##### 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 June 30,
    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
August 5, 2004 was 29,062,483.



---






---










TABLE OF CONTENTS

|                                                                                   |  |                                                                                           |    |      |       | 
|---------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------- | -- | ---- | ----- | 
|                                                                                   |  |                                                                                           |    | Page
|                                                                                   |  |                                                                                           |    |     
|PART I 
    FINANCIAL INFORMATION                                                
|ITEM 1.                                                                            |  | FINANCIAL STATEMENTS                                                                      |    |      |       | 
|                                                                                   |  | Consolidated Statements of
    Income (unaudited)                                         |    |      | 2-3   | 
|                                                                                   |  | Consolidated Statements of
    Comprehensive Income (unaudited)                           |    |      | 4-5   | 
|                                                                                   |  | Consolidated Balance Sheets
    (unaudited)                                               |    |      | 6     | 
|                                                                                   |  | Consolidated Statement of
    Cash Flows (unaudited)                                      |    |      | 7     | 
|                                                                                   |  | Notes to Consolidated
    Financial Statements (unaudited)                                |    |      | 8-19  | 
|ITEM 2.                                                                            |  | MANAGEMENTS DISCUSSION
    AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |    |      | 20-36 | 
|ITEM 3.                                                                            |  | QUANTITATIVE AND QUALITATIVE
    DISCLOSURES ABOUT MARKET RISK                            |    |      | 37-38 | 
|ITEM 4.                                                                            |  | CONTROLS AND PROCEDURES                                                                   |    |      | 38    | 
|PART II  OTHER
    INFORMATION                                                   
|ITEM 1.                                                                            |  | LEGAL PROCEEDINGS                                                                         |    |      | 39    | 
|ITEM 2.                                                                            |  | CHANGES IN SECURITIES, USE
    OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES      |    |      | 39    | 
|ITEM 4.                                                                            |  | SUBMISSION OF MATTERS TO A
    VOTE OF SECURITY HOLDERS                                   |    |      | 39    | 
|ITEM 6.                                                                            |  | EXHIBITS AND REPORTS ON FORM
    8-K                                                      |    |      | 40    | 
|SIGNATURES                                                                         |  |                                                                                           | 41 |     
|Long Term Incentive Plan                                                          
|Purchase and Sale Agreement                                                       
|Standard Offer, Agreement and Escrow Instructions                                 
|Indenture between Meadowbrook Ins. Group & JPMorgan Chase Bank                    
|Amended & Restated Loan and Security Agreement                                    
|Sixth Amendment to Restated Credit Agreement                                      
|Indenture between Meadowbrook Ins. Group & Wilmington Trust Company               
|Seventh Amendment to Restated Credit Agreement                                    
|First Amendment to Purchase & Sale Agreement                                      
|Land Contract between Meadowbrok Ins. Group & MB Center II LLC                    
|Certification of Robert S. Cubbin, Chief Executive Officer                        
|Certification of Karen M. Spaun, Senior Vice President and Chief Financial Officer
|Certification Pursuant to Section 906 by Robert S. Cubbin, CEO                    
|Certification Pursuant to Section 906 by Karen M. Spaun, 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 Six Months Ended
|                                             |                                                               | June 30,                
|                                             |                                                               |                         
|                                             |                                                               | 2004                     |       | 2003      
|                                             |                                                               |                          |       |           
|                                             |                                                               |                         
|                                             |                                                               | (Unaudited)             
|                                             |                                                               | (In thousands,          
|                                             |                                                               | except share data)      
|Revenues                                     |                                                               |                          |       |            |         |   |       |           
|                                             | Premiums earned                                               |                          |       |            |         |   |       |            |        
|                                             |                                                               | Gross                    |       | $          | 136,100 |   |       | $          | 93,590  |  
|                                             |                                                               | Ceded                    |       |            | (33,304 | ) |       |            | (29,976 | )
|                                             |                                                               |                          |       |            |         |   |       |           
|                                             | Net earned                                                    |                          |       | 102,796    |         |   |       | 63,614     |        
|                                             | Net commissions and fees                                      |                          |       | 20,125     |         |   |       | 24,627     |        
|                                             | Net investment income                                         |                          |       | 7,144      |         |   |       | 6,930      |        
|                                             | Net realized (losses) gains on disposition
    of investments |                          |       | (152       | )       |   |       | 579        |        
|                                             |                                                               |                          |       |            |         |   |       |           
|                                             |                                                               | Total revenues           |       |            | 129,913 |   |       |            | 95,750  |  
|                                             |                                                               |                          |       |            |         |   |       |           
|Expenses                                     |                                                               |                          |       |            |         |   |       |           
|                                             | Losses and loss adjustment expenses                           |                          |       | 101,411    |         |   |       | 76,240     |        
|                                             | Reinsurance recoveries                                        |                          |       | (36,076    | )       |   |       | (34,945    | )      
|                                             |                                                               |                          |       |            |         |   |       |           
|                                             | Net losses and loss adjustment expenses                       |                          |       | 65,335     |         |   |       | 41,295     |        
|                                             | Salaries and employee benefits                                |                          |       | 25,133     |         |   |       | 23,800     |        
|                                             | Policy acquisition and other underwriting expenses            |                          |       | 16,458     |         |   |       | 9,749      |        
|                                             | Other administrative expenses                                 |                          |       | 13,333     |         |   |       | 12,390     |        
|                                             | Interest expense                                              |                          |       | 843        |         |   |       | 449        |        
|                                             |                                                               |                          |       |            |         |   |       |           
|                                             |                                                               | Total expenses           |       |            | 121,102 |   |       |            | 87,683  |  
|                                             |                                                               |                          |       |            |         |   |       |           
|Income before taxes and equity earnings      |                                                               |                          | 8,811 |            |         |   | 8,067 |           
|                                             |                                                               |                          |       |            |         |   |       |           
|                                             | Federal income tax expense                                    |                          |       | 2,724      |         |   |       | 2,632      |        
|                                             | Equity earnings of affiliates                                 |                          |       | (35        | )       |   |       |           |        
|                                             |                                                               |                          |       |            |         |   |       |           
|Net income                                   |                                                               | $                        | 6,052 |            |         | $ | 5,435 |           
|                                             |                                                               |                          |       |            |         |   |       |           
|Earnings Per Share                           |                                                               |                          |       |            |         |   |       |           
|                                             | Basic                                                         |                          | $     | 0.21       |         |   | $     | 0.19       |        
|                                             | Diluted                                                       |                          | $     | 0.21       |         |   | $     | 0.18       |        
|Weighted average number of common
    shares |                                                               |                          |       |            |         |   |       |           
|                                             | Basic                                                         |                          |       | 29,030,836 |         |   |       | 29,358,267 |        
|                                             | Diluted                                                       |                          |       | 29,427,512 |         |   |       | 29,389,101 |        

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 INCOME

|                                             |                                                               |                            |       |            |         |   |       |            |         |  
|-------------------------------------------- | ------------------------------------------------------------- | -------------------------- | ----- | ---------- | ------- | - | ----- | ---------- | ------- | -
|                                             |                                                               |                           
|                                             |                                                               | For the Three Months Ended
|                                             |                                                               | June 30,                  
|                                             |                                                               |                           
|                                             |                                                               | 2004                       |       | 2003      
|                                             |                                                               |                            |       |           
|                                             |                                                               |                           
|                                             |                                                               | (Unaudited)               
|                                             |                                                               | (In thousands,            
|                                             |                                                               | except share data)        
|Revenues                                     |                                                               |                            |       |            |         |   |       |           
|                                             | Premiums earned                                               |                            |       |            |         |   |       |            |        
|                                             |                                                               | Gross                      |       | $          | 69,922  |   |       | $          | 48,277  |  
|                                             |                                                               | Ceded                      |       |            | (16,839 | ) |       |            | (12,047 | )
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             | Net earned                                                    |                            |       | 53,083     |         |   |       | 36,230     |        
|                                             | Net commissions and fees                                      |                            |       | 8,844      |         |   |       | 11,271     |        
|                                             | Net investment income                                         |                            |       | 3,547      |         |   |       | 3,577      |        
|                                             | Net realized (losses) gains on disposition
    of investments |                            |       | (32        | )       |   |       | 374        |        
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             |                                                               | Total revenues             |       |            | 65,442  |   |       |            | 51,452  |  
|                                             |                                                               |                            |       |            |         |   |       |           
|Expenses                                     |                                                               |                            |       |            |         |   |       |           
|                                             | Losses and loss adjustment expenses                           |                            |       | 49,997     |         |   |       | 48,917     |        
|                                             | Reinsurance recoveries                                        |                            |       | (17,171    | )       |   |       | (24,808    | )      
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             | Net losses and loss adjustment expenses                       |                            |       | 32,826     |         |   |       | 24,109     |        
|                                             | Salaries and employee benefits                                |                            |       | 12,325     |         |   |       | 11,868     |        
|                                             | Policy acquisition and other underwriting expenses            |                            |       | 8,896      |         |   |       | 5,993      |        
|                                             | Other administrative expenses                                 |                            |       | 6,705      |         |   |       | 5,306      |        
|                                             | Interest expense                                              |                            |       | 528        |         |   |       | 212        |        
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             |                                                               | Total expenses             |       |            | 61,280  |   |       |            | 47,488  |  
|                                             |                                                               |                            |       |            |         |   |       |           
|Income before taxes and equity earnings      |                                                               |                            | 4,162 |            |         |   | 3,964 |           
|                                             |                                                               |                            |       |            |         |   |       |           
|                                             | Federal income tax expense                                    |                            |       | 1,284      |         |   |       | 1,285      |        
|                                             | Equity earnings of affiliates                                 |                            |       | (58        | )       |   |       |           |        
|                                             |                                                               |                            |       |            |         |   |       |           
|Net income                                   |                                                               | $                          | 2,820 |            |         | $ | 2,679 |           
|                                             |                                                               |                            |       |            |         |   |       |           
|Earnings Per Share                           |                                                               |                            |       |            |         |   |       |           
|                                             | Basic                                                         |                            | $     | 0.10       |         |   | $     | 0.09       |        
|                                             | Diluted                                                       |                            | $     | 0.10       |         |   | $     | 0.09       |        
|Weighted average number of common
    shares |                                                               |                            |       |            |         |   |       |           
|                                             | Basic                                                         |                            |       | 29,036,164 |         |   |       | 29,214,563 |        
|                                             | Diluted                                                       |                            |       | 29,459,390 |         |   |       | 29,261,119 |        

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 STATEMENTS OF COMPREHENSIVE
INCOME


|           |                                         |                                                                                 |                                               |      |        |        |       |  |       |       | 
|---------- | --------------------------------------- | ------------------------------------------------------------------------------- | --------------------------------------------- | ---- | ------ | ------ | ----- |  | ----- | ----- | 
|           |                                         |                                                                                
|           |                                         | For the Six                                                                    
|           |                                         | Months Ended                                                                   
|           |                                         | June 30,                                                                       
|           |                                         |                                                                                
|           |                                         | 2004                                                                            |                                               | 2003
|           |                                         |                                                                                 |                                               |     
|           |                                         |                                                                                
|           |                                         | (Unaudited)                                                                    
|           |                                         | (In thousands)                                                                 
|Net income |                                         | $                                                                               | 6,052                                         |      |        | $      | 5,435 | 
|           | Other comprehensive income, net of tax: |                                                                                 |                                               |      |        |        |       |  |      
|           |                                         | Unrealized (losses) gains on securities                                         |                                               |      | (4,671 | )      |       |  | 2,303 |      
|           |                                         | Less: reclassification adjustment for losses
    (gains) included in net income |                                               |      | 60     |        |       |  | (229  | )    
|           |                                         |                                                                                 |                                               |      |        |        |       | 
|           |                                         |                                                                                 | Other comprehensive (loss) income, net of tax |      |        | (4,611 | )     |  |       | 2,074 | 
|           |                                         |                                                                                 |                                               |      |        |        |       | 
|           |                                         |                                                                                 | Comprehensive income                          |      | $      | 1,441  |       |  | $     | 7,509 | 
|           |                                         |                                                                                 |                                               |      |        |        |       | 

