##### 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 September 30,
    2004                                                
|  
|or
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-14094

Meadowbrook Insurance Group, Inc.

(Exact name of registrant as specified in its
charter)


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

26600 Telegraph Road, Southfield, Michigan
48034

(Address, zip code of principal executive
offices)


(248) 358-1100

(Registrants telephone number, including
area code)




---

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

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

The aggregate number of shares of the
Registrants Common Stock, $.01 par value, outstanding
on November 5, 2004 was 29,067,883.



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TABLE OF CONTENTS

|                                                                         |  |                                                                                           |    |      |       | 
|------------------------------------------------------------------------ |  | ----------------------------------------------------------------------------------------- | -- | ---- | ----- | 
|                                                                         |  |                                                                                           |    | Page
|                                                                         |  |                                                                                           |    |     
|PART I 
    FINANCIAL INFORMATION                                      
|ITEM 1.                                                                  |  | FINANCIAL STATEMENTS                                                                      |    |      |       | 
|                                                                         |  | Consolidated Statements of
    Income (unaudited)                                         |    |      | 2-3   | 
|                                                                         |  | Consolidated Statements of
    Comprehensive Income (unaudited)                           |    |      | 4-5   | 
|                                                                         |  | Consolidated Balance Sheets
    (unaudited)                                               |    |      | 6     | 
|                                                                         |  | Consolidated Statement of
    Cash Flows (unaudited)                                      |    |      | 7     | 
|                                                                         |  | Notes to Consolidated
    Financial Statements (unaudited)                                |    |      | 8-20  | 
|ITEM 2.                                                                  |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF
    FINANCIAL CONDITION AND RESULTS OF OPERATIONS |    |      | 21-37 | 
|ITEM 3.                                                                  |  | QUANTITATIVE AND QUALITATIVE
    DISCLOSURES ABOUT MARKET RISK                            |    |      | 38    | 
|ITEM 4.                                                                  |  | CONTROLS AND PROCEDURES                                                                   |    |      | 39    | 
|                                                                        
|PART II 
    OTHER INFORMATION                                         
|ITEM 1.                                                                  |  | LEGAL PROCEEDINGS                                                                         |    |      | 40    | 
|ITEM 2.                                                                  |  | UNREGISTERED SALES OF EQUITY
    SECURITIES AND USE OF PROCEEDS                           |    |      | 40    | 
|ITEM 6.                                                                  |  | EXHIBITS                                                                                  |    |      | 40    | 
|SIGNATURES                                                               |  |                                                                                           | 41 |     
|Addendum 1 to the Management Services Agreement                         
|Eighth Amendment to Restated Credit Agreement                           
|Certification of Robert S. Cubbin, CEO                                  
|Certification of Karen M. Spaun, Senior Vice President & CFO            
|Section 906 Certification of Robert S. Cubbin, CEO                      
|Section 906 Certification of Karen M. Spaun, Senior Vice President & CFO



1



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##### Table of Contents






PART 1  FINANCIAL
INFORMATION




ITEM
1.                     Financial
Statements

MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF INCOME


|                                         |                                                               |                           |        |         |            |   |        |         |            |  
|---------------------------------------- | ------------------------------------------------------------- | ------------------------- | ------ | ------- | ---------- | - | ------ | ------- | ---------- | -
|                                         |                                                               |                          
|                                         |                                                               | For the Nine Months Ended
|                                         |                                                               | September 30,            
|                                         |                                                               |                          
|                                         |                                                               | 2004                      |        | 2003   
|                                         |                                                               |                           |        |        
|                                         |                                                               |                          
|                                         |                                                               | (Unaudited)              
|                                         |                                                               | (In thousands,           
|                                         |                                                               | except share data)       
|Revenues                                 |                                                               |                           |        |         |            |   |        |        
|                                         | Premiums earned                                               |                           |        |         |            |   |        |         |           
|                                         |                                                               | Gross                     |        | $       | 211,125    |   |        | $       | 147,895    |  
|                                         |                                                               | Ceded                     |        |         | (55,366    | ) |        |         | (44,094    | )
|                                         |                                                               |                           |        |         |            |   |        |        
|                                         | Net earned premiums                                           |                           |        | 155,759 |            |   |        | 103,801 |           
|                                         | Net commissions and fees                                      |                           |        | 32,794  |            |   |        | 35,430  |           
|                                         | Net investment income                                         |                           |        | 10,901  |            |   |        | 10,127  |           
|                                         | Net realized (losses) gains on disposition of
    investments |                           |        | (73     | )          |   |        | 878     |           
|                                         |                                                               |                           |        |         |            |   |        |        
|                                         |                                                               | Total revenues            |        |         | 199,381    |   |        |         | 150,236    |  
|                                         |                                                               |                           |        |         |            |   |        |        
|Expenses                                 |                                                               |                           |        |         |            |   |        |        
|                                         | Losses and loss adjustment expenses                           |                           |        | 158,467 |            |   |        | 117,705 |           
|                                         | Reinsurance recoveries                                        |                           |        | (61,303 | )          |   |        | (50,053 | )         
|                                         |                                                               |                           |        |         |            |   |        |        
|                                         | Net losses and loss adjustment expenses                       |                           |        | 97,164  |            |   |        | 67,652  |           
|                                         | Salaries and employee benefits                                |                           |        | 39,417  |            |   |        | 36,172  |           
|                                         | Policy acquisition and other underwriting expenses            |                           |        | 24,633  |            |   |        | 15,745  |           
|                                         | Other administrative expenses                                 |                           |        | 20,202  |            |   |        | 18,206  |           
|                                         | Interest expense                                              |                           |        | 1,529   |            |   |        | 656     |           
|                                         |                                                               |                           |        |         |            |   |        |        
|                                         |                                                               | Total expenses            |        |         | 182,945    |   |        |         | 138,431    |  
|                                         |                                                               |                           |        |         |            |   |        |        
|Income before taxes and equity earnings  |                                                               |                           | 16,436 |         |            |   | 11,805 |        
|                                         |                                                               |                           |        |         |            |   |        |        
|                                         | Federal income tax expense                                    |                           |        | 5,160   |            |   |        | 3,870   |           
|                                         | Equity earnings of affiliates                                 |                           |        | 28      |            |   |        |        |           
|                                         |                                                               |                           |        |         |            |   |        |        
|Net income                               |                                                               | $                         | 11,304 |         |            | $ | 7,935  |        
|                                         |                                                               |                           |        |         |            |   |        |        
|Earnings Per Share                       |                                                               |                           |        |         |            |   |        |        
|                                         |                                                               | Basic                     |        | $       | 0.39       |   |        | $       | 0.27       |  
|                                         |                                                               | Diluted                   |        | $       | 0.38       |   |        | $       | 0.27       |  
|Weighted average number of common shares |                                                               |                           |        |         |            |   |        |        
|                                         |                                                               | Basic                     |        |         | 29,040,503 |   |        |         | 29,245,087 |  
|                                         |                                                               | Diluted                   |        |         | 29,420,049 |   |        |         | 29,287,573 |  

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

2



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF INCOME


|                                         |                                                    |                            |       |            |         |   |       |            |         |  
|---------------------------------------- | -------------------------------------------------- | -------------------------- | ----- | ---------- | ------- | - | ----- | ---------- | ------- | -
|                                         |                                                    |                           
|                                         |                                                    | For the Three Months Ended
|                                         |                                                    | September 30,             
|                                         |                                                    |                           
|                                         |                                                    | 2004                       |       | 2003      
|                                         |                                                    |                            |       |           
|                                         |                                                    |                           
|                                         |                                                    | (Unaudited)               
|                                         |                                                    | (In thousands,            
|                                         |                                                    | except share data)        
|Revenues                                 |                                                    |                            |       |            |         |   |       |           
|                                         | Premiums earned                                    |                            |       |            |         |   |       |            |        
|                                         |                                                    | Gross                      |       | $          | 75,025  |   |       | $          | 54,305  |  
|                                         |                                                    | Ceded                      |       |            | (22,062 | ) |       |            | (14,118 | )
|                                         |                                                    |                            |       |            |         |   |       |           
|                                         | Net earned premiums                                |                            |       | 52,963     |         |   |       | 40,187     |        
|                                         | Net commissions and fees                           |                            |       | 12,669     |         |   |       | 10,803     |        
|                                         | Net investment income                              |                            |       | 3,757      |         |   |       | 3,197      |        
|                                         | Net realized gains on disposition of investments   |                            |       | 79         |         |   |       | 299        |        
|                                         |                                                    |                            |       |            |         |   |       |           
|                                         |                                                    | Total revenues             |       |            | 69,468  |   |       |            | 54,486  |  
|                                         |                                                    |                            |       |            |         |   |       |           
|Expenses                                 |                                                    |                            |       |            |         |   |       |           
|                                         | Losses and loss adjustment expenses                |                            |       | 57,056     |         |   |       | 41,465     |        
|                                         | Reinsurance recoveries                             |                            |       | (25,227    | )       |   |       | (15,108    | )      
|                                         |                                                    |                            |       |            |         |   |       |           
|                                         | Net losses and loss adjustment expenses            |                            |       | 31,829     |         |   |       | 26,357     |        
|                                         | Salaries and employee benefits                     |                            |       | 14,284     |         |   |       | 12,372     |        
|                                         | Policy acquisition and other underwriting expenses |                            |       | 8,175      |         |   |       | 5,996      |        
|                                         | Other administrative expenses                      |                            |       | 6,869      |         |   |       | 5,816      |        
|                                         | Interest expense                                   |                            |       | 686        |         |   |       | 207        |        
|                                         |                                                    |                            |       |            |         |   |       |           
|                                         |                                                    | Total expenses             |       |            | 61,843  |   |       |            | 50,748  |  
|                                         |                                                    |                            |       |            |         |   |       |           
|Income before taxes and equity earnings  |                                                    |                            | 7,625 |            |         |   | 3,738 |           
|                                         |                                                    |                            |       |            |         |   |       |           
|                                         | Federal income tax expense                         |                            |       | 2,436      |         |   |       | 1,238      |        
|                                         | Equity earnings of affiliates                      |                            |       | 63         |         |   |       |           |        
|                                         |                                                    |                            |       |            |         |   |       |           
|Net income                               |                                                    | $                          | 5,252 |            |         | $ | 2,500 |           
|                                         |                                                    |                            |       |            |         |   |       |           
|Earnings Per Share                       |                                                    |                            |       |            |         |   |       |           
|                                         | Basic                                              |                            | $     | 0.18       |         |   | $     | 0.09       |        
|                                         | Diluted                                            |                            | $     | 0.18       |         |   | $     | 0.09       |        
|Weighted average number of common shares |                                                    |                            |       |            |         |   |       |           
|                                         | Basic                                              |                            |       | 29,059,626 |         |   |       | 29,022,419 |        
|                                         | Diluted                                            |                            |       | 29,425,674 |         |   |       | 29,169,826 |        

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

3



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME


|           |                                         |                                                                                 |                                               |      |        |        |       |  |      |       | 
|---------- | --------------------------------------- | ------------------------------------------------------------------------------- | --------------------------------------------- | ---- | ------ | ------ | ----- |  | ---- | ----- | 
|           |                                         |                                                                                
|           |                                         | For the Nine                                                                   
|           |                                         | Months Ended                                                                   
|           |                                         | September 30,                                                                  
|           |                                         |                                                                                
|           |                                         | 2004                                                                            |                                               | 2003
|           |                                         |                                                                                 |                                               |     
|           |                                         |                                                                                
|           |                                         | (Unaudited)                                                                    
|           |                                         | (In thousands)                                                                 
|Net income |                                         | $                                                                               | 11,304                                        |      |        | $      | 7,935 | 
|           | Other comprehensive income, net of tax: |                                                                                 |                                               |      |        |        |       |  |     
|           |                                         | Unrealized (losses) gains on securities                                         |                                               |      | (1,386 | )      |       |  | 297  |      
|           |                                         | Less: reclassification adjustment for losses
    (gains) included in net income |                                               |      | 41     |        |       |  | (236 | )    
|           |                                         |                                                                                 |                                               |      |        |        |       | 
|           |                                         |                                                                                 | Other comprehensive (loss) income, net of tax |      |        | (1,345 | )     |  |      | 61    | 
|           |                                         |                                                                                 |                                               |      |        |        |       | 
|           |                                         |                                                                                 | Comprehensive income                          |      | $      | 9,959  |       |  | $    | 7,996 | 
|           |                                         |                                                                                 |                                               |      |        |        |       | 

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

4



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME

|           |                                         |                                                                          |                                               |      |       |       |       |  |        |        |  
|---------- | --------------------------------------- | ------------------------------------------------------------------------ | --------------------------------------------- | ---- | ----- | ----- | ----- |  | ------ | ------ | -
|           |                                         |                                                                         
|           |                                         | For the Three                                                           
|           |                                         | Months Ended                                                            
|           |                                         | September 30,                                                           
|           |                                         |                                                                         
|           |                                         | 2004                                                                     |                                               | 2003
|           |                                         |                                                                          |                                               |     
|           |                                         |                                                                         
|           |                                         | (Unaudited)                                                             
|           |                                         | (In thousands)                                                          
|Net income |                                         | $                                                                        | 5,252                                         |      |       | $     | 2,500 | 
|           | Other comprehensive income, net of tax: |                                                                          |                                               |      |       |       |       |  |       
|           |                                         | Unrealized gains (losses) on securities                                  |                                               |      | 3,285 |       |       |  | (2,006 | )     
|           |                                         | Less: reclassification adjustment for
    (gains) included in net income |                                               |      | (19   | )     |       |  | (7     | )     
|           |                                         |                                                                          |                                               |      |       |       |       | 
|           |                                         |                                                                          | Other comprehensive income (loss), net of tax |      |       | 3,266 |       |  |        | (2,013 | )
|           |                                         |                                                                          |                                               |      |       |       |       | 
|           |                                         |                                                                          | Comprehensive income                          |      | $     | 8,518 |       |  | $      | 487    |  
|           |                                         |                                                                          |                                               |      |       |       |       | 

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

5



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.



