Table of Contents

  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington D.C. 20549** **Form 10-Q**   þ     **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    SECURITIES EXCHANGE ACT OF 1934**   **For the Quarter Ended March 31, 2005** **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.)***26255 American Drive, 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 filedall reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrantwas required to file such reports), and (2) has beensubject to such filing requirements for the past90 days.     Yes þ          No o     Indicate by check mark whether the Registrant is an acceleratedfiler (as defined in Rule 12b-2 of the ExchangeAct).     Yes þ          No o     The aggregate number of shares of the Registrant’s CommonStock, $.01 par value, outstanding on May 3, 2005 was28,997,182.  

**TABLE OF CONTENTS**           **Page**                **PART I — FINANCIAL INFORMATION**     ITEM 1 —      FINANCIAL STATEMENTS  2        Consolidated Statements of Income    (unaudited)  2        Consolidated Statements of Comprehensive    Income (unaudited)  3        Consolidated Balance Sheets (unaudited)  4        Consolidated Statement of Cash Flows    (unaudited)  5        Notes to Consolidated Financial Statements    (unaudited)  6-16      ITEM 2 —      MANAGEMENT’S DISCUSSION AND ANALYSIS    OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  17-30      ITEM 3 —      QUANTITATIVE AND QUALITATIVE DISCLOSURES    ABOUT MARKET RISK  30      ITEM 4 —      CONTROLS AND PROCEDURES  31      **PART II — OTHER    INFORMATION**     ITEM 1 —      LEGAL PROCEEDINGS  33      ITEM 2 —      UNREGISTERED SALES OF EQUITY SECURITIES AND    USE OF PROCEEDS  33      ITEM 6 —      EXHIBITS  33                SIGNATURES  34  Reinsurance Agreement Certification of Robert S. Cubbin, CEO to Rule 13a-14(a) Certification of Karen m. Spaun, SVP and CFO to Rule 13a-14(a) Certification of Robert S. Cubbin, CEO to Section 906 Certification of Karen m. Spaun, SVP and CFO to Section 906
1

Table of Contents
**PART 1 — FINANCIAL INFORMATION****ITEM 1*****Financial Statements*****MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF INCOME**             **For the Three Months Ended**  **March 31,**     **2005** **2004**       **(Unaudited)**  **(In thousands,**  **except share data)****Revenues**             Premiums earned              Gross $80,806  $66,178       Ceded  (20,019)  (16,465)            Net earned premiums  60,787   49,713      Net commissions and fees  10,099   11,281      Net investment income  4,091   3,597      Net realized losses  (114)  (120)             Total revenues  74,863   64,471        **Expenses**             Losses and loss adjustment expenses  56,342   51,414      Reinsurance recoveries  (19,208)  (18,905)            Net losses and loss adjustment expenses  37,134   32,509      Salaries and employee benefits  12,605   12,808      Policy acquisition and other underwriting expenses  10,822   7,546      Other administrative expenses  7,785   6,096      Interest expense  773   315              Total expenses  69,119   59,274            Income before taxes and equity earnings  5,744   5,197             Federal and state income tax expense  1,952   1,988      Equity (losses) earnings, of affiliates  (49)  23            Net income $3,743  $3,232            Earnings Per Share              Basic $0.13  $0.11       Diluted $0.13  $0.11     Weighted average number of common shares              Basic  29,072,619   29,025,509       Diluted  29,481,870   29,395,208 The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
2

Table of Contents
**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**              **For the Three**  **Months Ended**  **March 31,**     **2005** **2004**       **(Unaudited)**  **(In thousands)**    Net income $3,743  $3,232      Other comprehensive income, net of tax:              Unrealized (losses) gains on securities  (4,463)  1,734       Less: reclassification adjustment for losses included in net    income  77   73               Other comprehensive income, net of tax  (4,386)  1,807               Comprehensive (loss) income $(643) $5,039        The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
3

Table of Contents
**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED BALANCE SHEETS**             **March 31,** **December 31,**  **2005** **2004**       **(Unaudited)**    **(In thousands,**  **except share data)****ASSETS**    Investments             Debt securities available for sale, at fair value (amortized    cost of $361,728 and $324,966) $362,397  $332,242      Equity securities available for sale, at fair value (cost of $0)  —   39              Total investments  362,397   332,281      Cash and cash equivalents  49,860   69,875      Accrued investment income  4,393   4,331      Premiums and agent balances receivable, net  102,244   84,094      Reinsurance recoverable on:              Paid losses  15,388   17,908       Unpaid losses  162,747   151,161      Prepaid reinsurance premiums  28,059   26,075      Deferred policy acquisition costs  26,763   25,167      Deferred federal income taxes  17,265   14,956      Goodwill  28,997   28,997      Other assets  44,155   46,851              Total assets $842,268  $801,696         **LIABILITIES AND SHAREHOLDERS’ EQUITY**     Liabilities             Losses and loss adjustment expenses $398,866  $378,157      Unearned premiums  144,489   134,302      Debt  9,800   12,144      Debentures  35,310   35,310      Accounts payable and accrued expenses  48,375   38,837      Reinsurance funds held and balances payable  24,719   17,832      Payable to insurance companies  3,966   6,990      Other liabilities  9,965   10,614              Total liabilities  675,490   634,186            Commitments and contingencies (Note 6)            Shareholders’ Equity             Common stock, $0.01 stated value; authorized    50,000,000 shares; 29,017,682 and 29,074,832 shares    issued and outstanding  290   290      Additional paid-in capital  126,043   126,085      Retained earnings  40,867   37,175      Note receivable from officer  (864)  (868)     Accumulated other comprehensive income  442   4,828              Total shareholders’ equity  166,778   167,510              Total liabilities and shareholders’ equity $842,268  $801,696        The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
4

Table of Contents
**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF CASH FLOWS**              **For the Three Months**  **Ended March, 31**     **2005** **2004**       **(Unaudited)**  **(In thousands)****Cash Flows From Operating Activities**             Net income $3,743  $3,232             Adjustments to reconcile net income to net cash provided by    (used in) operating activities:              Amortization of other intangible assets  92   99       Amortization of deferred debenture issuance costs  38   11       Depreciation of furniture, equipment, and building  584   275       Net accretion of discount and premiums on bonds  581   318       Losses on sale of investments, net  136   110       Gain on sale of fixed assets  (22)  —       Stock-based employee compensation  14   27       Long term incentive plan expense  195   —       Deferred income tax benefit  (49)  (77)     Changes in operating assets and liabilities:             Decrease (increase) in:              Premiums and agent balances receivable  (18,150)  (10,882)      Reinsurance recoverable on paid and unpaid losses  (9,067)  (2,459)      Prepaid reinsurance premiums  (1,984)  (1,638)      Deferred policy acquisition costs  (1,596)  (2,946)      Other assets  2,894   1,571      Increase (decrease) in:              Losses and loss adjustment expenses  20,709   10,336       Unearned premiums  10,187   14,876       Payable to insurance companies  (3,024)  (4,020)      Reinsurance funds held and balances payable  6,887   1,212       Other liabilities  2,001   6,112               Total adjustments  10,426   12,925              Net cash provided by operating activities  14,169   16,157        **Cash Flows From Investing Activities**             Purchase of debt securities available for sale  (114,889)  (38,582)     Proceeds from sales and maturities of debt securities available    for sale  95,274   13,275      Proceeds from sales of equity securities available for sale  8   —      Capital expenditures  (11,734)  (835)     Purchase of books of business  (78)  (187)     Deconsolidation of subsidiary  —   (4,218)     Other investing activities  185   1,496              Net cash used in investing activities  (31,234)  (29,051)       **Cash Flows From Financing Activities**             Proceeds from lines of credit  —   4,947      Payment of lines of credit  (2,344)  (4,760)     Book overdraft  (254)  (445)     Issuance of common stock  5   22      Retirement of common stock  (308)  —      Other financing activities  (49)  5              Net cash used in by financing activities  (2,950)  (231)            Net decrease in cash and cash equivalents  (20,015)  (13,125)     Cash and cash equivalents, beginning of period  69,875   50,647             Cash and cash equivalents, end of period $49,860  $37,522        The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
5

Table of Contents
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****(Unaudited)****Note 1 — Summary of Significant AccountingPolicies*****Basis of Presentation and Management Representation***     The consolidated financial statements include accounts, afterelimination of intercompany accounts and transactions, ofMeadowbrook Insurance Group, Inc. (the “Company”), itswholly owned subsidiary Star Insurance Company(“Star”), and Star’s wholly owned subsidiaries,Savers Property and Casualty Insurance Company, WilliamsburgNational Insurance Company, and Ameritrust Insurance Corporation(which are collectively referred to as the “InsuranceCompany Subsidiaries”), and Preferred Insurance Company,Ltd. The consolidated financial statements also includeMeadowbrook, Inc., Crest Financial Corporation, and theirsubsidiaries. In addition, the consolidated financial statementsalso include the equity earnings of the Company’s whollyowned unconsolidated subsidiaries, American Indemnity InsuranceCompany, Ltd. and Meadowbrook Capital Trust I.     In the opinion of management, the consolidated financialstatements reflect all normal recurring adjustments necessary topresent a fair statement of the results for the interim period.Preparation of financial statements under generally acceptedaccounting principles requires management to make estimates.Actual results could differ from those estimates. The results ofoperations for the three months ended March 31, 2005, arenot necessarily indicative of the results expected for the fullyear.     These financial statements and the notes thereto should be readin conjunction with the Company’s audited financialstatements and accompanying notes included in its annual reporton Form 10-K, as filed with the United States Securitiesand Exchange Commission, for the year ended December 31,2004.     Certain amounts in the 2004 financial statements and notes toconsolidated financial statements have been reclassified toconform to the 2005 presentation. These amounts specificallyrelate to state income tax expense and the allocation ofcorporate overhead to the Company’s agency operationssegment. State income tax expense has been reclassified fromincome before taxes and equity earnings to federal and stateincome tax expense. The Company’s agency operations segmenthas been reclassified to include an allocation of corporateoverhead. Refer to Note 7 — *SegmentInformation*for additional information.***Revenue Recognition***     Premiums written are recognized as earned on a pro rata basisover the life of the policy term. Unearned premiums representthe portion of premiums written that are applicable to theunexpired terms of policies in force. Provisions for unearnedpremiums on reinsurance assumed from others are made on thebasis of ceding reports when received and actuarial estimates.Certain premiums are subject to retrospective premiumadjustments. Premiums are recognized over the term of theinsurance policy.     Fee income, which includes risk management consulting, losscontrol, and claims services, is recognized in the period theservices are provided. Claims processing fees are recognized asrevenue over the estimated life of the claims, or the estimatedlife of the contract. For those contracts that provide servicesbeyond the expiration or termination of the contract, fees aredeferred in an amount equal to management’s estimate of theCompany’s obligation to continue to provide services.     Commission income, which includes reinsurance placement, isrecorded on the later of the effective date or the billing dateof the policies on which they were earned. Commission income isreported net of sub-producer commission expense. Commission andother adjustments are recorded when they occur and the Companymaintains an allowance for estimated policy cancellations andcommission returns. Profit sharing commissions from insurancecompanies are recognized when determinable, which is when suchcommissions are received.     The Company reviews, on an ongoing basis, the collectibility ofits receivables and establishes an allowance for estimateduncollectible accounts.
6