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 COMPREHENSIVE
INCOME

|           |                                         |                                                                          |                                               |      |        |        |       |  |       |       | 
|---------- | --------------------------------------- | ------------------------------------------------------------------------ | --------------------------------------------- | ---- | ------ | ------ | ----- |  | ----- | ----- | 
|           |                                         |                                                                         
|           |                                         | For the Three                                                           
|           |                                         | Months Ended                                                            
|           |                                         | June 30,                                                                
|           |                                         |                                                                         
|           |                                         | 2004                                                                     |                                               | 2003
|           |                                         |                                                                          |                                               |     
|           |                                         |                                                                         
|           |                                         | (Unaudited)                                                             
|           |                                         | (In thousands)                                                          
|Net income |                                         | $                                                                        | 2,820                                         |      |        | $      | 2,679 | 
|           | Other comprehensive income, net of tax: |                                                                          |                                               |      |        |        |       |  |      
|           |                                         | Unrealized (losses) gains on securities                                  |                                               |      | (6,405 | )      |       |  | 2,011 |      
|           |                                         | Less: reclassification adjustment for
    (gains) included in net income |                                               |      | (13    | )      |       |  | (88   | )    
|           |                                         |                                                                          |                                               |      |        |        |       | 
|           |                                         |                                                                          | Other comprehensive (loss) income, net of tax |      |        | (6,418 | )     |  |       | 1,923 | 
|           |                                         |                                                                          |                                               |      |        |        |       | 
|           |                                         |                                                                          | Comprehensive (loss) income                   |      | $      | (3,598 | )     |  | $     | 4,602 | 
|           |                                         |                                                                          |                                               |      |        |        |       | 

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

5



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED BALANCE SHEETS


|                                         |                                                                                                                                 |                                            |   |              |         |  |   |         |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | - | ------------ | ------- |  | - | ------- | ------- | 
|                                         |                                                                                                                                 | June 30,                                   |   | December 31,
|                                         |                                                                                                                                 | 2004                                       |   | 2003        
|                                         |                                                                                                                                 |                                            |   |             
|                                         |                                                                                                                                 | (Unaudited)                                |   |             
|                                         |                                                                                                                                 |                                           
|                                         |                                                                                                                                 | (In thousands, except share               
|                                         |                                                                                                                                 | data)                                     
|ASSETS                                  
|Investments                              |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         | Debt securities available for sale, at fair value
    (amortized cost of $293,876 and $260,330)                                 |                                            | $ | 297,811      |         |  | $ | 271,217 |        
|                                         | Equity securities available for sale, at fair
    value (cost of $1,980 and $1,980)                                             |                                            |   | 2,360        |         |  |   | 2,371   |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total investments                          |   |              | 300,171 |  |   |         | 273,588 | 
|                                         | Cash and cash equivalents                                                                                                       |                                            |   | 58,750       |         |  |   | 50,647  |        
|                                         | Accrued investment income                                                                                                       |                                            |   | 3,856        |         |  |   | 3,441   |        
|                                         | Premiums and agent balances receivable, net                                                                                     |                                            |   | 95,113       |         |  |   | 77,554  |        
|                                         | Reinsurance recoverable on:                                                                                                     |                                            |   |              |         |  |   |         |        
|                                         |                                                                                                                                 | Paid losses                                |   |              | 13,370  |  |   |         | 17,566  | 
|                                         |                                                                                                                                 | Unpaid losses                              |   |              | 154,372 |  |   |         | 147,446 | 
|                                         | Prepaid reinsurance premiums                                                                                                    |                                            |   | 23,564       |         |  |   | 20,492  |        
|                                         | Deferred policy acquisition costs                                                                                               |                                            |   | 22,352       |         |  |   | 19,564  |        
|                                         | Deferred federal income taxes                                                                                                   |                                            |   | 17,416       |         |  |   | 15,201  |        
|                                         | Goodwill                                                                                                                        |                                            |   | 28,997       |         |  |   | 28,997  |        
|                                         | Other assets                                                                                                                    |                                            |   | 37,526       |         |  |   | 37,770  |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total assets                               |   | $            | 755,487 |  |   | $       | 692,266 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                        
|LIABILITIES AND SHAREHOLDERS
    EQUITY
|Liabilities                              |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         | Losses and loss adjustment expenses                                                                                             |                                            | $ | 360,138      |         |  |   | 339,465 |        
|                                         | Unearned premiums                                                                                                               |                                            |   | 125,502      |         |  |   | 109,677 |        
|                                         | Debt                                                                                                                            |                                            |   | 16,204       |         |  |   | 17,506  |        
|                                         | Debentures                                                                                                                      |                                            |   | 35,310       |         |  |   | 10,310  |        
|                                         | Accounts payable and accrued expenses                                                                                           |                                            |   | 29,789       |         |  |   | 26,283  |        
|                                         | Reinsurance funds held and balances payable                                                                                     |                                            |   | 17,638       |         |  |   | 13,961  |        
|                                         | Payable to insurance companies                                                                                                  |                                            |   | 3,312        |         |  |   | 7,853   |        
|                                         | Other liabilities                                                                                                               |                                            |   | 10,571       |         |  |   | 12,098  |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total liabilities                          |   |              | 598,464 |  |   |         | 537,153 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|Commitments and contingencies (Note 6)   |                                                                                                                                 |                                            |   |              |         |  |   |        
|Shareholders Equity                     |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         | Common stock, $0.01 stated value; authorized
    50,000,000 shares; 29,040,733 and 29,022,435 shares issued and
    outstanding |                                            |   | 290          |         |  |   | 290     |        
|                                         | Additional paid-in capital                                                                                                      |                                            |   | 125,595      |         |  |   | 125,181 |        
|                                         | Retained earnings                                                                                                               |                                            |   | 29,166       |         |  |   | 23,069  |        
|                                         | Note receivable from officer                                                                                                    |                                            |   | (876         | )       |  |   | (886    | )      
|                                         | Accumulated other comprehensive income                                                                                          |                                            |   | 2,848        |         |  |   | 7,459   |        
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total shareholders equity                 |   |              | 157,023 |  |   |         | 155,113 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                         |                                                                                                                                 | Total liabilities and shareholders equity |   | $            | 755,487 |  |   | $       | 692,266 | 
|                                         |                                                                                                                                 |                                            |   |              |         |  |   |        

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

6



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF CASH
FLOWS


|                                     |                                                                                                 |                                                          |                   |         |         |        |   |         |         |        | 
|------------------------------------ | ----------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ----------------- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | For the Six Months                                      
|                                     |                                                                                                 | Ended June 30,                                          
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | 2004                                                     |                   | 2003   
|                                     |                                                                                                 |                                                          |                   |        
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | (Unaudited)                                             
|                                     |                                                                                                 | (In thousands)                                          
|Cash Flows From Operating Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Net income                                                                                      |                                                          | $                 | 6,052   |         |        | $ | 5,435   |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Adjustments to reconcile net income to net cash
    provided by (used in) operating activities: |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Amortization of goodwill and other intangible
    assets |                   |         | 191     |        |   |         | 140     |       
|                                     |                                                                                                 | Amortization of deferred debenture issuance costs        |                   |         | 35      |        |   |         |        |       
|                                     |                                                                                                 | Depreciation of furniture and equipment                  |                   |         | 656     |        |   |         | 721     |       
|                                     |                                                                                                 | Net accretion of discount and premiums on bonds          |                   |         | 822     |        |   |         | 909     |       
|                                     |                                                                                                 | Gain (loss) on sale of investments                       |                   |         | 92      |        |   |         | (346    | )     
|                                     |                                                                                                 | Stock-based employee compensation                        |                   |         | 44      |        |   |         | 120     |       
|                                     |                                                                                                 | Long-term incentive plan expense                         |                   |         | 309     |        |   |         |        |       
|                                     |                                                                                                 | Deferred income tax expense                              |                   |         | 137     |        |   |         | 2,507   |       
|                                     | Changes in operating assets and liabilities:                                                    |                                                          |                   |         |         |        |   |         |        
|                                     | Decrease (increase) in:                                                                         |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Premiums and agent balances receivable                   |                   |         | (17,295 | )      |   |         | (6,178  | )     
|                                     |                                                                                                 | Reinsurance recoverable on paid and unpaid losses        |                   |         | (1,118  | )      |   |         | 1,112   |       
|                                     |                                                                                                 | Prepaid reinsurance premiums                             |                   |         | (2,645  | )      |   |         | (3,054  | )     
|                                     |                                                                                                 | Deferred policy acquisition costs                        |                   |         | (2,958  | )      |   |         | (5,049  | )     
|                                     |                                                                                                 | Other assets                                             |                   |         | 1,457   |        |   |         | (2,950  | )     
|                                     | Increase (decrease) in:                                                                         |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Losses and loss adjustment expenses                      |                   |         | 20,673  |        |   |         | (5,858  | )     
|                                     |                                                                                                 | Unearned premiums                                        |                   |         | 15,825  |        |   |         | 31,419  |       
|                                     |                                                                                                 | Payable to insurance companies                           |                   |         | (4,541  | )      |   |         | (4,384  | )     
|                                     |                                                                                                 | Reinsurance funds held and balances payable              |                   |         | 3,466   |        |   |         | 7,274   |       
|                                     |                                                                                                 | Other liabilities                                        |                   |         | 5,096   |        |   |         | 8,373   |       
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 |                                                          | Total adjustments |         |         | 20,246 |   |         |         | 24,756 | 
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash provided by operating activities                |                   |         | 26,298  |        |   |         | 30,191  |       
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|Cash Flows From Investing Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Purchase of debt securities available for sale                                                  |                                                          |                   | (62,411 | )       |        |   | (53,453 | )      
|                                     | Proceeds from sales and maturities of debt
    securities available for sale                    |                                                          |                   | 25,944  |         |        |   | 29,916  |        
|                                     | Capital expenditures                                                                            |                                                          |                   | (1,673  | )       |        |   | (476    | )      
|                                     | Purchase of books of business                                                                   |                                                          |                   | (272    | )       |        |   | (313    | )      
|                                     | Deconsolidation of subsidiary                                                                   |                                                          |                   | (4,218  | )       |        |   |        |        
|                                     | Other investing activities                                                                      |                                                          |                   | 1,775   |         |        |   | 1,689   |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash used in investing activities                    |                   |         | (40,855 | )      |   |         | (22,637 | )     
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|Cash Flows From Financing Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Proceeds from lines of credit                                                                   |                                                          |                   | 9,829   |         |        |   | 11,742  |        
|                                     | Payment of lines of credit                                                                      |                                                          |                   | (11,131 | )       |        |   | (23,454 | )      
|                                     | Net proceeds from debentures                                                                    |                                                          |                   | 24,250  |         |        |   |        |        
|                                     | Book overdraft                                                                                  |                                                          |                   | (343    | )       |        |   | 189     |        
|                                     | Share issuance (repurchases)                                                                    |                                                          |                   | 45      |         |        |   | (1,563  | )      
|                                     | Other financing activities                                                                      |                                                          |                   | 10      |         |        |   | (16     | )      
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash provided by (used in) financing
    activities  |                   |         | 22,660  |        |   |         | (13,102 | )     
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Net increase (decrease) in cash and cash
    equivalents                                        |                                                          |                   | 8,103   |         |        |   | (5,548  | )      
|                                     | Cash and cash equivalents, beginning of period                                                  |                                                          |                   | 50,647  |         |        |   | 39,385  |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Cash and cash equivalents, end of period                                                        |                                                          | $                 | 58,750  |         |        | $ | 33,837  |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        

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

7



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##### Table of Contents






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(Unaudited)

Note 1  Summary of Significant
Accounting Policies



| |                                                        
| | -------------------------------------------------------
| | Basis of Presentation and Management
    Representation

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.