CONSOLIDATED BALANCE SHEETS


|                                           |                                                                                                                                 |                                            |   |              |         |  |   |         |         | 
|------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | - | ------------ | ------- |  | - | ------- | ------- | 
|                                           |                                                                                                                                 | September 30,                              |   | December 31,
|                                           |                                                                                                                                 | 2004                                       |   | 2003        
|                                           |                                                                                                                                 |                                            |   |             
|                                           |                                                                                                                                 | (Unaudited)                                |   |             
|                                           |                                                                                                                                 |                                           
|                                           |                                                                                                                                 | (In thousands, except share               
|                                           |                                                                                                                                 | data)                                     
|ASSETS                                    
|Investments                                |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           | Debt securities available for sale, at fair value
    (amortized cost of $305,670 and $260,330)                                 |                                            | $ | 314,564      |         |  | $ | 271,217 |        
|                                           | Equity securities available for sale, at fair
    value (cost of $1,980 and $1,980)                                             |                                            |   | 2,349        |         |  |   | 2,371   |        
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           |                                                                                                                                 | Total investments                          |   |              | 316,913 |  |   |         | 273,588 | 
|                                           | Cash and cash equivalents                                                                                                       |                                            |   | 62,736       |         |  |   | 50,647  |        
|                                           | Accrued investment income                                                                                                       |                                            |   | 3,774        |         |  |   | 3,441   |        
|                                           | Premiums and agent balances receivable, net                                                                                     |                                            |   | 100,389      |         |  |   | 77,554  |        
|                                           | Reinsurance recoverable on:                                                                                                     |                                            |   |              |         |  |   |         |        
|                                           |                                                                                                                                 | Paid losses                                |   |              | 18,744  |  |   |         | 17,566  | 
|                                           |                                                                                                                                 | Unpaid losses                              |   |              | 158,983 |  |   |         | 147,446 | 
|                                           | Prepaid reinsurance premiums                                                                                                    |                                            |   | 24,433       |         |  |   | 20,492  |        
|                                           | Deferred policy acquisition costs                                                                                               |                                            |   | 23,312       |         |  |   | 19,564  |        
|                                           | Deferred federal income taxes                                                                                                   |                                            |   | 13,677       |         |  |   | 15,201  |        
|                                           | Goodwill                                                                                                                        |                                            |   | 28,997       |         |  |   | 28,997  |        
|                                           | Other assets                                                                                                                    |                                            |   | 33,104       |         |  |   | 37,770  |        
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           |                                                                                                                                 | Total assets                               |   | $            | 785,062 |  |   | $       | 692,266 | 
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                          
|LIABILITIES AND SHAREHOLDERS
    EQUITY  
|Liabilities                                |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           | Losses and loss adjustment expenses                                                                                             |                                            | $ | 372,142      |         |  | $ | 339,465 |        
|                                           | Unearned premiums                                                                                                               |                                            |   | 129,712      |         |  |   | 109,677 |        
|                                           | Debt                                                                                                                            |                                            |   | 13,750       |         |  |   | 17,506  |        
|                                           | Debentures                                                                                                                      |                                            |   | 35,310       |         |  |   | 10,310  |        
|                                           | Accounts payable and accrued expenses                                                                                           |                                            |   | 31,994       |         |  |   | 26,283  |        
|                                           | Reinsurance funds held and balances payable                                                                                     |                                            |   | 20,118       |         |  |   | 13,961  |        
|                                           | Payable to insurance companies                                                                                                  |                                            |   | 7,747        |         |  |   | 7,853   |        
|                                           | Other liabilities                                                                                                               |                                            |   | 8,457        |         |  |   | 12,098  |        
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           |                                                                                                                                 | Total liabilities                          |   |              | 619,230 |  |   |         | 537,153 | 
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|Commitments and contingencies
    (Note 6) |                                                                                                                                 |                                            |   |              |         |  |   |        
|Shareholders Equity                       |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           | Common stock, $0.01 stated value; authorized
    50,000,000 shares; 29,067,883 and 29,022,435 shares
    issued and outstanding |                                            |   | 290          |         |  |   | 290     |        
|                                           | Additional paid-in capital                                                                                                      |                                            |   | 125,880      |         |  |   | 125,181 |        
|                                           | Retained earnings                                                                                                               |                                            |   | 34,420       |         |  |   | 23,069  |        
|                                           | Note receivable from officer                                                                                                    |                                            |   | (872         | )       |  |   | (886    | )      
|                                           | Accumulated other comprehensive income                                                                                          |                                            |   | 6,114        |         |  |   | 7,459   |        
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           |                                                                                                                                 | Total shareholders equity                 |   |              | 165,832 |  |   |         | 155,113 | 
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        
|                                           |                                                                                                                                 | Total liabilities and shareholders equity |   | $            | 785,062 |  |   | $       | 692,266 | 
|                                           |                                                                                                                                 |                                            |   |              |         |  |   |        

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

6



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##### Table of Contents



MEADOWBROOK INSURANCE GROUP, INC.




CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                     |                                                                                                 |                                                          |                   |         |         |        |   |         |         |        | 
|------------------------------------ | ----------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ----------------- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | For the Nine Months                                     
|                                     |                                                                                                 | Ended September 30,                                     
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | 2004                                                     |                   | 2003   
|                                     |                                                                                                 |                                                          |                   |        
|                                     |                                                                                                 |                                                         
|                                     |                                                                                                 | (Unaudited)                                             
|                                     |                                                                                                 | (In thousands)                                          
|Cash Flows From Operating Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Net income                                                                                      |                                                          | $                 | 11,304  |         |        | $ | 7,935   |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Adjustments to reconcile net income to net cash
    provided by (used in) operating activities: |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Amortization of goodwill and other intangible
    assets |                   |         | 284     |        |   |         | 256     |       
|                                     |                                                                                                 | Amortization of deferred debenture issuance costs        |                   |         | 73      |        |   |         |        |       
|                                     |                                                                                                 | Depreciation of furniture and equipment                  |                   |         | 1,087   |        |   |         | 1,096   |       
|                                     |                                                                                                 | Net accretion of discount and premiums on bonds          |                   |         | 1,318   |        |   |         | 1,394   |       
|                                     |                                                                                                 | (Gain) loss on sale of investments                       |                   |         | 63      |        |   |         | (358    | )     
|                                     |                                                                                                 | Gain on sale of assets                                   |                   |         | (22     | )      |   |         |        |       
|                                     |                                                                                                 | Stock-based employee compensation                        |                   |         | 61      |        |   |         | 155     |       
|                                     |                                                                                                 | Long-term incentive plan expense                         |                   |         | 488     |        |   |         |        |       
|                                     |                                                                                                 | Deferred income tax expense                              |                   |         | 2,193   |        |   |         | 3,558   |       
|                                     | Changes in operating assets and liabilities:                                                    |                                                          |                   |         |         |        |   |         |        
|                                     | Decrease (increase) in:                                                                         |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Premiums and agent balances receivable                   |                   |         | (22,572 | )      |   |         | (17,191 | )     
|                                     |                                                                                                 | Reinsurance recoverable on paid and unpaid losses        |                   |         | (11,104 | )      |   |         | 4,825   |       
|                                     |                                                                                                 | Prepaid reinsurance premiums                             |                   |         | (3,514  | )      |   |         | (4,207  | )     
|                                     |                                                                                                 | Deferred policy acquisition costs                        |                   |         | (3,918  | )      |   |         | (6,833  | )     
|                                     |                                                                                                 | Other assets                                             |                   |         | 4,244   |        |   |         | (1,635  | )     
|                                     | Increase (decrease) in:                                                                         |                                                          |                   |         |         |        |   |         |        
|                                     |                                                                                                 | Losses and loss adjustment expenses                      |                   |         | 32,677  |        |   |         | (12,582 | )     
|                                     |                                                                                                 | Unearned premiums                                        |                   |         | 20,035  |        |   |         | 42,953  |       
|                                     |                                                                                                 | Payable to insurance companies                           |                   |         | (106    | )      |   |         | (1,996  | )     
|                                     |                                                                                                 | Reinsurance funds held and balances payable              |                   |         | 5,946   |        |   |         | 4,740   |       
|                                     |                                                                                                 | Other liabilities                                        |                   |         | 4,807   |        |   |         | 9,462   |       
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 |                                                          | Total adjustments |         |         | 32,040 |   |         |         | 23,637 | 
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash provided by operating activities                |                   |         | 43,344  |        |   |         | 31,572  |       
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|Cash Flows From Investing Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Purchase of debt securities available for sale                                                  |                                                          |                   | (87,022 | )       |        |   | (70,715 | )      
|                                     | Proceeds from sales and maturities of debt
    securities available for sale                    |                                                          |                   | 38,294  |         |        |   | 47,293  |        
|                                     | Capital expenditures                                                                            |                                                          |                   | (3,156  | )       |        |   | (696    | )      
|                                     | Purchase of books of business                                                                   |                                                          |                   | (361    | )       |        |   | (397    | )      
|                                     | Proceeds from sale of assets                                                                    |                                                          |                   | 2,784   |         |        |   |        |        
|                                     | Deconsolidation of subsidiary                                                                   |                                                          |                   | (4,218  | )       |        |   |        |        
|                                     | Other investing activities                                                                      |                                                          |                   | 2,398   |         |        |   | 2,091   |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash used in investing activities                    |                   |         | (51,281 | )      |   |         | (22,424 | )     
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|Cash Flows From Financing Activities |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Proceeds from lines of credit                                                                   |                                                          |                   | 9,829   |         |        |   | 16,824  |        
|                                     | Payment of lines of credit                                                                      |                                                          |                   | (13,585 | )       |        |   | (30,017 | )      
|                                     | Net proceeds from debentures                                                                    |                                                          |                   | 24,250  |         |        |   | 9,700   |        
|                                     | Book overdraft                                                                                  |                                                          |                   | (607    | )       |        |   | 1,180   |        
|                                     | Share issuance (repurchases)                                                                    |                                                          |                   | 125     |         |        |   | (1,563  | )      
|                                     | Other financing activities                                                                      |                                                          |                   | 14      |         |        |   | 5       |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     |                                                                                                 | Net cash provided by (used in) financing
    activities  |                   |         | 20,026  |        |   |         | (3,871  | )     
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Net increase in cash and cash equivalents                                                       |                                                          |                   | 12,089  |         |        |   | 5,277   |        
|                                     | Cash and cash equivalents, beginning of period                                                  |                                                          |                   | 50,647  |         |        |   | 39,385  |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        
|                                     | Cash and cash equivalents, end of period                                                        |                                                          | $                 | 62,736  |         |        | $ | 44,662  |        
|                                     |                                                                                                 |                                                          |                   |         |         |        |   |        

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

7



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##### Table of Contents






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

(Unaudited)

Note 1  Summary of
Significant Accounting Policies



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

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

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

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

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

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



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

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

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

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

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

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

8



---



##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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



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

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

Outstanding options of 976,020 and 2,090,149 for
the nine months ended September 30, 2004 and 2003,
respectively, have been excluded from the diluted earnings per
share, as they were anti-dilutive. Shares issuable pursuant to
stock options included in diluted earnings per share were
307,386 and 42,486 for the nine months ended September 30,
2004 and 2003, respectively. In addition, shares issuable
pursuant to outstanding warrants included in diluted earnings
per share were 72,160 for the nine months ended
September 30, 2004. Outstanding warrants of 300,000 for the
nine months ended September 30, 2003, have been excluded
from the diluted earnings per share, as they were anti-dilutive.

Outstanding options of 976,020 and 1,129,649 for
the three months ended September 30, 2004 and 2003,
respectively, have been excluded from the diluted earnings per
share, as they were anti-dilutive. Shares issuable pursuant to
stock options included in diluted earnings per share were
296,481 and 121,605 for the three months ended
September 30, 2004 and 2003, respectively. In addition,
shares issuable pursuant to outstanding warrants included in
diluted earnings per share were 69,567 and 25,802 for the three
months ended September 30, 2004 and 2003, respectively.



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

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

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

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

9



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


If compensation cost for stock option grants had
been determined based on a fair value method, net income and
earnings per share on a pro forma basis for the periods ending
September 30, 2004 and 2003 would be as follows (in
thousands):

|                                                                                                                                                     |                       |                     |        |      |  |   |       |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | ------------------- | ------ | ---- |  | - | ----- | ---- | 
|                                                                                                                                                     |                       |                    
|                                                                                                                                                     |                       | For the Nine Months
|                                                                                                                                                     |                       | Ended September 30,
|                                                                                                                                                     |                       |                    
|                                                                                                                                                     |                       | 2004                |        | 2003
|                                                                                                                                                     |                       |                     |        |     
|Net income, as reported                                                                                                                              |                       | $                   | 11,304 |      |  | $ | 7,935 |     
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                           |                       |                     | 40     |      |  |   | 102   |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value-based methods for all
    awards, net of related tax effects |                       |                     | (344   | )    |  |   | (699  | )   
|                                                                                                                                                     |                       |                     |        |      |  |   |       |     
|Pro forma net income                                                                                                                                 |                       | $                   | 11,000 |      |  | $ | 7,338 |     
|                                                                                                                                                     |                       |                     |        |      |  |   |       |     
|Earnings per share:                                                                                                                                  |                       |                     |        |      |  |   |       |     
|                                                                                                                                                     | Basic  as reported   |                     | $      | 0.39 |  |   | $     | 0.27 | 
|                                                                                                                                                     | Basic  pro forma     |                     | $      | 0.38 |  |   | $     | 0.25 | 
|                                                                                                                                                     | Diluted  as reported |                     | $      | 0.38 |  |   | $     | 0.27 | 
|                                                                                                                                                     | Diluted  pro forma   |                     | $      | 0.37 |  |   | $     | 0.25 | 

|                                                                                                                                                     |                       |                     |       |      |  |   |       |      | 
|---------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------- | ------------------- | ----- | ---- |  | - | ----- | ---- | 
|                                                                                                                                                     |                       |                    
|                                                                                                                                                     |                       | For the            
|                                                                                                                                                     |                       | Three Months       
|                                                                                                                                                     |                       | Ended September 30,
|                                                                                                                                                     |                       |                    
|                                                                                                                                                     |                       | 2004                |       | 2003
|                                                                                                                                                     |                       |                     |       |     
|Net income, as reported                                                                                                                              |                       | $                   | 5,252 |      |  | $ | 2,500 |     
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                           |                       |                     | 11    |      |  |   | 23    |     
|Deduct: Total stock-based employee compensation
    expense determined under fair-value-based methods for all
    awards, net of related tax effects |                       |                     | (93   | )    |  |   | (184  | )   
|                                                                                                                                                     |                       |                     |       |      |  |   |       |     
|Pro forma net income                                                                                                                                 |                       | $                   | 5,170 |      |  | $ | 2,339 |     
|                                                                                                                                                     |                       |                     |       |      |  |   |       |     
|Earnings per share:                                                                                                                                  |                       |                     |       |      |  |   |       |     
|                                                                                                                                                     | Basic  as reported   |                     | $     | 0.18 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Basic  pro forma     |                     | $     | 0.18 |  |   | $     | 0.08 | 
|                                                                                                                                                     | Diluted  as reported |                     | $     | 0.18 |  |   | $     | 0.09 | 
|                                                                                                                                                     | Diluted  pro forma   |                     | $     | 0.18 |  |   | $     | 0.08 | 

The Black-Scholes valuation model utilized the
following annualized assumptions for 2003: Risk-free interest
rate of 2.90%, no dividends were declared in 2003, the
volatility factor for the expected market price of the
Companys common stock is 0.586, and the weighted average
expected life of options is 5.0 for the 2003 grants. No options
were granted during the nine months ended September 30,
2004.

Compensation expense of $61,000 and $155,000 has
been recorded in the nine months ended September 30, 2004
and 2003, respectively, under SFAS 148. Compensation
expense of $17,000 and $35,000 has been recorded in the three
months ended September 30, 2004 and 2003, respectively.



