Fundamentally
                                      1998











                     PENN-AMERICA GROUP, INC. ANNUAL REPORT

<PAGE>
Penn-America Group, Inc. (NYSE: PNG) is a specialty niche insurance company
which, through its subsidiaries Penn-America Insurance Company and Penn-Star
Insurance Company, underwrites commercial property and casualty, general
liability, commercial multi-peril and commercial automobile insurance. The
company also underwrites minimum limits non-standard personal automobile
insurance in California.

Penn-America has developed a unique and profitable niche providing small premium
insurance products to individuals and small businesses in small cities and towns
in all 50 United States and the District of Columbia, through a controlled
network of 57 wholesale general agents. These entrepreneurial agents, with whom
the company has unique and enduring relationships, live and work in the very
markets they serve to provide a finely tuned, highly efficient system for
spotting and responding to market opportunities. The company was built upon a
general insurance agency established, in 1947, by the family that still holds
about one-third of the company's outstanding shares.

Penn-America's "small thinking" philosophy and its dogged adherence to the five
fundamental principles illustrated in this annual report to stockholders have
created a remarkable, profitable distribution system for serving markets in
which the demand for the company's insurance products is steady.

Penn-America, with 9,395,854 shares outstanding, is traded on the New York Stock
Exchange under the symbol PNG. In 1998, the company paid quarterly dividends of
$.05 per share. Rated "A" (Excellent) by A.M. Best Company, it is located in
Hatboro, Pennsylvania, a small town near Philadelphia.


Exchange/Symbol                              NYSE/PNG 
--------------------------------------------------------------
Shares Outstanding                           9,395,854 
--------------------------------------------------------------
Closing Price                                $ 9.0625
--------------------------------------------------------------
52-week Range                                $ 23.00-$8.25
--------------------------------------------------------------
Market Capitalization                        $ 85.1 million
--------------------------------------------------------------
Price/Book Ratio                             0.85x 
--------------------------------------------------------------
Stockholders' Equity                         $ 100.6 million 
--------------------------------------------------------------
Book Value Per Share                         $ 10.71
--------------------------------------------------------------
Net Operating Earnings 
        Per Share
        Basic                                $ 0.91  
        Diluted                              $ 0.90
--------------------------------------------------------------
Net Earnings Per Share
--------------------------------------------------------------
        Basic                                $ 0.91
        Diluted                              $ 0.90
--------------------------------------------------------------
Price/Earnings Ratio
        Basic                                9.96x
--------------------------------------------------------------
        Diluted                              10.07x
--------------------------------------------------------------
Dividends Per Share                          $ 0.20 annual
--------------------------------------------------------------
Dividend Yield                               2.2%
--------------------------------------------------------------
All figures as of 12/31/98

<PAGE>
Penn-America Group 1998 Annual Report


                                                   THE FUNDAMENTAL THINGS APPLY.

     It's still the same old story: the fundamentals of a well-managed insurance
company never change. But, as during most of 1998, there were times that this
core belief of ours was tested against the realities of a harsh environment. I
am proud to report that Penn-America passed the tests of 1998 and emerged
stronger, wiser and even more focused on the five principles on which we have
built an insurance company worthy of your investment:

* Solid relationships;
* Sound underwriting;
* Adequate reserves;
* Strong reinsurance partnerships; and
* Prudent investing.

     As you will see throughout this report, we believe that these fundamentals
are as enduring as the images we've chosen to represent them. And, as our agents
explain in their own words in the next few pages, these principles are the very
heart of Penn-America.

     Two things are true about those of us who make investments in the insurance
industry. First: we know that a well-managed insurance company is an excellent
business enterprise, an efficient machine for accumulating assets. Second: we
know that this statement is true only from the perspective of years rather than
moments in time. Managing or investing in a small, specialized insurance company
requires a steady hand - and steady nerves - especially when the confluence of
events produces a year such as 1998!

