<PAGE>   1
                                                                      EXHIBIT 13


                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

Meadowbrook Insurance Group, Inc. (the "Company") provides alternative risk
management programs and services primarily to industry, public entities, and
trade/professional groups. Revenues are generated from four principal sources:
fees from program management services, commissions earned on insurance placed by
a subsidiary with other carriers, earned insurance premiums, and investment
income. The subsidiaries of the Company that provide these services are Star
Insurance Company ("Star"), Savers Property and Casualty Insurance Company
("Savers"), Crest Financial Corporation ("Crest") and its wholly owned insurer
Williamsburg National Insurance Company ("Williamsburg"), American Indemnity
Insurance Company, Ltd. ("American Indemnity"), Association Self Insurance
Services, Inc. ("ASI") and Meadowbrook, Inc. ("Meadowbrook"), the risk
management company.

Through these subsidiaries the Company develops programs, which are customized
packages of services or coverages marketed to the group's members. The programs
are categorized by the level of risk assumed by the Company. In managed
programs, the Company usually assumes no insurance risk and generates fee
revenue through program management services. In risk-sharing programs, the
Company participates with the client or producing agent in the operating results
of the programs through a captive, retrospectively-rated program, or a
contingent commission. In fully-insured programs, the Company provides
traditional insurance without a risk-sharing mechanism and derives revenue
exclusively from earned premiums and investment income. Fully-insured programs
are developed only in response to a specific market opportunity and generally
when the Company believes there is potential to develop a long-term risk-sharing
partnership in the future.

The Company's major insurance subsidiaries, Star, Savers and Williamsburg, issue
insurance policies for both risk-sharing and fully-insured programs. These
companies are complimented by American Indemnity, which offers clients a
rent-a-captive vehicle for risk-sharing programs.

Managed programs and agency activities are provided through Meadowbrook, the
Company's risk management subsidiary. Meadowbrook was acquired by the Company in
November of 1995. Prior to its acquisition, it was an affiliated company. Fee
and commission revenues are generated through Meadowbrook and Crest Financial
Services primarily from the following sources: retail insurance agency
commissions, program management fees, claims handling and administration fees,
loss prevention and control fees, and reinsurance brokerage commissions.
Management fee revenue is also generated from the following services: program
design and implementation, sales and marketing to members of a client group,
captive formation and management, underwriting/risk selection, accounting and
financial statement preparation, regulatory compliance, actuarial and loss
reserve analysis. In addition to providing services to outside clients,
Meadowbrook also provides services to the Company's insurance subsidiaries which
include the management of their insurance operations.

The Company acquired ASI of Montgomery, Alabama in November of 1996. The
acquisition was not material to the Company's results of operations. ASI is a
full service risk-management operation focused on pools and funds whose services
include claims, loss control, managed care, and policy issuance. ASI's
operations were consolidated with the Company's existing operations in
Montgomery, Alabama.

In December of 1996, the Company entered into a five-year joint underwriting
agreement with Connecticut Surety Corporation. The agreement provides for the
transfer of the underwriting risk on the majority of the Company's existing
surety bond business. In addition, Star will continue to write new surety
business, utilizing its capital and licenses, and Connecticut Surety will manage
the operations and assume the risk. This arrangement substantially reduces the
Company's underwriting risk exposure while creating a five year fee arrangement.
This enables the Company to refocus its efforts on its core business,
alternative risk management.

                                       19
<PAGE>   2
                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

In July of 1997, the Company acquired Crest, a California based holding company
which owns 100% of Williamsburg, an insurance carrier, and Crest Financial
Services, a risk management service company. Crest provides these services
primarily to the trucking industry within California.

Management's discussion and analysis is presented on an actual and pro forma
basis for the year ended December 31, 1995. The data presented on an actual
basis, for 1995, reflects consolidated operations with Meadowbrook only for the
brief period from the date of acquisition (November 20, 1995) through year-end.
The pro forma financial information for 1995 is based on a consolidation of
operations, assuming that Meadowbrook had been a wholly-owned subsidiary for the
entire year ended December 31, 1995.

RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                            PRO
                                          ACTUAL           FORMA       CHANGE 97 VS. 96   CHANGE 96 VS. 95
                                   ---------------------------------------------------------------------------
(In thousands, except %'s)           1997       1996       1995         $            %        $            %
                                   ---------------------------------------------------------------------------
<S>                                <C>        <C>        <C>        <C>           <C>     <C>           <C>
Total revenues                     $101,125   $109,189   $103,349   $ (8,064)      (7.4%) $  5,840        5.7%
Total expenses                       83,739     98,321     90,179    (14,582)     (14.8%)    8,142        9.0%
                                   ---------------------------------------------------------------------------
Income before taxes                  17,386     10,868     13,170      6,518       60.0%    (2,302)     (17.5%)
Income taxes                          4,343      2,162      3,495      2,181      100.9%    (1,333)     (38.1%)
                                   ---------------------------------------------------------------------------
Net Income                         $ 13,043   $  8,706   $  9,675   $  4,337       49.8%  $   (969)     (10.0%)
                                   ---------------------------------------------------------------------------
<CAPTION>
                                                            PRO
                                          ACTUAL           FORMA       CHANGE 97 VS. 96   CHANGE 96 VS. 95
                                   ---------------------------------------------------------------------------
(In thousands, except %'s)           1997       1996       1995         $            %        $            %
                                   ---------------------------------------------------------------------------
<S>                                <C>        <C>        <C>        <C>           <C>     <C>            <C>
Total revenues                     $101,125   $109,189   $ 89,974   $ (8,064)      (7.4%) $ 19,215       21.4%
Total expenses                       83,739     98,321     80,486    (14,582)     (14.8%)   17,835       22.2%
                                   ---------------------------------------------------------------------------
Income before taxes                  17,386     10,868      9,488      6,518       60.0%     1,380       14.5%
Income taxes                          4,343      2,162      2,268      2,181      100.9%      (106)      (4.7%)
                                   ---------------------------------------------------------------------------
Net Income                         $ 13,043   $  8,706   $  7,220   $  4,337       49.8%  $  1,486       20.6%
                                   ---------------------------------------------------------------------------
</TABLE>


Net income in 1997 increased $4.3 million, or 49.8%, from $8.7 million in 1996
to $13.0 million in 1997. The increase in net income primarily reflects overall
growth from our fee-based risk management operations as well as profitable
underwriting results from our core program business. Total revenues decreased
$8.1 million, or 7.4%, while total expenses decreased $14.6 million, or 14.8%.
The decrease in expenses primarily relates to an increase in ceding commissions
of $7.3 million, or 49.3%, decrease in overall acquisition costs of $5.8
million, or 49.0%, associated with the transfer of the surety bond program, as
well as overall savings in administrative costs.

Net income in 1996 decreased $1.0 million, or 10.0%, from the pro forma net
income of $9.7 million in 1995. Net earned premiums increased $1.8 million, or
2.2%, over the prior year. Net investment income increased by $2.4 million, or
41.8%, in 1996 due to a full year's earnings on invested proceeds from the
Company's initial public offering. Salaries and employee benefits increased by
$5.0 million in 1996 as a result of additional new full-time employees. Other
operating expenses increased $4.2 million due to investments in new programs.


                                       20
<PAGE>   3
                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

REVENUE
<TABLE>
<CAPTION>
                                                     PRO
                                   ACTUAL           FORMA      CHANGE 97 VS. 96   CHANGE 96 VS. 95
                            ------------------------------------------------------------------------
(In thousands, except %'s)     1997       1996       1995        $           %        $          %
                            ------------------------------------------------------------------------
<S>                         <C>        <C>        <C>        <C>          <C>     <C>          <C>
Net earned premium          $ 68,493   $ 84,547   $ 82,698   $(16,054)    (19.0%) $  1,849      2.2%
Net commissions & fees        24,360     16,566     14,955      7,794      47.0%     1,611     10.8%
Investment & misc. income      8,272      8,076      5,696        196       2.4%     2,380     41.8%
                            ------------------------------------------------------------------------
Total Revenue               $101,125   $109,189   $103,349   $ (8,064)     (7.4%) $  5,840      5.7%
                            ------------------------------------------------------------------------
<CAPTION>

                                                    PRO
                                     ACTUAL        FORMA    CHANGE 97 VS. 96   CHANGE 96 VS. 95
                            ------------------------------------------------------------------------
(In thousands, except %'s)     1997       1996      1995         $          %          $        %
                            ------------------------------------------------------------------------
<S>                         <C>        <C>        <C>        <C>          <C>     <C>           <C>
Net earned premium          $ 68,493   $ 84,547   $ 82,698   $(16,054)    (19.0)% $  1,849       2.2%
Net commissions & fees        24,360     16,566      1,886      7,794      47.0%    14,680       778%
Investment & misc. income      8,272      8,076      5,390        196       2.4%     2,686      49.8%
                            ------------------------------------------------------------------------
Total Revenue               $101,125   $109,189   $ 89,974   $ (8,064)     (7.4%) $ 19,215      21.4%
                            ------------------------------------------------------------------------
<CAPTION>

The Company's written and earned premium were as follows:
                                  YEARS ENDED DECEMBER            CHANGE 97 VS. 96  CHANGE 96 VS. 95
                            ---------------------------------------------------------------------------
(In thousands, except %'s)     1997      1996        1995        $          %          $           %
                            ---------------------------------------------------------------------------
<S>                          <C>        <C>        <C>        <C>        <C>       <C>           <C>
Gross written premium        $146,739   $115,580   $123,119   $ 31,159      27.0%  $ (7,539)      (6.1%)
Net written premium            74,965     72,758     93,638      2,207       3.0%   (20,880)     (22.3%)
Net earned premium             68,493     84,547     82,698    (16,054)    (19.0%)    1,849        2.2%
</TABLE>


Gross written premium increased by $31.2 million, or 27.0%, to $146.7 million in
1997 from $115.6 million in 1996. The increase reflects growth in existing
business of $13.2 million and new programs totaling $31.1 million. This growth
was somewhat offset by the discontinuation of other programs in prior years. The
growth in existing business reflects a full year of premium writings in programs
initiated in 1996, assumed business, and expansion into additional states. The
increase in new business reflects the addition of twelve new programs in 1996,
and $3.7 million from premiums produced by Williamsburg.

Net written premium increased by $2.2 million, or 3.0%, to $75.0 million in 1997
from $72.8 million in 1996. The disproportionate growth between gross written
and net written resulted from higher participation by risk sharing clients, new
policy issuance services, and the transfer of the surety bond program in
December 1996.