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

On May 15, 2003, the Financial Accounting
Standards Board (FASB) issued SFAS No. 150
Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity. The
statement requires issuers to classify as liabilities (or assets
in some circumstances) three classes of freestanding financial
instruments that embody obligations for the issuer. Generally,
the statement is effective

10



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


for financial instruments entered into or
modified after May 31, 2003, and is otherwise effective at
the beginning of the first interim period beginning after
June 15, 2003. The adoption of this standard had no effect
on the Companys financial statements.

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

In January 2003, the FASB issued FIN No. 46,
Consolidation of Variable Interest Entities. The
primary objective of FIN No. 46 is to provide guidance on
the identification of, and financial reporting for, entities
over which control is achieved through means other than voting
rights; such entities are known as variable interest entities.
FIN No. 46 requires variable interest entities to be
consolidated by the primary beneficiary of the variable interest
entities and expands disclosure requirements for both variable
interest entities that are consolidated as well as those within
which an enterprise holds a significant variable interest. In
accordance with FIN No. 46, the Company performed an
evaluation of its business relationships and determined that
Meadowbrook Capital Trust I (Trust) was a
variable interest entity; however, it was also determined that
the Trust did not meet the qualifications for consolidation
because the Trust equity was deemed to not be at risk. The
adoption of FIN No. 46 did not have a material impact on
the Companys consolidated balance sheet or its
consolidated statement of income. See Note 3 for additional
information regarding the Companys unconsolidated
subsidiary trust.

In December 2003, FIN No. 46 was revised as
FIN No. 46(R) to address certain implementation issues and
to defer full adoption into financial statements for periods
ending after March 15, 2004, with earlier adoption
permitted. In accordance with FIN No. 46(R), the Company
performed an evaluation of its business relationships and
determined that its wholly-owned subsidiary, AIIC, did not meet
the tests for consolidation, because neither the Company, nor
Star are the primary beneficiaries of AIIC. Therefore, effective
January 1, 2004, the Company deconsolidated AIIC on a
prospective basis in accordance with the provisions of FIN
No. 46(R). The adoption of FIN No. 46(R) and the
deconsolidation of AIIC did not have a material impact on the
Companys consolidated balance sheet or consolidated
statement of income.

In November 2003, the FASB issued Emerging Issues
Task Force (EITF) 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. EITF Issue 03-1 requires that when the
fair value of an investment security is less than its carrying
value, an impairment exists for which the determination must be
made as to whether the impairment is other-than-temporary. EITF
Issue 03-1 applies to all investment securities accounted
for under SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities and to
investment securities accounted for under the cost method to the
extent an impairment indicator exists. Under the guidance, the
determination of whether an impairment is other-than-temporary
and therefore would result in a recognized loss depends on
market conditions and managements intent and ability to
hold the securities with unrealized losses for a period
sufficient for recovery of such losses. In September 2004, the
FASB approved FASB Staff Position (FSP) EITF
Issue 03-1-1, which delays the effective date for
measurement and recognition guidance contained in
paragraphs 10-20 of EITF 03-1 until certain issues are
resolved. The delay of the recognition and measurement
provisions is expected to be superceded concurrently with the
issuance of a FSP, which will provide additional implementation
guidance. The Company is currently evaluating the impact this
guidance will have on its financial statements and will adopt
the guidance at the time it is issued. The Company has
previously implemented the disclosure requirements of
EITF 03-1.

11



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 2  Reinsurance

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

At September 30, 2004, the Company had
reinsurance recoverables for paid and unpaid losses of
$177.7 million. The Company customarily collateralizes
reinsurance balances due from non-admitted reinsurers through
funds withheld trusts or letters of credit. The largest
unsecured reinsurance recoverable is due from an admitted
reinsurer with an A A.M. Best rating and accounts
for 32.5% of the total recoverable for paid and unpaid losses.

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

Under the workers compensation reinsurance
treaty, the reinsurers are responsible for 100% of each loss in
excess of $350,000 up to $5.0 million for each claimant. In
addition, there is coverage for loss events involving more than
one claimant up to $50.0 million per occurrence.

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

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

Effective September 30, 2004, the Company
amended an existing reinsurance agreement that provided
reinsurance coverage for policies with effective dates from
August 1, 2003 to July 31, 2004, which were written in
the Companys public entity excess liability program. This
reinsurance agreement provided coverage on an excess of loss
basis for each occurrence in excess of the self-insured
retention level for public entities and the Companys
retention. This reinsurance agreement was amended by revising
premium rate and loss coverage terms, which effected a transfer
of risk to the reinsurer and reduced the net estimated costs of
reinsurance to the Company. The amended reinsurance cost for
this coverage is a flat percentage of premium subject to this
treaty and provides reinsurance coverage of $4.0 million in
excess of $1.0 million for each occurrence in excess of the
self-insured retention level for public entities. The original
agreement provided for reinsurance coverage of $4.5 million
in excess of $500,000 for each occurrence. It included a minimum
premium charge, plus 110% of losses covered under the agreement
up to a maximum premium charge.

12



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Under the original terms, an actuarial study
indicated that significant timing or underwriting risk was not
transferred to the reinsurer. Therefore, under the provisions of
SFAS No. 113 Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts
(SFAS 113) and Statement of Position 98-7 Deposit
Accounting: Accounting for Insurance and Reinsurance Contracts
That Do Not Transfer Insurance Risk, the transactions
under the original terms of the reinsurance agreement were
accounted for using the interest method of deposit accounting
for quarters prior to September 30, 2004. Based upon an
actuarial study, management concluded that the amended
reinsurance agreement transferred significant timing and
underwriting risk to the reinsurer and, accordingly, it should
be accounted for as reinsurance for the quarter ended
September 30, 2004.

Because the amended reinsurance agreement covers
past insured events, it is accounted for as a retroactive
reinsurance contract under SFAS No. 113. As a result
of a transfer of risk to the reinsurer, the Company recorded a
$2.0 million reclassification of prior period amounts from
operating expense to ceded earned premium of $4.9 million
and ceded incurred loss and loss adjustment expense of
$2.9 million. Furthermore, as a result of the reduction in
net estimated costs for reinsurance, the Company recorded a
reduction of prior period estimated net reinsurance costs in the
statement of income for the nine months and the three months
ended September 30, 2004 of $813,000.

The same amended terms also apply to the renewal
of this reinsurance agreement for the period August 1, 2004
to January 31, 2006.

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

Additionally, several small programs have
separate reinsurance treaties in place, which limit the
Companys exposure to $300,000 or less.

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

In its risk-sharing programs, the Company is also
subject to credit risk with respect to the payment of claims by
its clients captive, rent-a-captive, large deductible
programs, indemnification agreements, and on the portion of risk
exposure either ceded to the captives, or retained by the
clients. The capitalization and credit worthiness of prospective
risk-sharing partners is one of the factors considered by the
Company in entering into and renewing risk-sharing programs. The
Company collateralizes balances due from its risk-sharing
partners through funds withheld trusts or letters of credit. At
September 30, 2004, the Company had risk exposure in excess
of collateral in the amount of $10.2 million on these
programs, for which the Company has an allowance of
$7.2 million related to these exposures. The Company has
historically maintained an allowance for the potential
uncollectibility of certain reinsurance balances due from some
risk-sharing partners, some of which are in litigation with the
Company. At the end of each quarter, an analysis of these
exposures is conducted to determine the potential exposure to
uncollectibility. As of September 30, 2004, management
believes that this allowance is adequate. To date, the Company
has not, in the aggregate, experienced material difficulties in
collecting balances from its risk-sharing partners. No assurance
can be given, however, regarding the future ability of any of
the Companys risk-sharing partners to meet their
obligations. At September 30, 2004, the exposure amount in
litigation with former risk-sharing partners, which is not
reserved or collateralized, is $1.2 million.

Note 3  Debt



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

The Company has a credit agreement that includes
a term loan and a revolving line of credit. This credit
agreement consists of a $20.0 million term loan and a
revolving line of credit for up to $8.0 million. The

13



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Company uses the revolving line of credit to meet
short-term working capital needs. At September 30, 2004,
the Companys term loan had an outstanding balance of
$10.25 million. The Company had no outstanding balance on
the revolving line of credit at September 30, 2004. At
December 31, 2003, the outstanding balance on the term loan
was $14.0 million. The Company had no outstanding balance
on the revolving line of credit at December 31, 2003. The
term loan calls for quarterly amortization through July 1,
2006, at which time the term loan will be paid in full. The
quarterly amortization requires payments of $1.25 million
in 2004, 2005 and 2006, with a final payment of
$1.5 million on July 1, 2006. As part of the loan
agreement, certain of the Companys non-regulated
subsidiaries guaranteed repayment of the credit facility and the
Company pledged the stock of its non-regulated subsidiaries as
collateral. The revolving line of credit expired on
November 1, 2004. The Company is currently renegotiating
the terms of the line of credit with its lender.

Both the term loan and revolving line of credit
provide for interest at a variable rate based, at the
Companys option, upon either the prime rate or
eurocurrency based rate. The applicable margin, which ranges
from 200 to 300 basis points above eurocurrency based
rates, is determined by the level of the fixed charge coverage
ratio. Of all the covenants, the most restrictive covenant is
the fixed charge coverage ratio. The fixed charge coverage
ratio, as defined by the credit facility, is the ratio of the
non-regulated earnings before interest and taxes for the four
preceding fiscal quarters to the sum of fixed charges which
include interest expense, principal payments payable, stock
repurchases, and dividends declared during the period. Any
unused portion of the revolving credit facility as of the date
of determination reduces the sum of these fixed charges. At
September 30, 2004, this ratio was 9.1 to 1.0, compared to
the covenant minimum of 1.2 to 1.0. The selected rate was the
eurocurrency based rate, which was 3.4% at September 30,
2004.

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

A non-insurance premium finance subsidiary of the
Company maintains a line of credit with a bank, which permits
borrowings up to 75% of the accounts receivable, which
collateralize the line of credit. At September 30, 2004,
this line of credit had an outstanding balance of
$3.5 million. The terms of this line of credit were amended
on May 7, 2004. The amendments to the line of credit
agreement included a change in the permitted borrowings from 80%
to 75% of the accounts receivable, an increase in the line of
credit from $6.0 million to $8.0 million, and
amendments to the interest rates. The interest terms were
amended to interest at the Prime Rate minus 0.5%, or a
LIBOR-based rate option, plus 2.0%. At September 30, 2004,
the LIBOR-based option was 3.8%.



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

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

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

The Company contributed $9.9 million of the
proceeds to its Insurance Company Subsidiaries as of
September 30, 2004. The remaining proceeds from the
issuance of the senior debentures may be used to support future
premium growth through further contributions to the Insurance
Company Subsidiaries and general corporate purposes.

14



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                                   
| | ----------------------------------
| | Junior Subordinated
    Debentures

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

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

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

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

Note 4  Shareholders
Equity

At September 30, 2004, shareholders
equity was $165.8 million, or a book value of
$5.70 per common share, compared to $155.1 million, or
a book value of $5.34 per common share, at
December 31, 2003.

On September 17, 2002, the Companys
Board of Directors authorized management to repurchase up to
1,000,000 shares of the Companys common stock in
market transactions for a period not to exceed twenty-four
months. On August 6, 2003, the Companys Board of
Directors authorized management to repurchase up to an
additional 1,000,000 shares of the Companys common
stock under the existing share repurchase plan. The share
repurchase plan expired on September 17, 2004. As of
September 30, 2004, the cumulative amount the Company
repurchased and retired was 764,800 shares of common stock
for a total cost of approximately $2.0 million. The Company
did not repurchase any common stock during the quarter ended
September 30, 2004.

At the Companys regularly scheduled board
meeting of November 3, 2004, the Companys Board of
Directors authorized management to repurchase up to
1,000,000 shares of the Companys common stock in
market transactions for a period not to exceed twenty-four
months.

Note 5  Regulatory
Matters and Rating Agencies

A significant portion of the Companys
consolidated assets represent assets of the Insurance Company
Subsidiaries that at this time, without prior approval of the
State of Michigan Office of Financial and Insurance Services
(OFIS), cannot be transferred to the holding company
in the form of dividends, loans or advances. The restriction on
the transferability to the holding company from its Insurance
Company Subsidiaries is dictated by Michigan insurance
regulatory guidelines which, in general, are as follows: the
maximum discretionary dividend that may be declared, based on
data from the preceding calendar year, is the greater of each
insurance companys net income (excluding realized capital
gains) or ten percent of the insurance companys surplus
(excluding unrealized gains). These dividends are further
limited by a clause in the Michigan law that prohibits an
insurer from declaring dividends, except from surplus earnings
of the company. Earned surplus balances are calculated on a
quarterly basis. Since Star is the parent insurance

15



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


company, its maximum dividend calculation
represents the combined Insurance Company Subsidiaries
surplus. Based upon the 2003 statutory financial statements,
Star may only pay dividends to the Company during 2004 with the
prior approval of OFIS. Stars earned surplus position at
December 31, 2003 was negative $24.6 million. At
September 30, 2004, earned surplus was negative
$23.1 million. No statutory dividends were paid in 2003 or
2004.

Insurance operations are subject to various
leverage tests (e.g. premium to statutory surplus ratios), which
are evaluated by regulators and rating agencies. The
Companys targets for gross and net written premium to
statutory surplus are 3.0 to 1.0 and 2.5 to 1.0, respectively.
As of September 30, 2004, on a statutory consolidated
basis, the gross and net premium leverage 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
and casualty insurance companies. The formula measures required
capital and surplus based on an insurance companys
products and investment portfolio and is used as a tool to
evaluate the capital of regulated companies. The RBC formula is
used by state insurance regulators to monitor trends in
statutory capital and surplus for the purpose of initiating
regulatory action. In general, an insurance company must submit
a calculation of its RBC formula to the insurance department of
its state of domicile as of the end of the previous calendar
year. These laws require increasing degrees of regulatory
oversight and intervention as an insurance companys RBC
declines. The level of regulatory oversight ranges from
requiring the insurance company to inform and obtain approval
from the domiciliary insurance commissioner of a comprehensive
financial plan for increasing its RBC to mandatory regulatory
intervention requiring an insurance company to be placed under
regulatory control in a rehabilitation or liquidation proceeding.

At December 31, 2003, all of the Insurance
Company Subsidiaries were in compliance with RBC requirements.
Star reported statutory surplus of $99.9 million at
December 31, 2003, compared to the threshold requiring the
minimum regulatory involvement of $45.7 million in 2003. At
September 30, 2004, Stars statutory surplus was
$111.2 million.