In the opinion of management, the consolidated
financial statements reflect all normal recurring adjustments
necessary to present a fair statement of the results for the
interim period. Preparation of financial statements under
generally accepted accounting principles requires management to
make estimates. Actual results could differ from those
estimates. The results of operations for the six months ended
June 30, 2004, are not necessarily indicative of the
results expected for the full year.

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, as filed with the United States
Securities and Exchange Commission, for the year ended
December 31, 2003.

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

8



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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 1,035,796 and 2,092,149
for the six months ended June 30, 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
340,659 and 30,834 for the six months ended June 30, 2004
and 2003, respectively. In addition, shares issuable pursuant to
outstanding warrants included in diluted earnings per share were
82,567 for the six months ended June 30, 2004. Outstanding
warrants of 300,000 for the six months ended June 30, 2003,
have been excluded from the diluted earnings per share, as they
were anti-dilutive.

Outstanding options of 1,035,796 and 2,092,149
for the three months ended June 30, 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 319,358 and 46,556
for the three months ended June 30, 2004 and 2003,
respectively. In addition, shares issuable pursuant to
outstanding warrants included in diluted earnings per share were
77,318 for the three months ended June 30, 2004.
Outstanding warrants of 300,000 for the three months ended
June 30, 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 plans require the exercise price of
the grants to be at the current fair market value of the 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.

9



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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 periods ending
June 30, 2004 and 2003 would be as follows (in thousands):

|                                                                                                                                                     |                       |                    |       |      |  |   |       |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | ------------------ | ----- | ---- |  | - | ----- | ---- | 
|                                                                                                                                                     |                       |                   
|                                                                                                                                                     |                       | For the Six Months
|                                                                                                                                                     |                       | Ended June 30,    
|                                                                                                                                                     |                       |                   
|                                                                                                                                                     |                       | 2004               |       | 2003
|                                                                                                                                                     |                       |                    |       |     
|Net income, as reported                                                                                                                              |                       | $                  | 6,052 |      |  | $ | 5,435 |     
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                           |                       |                    | 29    |      |  |   | 79    |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value-based methods for all
    awards, net of related tax effects |                       |                    | (251  | )    |  |   | (515  | )   
|                                                                                                                                                     |                       |                    |       |      |  |   |       |     
|Pro forma net income                                                                                                                                 |                       | $                  | 5,830 |      |  | $ | 4,999 |     
|                                                                                                                                                     |                       |                    |       |      |  |   |       |     
|Earnings per share:                                                                                                                                  |                       |                    |       |      |  |   |       |     
|                                                                                                                                                     | Basic  as reported   |                    | $     | 0.21 |  |   | $     | 0.19 | 
|                                                                                                                                                     | Basic  pro forma     |                    | $     | 0.20 |  |   | $     | 0.17 | 
|                                                                                                                                                     | Diluted  as reported |                    | $     | 0.21 |  |   | $     | 0.18 | 
|                                                                                                                                                     | Diluted  pro forma   |                    | $     | 0.20 |  |   | $     | 0.17 | 

|                                                                                                                                                     |                       |                |       |      |  |   |       |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | -------------- | ----- | ---- |  | - | ----- | ---- | 
|                                                                                                                                                     |                       |               
|                                                                                                                                                     |                       | For the       
|                                                                                                                                                     |                       | Three Months  
|                                                                                                                                                     |                       | Ended June 30,
|                                                                                                                                                     |                       |               
|                                                                                                                                                     |                       | 2004           |       | 2003
|                                                                                                                                                     |                       |                |       |     
|Net income, as reported                                                                                                                              |                       | $              | 2,820 |      |  | $ | 2,679 |     
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                           |                       |                | 11    |      |  |   | 22    |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value-based methods for all
    awards, net of related tax effects |                       |                | (117  | )    |  |   | (229  | )   
|                                                                                                                                                     |                       |                |       |      |  |   |       |     
|Pro forma net income                                                                                                                                 |                       | $              | 2,714 |      |  | $ | 2,472 |     
|                                                                                                                                                     |                       |                |       |      |  |   |       |     
|Earnings per share:                                                                                                                                  |                       |                |       |      |  |   |       |     
|                                                                                                                                                     | Basic  as reported   |                | $     | 0.10 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Basic  pro forma     |                | $     | 0.09 |  |   | $     | 0.08 | 
|                                                                                                                                                     | Diluted  as reported |                | $     | 0.10 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Diluted  pro forma   |                | $     | 0.09 |  |   | $     | 0.08 | 

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 six months ended June 30, 2004.

Compensation expense of $44,000 and $120,000 has
been recorded in the six months ended June 30, 2004 and
2003, respectively, under SFAS 148. Compensation expense of
$17,000 and $34,000 has been recorded in the three months ended
June 30, 2004 and 2003, respectively.

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

10



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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.

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 No. 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 3 for additional information regarding the
Companys unconsolidated subsidiary trust.

In December 2003, FIN No. 46 was revised as
FIN No. 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 No. 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 No. 46(R). The adoption of FIN
No. 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 June 30, 2004, the Company had
reinsurance recoverables for paid and unpaid losses of
$167.7 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 34.1% of the total recoverable for paid and unpaid losses.

11



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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 $350,000 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.

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 June 30, 2004, for transactions under this contract, the
Company carried a prepaid asset of $1.2 million and a
deposit liability of $941,000. For the six months and the three
months ended June 30, 2004, the Company recorded an
operating expense of $1.5 million and $816,000,
respectively, 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 $300,000 or less.

Facultative reinsurance 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
June 30, 2004, the Company had risk

12



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


exposure in excess of collateral in the amount of
$10.5 million, on these programs, of which the Company has
an allowance of $7.5 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 June 30, 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 June 30, 2004, the exposure amount in
litigation with former risk-sharing partners which is not
reserved or collateralized is $1.2 million.

Note 3  Debt



| |                              
| | -----------------------------
| | Term Loan and Lines of Credit

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 June 30, 2004, the Companys
term loan had an outstanding balance of $11.5 million. The
Company had no outstanding balance on the revolving line of
credit at June 30, 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 September 1,
2004, and is thereafter renewable on an annual basis. The
Company is currently renegotiating the terms of the line of
credit with its lender. 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 June 30, 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
June 30, 2004, this ratio was 10.4 to 1.0, compared to the
covenant minimum of 1.2 to 1.0.

As of June 30, 2004, the Company was in
compliance with all debt covenants.

A non-insurance premium finance subsidiary of the
Company maintains a line of credit with a bank, which permits
borrowings up to 75% of the accounts receivable, which
collateralize the line of credit. At June 30, 2004, this
line of credit had an outstanding balance of $4.7 million.
The terms of this line of credit were amended on May 7,
2004. The amendments to the line of credit agreement included a
change in the permitted borrowings from 80% to 75% of the
accounts receivable, an increase in the line of credit from
$6.0 million to $8.0 million, and amendments to the
interest rates. The interest terms were amended to interest at
the Prime Rate minus 0.5%, or a LIBOR-based rate option, plus
2.0%. On May 24, 2004, $3.5 million was moved into the
LIBOR-based rate. At June 30, 2004, the Prime Rate minus
0.5%, was 3.75% and the LIBOR-based option was 3.3%.

13



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                  
| | -----------------
| | Senior Debentures

On April 29, 2004, the Company issued senior
debentures in the amount of $13.0 million. The senior
debentures mature in thirty years and provide for interest at
the three-month LIBOR, plus 4.00%, which is non-deferrable. The
senior debentures are callable by the Company at par after five
years from the date of issuance. Associated with this
transaction the Company incurred $390,000 of commissions paid to
the placement agents. These issuance costs have been capitalized
and are included in other assets on the balance sheet, which
will be amortized over seven years as a component of interest
expense.

On May 26, 2004, the Company issued senior
debentures in the amount of $12.0 million. The senior
debentures mature in thirty years and provide for interest at
the three-month LIBOR, plus 4.20%, which is non-deferrable. The
senior debentures are callable by the Company at par after five
years from the date of issuance. Associated with this
transaction the Company incurred $360,000 of commissions paid to
the placement agents. These issuance costs have been capitalized
and are included in other assets on the balance sheet, which
will be amortized over seven years as a component of interest
expense.

The proceeds from the issuance of the senior
debentures may be used to support future premium growth through
contributions to its Insurance Company Subsidiaries and general
corporate purposes.



| |                                   
| | ----------------------------------
| | 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 thirty 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.

The Debentures are unsecured obligations of the
Company and are junior to the right of payment to all 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 4  Shareholders
Equity

At June 30, 2004, shareholders equity
was $157.0 million, or a book value of $5.41 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 September 17,
2004, or when the Company has repurchased all shares authorized
for

14



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


repurchase. As of June 30, 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 June 30, 2004. As of
June 30, 2004, the Company has 1,235,200 shares remaining
which could be purchased.

Note 5  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 June 30, 2004, earned
surplus was negative $25.1 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 2.5 to 1.0, respectively.
As of June 30, 2004, on a statutory consolidated basis, the
gross and net premium leverage ratios were 2.8 to 1.0 and 2.2 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 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
June 30, 2004, Stars statutory surplus was
$99.3 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.

15



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 6  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 June 30, 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.

Note 7  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

16



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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.

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

|                |                                            |                             |   |         |         |  |   |        |        | 
|--------------- | ------------------------------------------ | --------------------------- | - | ------- | ------- |  | - | ------ | ------ | 
|                |                                            |                            
|                |                                            | For the Six Months         
|                |                                            | Ended June 30,             
|                |                                            |                            
|                |                                            | 2004                        |   | 2003   
|                |                                            |                             |   |        
|Revenues        |                                            |                             |   |         |         |  |   |       
|                | Net earned premiums                        |                             | $ | 102,796 |         |  | $ | 63,614 |       
|                | Management fees                            |                             |   | 8,609   |         |  |   | 10,188 |       
|                | Claims fees                                |                             |   | 5,429   |         |  |   | 8,137  |       
|                | Loss control fees                          |                             |   | 1,077   |         |  |   | 1,126  |       
|                | Reinsurance brokerage                      |                             |   | 117     |         |  |   | 161    |       
|                | Investment income                          |                             |   | 7,133   |         |  |   | 6,904  |       
|                | Net realized (losses) gains on investments |                             |   | (152    | )       |  |   | 579    |       
|                |                                            |                             |   |         |         |  |   |       
|                |                                            | Specialty risk management   |   |         | 125,009 |  |   |        | 90,709 | 
|                | Agency operations                          |                             |   | 8,772   |         |  |   | 7,822  |       
|                | Reconciling items                          |                             |   | 11      |         |  |   | 26     |       
|                | Intersegment revenue                       |                             |   | (3,879  | )       |  |   | (2,807 | )     
|                |                                            |                             |   |         |         |  |   |       
|                |                                            | Consolidated revenue        |   | $       | 129,913 |  |   | $      | 95,750 | 
|                |                                            |                             |   |         |         |  |   |       
|Pre-tax income: |                                            |                             |   |         |         |  |   |       
|                | Specialty risk management                  |                             | $ | 6,870   |         |  | $ | 5,517  |       
|                | Agency operations*                         |                             |   | 4,236   |         |  |   | 3,600  |       
|                | Reconciling items                          |                             |   | (2,295  | )       |  |   | (1,050 | )     
|                |                                            |                             |   |         |         |  |   |       
|                |                                            | Consolidated pre-tax income |   | $       | 8,811   |  |   | $      | 8,067  | 
|                |                                            |                             |   |         |         |  |   |       