Net earned premiums decreased by $16.1 million, or 19.0%, to $68.5 million in
1997 from $84.5 million in 1996. This decrease reflects the impact of the
discontinuation of the surety bond program in December 1996 and offset by growth
in our core program business.

Gross written premium decreased by $7.5 million, or 6.1%, to $115.6 million in
1996 from $123.1 million in 1995. This decrease reflects favorable claims
experience in three of our retrospectively rated (retro) programs, changes in
residual market program assessments, and discontinued and downsized programs
which the Company deemed unprofitable. These factors were offset by growth in
our core program business from both new programs and cross-selling products in
existing programs.

Net written premium decreased by $20.9 million, or 22.3%, to $72.8 million in
1996 from



                                       21
<PAGE>   4
                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis


$93.6 million in 1995. The disproportionate growth between gross written and net
written resulted from higher participation by risk sharing clients as well as
the transfer of the unearned premium on the Surety Bond business to Connecticut
Surety which decreased net written premiums by $11.9 million.

Net earned premium increased by $1.8 million, or 2.2%, to $84.5 million in 1996
from $82.7 in 1995, due principally to growth in existing and new programs, and
premiums from the Surety Bond program. Offsetting these increases were the
decreases in earned premium corresponding to the retrospectively-rated programs,
residual markets, and discontinued programs.

Net Commissions and Fees. Net commissions and fees for Meadowbrook increased by
$7.8 million, or 47.0%, from $16.6 million in 1996 to $24.4 million in 1997. Net
commission and fees, on a pro forma basis, increased by $1.6 million, or 10.8%,
to $16.6 million in 1996 from $15.0 million in 1995. Commissions and fees are
derived from managed programs and the retail insurance agency operations and
consist of the following:


<TABLE>
<CAPTION>
                                                                           PRO
                                                     ACTUAL               FORMA
                                               ---------------------------------
(In thousands)                                   1997         1996         1995
                                               ---------------------------------
<S>                                            <C>          <C>          <C>
Management fees                                $ 6,799      $ 5,822      $ 5,490
Claims fees                                      8,155        3,720        2,332
Loss control fees                                1,168        1,390        1,413
Reinsurance brokerage                              560          797          906
Miscellaneous fees and charges                       8           23            7
                                               ---------------------------------
Total Risk Management Fees                      16,690       11,752       10,148
Agency and sales commissions                     7,670        4,814        4,807
                                               ---------------------------------
Net Commissions and Fees                       $24,360      $16,566      $14,955
                                               ---------------------------------
</TABLE>


Net commissions and fees increased $7.8 million, or 47.0%, during 1997. The
increase in Risk Management fees of $4.9 million primarily reflects additional
management fees of $1.3 million and ASI claims fees of $3.2 million. The
remaining increase resulted from Crest management fees of $0.5 million. The
increase in Agency and sales commissions reflect additional commissions from
Crest Financial of $2.1 million. The remaining increase resulted from growth in
our core programs.

Net commissions and fees increased $1.6 million during 1996. Management fees
increased 6.0%, or $0.3 million, due to fee increases for existing programs and
fees from newly formed captives. Claims fees increased 59.5%, or $1.4 million,
due to the two months of revenue generated from ASI, additional claim handling
services provided to an existing client, and fee increases to existing programs.
Agency and sales commissions were unchanged from the prior year.

Net Investment Income. Net investment income increased $0.2 million in 1997, or
2.4%, to $8.3 million from $8.1 million in 1996 and $2.4 million in 1996, or
41.8%, from 1995, on a pro forma basis. The increase in investment income in
1996 was primarily the result of growth in cash and invested assets related to
$43.8 million in new capital raised through the initial public offering at the
end of November 1995. The pre-tax weighted average yield on invested assets was
5.4% in 1997, and 5.3% in both 1996 and 1995. The Company's investment
philosophy is one of maximizing after-tax earnings through significant
investments in tax-exempt bonds. Accordingly, the weighted average yield on
invested assets on an after-tax basis was 4.7% in both 1997 and 1996 and 4.5%
for 1995.



                                       22
<PAGE>   5
                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

EXPENSES

Total expenses decreased by $14.6 million, or 14.8%, to $83.7 million in 1997
from $98.3 million in 1996 and increased, on a pro forma basis, by $8.1 million,
or 9.0%, to $98.3 million in 1996 from $90.2 million in 1995. Total expenses on
an actual basis increased $17.8 million, or 22.2%, to $98.3 million in 1996 from
$80.5 million in 1995. The expenses are as follows:

<TABLE>
<CAPTION>
                                                       PRO
                                    ACTUAL            FORMA                ACTUAL
                             -----------------------------------------------------------------
(In thousands)                  1997       1996       1995       1997        1996      1995
                             -----------------------------------------------------------------
<S>                          <C>         <C>        <C>        <C>         <C>        <C>
Net Losses & LAE:
Other than surety            $ 31,558    $ 32,971   $ 36,089   $ 31,558    $ 32,971   $ 38,231
Surety business                 4,585       8,294      5,584      4,585       8,294      5,564
Salaries and benefits          27,416      24,977     20,001     27,416      24,977      2,629
Interest                          649        --          576        649        --
                                                                                           341
Other operating expenses:
Expenses other than surety     20,910      21,962     18,095     20,910      21,962     23,921
Surety bond expenses           (1,379)     10,117      9,834     (1,379)     10,117      9,800
                             -----------------------------------------------------------------
Total expenses               $ 83,739    $ 98,321   $ 90,179   $ 83,739    $ 98,321   $ 80,486
                             -----------------------------------------------------------------
</TABLE>


NET LOSSES AND LOSS ADJUSTMENT EXPENSES (LAE)

Net losses and LAE incurred decreased by $5.1 million, or 12.4%, to $36.1
million in 1997 from $41.3 million in 1996, and decreased on a pro forma basis
by $0.4 million, or 1.0%, to $41.3 million for 1996 from $41.7 million for 1995.
Analysis of losses and LAE utilizing insurance ratios, on an overall and
non-surety basis, are reflected below.

The GAAP loss and LAE ratio was 55.7% and 52.1% in 1997 and 1996, respectively,
a 3.6 point change. On a pro forma basis, as if the Connecticut Surety
reinsurance ceding arrangement on the surety program had occurred at the
beginning of 1996, the GAAP loss and LAE ratio would have been 56.3% in 1996.
This change reflects favorable claims experience primarily in workers
compensation based programs and residual markets. This favorable experience was
somewhat offset by adverse development relating to the run-off of the surety
bond program which added 3.3 points in 1997.

The GAAP loss and LAE was 52.1% and 53.2% in 1996 and 1995, respectively, a one
point improvement. The major reason for the decline in 1996 was the reduction in
residual market participation, due to the shrinking size of the involuntary
pools. The GAAP loss and LAE ratio for non-surety business also improved one
point to 56.4% in 1996 from 57.4% in 1995. The decrease in the GAAP loss and LAE
ratio for non-surety business is also a result of the reduction in the residual
market assessments.

SALARIES AND EMPLOYEE BENEFITS

Salaries and employee benefits increased by $2.4 million, or 9.8%, to $27.4
million in 1997 compared to $25.0 million in 1996. This increase reflects
additional 1997 salary and employee expenses of $3.3 million from Crest and ASI
and somewhat offset by a reduction in surety department salaries due to the
Connecticut Surety arrangement. The average salaries and wages per associate in
1997 remained relatively consistent with 1996.

Salaries and employee benefits increased by $5.0 million, or 24.9%, to $25.0
million in 1996 compared to $20 million in 1995, on a pro forma basis, as a
result of additional new full-time



                                       23
<PAGE>   6
                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

employees. A major reason for this was the expansion of the bond operation that
began in mid-1995. Bond salary expense includes an entire twelve months of
expense in 1996 versus only six months in 1995. Marketing and other departments
grew to accommodate pending growth from several large new programs that were
under development during the year. The average salaries and wages per associate
in 1996 remained relatively consistent with 1995.

INTEREST EXPENSE

Interest expense of $649,000 and $576,000 for 1997 and 1995, respectively,
relates to the use of the Company's line of credit. There was no interest
expense recorded during 1996, as all debt was retired with the proceeds of the
initial public offering.

OTHER OPERATING EXPENSES

Other operating expenses from the non-surety business decreased $1.1 million, or
4.8%, to $20.9 million in 1997 from $22.0 million in 1996. This decrease
reflects a $3.3 million increase in ceding commission on risk sharing and
fronted programs, reduction in technology costs incurred in 1996 and overall
savings in administrative costs related to management's efforts to increase
operating efficiencies. These reductions were offset by incremental costs of
$3.1 million incurred by ASI and Crest in 1997.

Other operating expenses from the non-surety business increased $3.9 million, or
21.4%, to $22.0 million in 1996 from $18.1 million in 1995, on a pro forma
basis. This increase reflects 1996 consulting fees incurred in connection with
systems technology studies to assess the capabilities of, and set the future
direction for upgrades to, major operating systems. The remaining increase
reflects investments to build the Company's infrastructure to accommodate the
development of two large programs and other future growth.

Other operating expense from the surety business decreased $11.5 million to
($1.4) million in 1997 from $10.1 million in 1996. This decrease reflects the
run-off of the surety business and the increase in ceding commissions.

Other operating expense from the surety business increased $ 0.3 million to
$10.1 million in 1996 from $9.8 million in 1995, on a pro forma basis. The
increase reflects the amortization of deferred acquisition cost which was mostly
offset by ceding commission associated with the surety bond program transfer.

Other operating expenses, on an actual basis, decreased by $1.6 million in 1996,
or 4.9%, from $33.7 million in 1995. The decrease reflects an unusual charge-off
of an uncollectible premium receivable in 1995. In addition, the 1995 expenses
include management fees paid by the insurance subsidiaries to Meadowbrook prior
to its acquisition in November of 1995.

TAXES

The provision for income taxes on an actual basis was $4.3 million in 1997, $2.2
million in 1996, and $2.3 million in 1995, representing effective tax rates of
25.0%, 19.9%, and 23.9% in 1997, 1996, 1995, respectively. The tax rates were
significantly lower than the 34% corporate rate due to the Company's heavily
tax-exempt investment portfolio.

The increase in the effective tax rate in 1997 reflects the higher proportion of
underwriting and risk management service income in relation to net investment
income.

On a pro forma basis, the tax provision was $3.5 million in 1995, representing
an effective tax



                                       24
<PAGE>   7

                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

rate of 26.5%. The higher effective tax rate over the actual rate was due to
increased taxable income generated from Meadowbrook's risk-management
operations.