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

Note 6  Commitments and
Contingencies

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

On June 6, 2003, the Company entered into a
Guaranty Agreement with a bank. The Company is guaranteeing
payment of a $1.5 million term loan issued by the bank to
an unaffiliated insurance agency. In the event of default on the
term loan by the insurance agency, the Company is obligated to
pay any outstanding principal (up to a maximum of
$1.5 million), as well as any accrued interest on the loan,
and any costs incurred by the bank in the collection process. In
exchange for the Companys guaranty, the president and
member of the insurance agency pledged 100% of the common shares
of two other insurance agencies that he wholly owns. In the
event of default on the term loan by the insurance agency, the
Company has the right to sell any or all of the pledged
insurance agencies common shares and use the proceeds from
the sale to recover any amounts paid under the guaranty
agreement. Any excess proceeds would be paid to the shareholder.
As of September 30, 2004, no liability has been recorded
with respect to the Companys obligations under the
guaranty agreement, since the collateral is in excess of the
guaranteed amount.

The Company, and its subsidiaries, are subject at
times to various claims, lawsuits and proceedings relating
principally to alleged errors or omissions in the placement of
insurance, claims administration,

16



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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

Note 7  Segment
Information

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



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

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



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

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

17



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


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

|                |                                            |                             |   |         |         |  |   |         |         | 
|--------------- | ------------------------------------------ | --------------------------- | - | ------- | ------- |  | - | ------- | ------- | 
|                |                                            |                            
|                |                                            | For the Nine Months        
|                |                                            | Ended September 30,        
|                |                                            |                            
|                |                                            | 2004                        |   | 2003   
|                |                                            |                             |   |        
|Revenues        |                                            |                             |   |         |         |  |   |        
|                | Net earned premiums                        |                             | $ | 155,759 |         |  | $ | 103,801 |        
|                | Management fees                            |                             |   | 12,557  |         |  |   | 14,710  |        
|                | Claims fees(1)                             |                             |   | 11,427  |         |  |   | 11,600  |        
|                | Loss control fees                          |                             |   | 1,629   |         |  |   | 1,729   |        
|                | Reinsurance brokerage                      |                             |   | 301     |         |  |   | 218     |        
|                | Investment income                          |                             |   | 10,884  |         |  |   | 10,119  |        
|                | Net realized (losses) gains on investments |                             |   | (73     | )       |  |   | 878     |        
|                |                                            |                             |   |         |         |  |   |        
|                |                                            | Specialty risk management   |   |         | 192,484 |  |   |         | 143,055 | 
|                | Agency operations                          |                             |   | 13,196  |         |  |   | 11,349  |        
|                | Reconciling items                          |                             |   | 17      |         |  |   | 8       |        
|                | Intersegment revenue                       |                             |   | (6,316  | )       |  |   | (4,176  | )      
|                |                                            |                             |   |         |         |  |   |        
|                |                                            | Consolidated revenue        |   | $       | 199,381 |  |   | $       | 150,236 | 
|                |                                            |                             |   |         |         |  |   |        
|Pre-tax income: |                                            |                             |   |         |         |  |   |        
|                | Specialty risk management(1)               |                             | $ | 13,696  |         |  | $ | 8,341   |        
|                | Agency operations*                         |                             |   | 6,209   |         |  |   | 5,065   |        
|                | Reconciling items                          |                             |   | (3,469  | )       |  |   | (1,601  | )      
|                |                                            |                             |   |         |         |  |   |        
|                |                                            | Consolidated pre-tax income |   | $       | 16,436  |  |   | $       | 11,805  | 
|                |                                            |                             |   |         |         |  |   |        



---



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

|         |                                   |                           |   |        |        |  |   |        |        | 
|-------- | --------------------------------- | ------------------------- | - | ------ | ------ |  | - | ------ | ------ | 
|         |                                   |                          
|         |                                   | For the Three Months     
|         |                                   | Ended September 30,      
|         |                                   |                          
|         |                                   | 2004                      |   | 2003  
|         |                                   |                           |   |       
|Revenues |                                   |                           |   |        |        |  |   |       
|         | Net earned premiums               |                           | $ | 52,963 |        |  | $ | 40,187 |       
|         | Management fees                   |                           |   | 3,948  |        |  |   | 4,522  |       
|         | Claims fees(1)                    |                           |   | 5,998  |        |  |   | 3,463  |       
|         | Loss control fees                 |                           |   | 552    |        |  |   | 603    |       
|         | Reinsurance brokerage             |                           |   | 184    |        |  |   | 57     |       
|         | Investment income                 |                           |   | 3,751  |        |  |   | 3,215  |       
|         | Net realized gains on investments |                           |   | 79     |        |  |   | 299    |       
|         |                                   |                           |   |        |        |  |   |       
|         |                                   | Specialty risk management |   |        | 67,475 |  |   |        | 52,346 | 
|         | Agency operations                 |                           |   | 4,424  |        |  |   | 3,527  |       
|         | Reconciling items                 |                           |   | 6      |        |  |   | (18    | )     
|         | Intersegment revenue              |                           |   | (2,437 | )      |  |   | (1,369 | )     
|         |                                   |                           |   |        |        |  |   |       
|         |                                   | Consolidated revenue      |   | $      | 69,468 |  |   | $      | 54,486 | 
|         |                                   |                           |   |        |        |  |   |       

18



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


|                |                              |                             |   |        |       |  |   |       |       | 
|--------------- | ---------------------------- | --------------------------- | - | ------ | ----- |  | - | ----- | ----- | 
|                |                              |                            
|                |                              | For the Three Months       
|                |                              | Ended September 30,        
|                |                              |                            
|                |                              | 2004                        |   | 2003  
|                |                              |                             |   |       
|Pre-tax income: |                              |                             |   |        |       |  |   |      
|                | Specialty risk management(1) |                             | $ | 6,825  |       |  | $ | 2,824 |      
|                | Agency operations*           |                             |   | 1,973  |       |  |   | 1,465 |      
|                | Reconciling items            |                             |   | (1,173 | )     |  |   | (551  | )    
|                |                              |                             |   |        |       |  |   |      
|                |                              | Consolidated pre-tax income |   | $      | 7,625 |  |   | $     | 3,738 | 
|                |                              |                             |   |        |       |  |   |      



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Excluding the allocation of corporate overhead.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(1) | During the quarter ended September 30, 2004,
    the Company accelerated the recognition of the deferred claim
    revenue related to a multi-state claims run-off service
    contract. The acceleration of this revenue was a result of an
    earlier than anticipated termination of the Companys
    obligation under the contract. This contract was terminated by
    the Liquidator during the quarter after a liquidation order was
    entered against the entity for which the Company had serviced
    the claims. At the time of termination, the Company had
    $3.5 million of deferred revenue related to the claims
    contract. The revenue had been paid to the Company pursuant to
    an agreed upon schedule. However, the Company, in order to
    remain consistent with its own historic claim handling pattern,
    had previously adopted a more conservative revenue recognition
    pattern; therefore, resulting in the establishment of deferred
    revenue. Upon the termination of the contract, the Company is no
    longer obligated to handle the related claims, pursuant to the
    terms of the agreement. The $3.5 million of deferred
    revenue related to the claims contract was fully recognized as
    of September 30, 2004. Offsetting the recognition of
    deferred revenue were related expenses, which resulted in a net
    pre-tax benefit of $3.0 million. Had the contract not been
    terminated, the Company would have received additional claim fee
    revenue for continued claim handling services. Refer to the
    Companys revenue recognition accounting policy described
    in Note 1  Summary of Significant Accounting
    Policies of the Consolidated Financial Statements.

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

|                         |  |                     |        |      |  |   |        |  
|------------------------ |  | ------------------- | ------ | ---- |  | - | ------ | -
|                         |  |                    
|                         |  | For the Nine Months
|                         |  | Ended September 30,
|                         |  |                    
|                         |  | 2004                |        | 2003
|                         |  |                     |        |     
|Holding company expenses |  | $                   | (1,656 | )    |  | $ | (689   | )
|Amortization             |  |                     | (284   | )    |  |   | (256   | )
|Interest expense         |  |                     | (1,529 | )    |  |   | (656   | )
|                         |  |                     |        |      |  |   |        |  
|                         |  | $                   | (3,469 | )    |  | $ | (1,601 | )
|                         |  |                     |        |      |  |   |        |  

|                         |  |                      |        |      |  |   |      |  
|------------------------ |  | -------------------- | ------ | ---- |  | - | ---- | -
|                         |  |                     
|                         |  | For the Three Months
|                         |  | Ended September 30, 
|                         |  |                     
|                         |  | 2004                 |        | 2003
|                         |  |                      |        |     
|Holding company expenses |  | $                    | (395   | )    |  | $ | (228 | )
|Amortization             |  |                      | (92    | )    |  |   | (116 | )
|Interest expense         |  |                      | (686   | )    |  |   | (207 | )
|                         |  |                      |        |      |  |   |      |  
|                         |  | $                    | (1,173 | )    |  | $ | (551 | )
|                         |  |                      |        |      |  |   |      |  

19



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##### Table of Contents



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Note 8  Sale-Leaseback
Transaction

In July 2004, the Company entered into an
agreement with an unaffiliated third-party to sell its property
at 12641 East 116th Street, Cerritos, California, owned by
its subsidiary, Savers Property and Casualty Insurance Company
and subsequently leaseback the property to the Companys
subsidiary, Meadowbrook, Inc. There were no future commitments,
obligations, provisions, or circumstances included in either the
sale contract or the lease contract that would result in the
Companys continuing involvement; therefore, the assets
associated with the property were removed from the
Companys consolidated balance sheets.

The sale proceeds were $2.9 million and the
net book value of the property was $1.9 million. Direct
costs associated with the transaction were $158,000. A deferred
gain of $880,000 was recorded on the consolidated balance sheet
in Other Liabilities and is being amortized over the
ten-year term of the operating lease.

20



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##### Table of Contents






ITEM 2

MANAGEMENTS DISCUSSION AND ANALYSIS
OF


FINANCIAL CONDITION AND RESULTS OF
OPERATIONS


For the Periods ended September 30, 2004
and 2003


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

RESULTS OF OPERATIONS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 2004 AND 2003



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

Net income for the nine months ended
September 30, 2004 was $11.3 million, or
$0.38 per dilutive share, compared to net income of
$7.9 million, or $0.27 per dilutive share, for the
comparable period of 2003. This improvement reflects the earning
pattern of controlled growth of premium in profitable programs
which were written in the last quarter of 2003 and the first two
quarters of 2004, continued rate increases, growth in agency
commission, control over expenses, and leveraging of fixed
costs. In addition, this improvement in net income reflects a
$2.0 million after-tax benefit from the acceleration of revenue
recognition, net of expenses, relating to the termination of a
specific multi-state claims run-off contract.

Revenues for the nine months ended
September 30, 2004 increased $49.2 million, or 32.7%,
to $199.4 million from $150.2 million for the
comparable period in 2003. This increase reflects a
$52.0 million, or 50.1%, increase in net earned premiums.
The growth in net earned premium primarily reflects the earning
pattern of programs written in the last quarter of 2003 and the
first two quarters of 2004. These programs include the
conversion of an existing west-coast commercial transportation
program to the Companys insurance subsidiaries, the impact
of a renewal rights contract for a select group of
association-endorsed workers compensation programs which
had decades of profitable underwriting experience, the
implementation of an excess liability program for public
entities with a statistically proven twenty-year track record,
the return of profitable programs, the impact of an overall
13.6% rate increase achieved in 2003, and an overall 6.6% rate
increase in 2004, which consisted of 2.7% in the workers
compensation line of business and 11.8% in all other lines of
business combined. This increase was partially offset by the
anticipated reduction in managed fee revenue from two limited
duration or closed end administrative services and claims
contracts.

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During the quarter ended September 30, 2004,
the Company accelerated the recognition of the deferred claim
revenue related to a multi-state claims run-off service
contract. The acceleration of this revenue was a result of an
earlier than anticipated termination of the Companys
obligation under the contract. This contract was terminated by
the Liquidator during the third quarter after a liquidation
order was entered against the entity for which the Company had
serviced the claims. At the time of termination, the Company had
$3.5 million of deferred revenue related to the claims
contract. The revenue had been paid to the Company pursuant to
an agreed upon schedule. However, the Company, in order to
remain consistent with its historic claim handling pattern, had
previously adopted a more conservative revenue recognition
pattern; therefore, resulting in the establishment of deferred
revenue. At the termination of the contract, pursuant to the
contract terms, the Company is no longer obligated to handle the
related claims. The $3.5 million of deferred revenue
related to the claims contract, was fully recognized as of
September 30, 2004. Had the contract not been terminated, the
Company would have received additional claims fee revenue for
continued claims handling services. Refer to the Companys
revenue recognition accounting policy described in Note 1 
Summary of Significant Accounting Policies of the Consolidated
Financial Statements.



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

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

|               |                                            |                     |   |         |   |  |   |         | 
|-------------- | ------------------------------------------ | ------------------- | - | ------- | - |  | - | ------- | 
|               |                                            |                    
|               |                                            | For the Nine Months
|               |                                            | Ended September 30,
|               |                                            |                    
|               |                                            | 2004                |   | 2003   
|               |                                            |                     |   |        
|Revenue:       |                                            |                     |   |         |   |  |   |        
|               | Net earned premiums                        |                     | $ | 155,759 |   |  | $ | 103,801 | 
|               | Management fees                            |                     |   | 12,557  |   |  |   | 14,710  | 
|               | Claims fees                                |                     |   | 11,427  |   |  |   | 11,600  | 
|               | Loss control fees                          |                     |   | 1,629   |   |  |   | 1,729   | 
|               | Reinsurance brokerage                      |                     |   | 301     |   |  |   | 218     | 
|               | Investment income                          |                     |   | 10,884  |   |  |   | 10,119  | 
|               | Net realized (losses) gains on investments |                     |   | (73     | ) |  |   | 878     | 
|               |                                            |                     |   |         |   |  |   |        
|               | Total revenue                              |                     | $ | 192,484 |   |  | $ | 143,055 | 
|               |                                            |                     |   |         |   |  |   |        
|Pre-tax income |                                            |                     |   |         |   |  |   |        
|               | Specialty risk management operations       |                     | $ | 13,696  |   |  | $ | 8,341   | 

Revenues from specialty risk management
operations increased $49.4 million, or 34.6%, to
$192.5 million for the nine months ended September 30,
2004, from $143.1 million for the comparable period in 2003.

Net earned premiums increased $52.0 million,
or 50.1%, to $155.8 million for the nine months ended
September 30, 2004, from $103.8 million in the
comparable period in 2003. As previously mentioned, this
increase is the result of increased written premium in the last
quarter of 2003 and the first two quarters of 2004 that is
recognized as earned premium in 2004.

Management fees decreased $2.1 million, or
14.6%, to $12.6 million for the nine months ended
September 30, 2004, from $14.7 million for the
comparable period in 2003. The decrease in management fees
reflects an anticipated shift in fee-for-service revenue
previously generated from a third-party contract to internally
generated fee revenue that is eliminated upon consolidation. The
transition of such fees is directly related to the
Companys previously mentioned renewal rights contract.
Excluding revenue generated from the third-party contract,
management fee revenue increased approximately $1.2 million
in comparison to 2003. This increase is primarily the result of
higher premium volumes for specific programs in Nebraska,
Minnesota, and New England, which is the basis for the
calculation of fee-for-service revenue.