---



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

17



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                |                                            |                             |   |        |        |  |   |        |        | 
|--------------- | ------------------------------------------ | --------------------------- | - | ------ | ------ |  | - | ------ | ------ | 
|                |                                            |                            
|                |                                            | For the Three Months       
|                |                                            | Ended June 30,             
|                |                                            |                            
|                |                                            | 2004                        |   | 2003  
|                |                                            |                             |   |       
|Revenues        |                                            |                             |   |        |        |  |   |       
|                | Net earned premiums                        |                             | $ | 53,083 |        |  | $ | 36,230 |       
|                | Management fees                            |                             |   | 3,898  |        |  |   | 4,840  |       
|                | Claims fees                                |                             |   | 2,728  |        |  |   | 3,755  |       
|                | Loss control fees                          |                             |   | 532    |        |  |   | 549    |       
|                | Reinsurance brokerage                      |                             |   | (30    | )      |  |   | 106    |       
|                | Investment income                          |                             |   | 3,542  |        |  |   | 3,564  |       
|                | Net realized (losses) gains on investments |                             |   | (32    | )      |  |   | 374    |       
|                |                                            |                             |   |        |        |  |   |       
|                |                                            | Specialty risk management   |   |        | 63,721 |  |   |        | 49,418 | 
|                | Agency operations                          |                             |   | 3,993  |        |  |   | 3,675  |       
|                | Reconciling items                          |                             |   | 5      |        |  |   | 13     |       
|                | Intersegment revenue                       |                             |   | (2,277 | )      |  |   | (1,654 | )     
|                |                                            |                             |   |        |        |  |   |       
|                |                                            | Consolidated revenue        |   | $      | 65,442 |  |   | $      | 51,452 | 
|                |                                            |                             |   |        |        |  |   |       
|Pre-tax income: |                                            |                             |   |        |        |  |   |       
|                | Specialty risk management                  |                             | $ | 3,774  |        |  | $ | 2,881  |       
|                | Agency operations*                         |                             |   | 1,740  |        |  |   | 1,548  |       
|                | Reconciling items                          |                             |   | (1,352 | )      |  |   | (465   | )     
|                |                                            |                             |   |        |        |  |   |       
|                |                                            | Consolidated pre-tax income |   | $      | 4,162  |  |   | $      | 3,964  | 
|                |                                            |                             |   |        |        |  |   |       



---



|  |                                                
|- | -----------------------------------------------
|* | 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 (in
thousands):

|                         |  |                    |        |      |  |   |        |  
|------------------------ |  | ------------------ | ------ | ---- |  | - | ------ | -
|                         |  |                   
|                         |  | For the Six Months
|                         |  | Ended June 30,    
|                         |  |                   
|                         |  | 2004               |        | 2003
|                         |  |                    |        |     
|Holding company expenses |  | $                  | (1,261 | )    |  | $ | (461   | )
|Amortization             |  |                    | (191   | )    |  |   | (140   | )
|Interest expense         |  |                    | (843   | )    |  |   | (449   | )
|                         |  |                    |        |      |  |   |        |  
|                         |  | $                  | (2,295 | )    |  | $ | (1,050 | )
|                         |  |                    |        |      |  |   |        |  

|                         |  |                      |        |      |  |   |      |  
|------------------------ |  | -------------------- | ------ | ---- |  | - | ---- | -
|                         |  |                     
|                         |  | For the Three Months
|                         |  | Ended June 30,      
|                         |  |                     
|                         |  | 2004                 |        | 2003
|                         |  |                      |        |     
|Holding company expenses |  | $                    | (732   | )    |  | $ | (183 | )
|Amortization             |  |                      | (92    | )    |  |   | (70  | )
|Interest expense         |  |                      | (528   | )    |  |   | (212 | )
|                         |  |                      |        |      |  |   |      |  
|                         |  | $                    | (1,352 | )    |  | $ | (465 | )
|                         |  |                      |        |      |  |   |      |  

18



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 8  Subsequent Events

On May 19, 2004, the Company entered into a
Purchase and Sale Agreement (the Purchase Agreement)
with an unaffiliated third-party, whereby, the Company sold the
land and building located at 12641 W. 166th Street,
Cerritos, California 90703 (the Transaction). The
Transaction closed on July 19, 2004, with the acquirer
paying $2,942,000 to the Company for the land and building.
Contemporaneously, a subsidiary of the Company, Meadowbrook,
Inc. entered into a Lease Agreement (the Lease) of
the building with the acquirer commencing on July 19, 2004
and ending on July 19, 2014. Under the Lease, the initial
rental rate was $18,380 per month, which shall be increased at
the rate of 1.5% annually on each anniversary date of the lease
term. The Company is currently evaluating the impact of the
sale/leaseback agreement on its financial statements.

As a part of the Transaction, the Company entered
into an Exclusive Sale/Lease Agency Agreement (the Agency
Agreement) with GVA Strategis. Michael Ziecik, a principal
of GVA Strategis, is the son-in-law of the Chairman,
Merton J. Segal. Under the Agency Agreement, the Company
paid GVA Strategis a brokerage commission of $73,550 for its
services in the Transaction.

The Company owns certain real estate in
Southfield, Michigan, which consists of approximately
9.2 acres. As indicated in Note 6  Commitments
and Contingencies, on December 3, 2003, the Company entered
into a Development Agreement with Kirco Development, LLC, for
the construction of the Companys new corporate offices and
certain common areas. This new building will be located on
approximately 4.5 acres of the land.

On December 4, 2003, the Company entered
into a Purchase and Sale Agreement, wherein the Company sold the
remaining 4.5 acres to Kirco Acquisition, LLC for the
purpose of constructing an office building adjacent to the
Companys new corporate offices.

Kirco Acquisition, LLC agreed to pay the Company
$2,116,000, for the real estate and $1,239,310 for its share of
the costs related to the common areas. A Land Contract was
executed, whereby Kirco Acquisition, LLC agreed to pay the
principal balance of $2,722,110, plus seven percent (7%)
interest. The Land Contract will mature in 36 months and is
subject to a balloon payment for the outstanding balance and the
accrued interest thereon.

This transaction closed in escrow on
July 29, 2004, subject to the conveyance of certain land by
the City of Southfield to the Company and Kirco
Acquisition, LLC.

19



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##### Table of Contents






ITEM 2

MANAGEMENTS DISCUSSION AND ANALYSIS
OF


FINANCIAL CONDITION AND RESULTS OF
OPERATIONS


For the Periods ended June 30, 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 Six Months Ended
June 30, 2004 and 2003



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

Net income for the six months ended June 30,
2004 was $6.1 million, or $0.21 per dilutive share,
compared to net income of $5.4 million, or $0.18 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 the last
two quarters of 2003 and the first quarter of 2004, continued
rate increases, growth in agency commission, control over
expenses, and leveraging of fixed costs.

Revenues for the six months ended June 30,
2004 increased $34.2 million, or 35.7%, to
$129.9 million from $95.7 million for the comparable
period in 2003. This increase reflects a $39.2 million, or
61.6%, increase in net earned premium. The growth in net earned
premium reflects the earning pattern of programs written in the
last two quarters of 2003 and the first quarter of 2004. 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, the impact of an overall 13.6% rate increase achieved
in 2003, and an overall 5.7% rate increase in 2004, which
consisted of 2.3% in the workers compensation line of
business and 10.6% in all other lines of business combined. 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.

20



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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 Six Months
|               |                                            | Ended June 30,    
|               |                                            |                   
|               |                                            | 2004               |   | 2003   
|               |                                            |                    |   |        
|Revenue:       |                                            |                    |   |         |   |  |   |       
|               | Net earned premiums                        |                    | $ | 102,796 |   |  | $ | 63,614 | 
|               | Management fees                            |                    |   | 8,609   |   |  |   | 10,188 | 
|               | Claims fees                                |                    |   | 5,429   |   |  |   | 8,137  | 
|               | Loss control fees                          |                    |   | 1,077   |   |  |   | 1,126  | 
|               | Reinsurance brokerage                      |                    |   | 117     |   |  |   | 161    | 
|               | Investment income                          |                    |   | 7,133   |   |  |   | 6,904  | 
|               | Net realized (losses) gains on investments |                    |   | (152    | ) |  |   | 579    | 
|               |                                            |                    |   |         |   |  |   |       
|               | Total revenue                              |                    | $ | 125,009 |   |  | $ | 90,709 | 
|               |                                            |                    |   |         |   |  |   |       
|Pre-tax income |                                            |                    |   |         |   |  |   |       
|               | Specialty risk management operations       |                    | $ | 6,870   |   |  | $ | 5,517  | 

Revenues from specialty risk management
operations increased $34.3 million, or 37.8%, to
$125.0 million for the six months ended June 30, 2004,
from $90.7 million for the comparable period in 2003.

Net earned premium increased $39.2 million,
or 61.6%, to $102.8 million for the six months ended
June 30, 2004, from $63.6 million in the comparable
period in 2003. As previously mentioned, this increase is the
result of increased written premium in the last two quarters of
2003 and the first quarter of 2004 that is recognized as earned
premium in 2004.

Management fees decreased $1.6 million, or
15.5%, to $8.6 million for the six months ended
June 30, 2004, from $10.2 million for the comparable
period in 2003. The decrease in management fees reflects an
anticipated 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.
Excluding revenue generated from the third-party contract,
management fee revenue increased approximately $660,000 in
comparison to 2003. This increase is primarily the result of
higher premium volumes, which is the basis for the calculation
of fee-for-service revenue, related to existing managed programs.

Claim fees decreased $2.7 million, or 33.3%,
to $5.4 million, from $8.1 million for the comparable
period in 2003. The decrease in claim fees reflects a similar
anticipated 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.
Excluding revenue generated from the third-party contract, claim
fee revenue increased approximately $350,000 in comparison to
2003. This increase is primarily the result of higher premium
volumes, which is the basis for the calculation of
fee-for-service revenue, related to existing managed programs.

Net investment income increased $229,000, or
3.3%, to $7.1 million in 2004, from $6.9 million in
2003. Average invested assets increased $39.3 million, or
13.2%, to $336.1 million in 2004, from $296.8 million
for the comparable period in 2003. The increase in average
invested assets reflects cash flows from underwriting activities
and growth in gross written premiums during 2003 and 2004, as
well as, net proceeds from capital raised through the issuance
of long-term debt. The average investment yield for
June 30, 2004 was 4.3%, compared to 4.7% for the comparable
period in 2003. The current pre-tax book yield is 4.0% and
current after-tax book yield is 2.9%. The decline in investment
yield reflects the accelerated prepayment speeds in
mortgage-backed securities and the reinvestment of cash flows in
municipal bonds and other securities with lower interest rates.
Over the past two years, the reinvestment of cash flows has
shifted from maturing

21



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securities with higher yields being replaced by
securities with lower yields in a declining interest rate
environment. In addition, the capital raised during the period,
which will be utilized before the end of the year, has been
invested in short-term investments.


Specialty risk management operations generated
pre-tax income of $6.9 million for the six months ended
June 30, 2004, compared to pre-tax income of $5.5 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
accepted accounting principles (GAAP) combined ratio
was 101.7% for the six months ended June 30, 2004, compared
to 106.0% for the same period in 2003.

Net loss and loss adjustment expenses
(LAE) increased $24.0 million, or 58.2%, to
$65.3 million for the six months ended June 30, 2004,
from $41.3 million for the same period in 2003. The
Companys loss and LAE ratio decreased by 1.9 percentage
points to 68.3% for the six months ended June 30, 2004,
from 70.2% for the same period in 2003. This ratio is the
unconsolidated net loss and LAE in relation to net earned
premium. The decrease in the loss and LAE ratio reflects the
impact of a $2.5 million, or 2.4 percentage points,
increase in net ultimate loss estimates for prior accident years
in 2004 compared to $2.3 million, or 3.5 percentage points,
increase in net ultimate loss estimates, 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
2.4 percentage points to 33.4% for the six months ended
June 30, 2004, from 35.8% 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 leveraging of fixed
costs and a decrease in insurance related assessments. These
improvements were slightly offset by an increase in ceded excess
reinsurance expense primarily related to the previously
mentioned excess liability program for public entities.