LIQUIDITY AND CAPITAL RESOURCES

The principal sources of funds for the Company 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, and other operating
expenses. In addition, the Company has a high volume of intercompany
transactions due to the payment of management fees by the insurance subsidiaries
to the risk management subsidiaries. Such fees are subject to regulatory
approval by state insurance departments.

Cash flow (used by) from operations for 1997 was ($1.7) million as compared to
$11.6 million for 1996, and $25.0 million for 1995. The reduced cash from
operations in 1997 and 1996 reflect significant written, but uncollected,
premiums in the fourth quarter of 1997, the transfer of the surety bond program
to Connecticut Surety and the payment of claims associated with the run-off of
the surety bond program. The Company held $20.2 million in cash and cash
equivalents at December 31, 1997.

The Company has one unsecured line of credit totaling $15.0 million, of which
$10.3 was outstanding at December 31, 1997. The line expires on January 1, 2000.
The Company drew on this line of credit to meet cash flow needs, primarily to
consummate the acquisitions of both Crest and ASI and to settle claims on surety
and other discontinued programs. The Company had no debt outstanding during
1996.

The Company raised additional capital through an initial public offering in
November 1995, which generated net proceeds of $43.6 million.

As of December 31, 1997 and 1996, the recorded values of the Company's
investment portfolio, including cash and cash equivalents, were $167.3 million
and $156.5 million, respectively. The Company's investment portfolio consists
primarily of tax-exempt fixed income securities of varying maturities. In the
third quarter of 1997, the Company revised its investment policy to account for
its debt securities as available for sale which reflect industry practice. Also,
in the third quarter of 1997, the Company sold securities that had been
classified as held to maturity for the purpose of generating taxable realized
gains to utilize the tax loss carryforwards which expire in 1997 and for other
short-term operating needs. The Company has reclassified the remaining held to
maturity securities to the available for sale category.

Shareholders' equity was $115.4 million, or $13.33 per common share, at December
31, 1997, compared to $100.2 million at December 31, 1996, or $11.58 per common
share. Shareholders' equity reflects the increase of $3.1 million in the fair
values of available-for-sale debt and equity securities. Changes in
shareholders' equity related to the unrealized values of underlying portfolio
investments will continue to be volatile as market prices of debt securities
fluctuate with changes in the interest rate environment.

The insurance subsidiaries are required to maintain certain deposits with
regulatory authorities which totaled $17.6 million at December 31, 1997, and
$16.0 million at December 31, 1996.

REGULATORY ISSUES

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 seeks to maintain a ratio of consolidated gross written premium to
statutory surplus at or below 3 to 1 and a



                                       25
<PAGE>   8

                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

ratio at or below 2 to 1 on a net written premium basis. For 1997, premium
leverage ratios were 1.9 to 1 and 1.0 to 1 on a gross and net premium written
basis, 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 to be used as a
tool to identify weakly capitalized companies. At December 31, 1996, Star
Insurance Company, the parent insurance company had an RBC ratio that exceeded
applicable risk-based capital requirements. At December 31, 1997, Star's
statutory surplus was $70.0 million; the threshold requiring regulatory
involvement was $9.2 million.

REINSURANCE CONSIDERATIONS

The Company seeks to manage the risk exposure of its insurance subsidiaries and
its clients through the purchase of excess-of-loss and quota share reinsurance.
The Company's reinsurance requirements are analyzed on a specific program basis
to determine the appropriate retention levels and reinsurance coverage limits.
The Company secures this reinsurance based on the availability, cost, and
benefits of various reinsurance alternatives.

Reinsurance does not legally discharge an insurer from its primary liability for
the full amount of risks assumed under insurance policies it issues, but it does
make the assuming reinsurer liable to the insurer to the extent of the
reinsurance ceded. Therefore, the Company is subject to credit risk with respect
to the obligations of its reinsurers. In its selection of reinsurers, the
Company evaluates the financial stability of its prospective reinsurers. To
date, the Company has not experienced any material difficulties in collecting
reinsurance recoverables. No assurance can be given, however, regarding the
future ability of any of the Company's reinsurers to meet their obligations. The
following table sets forth certain information relating to the Company's five
largest reinsurers (other than client captive quota-share reinsurers) as of
December 31, 1997:

<TABLE>
<CAPTION>
                                         Reinsurance Premium Ceded      A.M. Best
REINSURER                                   December 31, 1997             Rating
                                              (in thousands)
                                         -----------------------------------------
<S>                                              <C>                      <C>
Connecticut Surety Company / NAC Re              $19,213                  * / A+
Swiss Reinsurance Corporation                      6,536                     A
Employers Reinsurance Corporation                  3,733                     A++
Lloyds of London Syndicate Number 314                585                     A
Lloyds of London Syndicate Number 205                488                     A
</TABLE>

* Not rated

In its risk-sharing programs, the Company is also subject to credit risk with
respect to the payment of claims by its clients' captive insurers on the portion
of risk exposure ceded to such captives. The capitalization and credit
worthiness of prospective captive insurers is one of the factors considered by
the Company in entering into and renewing risk-sharing programs. The Company
secures reinsurance balances due from its non-admitted reinsurers through funds
withheld trusts and letters of credit.

DEPENDENCE ON KEY PROGRAMS

The Company provides alternative risk management programs and services to
certain large client groups and associations and then markets them to their
individual members. In 1997, and in 1996, the Company's top four programs,
excluding the surety bond business, accounted for 46% and 37%, respectively, of
the Company's total revenue on an actual basis. The loss



                                       26
<PAGE>   9

                        Meadowbrook Insurance Group, Inc.

                       Management's Discussion & Analysis

or cancellation of any of the Company's significant programs by the relevant
client groups, or the general availability of commercial market coverage to
members of such groups on more favorable terms than provided under the Company's
programs, could have an adverse effect on the Company's results of operations.

NEW ACCOUNTING PRONOUNCEMENTS

In June of 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income", and SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information." SFAS No. 130 establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gains, and losses) in a full set of general-purpose
financial statements. SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements. It also requires companies to report selected information
about operating segments in interim financial reports issued to shareholders.
These standards will be adopted January 1, 1998 and are not expected to have a
material effect on the Company's financial statements.






                                       27

<PAGE>   10
                        Meadowbrook Insurance Group, Inc.

                      Selected Consolidated Financial Data

FOR THE YEARS ENDED DECEMBER 31,

<TABLE>
<CAPTION>
                                               1997         1996         1995         1994          1993
                                          --------------------------------------------------------------
                                                     (in thousands, except per share and ratio data)
<S>                                       <C>          <C>          <C>          <C>           <C>
INCOME STATEMENT DATA:
Gross written premium                     $ 146,739    $ 115,580    $ 123,119    $  90,625     $  64,816
Net written premium                          74,965       72,758       93,638       57,555        39,452
Net earned premium                           68,493       84,547       82,698       49,855        34,336

Net investment income                         8,128        8,002        5,325        3,257         2,639
Net realized gain (loss) on investments         134           25           45          (35)          (24)

Total revenue                               101,125      109,189       89,974       53,155        36,911

Net losses and LAE                           36,143       41,265       43,795       30,956        23,297
Policy acquisition and other expenses        20,180       32,079       33,721       16,950        10,527

Income before income taxes                   17,386       10,868        9,488        4,867         2,642

Net income                                   13,043        8,706        7,220        3,702         2,105

Earnings per share - Diluted                  $1.42        $0.95        $1.32        $0.95         $0.54
Dividends declared per share                  $0.08        $0.08          --           --            --

BALANCE SHEET DATA:
Total investments and
cash and cash equivalents                 $ 167,293    $ 156,495    $ 148,977    $  88,460     $  58,418
Total assets                                328,642      265,035      241,764      158,637       115,568
Loss and LAE reserves                        98,979       92,390       86,986       64,993        50,451
Shareholders' equity                        115,446      100,201       92,216       44,444        25,493

OTHER DATA:
GAAP ratios (insurance companies only)
Net loss and LAE ratio                         55.7%        52.1%        53.2%        62.1%         67.9%
Expense ratio                                  34.0%        45.0%        41.7%        34.0%         30.7%
                                          ---------------------------------------------------------------
Combined ratio                                 89.7%        97.1%        94.9%        96.1%         98.6%
                                          ===============================================================
Statutory combined ratio                       90.2%        98.1%        94.2%        96.4%         97.5%
                                          ===============================================================
Industry statutory combined ratio             101.6%       105.8%       106.4%       108.5%        106.9%
</TABLE>




                                       28
<PAGE>   11
                        Meadowbrook Insurance Group, Inc.

                Report of Management and Independent Accountants

Management is responsible for the accompanying consolidated financial statements
and all other financial information contained in the Annual Report. The
financial statements have been prepared in conformity with generally accepted
accounting principles and include amounts which of necessity are based on
management's best estimates and informed judgments under existing circumstances.

The Company maintains a system of internal controls designed to provide
reasonable assurance, at appropriate costs, that assets are safeguarded,
transactions are properly authorized and recorded, and that the financial
records provide a reliable basis for the preparation of financial statements
that are free of material misstatement.

The financial statements have been audited by the independent auditors Coopers &
Lybrand L.L.P.. Their role is to render an independent professional opinion on
management's financial statements based upon performance of procedures they deem
appropriate under generally accepted auditing standards. As part of their audit,
they evaluate the Company's internal control structure to the extent they
consider necessary to express their opinion on the consolidated financial
statements.

The Audit Committee of the Board of Directors, composed of directors who are not
officers or employees of the Company, meets periodically with management, the
Company's chief internal auditor, and with its independent auditors to discuss
their evaluation of internal accounting controls and the quality of financial
reporting. Both the independent auditors and the internal auditors have free
access to the Audit Committee to discuss the results of audits.




Merton J. Segal                                        Daniel G. Gibson
Chairman and                                           Vice President and
 Chief Executive Officer                               Chief Financial Officer


TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF MEADOWBROOK INSURANCE
GROUP, INC.:

We have audited the accompanying consolidated balance sheet of Meadowbrook
Insurance Group, Inc. (formerly "Star Holding Company") and Subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of income,
shareholders' equity, and cash flows for the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Meadowbrook
Insurance Group, Inc. and Subsidiaries as of December 31, 1997 and 1996 and the
consolidated results of their operations and cash flows for the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principals.



Detroit, Michigan
March 19, 1998




                                       29
<PAGE>   12

                        Meadowbrook Insurance Group, Inc.