     I have spent my entire life in this industry. Without hesitation I can say
that I have never seen a year such as the one we have just passed. You see, we
effectively sell two products: insurance and our stock. The markets for both of
our products were far from sanguine in 1998.

     As an insurance company, our marketplace was disrupted by a few large,
brand name companies that decided to mortgage their own futures, selling
products well below their costs, almost literally stealing market share, growing
for the sake of it.

     Some insurers responded in kind, borrowing against future earnings. We did
not and will not do the same. We put the brakes on our top line growth to
preserve bottom line profitability. No company can afford to sell its products
below cost for long. We are first, last and always an insurance company. If we
weren't making a profit at what we do - underwriting insurance - we wouldn't be
acting as stewards of our stockholders' capital and, plainly, we would have no
business being in the insurance business. 

     As a small cap public company, we also shared the fate of many public
companies like ours: the small cap sector fell out of favor and performed, for
the first time in memory, less well than large cap stocks. Investor confidence
in the stock market was shaken, too, as the markets whipsawed in the second half
of the year beginning, ironically, on the very day my dad, my brother and I rang
the opening bell at the New York Stock Exchange. 

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<PAGE>



At its heart, a successful business is nothing more than successful
relationships, at every level, in all directions. The things that make any
relationship work make business relationships work too: intimacy, trust,
respect, communication. These are the values that guide our relationships with
our employees, agents, insureds, stockholders, vendors, regulators, our
community and anyone else we touch.

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<PAGE>
     I don't mind saying that I struggled with my own urge to take actions to
grow this business at the same industry-leading pace we have maintained since
the day we first offered shares in Penn-America to the public. Like you, I would
rather be congratulated on phenomenal growth than questioned about merely
much-better-than-average performance. But I was supported at every turn by a
strong, deep team of senior executives and specialized managers who genuinely
believe that we are doing the right things here at Penn-America. At every turn,
we stood on our principles despite compelling internal and external pressures to
do otherwise. These principles always will stand-up to anything that either the
insurance or financial markets can deliver.

     You will not be surprised to learn that I am disappointed that our growth
during 1998 did not mirror the double-digit rates we've produced consistently
since we became a public company. But, as you must agree by virtue of the fact
that you are reading these pages, making a profit is a far sight better than the
alternative. I believe that keeping this sharp focus on the fundamentals is what
youpay us to do as the appointed stewards of your capital. That is precisely
why, in early 1999, we made the decision to focus our non-standard personal
automobile business exclusively in California.

     We have built a reputation as quick, nimble and responsive, guerilla night
fighters if you will. In 1998, we faced the reality of the marketplace, where
the enemy was short-term thinking, fueled by greed. Quickly, nimbly we responded
to the new threat, realizing that it would be foolhardy to engage in those same
tactics. To operate otherwise would have been completely out of character for
this company and wrong for its future.

     I hope you won't interpret these thoughts as an excuse because, bluntly,
nothing about Penn-America's performance last year begs for pardon! After all,
in 1998, we added $8.9 million to the bottom line of your company! And, as I've
said many times, it happened in typical non-dramatic fashion. We're constantly
tweaking, improving, experimenting, expanding, listening and moving forward in
small, incremental steps. For example:

*    We began trading on the New York Stock Exchange, in August, under the
     symbol PNG. Our move from the NASDAQ exchange was designed to broaden the
     market for our securities, to reduce the costs of trading shares in
     Penn-America and to reduce volatility in trading. We also believe that
     Penn-America benefits from the prestige of being associated with a position
     on "The Big Board;"

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<PAGE>

*    We distributed $1,951,000 in quarterly dividends of $.05 per share, a 25
     percent increase in the dividend paid during the previous year. To date, we
     have distributed $4,389,000 in dividends to our stockholders, made possible
     because of profitable growth through dedication to our core principles;

*    We expressed our continuing belief in the fundamental strengths of
     Penn-America - at a time during which the marketplace did not reflect the
     value of the company - by aggressively repurchasing our stock. By year-end,
     we had repurchased 542,325 shares of the one million we have been
     authorized to acquire;