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**     Realized gains or losses on sale of investments are determinedon the basis of specific costs of the investments. Dividend andinterest income are recognized when earned. Discount or premiumon debt securities purchased at other than par value isamortized using the constant yield method. Investments withother than temporary declines in fair value are written down totheir estimated net fair value and the related realized lossesare recognized in income.***Earnings Per Share***     Basic earnings per share are based on the weighted averagenumber of common shares outstanding during the period, whilediluted earnings per share includes the weighted average numberof common shares and potential dilution from shares issuablepursuant to stock options using the treasury stock method.     Outstanding options of 625,002 and 1,036,796 for the periodsended March 31, 2005 and 2004, respectively, have beenexcluded from the diluted earnings per share, as they wereanti-dilutive. Shares issuable pursuant to stock optionsincluded in diluted earnings per share were 329,731 and 298,131for the three months ended March 31, 2005 and 2004,respectively. In addition, shares issuable pursuant tooutstanding warrants included in diluted earnings per share were79,520 and 71,568 for the three months ended March 31, 2005and 2004, respectively.***Stock Options***     Effective January 1, 2003, the Company adopted therequirements of Statement of Financial Accounting Standards(“SFAS”) No. 148, *“Accounting forStock-Based Compensation — Transition andDisclosure — an amendment of FASB StatementNo. 123”*, utilizing the prospective method. Underthe prospective method, stock-based compensation expense isrecognized for awards granted after the beginning of the fiscalyear in which the change is made. Upon implementation ofSFAS No. 148 in 2003, the Company is recognizingstock-based compensation expense for awards granted afterJanuary 1, 2003.     Prior to the adoption of SFAS No. 148, the Companyapplied the intrinsic value-based provisions set forth in APBOpinion No. 25. Under the intrinsic value method,compensation expense is determined on the measurement date,which is the first date when both the number of shares theemployee is entitled to receive, and the exercise price areknown. Compensation expense, if any, resulting from stockoptions granted by the Company is determined based upon thedifference between the exercise price and the fair market valueof the underlying common stock at the date of grant. TheCompany’s Stock Option Plan requires the exercise price ofthe grants to be at the current fair market value of theunderlying common stock.     The Company, through its 1995 and 2002 Amended and RestatedStock Option Plans (the “Plans”), may grant options tokey executives and other members of management of the Companyand its subsidiaries in amounts not to exceed2,000,000 shares of the Company’s common stockallocated for each plan. The Plans are administered by theCompensation Committee (the “Committee”) of the Boardof Directors. Option shares may be exercised subject to theterms of the Plans and the terms prescribed by the Committee atthe time of grant. Currently, the Plans’ options haveeither five or ten-year terms and are exercisable and vest inequal increments over the option term.     In 2004, the Company’s Board of Directors approved theadoption of a Long Term Incentive Plan (the “LTIP”).The LTIP provides participants with the opportunity to earn cashand stock awards based upon the achievement of specifiedfinancial goals over a three-year performance period with thefirst performance period commencing January 1, 2004. At theend of the three-year performance period, and if the performancetarget is achieved, the Committee shall determine the amount ofLTIP awards that are payable to participants in the LTIP.One-half of any LTIP award will be payable in cash and one-halfof the award will be payable in the form of a restricted stockaward. If the Company achieves the three-year performancetarget, payment of the award would be made in three annualinstallments. The number of shares of Company’s commonstock subject to the restricted stock award shall equal thedollar amount of one-half of the LTIP award divided by the fairmarket value of Company’s common stock on the first date ofthe performance period. The restricted
7

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**stock awards shall be made subject to the terms and conditionsof the LTIP and Plans. The Company accrues awards based upon thecriteria set-forth and approved by the Committee, as included inthe LTIP. At March 31, 2005 and December 31, 2004, theCompany had $1.7 million and $1.3 million accruedunder the LTIP, respectively.     If compensation cost for stock option grants had been determinedbased on a fair value method, net income and earnings per shareon a pro forma basis for the three months ending March 31,2005 and 2004 would be as follows (in thousands):            **For the Three Months**  **Ended March 31,**     **2005** **2004**         Net income, as reported $3,743  $3,232     Add: Stock-based employee compensation expense included in    reported income, net of related tax effects  9   18     Deduct: Total stock-based employee compensation expense    determined under fair-value-based methods for all awards, net of    related tax effects  (66)  (134)           Pro forma net income $3,686  $3,116            Earnings per share:             Basic — as reported $0.13  $0.11      Basic — pro forma $0.13  $0.11      Diluted — as reported $0.13  $0.11      Diluted — pro forma $0.13  $0.11      No options were granted during the three months endedMarch 31, 2005 or 2004.     Compensation expense of $13,631 and $26,725 has been recorded inthe three months ended March 31, 2005 and 2004,respectively, under SFAS 148.***Recent Accounting Pronouncements***     On December 16, 2004, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 123 (revised2004), *“Share-Based Payment”*(“SFAS 123R”), which replacesSFAS No. 123, *“Accounting for Stock Issued toEmployees.”*SFAS 123R requires all share-basedpayments to employees to be recognized in the financialstatements based on their fair values. The pro forma disclosurespreviously permitted under SFAS 123, will no longer be analternative to financial statement recognition. Commencing inthe first quarter of 2003, the Company began expensing the fairvalue of all stock options granted since January 1, 2003under the prospective method. Under SFAS 123R, the Companymust determine the appropriate fair value model to be used forvaluing share-based payments, the amortization method forcompensation cost and the transition method to be used at thedate of adoption. The transition methods include prospective andretroactive adoption options. Under the retroactive options,prior periods may be restated either as of the beginning of theyear of adoption or for all periods presented. The prospectivemethod requires that compensation expense be recorded at thebeginning of the first quarter of adoption of SFAS 123R forall unvested stock options and restricted stock based upon thepreviously disclosed SFAS 123 methodology and amounts. Theretroactive methods would record compensation expense beginningwith the first period restated for all unvested stock optionsand restricted stock. On April 14, 2005, the Securities andExchange Commission adopted a new rule that delays thecompliance dates for SFAS 123R. Under the new rule,SFAS 123R is effective for public companies for annual,rather than interim periods, that begin after June 15,2005. Therefore, the Company is required to adopt SFAS 123Rin the first quarter of 2006, or beginning January 1, 2006.The Company is currently evaluating the requirements ofSFAS 123R and has not yet determined the method of adoptionor impact SFAS 123R will have on its financial statements.
8

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)****Note 2 —****Reinsurance**     The Insurance Company Subsidiaries cede insurance to otherinsurers under pro-rata and excess-of-loss contracts. Thesereinsurance arrangements diversify the Company’s businessand minimize its exposure to large losses or from hazards of anunusual nature. The ceding of insurance does not discharge theoriginal insurer from its primary liability to its policyholder.In the event that all or any of the reinsuring companies areunable to meet their obligations, the Insurance CompanySubsidiaries would be liable for such defaulted amounts.Therefore, the Company is subject to a credit risk with respectto the obligations of its reinsurers. In order to minimize itsexposure to significant losses from reinsurer insolvencies, theCompany evaluates the financial condition of its reinsurers andmonitors the economic characteristics of the reinsurers on anongoing basis. The Company also assumes insurance from otherinsurers and reinsurers, both domestic and foreign, underpro-rata and excess-of-loss contracts.     Inter-company pooling agreements are commonly entered intobetween affiliated insurance companies, so as to allow thecompanies to utilize the capital and surplus of all of thecompanies, rather than each individual company. Under poolingarrangements, companies share in the insurance business that isunderwritten and allocate the combined premium, losses andrelated expenses between the companies within the poolingarrangement. Effective January 1, 2005, the InsuranceCompany Subsidiaries entered into an Inter-Company ReinsuranceAgreement (the “Reinsurance Agreement”). ThisReinsurance Agreement includes Star, Ameritrust InsuranceCorporation (“Ameritrust”), Savers Property andCasualty Insurance Company (“Savers”) and WilliamsburgNational Insurance Company (“Williamsburg”). Pursuantto the Reinsurance Agreement, Savers, Ameritrust andWilliamsburg have agreed to cede to Star and Star has agreed toreinsure 100% of the liabilities and expenses of Savers,Ameritrust and Williamsburg, relating to all insurance andreinsurance policies issued by them. In return, Star agrees tocede and Savers, Ameritrust and Williamsburg have agreed toreinsure Star for their respective percentages of theliabilities and expenses of Star. The Reinsurance Agreement wasfiled with the applicable regulatory authorities and was notdisapproved. Any changes to the Reinsurance Agreement must besubmitted to the applicable regulatory authorities for reviewand approval.     At March 31, 2005, the Company had reinsurance recoverablesfor paid and unpaid losses of $178.1 million. The Companycustomarily collateralizes reinsurance balances due fromnon-admitted reinsurers through funds withheld trusts or lettersof credit. The largest unsecured reinsurance recoverable is duefrom an admitted reinsurer with an “A” A.M. Bestrating and accounts for 30.8% of the total recoverable for paidand unpaid losses.     The Company maintains an excess-of-loss reinsurance treatydesigned to protect against large or unusual loss and lossadjustment expense activity. The Company determines theappropriate amount of reinsurance based on the Company’sevaluation of the risks accepted and analysis prepared byconsultants and reinsurers and on market conditions includingthe availability and pricing of reinsurance. To date, there havebeen no material disputes with the Company’s excess-of-lossreinsurers. No assurance can be given, however, regarding thefuture ability of any of the Company’s excess-of-lossreinsurers to meet their obligations.     Under the workers’ compensation reinsurance treaty, thereinsurers 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 oneclaimant up to $50.0 million per occurrence.     Under the core liability reinsurance treaty, the reinsurers areresponsible for 100% of each loss in excess of $350,000, up to$2.0 million per occurrence. The Company also purchased anadditional $3.0 million of reinsurance clash coverage inexcess of the $2.0 million to cover amounts that may be inexcess of the $2.0 million policy limit, such as expensesassociated with the settlement of claims or awards in excess ofpolicy limits.     The Company has a separate treaty to cover liabilityspecifically related to commercial trucking, where reinsurersare responsible for 100% of each loss in excess of $350,000, upto $1.0 million. In addition, the
9

