and estimates the
impact of numerous factors such as (i) per claim
information; (ii) Company and industry historical loss
experience; (iii) legislative enactments, judicial
decisions, legal developments in the imposition of damages, and
changes in political attitudes; and (iv) trends in general
economic conditions, including the effects of inflation. This
process assumes that past experience, adjusted for the effects
of current developments and anticipated trends, is an
appropriate basis for predicting future events. There is no
precise method for subsequently evaluating the impact of any
specific factor on the adequacy of reserves, because the
eventual deficiency or redundancy is affected by multiple
factors.

The key assumptions used in managements
selection of ultimate reserves included the underlying actuarial
methodologies, a review of current pricing and underwriting
initiatives, an evaluation of reinsurance costs and retention
levels, and a detailed claims analysis with an emphasis on how
aggressive claims handling may be impacting the paid and
incurred loss data trends embedded in the traditional actuarial
methods. With respect to the ultimate estimates for losses and
LAE, the key assumptions remained consistent for the three
months ended March 31, 2004, and the years ended
December 31, 2003 and 2002.

For the three months ended March 31, 2004,
the Company reported an increase in net ultimate loss estimates
for accident years 2003 and prior to be $1.8 million, or
0.9% of $192.0 million of net loss and LAE reserves at
December 31, 2003. The increase in net ultimate loss
estimates reflected revisions in the estimated reserves as a
result of actual claims activity in calendar year 2004 that
differed from the projected activity. There were no significant
changes in the key assumptions utilized in the analysis and
calculations of the

20



---



##### Table of Contents



Companys reserves during 2004. The major
components of this change in ultimates are as follows
(in thousands):


|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  |   |         | 
|-------------------------------------------- |  | ------------ | ------- | -------------- |  | --------------- | ------ | ----------- |  | ----------- | ------ | ------- |  | ----- | ----- | ----- |  | --------- | ------ |  |  | - | ----- | - |  | - | ------ |  |  |  | ------ |  |  | - | ------- | 
|                                             |  |              |         | Reserves of    |  |                 |        |             |  |            
|                                             |  |              |         | Deconsolidated |  | Incurred Losses |        | Paid Losses |  |            
|                                             |  | Reserves at  |         | Subsidiary at  |  |                 |        |             |  | Reserves at
|                                             |  | December 31, |         | December 31,   |  | Current         |        | Prior       |  | Total       |        | Current |  | Prior |       | Total |  | March 31,
|Line of Business                             |  | 2003         |         | 2003(1)        |  | Year            |        | Years       |  | Incurred    |        | Year    |  | Years |       | Paid  |  | 2004     
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          
|Workers Compensation                        |  | $            | 91,587  |                |  | $               | (2,250 | )           |  | $           | 14,721 |         |  | $     | 1,387 |       |  | $         | 16,108 |  |  | $ | 102   |   |  | $ | 10,765 |  |  |  | 10,867 |  |  | $ | 94,578  | 
|Residual Markets                             |  |              | 14,506  |                |  |                 |       |             |  |             | 3,785  |         |  |       | (473  | )     |  |           | 3,312  |  |  |   | 1,254 |   |  |   | 372    |  |  |  | 1,626  |  |  |   | 16,192  | 
|Commercial Multiple Peril/ General Liability |  |              | 42,389  |                |  |                 | (737   | )           |  |             | 4,381  |         |  |       | 282   |       |  |           | 4,663  |  |  |   | (180  | ) |  |   | 4,900  |  |  |  | 4,720  |  |  |   | 41,595  | 
|Commercial Automobile                        |  |              | 27,515  |                |  |                 |       |             |  |             | 5,058  |         |  |       | 825   |       |  |           | 5,883  |  |  |   | 396   |   |  |   | 4,570  |  |  |  | 4,966  |  |  |   | 28,432  | 
|Other                                        |  |              | 16,022  |                |  |                 | (2     | )           |  |             | 2,761  |         |  |       | (218  | )     |  |           | 2,543  |  |  |   | 172   |   |  |   | 1,724  |  |  |  | 1,896  |  |  |   | 16,667  | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  |   |         | 
|Net Reserves                                 |  | $            | 192,019 |                |  | $               | (2,989 | )           |  | $           | 30,706 |         |  | $     | 1,803 |       |  | $         | 32,509 |  |  | $ | 1,744 |   |  | $ | 22,331 |  |  |  | 24,075 |  |  |   | 197,464 | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  |   |         | 
|Reinsurance Recoverable                      |  |              | 147,446 |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  |   | 152,337 | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  |   |         | 
|Consolidated                                 |  | $            | 339,465 |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  | $ | 349,801 | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |           |        |  |  |   |       |   |  |   |        |  |  |  |        |  |  |   |         | 