                           Consolidated Balance Sheet

DECEMBER 31, 1997 AND 1996

<TABLE>
<CAPTION>
ASSETS                                                                              1997             1996
Investments:
                                                                              ---------------------------------
<S>                                                                             <C>             <C>
    Debt securities held to maturity, at amortized cost                         $           -   $ 120,116,668
        (fair value of $122,485,366)
    Debt securities available for sale, at fair value                             141,465,353      15,955,481
        (cost of $137,613,515 and $16,025,804)
    Equity securities available for sale, at fair value                             5,612,207       1,420,949
        (cost of $4,951,545 and $1,562,999)
    Cash and cash equivalents                                                      20,214,994      19,002,241
                                                                              ---------------------------------
Total investments and cash and cash equivalents                                   167,292,554     156,495,339
Accrued investment income                                                           1,766,922       1,811,195
Premiums and agent balances receivable                                             51,132,125      25,907,407
Reinsurance recoverable on:
    Paid losses                                                                     9,887,997       6,672,133
    Unpaid losses                                                                  38,192,571      26,615,052
Prepaid reinsurance premiums                                                       27,231,424      20,271,068
Funds held by or deposited with reinsured companies                                    63,515       1,042,116
Deferred policy acquisition costs                                                   6,608,500       4,264,795
Deferred federal income taxes                                                       2,880,432       6,623,758
Furniture and equipment, less accumulated depreciation of $5,282,660
    and $2,891,725 in 1997 and 1996, respectively                                   4,831,037       3,587,364
Intangible assets, less accumulated amortization of $736,007
    and $312,768 in 1997 and 1996, respectively                                     9,636,559       5,414,073
Other assets                                                                        9,118,608       6,331,041
                                                                              ---------------------------------
    Total assets                                                                $ 328,642,244   $ 265,035,341
                                                                              ---------------------------------

LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
    Reserve for losses and loss adjustment expenses                             $  98,978,937   $  92,390,227
    Unearned premiums                                                              59,168,204      44,090,675
    Payable to insurance companies                                                 10,937,481       4,457,315
    Federal income taxes payable                                                       16,184       1,666,772
    Accounts payable and accrued expenses                                           7,909,648       7,823,567
    Reinsurance funds held and balances payable                                    20,107,964       2,909,353
    Other liabilities                                                               4,613,241      11,496,598
    Lines of credit                                                                11,464,179               -
                                                                              ---------------------------------
        Total liabilities                                                         213,195,838     164,834,507
                                                                              ---------------------------------

Commitments and contingencies (note 12)
Shareholders' Equity
    Common stock, $0.01 stated value; authorized 20,000,000 shares; 8,660,164
        and 8,649,346 shares issued and outstanding in
        1997 and 1996, respectively                                                    86,602          86,493
    Additional paid-in capital                                                     72,650,671      72,873,396
    Retained earnings                                                              39,730,884      27,381,111
    Unrealized appreciation (depreciation) on available for sale securities,
        net of deferred tax (expense) benefit of $1,534,251 and ($72,207)
        in 1997 and 1996,respectively                                               2,978,249        (140,166)
                                                                              ---------------------------------
        Total shareholders' equity                                                115,446,406     100,200,834
                                                                              ---------------------------------
            Total Liabilities and Shareholders' Equity                          $ 328,642,244   $ 265,035,341
                                                                              ---------------------------------
</TABLE>



                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                   OF THE CONSOLIDATED FINANCIAL STATEMENTS.



                                       30
<PAGE>   13



                        Meadowbrook Insurance Group, Inc.

                        Consolidated Statement of Income

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

<TABLE>
<CAPTION>
                                                                    1997            1996            1995
                                                               -----------------------------------------------
<S>                                                            <C>              <C>              <C>
REVENUES
    Premiums earned

        Gross                                                  $ 133,313,937    $ 116,924,848    $ 115,248,000
        Ceded                                                    (64,820,760)     (32,378,004)     (32,549,722)
                                                               -----------------------------------------------

    Net earned                                                    68,493,177       84,546,844       82,698,278

    Net commissions and fees                                      24,360,076       16,566,327        1,885,708

    Net investment income                                          8,128,007        8,002,072        5,324,921
    Net realized gains on disposition of investments                 133,549           25,354           45,082
    Miscellaneous income                                              10,379           48,040           20,158

                                                               -----------------------------------------------
        Total Revenues                                           101,125,188      109,188,637       89,974,147
                                                               -----------------------------------------------

EXPENSES
    Losses and loss adjustment expenses                           69,288,709       64,328,606       60,216,035
    Reinsurance recoveries                                       (33,145,711)     (23,063,948)     (16,421,185)
                                                               -----------------------------------------------

    Net losses and loss adjustment expenses                       36,142,998       41,264,658       43,794,850

    Salaries and employee benefits                                27,416,141       24,976,666        2,629,486
    Other operating expenses                                      19,531,083       32,015,980       33,721,329
    Interest on notes payable                                        649,271             --            340,952
    Policyholder dividends                                              --             63,378             --
                                                               -----------------------------------------------

        Total Expenses                                            83,739,493       98,320,682       80,486,617
                                                               -----------------------------------------------

        Income before taxes                                       17,385,695       10,867,955        9,487,530
                                                               -----------------------------------------------

Federal income taxes
    Current                                                        2,114,554        3,522,801        1,984,677
    Deferred expense (benefit)                                     2,228,685       (1,360,870)         282,983
                                                               -----------------------------------------------

        Total income taxes                                         4,343,239        2,161,931        2,267,660
                                                               -----------------------------------------------

        Net income                                             $  13,042,456    $   8,706,024    $   7,219,870
                                                               ===============================================
Earnings Per Share
    Basic                                                              $1.51            $1.01            $1.45
    Diluted                                                            $1.42            $0.95            $1.32

Weighted average number of common shares
    Basic                                                          8,657,677        8,630,150        4,970,626
    Diluted                                                        9,176,754        9,184,272        5,464,936
</TABLE>


                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                   OF THE CONSOLIDATED FINANCIAL STATEMENTS.



                                       31
<PAGE>   14
                        Meadowbrook Insurance Group, Inc.

                 Consolidated Statement of Shareholders' Equity

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
                                                                                 UNREALIZED
                                                                               (DEPRECIATION)
                                                                                APPRECIATION
                                                     CLASS A      ADDITIONAL    ON AVAILABLE                       TOTAL
                                         COMMON      COMMON        PAID-IN        FOR SALE       RETAINED       SHAREHOLDERS'
                                          STOCK       STOCK        CAPITAL       SECURITIES      EARNINGS          EQUITY
                                        ----------------------------------------------------------------------------------
<S>               <C>                   <C>         <C>        <C>             <C>            <C>             <C>
Balances, January 1, 1995               $ 41,135    $ 3,712    $ 32,431,039    $  (181,253)   $ 12,149,248    $ 44,443,881

Share exchange                             3,712     (3,712)           --             --              --              --

Purchase and retirement of
2,425 shares of common stock                 (24)      --           (27,631)          --              --           (27,655)

Issuance of 2,419,118 shares
of common stock to purchase
subsidiary                                24,191       --         3,313,120           --              --         3,337,311

Issuance of 2,331,811 shares
of common stock                           23,318       --        44,219,185           --              --        44,242,503

Unrealized appreciation on
available for sale securities               --         --              --           73,450            --            73,450

Retirement of 613,171 shares
of common stock                           (6,132)      --        (7,067,062)          --              --        (7,073,194)

Net income                                  --         --              --             --         7,219,870       7,219,870
                                        ----------------------------------------------------------------------------------

Balances, December 31, 1995               86,200       --        72,868,651       (107,803)     19,369,118      92,216,166

Unrealized depreciation on
available for sale securities               --         --              --          (32,363)           --           (32,363)

Dividends declared at $0.08 per share       --         --              --             --          (690,784)       (690,784)

Issuance of 45,608 shares
of common stock                              455       --           318,284           --              --           318,739

Retirement of 16,178 shares
of common stock                             (162)      --          (466,961)          --            (3,247)       (470,370)

Tax benefit of stock option exercises       --         --           374,440           --              --           374,440

Initial public offering
- additional expenses                       --         --          (221,018)          --              --          (221,018)

Net income                                  --         --              --             --         8,706,024       8,706,024
                                        ----------------------------------------------------------------------------------

Balances, December 31, 1996               86,493       --        72,873,396       (140,166)     27,381,111     100,200,834

Unrealized appreciation
on available for sale securities            --         --              --        3,118,415            --         3,118,415

Dividends declared at $0.08 per share       --         --              --             --          (692,683)       (692,683)

Issuance of 35,409 shares
of common stock                              354       --           241,022           --              --           241,376

Retirement of 24,591 shares
of common stock                             (245)      --          (574,363)          --              --          (574,608)

Tax benefit of stock
option exercises                            --         --           110,616           --              --           110,616

Net income                                  --         --              --             --        13,042,456      13,042,456
                                        ----------------------------------------------------------------------------------
Balances, December 31, 1997             $ 86,602    $  --      $ 72,650,671    $ 2,978,249    $ 39,730,884    $115,446,406
                                        ==================================================================================
</TABLE>

                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                   OF THE CONSOLIDATED FINANCIAL STATEMENTS.


                                       32
<PAGE>   15
                        Meadowbrook Insurance Group, Inc.