*    We established a new banking relationship with First Union National Bank
     through an initial $25 million revolving credit facility which may be used
     in 1999, in part, to fund the continuing stock repurchase program;

*    We  again  earned  an  "A   (Excellent)"   rating  by  A.M.  Best  Company.
     Significantly,  this rating also includes,  through a pooling  arrangement,
     our newest subsidiary, Penn-Star Insurance Company;

*    We upgraded key aspects of our technology. These included the addition of
     new Internet functions to provide our agents with secure, customized
     information about their relationship with us; and substantially upgrading
     the speed of our mainframe computer system. We also completely redesigned
     our presence on the World Wide Web at www.penn-america.com. (Last year, we
     reported that we were working toward remediating the Y2K problem. A
     detailed report begins on page 15;)

*    We increased the commission we pay to our commercial agents by two points
     (a ten percent increase) from 20 percent to 22 percent. While this
     increased our expenses, it was a vital change that also improved our
     competitive position;

*    We surveyed our agents again during 1998 and the results were gratifying:
     we are the number one or two carrier in 80 percent of our agents' offices
     for our type of business. And, even considering the appointment of six new
     agents and the addition of three offices to existing agents' networks - a
     total of 203 new people with underwriting authority ratings of our market
     share, position as a key supplier and levels of service actually improved
     slightly over last year's rating, to 6.5 on a scale of 7.0;

*    We continued to invest in our agency relationships through our annual
     agency "road show." In late summer, our underwriters and key executives
     visited personally with 160 commercial lines agency personnel at
     conferences we held in Nevada, Georgia, Texas, Illinois, Connecticut and
     here in Hatboro, Pennsylvania.

4
<PAGE>


"Penn-America is the best at what it does. There are a lot of reasons for that.
But one that particularly impresses me is the fact that their reinsurers also
understand my marketplace. No other company is so dedicated to understanding who
I am and what I need." 

     Curtis Anderson, CIC, Chairman
     SKANCO International, Ltd.
     Scottsdale AZ


5
<PAGE>
*    In October, we convened our annual Agents' Advisory Council as part of our
     ongoing effort to better understand and serve these crucial partners;

*    We continued to add, expand, refine and improve our product offerings,
     always because one or more of our agents has an opportunity that we can
     capture together with creative thinking, flexibility and fast action:

     *    The commercial auto and garage liability programs we introduced at the
          end of 1997 began to contribute in a significant way to revenues. To
          support this growing program, we ran a special series of educational
          and promotional seminars in the Spring. The product now is offered on
          an admitted basis in 30 states and in four states on a non-admitted
          basis;

     *    The commercial umbrella program, introduced at the end of 1997, also
          is performing well. It now is offered either on an admitted or a
          non-admitted basis in all but one state;

     *    Three new programs were started in 1998, including a motor truck cargo
          program introduced early in the year and available now in about
          one-third of the nation; a program that provides protection for small
          courier and messenger firms; and a dwelling program in Alaska;

     *    At the beginning of 1999, we re-focused our non-standard personal
          automobile insurance program. Now, we offer this product only in
          California and are running-off this business in six other states.
          Although we took many steps during 1998 to improve the profitability
          of this line, the marketplace changed fundamentally - from a very
          Penn-America niche market to a commodity business. In California,
          where our long-term agent has converted successfully to the direct
          selling model required to succeed in commodity markets, we have been
          very successful. Through this relationship, we will retain about 60%
          of our total portfolio of non-standard personal automobile business.

     We are an insurance company. The fundamental things still apply. Solid
relationships. Sound underwriting. Adequate reserves. Strong reinsurance
partnerships. Prudent investing. During 1998 we clung to these fundamentals.
Perhaps of greatest importance is the fact that we honored the relationships we
have with our agents by maintaining our pricing - and the long-term integrity of
our agents' livelihoods - at a time when many insurers did not. We never lost
sight of the fact that the success of our business is utterly dependent upon the
success of theirs. This fact will be the foundation of our success in 1999.