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**Company purchased an additional $1.0 million of reinsuranceclash coverage. The Company also established a separate treatyto cover liability related to chemical distributors andrepackagers, where reinsurers are responsible for 100% of eachloss in excess of $500,000, up to $1.0 million, appliedseparately to general liability and auto liability.     Under the property reinsurance treaty, reinsurers areresponsible for 100% of the amount of each loss in excess of$500,000, up to $5.0 million per location for anoccurrence. In addition, there is coverage for loss eventsinvolving multiple locations up to $20.0 million after theCompany has incurred $750,000 in loss.     Under the semi-automatic facultative umbrella reinsurancetreaties, the reinsurers are responsible for a minimum of 85% ofthe first million in coverage and 100% of each of the secondthrough fifth million of coverage, up to $5.0 million. Thereinsurers provide a ceding commission allowance to cover theCompany’s expenses.     Effective September 30, 2004, the Company amended anexisting reinsurance agreement that provided reinsurancecoverage for policies with effective dates from August 1,2003 to July 31, 2004, which were written in theCompany’s public entity excess liability program. Thisreinsurance agreement provided coverage on an excess-of-lossbasis for each occurrence in excess of the policyholder’sself-insured and the Company’s retained limit. Thisreinsurance agreement was amended by revising premium rate andloss coverage terms, which effected the transfer of risk to thereinsurer and reduced the net estimated costs of reinsurance tothe Company. The amended reinsurance cost for this coverage is aflat percentage of premium subject to this treaty and providesreinsurance coverage of $4.0 million in excess of$1.0 million for each occurrence in excess of thepolicyholder’s self-insured retention. These amended termswere applicable to the renewal of this reinsurance agreement forthe period August 1, 2004 to January 31, 2006.     In addition, the Company purchased $10.0 million in excessof $5.0 million for each occurrence, which is above theunderlying $5.0 million of coverage for the Company’spublic entity excess liability 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 corecatastrophic workers’ compensation treaty structure up to$50.0 million per occurrence.     Additionally, several small programs have separate reinsurancetreaties in place, which limit the Company’s exposure to$300,000 or less.     Facultative reinsurance is purchased for property values inexcess of $5.0 million, casualty limits excess of$2.0 million, or for coverage not covered by a treaty.     In its risk-sharing programs, the Company is also subject tocredit risk with respect to the payment of claims by itsclients’ captive, rent-a-captive, large deductibleprograms, indemnification agreements, and on the portion of riskexposure either ceded to the captives, or retained by theclients. The capitalization and credit worthiness of prospectiverisk-sharing partners is one of the factors considered by theCompany in entering into and renewing risk-sharing programs. TheCompany collateralizes balances due from its risk-sharingpartners through funds withheld trusts or letters of credit. AtMarch 31, 2005, the Company had risk exposure in excess ofcollateral in the amount of $10.4 million, on theseprograms, of which the Company has an allowance of$8.0 million, related to these exposures. The Company hashistorically maintained an allowance for the potentialuncollectibility of certain reinsurance balances due from somerisk-sharing partners, some of which are in litigation with theCompany. At the end of each quarter, an analysis of theseexposures is conducted to determine the potential exposure touncollectibility. As of March 31, 2005, management believesthat this allowance is adequate. To date, the Company has not,in the aggregate, experienced material difficulties incollecting balances from its risk-sharing partners. No assurancecan be given, however, regarding the future ability of any ofthe Company’s risk-sharing partners to meet theirobligations. At March 31, 2005, the exposure amount inlitigation with former risk-sharing partners which is notreserved or collateralized is $1.1 million.
10

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)****Note 3 — Debt*****Lines of Credit***     On November 12, 2004, the Company entered into a revolvingline of credit for up to $25.0 million. The revolving lineof credit replaces the Company’s previous line of creditand expires on November 11, 2007. The Company has drawnapproximately $9.0 million on this new revolving line ofcredit to pay off its former term loan. The Company will use therevolving line of credit to meet short-term working capitalneeds. Under the revolving line of credit, the Company andcertain of its non-regulated subsidiaries pledged securityinterest in certain property and assets of the Company and namedsubsidiaries.     At March 31, 2005 and December 31, 2004, the Companyhad an outstanding balance of $7.0 million and$9.0 million on the revolving line of credit, respectively.     The revolving line of credit provides for interest at a variablerate based, at the Company’s option, upon either a primebased rate or LIBOR-based rate. On prime based borrowings, theapplicable margin ranges from 75 to 25 basis points belowprime. On LIBOR-based borrowings, the applicable margin rangesfrom 125 to 175 basis points above LIBOR. The margin forall loans is dependent on the sum of non-regulated earningsbefore interest, taxes, depreciation, amortization, and non-cashimpairment charges related to intangible assets for thepreceding four quarters, plus dividends paid or payable to theCompany from subsidiaries during such period (“AdjustedEBITDA”). As of March 31, 2005, the average interestrate for LIBOR-based borrowings outstanding was 4.1%.     Debt covenants consist of: (1) maintenance of the ratio ofAdjusted EBITDA to interest expense of 2.0 to 1.0,(2) minimum net worth of $130.0 million and increasingannually commencing June 30, 2005, by fifty percent of theprior year’s positive net income, (3) minimum A.M.Best rating of “B”, and (4) minimum Risk BasedCapital Ratio for Star of 1.75 to 1.00. As of March 31,2005, the Company was in compliance with these covenants.     In addition, a non-insurance premium finance subsidiary of theCompany maintains a line of credit with a bank, which permitsborrowings up to 75% of the accounts receivable, whichcollateralize the line of credit. At March 31, 2005, thisline of credit had an outstanding balance of $2.8 million.The interest terms of this line of credit provide for interestat the prime rate minus 0.5%, or a LIBOR-based rate option, plus2.0%. At March 31, 2005, the LIBOR-based option was 4.7%and the average interest rate was 4.5%. The line will expire onMay 14, 2005. Management expects to negotiate an extensionor new line of credit.***Senior Debentures***     On April 29, 2004, the Company issued senior debentures inthe amount of $13.0 million. The senior debentures maturein thirty years and provide for interest at the three-monthLIBOR, plus 4.00%, which is non-deferrable. The seniordebentures are callable by the Company at par after five yearsfrom the date of issuance. Associated with this transaction theCompany incurred $390,000 of commissions paid to the placementagents. These issuance costs have been capitalized and areincluded in other assets on the balance sheet, which will beamortized over seven years as a component of interest expense.     On May 26, 2004, the Company issued senior debentures inthe amount of $12.0 million. The senior debentures maturein thirty years and provide for interest at the three-monthLIBOR, plus 4.20%, which is non-deferrable. The seniordebentures are callable by the Company at par after five yearsfrom the date of issuance. Associated with this transaction theCompany incurred $360,000 of commissions paid to the placementagents. These issuance costs have been capitalized and areincluded in other assets on the balance sheet, which will beamortized over seven years as a component of interest expense.     The Company contributed $9.9 million of the proceeds to itsInsurance Company Subsidiaries as of December 31, 2004. Theremaining proceeds from the issuance of the senior debenturesmay be used to
11

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**support future premium growth through further contributions tothe Insurance Company Subsidiaries and general corporatepurposes.***Junior Subordinated Debentures***     On September 30, 2003, Meadowbrook Capital Trust (the“Trust”), an unconsolidated subsidiary trust of theCompany, issued $10.0 million of mandatorily redeemabletrust preferred securities (“TPS”) to a trust formedby an institutional investor. Contemporaneously, the Companyissued $10.3 million in junior subordinated debentures,which includes the Company’s investment in the trust of$310,000. These debentures have financial terms similar to thoseof the TPS, which includes the deferral of interest payments atany time, or from time-to-time, for a period not exceeding fiveyears, provided there is no event of default. These debenturesmature in thirty years and provide for interest at thethree-month LIBOR, plus 4.05%, which started in December 2003.These debentures are callable by the Company at par beginning inOctober 2008.     The Company received a total of $9.7 million in netproceeds, after the deduction of approximately $300,000 ofcommissions paid to the placement agents in the transaction.These issuance costs have been capitalized and are included inother assets on the balance sheet, which will be amortized overseven years as a component of interest expense. The Companyestimates that the fair value of these debentures issuedapproximates the gross proceeds of cash received at the time ofissuance.     These debentures are unsecured obligations of the Company andare junior to the right of payment to all senior indebtedness ofthe Company. The Company has guaranteed that the payments madeto the Trust will be distributed by the Trust to the holders ofthe TPS.     The Company contributed $6.3 million of the proceeds fromthe issuance of these debentures to its Insurance CompanySubsidiaries and the remaining balance has been used for generalcorporate purposes.**Note 4 —****Shareholders’ Equity**     At March 31, 2005, shareholders’ equity was$166.8 million, or a book value of $5.75 per commonshare, compared to $167.5 million, or a book value of$5.76 per common share, at December 31, 2004.     On September 17, 2002, the Company’s Board ofDirectors authorized management to repurchase up to1,000,000 shares of the Company’s common stock inmarket transactions for a period not to exceed twenty-fourmonths. On August 6, 2003, the Company’s Board ofDirectors authorized management to repurchase up to anadditional 1,000,000 shares of the Company’s commonstock under the existing share repurchase plan. The originalshare repurchase plan expired on September 17, 2004. OnNovember 3, 2004, the Company’s Board of Directorsauthorized management to repurchase up to 1,000,000 sharesof its common stock in market transactions for a period not toexceed twenty-four months. For the three months endedMarch 31, 2005, the Company purchased and retired59,400 shares of common stock for a total cost ofapproximately $308,000. The Company did not repurchase anycommon stock during 2004. As of March 31, 2005, thecumulative amount the Company has repurchased and retired underthe current share repurchase plan was 59,400 shares ofcommon stock for a total cost of approximately $308,000. As ofMarch 31, 2005, the Company has available up to940,600 shares remaining to be purchased.**Note 5 —****Regulatory Matters and Rating Agencies**     A significant portion of the Company’s consolidated assetsrepresent assets of the Insurance Company Subsidiaries that atthis time, without prior approval of the State of MichiganOffice of Financial and Insurance Services (“OFIS”),cannot be transferred to the holding company in the form ofdividends, loans or advances. The restriction on thetransferability to the holding company from its InsuranceCompany Subsidiaries is regulated by Michigan insuranceregulatory statutes which, in general, are as follows: themaximum discretionary dividend that may be declared, based ondata from the preceding calendar year, is the
12

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**greater of each insurance company’s net income (excludingrealized capital gains) or ten percent of the insurancecompany’s surplus (excluding unrealized gains). Thesedividends are further limited by a clause in the Michigan lawthat prohibits an insurer from declaring dividends, except fromsurplus earnings of the company. Earned surplus balances arecalculated on a quarterly basis. Since Star is the parentinsurance company, its maximum dividend calculation representsthe combined Insurance Company Subsidiaries’ surplus. Basedupon the 2004 statutory financial statements, Star may only paydividends to the Company during 2005 with the prior approval ofOFIS. Star’s earned surplus position at December 31,2004 was negative $13.7 million. At March 31, 2005,earned surplus was negative $12.0 million. No statutorydividends were paid in 2004.     Insurance operations are subject to various leverage tests (e.g.premium to statutory surplus ratios), which are evaluated byregulators and rating agencies. The Company’s targets forgross and net written premium to statutory surplus are 3.0 to1.0 and 2.5 to 1.0, respectively. As of March 31, 2005, ona statutory consolidated basis, the gross and net premiumleverage ratios were 2.6 to 1.0 and 2.0 to 1.0, respectively.     The National Association of Insurance Commissioners(“NAIC”) has adopted a risk-based capital(“RBC”) formula to be applied to all property andcasualty insurance companies. The formula measures requiredcapital and surplus based on an insurance company’sproducts and investment portfolio and is used as a tool toevaluate the capital of regulated companies. The RBC formula isused by state insurance regulators to monitor trends instatutory capital and surplus for the purpose of initiatingregulatory action. In general, an insurance company must submita calculation of its RBC formula to the insurance department ofits state of domicile as of the end of the previous calendaryear. These laws require increasing degrees of regulatoryoversight and intervention as an insurance company’s RBCdeclines. The level of regulatory oversight ranges fromrequiring the insurance company to inform and obtain approvalfrom the domiciliary insurance commissioner of a comprehensivefinancial plan for increasing its RBC to mandatory regulatoryintervention requiring an insurance company to be placed underregulatory control in a rehabilitation or liquidation proceeding.     At December 31, 2004, all of the Insurance CompanySubsidiaries were in compliance with RBC requirements. Starreported statutory surplus of $120.7 million atDecember 31, 2004, compared to the threshold requiring theminimum regulatory involvement of $56.9 million in 2004. AtMarch 31, 2005, Star’s statutory surplus was$122.4 million.**Note 6 —****Commitments and Contingencies**     On June 6, 2003, the Company entered into a GuarantyAgreement with a bank. The Company is guaranteeing payment of a$1.5 million term loan issued by the bank to anunaffiliated insurance agency. In the event of default on theterm loan by the insurance agency, the Company is obligated topay 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. Inexchange for the Company’s guaranty, the president andmember of the unaffiliated insurance agency pledged 100% of thecommon stock of two insurance agencies that he wholly owns. Inthe event of default of the term loan by the unaffiliatedinsurance agency, the Company has the right to sell all or aportion of the pledged assets (the common stock of the twoinsurance agencies) and use the proceeds from the sale torecover any amounts paid under the Guaranty Agreement. Anyexcess proceeds would be paid to the shareholder. As ofMarch 31, 2005, no liability has been recorded with respectto 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 tovarious claims, lawsuits and proceedings relating principally toalleged errors or omissions in the placement of insurance,claims administration, consulting services and other businesstransactions arising in the ordinary course of business. Whereappropriate, the Company vigorously defends such claims,lawsuits and proceedings. Some of these claims, lawsuits andproceedings seek damages, including consequential, exemplary orpunitive damages, in amounts
13