Claim fees decreased $173,000, or 1.5%, to
$11.4 million, from $11.6 million for the comparable
period in 2003. This decrease reflects a similar $4.0 million
anticipated shifting of revenue previously generated from

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the multi-state claims run-off service contract,
to internally generated fee revenue that is eliminated upon
consolidation. The transition of such fees is directly related
to the Companys renewal rights contract. Offsetting this
anticipated reduction is the previously mentioned
$3.5 million in deferred revenue recognized during the
third quarter related to the multi-state claims run-off service
contract. Excluding revenue previously generated from this
contract and the revenue recognized due to the termination of
this contract, claim fee revenue increased $421,000 in
comparison to 2003. This increase is primarily the result of
growth in claims handling revenue in New England.


Net investment income increased $765,000, or
7.6%, to $10.9 million in 2004, from $10.1 million in
2003. Average invested assets increased $50.3 million, or
17.0%, to $346.0 million in 2004, from $295.7 million
for the comparable period in 2003. The increase in average
invested assets reflects cash flows from underwriting activities
and growth in gross written premiums during 2003 and 2004, as
well as, net proceeds from capital raised through the issuance
of long-term debt. The average investment yield for
September 30, 2004 was 4.2%, compared to 4.6% for the
comparable period in 2003. The current pre-tax book yield was
4.0% and current after-tax book yield was 2.9%. The decline in
investment yield reflects the accelerated prepayment speeds in
mortgage-backed securities and the reinvestment of cash flows in
municipal bonds and other securities with lower interest rates.
Over the past two years, the reinvestment of cash flows has
shifted from maturing securities with higher yields being
replaced by securities with lower yields in a declining interest
rate environment. In addition, the capital raised during the
period, which will be utilized before the end of the year, has
been invested in short-term investments.

Specialty risk management operations generated
pre-tax income of $13.7 million for the nine months ended
September 30, 2004, compared to pre-tax income of
$8.3 million for the comparable period in 2003. This
increase in pre-tax income demonstrates the improvement in
underwriting results and the further leveraging of fixed costs
as the Company continues to experience controlled growth of
premium volume. In addition, this improvement in pre-tax income
reflects a $3.0 million benefit from the previously
mentioned acceleration of revenue recognition, net of expenses,
relating to the termination of a specific multi-state claims
run-off contract. The generally accepted accounting principles
(GAAP) combined ratio was 100.9% for the nine months
ended September 30, 2004, compared to 105.1% for the same
period in 2003.

Net loss and loss adjustment expenses
(LAE) increased $29.5 million, or 43.6%, to
$97.2 million for the nine months ended September 30,
2004, from $67.7 million for the same period in 2003. The
Companys loss and LAE ratio decreased 3.3 percentage
points to 67.1% for the nine months ended September 30,
2004, from 70.4% for the same period in 2003. This ratio is the
unconsolidated net loss and LAE in relation to net earned
premium. The decrease in the loss and LAE ratio reflects the
impact of a $1.7 million, or 1.1 percentage points,
increase in net ultimate loss estimates for prior accident years
in 2004 compared to $1.3 million, or 1.3 percentage
points, increase in net ultimate loss estimates, for the
comparable period of 2003. The change in net ultimate loss
estimates in 2004 is described in the reserve section below. The
decrease in the prior year loss ratio percentage is further
enhanced by an improvement in the current accident year loss
ratio, which reflects rate increases achieved during 2004 and
the addition of earned premium from profitable programs.

The Companys expense ratio improved
0.9 percentage points to 33.8% for the nine months ended
September 30, 2004, from 34.7% for the same period in 2003.
This ratio is the unconsolidated policy acquisition and other
underwriting expenses in relation to net earned premium. This
improvement reflects an overall reduction in insurance related
assessments and the leveraging of fixed costs.

23



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##### Table of Contents





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

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

|               |                 |                     |        |       |  |   |        |       | 
|-------------- | --------------- | ------------------- | ------ | ----- |  | - | ------ | ----- | 
|               |                 |                    
|               |                 | For the Nine Months
|               |                 | Ended September 30,
|               |                 |                    
|               |                 | 2004                |        | 2003 
|               |                 |                     |        |      
|Net commission |                 | $                   | 13,196 |       |  | $ | 11,349 |      
|               | Pre-tax income* |                     | $      | 6,209 |  |   | $      | 5,065 | 



---



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

Revenue from agency operations, which consists
primarily of agency commission revenue, increased
$1.9 million, or 16.3%, to $13.2 million for the nine
months ended September 30, 2004, from $11.3 million
for the comparable period in 2003. This increase is primarily
the result of increases in new business and profit sharing
commission, higher renewal retentions, and rate increases.

Agency operations generated pre-tax income,
before corporate overhead, of $6.2 million for the nine
months ended September 30, 2004, compared to
$5.1 million for the comparable period in 2003. The
improvement in the pre-tax margin is primarily attributable to
the overall increase in revenue.

Other Items

Reserves

At September 30, 2004, managements
best estimate for the ultimate liability for loss and LAE
reserves, net of reinsurance recoverables, was
$213.2 million. Management established a reasonable range
of reserves of approximately $198.6 million to
$227.5 million. This range was established primarily by
considering the various indications derived from standard
actuarial techniques and other appropriate reserve
considerations. The following table sets forth this range by
line of business (in thousands):

|                                            |  |         |         |         |  |          |         |  |  |   |         | 
|------------------------------------------- |  | ------- | ------- | ------- |  | -------- | ------- |  |  | - | ------- | 
|                                            |  | Minimum |         | Maximum |  |         
|                                            |  | Reserve |         | Reserve |  | Selected
|Line of Business                            |  | Range   |         | Range   |  | Reserves
|                                            |  |         |         |         |  |         
|Workers Compensation(1)                    |  | $       | 113,228 |         |  | $        | 126,729 |  |  | $ | 119,961 | 
|Commercial Multiple Peril/General Liability |  |         | 38,699  |         |  |          | 47,642  |  |  |   | 42,981  | 
|Commercial Automobile                       |  |         | 29,318  |         |  |          | 33,357  |  |  |   | 31,663  | 
|Other                                       |  |         | 17,335  |         |  |          | 19,764  |  |  |   | 18,554  | 
|                                            |  |         |         |         |  |          |         |  |  |   |         | 
|Total Net Reserves                          |  | $       | 198,580 |         |  | $        | 227,492 |  |  | $ | 213,159 | 
|                                            |  |         |         |         |  |          |         |  |  |   |         | 



---



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

Reserves are reviewed by internal and independent
actuaries for adequacy on a quarterly basis. When reviewing
reserves, the Company analyzes historical data and estimates the
impact of numerous factors such as (1) per claim
information; (2) Company and industry historical loss
experience; (3) legislative enactments, judicial decisions,
legal developments in the imposition of damages, and changes in
political attitudes; and (4) trends in general economic
conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of
current developments and anticipated trends, is an appropriate
basis for predicting future events. There is no precise method
for subsequently evaluating the impact of any specific factor on
the adequacy of reserves, because the eventual deficiency or
redundancy is affected by multiple factors.

The key assumptions used in managements
selection of ultimate reserves included the underlying actuarial
methodologies, a review of current pricing and underwriting
initiatives, an evaluation of reinsurance costs and retention
levels, and a detailed claims analysis with an emphasis on how
aggressive claims handling may be impacting the paid and
incurred loss data trends embedded in the traditional actuarial
methods. With

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##### Table of Contents



respect to the ultimate estimates for losses and
LAE, the key assumptions remained consistent for the nine months
ended September 30, 2004, and the year ended
December 31, 2003.


For the nine months ended September 30,
2004, the Company reported an increase in net ultimate loss
estimates for accident years 2003 and prior of
$1.7 million, or 0.9% of $192.0 million of net loss
and LAE reserves at December 31, 2003. The increase in net
ultimate loss estimates reflected revisions in the estimated
reserves as a result of actual claims activity in calendar year
2004 that differed from the projected activity. There were no
significant changes in the key assumptions utilized in the
analysis and calculations of the Companys reserves during
2004. The major components of this change in ultimates are as
follows (in thousands):

|                                            |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |         | 
|------------------------------------------- |  | ------------ | ------- | -------------- |  | --------------- | ------ | ----------- |  | ----------- | ------ | ------- |  | ----- | ------ | ----- |  | ------------- | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------- | 
|                                            |  |              |         | Reserves of    |  |                 |        |             |  |            
|                                            |  |              |         | Deconsolidated |  | Incurred Losses |        | Paid Losses |  |            
|                                            |  | Reserves at  |         | Subsidiary at  |  |                 |        |             |  | Reserves at
|                                            |  | December 31, |         | December 31,   |  | Current         |        | Prior       |  | Total       |        | Current |  | Prior |        | Total |  | September 30,
|Line of Business                            |  | 2003         |         | 2003(1)        |  | Year            |        | Years       |  | Incurred    |        | Year    |  | Years |        | Paid  |  | 2004         
|                                            |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |              
|Workers Compensation                       |  | $            | 91,587  |                |  | $               | (2,250 | )           |  | $           | 45,680 |         |  | $     | 1,118  |       |  | $             | 46,798 |  |  | $ | 5,837  |  |  | $ | 27,911 |  |  | $ | 33,748 |  |  | $ | 102,387 | 
|Residual Markets                            |  |              | 14,506  |                |  |                 |       |             |  |             | 9,477  |         |  |       | (1,406 | )     |  |               | 8,071  |  |  |   | 2,353  |  |  |   | 2,650  |  |  |   | 5,003  |  |  |   | 17,574  | 
|Commercial Multiple Peril/General Liability |  |              | 42,389  |                |  |                 | (737   | )           |  |             | 13,478 |         |  |       | 1,871  |       |  |               | 15,349 |  |  |   | 218    |  |  |   | 13,802 |  |  |   | 14,020 |  |  |   | 42,981  | 
|Commercial Automobile                       |  |              | 27,515  |                |  |                 |       |             |  |             | 16,828 |         |  |       | 1,216  |       |  |               | 18,044 |  |  |   | 3,440  |  |  |   | 10,456 |  |  |   | 13,896 |  |  |   | 31,663  | 
|Other                                       |  |              | 16,022  |                |  |                 | (2     | )           |  |             | 10,000 |         |  |       | (1,098 | )     |  |               | 8,902  |  |  |   | 2,490  |  |  |   | 3,878  |  |  |   | 6,368  |  |  |   | 18,554  | 
|                                            |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |         | 
|Net Reserves                                |  |              | 192,019 |                |  | $               | (2,989 | )           |  | $           | 95,463 |         |  | $     | 1,701  |       |  | $             | 97,164 |  |  | $ | 14,338 |  |  | $ | 58,697 |  |  | $ | 73,035 |  |  |   | 213,159 | 
|                                            |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |         | 
|Reinsurance Recoverable                     |  |              | 147,446 |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   | 158,983 | 
|                                            |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |         | 
|Consolidated                                |  | $            | 339,465 |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  | $ | 372,142 | 
|                                            |  |              |         |                |  |                 |        |             |  |             |        |         |  |       |        |       |  |               |        |  |  |   |        |  |  |   |        |  |  |   |        |  |  |   |         | 

|                                             |  |              |         |             |  |                    |         |                 |  |   |         |  |  |  |       |  
|-------------------------------------------- |  | ------------ | ------- | ----------- |  | ------------------ | ------- | --------------- |  | - | ------- |  |  |  | ----- | -
|                                             |  |              |         |             |  | Re-estimated       |         | Development    
|                                             |  | Reserves at  |         | Reserves at |  | Reserves at        |         | as a Percentage
|                                             |  | December 31, |         | January 1,  |  | September 30, 2004 |         | of Prior       
|Line of Business                             |  | 2003         |         | 2004(1)     |  | on Prior Years     |         | Year Reserves  
|                                             |  |              |         |             |  |                    |         |                
|Workers Compensation                        |  | $            | 91,587  |             |  | $                  | 89,337  |                 |  | $ | 90,455  |  |  |  | 1.3%  |  
|Commercial Multiple Peril/ General Liability |  |              | 42,389  |             |  |                    | 41,652  |                 |  |   | 43,523  |  |  |  | 4.5%  |  
|Commercial Automobile                        |  |              | 27,515  |             |  |                    | 27,515  |                 |  |   | 28,731  |  |  |  | 4.4%  |  
|Other                                        |  |              | 16,022  |             |  |                    | 16,020  |                 |  |   | 14,922  |  |  |  | (6.9% | )
|                                             |  |              |         |             |  |                    |         |                 |  |   |         |  |  |  |       |  
|Sub-total                                    |  |              | 177,513 |             |  |                    | 174,524 |                 |  |   | 177,631 |  |  |  | 1.8%  |  
|Residual Markets                             |  |              | 14,506  |             |  |                    | 14,506  |                 |  |   | 13,100  |  |  |  | (9.7% | )
|                                             |  |              |         |             |  |                    |         |                 |  |   |         |  |  |  |       |  
|Total Net Reserves                           |  | $            | 192,019 |             |  | $                  | 189,030 |                 |  | $ | 190,731 |  |  |  | 0.9%  |  
|                                             |  |              |         |             |  |                    |         |                 |  |   |         |  |  |  |       |  



---



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

Workers Compensation Excluding Residual
Markets

The projected net ultimate loss estimate for the
workers compensation line of business excluding residual
markets increased $1.1 million, or 1.3% of net
workers compensation reserves. This net overall increase
reflects an increase of $2.9 million in accident year 2003
from higher than expected emergence of claim activity related to
one Alabama program and the acceleration of amortization of
prepaid claims handling costs. This increase was partially
offset by reductions of $1.0 million and $1.6 million
in the ultimate loss estimate for accident years 2001 and 1999,
respectively. The decrease in the ultimate loss estimate for
2001 reflects better than expected experience on the
Companys core workers compensation programs,
primarily in

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##### Table of Contents



Massachusetts and Tennessee, while the decrease
in 1999 reflects a re-allocation of estimated reserves between
accident years 2000 and 1999. The change in ultimate loss
estimates for all other accident years was insignificant.


Commercial Multiple Peril/ General
Liability

The commercial multiple peril line/general
liability line of business had an increase in net ultimate loss
estimates of $1.9 million, or 4.5% of net commercial
multiple peril/general liability reserves. The net increase
reflects an increase of $1.1 million and $573,000 in
accident years 2001 and 1999, respectively. The increase in the
ultimate loss estimate for accident year 2001 reflects higher
than expected emergence in claim activity in a general liability
occurrence program within the Kansas City Branch during the nine
months ended September 30, 2004. The increase in accident
year 1999 reflects an increase in one claim in an excess
professional liability program and a higher than expected
increase in reserves on one discontinued program. These
increases were partially offset by a reduction of $643,000 in
the ultimate loss estimate for accident year 2000. The
improvement in accident year 2000 reflects better than expected
claims activity in two previously discontinued programs. The
change in ultimate loss estimates for all other accident years
was insignificant.