|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 
|-------------------------------------------- |  | ------------ | ------- | ----------- |  | -------------- | ------- | --------------- |  | - | ------- |  |  |  | ----- | 
|                                             |  |              |         |             |  | Re-estimated   |         | Development    
|                                             |  | Reserves at  |         | Reserves at |  | Reserves at    |         | as a Percentage
|                                             |  | December 31, |         | January 1,  |  | March 31, 2004 |         | of Prior       
|Line of Business                             |  | 2003         |         | 2004(1)     |  | on Prior Years |         | Year Reserves  
|                                             |  |              |         |             |  |                |         |                
|Workers Compensation                        |  | $            | 91,587  |             |  | $              | 89,337  |                 |  | $ | 90,724  |  |  |  | 1.5%  | 
|Commercial Multiple Peril/ General Liability |  |              | 42,389  |             |  |                | 41,652  |                 |  |   | 41,934  |  |  |  | 0.7%  | 
|Commercial Automobile                        |  |              | 27,515  |             |  |                | 27,515  |                 |  |   | 28,340  |  |  |  | 2.9%  | 
|Other                                        |  |              | 16,022  |             |  |                | 16,020  |                 |  |   | 15,802  |  |  |  | -1.4% | 
|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 
|Sub-total                                    |  |              | 177,513 |             |  |                | 174,524 |                 |  |   | 176,800 |  |  |  | 1.3%  | 
|Residual Markets                             |  |              | 14,506  |             |  |                | 14,506  |                 |  |   | 14,033  |  |  |  | -3.4% | 
|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 
|Total Net Reserves                           |  | $            | 192,019 |             |  | $              | 189,030 |                 |  | $ | 190,833 |  |  |  | 0.9%  | 
|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In accordance with FIN 46(R), the Company
    performed an evaluation of its business relationships and
    determined that its wholly-owned subsidiary, American Indemnity
    Insurance Company, Ltd., (AIIC), did not meet the
    tests for consolidation, as neither the Company, nor its
    subsidiary Star, are the primary beneficiaries of AIIC.
    Therefore, effective January 1, 2004, the Company
    deconsolidated AIIC on a prospective basis in accordance with
    the provisions of FIN 46(R). The adoption of FIN 46(R) and the
    deconsolidation of AIIC did not have a material impact on the
    Companys consolidated balance sheet or consolidated
    statement of income. Refer to New Accounting Pronouncements of
    Managements Discussion and Analysis.

Workers Compensation Excluding Residual
Markets

The projected net ultimate loss estimate for the
workers compensation line of business excluding residual
markets increased $1.4 million, or 1.5% of net
workers compensation reserves. This net overall increase
reflects an increase of $2.6 million and $1.5 million
in accident years 2003 and 2000, respectively. The increase in
ultimate loss estimates for accident year 2003 reflects higher
than expected emergence of claim activity related to one Alabama
program and the acceleration of amortization of prepaid claims
handling costs, while the increase in accident year 2000
reflects a re-allocation of estimated reserves between accident
years 2000 and 1999. These increases were partially offset by
reductions of $1.0 million, $1.1 million, and
$1.1 million in the ultimate loss estimate for accident
years 2002, 2001 and 1999, respectively. The decrease in
ultimate loss estimates for 2002, 2001, and 1999, reflect better
than expected experience on the Companys core
workers compensation programs primarily in Massachusetts
and Tennessee. The change in ultimate loss estimates for all
other accident years was insignificant.

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Commercial Multiple Peril/ General
Liability

The commercial multiple peril line/general
liability line of business had an increase in net ultimate loss
estimates of $282,000, or 0.7% of net commercial multiple
peril/general liability reserves. The net increase reflects an
increase of $789,000, $436,000, and $307,000 in accident years
2003, 2001, and 1999, respectively. These increases in accident
years 2003 and 2001 ultimate loss estimates reflect higher than
expected emergence in claim activity in a general liability
occurrence program within the Kansas City Branch during the
three months ended March 31, 2004. In addition,
approximately $500,000 of the increase in the ultimate loss
estimate in 2003 reflects a re-allocation of reserves between
accident years 2003 and 2002. The increase in accident year 1999
reflects an increase in one claim in an excess professional
liability program. These increases were partially offset by
reductions in the ultimate loss estimates of $390,000 and
$768,000 for accident years 2002 and 2000, respectively. As
mentioned above, the 2002 accident year was impacted by a
re-allocation of reserves between accident years 2003 and 2002.
The improvement in accident year 2000 reflects better than
expected claims activity in two previously discontinued
programs. The change in ultimate loss estimates for all other
accident years was insignificant.

Commercial Automobile

The projected net ultimate loss estimate for the
commercial automobile line of business increased $825,000, or
2.9% of net commercial automobile reserves. This net overall
increase reflects an increase of $516,000 and $468,000 in
accident years 2002 and 2000, respectively. These increases
reflect the impact of the change in the case reserve for one
claim in a California program and the impact of higher than
expected emergence in claims activity in a previously
discontinued program. These increases were partially offset by a
reduction of $149,000 in the ultimate loss estimate for accident
year 2003 primarily related to automobile physical damage claim
activity. The change in ultimate loss estimates for all other
accident years was insignificant.

Other

The other lines of business had a decrease in net
ultimate loss estimates of $218,000, or 1.4% of net reserves on
the other lines of business. The change reflects a reduction of
$328,000 in accident year 2003, primarily from the property line
of business. The change in ultimate loss estimates for all other
accident years was insignificant.

Residual Markets

The workers compensation residual market
line of business had a decrease in net ultimate loss estimates
of $473,000, or 3.4% of net reserves on the workers
compensation residual market line of business. The change
reflects a reduction of $546,000 in accident year 2003. The
Company records loss reserves as reported by the National
Council on Compensation Insurance (NCCI), plus a
provision for the reserves incurred but not yet analyzed and
reported to the Company due to a two quarter lag in reporting.
This 2003 change reflects a difference between the
Companys estimate of the lag incurred but not reported and
the amounts reported by the NCCI in the quarter. The change in
ultimate loss estimates for all other accident years was
insignificant.



| |                                                                   
| | ------------------------------------------------------------------
| | Salary and Employee Benefits and Other
    Administrative Expenses

Salary and employee benefits for the three months
ended March 31, 2004, increased $876,000, or 7.3%, to
$12.8 million, from $11.9 million for the comparable
period in 2003. This increase primarily reflects both merit
increases and the accrual of anticipated variable compensation,
which is directly tied to performance and profitability. These
increases were partially offset by a slight decrease in staffing
levels.