     I have enormous optimism for the future. Most important, because of the
decisive actions we took during the past year, Penn-America is ready for that
future, standing on a foundation that has proven to be rock solid. During a
difficult year, we outperformed the great majority of our competitors and the
insurance industry at large. I have no doubt that we are fully prepared to take
advantage of market conditions that will, no doubt, return to normal.

     For us, nothing is more fundamental than making an underwriting profit and
assuring a solid future for Penn-America. With your continued investment and
support, we're confident that our stubborn adherence to these fundamental
principles will produce just those results.

Sincerely,



/s/ Jon S. Saltzman
Jon S. Saltzman
President and Chief Executive Officer

6
<PAGE>
"Penn-America is focused on making money at what I do every day: underwriting
insurance. It gives me comfort knowing that they are committed to providing the
support and product I need to underwrite profitable accounts. They're not
looking to some unrealistic investment goals that require underwriting risks
they shouldn't take. After all, I am not just an agent, I'm a stockholder, too!"
     Stanley Freerks, CPCU, CPD
     President
     S.A. Freerks & Associates, Inc.
     St. Louis MO

7
<PAGE>
Financial Review
<TABLE>
<CAPTION>
<S>                                                  <C>              <C>              <C>              <C>             <C>    
Selected Five Year Financial Data
(in thousands except per share data)                                      At or for the years ended December 31,
                                                       1998             1997             1996             1995            1994
                                                   ------------------------------------------------------------------------------
Income statement data
Revenues
   Premiums earned                                   $89,493          $91,649          $69,081          $57,228         $39,985
   Net investment income                              10,763            9,218            6,705            5,067           3,635
   Net realized investment gains (losses)                 18            1,314              906            1,279            (713)
   Other income                                           --              672               --               --              --
                                                   ------------------------------------------------------------------------------
        Total revenues                               100,274          102,853           76,692           63,574           42,907
                                                   ------------------------------------------------------------------------------

Losses and expenses
   Losses and loss adjustment expenses                55,733           57,728           43,292           35,835           24,855
   Amortization of deferred policy  
     acquisition costs                                25,452           24,984           17,785           14,237            9,381
   Other underwriting expenses                         6,389            5,840            4,349            4,356            3,600
   Interest expense                                      177              520              884              239               81
                                                   ------------------------------------------------------------------------------
        Total losses & expenses                       87,751           89,072           66,310           54,667           37,917
                                                   ------------------------------------------------------------------------------
Earnings before income taxes                          12,523           13,781           10,382            8,907            4,990
Income taxes                                           3,642            4,136            3,389            2,881            1,579
                                                   ------------------------------------------------------------------------------
Net earnings                                          $8,881           $9,645           $6,993           $6,026           $3,411
                                                   ------------------------------------------------------------------------------

Per share data (1)
Basic
   Net operating earnings(2)                           $0.91            $1.08            $0.96            $0.78            $0.59
   Net earnings                                        $0.91            $1.19            $1.05            $0.91            $0.51
   Weighted average shares outstanding                 9,766            8,126            6,663            6,645            6,645
Diluted
   Net operating earnings(2)                           $0.90            $1.07            $0.95            $0.78            $0.59
   Net earnings                                        $0.90            $1.17            $1.04            $0.91            $0.51
   Weighted average shares outstanding                 9,873            8,228            6,743            6,655            6,645
Cash dividends per share                               $0.20            $0.16            $0.11            $0.06              --

Other data
   Gross written premiums                            $95,097         $104,694          $80,496          $66,953          $53,926
   Net written premiums                               87,829           96,561           73,469           61,286           48,343
   Net operating earnings(2)                           8,869            8,781            6,395            5,182            3,882
   Return on average stockholders' equity                9.0%            13.8%            17.8%            18.7%            12.2%