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**that could, if awarded, be significant. Most of the claims,lawsuits and proceedings arising in the ordinary course ofbusiness are covered by errors and omissions insurance or otherappropriate insurance. In terms of deductibles associated withsuch insurance, the Company has established provisions againstthese items, which are believed to be adequate in light ofcurrent information and legal advice. In accordance withSFAS No. 5, *“Accounting forContingencies,”*if it is probable that an asset hasbeen impaired or a liability has been incurred as of the date ofthe financial statements and the amount of loss is estimable, anaccrual for the costs to resolve these claims is recorded by theCompany in its consolidated balance sheets. Period expensesrelated to the defense of such claims are included in otheroperating expenses in the accompanying consolidated statementsof income. Management, with the assistance of outside counsel,adjusts such provisions according to new developments or changesin the strategy in dealing with such matters. On the basis ofcurrent information, the Company does not expect the outcome ofthe claims, lawsuits and proceedings to which the Company issubject to, either individually, or in the aggregate, will havea material adverse effect on the Company’s financialcondition. However, it is possible that future results ofoperations or cash flows for any particular quarter or annualperiod could be materially affected by an unfavorable resolutionof any such matters.**Note 7 —****Segment Information**     The Company defines its operations as specialty risk managementoperations and agency operations based upon differences inproducts and services. The separate financial information ofthese segments is consistent with the way results are regularlyevaluated by management in deciding how to allocate resourcesand in assessing performance. Intersegment revenue is eliminatedin consolidation. It would be impracticable for the Company todetermine the allocation of assets between the two segments.***Specialty Risk Management Operations***     The specialty risk management operations segment focuses onspecialty or niche insurance business in which it providesvarious services and coverages tailored to meet specificrequirements of defined client groups and their members. Theseservices include, risk management consulting, claimsadministration and handling, loss control and prevention, andreinsurance placement, along with various types of property andcasualty insurance coverage, including workers’compensation, commercial multiple peril, general liability,commercial auto liability, and inland marine. Insurance coverageis provided primarily to associations or similar groups ofmembers and to specified classes of business of theCompany’s agent-partners. The Company recognizes revenuerelated to the services and coverages the specialty riskmanagement operations provides within seven categories: netearned premiums, management fees, claims fees, loss controlfees, reinsurance placement, investment income, and net realizedgains (losses).***Agency Operations***     The Company earns commissions through the operation of itsretail property and casualty insurance agency, which was formedin 1955. The agency has grown to be one of the largest agenciesin Michigan and, with acquisitions, has expanded intoCalifornia. The agency operations produce commercial, personallines, life, and accident and health insurance, for more thanfifty unaffiliated insurance carriers.
14

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**     The following table sets forth the segment results (inthousands):             **For the Three Months**  **Ended March 31,**     **2005** **2004**         Revenues             Net earned premiums $60,787  $49,713      Management fees  4,196   4,711      Claims fees  1,752   2,701      Loss control fees  573   545      Reinsurance placement  345   147      Investment income  4,084   3,591      Net realized losses  (114)  (120)             Specialty risk management  71,623   61,288      Agency operations(2)  3,960   3,219      Reconciling items  7   6      Intersegment revenue(2)  (727)  (42)             Consolidated revenue $74,863  $64,471            Pre-tax income:             Specialty risk management $5,400  $4,607      Agency operations(1)&(2)  1,913   1,441      Reconciling items  (1,569)  (851)             Consolidated pre-tax income $5,744  $5,197         (1)     The Company’s agency operations include an allocation of    corporate overhead. In prior years, corporate overhead was    previously reflected only in the specialty risk management    operations segment. This reclassification for the allocation of    corporate overhead more accurately presents the Company’s    segments as a result of improved cost allocation information. As    a result, the segment information for the three months ended    March 31, 2004, has been adjusted to reflect this    allocation. For the three months ended March 31, 2005, and    2004, the allocation of corporate overhead to the agency    operations segment was $725,000 and $731,000, respectively. (2)     In addition to the reclassification for the allocation of    corporate overhead as described above, the Company also    reclassified revenues related to the conversion of a west-coast    commercial transportation program, which was converted to a    specialty risk program with one of its insurance subsidiaries,    from the agency operations segment to the specialty risk    management operations segment. Accordingly, the agency    operations revenue and intersegment revenue has been    reclassified. As a result, $1.6 million was reclassified    within the agency operations segment and the intersegment    revenue for the three months ended March 31, 2004.     The reconciling item included in the revenue relates to interestincome in the holding company. The following table sets forththe pre-tax income reconciling items:           **For the Three Months**  **Ended March 31,**     **2005** **2004**         Holding company expenses $(704) $(437)    Amortization  (92)  (99)    Interest expense  (773)  (315)         $(1,569) $(851)       
15

Table of Contents
**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)****Note 8 —****Subsequent Events**     On April 19, 2005, the Company announced an upgrade from A.M. Best of certain of its Insurance Company Subsidiaries from B+(positive outlook) to B++ (Very Good). The ratings upgradeapplies to Star Insurance Company, Savers Property and CasualtyInsurance Company, and Williamsburg National Insurance Company.Additionally, A.M. Best reaffirmed the rating for AmeritrustInsurance Corporation as B+, with a positive outlook.     Effective April 1, 2005, the Company increased itsretention under its workers’ compensation reinsurancetreaty from $350,000 to $750,000, for losses occurring effectiveApril 1, 2005. The remainder of the treaty did not change.
16

Table of Contents
**ITEM 2****MANAGEMENT’S DISCUSSION AND ANALYSIS OF****FINANCIAL CONDITION AND RESULTS OF OPERATIONS****For the Quarters ended March 31, 2005 and 2004****     *Forward-LookingStatements***     *This quarterly report may provide information includingcertain statements which constitute forward-looking statementswithin the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. These include statementsregarding the intent, belief, or current expectations ofmanagement, including, but not limited to, those statements thatuse the words “believes”, “expects”,“anticipates”, “estimates”, or similarexpressions. You are cautioned that any such forward-lookingstatements are not guarantees of future performance and involvea number of risks and uncertainties, and results could differmaterially from those indicated by such forward-lookingstatements. Among the important factors that could cause actualresults to differ materially from those indicated by suchforward-looking statements are: the frequency and severity ofclaims; uncertainties inherent in reserve estimates;catastrophic events; a change in the demand for, pricing of,availability or collectibility of reinsurance; increased ratepressure on premiums; obtainment of certain rate increases incurrent market conditions; investment rate of return; changes inand adherence to insurance regulation; actions taken byregulators, rating agencies or lenders; obtainment of certainprocessing efficiencies; changing rates of inflation; generaleconomic conditions and other risks identified in our reportsand registration statements filed with the Securities andExchange Commission. We are not under any obligation to (andexpressly disclaim any such obligation to) update or alter ourforward-looking statements whether as a result of newinformation, future events or otherwise***Description of Business**     We are a publicly traded specialty risk management company, withan emphasis on alternative market insurance and risk managementsolutions for agents, professional and trade associations, andinsureds of all sizes. The alternative market includes a widerange of approaches to financing and managing risk exposures,such as captives, rent-a-captives, risk retention and riskpurchasing groups, governmental pools and trusts, andself-insurance plans. The alternative market developed as aresult of the historical volatility in the cost and availabilityof traditional commercial insurance coverages, and usuallyinvolves some form of self-insurance or risk-sharing on the partof the client. We develop and manage alternative risk managementprograms for defined client groups and their members. We alsooperate as an insurance agency representing unaffiliatedinsurance companies in placing insurance coverages forpolicyholders. We define our business segments as specialty riskmanagement operations and agency operations.**Critical Accounting Estimates**     In certain circumstances, we are required to make estimates andassumptions that affect amounts reported in our consolidatedfinancial statements and related footnotes. We evaluate theseestimates and assumptions on an on-going basis based on avariety of factors. There can be no assurance, however, thatactual results will not be materially different than ourestimates and assumptions, and that reported results ofoperation will not be affected by accounting adjustments neededto reflect changes in these estimates and assumptions. Theaccounting estimates and related risks described in our annualreport on Form 10-K as filed with the United StatesSecurities and Exchange Commission on March 16, 2005, arethose that we consider to be our critical accounting estimates.As of the three months ended March 31, 2005, there havebeen no material changes in regard to any of our criticalaccounting estimates.
17

Table of Contents
**RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDEDMARCH 31, 2005 AND 2004*****Executive Overview***     During the first quarter of 2005, our underwriting resultscontinued to show improvement. This improvement primarilyreflects the earning pattern from our controlled growth ofpremiums written in 2004, as well as the impact of rateincreases achieved in 2004. Net income for the first quarter of2005, continued to demonstrate our commitment to a strongunderwriting discipline, our consistent focus on growingprofitable specialty and fee-for-service programs, along withour on-going plan to leverage fixed costs. As a result, ourgenerally accepted accounting principles (“GAAP”)combined ratio improved 2.7 percentage points to 99.3% inthe first quarter of 2005 from 102.0% in the comparable periodin 2004.     On April 19, 2005, we announced an upgrade from A.M. Bestof certain of our Insurance Company Subsidiaries from B+(positive outlook) to B++ (Very Good) by A.M. Best. The ratingsupgrade applies to Star Insurance Company, Savers Property andCasualty Insurance Company, and Williamsburg National InsuranceCompany. Additionally, A.M. Best reaffirmed the rating forAmeritrust Insurance Corporation as B+, with a positive outlook.**     *Results of Operations***     Net income for the three months ended March 31, 2005, was$3.7 million, or $0.13 per dilutive share, compared tonet income of $3.2 million, or $0.11 per dilutiveshare, for the comparable period of 2004. This improvementprimarily reflects the earning pattern from our controlledgrowth of premiums written in 2004, the impact from rateincreases achieved in 2004, and the continued leveraging offixed costs. In addition, net income was favorably impacted byapproximately $800,000 from profit-sharing commissions, whichwere offset by an increase in expenses primarily related to theimplementation of Section 404 of the Sarbanes-Oxley Act.     Revenues for the three months ended March 31, 2005,increased $10.4 million, or 16.1%, to $74.9 million,from $64.5 million for the comparable period in 2004. Thisincrease reflects an $11.1 million, or 22.3%, increase innet earned premiums. The increase in net earned premiums is theresult of the earning pattern from the controlled growth inwritten premiums experienced in 2004. This growth was primarilydue to growth in existing programs, which included a west-coastcommercial transportation program, an excess liability programfor public entities, and other various programs. The growth innet earned premiums was also attributable to new programsimplemented in 2004 which had proven track records ofprofitability. The impact of an overall 8.4% rate increaseachieved in 2004 also contributed to the increase in net earnedpremiums, as well as an increase in audit related premiums.Partially offsetting the increase in revenue was the anticipatedreduction in managed fee revenue from two limited durationadministrative services and multi-state claims run-off contract,terminated in 2004.
18