Commercial Automobile

The projected net ultimate loss estimate for the
commercial automobile line of business increased
$1.2 million, or 4.4% of net commercial automobile
reserves. This net overall increase reflects an increase of
$1.3 million and $705,000 in accident years 2002 and 2001,
respectively. These increases reflect the impact of the change
in the case reserve for one claim in a California program and
the impact of higher than expected emergence in claims activity
in three previously discontinued programs. These increases were
partially offset by a reduction of $815,000 in the ultimate loss
estimate for accident year 2003 related to automobile physical
damage claim activity and better than expected emergence in
other programs. The change in ultimate loss estimates for all
other accident years was insignificant.

Other

The other lines of business had a decrease in net
ultimate loss estimates of $1.1 million, or 6.9% of net
reserves on the other lines of business. The net decrease
reflects a decrease of $176,000, $160,000, $161,000, and
$131,000 in accident years 2003, 2002, 2001, and 1999,
respectively. The improvement in these accident years reflects
better than expected claims activity in several different
programs. The change in ultimate loss estimates for all other
accident years was insignificant.

Residual Markets

The workers compensation residual market
line of business had a decrease in net ultimate loss estimates
of $1.4 million, or 9.7% of net reserves on the
workers compensation residual market line of business. The
change reflects a reduction of $1.4 million in accident
year 2003. The Company records loss reserves as reported by the
National Council on Compensation Insurance (NCCI),
plus a provision for the reserves incurred but not yet analyzed
and reported to the Company due to a two quarter lag in
reporting. This 2003 change reflects a difference between the
Companys estimate of the lag incurred but not reported and
the amounts reported by the NCCI in the quarter. The change in
ultimate loss estimates for all other accident years was
insignificant.



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

Salary and employee benefits for the nine months
ended September 30, 2004, increased $3.2 million, or
9.0%, to $39.4 million, from $36.2 million for the
comparable period in 2003. This increase primarily reflects both
merit increases and the accrual of anticipated variable
compensation, which is directly tied to Company performance and
profitability. These increases were partially offset by a slight
decrease in staffing levels.

Other administrative expenses increased
$2.0 million, or 11.0%, to $20.2 million, from
$18.2 million for the comparable period in 2003. This
increase is primarily attributable to an increase in
policyholder dividends

26



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##### Table of Contents



for 2004 as opposed to a $1.9 million
reduction in anticipated policyholder dividends reflected in
2003, due to managements evaluation of the appropriateness
of dividend payments in conjunction with overall underwriting
results. Partially offsetting this decrease was a reduction in
overall bad debt expense in 2004 as compared to increases in
related allowances recorded in 2003 on previously discontinued
programs.


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



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

Interest expense for the nine months ended
September 30, 2004, increased by $873,000, or 133.1%, to
$1.5 million, from $656,000 for the comparable period in
2003. Interest expense is primarily attributable to the
Companys term loan, line of credit, and debentures, which
are described within the Liquidity and Capital Resources section
of Managements Discussion and Analysis. Interest expense
increased $957,000 as a result of the senior debentures and
junior subordinated debentures. Offsetting this increase was a
reduction in interest associated with the Companys term
loan and line of credit of $83,000, or 12.7%, to $573,000 in
2004, from $656,000 in 2003. This decrease reflects a reduction
in the average outstanding balance, offset by an increase in the
average interest rate. The average outstanding balance during
the nine months ending September 30, 2004, was
$15.6 million, compared to $25.9 million for the same
period in 2003. The average interest rate increased in 2004 to
4.9%, compared to 3.4% in 2003 as a result of increases in the
underlying eurocurrency based rate.

Taxes

Federal income tax expense for the nine months
ended September 30, 2004, was $5.2 million, or 31.4%
of income before taxes. For the comparable period in 2003, the
Company reflected a federal income tax expense of
$3.9 million, or 32.8% of income before taxes. The
Companys effective tax rate differs from the 34% statutory
rate primarily due to a shift towards increasing investments in
tax-exempt securities in an effort to maximize after-tax
investment yields.

At September 30, 2004, the Company had a
deferred tax asset of $13.7 million, $392,000 of which is
related to a net operating loss carryforward (NOL).
Realization of the deferred tax asset is dependent on generating
sufficient taxable income to absorb both the applicable
reversing temporary differences and the NOL. At
September 30, 2004, management concluded that the positive
evidence supporting the generation of future taxable income
sufficient to realize the deferred tax asset outweighed the
negative evidence of the previous cumulative losses reported for
the periods ended December 31, 2001, 2000, and 1999, which
generated the NOL. This positive evidence includes cumulative
pre-tax income of $7.0 million for the three years ended
December 31, 2003, in addition to pre-tax income of
$16.4 million for the nine months ended September 30,
2004. Also, the Company continues to have alternative tax
strategies, which could generate capital gains from the
potential sale of assets and/or subsidiaries. These capital
gains would fully utilize the net operating loss of $392,000 at
September 30, 2004.



| |                                 
| | --------------------------------
| | Other than Temporary Impairments

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

At September 30, 2004, the Company had
ninety-eight securities that were in an unrealized loss
position. These investments all had unrealized losses of less
than ten percent. Positive evidence considered in reaching

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the Companys conclusion that the
investments in an unrealized loss position are not other than
temporarily impaired consisted of: 1) there were no
specific events which caused concerns; 2) there were no
past due interest payments; 3) there has been a rise in
market prices; 4) the Companys ability and intent to
retain the investment for a sufficient amount of time to allow
an anticipated recovery in value; and 5) the Company also
determined that the changes in market value were considered
temporary in relation to minor fluctuations in interest rates.


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

|                                                           |        |                     |        |                        |  |                   |      |            |   |   |       |        |  |   |      |      |  
|---------------------------------------------------------- | ------ | ------------------- | ------ | ---------------------- |  | ----------------- | ---- | ---------- | - | - | ----- | ------ |  | - | ---- | ---- | -
|                                                           |        |                    
|                                                           |        | September 30, 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 |        | $                   | 8,164  |                        |  | $                 | (80  | )          |   | $ | 6,885 |        |  | $ | (174 | )   
|Obligations of states and political subdivisions           |        |                     | 18,677 |                        |  |                   | (184 | )          |   |   | 553   |        |  |   | (12  | )   
|Corporate securities                                       |        |                     | 17,302 |                        |  |                   | (181 | )          |   |   | 3,013 |        |  |   | (123 | )   
|Mortgage-backed securities                                 |        |                     | 14,874 |                        |  |                   | (129 | )          |   |   | 7,480 |        |  |   | (129 | )   
|                                                           |        |                     |        |                        |  |                   |      |            |   |   |       |        |  |   |      |     
|                                                           | Totals |                     | $      | 59,017                 |  |                   | $    | (574       | ) |   | $     | 17,931 |  |   | $    | (438 | )
|                                                           |        |                     |        |                        |  |                   |      |            |   |   |       |        |  |   |      |     

As of September 30, 2004, gross unrealized
gains and (losses) on securities were $10.3 million and
($1.0) million, respectively.

RESULTS OF OPERATIONS FOR THE THREE MONTHS
ENDED SEPTEMBER 30, 2004 AND 2003

Overview

Net income for the three months ended
September 30, 2004 was $5.3 million, or $0.18 per
dilutive share, compared to net income of $2.5 million, or
$0.09 per dilutive share, for the comparable period of
2003. Net income for the three months ended September 30,
2004 reflects the earning pattern of controlled growth of
premium in profitable programs which were written in the last
quarter of 2003 and the first two quarters of 2004, continued
rate increases, growth in agency commission, and control over
expenses. In addition, this improvement is also the result of
the acceleration of revenue recognition, net of expenses,
relating to the termination of a specific multi-state claims
run-off contract. The favorable benefit of the amendment of the
public entity reinsurance agreement, as described in
Note 2  Reinsurance to the
Consolidated Financial Statements, also contributed to the
improvement in net income.

Revenues for the three months ended
September 30, 2004 increased $15.0 million, or 27.5%,
to $69.5 million from $54.5 million for the comparable
period in 2003. This increase reflects a $12.8 million, or
31.8%, increase in net earned premiums. The growth in net earned
premium reflects the earning pattern of programs written in the
last quarter of 2003 and the first two quarters of 2004. These
programs include the conversion of an existing west-coast
commercial transportation program to the Companys
insurance subsidiaries, the implementation of an excess
liability program for public entities with a statistically
proven twenty-year track record, the impact of a renewal rights
contract for a select group of association-endorsed
workers compensation programs which had decades of
profitable underwriting experience, the return of profitable
programs, and the impact of rate increases achieved in 2003 and
2004. In addition, this increase reflects the acceleration of
claim fee revenue related to the previously mentioned
termination of the claims handling obligation under the
multi-state claims run-off contract. As indicated, this contract
was terminated during the third quarter following a liquidation
order being entered against the entity for which the Company

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had serviced the claims. At the time of the
termination, the Company had deferred revenue of $3.5 million,
which was fully recognized as of September 30, 2004.


Partially offsetting the increase in revenue is
the anticipated reduction in managed fee revenue from the
limited duration or closed end administrative services contract.



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

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

|               |                                      |                      |   |        |  |  |   |        | 
|-------------- | ------------------------------------ | -------------------- | - | ------ |  |  | - | ------ | 
|               |                                      |                     
|               |                                      | For the Three Months
|               |                                      | Ended September 30, 
|               |                                      |                     
|               |                                      | 2004                 |   | 2003  
|               |                                      |                      |   |       
|Revenue:       |                                      |                      |   |        |  |  |   |       
|               | Net earned premiums                  |                      | $ | 52,963 |  |  | $ | 40,187 | 
|               | Management fees                      |                      |   | 3,948  |  |  |   | 4,522  | 
|               | Claims fees                          |                      |   | 5,998  |  |  |   | 3,463  | 
|               | Loss control fees                    |                      |   | 552    |  |  |   | 603    | 
|               | Reinsurance brokerage                |                      |   | 184    |  |  |   | 57     | 
|               | Investment income                    |                      |   | 3,751  |  |  |   | 3,215  | 
|               | Net realized gains on investments    |                      |   | 79     |  |  |   | 299    | 
|               |                                      |                      |   |        |  |  |   |       
|               | Total revenue                        |                      | $ | 67,475 |  |  | $ | 52,346 | 
|               |                                      |                      |   |        |  |  |   |       
|Pre-tax income |                                      |                      |   |        |  |  |   |       
|               | Specialty risk management operations |                      | $ | 6,825  |  |  | $ | 2,824  | 

Revenues from specialty risk management
operations increased $15.2 million, or 28.9%, to
$67.5 million for the three months ended September 30,
2004, from $52.3 million for the comparable period in 2003.

Net earned premiums increased $12.8 million,
or 31.8%, to $53.0 million for the three months ended
September 30, 2004, from $40.2 million in the
comparable period in 2003. As previously mentioned, this
increase is the result of increased written premium in the last
quarter of 2003 and the first two quarters of 2004 that are
recognized as earned premium in 2004.

Management fees decreased $574,000, or 12.7%, to
$3.9 million for the three months ended September 30,
2004, from $4.5 million for the comparable period in 2003.
The decrease in management fees reflects an anticipated shift in
fee-for-service revenue previously generated from a third-party
contract to internally generated fee revenue that is eliminated
upon consolidation. The transition of such fees is directly
related to the Companys previously mentioned renewal
rights contract. Excluding revenue generated from the
third-party contract, management fee revenue increased
approximately $547,000 in comparison to 2003. This increase is
primarily the result of higher premium volumes for specific
programs in Nebraska, Minnesota, and New England, which is the
basis for the calculation of fee-for-service revenue.

Claim fees increased $2.5 million, or 73.2%,
to $6.0 million, from $3.5 million for the comparable
period in 2003. The increase in claim fees reflects the
previously mentioned $3.5 million in deferred revenue
recognized during the quarter. Excluding the recognition of the
deferred revenue, claim fees recognized prior to the contract
termination, decreased in comparison to 2003. This decrease
reflects an anticipated shifting of revenue previously generated
from the multi-state claims run-off contract, to internally
generated fee revenue that is eliminated upon consolidation. The
transition of such fees is directly related to the
Companys renewal rights contract. Excluding revenue
generated from the multi-state claims run-off service contract
and the revenue recognized due to the termination of this
contract, claim fee revenue remained relatively constant in
comparison to 2003.

Net investment income increased $536,000, or
16.7%, to $3.8 million in 2004. Average invested assets
increased $62.8 million, or 20.5%, to $369.3 million
for the three months ended September 30, 2004, from

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$306.5 million for the comparable in 2003.
The increase in average invested assets reflects cash flows from
underwriting activities and growth in gross written premiums
during 2003 and 2004, as well as, net proceeds from capital
raised through the issuance of long-term debt. The average
investment yield for September 30, 2004 was 4.1%, compared
to 4.2% for the comparable period in 2003. The current pre-tax
book yield was 4.0% and current after-tax book yield was 2.9%.
The decline in investment yield reflects the accelerated
prepayment speeds in mortgage-backed securities and the
reinvestment of cash flows in municipal bonds and other
securities with lower interest rates. Over the past two years,
the reinvestment of cash flows has shifted from maturing
securities with higher yields being replaced by securities with
lower yields in a declining interest rate environment. In
addition, the capital raised during the second quarter, which
will be utilized before the end of the year, has been invested
in short-term investments.


Specialty risk management operations generated
pre-tax income of $6.8 million for the three months ended
September 30, 2004, compared to pre-tax income of
$2.8 million for the comparable period in 2003. This
increase in pre-tax income demonstrates the improvement in
underwriting results as the Company continues to experience
controlled growth of premium volume. In addition, this
improvement reflects the previously mentioned pre-tax benefit of
$3.0 million from the acceleration of revenue recognition,
net of expenses, relating to the termination of a specific
multi-state claims run-off contract. The GAAP combined ratio was
99.5% for the three months ended September 30, 2004,
compared to 103.5% for the same period in 2003.

Net loss and loss adjustment expenses
(LAE) increased $5.4 million, or 20.8%, to
$31.8 million for the three months ended September 30,
2004, from $26.4 million for the same period in 2003. The
Companys loss and LAE ratio decreased by
5.8 percentage points to 64.8% for the three months ended
September 30, 2004, from 70.6% for the same period in 2003.
This ratio is the unconsolidated net loss and LAE in relation to
net earned premium. The decrease in the loss and LAE ratio
reflects the impact of a $749,000, or 1.4 percentage
points, decrease in net ultimate loss estimates for prior
accident years in 2004 compared to $585,000, or
1.5 percentage points, decrease in net ultimate loss
estimates, for the comparable period of 2003. The improvement in
the current accident year loss ratio reflects rate increases
achieved during 2004 and the addition of earned premium from
profitable programs.