GAAP data
   Loss ratio                                           62.3%            63.0%            62.7%            62.6%            62.2%
   Expense ratio                                        35.6             33.6             32.0             32.5             32.4
                                                   ------------------------------------------------------------------------------
   Combined ratio                                       97.9%            96.6%            94.7%            95.1%            94.6%

Statutory data
   Policyholders' surplus                            $85,358          $83,459          $41,665          $39,118          $25,677
   Loss ratio                                           62.3%            63.0%            62.7%            62.6%            62.2%
   Expense ratio                                        35.0             32.3             31.6             30.4             32.3
                                                   ------------------------------------------------------------------------------
   Combined ratio                                       97.3%            95.3%            94.3%            93.0%            94.5%
                                                   ------------------------------------------------------------------------------
   Property-casualty industry combined ratio(2)        104.3%           101.1%           105.9%           106.4%           108.3%

Balance sheet data (at end of period)
   Cash and investments                             $182,866         $177,819         $115,550         $100,428          $72,896
   Total assets                                      230,504          225,157          158,605          137,763          100,112
   Notes payable                                          --               --            9,000           10,150            1,350
   Total stockholders' equity                        100,630           97,307           42,337           36,250           28,366
   Total stockholders' equity per share(2)            $10.71            $9.85            $6.34            $5.46            $4.27
<FN>
(1) Adjusted to reflect a three-for-two split of the Company's common stock
effected on March 7, 1997. (2) Excludes realized investment gains (losses),
assuming 34.2% for 1997 and 34% marginal tax rate for all other years. (3)
Source: For 1998 nine months results, BestWeek P/C, December 14, 1998 edition;
1994 through 1997, Best Aggregates & Averages-Property Casualty.
</FN>
</TABLE>

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<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations

The following discussion should be read in conjunction with the Consolidated
Financial Statements of the Company and related notes included therein. 

General

Penn-America  Group, Inc. (PAGI) is a specialty  property and casualty insurance
holding company which, through its subsidiaries,  Penn-America Insurance Company
and  its  subsidiary  Penn-Star  Insurance  Company,   markets  and  underwrites
commercial  property,  general  liability  and  multi-peril  insurance for small
businesses  located  primarily in small towns and suburban and rural areas,  and
non-standard   personal  automobile  insurance   principally  in  the  state  of
California. The Company provides commercial property and casualty insurance both
on an excess and surplus lines basis and on an admitted basis,  and non-standard
personal  automobile  insurance on an admitted  basis.  The Company  markets its
products  through 57 high-quality  general agents,  who in turn produce business
through more than 25,000 retail insurance brokers located  throughout the United
States.  The  Company  focuses  on  serving  the  insurance  needs  of  small or
non-standard  markets which generally are  characterized by small average policy
premiums and are  serviced by retail  insurance  brokers with limited  access to
larger,  standard  lines  insurers.  The  Company  believes  that these  markets
generally are  underserved by larger,  standard lines insurers which often limit
their underwriting to policies greater than a certain minimum premium size or to
certain risk classes and which operate in large-scale  markets in which they can
achieve  economies of scale. The Company believes that its distribution  network
enables it to access  effectively  these  numerous small markets at a relatively
low fixed-cost through the marketing, underwriting and administrative support of
its general agents,  as well as the localized  market knowledge and expertise of
its general agents and their retail insurance brokers.

The  success  of the  Company's  strategy  is  demonstrated  by its  strong  and
consistent growth and  profitability.  From 1993 to 1998, gross written premiums
grew at a 21.8% compound annual rate from $35.5 million to $95.1 million and net
operating  earnings  (excluding  realized  investment  gains)  grew  at a  34.6%
compound  annual  rate,  from $2.0  million to $8.9  million.  The  Company  has
operated at a SAP  combined  ratio of less than 100.0% in every year since 1993.
The  Company's  average SAP  combined  ratio from 1993 to 1998 was 95.4% and the
Company's average return on average  stockholders' equity during the same period
was 13.8%.