Other administrative expenses decreased $456,000,
or 6.4%, to $6.6 million, from $7.1 million for the
comparable period in 2003. This decrease is primarily
attributable to a reduction in overall bad debt expense in 2004
as compared to increases in related allowances recorded in 2003
on previously discontinued programs. Partially offsetting this
decrease was an increase in policyholder dividends for 2004 as
opposed to an $821,000 reduction in anticipated policyholder
dividends reflected in 2003.

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Salary and employee benefits and administrative
expenses include both corporate overhead and the holding company
expenses included in the reconciling items of the Companys
segment information.



| |                 
| | ----------------
| | Interest Expense

Interest expense for the three months ended
March 31, 2004, increased by $78,000, or 32.9%, to
$315,000, from $237,000 for the comparable period in 2003.
Interest expense is primarily attributable to the Companys
term loan, line of credit, and the junior subordinated
debentures, which are described below. Interest expense
increased $136,000 as a result of the debentures issued on
September 30, 2003. Offsetting this increase was a
reduction in interest associated with the Companys term
loan and line of credit of $58,000, or 24.5%, to $179,000, from
$237,000 in comparison to 2003. This decrease reflects a
reduction in the average outstanding balance, offset by an
increase in the average interest rate. The average outstanding
balance during the three months ending March 31, 2004, was
$17.6 million, compared to $26.8 million for the same
period in 2003. The average interest rate increased in 2004 to
4.1%, compared to 3.5% in 2003 as a result of increases in the
underlying eurocurrency based rate.



| |      
| | -----
| | Taxes

Federal income tax expense for the three months
ended March 31, 2004, was $1.4 million, or 31.0% of
income before taxes. For the same period last year, the Company
reflected a federal income tax expense of $1.3 million, or
32.8% of income before taxes. The increase in tax expense is the
result of an increase in earnings. The Companys effective
tax rate differs from the 34% statutory rate primarily due to a
shift towards increasing investments in tax-exempt securities in
an effort to maximize after-tax investment yields.

At March 31, 2004, the Company had a
deferred tax asset of $14.3 million, $1.9 million of
which is related to a net operating loss carryforward
(NOL). Realization of the deferred tax asset is
dependent on generating sufficient taxable income to absorb both
the applicable reversing temporary differences and the NOL. At
March 31, 2004, management concluded that the positive
evidence supporting the generation of future taxable income
sufficient to realize the deferred tax asset outweighed the
negative evidence of the previous cumulative losses reported for
the periods ended December 31, 2001, 2000, and 1999, which
generated the NOL. This positive evidence includes cumulative
pre-tax income of $7.0 million for the three years ended
December 31, 2003, in addition to pre-tax income of
$4.6 million for the three months ended March 31,
2004. Furthermore, the current market conditions that supported
cumulative rate increases of 80.6% since the beginning of 2000
is expected to continue in 2004. In addition, while the Company
had adverse development of $1.8 million, or 0.9% of
$192.0 million of net loss and LAE reserves at
December 31, 2003, loss reserves continue to stabilize with
a calendar year 2004 loss and LAE ratio of 70.2% for the three
months ended March 31, 2004. Also, the Company continues to
have alternative tax strategies, which could generate capital
gains from the potential sale of assets and/or subsidiaries.
These capital gains would fully utilize the net operating loss
of $1.9 million at March 31, 2004.



| |                                 
| | --------------------------------
| | Other Than Temporary Impairments

The Companys policy for the valuation of
temporarily impaired securities is to determine impairment based
on analysis of the following factors: market value less than
amortized cost for a six month period; rating downgrade or other
credit event, e.g., failure to pay interest when due; financial
condition and near-term prospects of the issuer, including any
specific events which may influence the operations of the issuer
such as changes in technology or discontinuance of a business
segment; prospects for the issuers industry segment;
intent and ability of the Company to retain the investment for a
period of time sufficient to allow for anticipated recovery in
market value. The Company evaluates its investments in
securities to determine other than temporary impairment, no less
than quarterly. Investments which are deemed impaired are
written down to their estimated net fair value and the related
losses recognized in income.

At March 31, 2004, the Company had
fifty-four securities that were in an unrealized loss position.
These investments all had unrealized losses of less than ten
percent. Positive evidence considered in reaching the
Companys conclusion that the investments in an unrealized
loss position are not other than temporarily

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impaired consisted of: 1) there were no
specific events which caused concerns; 2) there were no
past due interest payments; 3) there has been a rise in
market prices; 4) the Companys ability and intent to
retain the investment for a sufficient amount of time to allow
an anticipated recovery in value; and 5) the Company also
determined that the changes in market value were considered
normal in relation to overall fluctuations in interest rates.


The fair value and amount of unrealized losses
segregated by the time period the investment has been in an
unrealized loss position is as follows (in thousands):

|                                                           |        |                     |        |                        |  |                 |      |            |   |   |       |       |  |   |     |     |  
|---------------------------------------------------------- | ------ | ------------------- | ------ | ---------------------- |  | --------------- | ---- | ---------- | - | - | ----- | ----- |  | - | --- | --- | -
|                                                           |        |                    
|                                                           |        | March 31, 2004     
|                                                           |        |                    
|                                                           |        |                     |        |                       
|                                                           |        | Less than 12 months |        | Greater than 12 months
|                                                           |        |                     |        |                       
|                                                           |        | Fair Value          |        |                        |  | Fair Value      |      |           
|                                                           |        | of Investments      |        | Gross                  |  | of Investments  |      | Gross     
|                                                           |        | with Unrealized     |        | Unrealized             |  | with Unrealized |      | Unrealized
|                                                           |        | Losses              |        | Losses                 |  | Losses          |      | Losses    
|                                                           |        |                     |        |                        |  |                 |      |           
|Debt Securities:                                           |        |                     |        |                        |  |                 |      |            |   |   |       |       |  |   |     |    
|Debt securities issued by U.S. government and
    agencies |        | $                   | 4,988  |                        |  | $               | (31  | )          |   | $ | 2,043 |       |  | $ | (16 | )  
|Obligations of states and political subdivisions           |        |                     | 12,360 |                        |  |                 | (163 | )          |   |   | 114   |       |  |   |    |    
|Corporate securities                                       |        |                     | 7,017  |                        |  |                 | (90  | )          |   |   |      |       |  |   |    |    
|Mortgage-backed securities                                 |        |                     | 13,907 |                        |  |                 | (92  | )          |   |   | 1,053 |       |  |   | (4  | )  
|                                                           |        |                     |        |                        |  |                 |      |            |   |   |       |       |  |   |     |    
|                                                           | Totals |                     | $      | 38,272                 |  |                 | $    | (376       | ) |   | $     | 3,210 |  |   | $   | (20 | )
|                                                           |        |                     |        |                        |  |                 |      |            |   |   |       |       |  |   |     |    