                      Consolidated Statement of Cash Flows

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

<TABLE>
<CAPTION>
                                                           1997            1996           1995
                                                      --------------------------------------------
<S>                                                   <C>             <C>             <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                         $ 13,042,456    $  8,706,024    $  7,219,870
                                                      --------------------------------------------
      Adjustments to reconcile net income to
      net cash provided by operating activities:
         Amortization of intangible assets                 423,239         152,968         108,887
         Depreciation of furniture and equipment         2,390,935       1,359,752         140,817
         Net accretion of discount on bonds               (191,050)       (232,278)       (178,093)
         Gain on sale of investments                      (493,545)        (25,354)        (45,082)
         Deferred income tax (benefit) expense           2,228,685      (1,360,870)        282,983
   Changes in operating assets and liabilities:
      Decrease (increase) in:
         Accrued investment income                          44,273        (428,248)       (555,370)
         Premiums and agent balances receivable        (22,723,438)      4,027,680        (250,351)
         Reinsurance recoverable on
         paid and unpaid losses                        (14,793,383)     (7,704,557)     (5,143,566)
         Prepaid reinsurance premiums                   (6,960,356)    (10,444,335)      3,068,355
         Funds held by or deposited with
         reinsured companies                             1,014,096        (381,202)         (1,264)
         Deferred policy acquisition costs              (1,866,365)      4,799,194      (4,373,099)
         Other assets                                      (14,459)      3,154,437      (1,119,594)
      Increase (decrease) in:
         Losses and loss adjustment expenses             5,036,469       5,404,613      21,992,912
         Unearned premiums                              12,955,672        (302,298)      7,875,927
         Federal income taxes payable                   (1,590,553)      1,345,900         612,955
         Accounts payable and accrued expenses              24,808         348,059         350,668
         Insurance company payable                       2,382,159        (925,815)     (1,924,372)
         Reinsurance funds held and
         balances payable                               17,091,314      (1,311,180)     (1,612,779)
         Due to affiliates                                    --              --        (1,116,388)
         Other liabilities                              (9,733,948)      5,403,118        (286,374)
                                                      --------------------------------------------
            Total adjustments                          (14,775,447)      2,879,584      17,827,172
                                                      --------------------------------------------
         Net cash provided by operating activities      (1,732,991)     11,585,608      25,047,042
                                                      --------------------------------------------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of equity securities available for sale     (3,866,284)        (63,953)        (40,447)
   Purchase of debt securities available for sale      (25,927,260)    (17,276,583)           --
   Purchase of debt securities held to maturity               --       (26,419,086)    (45,299,301)
   Proceeds from sale of equity
   securities available for sale                           460,691         723,058          98,225
   Proceeds from sale of debt
   securities available for sale                        28,367,199       1,185,731            --
   Proceeds from maturity of
   securities held to maturity                           4,611,894      11,661,884       7,901,310
   Capital expenditures                                 (3,427,740)     (2,523,979)       (445,183)
   Proceeds from sale of furniture and equipment              --              --            65,945
   Purchase of subsidiary                               (7,821,636)       (886,570)           --
                                                      --------------------------------------------
      Net cash used in investing activities             (7,603,136)    (33,599,498)    (37,719,451)
                                                      --------------------------------------------
</TABLE>


                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                   OF THE CONSOLIDATED FINANCIAL STATEMENTS.



                                       33
<PAGE>   16
                        Meadowbrook Insurance Group, Inc.

                      Consolidated Statement of Cash Flows

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

<TABLE>
<CAPTION>
                                                                1997           1996           1995
                                                            --------------------------------------------
<S>                                                         <C>             <C>             <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from lines of credit                            $ 30,410,119    $       --      $       --
   Payments on lines of credit                               (18,945,940)           --        (8,654,672)
   Use of initial public offering proceeds                                      (221,018)           --
   Dividends paid on common stock                               (692,683)       (517,797)           --
   Retirement of common stock                                   (222,616)       (470,370)        (27,655)
   Issuance of common stock                                                      318,739      44,242,503
                                                            --------------------------------------------
      Net cash (used in) provided by financing activities     10,548,880        (890,446)     35,560,176
                                                            --------------------------------------------
   Increase (decrease) in cash and cash equivalents            1,212,753     (22,904,336)     22,887,767
   Cash and cash equivalents, beginning of year               19,002,241      41,906,577      19,018,810
                                                            --------------------------------------------
   Cash and cash equivalents, end of year                   $ 20,214,994    $ 19,002,241    $ 41,906,577
                                                            ============================================

SUPPLEMENTAL DISCLOSURE OF
   CASH FLOW INFORMATION:
   Interest paid                                            $    644,403    $     21,638    $    262,916
   Income taxes paid, net of refund                         $  3,705,108    $  2,089,225    $  1,377,251

SUPPLEMENTAL DISCLOSURE OF
NONCASH INVESTING AND FINANCING ACTIVITIES:
   Common stock issued for net
   noncash assets of acquired subsidiary                    $       --      $       --      $  3,337,311
   Dividend and retirement of common stock
   in connection with the acquisition of subsidiary         $       --      $       --      $  7,073,194
   Tax benefit from stock option exercises                  $    110,616    $    374,440    $       --
</TABLE>


                  THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
                   OF THE CONSOLIDATED FINANCIAL STATEMENTS.

                                       34

<PAGE>   17
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF FINANCIAL PRESENTATION

The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles ("GAAP"), which differ
from statutory accounting practices prescribed or permitted for insurance
companies by regulatory authorities. Prescribed statutory accounting practices
include a variety of publications of the National Association of Insurance
Commissioners ("NAIC"), as well as state laws, regulations and general
administrative rules. Permitted statutory accounting practices encompass all
accounting practices not so prescribed.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts, after intercompany
eliminations, of Meadowbrook Insurance Group, Inc., formerly known as Star
Holding Company, (the "Company"), its wholly owned subsidiary, Star Insurance
Company ("Star"), Star's wholly owned subsidiary, Savers Property and Casualty
Insurance Company ("Savers"), American Indemnity Insurance Company, Ltd.
("American Indemnity"), which is owned 50% by Star and 50% by the Company,
Meadowbrook, Inc. and its consolidated subsidiaries ("Meadowbrook"), a wholly
owned subsidiary which was acquired in November of 1995 (see Note 10), and Crest
Financial Corporation ("Crest") and its subsidiaries, including Williamsburg
National Insurance Co. ("Williamsburg"), which was acquired in July of 1997.

BUSINESS

The Company, through its subsidiaries, is engaged primarily in developing and
managing Alternative Market risk management programs for defined client groups
and their members. This includes providing services, such as reinsurance
brokering, risk management consulting, claims handling, administrative services,
along with various types of property and casualty insurance coverage, including
workers' compensation, general liability and commercial multiple peril. The
Company does not have significant exposures to environmental/asbestos and
catastrophic coverages. Insurance coverage is primarily provided to associations
or similar groups of members, commonly referred to as programs. Four programs
accounted for 46.0%, 37.1%, and 33.6% of the Company's premium revenue in 1997,
1996 and 1995, respectively. The net earned premium of the largest program in
each respective year represented 14.7%, 11.7% and 10.0% of the Company's premium
revenues in 1997, 1996 and 1995, respectively.

USE OF ESTIMATES

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

INVESTMENTS

Trading securities are investments which are purchased with the intent of
selling them in the near future. Trading securities are reported at fair value,
with changes in the fair value included in earnings. The Company does not hold
any trading securities. Held to maturity securities are those securities that
the Company has both the intent and ability to hold to maturity, and are
reported at amortized cost. Available for sale securities are those securities
that do not



                                       35
<PAGE>   18
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements

meet the requirements of the trading or held to maturity categories. Investments
are classified as available for sale securities in order to be available to be
sold in the future in response to the Company's liquidity needs, changes in
market interest rates, and asset-liability management strategies, among other
reasons. Available for sale securities are reported at fair value, with
unrealized gains and losses reported as a separate component of shareholders'
equity, net of deferred taxes. The Company's investment securities at December
31, 1996 include both available for sale and held to maturity debt securities
whereas at December 31, 1997 there were no held to maturity debt securities.

Realized gains or losses on sale or maturity of investments are determined on
the basis of specific costs of the investments. Discount or premium on debt
securities purchased at other than par value is amortized using the constant
yield method. Investments with other than temporary declines in fair value are
written down to estimated fair value and the related realized losses recognized
in income.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents includes cash on hand and highly liquid short-term
investments. The Company considers all short-term investments purchased with a
maturity of three months or less at the time of acquisition to be cash
equivalents.

DEFERRED POLICY ACQUISITION COSTS

Commissions and other costs of acquiring insurance business that vary with and
are primarily related to the production of new and renewal business are deferred
and amortized over the terms of the policies or reinsurance treaties to which
they relate. Investment earnings are anticipated in determining the
recoverability of such deferred amounts.

FURNITURE AND EQUIPMENT

Furniture and equipment are stated at cost and are depreciated using both
accelerated and straight-line methods over the estimated useful lives of the
assets, generally five to ten years. Upon sale or retirement, the cost of the
asset and related accumulated depreciation are eliminated from their respective
accounts, and the resulting gain or loss is included in income. Repairs and
maintenance are charged to operations when incurred.

INTANGIBLE ASSETS

Goodwill resulting from the acquisition of Crest in 1997 and Association Self
Insurance Services, Inc. ("ASI") in 1996 are amortized on a straight-line basis
over 20 years. Other intangibles are amortized on a straight-line basis over 3
to 5 years.

Annually, the Company evaluates the net carrying value of goodwill to determine
if there has been any impairment in value. The methodology used for this
evaluation entails review of annual operating performance along with anticipated
results for the ensuing year based on operating budgets. At December 31, 1997
the Company concluded that there had been no impairment in the net carrying
value of goodwill.

LOSSES AND LOSS ADJUSTMENT EXPENSES

The liability for losses and loss adjustment expenses ("LAE") represents (1)
case basis estimates of reported losses on direct business, (2) estimates
received from ceding reinsurers on assumed business and (3) actuarial estimates
of incurred but not reported losses and LAE. Such liabilities, by necessity, are
based upon estimates and, while management believes that



                                       36
<PAGE>   19
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements

the amount accrued is adequate, the ultimate liability may be greater or less
than the amount provided. The methods for making such estimates and for
establishing the resulting reserves are continually reviewed and updated.

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
which 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. Certain premiums are subject to retrospective
premium adjustments. The estimated ultimate premium is recognized over the term
of the insurance contract.

Commission and fee income is recorded on the later of the effective date or the
billing date of the policies on which it was earned.

Meadowbrook occasionally guarantees the financing of policies it writes. No
material premium financing guarantees were in effect at December 31, 1997.

The majority of claims processing fees are recognized as revenue over the
estimated life of the claims. For those contracts that provide services beyond
the contractually defined termination date of the related contracts, fees are
defined in an amount equal to management's estimate of the Company's obligation
to continue to provide services.

INCOME TAXES

The Company accounts for its income taxes under Statement of Financial
Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," which
requires the asset and liability method of recording income taxes. Under the
asset and liability method, deferred federal income taxes are recognized for the
tax consequences of "temporary differences" by applying enacted statutory tax
rates to differences between the financial statement carrying amounts and the
tax bases of existing assets and liabilities.

STOCK OPTIONS

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.

EARNINGS PER SHARE

The Company adopted Statement of Financial Accounting Standards ("SFAS") No 128,
`Earnings Per Share', which replaced the presentation of primary and fully
diluted earnings per share, as computed under Accounting Principles Board (APB)
No. 15 with a presentation of basic and diluted earnings per share. Adoption of
this standard did not have a material impact on reported earnings per share.

Basic earnings per share are based on the weighted average number of common
shares while diluted earnings per share included weighted average number of
common shares and stock options outstanding during the year. Stock options
included in diluted earnings per share are 519,077, 554,122 and 494,310 for the
years ended December 31, 1997, 1996, and 1995, respectively.



                                       37
<PAGE>   20

                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements



Earnings per share for 1995 has been retroactively adjusted for the effect of
the 2.975532 stock split that occurred on November 20, 1995.