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

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

|               |                 |                    |       |       |  |   |       |       | 
|-------------- | --------------- | ------------------ | ----- | ----- |  | - | ----- | ----- | 
|               |                 |                   
|               |                 | For the Six Months
|               |                 | Ended June 30,    
|               |                 |                   
|               |                 | 2004               |       | 2003 
|               |                 |                    |       |      
|Net commission |                 | $                  | 8,772 |       |  | $ | 7,822 |      
|               | Pre-tax income* |                    | $     | 4,236 |  |   | $     | 3,600 | 



---



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

Revenue from agency operations, which consists
primarily of agency commission revenue, increased $950,000, or
12.1%, to $8.8 million for the six months ended
June 30, 2004, from $7.8 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 $4.2 million for the six months
ended June 30, 2004, compared to $3.6 million for the
comparable period in 2003. The improvement in the pre-tax margin
is primarily attributable to the overall increase in revenue.

22



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Other Items



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

At June 30, 2004, managements best
estimate for the ultimate liability for loss and LAE reserves,
net of reinsurance recoverables, was $205.8 million.
Management established a reasonable range of reserves of
approximately $191.8 million to $220.6 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)                    |  | $       | 108,048 |         |  | $        | 120,415 |  |  | $ | 114,317 | 
|Commercial Multiple Peril/General Liability |  |         | 38,710  |         |  |          | 48,580  |  |  |   | 43,511  | 
|Commercial Automobile                       |  |         | 27,898  |         |  |          | 31,787  |  |  |   | 29,498  | 
|Other                                       |  |         | 17,130  |         |  |          | 19,775  |  |  |   | 18,440  | 
|                                            |  |         |         |         |  |          |         |  |  |   |         | 
|Net Reserves                                |  | $       | 191,786 |         |  | $        | 220,557 |  |  | $ | 205,766 | 
|                                            |  |         |         |         |  |          |         |  |  |   |         | 



---



|    |                          
|--- | -------------------------
|(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 six months
ended June 30, 2004, and the years ended December 31,
2003 and 2002.

For the six months ended June 30, 2004, the
Company reported an increase in net ultimate loss estimates for
accident years 2003 and prior to be $2.5 million, or 1.3%
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

23



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##### Table of Contents



significant changes in the key assumptions
utilized in the analysis and calculations of the 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 |  | June 30,
|Line of Business                             |  | 2003         |         | 2003(1)        |  | Year            |        | Years       |  | Incurred    |        | Year    |  | Years |       | Paid  |  | 2004    
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |         
|Workers Compensation                        |  | $            | 91,587  |                |  | $               | (2,250 | )           |  | $           | 30,036 |         |  | $     | 935   |       |  | $        | 30,971 |  |  | $ | 2,605 |   |  | $ | 20,030 |  |  | $ | 22,635 |  |  | $ | 97,673  | 
|Residual Markets                             |  |              | 14,506  |                |  |                 |       |             |  |             | 6,297  |         |  |       | (927  | )     |  |          | 5,370  |  |  |   | 2,064 |   |  |   | 1,168  |  |  |   | 3,232  |  |  |   | 16,644  | 
|Commercial Multiple Peril/ General Liability |  |              | 42,389  |                |  |                 | (737   | )           |  |             | 9,347  |         |  |       | 1,498 |       |  |          | 10,845 |  |  |   | (249  | ) |  |   | 9,235  |  |  |   | 8,986  |  |  |   | 43,511  | 
|Commercial Automobile                        |  |              | 27,515  |                |  |                 |       |             |  |             | 10,688 |         |  |       | 1,015 |       |  |          | 11,703 |  |  |   | 1,753 |   |  |   | 7,967  |  |  |   | 9,720  |  |  |   | 29,498  | 
|Other                                        |  |              | 16,022  |                |  |                 | (2     | )           |  |             | 6,516  |         |  |       | (70   | )     |  |          | 6,446  |  |  |   | 1,162 |   |  |   | 2,864  |  |  |   | 4,026  |  |  |   | 18,440  | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          |        |  |  |   |       |   |  |   |        |  |  |   |        |  |  |   |         | 
|Net Reserves                                 |  |              | 192,019 |                |  | $               | (2,989 | )           |  | $           | 62,884 |         |  | $     | 2,451 |       |  | $        | 65,335 |  |  | $ | 7,335 |   |  | $ | 41,264 |  |  | $ | 48,599 |  |  |   | 205,766 | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          |        |  |  |   |       |   |  |   |        |  |  |   |        |  |  |   |         | 
|Reinsurance Recoverable                      |  |              | 147,446 |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          |        |  |  |   |       |   |  |   |        |  |  |   |        |  |  |   | 154,372 | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          |        |  |  |   |       |   |  |   |        |  |  |   |        |  |  |   |         | 
|Consolidated                                 |  | $            | 339,465 |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          |        |  |  |   |       |   |  |   |        |  |  |   |        |  |  | $ | 360,138 | 
|                                             |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |       |       |  |          |        |  |  |   |       |   |  |   |        |  |  |   |        |  |  |   |         | 

|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 
|-------------------------------------------- |  | ------------ | ------- | ----------- |  | -------------- | ------- | --------------- |  | - | ------- |  |  |  | ----- | 
|                                             |  |              |         |             |  | Re-estimated   |         | Development    
|                                             |  | Reserves at  |         | Reserves at |  | Reserves at    |         | as a Percentage
|                                             |  | December 31, |         | January 1,  |  | June 30, 2004  |         | of Prior       
|Line of Business                             |  | 2003         |         | 2004(1)     |  | on Prior Years |         | Year Reserves  
|                                             |  |              |         |             |  |                |         |                
|Workers Compensation                        |  | $            | 91,587  |             |  | $              | 89,337  |                 |  | $ | 90,272  |  |  |  | 1.0%  | 
|Commercial Multiple Peril/ General Liability |  |              | 42,389  |             |  |                | 41,652  |                 |  |   | 43,150  |  |  |  | 3.5%  | 
|Commercial Automobile                        |  |              | 27,515  |             |  |                | 27,515  |                 |  |   | 28,530  |  |  |  | 3.6%  | 
|Other                                        |  |              | 16,022  |             |  |                | 16,020  |                 |  |   | 15,950  |  |  |  | -0.4% | 
|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 
|Sub-total                                    |  |              | 177,513 |             |  |                | 174,524 |                 |  |   | 177,902 |  |  |  | 1.9%  | 
|Residual Markets                             |  |              | 14,506  |             |  |                | 14,506  |                 |  |   | 13,579  |  |  |  | -6.8% | 
|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 
|Total Net Reserves                           |  | $            | 192,019 |             |  | $              | 189,030 |                 |  | $ | 191,481 |  |  |  | 1.3%  | 
|                                             |  |              |         |             |  |                |         |                 |  |   |         |  |  |  |       | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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 $935,000, or 1.0% of net workers
compensation reserves. This net overall increase reflects an
increase of $3.9 million and $1.0 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
$1.4 million, $1.6 million, and $1.8 million in
the ultimate loss estimate for accident years 2002, 2001 and
1999, respectively. The decrease in ultimate loss estimates for
2002 and 2001 reflect better than expected experience on the
Companys core workers compensation programs,
primarily in Massachusetts and Tennessee, while the decrease in
1999 reflects a re-allocation of estimated reserves between
accident years 2000 and 1999. The change in ultimate loss
estimates for all other accident years was insignificant.

24



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##### Table of Contents



Commercial Multiple Peril/ General
Liability

The commercial multiple peril line/general
liability line of business had an increase in net ultimate loss
estimates of $1.5 million, or 3.5% of net commercial
multiple peril/general liability reserves. The net increase
reflects an increase of $847,000, $736,000, $535,000 and
$461,000 in accident years 2003, 2002, 2001 and 1999,
respectively. The increases in accident years 2003 and 2002
ultimate loss estimates reflect higher than expected emergence
in claim activity in a general liability occurrence program
within the Kansas City Branch during the six months ended
June 30, 2004. The increase in accident year 2001 reflects
higher than expected claims activity in one program in the
Alabama branch. The increase in accident year 1999 reflects an
increase in one claim in an excess professional liability
program and development on a settlement in one discontinued
program. These increases were partially offset by a reduction of
$894,000 in the ultimate loss estimate for accident year 2000.
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
$1.0 million, or 3.6% of net commercial automobile
reserves. This net overall increase reflects an increase of
$516,000, $668,000 and $701,000 in accident years 2002, 2001 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 $802,000 in the ultimate
loss estimate for accident year 2003 related to automobile
physical damage claim activity and a $271,000 reallocation of
ultimate losses between 2003 and 2002. 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 $70,000, or 0.4% of net reserves on
the other lines of business. The change in ultimate loss
estimates for all accident years was insignificant.

Residual Markets

The workers compensation residual market
line of business had a decrease in net ultimate loss estimates
of $927,000, or 6.8% of net reserves on the workers
compensation residual market line of business. The change
reflects a reduction of $1.0 million 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 six months
ended June 30, 2004, increased $1.3 million, or 5.6%,
to $25.1 million, from $23.8 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 increased $943,000,
or 7.6%, to $13.3 million, from $12.4 million for the
comparable period in 2003. This increase is primarily
attributable to an increase in policyholder dividends for 2004
as opposed to a $1.7 million reduction in anticipated
policyholder dividends reflected in 2003. Partially offsetting
this decrease was a reduction in overall bad debt expense in
2004 as compared to increases in related allowances recorded in
2003 on previously discontinued programs.

25



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##### Table of Contents



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 six months ended
June 30, 2004, increased by $394,000, or 87.8%, to
$843,000, from $449,000 for the comparable period in 2003.
Interest expense is primarily attributable to the Companys
term loan, line of credit, and debentures, which are described
below. Interest expense increased $454,000 as a result of the
senior debentures and junior subordinated debentures. Offsetting
this increase was a reduction in interest associated with the
Companys term loan and line of credit of $59,000, or
13.1%, to $390,000, from $449,000 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 six months ending
June 30, 2004, was $16.9 million, compared to
$26.6 million for the same period in 2003. The average
interest rate increased in 2004 to 4.6%, compared to 3.4% in
2003 as a result of increases in the underlying eurocurrency
based rate.