Table of Contents
**     Specialty Risk ManagementOperations**     The following table sets forth the revenues and results fromoperations for specialty risk management operations (inthousands):            **For the Three Months**  **Ended March 31,**     **2005** **2004**         Revenue:             Net earned premiums $60,787  $49,713      Management fees  4,196   4,711      Claims fees  1,752   2,701      Loss control fees  573   545      Reinsurance placement  345   147      Investment income  4,084   3,591      Net realized losses  (114)  (120)            Total revenue $71,623  $61,288            Pre-tax income             Specialty risk management operations $5,400  $4,607      Revenues from specialty risk management operations increased$10.3 million, or 16.9%, to $71.6 million for thethree months ended March 31, 2005, from $61.3 millionfor the comparable period in 2004.     Net earned premiums increased $11.1 million, or 22.3%, to$60.8 million in the three months ended March 31,2005, from $49.7 million in the comparable period in 2004.This increase primarily reflects the earning pattern resultingfrom the controlled growth of programs written in 2004, as wellas an increase in audit related premiums.     Management fees decreased $515,000, or 10.9%, to$4.2 million for the three months ended March 31,2005, from $4.7 million for the comparable period in 2004.The decrease in management fees reflects an anticipated shift infee-for-service revenue previously generated from a third partycontract to internally generated fee revenue from a specificrenewal rights agreement that is eliminated upon consolidation.Excluding revenue generated from the third party contract,management fee revenue increased approximately $533,000 incomparison to 2004. This increase is primarily the result ofgrowth in a specific New England based program.     Claim fees decreased $949,000, or 35.1%, to $1.8 million,from $2.7 million for the comparable period in 2004. Thisdecrease reflects a similar anticipated shifting of revenuepreviously generated from a multi-state claims run-off servicecontract, to internally generated fee revenue from a specificrenewal rights agreement that is eliminated upon consolidation.Excluding revenue generated from the third party contract, claimfee revenue remained relatively consistent in comparison to 2004.     Net investment income increased $493,000, or 13.7%, to$4.1 million in 2005, from $3.6 million in 2004.Average invested assets increased $76.1 million, or 23.0%,to $407.2 million in 2005, from $331.1 million in2004. The increase in average invested assets reflects cashflows from underwriting activities and growth in gross writtenpremiums during 2004 and 2005, as well, as net proceeds fromcapital raised in 2004 through the issuances of debentures. Theaverage investment yield for March 31, 2005, was 4.0%,compared to 4.4% for the comparable period in 2004. The currentpre-tax book yield is 4.1% and current after-tax book yield is3.0%. The decline in investment yield reflects the acceleratedprepayments in mortgage-backed securities and the reinvestmentof cash flows in municipal bonds and other securities with lowerinterest rates. Over the past two years, the reinvestment ofcash flows has shifted from maturing securities with higheryields which have been replaced by securities with lower yieldsin a declining interest rate environment.     Specialty risk management operations generated pre-tax income of$5.4 million for the three months ended March 31,2005, compared to pre-tax income of $4.6 million for thecomparable period in 2004. This
19

Table of Contents
increase in pre-tax income demonstrates a continued improvementin underwriting results as a result of our controlled growth inpremium volume and our continued focus on leveraging of fixedcosts. The GAAP combined ratio was 99.3% for the three monthsended March 31, 2005, compared to 102.0% for the sameperiod in 2004.     Net loss and loss adjustment expenses (“LAE”)increased $4.6 million, or 14.2%, to $37.1 million forthe three months ended March 31, 2005, from$32.5 million for the same period in 2004. Our loss and LAEratio decreased 4.6 percentage points to 65.6% for thethree months ended March 31, 2005, from 70.2% for the sameperiod in 2004. This ratio is the unconsolidated net loss andLAE in relation to net earned premiums. The improvement in theloss and LAE ratio reflects a 1.2 percentage point decreasein the change in net ultimate loss estimates for prior accidentyears in 2005 as compared to 2004. Development on prior accidentyear reserves added $1.5 million, or 2.4 percentagepoints, to net loss and LAE in 2005, compared to$1.8 million, or 3.6 percentage points in 2004. Inaddition, there was a 1.2 percentage point decrease in thenet loss and LAE ratio as a result of efficiencies within ourclaims handling activities. This overall improvement in the lossand LAE ratio also reflects the impact of earned premiums fromthe controlled growth of profitable programs which have hadfavorable underwriting experience, as well as, our intendedshift in the balance between workers’ compensation andgeneral liability line of business. Historically, the generalliability line of business has a lower loss ratio; however, ithas a higher commission rate. Additional discussion of ourreserve activity is described below within the *OtherItems — Reserves*section.     Our expense ratio increased 1.9 percentage points to 33.7%for the three months ended March 31, 2005, from 31.8% forthe same period in 2004. This ratio is the unconsolidated policyacquisition and other underwriting expenses in relation to netearned premiums. The increase in our expense ratio is primarilythe result of an increase in gross outside commissions, due to ashift in the balance between workers’ compensation andgeneral liability. The general liability line of business has ahigher commission rate and, as previously indicated, a lowerloss ratio. In addition, the increase in the expense ratio wasalso impacted by higher insurance related assessments and anincrease in net excess reinsurance costs. Offsetting theincrease in the expense ratio was a favorable impact due to adecrease in fixed costs.**     Agency Operations**     The following table sets forth the revenues and results fromagency operations (in thousands):           **For the Three Months**  **Ended March 31,**     **2005** **2004**         Net commission(1) $3,960  $3,219     Pre-tax income(2) $1,913  $1,441  (1)     We reclassified revenues related to the conversion of a west    coast commercial transportation program, which was converted to    a specialty risk program with one of our insurance subsidiaries,    from the agency operations segment to the specialty risk    management operations segment. Accordingly, the agency    operations revenue and intersegment revenue has been    reclassified. As a result, $1.6 million was reclassified    within the agency operations segment and the intersegment    revenue for the three months ended March 31, 2004. (2)     Our agency operations include an allocation of corporate    overhead. In prior years, corporate overhead was previously    reflected only in the specialty risk management operations    segment. This reclassification for the allocation of corporate    overhead more accurately presents our segments as a result of    improved cost allocation information. As a result, the segment    information for the three months ended March 31, 2004, has    been adjusted to reflect this allocation. For the three months    ended March 31, 2005, and 2004, the allocation of corporate    overhead to the agency operations segment was $725,000 and    $731,000, respectively.    Revenue from agency operations, which consists primarily ofagency commission revenue, increased $741,000, or 23.0%, to$4.0 million for the three months ended March 31,2005, from $3.2 million for the comparable period in 2004.This increase is primarily the result of profit sharingcommissions. In addition, the agency operations experienced anincrease in new business, offset by a reduction in renewal rates.     Agency operations generated pre-tax income, before corporateoverhead, of $1.9 million for the three months endedMarch 31, 2005, compared to $1.4 million for thecomparable period in 2004. The improvement
20

Table of Contents
in the pre-tax margin is primarily attributable to the overallincrease in commissions and leveraging of fixed costs. Excludingfixed costs and the allocation of corporate overhead, all otherexpenses remained relatively consistent.**Other Items****     Reserves**     At March 31, 2005, our best estimate for the ultimateliability for loss and LAE reserves, net of reinsurancerecoverables, was $236.1 million. We established areasonable range of reserves of approximately$220.8 million to $250.9 million. This range wasestablished primarily by considering the various indicationsderived from standard actuarial techniques and other appropriatereserve considerations. The following table sets forth thisrange by line of business (in thousands):               **Minimum** **Maximum**    **Reserve** **Reserve** **Selected****Line of Business** **Range** **Range** **Reserves**           Workers’ Compensation(1) $128,082  $143,854  $136,099     Commercial Multiple Peril/ General Liability  41,443   49,029   44,943     Commercial Automobile  34,162   38,688   36,867     Other  17,084   19,327   18,210               Total Net Reserves $220,771  $250,898  $236,119            (1)     Includes Residual Markets    Reserves are reviewed by internal and independent actuaries foradequacy on a quarterly basis. When reviewing reserves, weanalyze historical data and estimate the impact of numerousfactors such as (1) per claim information;(2) industry and our historical loss experience;(3) legislative enactments, judicial decisions, legaldevelopments in the imposition of damages, and changes inpolitical attitudes; and (4) trends in general economicconditions, including the effects of inflation. This processassumes that past experience, adjusted for the effects ofcurrent developments and anticipated trends, is an appropriatebasis for predicting future events. There is no precise methodfor subsequently evaluating the impact of any specific factor onthe adequacy of reserves, because the eventual deficiency orredundancy is affected by multiple factors.     The key assumptions used in our selection of ultimate reservesincluded the underlying actuarial methodologies, a review ofcurrent pricing and underwriting initiatives, an evaluation ofreinsurance costs and retention levels, and a detailed claimsanalysis with an emphasis on how aggressive claims handling maybe impacting the paid and incurred loss data trends embedded inthe traditional actuarial methods. With respect to the ultimateestimates for losses and LAE, the key assumptions remainedconsistent for the three months ended March 31, 2005 andthe year ended December 31, 2004.     For the three months ended March 31, 2005, we reported anincrease in net ultimate loss estimates for accident years 2004and prior to be $1.5 million, or 0.6% of$227.0 million of net loss and LAE reserves atDecember 31, 2004. The increase in net ultimate lossestimates reflected revisions in the estimated reserves as aresult of actual claims activity in calendar year 2005 thatdiffered from the projected activity. There were no significantchanges in the key assumptions utilized in the analysis andcalculations of our reserves during 2004
21