The Companys expense ratio increased
1.8 percentage points to 34.7% for the three months ended
September 30, 2004, from 32.9% for the same period in 2003.
This ratio is the unconsolidated policy acquisition and other
underwriting expenses in relation to net earned premium. The
increase in the expense ratio reflects the anticipated increase
in gross commissions as a percentage of earned premium. This is
a result of a shift in the balance between workers
compensation and general liability. The general liability line
of business has a higher commission rate and a lower loss ratio.
This increase is offset by a reduction in insurance related
assessments and the leveraging of fixed costs.



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

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

|                |  |               |       |      |  |   |       | 
|--------------- |  | ------------- | ----- | ---- |  | - | ----- | 
|                |  |              
|                |  | For the Three
|                |  | Months Ended 
|                |  | September 30,
|                |  |              
|                |  | 2004          |       | 2003
|                |  |               |       |     
|Net commission  |  | $             | 4,424 |      |  | $ | 3,527 | 
|Pre-tax income* |  | $             | 1,973 |      |  | $ | 1,465 | 



---



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

Revenue from agency operations, which consists
primarily of agency commission revenue, increased $897,000, or
25.4%, to $4.4 million for the three months ended
September 30, 2004, from $3.5 million for the
comparable period in 2003. This increase is primarily the result
of increases in new business and profit sharing commissions,
higher renewal retentions, and rate increases.

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Agency operations generated pre-tax income,
before corporate overhead, of $2.0 million for the three
months ended September 30, 2004, compared to
$1.5 million for the comparable period in 2003. The
improvement in the pre-tax margin is primarily attributable to
the overall increase in revenue.

Other Items

Reserves

For the three months ended September 30,
2004, the Company reported a decrease in net ultimate loss
estimates for accident years 2003 and prior to be $749,000, or
0.4% of $192.0 million of net loss and LAE reserves at
December 31, 2003. There were no significant changes in the
key assumptions utilized in the analysis and calculations of the
Companys reserves during 2004.

Salary and
Employee Benefits and Other Administrative Expenses

Salary and employee benefits for the three months
ended September 30, 2004, increased $1.9 million, or
15.5%, to $14.3 million, from $12.4 million for the
comparable period in 2003. This increase primarily reflects both
merit increases and the accrual of anticipated variable
compensation, which is directly tied to Company performance and
profitability. These increases were partially offset by a slight
decrease in staffing levels.

Other administrative expenses increased
$1.1 million, or 18.1%, to $6.9 million, from
$5.8 million for the comparable period in 2003. This
increase is primarily attributable to an increase in accrued
policyholder dividends for 2004, as well as, an overall increase
in bad debt expense and various increases in other general
operating expenses in comparison to 2003.

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

Interest
Expense

Interest expense for the three months ended
September 30, 2004, increased $479,000, or 231.4%, to
$686,000, from $207,000 for the comparable period in 2003.
Interest expense is primarily attributable to the Companys
term loan, line of credit, and debentures, which are described
within the Liquidity and Capital Resources section of
Managements Discussion and Analysis. Interest expense
increased $503,000 as a result of the senior debentures and
junior subordinated debentures. Offsetting this increase was a
reduction in interest associated with the Companys term
loan and line of credit of $24,000, or 11.6%, to $183,000, from
$207,000 in comparison to 2003. This decrease reflects a
reduction in the average outstanding balance, offset by an
increase in the average interest rate. The average outstanding
balance during the three months ending September 30, 2004,
was $15.0 million, compared to $20.0 million for the
same period in 2003. The average interest rate for the three
months ended September 30, 2004, increased to 4.9%,
compared to 4.1% for the comparable period in 2003. This
increase is a result of increases in the underlying eurocurrency
based rate.

Taxes

Federal income tax expense for the three months
ended September 30, 2004, was $2.4 million, or 31.9%
of income before taxes. For the same period last year, the
Company reflected a federal income tax expense of
$1.2 million, or 33.1% of income before taxes. The
Companys effective tax rate differs from the 34% statutory
rate primarily due to a shift towards increasing investments in
tax-exempt securities in an effort to maximize after-tax
investment yields.

Liquidity and Capital Resources

The principal sources of funds, which include
both regulated and non-regulated cash flows, for the Company and
its subsidiaries, are insurance premiums, investment income,
proceeds from the maturity and sale of invested assets, risk
management fees, and agency commissions. Funds are primarily
used for the payment of claims, commissions, salaries and
employee benefits, other operating expenses, shareholder
dividends, and debt service. The regulated sources of funds are
insurance premiums, investment income, and

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proceeds from the maturity and sale of invested
assets. These regulated funds are used for the payment of
claims, policy acquisition and other underwriting expenses, and
taxes relating to the regulated portion of net income. The
non-regulated sources of funds are in the form of commission
revenue, outside management fees, and intercompany management
fees. These non-regulated sources of funds are used to meet debt
service, shareholder dividends, and other operating expenses of
the holding company and non-regulated subsidiaries. The
following tables illustrate net income, excluding interest,
depreciation, and amortization, between the Companys
regulated and non-regulated subsidiaries, which reconciles to
the Companys consolidated statement of income and
statement of cash flows (in thousands):


|                                                           |                                                                    |                                                                                      |        |        |        |   |        |        |        | 
|---------------------------------------------------------- | ------------------------------------------------------------------ | ------------------------------------------------------------------------------------ | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                           |                                                                    |                                                                                     
|                                                           |                                                                    | For the Nine Months                                                                 
|                                                           |                                                                    | Ended September 30,                                                                 
|                                                           |                                                                    |                                                                                     
|                                                           |                                                                    | 2004                                                                                 |        | 2003  
|                                                           |                                                                    |                                                                                      |        |       
|Net income                                                 |                                                                    | $                                                                                    | 11,304 |        |        | $ | 7,935  |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|Regulated Subsidiaries:                                    |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           |                                                                    | Net income                                                                           |        | $      | 5,297  |   |        | $      | 3,029  | 
|                                                           |                                                                    | Depreciation and amortization                                                        |        |        |       |   |        |        | 6      | 
|                                                           |                                                                    | Interest                                                                             |        |        |       |   |        |        |       | 
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                      |        | 5,297  |        |   |        | 3,035  |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    provided by operating activities |        |        | 2,362  |   |        |        | 1,484  | 
|                                                           |                                                                    | Changes in operating assets and liabilites                                           |        |        | 23,680 |   |        |        | 11,071 | 
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           | Total adjustments                                                  |                                                                                      |        | 26,042 |        |   |        | 12,555 |       
|                                                           | Depreciation and amortization                                      |                                                                                      |        |       |        |   |        | (6     | )     
|                                                           | Interest                                                           |                                                                                      |        |       |        |   |        |       |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                      | $      | 31,339 |        |   | $      | 15,584 |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|Non-regulated Subsidiaries:                                |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           |                                                                    | Net income                                                                           |        | $      | 6,007  |   |        | $      | 4,906  | 
|                                                           |                                                                    | Depreciation and amortization                                                        |        |        | 1,371  |   |        |        | 1,346  | 
|                                                           |                                                                    | Interest                                                                             |        |        | 1,719  |   |        |        | 843    | 
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                      |        | 9,097  |        |   |        | 7,095  |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    provided by operating activities |        |        | 3,182  |   |        |        | 4,617  | 
|                                                           |                                                                    | Changes in operating assets and liabilites                                           |        |        | 2,816  |   |        |        | 6,465  | 
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           | Total adjustments                                                  |                                                                                      |        | 5,998  |        |   |        | 11,082 |       
|                                                           | Depreciation and amortization                                      |                                                                                      |        | (1,371 | )      |   |        | (1,346 | )     
|                                                           | Interest                                                           |                                                                                      |        | (1,719 | )      |   |        | (843   | )     
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                      | $      | 12,005 |        |   | $      | 15,988 |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|Consolidated total adjustments                             |                                                                    |                                                                                      | 32,040 |        |        |   | 23,637 |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       
|Consolidated net cash provided by operating
    activities |                                                                    | $                                                                                    | 43,344 |        |        | $ | 31,572 |       
|                                                           |                                                                    |                                                                                      |        |        |        |   |        |       

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|                                                           |                                                                    |                                                                                      |        |        |       |   |        |        |        |  
|---------------------------------------------------------- | ------------------------------------------------------------------ | ------------------------------------------------------------------------------------ | ------ | ------ | ----- | - | ------ | ------ | ------ | -
|                                                           |                                                                    |                                                                                     
|                                                           |                                                                    | For the Three Months                                                                
|                                                           |                                                                    | Ended September 30,                                                                 
|                                                           |                                                                    |                                                                                     
|                                                           |                                                                    | 2004                                                                                 |        | 2003  
|                                                           |                                                                    |                                                                                      |        |       
|Net income                                                 |                                                                    | $                                                                                    | 5,252  |        |       | $ | 2,500  |       
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|Regulated Subsidiaries:                                    |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           |                                                                    | Net income                                                                           |        | $      | 2,281 |   |        | $      | 771    |  
|                                                           |                                                                    | Depreciation and amortization                                                        |        |        |      |   |        |        |       |  
|                                                           |                                                                    | Interest                                                                             |        |        |      |   |        |        |       |  
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                      |        | 2,281  |       |   |        | 771    |       
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    provided by operating activities |        |        | 1,452 |   |        |        | 146    |  
|                                                           |                                                                    | Changes in operating assets and liabilites                                           |        |        | 3,057 |   |        |        | (2,393 | )
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           | Total adjustments                                                  |                                                                                      |        | 4,509  |       |   |        | (2,247 | )     
|                                                           | Depreciation and amortization                                      |                                                                                      |        |       |       |   |        |       |       
|                                                           | Interest                                                           |                                                                                      |        |       |       |   |        |       |       
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           | Net cash provided by (used in) operating
    activities            |                                                                                      | $      | 6,790  |       |   | $      | (1,476 | )     
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|Non-regulated Subsidiaries:                                |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           |                                                                    | Net income                                                                           |        | $      | 2,971 |   |        | $      | 1,729  |  
|                                                           |                                                                    | Depreciation and amortization                                                        |        |        | 523   |   |        |        | 492    |  
|                                                           |                                                                    | Interest                                                                             |        |        | 750   |   |        |        | 266    |  
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           | Net income, excluding interest, depreciation, and
    amortization |                                                                                      |        | 4,244  |       |   |        | 2,487  |       
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           |                                                                    | Adjustments to reconcile net income to net cash
    provided by operating activities |        |        | 1,806 |   |        |        | 1,904  |  
|                                                           |                                                                    | Changes in operating assets and liabilites                                           |        |        | 5,478 |   |        |        | (776   | )
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           | Total adjustments                                                  |                                                                                      |        | 7,284  |       |   |        | 1,128  |       
|                                                           | Depreciation and amortization                                      |                                                                                      |        | (523   | )     |   |        | (492   | )     
|                                                           | Interest                                                           |                                                                                      |        | (750   | )     |   |        | (266   | )     
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|                                                           | Net cash provided by operating activities                          |                                                                                      | $      | 10,255 |       |   | $      | 2,857  |       
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|Consolidated total adjustments                             |                                                                    |                                                                                      | 11,793 |        |       |   | (1,119 | )     
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       
|Consolidated net cash provided by operating
    activities |                                                                    | $                                                                                    | 17,045 |        |       | $ | 1,381  |       
|                                                           |                                                                    |                                                                                      |        |        |       |   |        |       

Consolidated cash flow provided by operations for
the nine months ended September 30, 2004, was
$43.3 million, compared to consolidated cash flow provided
by operations of $31.6 million for the comparable period in
2003.

Regulated subsidiaries cash flow provided
by operations for the nine months ended September 30, 2004,
was $31.3 million, compared to $15.6 million for the
comparable period in 2003. The increase in regulated cash flow
from operations primarily reflects growth in written premiums
and overall improved underwriting results.

Non-regulated subsidiaries cash flow
provided by operations for the nine months ended
September 30, 2004, was $12.0 million, compared to
$16.0 million for the comparable period in 2003. The
decrease in non-regulated cash flow from operations primarily
reflects the inflow of cash related to the previously mentioned
limited duration administrative services contract and a
multi-state claims run-off contract entered into at the
beginning of 2003. At inception, these contracts resulted in a
higher inflow of cash during the first quarter of 2003. As
anticipated, for the duration of the remaining life of these
contracts, there will be a decrease in the associated inflow of
cash in comparison to prior periods. In addition, the decrease
in cash flow from operations

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is also the result of intercompany tax payments
made during the first half of 2004 to the regulated subsidiaries
in accordance with the Companys tax sharing agreement.
These intercompany tax payments were made to compensate the
regulated subsidiaries for the utilization of the previously
mentioned NOL. These intercompany tax payments also contributed
to the increase in regulated cash flow from operations. Although
the non-regulated cash flow from operations significantly
decreased in comparison to 2003, which was mainly the result of
timing variances associated with the inflow of cash; net income,
excluding interest, depreciation, and amortization, increased
$2.0 million in comparison to 2003. This improvement
reflects the acceleration of the previously mentioned deferred
revenue recognition, net of expenses, relating to the
termination of a specific multi-state claims run-off contract.


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

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

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

The Company contributed $9.9 million of the
proceeds to its Insurance Company Subsidiaries as of
September 30, 2004. The remaining proceeds from the
issuance of the senior debentures may be used to support future
premium growth through further contributions to the Insurance
Company Subsidiaries and general corporate purposes.

The Company has a credit agreement that includes
a term loan and a revolving line of credit. This credit
agreement consists of a $20.0 million term loan and a
revolving line of credit for up to $8.0 million. The
Company uses the revolving line of credit to meet short-term
working capital needs. At September 30, 2004, the
Companys term loan had an outstanding balance of
$10.25 million. The Company had no outstanding balance on
the revolving line of credit at September 30, 2004. At
December 31, 2003, the outstanding balance on the term loan
was $14.0 million. The Company had no outstanding balance
on the revolving line of credit at December 31, 2003. The
term loan calls for quarterly amortization through July 1,
2006, at which time the term loan will be paid in full. The
quarterly amortization requires payments of $1.25 million
in 2004, 2005 and 2006, with a final payment of
$1.5 million on July 1, 2006. As part of the loan
agreement, certain of the Companys non-regulated
subsidiaries guaranteed repayment of the credit facility and the
Company pledged the stock of its non-regulated subsidiaries as
collateral. The revolving line of credit expired on
November 1, 2004. The Company is currently renegotiating
the terms of the line of credit with its lender.

Both the term loan and revolving line of credit
provide for interest at a variable rate based, at the
Companys option, upon either the prime rate or
eurocurrency based rate. The applicable margin, which ranges
from 200 to 300 basis points above eurocurrency based
rates, is determined by the level of the fixed charge coverage
ratio. Of all the covenants, the most restrictive covenant is
the fixed charge coverage ratio. The fixed charge coverage
ratio, as defined by the credit facility, is the ratio of the
non-regulated earnings before interest and taxes for the four
preceding fiscal quarters to the sum of fixed charges which
include

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interest expense, principal payments payable,
stock repurchases, and dividends declared during the period. Any
unused portion of the revolving credit facility as of the date
of determination reduces the sum of these fixed charges. At
September 30, 2004, this ratio was 9.1 to 1.0, compared to
the covenant minimum of 1.2 to 1.0. The selected rate was the
eurocurrency based rate, which was 3.4% at September 30,
2004.