The Company's  distribution  strategy is to maintain strong  relationships  with
fewer and  higher-quality  general  agents  than its  competitors.  The  Company
carefully  selects a limited  number  of  agents  in each  state  based on their
experience and reputation and strives to preserve each agent's  franchise  value
within its  marketing  territory.  The Company  seeks to grow with these general
agents and develop strong, long-standing relationships by providing a high level
of  service  and  support.  From  1993 to  1998,  the  Company  achieved  168.8%
cumulative growth in gross written premiums with a 50% increase in the number of
general  agents,  from  38 to 57.  The  Company  maintains  low  fixed-costs  by
underwriting  the  substantial  majority of its policies on a binding  authority
basis.


  (Dollars in millions)         1993       1998    Increase

Gross Written Premiums         $35.5      $95.1     168.8%

Number of General Agents          38         57       50%

Gross Written Premiums          $0.9      $1.67      85.5%
  per General Agent


The Company closely monitors the quality of business it underwrites. The Company
provides its general agents with a comprehensive, regularly updated underwriting
manual which clearly outlines the Company's pricing and underwriting guidelines.
The  Company  does not  write  high-risk  policies  (e.g.  medical  malpractice,
environmental  and aviation  liability).  The Company  generally reviews new and
renewal  commercial  policies on a continuous  basis and  non-standard  personal
automobile  policies  on a  quarterly  basis to  ensure  that  its  underwriting
guidelines are being followed. In addition to standard commissions,  the Company
provides strong incentives to its general agents to produce profitable  business
through a con-

9
<PAGE>

tingent  commission  structure  which  is  tied  substantially  to  underwriting
profitability and through the issuance of shares of common stock in lieu of cash
for a portion of the contingent commissions. Since 1996, the Company has awarded
agents 64,586 shares of the Company's  stock through its  contingent  commission
structure.  Historically,  the  Company  has  underwritten  the  majority of its
commercial  lines business on an excess and surplus basis. In recent years,  the
Company has  underwritten a greater  proportion of its commercial lines business
on an admitted basis,  as it has identified  profitable  admitted  markets which
remain underserved by larger standard insurers.  The Company expects to continue
to expand its  commercial  lines  business by offering  additional  products and
packages  which  enhance  its  current  property  and  liability  coverages,  by
identifying  profitable programs and books of business and by selectively adding
high-quality  general agents.  Examples of such additional products and programs
include a  commercial  automobile  product and  specialty  programs,  commercial
umbrella and some miscellaneous professional liability coverages. Currently, the
Company  underwrites all of its non-standard  personal automobile business on an
admitted  basis.  The  Company  announced  in  January  1999  that it  would  be
running-off  the  non-standard  personal  automobile  business in six states and
would continue to write this line only in the state of California.  California's
non-standard  automobile  business  represented  approximately  60% of the total
non-standard personal automobile premium written by the Company in 1998.

The Company's  commercial  insureds  consist  primarily of small,  "Main Street"
businesses,  including restaurants,  taverns, retailers and artisan contractors,
located  principally  in small towns and suburban and rural areas.  In addition,
the Company has  developed  customized  products and  coverages  for other small
commercial  insureds such as day care  facilities,  fitness  centers and special
events. The Company believes it has benefitted from a general migration of small
businesses  out of urban  centers and into  suburban and rural  areas.  Industry
consolidation,  corporate  downsizing  and the increased  use of  communications
technology and personal computers,  among other factors, have contributed to the
high growth in the number of small businesses in these areas.

The Company's  non-standard  personal automobile insurance products are designed
for insureds who do not qualify for preferred or standard  automobile  insurance
because of their payment  histories,  driving  records,  ages,  vehicle types or
other  underwriting   criteria  or  market  conditions.   Non-standard  personal
automobile business represented approximately 25% of the Company's gross written
premiums in 1998 as compared to  approximately  35% of gross written premiums in
1997.