Table of Contents
and the three months ended March 31, 2005. The majorcomponents of this change in ultimate loss estimates are asfollows (in thousands):                                     **Incurred Losses** **Paid Losses**    **Reserves at**     **Reserves at**  **December 31,** **Current** **Prior** **Total** **Current** **Prior**   **March 31,****Line of Business** **2004** **Year** **Years** **Incurred** **Year** **Years** **Total Paid** **2005**                     Workers’ Compensation $112,086  $15,402  $(9) $15,393  $(386) $12,641  $12,255  $115,224     Residual Markets  19,391   3,299   315   3,614   464   1,666   2,130   20,875     Commercial Multiple Peril/ General Liability  44,217   5,336   (615)  4,721   (112)  4,107   3,995   44,943     Commercial Automobile  33,235   8,226   1,382   9,608   719   5,257   5,976   36,867     Other  18,067   3,400   398   3,798   61   3,594   3,655   18,210                              Net Reserves  226,996  $35,663  $1,471  $37,134  $746  $27,265  $28,011   236,119                              Reinsurance Recoverable  151,161                           162,747                              Consolidated $378,157                          $398,866                                           **Re-estimated** **Development**  **Reserves at** **Reserves at** **as a Percentage**  **December 31,** **March 31, 2005** **of Prior Year****Line of Business** **2004** **on Prior Years** **Reserves**           Workers’ Compensation $112,086  $112,077   0.0%    Commercial Multiple Peril/ General Liability  44,217   43,602   (1.4%)    Commercial Automobile  33,235   34,617   4.2%    Other  18,067   18,465   2.2%              Sub-total  207,605   208,761   0.6%    Residual Markets  19,391   19,706   1.6%              Total Net Reserves $226,996  $228,467   0.6%          **Workers’ Compensation Excluding Residual Markets**     The projected net ultimate loss estimate for the workers’compensation line of business, excluding residual markets,decreased $9,000. This net overall decrease reflects increasesof $1.1 million and $936,000, in accident years 2003 and2002, respectively, due to higher than expected emergence ofclaim activity primarily related to a SoutheasternU.S. business based program. This increase was offset byreductions of $843,000 and $455,000, in the ultimate lossestimate for accident years 2001 and 1999, respectively. Thedecrease in the ultimate loss estimate reflects better thanexpected experience on most of our workers’ compensationprograms. In addition, there was a reallocation of loss reservesof $2.6 million from accident year 2001 to accident year2000, to align the incurred but not reported (“IBNR”)reserves with the case reserves for a specific Tennesseeprogram. The change in ultimate loss estimates for all otheraccident years was insignificant.**Commercial Multiple Peril and General Liability**     The commercial multiple peril and general liability line ofbusiness had a decrease in net ultimate loss estimates of$615,000, or 1.4% of net commercial multiple peril and generalliability reserves. This decrease was the result of a $262,000,$892,000, and a $365,000, reduction in the ultimate lossestimates for accident years 2002, 2003, and 2004, respectively.The improvements in accident years 2002 and 2003 reflect areinsurance transaction reallocation of incurred losses fromIBNR to paid losses associated with three specific automobileline of business claims. The improvement in accident year 2004reflected better than expected claim emergence on severalprograms. These decreases were offset by increases of $166,000and $535,000 in accident years 1995 and 2000, respectively. Theincrease in accident year 1995 reflects slightly higher than
22

Table of Contents
expected emergence of claim activity in several differentprograms. The increase in accident year 2000 was offset by asimilar decrease in the automobile line of business associatedwith a discontinued program. These changes were made to alignthe IBNR reserves with the case reserves. The change in ultimateloss estimates for all other accident years was insignificant.**Commercial Automobile**     The projected net ultimate loss estimate for the commercialautomobile line of business increased $1.4 million, or 4.2%of net commercial automobile reserves. This increase reflectsincreases of $443,000, $277,000, and $979,000, in accident years2003, 2002, and 2001, respectively. These increases reflect theimpact from the three automobile line of business claimsmentioned in the above commercial multiple peril and generalliability section. These increases also reflect higher thanexpected emergence of claim activity in an inactive program.Partially offsetting these increases were reductions of $317,000and $390,000, in the ultimate loss estimates for accident years2004 and 2000, respectively. The accident year 2004 reductionreflected better than expected claim emergence from a truckingprogram in California. The accident year 2000 reduction reflectsthe reallocation in IBNR on a discontinued program mentionedabove. The change in ultimate loss estimates for all otheraccident years was insignificant.**Other**     The other lines of business had an increase in net ultimate lossestimates of $398,000, or 2.2% of net reserves on the otherlines of business. This net increase reflects increases of$655,000 and $239,000, in accident years 2004 and 2003,respectively, offset by a decrease of $513,000 in accident year2002. The increases in accident years 2004 and 2003 reflecthigher than expected claims activity and the decrease inaccident year 2002 reflects better than expected claimsactivity, all of which were associated with some Michiganprofessional liability programs. The change in ultimate lossestimates for all other accident years was insignificant.**Residual Markets**     The workers’ compensation residual market line of businesshad an increase in net ultimate loss estimates of $315,000, or1.6% of net reserves on the workers’ compensation residualmarket line of business. The change reflects an increase of$1.8 million in accident year 2003, offset by a$1.2 million decrease in accident year 2004. We record lossreserves as reported by the National Council on CompensationInsurance (“NCCI”), plus a provision for the reservesincurred but not yet analyzed and reported to us due to a twoquarter lag in reporting. These changes reflect a differencebetween our estimate of the lag between incurred but notreported and the amounts reported by the NCCI in the quarter.The change in ultimate loss estimates for all other accidentyears was insignificant.**     Salary and Employee Benefitsand Other Administrative Expenses**     Salary and employee benefits for the three months endedMarch 31, 2005, decreased $203,000, or 1.6%, to$12.6 million, from $12.8 million for the comparableperiod in 2004. This decrease primarily reflects both a decreasein variable compensation, which is directly related toperformance and profitability, as well as, a slight decrease instaffing levels in comparison to 2004. These decreases werepartially offset by merit increases for associates.     Other administrative expenses increased $1.7 million, or27.7%, to $7.8 million, from $6.1 million for thecomparable period in 2004. This increase is primarilyattributable to consulting and audit expenses associated withSection 404 of the Sarbanes-Oxley Act. In addition, thisincrease in other administrative expenses is the result ofinformation technology enhancements, policyholder dividends, andcosts associated with our new building.     Salary and employee benefits and other administrative expensesinclude both corporate overhead and the holding company expensesincluded in the reconciling items of our segment information.
23

Table of Contents
**     Interest Expense**     Interest expense for the three months ended March 31, 2005,increased $458,000, or 145.4%, to $773,000, from $315,000 forthe comparable period in 2004. Interest expense is primarilyattributable to our debentures, which are described within the*Liquidity and Capital Resources*section ofManagement’s Discussion and Analysis, as well as ourcurrent lines of credit. Interest expense increased $450,000 asa result of the debentures. The remaining increase is related toour lines of credit. This increase is the result of an increasein the average interest rate, offset by a decrease in theaverage outstanding balance. The average outstanding balanceduring the three months ending March 31, 2005, was$11.0 million, compared to $17.6 million for the sameperiod in 2004. The average interest rate, excluding thedebentures, increased in 2005 to 4.2%, compared to 4.1% in 2004as a result of increases in the underlying eurocurrency basedrate.**     Income Taxes**     Income tax expense, which includes both federal and state taxes,for the three months ended March 31, 2005, was$2.0 million, or 34.0% of income before taxes. For the sameperiod last year, we reflected an income tax expense of$2.0 million, or 38.3% of income before taxes. Oureffective tax rate differs from the 35% statutory rate primarilydue to a shift towards increasing investments in tax-exemptsecurities in an effort to maximize after-tax investment yields.Our current taxes are calculated using a 35% statutory ratebased on taxable income greater than $18.3 million.Deferred taxes are calculated based on a 34% statutory rate. Weare currently evaluating the expected tax rate for therealization of the deferred taxes.**     Other than TemporaryImpairments**     Our policy for the valuation of temporarily impaired securitiesis to determine impairment based on analysis of the followingfactors: (1) market value less than amortized cost for asix month period; (2) rating downgrade or other creditevent (e.g., failure to pay interest when due);(3) financial condition and near-term prospects of theissuer, including any specific events which may influence theoperations of the issuer such as changes in technology ordiscontinuance of a business segment; (4) prospects for theissuer’s industry segment; and (5) our intent andability to retain the investment for a period of time sufficientto allow for anticipated recovery in market value. We evaluateour investments in securities to determine other than temporaryimpairment, no less than quarterly. Investments which are deemedimpaired are written down to their estimated net fair value andthe related losses recognized in income.     At March 31, 2005, we had 234 securities that were in anunrealized loss position. These investments all had unrealizedlosses of less than ten percent. At March 31, 2005, fifteenof those investments, with an aggregate $14.0 million and$633,500 fair value and unrealized loss, respectively, have beenin an unrealized loss position for more than eighteen months.Positive evidence considered in reaching our conclusion that theinvestments in an unrealized loss position are not other thantemporarily impaired consisted of: 1) there were no specificevents which caused concerns; 2) there were no past dueinterest payments; 3) there has been a rise in marketprices; 4) our ability and intent to retain the investmentfor a sufficient amount of time to allow an anticipated recoveryin value; and 5) we also determined that the changes inmarket value were considered normal in relation to overallfluctuations in interest rates.
24

Table of Contents
     The fair value and amount of unrealized losses segregated by thetime period the investment has been in an unrealized lossposition is as follows (in thousands):                    **March 31, 2005**     **Less than 12 Months** **Greater than 12 Months**       **Fair Value of** **Gross** **Fair Value of** **Gross**  **Investments with** **Unrealized** **Investments with** **Unrealized**  **Unrealized Losses** **Losses** **Unrealized Losses** **Losses**         **Debt Securities:**                    Debt securities issued by U.S. government and agencies $21,527  $(431) $4,771  $(241)    Obligations of states and political subdivisions  78,763   (1,442)  10,741   (369)    Corporate securities  43,058   (991)  7,787   (377)    Mortgage and asset-backed securities  41,473   (605)  9,185   (302)                  Totals $184,821  $(3,469) $32,484  $(1,289)                  As of March 31, 2005, gross unrealized gains and (losses)on securities were $5.4 million and ($4.8 million),respectively.                    **December 31, 2004**     **Less than 12 months** **Greater than 12 months**       **Fair Value of** **Gross** **Fair Value of** **Gross**  **Investments with** **Unrealized** **Investments with** **Unrealized**  **Unrealized Losses** **Losses** **Unrealized Losses** **Losses**         **Debt Securities:**                    Debt securities issued by U.S. government and agencies $18,480  $(138) $4,871  $(150)    Obligations of states and political subdivisions  28,581   (257)  551   (14)    Corporate securities  23,323   (220)  7,450   (226)    Mortgage and asset backed securities  19,583   (167)  6,442   (129)                  Totals $89,967  $(782) $19,314  $(519)                  As of December 31, 2004, gross unrealized gains and(losses) on securities were $8.6 million and($1.3 million), respectively.
25

Table of Contents
**Liquidity and Capital Resources**     Our principal sources of funds, which include both regulated andnon-regulated cash flows, are insurance premiums, investmentincome, proceeds from the maturity and sale of invested assets,risk management fees, and agency commissions. Funds areprimarily used for the payment of claims, commissions, salariesand employee benefits, other operating expenses, shareholderdividends, and debt service. Our regulated sources of funds areinsurance premiums, investment income, and proceeds from thematurity and sale of invested assets. These regulated funds areused for the payment of claims, policy acquisition and otherunderwriting expenses, and taxes relating to the regulatedportion of net income. Our non-regulated sources of funds are inthe form of commission revenue, outside management fees, andintercompany management fees. These non-regulated sources offunds are used to service debt, shareholders’ dividends,and other operating expenses of the holding company andnon-regulated subsidiaries. The following table illustrates netincome, excluding interest, depreciation, and amortization,between our regulated and non-regulated subsidiaries, whichreconciles to our consolidated statement of income and statementof cash flows (in thousands):             **For the Three Months**  **Ended March 31,**     **2005** **2004**         Net income $3,743  $3,232            Regulated Subsidiaries:              Net income $2,618  $1,411       Depreciation and amortization  —   —       Interest  —   —             Net income, excluding interest, depreciation, and amortization  2,618   1,411              Adjustments to reconcile net income to net cash provided by    operating activities  707   898       Changes in operating assets and liabilities  12,013   13,158             Total adjustments  12,720   14,056      Depreciation and amortization  —   —      Interest  —   —             Net cash provided by operating activities $15,338  $15,467            Non-regulated Subsidiaries:              Net income $1,125  $1,821       Depreciation and amortization  676   374       Interest  773   378             Net income, excluding interest, depreciation, and amortization  2,574   2,573              Adjustments to reconcile net income to net cash provided by    (used in) operating activities  845   (135)      Changes in operating assets and liabilities  (3,139)  (996)            Total adjustments  (2,294)  (1,131)     Depreciation and amortization  (676)  (374)     Interest  (773)  (378)            Net cash (used in) provided by operating activities $(1,169) $690            Consolidated total adjustments  10,426   12,925            Consolidated net cash provided by operating activities $14,169  $16,157        
26