RECLASSIFICATIONS

Certain amounts in the 1996 and 1995 financial statements have been reclassified
to conform with the 1997 presentation.

2. INVESTMENTS AND OTHER FINANCIAL INSTRUMENTS

The estimated fair value of investments in securities is determined based on
published market quotations. Due to the short-term nature of other financial
instruments such as cash equivalents, carrying value approximates fair value.
The cost or amortized cost and estimated fair values of investments in
securities at December 31, 1997 and 1996 are as follows:

<TABLE>
<CAPTION>
                                                             December 31, 1997
                                           ----------------------------------------------------------
                                              Cost or        Gross         Gross        Estimated
                                            Amortized     Unrealized     Unrealized        Fair
                                               Cost          Gains         Losses          Value
                                           -------------------------------------------------------
<S>                                        <C>            <C>           <C>           <C>
SECURITIES AVAILABLE FOR SALE
DEBT SECURITIES:
Debt securities issued by the
U.S. government and agencies               $  9,997,471   $  226,050    $ (68,369)    $ 10,155,152
Obligations of states and
political subdivisions                      116,810,570    3,752,699     (127,293)     120,435,976
Corporate securities                          3,586,610       21,192      (59,462)       3,548,340
Certificates of deposit                            --           --           --              --
Mortgage-backed securities                    7,218,864      138,096      (31,075)       7,325,885
                                           -------------------------------------------------------
Total Debt Securities Available for Sale    137,613,515    4,138,037     (286,199)     141,465,353

EQUITY SECURITIES:
Preferred Stocks                              3,542,663      277,380         --          3,820,043
Common Stocks                                 1,408,882      465,540      (82,258)       1,792,164
                                           -------------------------------------------------------
Total Securities Available for Sale        $142,565,060   $4,880,957    $(368,457)    $147,077,560
                                           =======================================================
</TABLE>

                                       38
<PAGE>   21
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


In the third quarter of 1997, the Company sold securities that had been
classified as held to maturity for the purpose of generating taxable realized
gains to utilize the tax loss carryforwards which expire in 1997 and for other
short-term operating needs. The specific securities sold and the related
amortized cost and realized gains are as follow:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
         SECURITY                                    AMORTIZED COST   REALIZED GAIN
-----------------------------------------------------------------------------------
<S>                                                      <C>            <C>
Municipal Bond, Chicago, IL                              $192,400       $ 16,006
Municipal Bond, Santa Ana, CA                             116,295         16,366
Municipal Bond, Wayne County, MI                          279,977         25,729
Municipal Bond, Northeastern PA Hospital                  201,173         18,355
Municipal Bond, San Diego County, CA COP                  178,170         21,174
Municipal Bond, Indiana St Education                      180,640         21,560
Municipal Bond, Massachusetts Muni                        187,857         15,725
Municipal Bond, Northeastern PA Hospital                  200,000         19,528
</TABLE>

The sale of the above held to maturity securities were for reasons other than
those permitted by Statement of Financial Accounting Standards No. 115.
Accordingly, the Company has reclassified the remaining held to maturity
securities (with an amortized cost of $114.1 million and fair value of $115.8
million) to the available for sale category.

<TABLE>
<CAPTION>
                                                                December 31, 1996
                                           ----------------------------------------------------------
                                              Cost or        Gross           Gross        Estimated
                                             Amortized     Unrealized     Unrealized         Fair
                                               Cost           Gains          Losses          Value
                                           ----------------------------------------------------------
<S>                                        <C>            <C>            <C>             <C>
SECURITIES HELD TO MATURITY
DEBT SECURITIES:
Debt securities issued by the
U.S. government and agencies               $  3,287,309   $   67,895     $   (2,213)     $  3,352,991
Obligations of states and
political subdivisions                      110,265,406    2,456,081        (70,308)      112,651,179
Corporate securities                            299,902       18,878           --             318,780
Certificates of deposit                          95,000         --             --              95,000
Mortgage-backed securities                    6,169,051       34,293       (135,928)        6,067,416
                                           ----------------------------------------------------------
Total Debt Securities Held to Maturity     $120,116,668   $2,577,147     ($ 208,449)     $122,485,366
                                           ==========================================================

SECURITIES AVAILABLE FOR SALE
DEBT SECURITIES:
Debt securities issued by the
U.S. government and agencies               $  2,995,204   $    3,856     $   (1,250)     $  2,997,810
Obligations of states and
political subdivisions                        7,897,953       15,279       (105,136)        7,808,096
Corporate securities                          2,200,733       22,818         (1,427)        2,222,124
Mortgage-backed securities                    2,931,914        2,874         (7,337)        2,927,451
                                           ----------------------------------------------------------
Total Debt Securities Available for Sale     16,025,804       44,827       (115,150)       15,955,481

EQUITY SECURITIES:
Mutual funds                                  1,562,999         --         (142,050)        1,420,949
                                           ----------------------------------------------------------
Total Securities Available for Sale        $ 17,588,803   $   44,827     $ (257,200)     $ 17,376,430
</TABLE>

                                       39
<PAGE>   22
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


Gross unrealized appreciation and depreciation on available for sale securities
were as follows:

<TABLE>
<CAPTION>
December 31,                                             1997           1996
                                                     ------------------------
<S>                                                  <C>            <C>
Unrealized appreciation                              $ 4,880,957    $  44,827
Unrealized depreciation                                 (368,457)    (257,200)
                                                     ------------------------

Net unrealized appreciation (depreciation)             4,512,500     (212,373)
Deferred federal income taxes                         (1,534,251)      72,207
                                                     ------------------------

Net unrealized appreciation (depreciation) on
investments, net of deferred federal income taxes    $ 2,978,249    $(140,166)
                                                     ========================
</TABLE>


The gross change, before tax (expense)/benefit, in unrealized
appreciation/(depreciation), on available for sale debt securities was
$3,922,161 for 1997, ($70,323) for 1996 and zero for 1995, as no available for
sale debt securities were owned during 1995. The gross change in unrealized
appreciation/(depreciation) on available for sale equity securities was
$802,712, $21,288, and $111,287 in 1997, 1996 and 1995, respectively. The
unrecorded change in market value over book value on held to maturity debt
securities was ($172,092) and $4,705,510 for 1996 and 1995, respectively. There
were no held to maturity debt securities at December 31, 1997.

The realized gains (losses) on the sale of available for sale debt securities
and equity securities for the year ended December 31, 1997 were $510,659 and
($377,110), respectively. The proceeds from these sales were $19.4 million and
$0.5 million, respectively.

The amortized cost and estimated fair value of available for sale securities at
December 31, 1997, by contractual maturity, are shown below. Expected maturities
may differ from contractual maturities because certain borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.

<TABLE>
<CAPTION>
                                                      Available for Sale
                                                   -----------------------------
                                                                     Estimated
                                                    Amortized           Fair
                                                       Cost             Value
                                                   -----------------------------
<S>                                                <C>              <C>
Due in one year or less                            $ 12,057,540     $ 12,106,695
Due after one year through five years                43,097,364       44,004,886
Due after five years through ten years               47,807,558       50,003,753
Due after ten years                                  26,612,431       27,209,599
Mortgage-backed securities                            8,038,622        8,140,420
                                                   -----------------------------
                                                   $137,613,515     $141,465,353
                                                   =============================
</TABLE>


                                       40
<PAGE>   23
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


Net investment income for the last three years ended December 31 was as follows:

<TABLE>
<CAPTION>
                                           1997           1996            1995
                                        ----------------------------------------
<S>                                     <C>            <C>            <C>
INVESTMENT INCOME ON:
Debt securities                         $7,154,057     $6,474,620     $4,534,225
Equity securities                          245,449        120,617        120,704
Cash and cash equivalents                1,070,328      1,706,296        925,736
                                        ----------------------------------------
Total gross investment income            8,469,834      8,301,533      5,580,665
Less investment expenses                   341,827        299,461        255,744
                                        ----------------------------------------
Net investment income                   $8,128,007     $8,002,072     $5,324,921
                                        ========================================
</TABLE>


United States government obligations, municipal bonds, and bank certificates of
deposit aggregating $17,628,773 and $16,027,911 were on deposit with state
regulatory authorities as required by law at December 31, 1997 and 1996,
respectively.

3. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

The Company regularly updates its reserve estimates as new information becomes
available and further events occur which may impact the resolution of unsettled
claims. Changes in prior reserve estimates are reflected in results of
operations in the year such changes are determined to be needed and recorded.
Activity in the reserves for losses and loss adjustment expenses is summarized
as follows (in thousands):

<TABLE>
<CAPTION>
                                                            1997          1996
                                                          -----------------------
<S>                                                        <C>           <C>
Balance, beginning of year                                 $92,390       $86,986
Less reinsurance recoverables                               26,615        22,318
                                                          -----------------------
Net balance, beginning of year                              65,775        64,668
                                                          -----------------------
Incurred related to:
         Current year                                       34,908        40,875
         Prior years                                         1,235           390
                                                          -----------------------
Total incurred                                              36,143        41,265
                                                          -----------------------
Paid related to:
         Current year                                        9,506        16,754
         Prior years                                        31,626        23,404
                                                          -----------------------
Total paid                                                  41,132        40,158
                                                          -----------------------
Net balance, end of year                                    60,786        65,775
         Plus reinsurance recoverables                      38,193        26,615
                                                          -----------------------
Balance, end of year                                       $98,979       $92,390
                                                          =======================
</TABLE>


As a result of unfavorable development in estimates of prior accident years'
reserves, the provision for losses and loss adjustment expenses increased by
$1,235,000 and $390,000 in 1997 and 1996, respectively. This adverse development
reflects the runoff of discontinued Surety Bond business.

4. REINSURANCE

The insurance 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 losses arising from large risks or from hazards of an
unusual nature. The ceding of insurance does not discharge the original insurer
from its primary liability to its policyholder, and in the event that all or any
of the reinsuring companies are unable to meet their obligations under



                                       41
<PAGE>   24
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


existing reinsurance agreements, the subsidiaries would be liable for such
defaulted amounts. 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.

The Company receives ceding commissions in conjunction with reinsurance
activities. These ceding commissions are offset against the related underwriting
expenses and were $22,168,969, $14,843,140, and $7,931,632 for 1997, 1996, and
1995, respectively.


In December 1996, Star ceded $11.9 million of surety bond unearned premium to
Connecticut Surety Company. Liabilities due to Star at December 31, 1996 were
secured by a cut-through reinsurance endorsement provided by NAC Reinsurance
Corporation. Future liabilities will be further secured by letters of credit and
funds withheld trusts. This transaction had no material impact on net income,
since ceding commissions received offset the amortization of deferred
acquisition costs.