Taxes

Federal income tax expense for the six months
ended June 30, 2004, was $2.7 million, or 30.9% of income
before taxes. For the comparable period in 2003, the Company
reflected a federal income tax expense of $2.6 million, or
32.6% of income before taxes. 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 June 30, 2004, the Company had a deferred
tax asset of $17.4 million, $548,000 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 June 30, 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 $8.8 million for the
six months ended June 30, 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 $548,000 at June 30, 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 June 30, 2004, the Company had 183
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 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

26



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##### Table of Contents



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):

|                                                           |        |                     |        |                        |  |                 |        |            |   |   |       |        |  |   |      |      |  
|---------------------------------------------------------- | ------ | ------------------- | ------ | ---------------------- |  | --------------- | ------ | ---------- | - | - | ----- | ------ |  | - | ---- | ---- | -
|                                                           |        |                    
|                                                           |        | June 30, 2004      
|                                                           |        |                    
|                                                           |        |                     |        |                       
|                                                           |        | Less than 12 Months |        | Greater than 12 Months
|                                                           |        |                     |        |                       
|                                                           |        | Fair Value of       |        |                        |  | Fair Value of   |        |           
|                                                           |        | Investments         |        | Gross                  |  | Investments     |        | Gross     
|                                                           |        | with Unrealized     |        | Unrealized             |  | with Unrealized |        | Unrealized
|                                                           |        | Losses              |        | Losses                 |  | Losses          |        | Losses    
|                                                           |        |                     |        |                        |  |                 |        |           
|Debt Securities:                                           |        |                     |        |                        |  |                 |        |            |   |   |       |        |  |   |      |     
|Debt securities issued by U.S. government
    and agencies |        | $                   | 22,832 |                        |  | $               | (343   | )          |   | $ | 5,755 |        |  | $ | (264 | )   
|Obligations of states and political subdivisions           |        |                     | 41,396 |                        |  |                 | (1,172 | )          |   |   | 1,077 |        |  |   | (66  | )   
|Corporate securities                                       |        |                     | 28,651 |                        |  |                 | (723   | )          |   |   | 2,918 |        |  |   | (221 | )   
|Mortgage-backed securities                                 |        |                     | 26,672 |                        |  |                 | (570   | )          |   |   | 5,974 |        |  |   | (93  | )   
|                                                           |        |                     |        |                        |  |                 |        |            |   |   |       |        |  |   |      |     
|                                                           | Totals |                     | $      | 119,551                |  |                 | $      | (2,808     | ) |   | $     | 15,724 |  |   | $    | (644 | )
|                                                           |        |                     |        |                        |  |                 |        |            |   |   |       |        |  |   |      |     

As of June 30, 2004, gross unrealized gains
and (losses) on securities were $7.8 million and
($3.5) million, respectively.

Results of Operations for the Three Months
Ended June 30, 2004 and 2003

Overview

Net income for the three months ended
June 30, 2004 was $2.8 million, or $0.10 per dilutive
share, compared to net income of $2.7 million, or $0.09 per
dilutive share, for the comparable period of 2003. Net income
for the three months ended June 30, 2004 reflects the
earning pattern of controlled growth of premium in profitable
programs which were written in the last two quarters of 2003 and
the first quarter of 2004, continued rate increases, growth in
agency commission, and control over expenses.

Revenues for the three months ended June 30,
2004 increased $13.9 million, or 27.2%, to
$65.4 million from $51.5 million for the comparable
period in 2003. This increase reflects a $16.9 million, or
46.5%, increase in net earned premium. The growth in net earned
premium reflects the earning pattern of programs written in the
last two quarters of 2003 and the first quarter of 2004. 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 rate increases achieved in 2003 and
2004. 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.

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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 June 30,      
|                                                        |                                            |                     
|                                                        |                                            | 2004                 |       | 2003  
|                                                        |                                            |                      |       |       
|Revenue:                                                |                                            |                      |       |        |   |   |       |       
|                                                        | Net earned premiums                        |                      | $     | 53,083 |   |   | $     | 36,230 | 
|                                                        | Management fees                            |                      |       | 3,898  |   |   |       | 4,840  | 
|                                                        | Claims fees                                |                      |       | 2,728  |   |   |       | 3,755  | 
|                                                        | Loss control fees                          |                      |       | 532    |   |   |       | 549    | 
|                                                        | Reinsurance brokerage                      |                      |       | (30    | ) |   |       | 106    | 
|                                                        | Investment income                          |                      |       | 3,542  |   |   |       | 3,564  | 
|                                                        | Net realized (losses) gains on investments |                      |       | (32    | ) |   |       | 374    | 
|                                                        |                                            |                      |       |        |   |   |       |       
|                                                        | Total revenue                              |                      | $     | 63,721 |   |   | $     | 49,418 | 
|                                                        |                                            |                      |       |        |   |   |       |       
|Pre-tax income
    Specialty risk management operations |                                            | $                    | 3,774 |        |   | $ | 2,881 |       

Revenues from specialty risk management
operations increased $14.3 million, or 28.9%, to
$63.7 million for the three months ended June 30,
2004, from $49.4 million for the comparable period in 2003.

Net earned premium increased $16.9 million,
or 46.5%, to $53.1 million for the three months ended
June 30, 2004, from $36.2 million in the comparable
period in 2003. As previously mentioned, this increase is the
result of increased written premium in the last two quarters of
2003 and the first quarter of 2004 that are recognized as earned
premium in 2004.

Management fees decreased $942,000, or 19.5%, to
$3.9 million for the three months ended June 30, 2004,
from $4.8 million for the comparable period in 2003. The
decrease in management fees reflects an anticipated 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. Excluding revenue generated from the
third-party contract, management fee revenue increased
approximately $600,000 in comparison to 2003. This increase is
partially the result of higher premium volumes, which is the
basis for the calculation of fee-for-service revenue, related to
specific existing managed programs. Also contributing to this
increase was the recognition of $250,000 in profit sharing
revenue related to a specific managed program. The profit
sharing revenue related to this program for 2003 was recognized
in the first quarter of 2003.

Claim fees decreased $1.0 million, or 27.4%,
to $2.7 million, from $3.7 million for the comparable
period in 2003. The decrease in claim fees reflects a similar
anticipated 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.
Excluding revenue generated from the third-party contract, claim
fee revenue increased approximately $320,000 in comparison to
2003. This increase is partially the result of higher premium
volumes, which is the basis for the calculation of
fee-for-service revenue, related to specific existing managed
programs.

Net investment income decreased $22,000, or 0.6%,
to $3.5 million in 2004. Average invested assets increased
$42.6 million, or 14.2%, to $343.0 million for the
three months ended June 30, 2004, from $300.4 million
for the comparable in 2003. The increase in average invested
assets reflects cash flows from underwriting activities and
growth in gross written premiums during 2003 and 2004, as well
as, net proceeds from capital raised through the issuance of
long-term debt. The average investment yield for June 30,
2004 was 4.1%, compared to 4.8% for the comparable period in
2003. The current pre-tax book yield is 4.0% and current
after-tax book yield is 2.9%. The decline in investment yield
reflects the accelerated prepayment speeds in mortgage-backed
securities and the reinvestment of cash flows in municipal bonds
and other

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securities with lower interest rates. Over the
past two years, the reinvestment of cash flows has shifted from
maturing securities with higher yields being replaced by
securities with lower yields in a declining interest rate
environment. In addition, the capital raised during the period,
which will be utilized before the end of the year, has been
invested in short-term investments.


Specialty risk management operations generated
pre-tax income of $3.8 million for the three months ended
June 30, 2004, compared to pre-tax income of $2.9 million
for the comparable period in 2003. This increase in pre-tax
income demonstrates the improvement in underwriting results as
the Company continues to experience controlled growth of premium
volume. The GAAP combined ratio was 101.3% for the three months
ended June 30, 2004, compared to 106.4% for the same period
in 2003.

Net loss and loss adjustment expenses
(LAE) increased $8.7 million, or 36.2%, to
$32.8 million for the three months ended June 30,
2004, from $24.1 million for the same period in 2003. The
Companys loss and LAE ratio decreased by 4.6 percentage
points to 66.5% for the three months ended June 30, 2004,
from 71.1% for the same period in 2003. This ratio is the
unconsolidated net loss and LAE in relation to net earned
premium. The decrease in the loss and LAE ratio reflects a
reduction in the increase in net ultimate loss estimates for
prior accident years in 2004 compared to the same period in
2003. In 2004, the increase in net ultimate loss estimates for
prior accident years was $648,000, compared to $1.9 million
in 2003. This remaining improvement in the current accident year
loss ratio reflects rate increases achieved during 2004 and the
addition of earned premium from profitable programs.

The Companys expense ratio improved
0.5 percentage points to 34.8% for the three months ended
June 30, 2004, from 35.3% 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 a decrease in insurance related
assessments. This decrease was partially offset by an increase
in ceded excess reinsurance expense primarily related to the
previously mentioned excess liability program for public
entities.



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

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

|                |  |               |       |      |  |   |       | 
|--------------- |  | ------------- | ----- | ---- |  | - | ----- | 
|                |  |              
|                |  | For the Three
|                |  | Months Ended 
|                |  | June 30,     
|                |  |              
|                |  | 2004          |       | 2003
|                |  |               |       |     
|Net commission  |  | $             | 3,993 |      |  | $ | 3,675 | 
|Pre-tax income* |  | $             | 1,740 |      |  | $ | 1,548 | 



---



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

Revenue from agency operations, which consists
primarily of agency commission revenue, increased $318,000, or
8.7%, to $4.0 million for the three months ended
June 30, 2004, from $3.7 million for the comparable
period in 2003. This increase is primarily the result of rate
increases and increases in new business.

Agency operations generated pre-tax income,
before corporate overhead, of $1.7 million for the three months
ended June 30, 2004, compared to $1.5 million for the
comparable period in 2003. The improvement in the pre-tax margin
is primarily attributable to the overall increase in revenue.

Other Items

Reserves

For the quarter ended June 30, 2004, the
Company reported an increase in net ultimate loss estimates for
accident years 2003 and prior to be $648,000, or 0.3% of
$192.0 million of net loss and LAE reserves at
December 31, 2003. There were no significant changes in the
key assumptions utilized in the analysis and calculations of the
Companys reserves during 2004.

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Salary and
Employee Benefits and Other Administrative Expenses

Salary and employee benefits for the three months
ended June 30, 2004, increased $457,000, or 3.9%, to
$12.3 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 increased
$1.4 million, or 26.4%, to $6.7 million, from
$5.3 million for the comparable period in 2003. This
increase is primarily attributable to an increase in
policyholder dividends for 2004 as opposed to an $872,000
reduction in anticipated policyholder dividends reflected in
2003.

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
June 30, 2004, increased by $316,000, or 149.1%, to
$528,000, from $212,000 for the comparable period in 2003.
Interest expense is primarily attributable to the Companys
term loan, line of credit, and debentures, which are described
below. Interest expense increased $318,000 as a result of the
senior debentures and junior subordinated debentures. Excluding
the interest related to the debentures, interest expense
remained constant in comparison to 2003. This is a result of a
reduction of the average outstanding balance of the
companys term loan and line of credit being offset by an
increase in the average interest rate. The average outstanding
balance during the three months ending June 30, 2004, was
$16.9 million, compared to $20.9 million for the same
period in 2003. The average interest rate for the three months
ended June 30, 2004, increased to 5.0%, compared to 4.1%
for the comparable period in 2003. This increase is a result of
increases in the underlying eurocurrency based rate.

Taxes

Federal income tax expense for the three months
ended June 30, 2004, was $1.3 million, or 30.9% of income
before taxes. For the same period last year, the Company
reflected a federal income tax expense of $1.3 million, or
32.4% of income before taxes. 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.