Table of Contents
     Consolidated cash flow provided by operations for the threemonths ended March 31, 2005, was $14.2 million,compared to consolidated cash flow provided by operations of$16.2 million for the comparable period in 2004.     Regulated subsidiaries’ cash flow provided by operationsfor the three months ended March 31, 2005, was$15.3 million, compared to $15.5 million for thecomparable period in 2004. This decrease is the result of a taxbenefit reduction from the utilization of the net operating losscarryforward in 2004. This reduction was offset by improvedunderwriting results and an increase in investment income.     Non-regulated subsidiaries’ cash flow used in operationsfor the three months ended March 31, 2005, was$1.2 million, compared to $690,000 provided by operationsfor the comparable period in 2004. The decrease in non-regulatedcash flow from operations primarily reflects the decrease in netincome as a result of an increase in administrative costsassociated with the implementation of Section 404 of theSarbanes-Oxley Act, offset by an increase in revenue associatedwith profit-sharing commissions. In addition, the decrease incash flow from operations is the result of variable compensationpayments made in the first quarter of 2005, related to 2004performance and profitability. Offsetting these decreases incash flow was an increase in cash as a result of tax payments.     In addition to the changes described above in relation to ourcash provided by operations, we had an increase in cash used ininvesting activities as a result of an $11.6 cash payment forour new corporate headquarters. The proceeds from the 2004issuance of debentures, which are described below, were used forthe purchase of our new building. On January 1, 2005, weentered into a Lease Agreement for our furniture and phonesystem in relation to our new building. As of March 31,2005, the total liability in relation to this lease was$1.1 million. Total lease payments made for the threemonths ended March 31, 2005, were approximately $52,000.     We anticipate a temporary increase in cash outflows related toinvestments in technology as we enhance our operating systemsand controls.**Other Items**     On September 30, 2003, an unconsolidated subsidiary trustof ours issued $10.0 million of mandatory redeemable trustpreferred securities (“TPS”) to a trust formed by aninstitutional investor. Contemporaneously, we issued$10.3 million in junior subordinated debentures, whichincludes our $310,000 investment in the trust. We received atotal of $9.7 million in net proceeds, after the deductionof approximately $300,000 of commissions paid to the placementagents in the transaction. These issuance costs have beencapitalized and are included in other assets on the balancesheet, which will be amortized over seven years as a componentof interest expense. We contributed $6.3 million of theproceeds to our Insurance Company Subsidiaries and the remainingbalance was used for general corporate purposes. The debenturesmature in thirty years and provide for interest at thethree-month LIBOR, plus 4.05%.     On April 29, 2004, we issued senior debentures in theamount of $13.0 million. The senior debentures mature inthirty years and provide for interest at the three-month LIBOR,plus 4.00%, which is non-deferrable. The senior debentures arecallable at par after five years from the date of issuance.Associated with this transaction we incurred $390,000 ofcommissions paid to the placement agents. These issuance costshave been capitalized and are included in other assets on thebalance sheet, which will be amortized over seven years as acomponent of interest expense.     On May 26, 2004, we issued senior debentures in the amountof $12.0 million. The senior debentures mature in thirtyyears and provide for interest at the three-month LIBOR, plus4.20%, which is non-deferrable. The senior debentures arecallable at par after five years from the date of issuance.Associated with this transaction we incurred $360,000 ofcommissions paid to the placement agents. These issuance costshave been capitalized and are included in other assets on thebalance sheet, which will be amortized over seven years as acomponent of interest expense.     We contributed $9.9 million of the proceeds from the seniordebentures to our Insurance Company Subsidiaries as ofDecember 31, 2004. The remaining proceeds from the issuanceof the senior debentures
27

Table of Contents
may be used to support future premium growth through furthercontributions to our Insurance Company Subsidiaries and generalcorporate purposes.     On November 12, 2004, we entered into a revolving line ofcredit for up to $25.0 million. The revolving line ofcredit replaces our previous line of credit and expires onNovember 11, 2007. We had drawn approximately$9.0 million on this new revolving line of credit to payoff our former term loan. We will use the revolving line ofcredit to meet short-term working capital needs. Under therevolving line of credit, we and certain of our non-regulatedsubsidiaries pledged security interest in certain property andassets of named subsidiaries.     At March 31, 2005 and December 31, 2004, we had anoutstanding balance of $7.0 million and $9.0 millionon the new revolving line of credit, respectively.     The revolving line of credit provides for interest at a variablerate based, at our option, upon either a prime based rate orLIBOR-based rate. On prime based borrowings, the applicablemargin ranges from 75 to 25 basis points below prime. OnLIBOR-based borrowings, the applicable margin ranges from 125 to175 basis points above LIBOR. The margin for all loans isdependent on the sum of non-regulated earnings before interest,taxes, depreciation, amortization, and non-cash impairmentcharges related to intangible assets for the preceding fourquarters, plus dividends paid or payable to us from subsidiariesduring such period (“Adjusted EBITDA”). As ofMarch 31, 2005, the average interest rate for LIBOR-basedborrowings outstanding was 4.1%.     Debt covenants consist of: (1) maintenance of the ratio ofAdjusted EBITDA to interest expense of 2.0 to 1.0,(2) minimum net worth of $130.0 million and increasingannually commencing June 30, 2005, by fifty percent of theprior year’s positive net income, (3) minimum A.M.Best rating of “B”, and (4) minimum Risk BasedCapital Ratio for Star of 1.75 to 1.00. As of March 31,2005, we were in compliance with these covenants.     In addition, our non-insurance premium finance subsidiarymaintains a line of credit with a bank, which permits borrowingsup to 75% of the accounts receivable, which collateralize theline of credit. At March 31, 2005, this line of credit hadan outstanding balance of $2.8 million. The interest termsof this line of credit provide for interest at the prime rateminus 0.5%, or a LIBOR-based rate option, plus 2.0%. AtMarch 31, 2005, the LIBOR-based option was 4.7% and theaverage interest was 4.5%. The line will expire on May 14,2005. We expect to negotiate an extension or new line of credit.     At March 31, 2005, shareholders’ equity was$166.8 million, or $5.75 per common share, compared to$167.5 million, or $5.76 per common share, atDecember 31, 2004.     On September 17, 2002, our Board of Directors authorizedmanagement to repurchase up to 1,000,000 shares of ourcommon stock in market transactions for a period not to exceedtwenty-four months. On August 6, 2003, our Board ofDirectors authorized management to repurchase up to anadditional 1,000,000 shares of our common stock under theexisting share repurchase plan. The original share repurchaseplan expired on September 17, 2004. On November 3,2004, our Board of Directors authorized management to repurchaseup to 1,000,000 shares of our common stock in markettransactions for a period not to exceed twenty-four months. Forthe three months ended March 31, 2005, we purchased andretired 59,400 shares of common stock for a total cost ofapproximately $308,000. We did not repurchase any common stockduring 2004. As of March 31, 2005, the cumulative amount wehave repurchased and retired was 59,400 shares of commonstock for a total cost of approximately $308,000. As ofMarch 31, 2005, we have available up to 940,600 sharesremaining to be purchased.     A significant portion of our consolidated assets representassets of our Insurance Company Subsidiaries that at this time,without prior approval of the State of Michigan Office ofFinancial and Insurance Services (“OFIS”), cannot betransferred to us in the form of dividends, loans or advances.The restriction on the transferability to us from the InsuranceCompany Subsidiaries is regulated by Michigan insurance statuteswhich, in general, are as follows: the maximum discretionarydividend that may be declared, based on data from the precedingcalendar year, is the greater of each insurance company’snet income (excluding realized capital gains) or ten percent ofthe insurance company’s surplus (excluding unrealizedgains). These
28

Table of Contents
dividends are further limited by a clause in the Michigan lawthat prohibits an insurer from declaring dividends except out ofsurplus earnings of the company. Earned surplus balances arecalculated on a quarterly basis. Since Star is the parentinsurance company, its maximum dividend calculation representsthe combined Insurance Company Subsidiaries’ surplus. Basedupon the 2004 statutory financial statements, Star may only paydividends to us during 2005 with the prior approval of OFIS.Star’s earned surplus position at December 31, 2004was negative $13.7 million. At March 31, 2005, earnedsurplus was negative $12.0 million. No dividends were paidin 2004.***Contractual Obligations and Commitments***     There were no material changes outside the ordinary course ofour business in relation to our contractual obligations andcommitments for the three months ended March 31, 2005.**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 andcasualty insurance companies. The formula measures requiredcapital and surplus based on an insurance company’sproducts and investment portfolio and is used as a tool toevaluate the capital of regulated companies. The RBC formula isused by state insurance regulators to monitor trends instatutory capital and surplus for the purpose of initiatingregulatory action. In general, an insurance company must submita calculation of its RBC formula to the insurance department ofits state of domicile as of the end of the previous calendaryear. These laws require increasing degrees of regulatoryoversight and intervention as an insurance company’s RBCdeclines. The level of regulatory oversight ranges fromrequiring the insurance company to inform and obtain approvalfrom the domiciliary insurance commissioner of a comprehensivefinancial plan for increasing its RBC to mandatory regulatoryintervention requiring an insurance company to be placed underregulatory control in a rehabilitation or liquidation proceeding.     At December 31, 2004, all of our Insurance CompanySubsidiaries were in compliance with RBC requirements. Starreported statutory surplus of $120.7 million atDecember 31, 2004, compared to the threshold requiring theminimum regulatory involvement of $56.9 million in 2004. AtMarch 31, 2005, Star’s statutory surplus increased$1.7 million to $122.4 million.     Insurance operations are subject to various leverage tests (e.g.premium to statutory surplus ratios), which are evaluated byregulators and rating agencies. Our targets for gross and netwritten premium to statutory surplus are 3.0 to 1.0 and 2.5 to1.0, respectively. As of March 31, 2005, on a statutoryconsolidated basis, gross and net premium leverage ratios were2.6 to 1.0 and 2.0 to 1.0, respectively.**     Reinsurance**     Inter-company pooling agreements are commonly entered intobetween affiliated insurance companies, so as to allow thecompanies to utilize the capital and surplus of all of thecompanies, rather than each individual company. Under poolingarrangements, companies share in the insurance business that isunderwritten and allocate the combined premium, losses andrelated expenses between the companies within the poolingarrangement. Effective January 1, 2005, the InsuranceCompany Subsidiaries entered into an Inter-Company ReinsuranceAgreement (the “Reinsurance Agreement”). ThisReinsurance Agreement includes Star, Ameritrust InsuranceCorporation (“Ameritrust”), Savers Property andCasualty Insurance Company (“Savers”) and WilliamsburgNational Insurance Company (“Williamsburg”). Pursuantto the Reinsurance Agreement, Savers, Ameritrust andWilliamsburg have agreed to cede to Star and Star has agreed toreinsure 100% of the liabilities and expenses of Savers,Ameritrust and Williamsburg, relating to all insurance andreinsurance policies issued by them. In return, Star agrees tocede and Savers, Ameritrust and Williamsburg have agreed toreinsure Star for their respective percentages of theliabilities and expenses of Star. The Reinsurance Agreement wasfiled with the applicable regulatory authorities and was notdisapproved. Any changes to the Reinsurance Agreement must besubmitted to the applicable regulatory authorities for reviewand approval.
29