As of March 31, 2004, gross unrealized gains
and (losses) on securities were $14.5 million and
($396,000), respectively.

Liquidity and Capital Resources

The principal sources of funds, which include
both regulated and non-regulated cash flows, for the Company and
its subsidiaries, are insurance premiums, investment income,
proceeds from the maturity and sale of invested assets, risk
management fees, and agency commissions. Funds are primarily
used for the payment of claims, commissions, salaries and
employee benefits, other operating expenses, shareholder
dividends, and debt service. The regulated sources of funds are
insurance premiums, investment income, and proceeds from the
maturity and sale of invested assets. These regulated funds are
used for the payment of claims, policy acquisition and other
underwriting expenses, and taxes relating to the regulated
portion of net income. The non-regulated sources of funds are in
the form of commission revenue, outside management fees, and
intercompany management fees. These non-regulated sources of
funds are used to meet debt service, shareholders
dividends, and other operating expenses of the holding company
and non-regulated subsidiaries. The following table illustrates
net income, excluding interest, depreciation, and amortization,
between the Companys regulated and non-regulated
subsidiaries, which reconciles to the Companys
consolidated statement of income and statement of cash flows (in
thousands):

|                                                                   |                               |                      |       |       |  |   |       |     | 
|------------------------------------------------------------------ | ----------------------------- | -------------------- | ----- | ----- |  | - | ----- | --- | 
|                                                                   |                               |                     
|                                                                   |                               | For the Three Months
|                                                                   |                               | Ended March 31,     
|                                                                   |                               |                     
|                                                                   |                               | 2004                 |       | 2003 
|                                                                   |                               |                      |       |      
|Net income                                                         |                               | $                    | 3,232 |       |  | $ | 2,756 |    
|                                                                   |                               |                      |       |       |  |   |       |    
|Regulated Subsidiaries:                                            |                               |                      |       |       |  |   |       |    
|                                                                   | Net income                    |                      | $     | 1,411 |  |   | $     | 866 | 
|                                                                   | Depreciation and amortization |                      |       |      |  |   |       | 3   | 
|                                                                   | Interest                      |                      |       |      |  |   |       | 1   | 
|                                                                   |                               |                      |       |       |  |   |       |    
|Net income, excluding interest, depreciation, and
    amortization |                               |                      | 1,411 |       |  |   | 870   |    
|                                                                   |                               |                      |       |       |  |   |       |    

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|                                                                   |                                                                                                |                      |        |        |   |   |        |       | 
|------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------- | -------------------- | ------ | ------ | - | - | ------ | ----- | 
|                                                                   |                                                                                                |                     
|                                                                   |                                                                                                | For the Three Months
|                                                                   |                                                                                                | Ended March 31,     
|                                                                   |                                                                                                |                     
|                                                                   |                                                                                                | 2004                 |        | 2003  
|                                                                   |                                                                                                |                      |        |       
|                                                                   | Adjustments to reconcile net income to net cash
    provided by operating activities           |                      |        | 898    |   |   |        | 594   | 
|                                                                   | Changes in operating assets and liabilities                                                    |                      |        | 13,158 |   |   |        | 1,333 | 
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Total adjustments                                                  |                                                                                                |                      | 14,056 |        |   |   | 1,927  |      
|Depreciation and amortization                                      |                                                                                                |                      |       |        |   |   | (3     | )    
|Interest                                                           |                                                                                                |                      |       |        |   |   | (1     | )    
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Net cash provided by operating activities                          |                                                                                                | $                    | 15,467 |        |   | $ | 2,793  |      
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Non-regulated Subsidiaries:                                        |                                                                                                |                      |        |        |   |   |        |      
|                                                                   | Net income                                                                                     |                      | $      | 1,821  |   |   | $      | 1,890 | 
|                                                                   | Depreciation and amortization                                                                  |                      |        | 374    |   |   |        | 447   | 
|                                                                   | Interest                                                                                       |                      |        | 378    |   |   |        | 300   | 
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Net income, excluding interest, depreciation, and
    amortization |                                                                                                |                      | 2,573  |        |   |   | 2,637  |      
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|                                                                   | Adjustments to reconcile net income to net cash
    (used in) provided by operating activities |                      |        | (135   | ) |   |        | 1,545 | 
|                                                                   | Changes in operating assets and liabilities                                                    |                      |        | (996   | ) |   |        | 6,586 | 
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Total adjustments                                                  |                                                                                                |                      | (1,131 | )      |   |   | 8,131  |      
|Depreciation and amortization                                      |                                                                                                |                      | (374   | )      |   |   | (447   | )    
|Interest                                                           |                                                                                                |                      | (378   | )      |   |   | (300   | )    
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Net cash provided by operating activities                          |                                                                                                | $                    | 690    |        |   | $ | 10,021 |      
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Consolidated total adjustments                                     |                                                                                                |                      | 12,925 |        |   |   | 10,058 |      
|                                                                   |                                                                                                |                      |        |        |   |   |        |      
|Consolidated net cash provided by operating
    activities         |                                                                                                | $                    | 16,157 |        |   | $ | 12,814 |      
|                                                                   |                                                                                                |                      |        |        |   |   |        |      

Consolidated cash flow provided by operations for
the three months ended March 31, 2004, was
$16.2 million, compared to consolidated cash flow provided
by operations of $12.8 million for the comparable period
in 2003.