Reconciliations of direct to net premiums, on both written and earned bases, for
1997, 1996, and 1995 are as follows:

<TABLE>
<CAPTION>
                      1997                               1996                           1995
          --------------------------------------------------------------------------------------------------
             Written           Earned          Written           Earned          Written           Earned
          --------------------------------------------------------------------------------------------------
<S>       <C>              <C>              <C>              <C>              <C>              <C>
Direct    $ 133,476,972    $ 118,980,133    $ 112,279,247    $ 113,874,603    $ 117,633,933    $ 108,332,771
Assumed      13,262,230       14,333,787        3,300,609        3,050,245        5,485,181        6,915,229
Ceded       (71,774,361)     (64,820,760)     (42,822,340)     (32,378,004)     (29,481,367)     (32,549,722)
          --------------------------------------------------------------------------------------------------
Net       $  74,964,841    $  68,493,160    $  72,757,516    $  84,546,844    $  93,637,747    $  82,698,278
          ==================================================================================================
</TABLE>

One reinsurer accounts for 26.8% of ceded premiums.

5. DEFERRED POLICY ACQUISITION COSTS

The following reflects the amounts of policy acquisition costs deferred and
amortized (in thousands):

<TABLE>
<CAPTION>
                                               --------------------------------
For the years ended December 31:                   1997        1996        1995
                                               --------------------------------
<S>                                            <C>         <C>         <C>
Balance, beginning of period                   $  4,265    $  9,064    $  4,691
Acquisition costs deferred                        8,374       7,036      19,119
Amortized to expense during the period           (6,030)    (11,835)    (14,746)
                                               --------------------------------
Balance, end of period                         $  6,609    $  4,265    $  9,064
                                               ================================
</TABLE>


6. INCOME TAXES

The provision for income taxes consists of the following (in thousands):

<TABLE>
<CAPTION>
                                              ----------------------------------
For the years ended December 31:                 1997         1996          1995
                                              ----------------------------------
<S>                                           <C>          <C>           <C>
Current tax expense                           $ 2,114      $ 3,523       $ 1,985
Deferred tax expense/(benefit)                  2,229       (1,361)          283
                                              ----------------------------------
Total provision for income taxes              $ 4,343      $ 2,162       $ 2,268
                                              ==================================
</TABLE>




                                       42
<PAGE>   25
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


A reconciliation of the Company's tax provision on income from operations to the
U.S. federal income tax rate of 34% in 1997, 1996, and 1995 is as follows (in
thousands):

<TABLE>
<CAPTION>
                                                For the Years Ended
                                                     December 31
                                           -----------------------------------
                                              1997          1996          1995
                                           -----------------------------------
<S>                                        <C>           <C>           <C>
Tax provision at statutory rate            $ 5,911       $ 3,695       $ 3,226
Tax effect of:
         Tax exempt interest                (1,658)       (1,566)       (1,016)
         Other, net                             90            33            58
                                           -----------------------------------
Federal income tax expense                 $ 4,343       $ 2,162       $ 2,268
                                           ===================================
Effective tax rate                            25.0%         19.9%         23.9%
</TABLE>


Deferred federal income taxes, under SFAS No. 109, reflect the estimated future
tax effect of temporary differences between the bases of assets and liabilities
for financial reporting purposes and such amounts as measured by tax laws and
regulations.

The components of deferred tax assets and liabilities as of December 31, 1997
and 1996 are as follows (in thousands):

<TABLE>
<CAPTION>
                                                         1997                                1996
                                            ----------------------------------------------------------------
                                             Deferred          Deferred          Deferred        Deferred
                                               Tax                Tax              Tax              Tax
                                              Assets          Liabilities         Assets         Liabilities
                                            ----------------------------------------------------------------
<S>                                            <C>               <C>               <C>               <C>
Unpaid losses and loss
adjustment expenses                            $4,263            $ --              $4,613            $ --
Unearned premium reserves                       1,976              --               1,325              --
Unrealized (Gain) / Loss                         --               1,534                72              --
Deferred policy acquisition expense              --               2,247              --               1,442
Deferred compensation                             391              --                 500              --
Deferred fee recognition                          385              --               1,564              --
Other                                             150               504                56                64
                                            ----------------------------------------------------------------
Total deferred taxes                           $7,165            $4,285            $8,130            $1,506
                                            ----------------------------------------------------------------
Net deferred tax assets                        $2,880                              $6,624
                                            ================================================================
</TABLE>


7. LINES OF CREDIT AND LETTERS OF CREDIT

At December 31, 1997, the Company and its subsidiaries had one unsecured line of
credit with a bank which permits borrowings up to $15,000,000 and expires on and
is payable by January 1, 2000. This line bears interest at one percent under the
prime rate (prime was 8.50% at December 31, 1997). The Company also has the
option to elect a eurodollar based rate in place of prime. At December 31, 1997,
$10,339,507 was outstanding under this line.

In addition, one subsidiary had a secured line of credit with a bank which
permits borrowings up to 30% of the accounts receivable which secure the line.
The line expires February 28, 1998 and is automatically renewable each year.
This line bears interest at 3/4% under the prime rate (prime was 8.50% at
December 31, 1997). At December 31, 1997, $1,124,671 was outstanding under this
line.

As of December 31, 1997, a standby letter of credit of $10,320,000 had been
issued by a bank to an insurance subsidiary of the Company, under an agreement
expiring June 30, 1998, with extensions granted on a yearly basis. This letter
of credit is being utilized as security for a surety bond filed with one state.
This bond was filed as a requirement for writing workers'



                                       43
<PAGE>   26
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


compensation business in that state. The letter of credit is collateralized by
specifically identified marketable securities of the subsidiary, with a total
fair market value of 110% of the $10,320,000 letter of credit.

8. SHAREHOLDERS' EQUITY

The Company issued 2,300,000 shares of common stock at a price of $21 a share
through an initial public offering in November 1995. Simultaneously, the Company
changed its name from Star Holding Company to Meadowbrook Insurance Group, Inc.
and acquired the common stock of Meadowbrook in exchange for 2,419,118 shares of
common stock of the Company. Upon acquisition, Meadowbrook declared and paid a
dividend to the Company in the form of 613,171 shares of common stock of the
Company which it held; such shares have been retired.

A significant portion of the Company's consolidated assets represents assets of
the Company's insurance subsidiaries that may not be transferable to the holding
company in the form of dividends, loans or advances. The restriction on the
transferability to the holding company from its insurance subsidiaries is
limited by Michigan regulatory guidelines which are as follows: The maximum
discretionary dividend that may be declared, based on data from the preceding
calendar year, is the greater of the insurance company's net income (excluding
realized capital gains) OR ten percent of the insurance company's policyholders'
surplus (excluding unrealized gains). These dividends are further limited by a
clause in the Michigan law which prohibits an insurer from declaring dividends
except out of earned surplus earnings of the company. Since Star is the parent
insurance company, its maximum dividend calculation represents the combined
insurance companies. Based upon the 1997 statutory financial statements of Star
Insurance Company, the maximum dividend that may be paid by Star as of January
1, 1998, without prior approval of the Michigan Commissioner of Insurance, is
$6.9 million, which is the amount of earned surplus. No dividends were paid or
returned in 1997,1996 and 1995.

Summarized 1997 and 1996 statutory basis information for the primary insurance
subsidiaries, which differs from generally accepted accounting principles,
follows:

<TABLE>
<CAPTION>
                                             1997                          1996
                                  -----------------------------      ----------------------------
                                        Star          Savers              Star          Savers
                                  -----------------------------      ----------------------------
<S>                               <C>              <C>               <C>             <C>
Statutory capital and surplus     $ 70,050,890     $ 21,777,562      $ 64,642,412    $ 20,711,906
Minimum statutory capital
and surplus                          5,000,000       20,000,000         5,000,000      20,000,000
Statutory net income                 8,274,148        4,175,272         7,503,071       3,920,748
Net investment income                6,760,010        2,978,422         4,810,325       2,380,230
</TABLE>

The net investment income and statutory net income in 1995 for Star were
$3,048,077 and $196,706, respectively, and for Savers were $2,053,687 and
$2,587,872.

The statutory capital and surplus, net investment income and statutory net
income since the date of acquisition July 1, 1997 for Williamsburg were
$6,372,522, $257,914 and $400,884, respectively.

9. STOCK OPTIONS

The Company, through its 1995 Stock Option Plan ("the Plan"), may grant options
to key executives of the Company and its subsidiaries of up to 2,000,000 shares
of the Company's common stock. The Plan is administered by a committee (the
"Committee") appointed by the Board of Directors. Option shares may be exercised
subject to the terms of the Plan and the terms prescribed by the Committee at
the time of grant. Currently, the Plan's options have either five or ten year
terms and are exercisable/vest in equal increments over the option term.

                                       44
<PAGE>   27
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


Effective for December 31, 1996 year-end financial statements, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standards
No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation." This standard
permits the Company to adopt the SFAS No. 123 fair value based method of
accounting for stock based compensation plans or to continue to apply the
valuation provisions of existing accounting standards (APB No. 25). The Company
has elected to continue measuring compensation expense under APB No. 25 and has
adopted the disclosure requirements of SFAS No. 123. If compensation cost for
stock option grants had been determined based on the fair value method
prescribed by SFAS No. 123, net income and earnings per share on a pro forma
basis for 1997, 1996 and 1995 would be as follows:

<TABLE>
<CAPTION>
                                                       1997                1996                    1995
                                                ------------------------------------------------------------
<S>                                               <C>                  <C>                    <C>
Reported net income                               $ 13,042,456         $ 8,706,024             $ 7,219,870
Pro forma net income, using SFAS No. 123          $ 12,784,733         $ 8,635,170            *$ 7,219,870
Earnings per share, diluted:
         Reported                                      $  1.42             $  0.95                  $  1.32
         Pro forma, using SFAS No. 123                 $  1.39             $  0.94                 *$  1.32
</TABLE>

*Options granted during 1995 did not become exercisable until 1996, and
therefore no pro forma compensation expense until 1996.

The Black-Scholes valuation model utilized the following annualized assumptions
for all applicable years: Risk-free interest rate of 6.25% for 1997 and 6.5% for
both 1996 and 1995, dividend yield of $.08 per share, and volatility factor for
the expected market price of the Company's common stock of .243. The
weighted-average expected life of options for the 1997, 1996 and 1995 grants are
7.5, 7.61, and 7.74 years, respectively.