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

A non-insurance premium finance subsidiary of the
Company maintains a line of credit with a bank, which permits
borrowings up to 75% of the accounts receivable, which
collateralize the line of credit. At September 30, 2004,
this line of credit had an outstanding balance of
$3.5 million. The terms of this line of credit were amended
on May 7, 2004. The amendments to the line of credit
agreement included a change in the permitted borrowings from 80%
to 75% of the accounts receivable, an increase in the line of
credit from $6.0 million to $8.0 million, and
amendments to the interest rates. The interest terms were
amended to interest at the Prime Rate minus 0.5%, or a
LIBOR-based rate option, plus 2.0%. At September 30,
2004, the LIBOR-based option was 3.8%.

At September 30, 2004, shareholders
equity was $165.8 million, or $5.70 per common share,
compared to $155.1 million, or $5.34 per common share,
at December 31, 2003.

On September 17, 2002, the Companys
Board of Directors authorized management to repurchase up to
1,000,000 shares of the Companys common stock in
market transactions for a period not to exceed twenty-four
months. On August 6, 2003, the Companys Board of
Directors authorized management to repurchase up to an
additional 1,000,000 shares of the Companys common
stock under the existing share repurchase plan. The share
repurchase plan expired on September 17, 2004. As of
September 30, 2004, the cumulative amount the Company
repurchased and retired was 764,800 shares of common stock
for a total cost of approximately $2.0 million. The Company
did not repurchase any common stock during the quarter ended
September 30, 2004.

At the Companys regularly scheduled board
meeting of November 3, 2004, the Companys Board of
Directors authorized management to repurchase up to
1,000,000 shares of the Companys common stock in
market transactions for a period not to exceed twenty-four
months.

A significant portion of the Companys
consolidated assets represent assets of the Insurance Company
Subsidiaries that at this time, without prior approval of the
State of Michigan Office of Financial and Insurance Services
(OFIS), cannot be transferred to the holding company
in the form of dividends, loans or advances. The restriction on
the transferability to the holding company from its Insurance
Company Subsidiaries is limited by Michigan insurance regulatory
guidelines which, in general, are as follows: the maximum
discretionary dividend that may be declared, based on data from
the preceding calendar year, is the greater of each insurance
companys net income (excluding realized capital gains) or
ten percent of the insurance companys surplus (excluding
unrealized gains). These dividends are further limited by a
clause in the Michigan law that prohibits an insurer from
declaring dividends, except from surplus earnings of the
company. Earned surplus balances are calculated on a quarterly
basis. Since Star is the parent insurance company, its maximum
dividend calculation represents the combined Insurance Company
Subsidiaries surplus. Based upon the 2003 statutory
financial statements, Star may only pay dividends to the Company
during 2004 with the prior approval of OFIS. Stars earned
surplus position at December 31, 2003 was negative
$24.6 million. At September 30, 2004, earned surplus
was negative $23.1 million. No statutory dividends were
paid in 2003 or 2004.

Disclosure of
Contractual Arrangements

Except as described herein in
Note 8  Sale-Leaseback Transaction
to the Consolidated Financial Statements during the three months
ended September 30, 2004, the Companys contractual
obligations changed immaterially from those discussed in the
Companys Annual Report and Form 10-K for the year

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ended December 31, 2003. The lease described
in Note 8 has a ten-year lease term. The following is a
summary of the increase in the Companys contractual
obligations in relation to the lease (in thousands):


Contractual
Obligations

|                            |  |                        |       |           |  |             |     |            |  |            |     |  |  |   |     |  |  |   |       | 
|--------------------------- |  | ---------------------- | ----- | --------- |  | ----------- | --- | ---------- |  | ---------- | --- |  |  | - | --- |  |  | - | ----- | 
|                            |  |                       
|                            |  | Payments Due by Period
|                            |  |                       
|                            |  |                        |       | Less Than |  | One to      |     | Three to   |  | More Than 
|                            |  | Total                  |       | One Year  |  | Three Years |     | Five Years |  | Five Years
|                            |  |                        |       |           |  |             |     |            |  |           
|Operating lease obligations |  | $                      | 2,306 |           |  | $           | 221 |            |  | $          | 453 |  |  | $ | 467 |  |  | $ | 1,165 | 

Regulatory and Rating Issues

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

At December 31, 2003, all of the Insurance
Company Subsidiaries were in compliance with RBC requirements.
Star reported statutory surplus of $99.9 million at
December 31, 2003, compared to the threshold requiring the
minimum regulatory involvement of $45.7 million in 2003. At
September 30, 2004, Stars statutory surplus increased
$11.3 to $111.2 million. As previously indicated, the
Company contributed $9.9 million of the proceeds from the
issuance of the senior debentures to its Insurance Company
Subsidiaries as of September 30, 2004.

Insurance operations are subject to various
leverage tests (e.g. premium to statutory surplus ratios),
which are evaluated by regulators and rating agencies. The
Companys targets for gross and net written premium to
statutory surplus are 3.0 to 1 and 2.5 to 1, respectively.
As of September 30, 2004, on a statutory consolidated
basis, gross and net premium leverage ratios were 2.6 to 1.0 and
2.0 to 1.0, respectively.

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

Off-Balance
Sheet Arrangements

On June 6, 2003, the Company entered into a
Guaranty Agreement with a bank. The Company is guaranteeing
payment of a $1.5 million term loan issued by the bank to
an unaffiliated insurance agency. In the event of default on the
term loan by the insurance agency, the Company is obligated to
pay any outstanding principal (up to a maximum of
$1.5 million), as well as any accrued interest on the loan,
and any costs incurred by the bank in the collection process. In
exchange for the Companys guaranty, the president and
member of the insurance agency pledged 100% of the common shares
of two other insurance agencies that he wholly owns. In the
event of default on the term loan by the insurance agency, the
Company has the right to sell any or all of the pledged
insurance agencies common shares and use the proceeds from
the sale to recover any amounts paid under the guaranty
agreement. Any excess proceeds would be paid to the shareholder.
As of June 30, 2004, no liability has been recorded with
respect to the Companys obligations under the guaranty
agreement, since the collateral is in excess of the guaranteed
amount.

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New Accounting Pronouncements

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

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

In January 2003, the FASB issued FIN No. 46,
Consolidation of Variable Interest Entities. The
primary objective of FIN No. 46 is to provide guidance on
the identification of, and financial reporting for, entities
over which control is achieved through means other than voting
rights; such entities are known as variable interest entities.
FIN No. 46 requires variable interest entities to be
consolidated by the primary beneficiary of the variable interest
entities and expands disclosure requirements for both variable
interest entities that are consolidated as well as those within
which an enterprise holds a significant variable interest. In
accordance with FIN No. 46, the Company performed an
evaluation of its business relationships and determined that
Meadowbrook Capital Trust I (Trust) was a
variable interest entity; however, it was also determined that
the Trust did not meet the qualifications for consolidation
because the Trust equity was deemed to not be at risk. The
adoption of FIN No. 46 did not have a material impact on
the Companys consolidated balance sheet or its
consolidated statement of income. See Note 3 for additional
information regarding the Companys unconsolidated
subsidiary trust.

In December 2003, FIN No. 46 was revised as
FIN No. 46(R), to address certain implementation issues and
to defer full adoption into financial statements for periods
ending after March 15, 2004, with earlier adoption
permitted. In accordance with FIN No. 46(R), the Company
performed an evaluation of its business relationships and
determined that its wholly-owned subsidiary, AIIC, did not meet
the tests for consolidation, because neither the Company, nor
Star are the primary beneficiaries of AIIC. Therefore, effective
January 1, 2004, the Company deconsolidated AIIC on a
prospective basis in accordance with the provisions of FIN
No. 46(R). The adoption of FIN No. 46(R) and the
deconsolidation of AIIC did not have a material impact on the
Companys consolidated balance sheet or consolidated
statement of income.

In November 2003, the FASB issued Emerging Issues
Task Force (EITF) 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. EITF Issue 03-1 requires that when the
fair value of an investment security is less than its carrying
value, an impairment exists for which the determination must be
made as to whether the impairment is other-than-temporary. EITF
Issue 03-1 applies to all investment securities accounted
for under SFAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities and to
investment securities accounted for under the cost method to the
extent an impairment indicator exists. Under the guidance, the
determination of whether an impairment is other-than-temporary
and therefore would result in a recognized loss depends on
market conditions and managements intent and ability to
hold the securities with unrealized losses for a period
sufficient for recovery of such losses. In September 2004, the
FASB approved FASB Staff Position (FSP) EITF
Issue 03-1-1, which delays the effective date for
measurement and recognition guidance contained in
paragraphs 10-20 of EITF 03-1 until certain issues are
resolved. The delay of the recognition and measurement
provisions is expected to be superceded concurrently with the
issuance of a FSP, which will provide additional implementation
guidance. The Company is currently evaluating the impact this
guidance will have on its financial

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statements and will adopt the guidance at the
time it is issued. The Company has previously implemented the
disclosure requirements of EITF 03-1.


Forward-Looking Statements

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






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

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

Interest rate risk is managed within the context
of asset and liability management strategy where the target
duration for the fixed income portfolio is based on the estimate
of the liability duration and takes into consideration the
Companys surplus. The investment policy guidelines provide
for a fixed income portfolio duration of between three and five
years. At September 30, 2004, the Companys fixed
income portfolio had a modified duration of 3.45, compared to
3.27 at December 31, 2003.

At September 30, 2004 the fair value of the
Companys investment portfolio was $316.9 million,
99.3% of which is invested in debt securities. The remaining
0.7% is invested in preferred stocks. The Companys market
risk to the investment portfolio is interest rate risk
associated with debt securities. The Companys exposure to
equity price risk is not significant. The Companys
investment philosophy is one of maximizing after-tax earnings
and has historically included significant investments in
tax-exempt bonds. In 2002, the Company emphasized taxable
securities over tax-exempt securities in order to maximize
after-tax income and the utilization of the net operating loss
carryforward. During 2003 and continuing in 2004, the Company
began to increase its holdings of tax-exempt securities based on
the Companys return to profitability and its desire to
maximize after-tax investment income. For the Companys
investment portfolio, there were no significant changes in the
Companys primary market risk exposures or in how those
exposures are managed compared to the year ended
December 31, 2003. The Company does not anticipate
significant changes in the Companys primary market risk
exposures or in how those exposures are managed in future
reporting periods based upon what is known or expected to be in
effect.

A sensitivity analysis is defined as the
measurement of potential loss in future earnings, fair values,
or cash flows of market sensitive instruments resulting from one
or more selected hypothetical changes in interest rates and
other market rates or prices over a selected period. In the
Companys sensitivity analysis model, a

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hypothetical change in market rates is selected
that is expected to reflect reasonable possible near-term
changes in those rates. Near term means a period of
up to one year from the date of the consolidated financial
statements. In its sensitivity model, the Company uses fair
values to measure its potential loss of debt securities assuming
an upward parallel shift in interest rates to measure the
hypothetical change in fair values. Based upon this sensitivity
model, a 100 basis point immediate increase in interest
rates produces a loss in fair value of market sensitive
instruments of approximately $10.9 million, or 3.45%. This
loss in fair value only reflects the impact of interest rate
increases on the fair value of the Companys debt
securities. This loss after tax constitutes 4.3% of
shareholders equity. The other financial instruments,
which include cash and cash equivalents, equity securities,
premium receivables, reinsurance recoverables, line of credit
and other assets and liabilities, when included in the
sensitivity model, do not produce a material loss in fair values.







|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

As of September 30, 2004, the Companys
management, with the participation of its Chief Executive
Officer (CEO) and Chief Financial Officer
(CFO), carried out an evaluation of the
effectiveness of the design and operation of the Companys
disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities and
Exchange Act of 1934, as amended). It should be noted that in
designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no
matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible
controls and procedures. The Company has designed its disclosure
controls and procedures to reach a level of reasonable assurance
of achieving desired control objectives and, based on the
evaluation described above, the Companys CEO and CFO
concluded that the Companys disclosure controls and
procedures are effective to ensure that all material information
relating to the Company (including its consolidated
subsidiaries) required to be included in this quarterly report
has been made known in a timely manner. There have been no
significant changes in the Companys internal controls or
in other factors that could significantly affect these internal
controls during the quarter ended September 30, 2004.

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PART II  OTHER
INFORMATION






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

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






|        |                                                                
|------- | ---------------------------------------------------------------
|Item 2. | Unregistered Sales of Equity Securities and
    Use of Proceeds

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






|        |         
|------- | --------
|Item 6. | Exhibits

The following documents are filed as part of this
Report:

|        |    |             |  |                                                                                                                                                                                                                                    
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 10 | .1          |  | Addendum 1 to the Management Services
    Agreement between Meadowbrook, Inc., and the Department of
    Insurance of the State of Missouri, dated April 1, 2004.                                                                  
|        | 10 | .2          |  | Eighth Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated August 30, 2004.                                                                                          
|        | 31 | .1          |  | Certification of Robert S. Cubbin, Chief
    Executive Officer of the Corporation, pursuant to Securities
    Exchange Act Rule 13a-14(a).                                                                                         
|        | 31 | .2          |  | Certification of Karen M. Spaun, Senior Vice
    President and Chief Financial Officer of the Corporation,
    pursuant to Securities Exchange Act Rule 13a-14(a).                                                                 
|        | 32 | .1          |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002, signed by Robert S. Cubbin,
    Chief Executive Officer of the Corporation.                        
|        | 32 | .2          |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002, signed by Karen M. Spaun, Senior
    Vice President and Chief Financial Officer of the Corporation.

40



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SIGNATURES

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



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



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

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

Dated: November 8, 2004

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EXHIBIT INDEX

|        |      |             |  |                                                                                                                                                                                                                                    
|------- | ---- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|No.     |      | Description
|        |      |            
|        | 10.1 |             |  | Addendum 1 to the Management Services
    Agreement between Meadowbrook, Inc., and the Department of
    Insurance of the State of Missouri, dated April 1, 2004.                                                                  
|        | 10.2 |             |  | Eighth Amendment to Restated Credit Agreement
    between Meadowbrook Insurance Group, Inc. and Comerica Bank,
    dated August 30, 2004.                                                                                          
|        | 31.1 |             |  | Certification of Robert S. Cubbin, Chief
    Executive Officer of the Corporation, pursuant to Securities
    Exchange Act Rule 13a-14(a).                                                                                         
|        | 31.2 |             |  | Certification of Karen M. Spaun, Senior Vice
    President and Chief Financial Officer of the Corporation,
    pursuant to Securities Exchange Act Rule 13a-14(a).                                                                 
|        | 32.1 |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002, signed by Robert S. Cubbin,
    Chief Executive Officer of the Corporation.                        
|        | 32.2 |             |  | Certification pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes-Oxley Act of 2002, signed by Karen M. Spaun, Senior
    Vice President and Chief Financial Officer of the Corporation.