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, shareholder dividends, and
other operating expenses of the holding company and
non-regulated subsidiaries. The following tables illustrate net
income, excluding interest, depreciation, and amortization,
between the

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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 Six Months                                                                            
|                                                           |                                                                    | Ended June 30,                                                                                
|                                                           |                                                                    |                                                                                               
|                                                           |                                                                    | 2004                                                                                           |        | 2003  
|                                                           |                                                                    |                                                                                                |        |       
|Net income                                                 |                                                                    | $                                                                                              | 6,052  |        |        | $ | 5,435  |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|Regulated Subsidiaries:                                    |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           |                                                                    | Net income                                                                                     |        | $      | 3,015  |   |        | $      | 2,258  | 
|                                                           |                                                                    | Depreciation and amortization                                                                  |        |        |       |   |        |        | 6      | 
|                                                           |                                                                    | Interest                                                                                       |        |        |       |   |        |        |       | 
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                                |        | 3,015  |        |   |        | 2,264  |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    provided by operating activities           |        |        | 910    |   |        |        | 1,338  | 
|                                                           |                                                                    | Changes in operating assets and liabilities                                                    |        |        | 20,623 |   |        |        | 13,465 | 
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           | Total adjustments                                                  |                                                                                                |        | 21,533 |        |   |        | 14,803 |       
|                                                           | Depreciation and amortization                                      |                                                                                                |        |       |        |   |        | (6     | )     
|                                                           | Interest                                                           |                                                                                                |        |       |        |   |        |       |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                                | $      | 24,548 |        |   | $      | 17,061 |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|Non-regulated Subsidiaries:                                |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           |                                                                    | Net income                                                                                     |        | $      | 3,037  |   |        | $      | 3,177  | 
|                                                           |                                                                    | Depreciation and amortization                                                                  |        |        | 848    |   |        |        | 854    | 
|                                                           |                                                                    | Interest                                                                                       |        |        | 969    |   |        |        | 577    | 
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                                |        | 4,854  |        |   |        | 4,608  |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    (used in) provided by operating activities |        |        | 1,376  |   |        |        | 2,712  | 
|                                                           |                                                                    | Changes in operating assets and liabilities                                                    |        |        | (2,663 | ) |        |        | 7,241  | 
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           | Total adjustments                                                  |                                                                                                |        | (1,287 | )      |   |        | 9,953  |       
|                                                           | Depreciation and amortization                                      |                                                                                                |        | (848   | )      |   |        | (854   | )     
|                                                           | Interest                                                           |                                                                                                |        | (969   | )      |   |        | (577   | )     
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                                | $      | 1,750  |        |   | $      | 13,130 |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|Consolidated total adjustments                             |                                                                    |                                                                                                | 20,246 |        |        |   | 24,756 |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       
|Consolidated net cash provided by operating
    activities |                                                                    | $                                                                                              | 26,298 |        |        | $ | 30,191 |       
|                                                           |                                                                    |                                                                                                |        |        |        |   |        |       

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|                                                           |                                                                    |                                                                                                |        |       |        |   |        |        |        |  
|---------------------------------------------------------- | ------------------------------------------------------------------ | ---------------------------------------------------------------------------------------------- | ------ | ----- | ------ | - | ------ | ------ | ------ | -
|                                                           |                                                                    |                                                                                               
|                                                           |                                                                    | For the Three Months                                                                          
|                                                           |                                                                    | Ended June 30,                                                                                
|                                                           |                                                                    |                                                                                               
|                                                           |                                                                    | 2004                                                                                           |        | 2003 
|                                                           |                                                                    |                                                                                                |        |      
|Net income                                                 |                                                                    | $                                                                                              | 2,820  |       |        | $ | 2,679  |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|Regulated Subsidiaries:                                    |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           |                                                                    | Net income                                                                                     |        | $     | 1,605  |   |        | $      | 1,392  |  
|                                                           |                                                                    | Depreciation and amortization                                                                  |        |       |       |   |        |        | 3      |  
|                                                           |                                                                    | Interest                                                                                       |        |       |       |   |        |        | (1     | )
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                                |        | 1,605 |        |   |        | 1,394  |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    provided by operating activities           |        |       | 12     |   |        |        | 744    |  
|                                                           |                                                                    | Changes in operating assets and liabilities                                                    |        |       | 7,465  |   |        |        | 12,132 |  
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           | Total adjustments                                                  |                                                                                                |        | 7,477 |        |   |        | 12,876 |       
|                                                           | Depreciation and amortization                                      |                                                                                                |        |      |        |   |        | (3     | )     
|                                                           | Interest                                                           |                                                                                                |        |      |        |   |        | 1      |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                                | $      | 9,082 |        |   | $      | 14,268 |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|Non-regulated Subsidiaries:                                |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           |                                                                    | Net income                                                                                     |        | $     | 1,215  |   |        | $      | 1,287  |  
|                                                           |                                                                    | Depreciation and amortization                                                                  |        |       | 474    |   |        |        | 408    |  
|                                                           |                                                                    | Interest                                                                                       |        |       | 591    |   |        |        | 277    |  
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                                |        | 2,280 |        |   |        | 1,971  |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    (used in) provided by operating activities |        |       | 1,511  |   |        |        | 1,167  |  
|                                                           |                                                                    | Changes in operating assets and liabilities                                                    |        |       | (1,667 | ) |        |        | 655    |  
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           | Total adjustments                                                  |                                                                                                |        | (156  | )      |   |        | 1,822  |       
|                                                           | Depreciation and amortization                                      |                                                                                                |        | (474  | )      |   |        | (408   | )     
|                                                           | Interest                                                           |                                                                                                |        | (591  | )      |   |        | (277   | )     
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                                | $      | 1,059 |        |   | $      | 3,109  |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|Consolidated total adjustments                             |                                                                    |                                                                                                | 7,321  |       |        |   | 14,698 |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       
|Consolidated net cash provided by operating
    activities |                                                                    | $                                                                                              | 10,141 |       |        | $ | 17,377 |       
|                                                           |                                                                    |                                                                                                |        |       |        |   |        |       

Consolidated cash flow provided by operations for
the six months ended June 30, 2004, was $26.3 million,
compared to consolidated cash flow provided by operations of
$30.2 million for the comparable period in 2003.

Regulated subsidiaries cash flow provided
by operations for the six months ended June 30, 2004, was
$24.5 million, compared to $17.1 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 six months ended June 30,
2004, was $1.8 million, compared to $13.1 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

32



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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 in comparison to 2003.


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. Debentures mature
in thirty years and provide for interest at the three-month
LIBOR, plus 4.05%.

On April 29, 2004, the Company issued senior
debentures in the amount of $13.0 million. The senior
debentures mature in thirty years and provide for interest at
the three-month LIBOR, plus 4.00%, which is non-deferrable. The
senior debentures are callable by the Company at par after five
years from the date of issuance. Associated with this
transaction the Company incurred $390,000 of commissions paid to
the placement agents. These issuance costs have been capitalized
and are included in other assets on the balance sheet, which
will be amortized over seven years as a component of interest
expense.

On May 26, 2004, the Company issued senior
debentures in the amount of $12.0 million. The senior
debentures mature in thirty years and provide for interest at
the three-month LIBOR, plus 4.20%, which is non-deferrable. The
senior debentures are callable by the Company at par after five
years from the date of issuance. Associated with this
transaction the Company incurred $360,000 of commissions paid to
the placement agents. These issuance costs have been capitalized
and are included in other assets on the balance sheet, which
will be amortized over seven years as a component of interest
expense.

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 June 30, 2004, the Companys
term loan had an outstanding balance of $11.5 million. The
Company had no outstanding balance on the revolving line of
credit at June 30, 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 September 1,
2004, and is thereafter renewable on an annual basis. The
Company is currently renegotiating the terms of the line of
credit with its lender. 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 June 30, 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
June 30, 2004, this ratio was 10.4 to 1.0, compared to the
covenant minimum of 1.2 to 1.0.

As of June 30, 2004, the Company was in
compliance with all debt covenants.

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A non-insurance premium finance subsidiary of the
Company maintains a line of credit with a bank, which permits
borrowings up to 75% of the accounts receivable, which
collateralize the line of credit. At June 30, 2004, this
line of credit had an outstanding balance of $4.7 million.
The terms of this line of credit were amended on May 7,
2004. The amendments to the line of credit agreement included a
change in the permitted borrowings from 80% to 75% of the
accounts receivable, an increase in the line of credit from
$6.0 million to $8.0 million, and amendments to the
interest rates. The interest terms were amended to interest at
the Prime Rate minus 0.5%, or a LIBOR-based rate option, plus
2.0%. On May 24, 2004, $3.5 million was moved into the
LIBOR-based rate. At June 30, 2004, the Prime Rate minus
0.5%, was 3.75% and the LIBOR-based option was 3.3%.

At June 30, 2004, shareholders equity
was $157.0 million, or $5.41 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 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 September 17,
2004, or when the Company has repurchased all shares authorized
for repurchase. As of June 30, 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 June 30, 2004. As of June 30, 2004, the Company
has 1,235,200 shares remaining which could 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 June 30, 2004, earned surplus was
negative $25.1 million. No statutory dividends were paid in
2003.

Disclosure of
Contractual Arrangements

During the three months ended June 30, 2004,
the Companys contractual obligations changed materially
from those discussed in the Companys Annual Report and
Form 10-K for the year ended December 31, 2003 in
relation to the senior debentures described above and in
Note 3 to the Consolidated Financial Statements. The
debentures described above and in Note 3 mature in thirty
years, therefore the Companys contractual obligations for
more than a five year period increased $25.0 million.

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

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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 threshold requiring the
minimum regulatory involvement of $45.7 million in 2003. At
June 30, 2004, Stars statutory surplus decreased
$600,000 to $99.3 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 June 30, 2004, the Companys asset for deferred
policy acquisition costs increased $2.8 million, or 14.3%,
to $22.4 million, compared to $19.6 million at
December 31, 2003. This increase reflects the increase in gross
unearned premiums of $15.8 million, or 14.4%, to
$125.5 million at June 30, 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 2.5 to 1, respectively. As of
June 30, 2004, on a statutory consolidated basis, gross and
net premium leverage ratios were 2.8 to 1.0 and 2.2 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 June 30, 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.

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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.

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 No. 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 3 for additional information
regarding the Companys unconsolidated subsidiary trust.

In December 2003, FIN No. 46 was revised as
FIN No. 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 No. 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 No. 46(R). The adoption of FIN
No. 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.

Subsequent Events

On May 19, 2004, the Company entered into a
Purchase and Sale Agreement (the Purchase Agreement)
with an unaffiliated third-party, whereby, the Company sold the
land and building located at 12641 W. 166th Street,
Cerritos, California 90703 (the Transaction). The
Transaction closed on July 19, 2004, with the acquirer
paying $2,942,000 to the Company for the land and building.
Contemporaneously, a subsidiary of the Company, Meadowbrook,
Inc. entered into a Lease Agreement (the Lease) of
the building with the acquirer commencing on July 19, 2004
and ending on July 19, 2014. Under the Lease, the initial
rental rate was $18,380 per month, which shall be increased at
the rate of 1.5% annually on each anniversary date of the lease
term. The Company is currently evaluating the impact of the
sale/leaseback agreement on its financial statements.

As a part of the Transaction, the Company entered
into an Exclusive Sale/Lease Agency Agreement (the Agency
Agreement) with GVA Strategis. Michael Ziecik, a principal
of GVA Strategis, is the son-in-law of the Chairman,
Merton J. Segal. Under the Agency Agreement, the Company
paid GVA Strategis a brokerage commission of $73,550 for its
services in the Transaction.

The Company owns certain real estate in
Southfield, Michigan, which consists of approximately
9.2 acres. As indicated in Note 6  Commitments
and Contingencies, on December 3, 2003, the Company entered
into a Development Agreement with Kirco Development, LLC, for
the construction of the Companys new corporate offices and
certain common areas. This new building will be located on
approximately 4.5 acres of the land.

On December 4, 2003, the Company entered
into a Purchase and Sale Agreement, wherein the Company sold the
remaining 4.5 acres to Kirco Acquisition, LLC for the
purpose of constructing an office building adjacent to the
Companys new corporate offices.

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Kirco Acquisition, LLC agreed to pay the Company
$2,116,000, for the real estate and $1,239,310 for its share of
the costs related to the common areas. A Land Contract was
executed, whereby Kirco Acquisition, LLC agreed to pay the
principal balance of $2,722,110, plus seven percent (7%)
interest. The Land Contract will mature in 36 months and is
subject to a balloon payment for the outstanding balance and the
accrued interest thereon.

This transaction closed in escrow on
July 29, 2004, subject to the conveyance of certain land by
the City of Southfield to the Company and Kirco
Acquisition, LLC.