The following is a summary of the Company's stock option activity and related
information for the years ended December 31:

<TABLE>
<CAPTION>
                                           1997                      1996                  1995
                                  --------------------------------------------------------------------------
                                                  Weighted-              Weighted-                Weighted-
                                                  Average                 Average                 Average
                                                  Exercise                Exercise                Exercise
                                     Options       Price    Options        Price      Options       Price
                                  --------------------------------------------------------------------------
<S>                               <C>             <C>      <C>           <C>          <C>        <C>
Outstanding - beginning of year      953,799      $11.78   949,434       $ 10.28      209,775     $8.34
Exchange of existing options              --          --        --            --      572,285    $11.34
Granted                              101,754      $22.71    63,280        $30.45      167,374     $9.11
Exercised                            (35,409)      $6.82   (45,524)        $7.00           --        --
Forfeited                                 --                    --       (13,391)      $10.25        --
                                  --------------------------------------------------------------------------
Outstanding - end of year          1,020,144      $13.04   953,799        $11.78      949,434    $10.28
                                  ==========================================================================
Exercisable at end of year           442,829      $10.65   326,017         $9.03      227,952     $6.64
Weighted-average fair value of
options granted during the year   $     7.30          --     $7.65            --        $1.82*       --
</TABLE>

Note: SFAS 123 requires disclosure for 1995 and 1996 only.
* Options granted during 1995 did not become exercisable until 1996, and
therefore no pro forma compensation expense until 1996.

                                       45
<PAGE>   28
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


The following table summarizes information about stock options outstanding at
December 31, 1997:

<TABLE>
<CAPTION>
                                                    Options Outstanding          Options Exercisable
                                  --------------------------------------------------------------------
                                                  Weighted-        Weighted-                 Weighted-
                                                   Average         Average                    Average
     Range of                                     Remaining        Exercise                   Exercise
  Exercise Prices                  Options          Lie             Price        Options        Price
------------------------------------------------------------------------------------------------------
<S>                                 <C>           <C>               <C>           <C>           <C>
$ 5.10   to   $ 8.11                515,661       3.8 years         $ 6.32        277,461       $ 5.81
$10.25   to   $12.17                133,900          7.1            $11.10         46,117       $11.24
$21.00   to   $30.45                370,583          7.8            $23.08        119,251       $21.68
                                  --------------------------------------------------------------------
                                  1,020,144          6.8            $13.04        442,829       $10.65
                                  ====================================================================
</TABLE>

No compensation cost has been recorded for stock option grants issued during
1997, 1996 and 1995, as the market value equaled the exercise price at the date
of grant. All pre-IPO outstanding options of Meadowbrook and the Company were
exchanged for 743,885 options to purchase the Company's stock under the
Meadowbrook Insurance Group, Inc. 1995 Stock Option Plan. The exercise prices of
the new options are equivalent to the exercise prices of the exchanged options
after reflecting the effects of the stock split and share exchange related to
the acquisition of Meadowbrook (refer to Note 10). Additionally, all non-vested
Meadowbrook stock awards were exchanged for 205,549 options to purchase the
Company's common stock at $21 a share.



                                       46
<PAGE>   29
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements


10. ACQUISITION OF SUBSIDIARY

In July of 1997, the Company acquired Crest, at a purchase price of $9.4
million, resulting in $3.2 million of goodwill. Crest is a California based
holding company which holds 100% of Williamsburg, an insurance carrier, and
Crest Financial Services, a risk management service company. Crest provides
these services primarily to the trucking industry within California.

In November of 1996, the Company acquired ASI of Alabama at a purchase price of
$5.2 million, resulting in $5.2 million of goodwill. The purchase price is
subject to reduction, contingent on a specific contract renewal. The acquisition
was accounted for as a purchase. The effect of the acquisition was not material
to the Company's results of operations.

On November 20, 1995, the Company acquired Meadowbrook, Inc., an affiliated
company formed in 1955. The acquisition of Meadowbrook represents an exchange of
non-monetary assets by a promoter/shareholder for common stock of the Company
and is recorded at the transferor's historical basis (see Note 10).

The following pro forma financial information reflects this transaction as if it
has been completed as of January 1, 1995 (unaudited):

<TABLE>
<CAPTION>
                                                                        1995
                                                                      ---------
<S>                                                                   <C>
Revenues
    Risk management fees and commissions                              $  15,766
    Net earned premium                                                   82,698
    Net investment income                                                 5,613
    Other income                                                             83
                                                                      ---------
    Total revenues                                                      104,160
                                                                      ---------
Expenses
    Net losses and LAE                                                   41,673
    Underwriting and other expenses                                      28,740
    Salaries and employees benefits                                      20,001
    Interest expense                                                        576
                                                                      ---------
           Total expenses                                                90,990
                                                                      ---------
Pretax Income                                                            13,170
    Taxes                                                                (3,495)
                                                                      ---------
Net Income                                                            $   9,675
                                                                      =========
    Earnings per share                                                $    1.37
</TABLE>

11. EMPLOYEE BENEFIT PLANS

Company employees over the age of 21 who have completed 12 months of service and
worked at least 1,000 hours during those 12 months are eligible for
participation in Meadowbrook's 401(K) Profit Sharing Plan. The plan provides for
discretionary matching contributions and/or profit sharing contributions at the
discretion of the Board of Directors. In 1997, 1996 and 1995, the matching
contributions were $357,542, $295,671 and $23,721, respectively. Profit sharing
contributions were $424,459 and $53,916 in 1996 and 1995, respectively. There
were no profit sharing contributions in 1997. The increases in 1996 over 1995
reflects that there was only forty days of activity during 1995, from the date
of the Meadowbrook acquisition on November 20,1995 through December 31, 1995.



                                       47
<PAGE>   30

                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements

12. COMMITMENTS AND CONTINGENCIES

The Company has certain operating lease agreements for its offices and
equipment. At December 31, 1997, future minimum rental payments required under
non-cancelable long-term operating leases are as follows:

<TABLE>
<CAPTION>
<S>                                                     <C>
         1998                                           $  2,495,318
         1999                                              2,228,231
         2000                                              2,154,920
         2001                                              1,646,569
         2002                                              1,335,113
         Thereafter                                        2,248,327
                                                        ------------
         Total minimum lease commitments                $ 12,108,478
                                                        ============
</TABLE>


Rent expense for the year ended December 31, 1997, and 1996 amounted to
$1,972,044, and $1,480,000, respectively. Rent expense during 1995 was
immaterial.

On June 26, 1995, two shareholders of a former agent of Star initiated legal
proceedings against, among others, Star and Meadowbrook. The plaintiffs have
requested injunctive relief, compensatory damages, punitive and exemplary
damages, and attorney's fees in an unspecified amount. The Nevada Insurance
Department revoked the license of the first plaintiff and denied further
licensing of the second plaintiff. The Company is vigorously defending itself
and has filed counterclaims against the plaintiffs. While the Company believes
that it has meritorious defenses and counterclaims in this lawsuit, there can be
no assurance that the Company's results of operations and financial condition
will not be materially adversely affected by this lawsuit. The ultimate outcome
of the lawsuit cannot be determined at this time, and the Company is unable to
estimate the range of possible loss, if any.

13. RELATED PARTY TRANSACTIONS

The Company and its subsidiaries have a management services agreement with
Meadowbrook, under which Meadowbrook furnishes their accounting, financial
reporting, underwriting, reinsurance, sales, claims, loss prevention and general
management services. The terms of the agreement continue through 1997 and
automatically renew for successive five-year periods unless terminated by either
party 90 days prior to expiration.

Fees under the agreement are a combination of fixed charges and profit sharing
based on the results of operations. The fees expensed were $10,571,636 for 1995
prior to acquisition. Subsequent to the acquisition in November 1995, such fees
are eliminated in consolidation.

Prior to the acquisition of Meadowbrook, it acted as an agent and produced a
significant portion of the business written by the Company's insurance
subsidiaries. Subsequent to the acquisition, effects of the transactions are
eliminated in consolidation. There are no amounts as of and for the years ended
December 31, 1997 and 1996, as the effects of related party transactions are now
eliminated in consolidation. The 1995 results of operations include commissions
and claims & loss control fees from affiliates of $775,179 and $2,927,998,
respectively.



                                       48
<PAGE>   31
                        Meadowbrook Insurance Group, Inc.

                   Notes to Consolidated Financial Statements



13. QUARTERLY FINANCIAL DATA (unaudited)


<TABLE>
<CAPTION>
                                               1st Quarter   2nd Quarter     3rd Quarter    4th Quarter
-------------------------------------------------------------------------------------------------------
                                                     (in thousands, except per share and ratio data)
<S>                                               <C>            <C>            <C>            <C>
1997:
Gross written premium                             $32,990        $30,558        $33,347        $49,844
Net written premium                                18,256         16,246         16,178         24,285
Net earned premium                                 14,791         16,963         17,150         19,589
Net commissions and fees                            5,640          5,406          7,166          6,148
Net investment income and realized gains/losses     1,947          2,031          2,056          2,228
Net losses and LAE incurred                         7,879         11,253          8,400          8,611
Policy acquisition and other expenses               4,329          2,189          6,725          6,937

Net income                                          2,973          3,495          3,178          3,397
Earnings per share                                  $0.33          $0.38          $0.35          $0.37
Dividends declared per share                        $0.02          $0.02          $0.02          $0.02

GAAP combined ratio                                  88.1%          89.4%          89.9%          91.3%
</TABLE>

<TABLE>
<CAPTION>
                                               1st Quarter   2nd Quarter     3rd Quarter    4th Quarter
-------------------------------------------------------------------------------------------------------
                                                     (in thousands, except per share and ratio data)
<S>                                               <C>         <C>           <C>           <C>
1996:
Gross written premium                             $31,231      $27,995       $25,791         $30,563
Net written premium                                22,675       20,400        18,664          11,019
Net earned premium                                 21,266       20,103        22,429          20,749
Net commissions and fees                            4,598        4,043         3,291           4,634
Net investment income and realized gains/losses     2,002        1,993         1,945           2,087
Net losses and LAE incurred                        11,709        7,746        11,738          10,072
Policy acquisition and other expenses               6,701        8,455         9,392           7,531

Net income                                          2,773        3,114           492*          2,327
Earnings per share                                  $0.30        $0.34         $0.05           $0.26
Dividends declared per share                       ,$0.02        $0.02         $0.02           $0.02

GAAP combined ratio                                  97.4%        93.5%        101.4%           95.8%
</TABLE>

*Due to the adverse development in the surety bond business related to
discounted agents



                                       49