Regulated subsidiaries cash flow provided
by operations for the three months ended March 31, 2004,
was $15.5 million, compared to $2.8 million for the
comparable period in 2003. The increase in regulated cash flow
from operations primarily reflects growth in written premiums
and overall improved underwriting results.

Non-regulated subsidiaries cash flow
provided by operations for the three months ended March 31,
2004, was $691,000, compared to $10.0 million for the
comparable period in 2003. The decrease in non-regulated cash
flow from operations primarily reflects the inflow of cash
related to the previously mentioned limited duration
administrative services and claims contracts entered in the
State of Missouri, beginning in 2003. At inception, these
contracts resulted in a higher inflow of cash during the first
quarter of 2003. As anticipated, for the duration of the
remaining life of these contracts, there will be a decrease in
the associated inflow of cash in comparison to prior periods. In
addition, the decrease in cash flow from operations is the
result of variable compensation payments made in the first
quarter of 2004, related to 2003 performance and profitability.
The decrease in cash flow from operations is also the result of
intercompany tax payments made in the first quarter of 2004 to
the regulated subsidiaries in accordance with the Companys
tax sharing agreement. These intercompany tax payments were made
to compensate the regulated subsidiaries for the utilization of
the previously mentioned NOL. These intercompany tax payments
also contributed to the increase in regulated cash flow from
operations. Although the non-regulated cash flow from operations
significantly decreased in comparison to 2003, which was mainly
the result of timing variances associated with the inflow of
cash, net income, excluding interest, depreciation, and
amortization, remained relatively consistent at
$2.6 million, in comparison to 2003.

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On September 30, 2003, an unconsolidated
subsidiary trust of the Company issued $10.0 million of
mandatory redeemable trust preferred securities
(TPS) to a trust formed by an institutional
investor. The Companys trust received a total of
$9.7 million in net proceeds, after the deduction of
approximately $300,000 of commissions paid to the placement
agents in the transaction. The gross proceeds from the issuance
of the TPS were used to purchase floating rate junior
subordinated deferrable interest debentures (the
Debentures) issued by the Company. The Company
contributed $6.3 million of the proceeds to its insurance
company subsidiaries and the remaining balance will be used for
general corporate purposes. The Debentures mature in
30 years and provide for interest at the three-month LIBOR,
plus 4.05%, which started in December 2003.

The Company has a credit agreement that includes
a term loan and a revolving line of credit. This credit
agreement consists of a $20.0 million term loan and a
revolving line of credit for up to $8.0 million. The
Company uses the revolving line of credit to meet short-term
working capital needs. At March 31, 2004, the
Companys term loan had an outstanding balance of
$12.8 million. The Company had no outstanding balance on
the revolving line of credit at March 31, 2004. At
December 31, 2003, the outstanding balance on the term loan
was $14.0 million. The Company had no outstanding balance
on the revolving line of credit at December 31, 2003. The
term loan calls for quarterly amortization through July 1,
2006, at which time the term loan will be paid in full. The
quarterly amortization requires payments of $1.25 million
in 2004, 2005 and 2006, with a final payment of
$1.5 million on July 1, 2006. The revolving line of
credit will expire on July 1, 2004, and is thereafter
renewable on an annual basis. As part of the loan agreement,
certain of the Companys non-regulated subsidiaries
guaranteed repayment of the credit facility and the Company
pledged the stock of its non-regulated subsidiaries as
collateral. The eurocurrency based rate as of March 31,
2004, for the term loan was 3.3%.

Both the term loan and revolving line of credit
provide for interest at a variable rate based, at the
Companys option, upon either the prime rate or
eurocurrency based rate. The applicable margin, which ranges
from 200 to 300 basis points above eurocurrency based rates, is
determined by the level of the fixed charge coverage ratio. Of
all the covenants, the most restrictive covenant is the fixed
charge coverage ratio. The fixed charge coverage ratio, as
defined by the credit facility, is the ratio of the
non-regulated earnings before interest and taxes for the four
preceding fiscal quarters to the sum of fixed charges which
include interest expense, principal payments payable, stock
repurchases, and dividends declared during the period. Any
unused portion of the revolving credit as of the date of
determination reduces the sum of these fixed charges. At
March 31, 2004, this ratio was 6.9 to 1.0, compared to the
covenant minimum of 1.2 to 1.0.

The Company was in compliance with all of its
debt covenants, with the exception of one. The Insurance Company
Subsidiaries are subject to two covenants which limit the gross
written premium to surplus and net written premium to surplus
ratios. Williamsburg National Insurance Company
(Williamsburg) was in violation of the gross written
premium to surplus ratio. This ratio was 3.3 to 1.0, compared to
the covenant maximum of 3.0 to 1.0. Williamsburg was well within
the net written premium to surplus ratio. This ratio was 0.3 to
1.0, compared to the covenant maximum of 2.5 to 1.0. The Company
has obtained a waiver from its lender for the violation. Because
Williamsburg has an intercompany reinsurance agreement with the
Companys leading insurance company subsidiary, Star, the
relevancy of the gross written premium ratio on a subsidiary
basis is minimal. The majority of Williamsburgs gross
written premiums are ceded to Star. Stars gross and net
written premium ratios were 1.3 to 1.0 and 1.5 to 1.0,
respectively.