Forward-Looking Statements

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

Market risk is the risk of loss arising from
adverse changes in market rates and prices, such as interest
rates as well as other relevant market rate or price changes.
The volatility and liquidity in the markets in which the
underlying assets are traded directly influence market risk. The
following is a discussion of the Companys primary risk
exposures and how those exposures are currently managed as of
June 30, 2004. The Companys market risk sensitive
instruments are primarily related to fixed income securities,
which are available for sale and not held for trading purposes.

Interest rate risk is managed within the context
of asset and liability management strategy where the target
duration for the fixed income portfolio is based on the estimate
of the liability duration and takes into consideration the
Companys surplus. The investment policy guidelines provide
for a fixed income portfolio duration of between three and five
years. At June 30, 2004, the Companys fixed income
portfolio had a modified duration of 3.43, compared to 3.27 at
December 31, 2003.

At June 30, 2004 the fair value of the
Companys investment portfolio was $300.2 million,
99.2% of which is invested in debt securities. The remaining
0.8% is invested in preferred stocks. The Companys market
risk to the investment portfolio is interest rate risk
associated with debt securities. The Companys exposure to
equity price risk is not significant. The Companys
investment philosophy is one of maximizing after-tax earnings
and has historically included significant investments in
tax-exempt bonds. In 2002, the Company emphasized taxable
securities over tax-exempt securities in order to maximize
after-tax income and the utilization of the net operating loss
carryforward. During 2003 and continuing in 2004, the Company
began to increase its holdings of tax-exempt securities based on
the Companys return to profitability and its desire to
maximize after-tax investment income. For the Companys
investment portfolio, there were no significant changes in the
Companys primary market risk exposures or in how those
exposures are managed compared to the year ended
December 31, 2003. The Company does not anticipate
significant changes in the Companys

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primary market risk exposures or in how those
exposures are managed in future reporting periods based upon
what is known or expected to be in effect.


A sensitivity analysis is defined as the
measurement of potential loss in future earnings, fair values,
or cash flows of market sensitive instruments resulting from one
or more selected hypothetical changes in interest rates and
other market rates or prices over a selected period. In the
Companys sensitivity analysis model, a hypothetical change
in market rates is selected that is expected to reflect
reasonable possible near-term changes in those rates. Near
term means a period of up to one year from the date of the
consolidated financial statements. In its sensitivity model, the
Company uses fair values to measure its potential loss of debt
securities assuming an upward parallel shift in interest rates
to measure the hypothetical change in fair values. Based upon
this sensitivity model, a 100 basis point immediate increase in
interest rates produces a loss in fair value of market sensitive
instruments of approximately $11.2 million, or 3.73%. This
loss in fair value only reflects the impact of interest rate
increases on the fair value of the Companys debt
securities. This loss after tax constitutes 4.7% of
shareholders equity. The other financial instruments,
which include cash and cash equivalents, equity securities,
premium receivables, reinsurance recoverables, line of credit
and other assets and liabilities, when included in the
sensitivity model, do not produce a material loss in fair values.




Item
4.Controls and
Procedures

As of June 30, 2004, the Companys
management, with the participation of its Chief Executive
Officer (CEO) and Chief Financial Officer
(CFO), carried out an evaluation of the
effectiveness of the design and operation of the Companys
disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities and
Exchange Act of 1934, as amended). It should be noted that in
designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no
matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible
controls and procedures. The Company has designed its disclosure
controls and procedures to reach a level of reasonable assurance
of achieving desired control objectives and, based on the
evaluation described above, the Companys CEO and CFO
concluded that the Companys disclosure controls and
procedures were effective at reaching that level of reasonable
assurance, except as discussed in the paragraph below.

During the quarter ended June 30, 2004, the
CFO identified an error in the accounting for a reinsurance
contract as it applies to a unique and newly implemented
program. Upon investigation of this error, management concluded
that a significant deficiency in internal controls over the
reinsurance process existed. This deficiency was the result of
the lack of adequate control procedures to incorporate on a
timely basis specific provisions of reinsurance contracts into
the financial reporting process. For the second quarter of 2004,
and going forward, the reinsurance process now incorporates a
second level of review for the accounting relating to new or
changed reinsurance provisions by the Controller or CFO and the
reinsurance department. This review also includes a verification
of the accounting impact of all new or changed reinsurance
provisions to the general ledger.

Management has reviewed the impact of the error
on the financial statements of prior periods and believes it
does not have a material effect on the reported earnings in any
quarter for 2003 and 2004. As a result, management has not
restated its prior period financial statements.

Management is assigning high priority to the
short-term and long-term correction of this internal control
deficiency. Management will continue to evaluate the
effectiveness of the Companys internal controls and
procedures on an on-going basis and will take further action as
appropriate. Other than implementing the improvements discussed
above, there have been no other changes required in the
Companys internal controls over financial reporting during
its most recent fiscal quarter that have materially affected, or
are reasonably likely to materially affect, the Companys
internal controls over financial reporting.

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PART II  OTHER
INFORMATION






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

The information required by this item is included
under Note 6  Commitments and
Contingencies of the Companys Form 10-Q for the
six months ended June 30, 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 4  Shareholders Equity
of the Companys Form 10-Q for the six months ended
June 30, 2004, which is hereby incorporated by reference.






|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

On May 11, 2004, the Company held its Annual
Meeting of Shareholders (Annual Meeting) to consider
and act upon the following proposals:



| |                                                                                                                                     
| | ------------------------------------------------------------------------------------------------------------------------------------
| | (1) The election of five (5) members to
    the Board of Directors of the Company;                                                  
|
| | (2) Ratification of the appointment of the
    Companys independent accountants, PricewaterhouseCoopers,
    LLP; and              
|
| | (3) The approval of the Restatement and
    Amendment of the 1995 and 2002 Stock Option Plans to permit
    restricted stock awards.

The following Directors stood for election at the
Annual Meeting: (1) Joseph S. Dresner; (2) Ralph Milo;
(3) David Page; (4) Merton J. Segal; and
(5) Herbert Tyner. The shareholders re-elected the
Directors at the Annual Meeting and therefore, each shall
continue in office. The vote tabulation for each Director was:
(1) Joseph S. Dresner  27,491,311 in favor and
171,021 withheld; (2) Ralph Milo  27,575,909 in
favor and 86,423 withheld; (3) David K. Page 
27,581,491 in favor and 80,841 withheld; (4) Merton J.
Segal  27,487,678 for and 174,654 withheld and
(5) Herbert Tyner  27,490,311 for and 172,021
withheld. Other Directors continuing in office after the meeting
were as follows: Robert S. Cubbin, Hugh W. Greenberg, Florine
Mark, Robert H. Naftaly, Robert W. Sturgis, Irvin F. Swider,
Sr., and Bruce E. Thal.

The shareholders ratified the appointment of
PricewaterhouseCoopers, LLP by a vote of 27,622,442 in favor,
30,212 against and 9,678 abstained.

The shareholders approved the Restatement and
Amendment of the 1995 and 2002 Stock Option Plans to permit
restricted stock awards by a vote of 18,314,377 in favor,
986,028 against, and 20,294 abstained. There were 8,341,633
broker non-votes on this proposal.

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|        |                                     
|------- | ------------------------------------
|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          |  | Meadowbrook Insurance Group, Inc. Amended and
    Restated 1995 Stock Option Plan (incorporated by reference from
    Proxy Statement for 2004 Annual Meeting of Shareholders).                                                    
|        | 10 | .2          |  | Meadowbrook Insurance Group, Inc. Amended and
    Restated 2002 Stock Option Plan (incorporated by reference from
    Proxy Statement for 2004 Annual Meeting of Shareholders).                                                    
|        | 10 | .3          |  | Meadowbrook Insurance Group, Inc. Long Term
    Incentive Plan.                                                                                                                                                                    
|        | 10 | .4          |  | Purchase and Sale Agreement between Kirco
    Acquisition LLC and Meadowbrook Insurance Group, Inc., dated
    December 4, 2003.                                                                                                   
|        | 10 | .5          |  | Standard Offer, Agreement and Escrow Instructions
    for Purchase of Real Estate, dated April 26, 2004.                                                                                                                           
|        | 10 | .6          |  | Indenture between Meadowbrook Insurance Group,
    Inc. and JPMorgan Chase Bank, as Trustee, dated April 29,
    2004.                                                                                                             
|        | 10 | .7          |  | Amended and Restated Loan and Security Agreement
    between Liberty Premium Finance, Inc., and Comerica Bank, dated
    May 7, 2004.                                                                                              
|        | 10 | .8          |  | Sixth Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated May 26, 2004.                                                                                              
|        | 10 | .9          |  | Indenture between Meadowbrook Insurance Group,
    Inc. and Wilmington Trust Company, as Trustee, dated as of
    May 26, 2004.                                                                                                    
|        | 10 | .10         |  | Seventh Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated June 30, 2004.                                                                                           
|        | 10 | .11         |  | First Amendment to Purchase and Sale Agreement
    between Kirco Acquisition LLC and Meadowbrook Insurance Group,
    Inc., dated July 15, 2004.                                                                                   
|        | 10 | .12         |  | Land Contract between Meadowbrook Insurance
    Group, Inc. and MB Center II LLC, dated July 15, 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 May 3, 2004, announcing the completion
of a pooled transaction in which the Registrant raised
$13.0 million. A copy of the press release was included by
exhibit.

The Registrant filed a Current Report on
Form 8-K dated May 10, 2004 for the purpose of
furnishing the Companys first quarter 2004 earnings
release.

The Registrant filed a Current Report on
Form 8-K dated May 27, 2004, announcing the completion
of a pooled transaction in which the Registrant raised
$12.0 million. A copy of the press release was included by
exhibit.

40



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##### Table of Contents






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: August 9, 2004

41



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EXHIBIT INDEX

|        |       |             |  |                                                                                                                                                                                                                                    
|------- | ----- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |       |            
|No.     |       | Description
|        |       |            
|        | 10.1  |             |  | Meadowbrook Insurance Group, Inc. Amended and
    Restated 1995 Stock Option Plan (incorporated by reference from
    Proxy Statement for 2004 Annual Meeting of Shareholders).                                                    
|        | 10.2  |             |  | Meadowbrook Insurance Group, Inc. Amended and
    Restated 2002 Stock Option Plan (incorporated by reference from
    Proxy Statement for 2004 Annual Meeting of Shareholders).                                                    
|        | 10.3  |             |  | Meadowbrook Insurance Group, Inc. Long Term
    Incentive Plan.                                                                                                                                                                    
|        | 10.4  |             |  | Purchase and Sale Agreement between Kirco
    Acquisition LLC and Meadowbrook Insurance Group, Inc., dated
    December 4, 2003.                                                                                                   
|        | 10.5  |             |  | Standard Offer, Agreement and Escrow Instructions
    for Purchase of Real Estate, dated April 26, 2004.                                                                                                                           
|        | 10.6  |             |  | Indenture between Meadowbrook Insurance Group,
    Inc. and JPMorgan Chase Bank, as Trustee, dated April 29,
    2004.                                                                                                             
|        | 10.7  |             |  | Amended and Restated Loan and Security Agreement
    between Liberty Premium Finance, Inc., and Comerica Bank, dated
    May 7, 2004.                                                                                              
|        | 10.8  |             |  | Sixth Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated May 26, 2004.                                                                                              
|        | 10.9  |             |  | Indenture between Meadowbrook Insurance Group,
    Inc. and Wilmington Trust Company, as Trustee, dated as of
    May 26, 2004.                                                                                                    
|        | 10.10 |             |  | Seventh Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated June 30, 2004.                                                                                           
|        | 10.11 |             |  | First Amendment to Purchase and Sale Agreement
    between Kirco Acquisition LLC and Meadowbrook Insurance Group,
    Inc., dated July 15, 2004.                                                                                   
|        | 10.12 |             |  | Land Contract between Meadowbrook Insurance
    Group, Inc. and MB Center II LLC, dated July 15, 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.