The  Company's  financial  position  and  results of  operations  are subject to
fluctuations due to a variety of factors.  Abnormally high severity or frequency
of claims in any period could have a material  adverse  effect on the  Company's
business,  results of operations or financial condition. Also, re-evaluations of
the Company's  loss reserves could result in an increase or decrease in reserves
and a corresponding adjustment to earnings. Additionally, the insurance industry
is highly  competitive.  The Company  competes with  domestic and  international
insurers, some of which have greater financial,  marketing, management resources
and experience than the Company,  and it may compete with new market entrants in
the future. Competition is based on many factors, including the perceived market
strength  of the  insurer,  pricing  and other  terms and  conditions,  services
provided,  the speed of claims  payment,  the  reputation  and experience of the
insurer and ratings assigned by independent  rating  organizations  such as A.M.
Best Company. Penn-America and its subsidiary, Penn-Star currently have a pooled
rating from A.M. Best of "A  (Excellent)."  This rating is based upon factors of
concern to policyholders,  including financial condition and solvency and is not
directed to the protection of investors.

[GRAPHIC OMITTED - PIE CHART ENTITLED "GEOGRAPHICALLY DIVERSIFIED"]

The  following is a brief  description  of the Company's  business  segments and
lines of insurance

The Company manages the business in two segments:  commercial lines and personal
lines.  Commercial lines consists of general liability,  property,  multi-peril,
business automobile and commercial  umbrella.  Personal lines consists solely of
non-standard personal automobile.

Commercial General Liability 

The Company's commercial general liability insurance is written on an occurrence
policy  form (as  opposed to a  claims-made  policy  form) and  provides  limits
generally ranging from $25,000 to $3 million, with the majority of such policies
having  limits  of  between  $500,000  and $1  million.  The  Company's  general
liability policies pay defense and

10
<PAGE>
related  expenses in addition to per  occurrence  and aggregate  policy  limits.
General  liability  insureds  include  restaurants,  bars  and  taverns,  retail
operations, artisan contractors and similar classes.

Commercial Property 

The Company's commercial property lines provide limits usually no higher than $4
million,  with almost all of the policies  being  written at limits less than $1
million.  Properties  insured  include  restaurants,  bars, and taverns,  retail
operations, vacant buildings and other similar classes.

Commercial Multi-Peril 

The Company also writes the same commercial property and general liability risks
together as a "package" for its insureds,  generally  referred to as "commercial
multi-peril."  The  limits on these  policies  are the same as if  written  on a
monoline basis. Consistent with the current industry trend, the Company has been
writing more commercial  multi-peril policies during the last several years than
individual  property and liability  policies.  The Company expects this trend to
continue  in  light of the  fact  that a  substantial  number  of the  Company's
commercial  insureds  customarily  require both liability and property insurance
coverage, together with the fact that Insurance Services Office (ISO) forms make
it easier and more efficient to write such multi-peril policies.

[GRAPHIC OMITTED - PIE CHART ENTITLED "PRODUCT MIX"]

Business Automobile and Commercial Umbrella 

The Company  recently added both business  automobile  and  commercial  umbrella
coverages to enhance its commercial multi-peril  ("package") writings. The types
of risks and insureds  targeted are similar to those already  written,  such as,
restaurants,  bars and  taverns,  retail  operations,  artisan  contractors  and
similar classes.  The business automobile  insurance (cars and light trucks) can
be written with liability limits up to $1 million. Commercial umbrella insurance
can be written for limits up to $5 million with significant  reinsurance support
from  General   Reinsurance   Corporation.   For  commercial  umbrella  coverage
Penn-America  usually writes the primary $1 million liability limit. The Company
expects  that the  addition  of these  coverages  will expand  package  writings
further and help to increase renewal retention of existing  policies.  In all of
its commercial product lines, the Company continuously is developing specialized
programs for certain industry segments to meet the needs of these  marketplaces.
For example, the Company has developed programs for independent fitness centers,
day care operations,  low-hazard miscellaneous  professional liability coverages
and special events. As a group, these programs are a significant  benefit to the
Company's marketing efforts,  although they do not generate a material amount of
the Company's gross written  premiums.  During 1998, the Company began cargo and
courier   programs  for  specific   agents.   These  programs  each  contributed
approximately $300,000 in written premiums.