In addition, a non-insurance premium finance
subsidiary of the Company maintains a line of credit with a
bank, which permits borrowings up to 80% of the accounts
receivable, which collateralize the line of credit. At
March 31, 2004, this line of credit had an outstanding
balance of $4.9 million. The line bears interest at the
Prime Rate, which was 4.0% at March 31, 2004.

At March 31, 2004, shareholders equity
was $160.3 million, or $5.52 per common share, compared to
$155.1 million, or $5.34 per common share, at
December 31, 2003.

On September 17, 2002, the Companys
Board of Directors authorized management to repurchase up to
1,000,000 shares of the Companys common stock in market
transactions for a period not to exceed twenty-four months. On
August 6, 2003, the Companys Board of Directors
authorized management to repurchase up

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##### Table of Contents



to an additional 1,000,000 shares of the
Companys common stock under the existing share repurchase
plan. Unless terminated earlier by resolution of the
Companys Board of Directors, the share repurchase plan
will expire on the earlier of such expiration date or when the
Company has repurchased all shares authorized for repurchase. As
of March 31, 2004, the cumulative amount the Company
repurchased and retired was 764,800 shares of common stock for a
total cost of approximately $2.0 million. The Company did
not repurchase any common stock during the quarter ended
March 31, 2004. As of March 31, 2004, the Company has
1,235,200 shares remaining to be purchased.


A significant portion of the Companys
consolidated assets represent assets of the Insurance Company
Subsidiaries that at this time, without prior approval of the
State of Michigan Office of Financial and Insurance Services
(OFIS), cannot be transferred to the holding company
in the form of dividends, loans or advances. The restriction on
the transferability to the holding company from its Insurance
Company Subsidiaries is limited by Michigan insurance regulatory
guidelines which, in general, are as follows: the maximum
discretionary dividend that may be declared, based on data from
the preceding calendar year, is the greater of each insurance
companys net income (excluding realized capital gains) or
ten percent of the insurance companys surplus (excluding
unrealized gains). These dividends are further limited by a
clause in the Michigan law that prohibits an insurer from
declaring dividends, except from surplus earnings of the
company. Earned surplus balances are calculated on a quarterly
basis. Since Star is the parent insurance company, its maximum
dividend calculation represents the combined Insurance Company
Subsidiaries surplus. Based upon the 2003 statutory
financial statements, Star may only pay dividends to the Company
during 2004 with the prior approval of OFIS. Stars earned
surplus position at December 31, 2003 was negative
$24.6 million. At March 31, 2004, earned surplus was
negative $26.0 million. No statutory dividends were paid in
2003.

Tabular Disclosure of Contractual
Arrangements

The following table is a summary of the
Companys contractual obligations as of March 31, 2004
(in thousands):

|                               |  |                        |        |           |  |             |       |            |  |            |        |  |  |   |       |  |  |   |        | 
|------------------------------ |  | ---------------------- | ------ | --------- |  | ----------- | ----- | ---------- |  | ---------- | ------ |  |  | - | ----- |  |  | - | ------ | 
|                               |  |                       
|                               |  | Payments Due by Period
|                               |  |                       
|                               |  |                        |        | Less Than |  | One to      |       | Three to   |  | More than 
|Contractual Obligations        |  | Total                  |        | One Year  |  | Three Years |       | Five Years |  | Five Years
|                               |  |                        |        |           |  |             |       |            |  |           
|Long-term debt                 |  | $                      | 12,750 |           |  | $           | 5,000 |            |  | $          | 7,750  |  |  | $ |      |  |  | $ |       | 
|Operating lease obligations    |  |                        | 10,954 |           |  |             | 2,885 |            |  |            | 3,012  |  |  |   | 1,753 |  |  |   | 3,304  | 
|Junior subordinated debentures |  |                        | 10,310 |           |  |             |      |            |  |            |       |  |  |   |      |  |  |   | 10,310 | 
|                               |  |                        |        |           |  |             |       |            |  |            |        |  |  |   |       |  |  |   |        | 
|Total                          |  | $                      | 34,014 |           |  | $           | 7,885 |            |  | $          | 10,762 |  |  | $ | 1,753 |  |  | $ | 13,614 | 
|                               |  |                        |        |           |  |             |       |            |  |            |        |  |  |   |       |  |  |   |        | 

Regulatory and Rating Issues

The National Association of Insurance
Commissioners (NAIC) has adopted a risk-based
capital (RBC) formula to be applied to all property
and casualty insurance companies. The formula measures required
capital and surplus based on an insurance companys
products and investment portfolio and is used as a tool to
evaluate the capital of regulated companies. The RBC formula is
used by state insurance regulators to monitor trends in
statutory capital and surplus for the purpose of initiating
regulatory action. In general, an insurance company must submit
a calculation of its RBC formula to the insurance department of
its state of domicile as of the end of the previous calendar
year. These laws require increasing degrees of regulatory
oversight and intervention as an insurance companys RBC
declines. The level of regulatory oversight ranges from
requiring the insurance company to inform and obtain approval
from the domiciliary insurance commissioner of a comprehensive
financial plan for increasing its RBC to mandatory regulatory
intervention requiring an insurance company to be placed under
regulatory control in a rehabilitation or liquidation proceeding.

At December 31, 2003, all of the Insurance
Company Subsidiaries were in compliance with RBC requirements.
Star reported statutory surplus of $99.9 million at
December 31, 2003, compared to the

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threshold requiring the minimum regulatory
involvement of $45.7 million in 2003. At March 31,
2004, Stars statutory surplus decreased $1.5 million
to $98.4 million.