Table of Contents
**     Off-Balance SheetArrangements**     On June 6, 2003, we entered into a Guaranty Agreement witha bank. We are guaranteeing payment of a $1.5 million termloan issued by the bank to an unaffiliated insurance agency. Inthe event of default on the term loan by the insurance agency,we are obligated to pay any outstanding principal (up to amaximum of $1.5 million), as well as any accrued intereston the loan, and any costs incurred by the bank in thecollection process. In exchange for our guaranty, the presidentand member of the unaffiliated insurance agency pledged 100% ofthe common shares of two other insurance agencies that he whollyowns. In the event of default on the term loan by theunaffiliated insurance agency, we have the right to sell any orall of the pledged assets (the common stock of the two insuranceagencies) and use the proceeds from the sale to recover anyamounts paid under the Guaranty Agreement. Any excess proceedswould be paid to the shareholder. As of March 31, 2005, noliability has been recorded with respect to our obligationsunder the Guaranty Agreement, since the collateral is in excessof the guaranteed amount.**Recent Accounting Pronouncements**     On December 16, 2004, the Financial Accounting StandardsBoard (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 123 (revised2004), *“Share-Based Payment”*(“SFAS 123R”), which replacesSFAS No. 123, *“Accounting for Stock Issued toEmployees.”*SFAS 123R requires all share-basedpayments to employees to be recognized in the financialstatements based on their fair values. The pro forma disclosurespreviously permitted under SFAS 123, will no longer be analternative to financial statement recognition. Commencing inthe first quarter of 2003, we began expensing the fair value ofall stock options granted since January 1, 2003 under theprospective method. Under SFAS 123R, we must determine theappropriate fair value model to be used for valuing share-basedpayments, the amortization method for compensation cost and thetransition method to be used at the date of adoption. Thetransition methods include prospective and retroactive adoptionoptions. Under the retroactive options, prior periods may berestated either as of the beginning of the year of adoption orfor all periods presented. The prospective method requires thatcompensation expense be recorded at the beginning of the firstquarter of adoption of SFAS 123R for all unvested stockoptions and restricted stock based upon the previously disclosedSFAS 123 methodology and amounts. The retroactive methodswould record compensation expense beginning with the firstperiod restated for all unvested stock options and restrictedstock. On April 14, 2005, the Securities and ExchangeCommission adopted a new rule that delays the compliance datesfor SFAS 123R. Under the new rule, SFAS 123R iseffective for public companies for annual, rather than interimperiods, that begin after June 15, 2005. Therefore, we arerequired to adopt SFAS 123R in the first quarter of 2006,or beginning January 1, 2006. We are currently evaluatingthe requirements of SFAS 123R and have not yet determinedthe method of adoption or impact SFAS 123R will have on ourfinancial statements.**Subsequent Events**     On April 19, 2005, we announced an upgrade from A. M. Bestof certain of our Insurance Company Subsidiaries from B+(positive outlook) to B++ (Very Good). The ratings upgradeapplies to Star Insurance Company, Savers Property and CasualtyInsurance Company, and Williamsburg National Insurance Company.Additionally, A.M. Best reaffirmed the rating for AmeritrustInsurance Corporation as B+, with a positive outlook.     Effective April 1, 2005, we increased our retention underour workers’ compensation reinsurance treaty from $350,000to $750,000 for losses occurring effective April 1, 2005.The remainder of the treaty did not change. We anticipate thischange will result in a slight increase in our net excessreinsurance costs.**Item 3.*****Quantitative and Qualitative Disclosures About Market    Risk***     Market risk is the risk of loss arising from adverse changes inmarket rates and prices, such as interest rates as well as otherrelevant market rate or price changes. The volatility andliquidity in the markets in which the underlying assets aretraded directly influence market risk. The following is adiscussion of our primary risk exposures and how those exposuresare currently managed as of March 31, 2005. Our market risksensitive
30

Table of Contents
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 andliability management strategy where the target duration for thefixed income portfolio is based on the estimate of the liabilityduration and takes into consideration our surplus. Theinvestment policy guidelines provide for a fixed incomeportfolio duration of between three and five years. AtMarch 31, 2005, our fixed income portfolio had a modifiedduration of 3.64, compared to 3.46 at December 31, 2004.     At March 31, 2005 the fair value of our investmentportfolio was $362.4 million. Our market risk to theinvestment portfolio is interest rate risk associated with debtsecurities. Our exposure to equity price risk is notsignificant. Our investment philosophy is one of maximizingafter-tax earnings and has historically included significantinvestments in tax-exempt bonds. During 2003 and 2004, we beganto increase our holdings of tax-exempt securities based on ourreturn to profitability and our desire to maximize after-taxinvestment income. For our investment portfolio, there were nosignificant changes in our primary market risk exposures or inhow those exposures are managed compared to the year endedDecember 31, 2004. We do not anticipate significant changesin our primary market risk exposures or in how those exposuresare managed in future reporting periods based upon what is knownor expected to be in effect.     A sensitivity analysis is defined as the measurement ofpotential loss in future earnings, fair values, or cash flows ofmarket sensitive instruments resulting from one or more selectedhypothetical changes in interest rates and other market rates orprices over a selected period. In our sensitivity analysismodel, a hypothetical change in market rates is selected that isexpected to reflect reasonable possible near-term changes inthose rates. “Near term” means a period of up to oneyear from the date of the consolidated financial statements. Inour sensitivity model, we use fair values to measure ourpotential loss of debt securities assuming an upward parallelshift in interest rates to measure the hypothetical change infair values. The table below presents our model’s estimateof changes in fair values given a change in interest rates.Dollar values are rounded and in thousands.               **Rates Down** **Rates** **Rates Up**  **100bps** **Unchanged** **100bps**           Market Value $377,401  $362,397  $347,503     Yield to Maturity or Call  3.21%  4.21%  5.21%    Effective Duration  4.01   4.12   4.24      The other financial instruments, which include cash and cashequivalents, equity securities, premium receivables, reinsurancerecoverables, line of credit and other assets and liabilities,when included in the sensitivity model, do not produce amaterial loss in fair values.     At March 31, 2005 and December 31, 2004, our$35.3 million of debentures are subject to variableinterest rates. Thus, our interest expense on these debenturesis directly correlated to market interest rates. At this level,a 1% change in market rates would change interest expense by$353,000.     In addition, our credit facility under which we can borrow up to$25.0 million is subject to variable interest rates. Thus,our interest expense on the credit facility is directlycorrelated to market interest rates. At March 31, 2005, wehad $7.0 million outstanding. At this level, a one percentchange in market rates would change interest expense by $70,000.At December 31, 2004, we had $9.0 million outstanding.At this level, a one percent change in market rates would havechanged interest expense by $90,000.**Item 4.*****Controls and Procedures*****Evaluation of Disclosure Controls and Procedures.**     Our disclosure controls and procedures (as defined inRule 13a-15(e) under the Securities Exchange Act of 1934,the “Exchange Act”), which we refer to as disclosurecontrols, are controls and procedures that are designed with theobjective of ensuring that information required to be disclosedin our reports filed under the Exchange Act, such as thisForm 10-Q, is recorded, processed, summarized and reportedwithin the time
31

Table of Contents
periods specified in the Securities and ExchangeCommission’s rules and forms. Disclosure controls are alsodesigned with the objective of ensuring that such information isaccumulated and communicated to management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure. There areinherent limitations to the effectiveness of any control system.A control system, no matter how well conceived and operated, canprovide only reasonable assurance that its objectives are met.No evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, have beendetected.     As of March 31, 2005, an evaluation was carried out underthe supervision and with the participation of our management,including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation ofdisclosure controls. Based upon our evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that thedesign and operation of our disclosure controls were effectivein recording, processing, summarizing, and reporting, on atimely basis, material information required to be disclosed inthe reports we file under the Exchange Act and is accumulatedand communicated, as appropriate to allow timely decisionsregarding required disclosure.**Changes in Internal Control over Financial Reporting**     There were no significant changes in our internal control overfinancial reporting during the three month period endedMarch 31, 2005, which have materially affected, or arereasonably likely to materially affect, our internal controlover financial reporting.
32

Table of Contents
**PART II — OTHER INFORMATION****Item 1.*****Legal Proceedings***The information required by this item is included underNote 6 — *Commitments and Contingencies*ofthe Notes to the Consolidated Financial Statements of theCompany’s Form 10-Q for the three months endedMarch 31, 2005, which is hereby incorporated by reference.**Item 2.*****Unregistered Sales of Equity Securities and Use of    Proceeds***     On November 3, 2004, the Company’s Board of Directorsauthorized management to repurchase up to 1,000,000 sharesof its common stock in market transactions for a period not toexceed twenty-four months. For the three months endedMarch 31, 2005, the Company purchased and retired59,400 shares of common stock for a total cost ofapproximately $308,000.                       **Total Number of** **Maximum**      **Shares** **Number of**      **Purchased as** **Shares that may**      **Part of Publicly** **yet be**  **Total** **Average** **Announced** **Repurchased**  **Number of** **Price Paid** **Plans or** **Under the Plans****Period** **Shares** **Per Share** **Programs** **or Programs**             January 1, 2005 — January 31, 2005  —   —   —   1,000,000     February 1, 2005 — February 28, 2005  —   —   —   1,000,000     March 1, 2005 — March 31, 2005  59,400  $5.14   59,400   940,600                  Total  59,400  $5.14   59,400                  **Item 6.*****Exhibits***     The following documents are filed as part of this Report:     **Exhibit**  **No.** **Description**    10.1     Inter-Company Reinsurance Agreement by and between Star    Insurance Company and Ameritrust Insurance Company, Savers    Property and Casualty Insurance Company, and Williamsburg    National Insurance Company, dated January 1, 2005.  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.
33

Table of Contents
**SIGNATURES**     Pursuant to the requirements of the Securities and Exchange Actof 1934, the Registrant has duly caused this Report to be signedon its behalf by the undersigned, thereunto duly authorized. Meadowbrook Insurance    Group, Inc.     By:     /s/ Karen M. Spaun       *Senior Vice President and* *Chief Financial Officer*Dated: May 10, 2005
34

Table of Contents
**EXHIBIT INDEX**     **Exhibit**  **No.** **Description**    10.1     Inter-Company Reinsurance Agreement by and between Star    Insurance Company and Ameritrust Insurance Company, Savers    Property and Casualty Insurance Company, and Williamsburg    National Insurance Company, dated January 1, 2005.  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.