Statutory accounting principles differ in some
respects from generally accepted accounting principles
(GAAP). These differences, among other differences,
include the costs of acquiring and renewing business. Under
statutory accounting principles these acquisition costs are
expensed as premium is written, while under GAAP these costs are
deferred and recognized as premium is earned over the terms of
the policies or reinsurance treaties to which the costs relate.
At March 31, 2004, the Companys asset for deferred
policy acquisition costs increased $2.7 million, or 14.2%,
to $22.3 million, compared to $19.6 million at
December 31, 2003. This increase reflects the increase in
gross unearned premiums of $14.9 million, or 13.6%, to
$124.6 million at March 31, 2004, compared to
$109.7 million at December 31, 2003.

Insurance operations are subject to various
leverage tests (e.g. premium to statutory surplus ratios), which
are evaluated by regulators and rating agencies. The
Companys targets for gross and net written premium to
statutory surplus are 3.0 to 1 and 2.0 to 1, respectively. As of
March 31, 2004, on a statutory consolidated basis, gross
and net premium leverage ratios were 2.7 to 1.0 and 2.0 to 1.0,
respectively.

The Insurance Company Subsidiaries A.M.
Best financial strength rating is a B+ (Very Good)
with a positive outlook. A positive outlook is placed on a
companys rating if its financial and market trends are
favorable, relative to its current rating level.

Off-Balance Sheet Arrangements

On June 6, 2003, the Company entered into a
Guaranty Agreement with a bank. The Company is guaranteeing
payment of a $1.5 million term loan issued by the bank to
an unaffiliated insurance agency. In the event of default on the
term loan by the insurance agency, the Company is obligated to
pay any outstanding principal (up to a maximum of
$1.5 million), as well as any accrued interest on the loan,
and any costs incurred by the bank in the collection process. In
exchange for the Companys guaranty, the president and
member of the insurance agency pledged 100% of the common shares
of two other insurance agencies that he wholly owns. In the
event of default on the term loan by the insurance agency, the
Company has the right to sell any or all of the pledged
insurance agencies common shares and use the proceeds from
the sale to recover any amounts paid under the guaranty
agreement. Any excess proceeds would be paid to the shareholder.
As of March 31, 2004, no liability has been recorded with
respect to the Companys obligations under the guaranty
agreement, since the collateral is in excess of the guaranteed
amount.

New Accounting Pronouncements

On May 15, 2003, the Financial Accounting
Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 150
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity. The
statement requires issuers to classify as liabilities (or assets
in some circumstances) three classes of freestanding financial
instruments that embody obligations for the issuer. Generally,
the statement is effective for financial instruments entered
into or modified after May 31, 2003, and is otherwise
effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of this standard had no
effect on the Companys financial statements.

In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN No. 45 clarifies the requirements of SFAS
No. 5, Accounting for Contingencies, relating
to a guarantors accounting for, and disclosure of, the
issuance of certain types of guarantees. For certain guarantees
issued after December 31, 2002, FIN No. 45 requires a
guarantor to recognize, upon issuance of a guarantee, a
liability for the fair value of the obligations it assumes under
the guarantee. Guarantees issued prior to January 1, 2003,
are not subject to liability recognition, but are subject to
expanded disclosure requirements. Refer to Note 4 and Note 7 to
the Consolidated Financial Statements for additional information
regarding the effect of the adoption of FIN No. 45.

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In January 2003, the FASB issued FIN No. 46,
Consolidation of Variable Interest Entities. The
primary objective of FIN No. 46 is to provide guidance on
the identification of, and financial reporting for, entities
over which control is achieved through means other than voting
rights; such entities are known as variable interest entities.
FIN No. 46 requires variable interest entities to be
consolidated by the primary beneficiary of the variable interest
entities and expands disclosure requirements for both variable
interest entities that are consolidated as well as those within
which an enterprise holds a significant variable interest. In
accordance with FIN 46, the Company performed an evaluation of
its business relationships and determined that Meadowbrook
Capital Trust I (Trust) was a variable interest
entity; however, it was also determined that the Trust did not
meet the qualifications for consolidation as the Trust equity
was deemed to not be at risk. The adoption of FIN No. 46
did not have a material impact on the Companys
consolidated balance sheet or its consolidated statement of
income. See Note 4 for additional information regarding the
Companys unconsolidated subsidiary trust.

In December 2003, FIN 46 was revised as FIN
46(R), to address certain implementation issues and to defer
full adoption into financial statements for periods ending after
March 15, 2004, with earlier adoption permitted. In
accordance with FIN 46(R), the Company performed an evaluation
of its business relationships and determined that its
wholly-owned subsidiary, AIIC, did not meet the tests for
consolidation, as neither the Company, nor its subsidiary Star,
are the primary beneficiaries of AIIC. Therefore, effective
January 1, 2004, the Company deconsolidated AIIC on a
prospective basis in accordance with the provisions of
FIN 46(R). The adoption of FIN 46(R) and the
deconsolidation of AIIC did not have a material impact on the
Companys consolidated balance sheet or consolidated
statement of income.

This quarterly report may provide information
including certain statements which constitute forward-looking
statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These include
statements regarding the intent, belief, or current expectations
of the Companys management, including, but not limited to,
those statements that use the words believes,
expects, anticipates,
estimates, or similar expressions. You are cautioned
that any such forward-looking statements are not guarantees of
future performance and involve a number of risks and
uncertainties, and results could differ materially from those
indicated by such forward-looking statements. Among the
important factors that could cause actual results to differ
materially from those indicated by such forward-looking
statements are: the frequency and severity of claims;
uncertainties inherent in reserve estimates; catastrophic
events; a change in the demand for, pricing of, availability or
collectibility of reinsurance; increased rate pressure on
premiums; obtainment of certain rate increases in current market
conditions; investment rate of return; changes in and adherence
to insurance regulation; actions taken by regulators, rating
agencies or lenders; obtainment of certain processing
efficiencies; changing rates of inflation; general economic
conditions and other risks identified in the Companys
reports and registration statements filed with the Securities
and Exchange Commission. The Company is not under any obligation
to (and expressly disclaims any such obligation to) update or
alter its forward-looking statements whether as a result of new
information, future events or otherwise.




Item
3.Quantitative and Qualitative
Disclosures About Market Risk

No material changes since December 31, 2003
Annual Report on Form 10-K.




Item
4.Controls and
Procedures

The Company carried out an evaluation, as of
March 31, 2004, under the supervision and with the
participation of the Companys management, including the
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 Exchange Act
Rule 13a-14(c) and 15d-14(c) 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 ensure that all material information relating to the Company
(including its consolidated subsidiaries) required to be
included in this quarterly report has been made known in a
timely manner. There have been no significant changes in the
Companys internal controls or in other factors that could
significantly affect these internal controls during the quarter
ended March 31, 2004.

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PART II  OTHER
INFORMATION






|        |                  
|------- | -----------------
|Item 1. | Legal Proceedings

The information required by this item is included
under Note 7  Commitments and
Contingencies of the Companys Form 10-Q for the
three months ended March 31, 2004, which is hereby
incorporated by reference.



|        |                                                                                     
|------- | ------------------------------------------------------------------------------------
|Item 2. | Changes in Securities, Use of Proceeds and
    Issuer Purchases of Equity Securities

The information required by this item is included
under Note 5  Shareholders Equity of the
Companys Form 10-Q for the three months ended
March 31, 2004, which is hereby incorporated by reference.






|        |                                     
|------- | ------------------------------------
|Item 6. | Exhibits and Reports on
    Form 8-K

(A) The following documents are filed as
part of this Report:

|        |    |             |  |                                                                                                                                                                                                                                    
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 10 | .1          |  | Tri-Party Agreement between Meadowbrook Insurance
    Group, Inc., Kirco Development LLC, and Standard Federal Bank
    N.A., dated March 24, 2004.                                                                                
|        | 10 | .2          |  | Fourth Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated April 29, 2004.                                                                                           
|        | 10 | .3          |  | Fifth Amendment to Restated Credit Agreement and
    Waiver Under Restated Credit Agreement between Meadowbrook
    Insurance Group, Inc. and Comerica Bank, dated May 7, 2004.                                                    
|        | 31 | .1          |  | Certification of Robert S. Cubbin, Chief
    Executive Officer of the Corporation, pursuant to Securities
    Exchange Act Rule 13a-14(a).                                                                                         
|        | 31 | .2          |  | Certification of Karen M. Spaun, Senior Vice
    President and Chief Financial Officer of the Corporation,
    pursuant to Securities Exchange Act Rule 13a-14(a).                                                                 
|        | 32 | .1          |  | Certification pursuant to 18 U.S.C. Section 1350,
    as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002, signed by Robert S. Cubbin, Chief Executive Officer of the
    Corporation.                        
|        | 32 | .2          |  | Certification pursuant to 18 U.S.C. Section 1350,
    as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002, signed by Karen M. Spaun, Senior Vice President and Chief
    Financial Officer of the Corporation.

(B) Reports on Form 8-K:

The Registrant filed a Current Report on
Form 8-K dated February 17, 2004 for the purpose of
furnishing the Companys fourth quarter 2003 earnings
release.

The Registrant filed a Current Report on
Form 8-K dated March 30, 2004, announcing the adoption
of a rule 10b5-1 plan by the Registrants Chairman. A copy
of the press release was included by exhibit.

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SIGNATURES

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



| |                                  
| | ---------------------------------
| | MEADOWBROOK INSURANCE GROUP, INC.



| |     |                   
| | --- | ------------------
| | By: | /s/ KAREN M. SPAUN

| |                          
| | -------------------------
| |                          
| | Senior Vice President and
| | Chief Financial Officer  

Dated: May 10, 2004

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EXHIBIT INDEX

|        |      |             |  |                                                                                                                                                                                                                                    
|------- | ---- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|No.     |      | Description
|        |      |            
|        | 10.1 |             |  | Tri-Party Agreement between Meadowbrook Insurance
    Group, Inc., Kirco Development LLC, and Standard Federal Bank
    N.A., dated March 24, 2004.                                                                                
|        | 10.2 |             |  | Fourth Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated April 29, 2004.                                                                                           
|        | 10.3 |             |  | Fifth Amendment to Restated Credit Agreement and
    Waiver Under Restated Credit Agreement between Meadowbrook
    Insurance Group, Inc. and Comerica Bank, dated May 7, 2004.                                                    
|        | 31.1 |             |  | Certification of Robert S. Cubbin, Chief
    Executive Officer of the Corporation, pursuant to Securities
    Exchange Act Rule 13a-14(a).                                                                                         
|        | 31.2 |             |  | Certification of Karen M. Spaun, Senior Vice
    President and Chief Financial Officer of the Corporation,
    pursuant to Securities Exchange Act Rule 13a-14(a).                                                                 
|        | 32.1 |             |  | Certification pursuant to 18 U.S.C. Section 1350,
    as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002, signed by Robert S. Cubbin, Chief Executive Officer of the
    Corporation.                        
|        | 32.2 |             |  | Certification pursuant to 18 U.S.C. Section 1350,
    as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
    2002, signed by Karen M. Spaun, Senior Vice President and Chief
    Financial Officer of the Corporation.