Non-Standard Personal Automobile 

The Company currently writes  non-standard  personal  automobile policies in the
state  of  California.  In  January  1999,  the  Company  announced  that it was
pulling-out  of this  line in the  states of  Alabama,  Montana,  Nevada,  North
Dakota,  South Dakota and Washington.  Business in all states except  California
will be run-off throughout most of 1999. This business being run-off represented
$9.3 million of gross  premiums  written in 1998.  Risks  written in  California
typically  do not  qualify for  preferred  or  standard  insurance  because of a
driver's age,  driving record,  vehicle type or other factors.  The non-standard
personal  automobile  business  is  written  at very low  coverage  limits.  The
policies  in force at December  31, 1998  provide  physical  damage  coverage of
$35,000 or less and the Company writes minimum state statutory liability limits.
The coverage is written  predominantly  on a monthly basis though terms of up to
six months are available.

Results of Operations 

Year ended December 31, 1998 compared to year ended December 31, 1997 

Gross  written  premiums  decreased  9.2% to $95.1  million  for the year  ended
December 31, 1998 from $104.7  million for the year ended December 31, 1997. The
decrease resulted from a 34.0% decline in the non-standard  personal  automobile
line's gross written  premiums to $23.7 million.  Commercial lines gross written
premiums  grew 3.8% to $71.4  million.  The overall  decrease  in gross  written
premiums was attributable  primarily to actions taken by the Company  throughout
1998 to limit losses in certain states'  automobile  programs by cutting-back on
production. Further, in January 1999, the Company announced that it would

11
<PAGE>

focus  its  non-standard  automobile  premium  writings  solely  in the state of
California and would run-off the non-standard  personal  automobile  business in
six other states.

Net written premiums decreased 9.0% to $87.8 million for the year ended December
31,  1998 from  $96.6 for the year  ended  December  31,  1997.  During the same
periods,  net premiums  earned  decreased 2.4% to $89.5 from $91.6 million.  Net
premiums earned decreased due to the decrease in gross written premiums.

Net  investment  income  increased  16.8% to $10.8  million  for the year  ended
December  31, 1998 from $9.2 million for the year ended  December 31, 1997.  The
increase resulted principally from growth in invested assets funded primarily by
net  proceeds  from  the  secondary  offering  in July  1997,  cash  flows  from
operations,  partially  offset by an increase in  tax-exempt  securities  in the
portfolio  which grew to $35.3  million  from  $550,000 at year end December 31,
1997. The average tax equivalent  investment yield on the fixed income portfolio
as of December 31, 1998 was 6.30% compared to 6.70% for December 31, 1997.

Net realized  investment  gains after taxes for the year ended December 31, 1998
were $12,000 as compared to $864,000 for the year ended December 31, 1997.

Losses and loss adjustment  expenses  decreased 3.5% to $55.7 million in 1998 as
compared to $57.7  million in 1997 due primarily to the decrease in net premiums
earned.

Amortization of deferred  acquisition  costs increased 1.9% to $25.5 million for
the year ended  December 31, 1998 from $25.0 million for the year ended December
31, 1997. The increase was  attributable  primarily to an increase in commercial
lines commission rates from 20% to 22%, a 10% increase during 1998 and partially
offset by the decline in earned premiums.

[GRAPHIC OMITTED - BAR CHART ENTITLED "GROSS WRITTEN PREMIUMS"]

[GRAPHIC OMITTED - BAR CHART ENTITLED "NET EARNINGS"]

Other  underwriting  expenses  increased 9.4% to $6.4 million for the year ended
December  31, 1998 from $5.8 million for the year ended  December 31, 1997.  The
increase in 1998 expenses was due primarily to expenses  related to new programs
and other non-recurring expenses of the holding company.

The loss ratio  decreased  to 62.3% for the year ended  December  31,  1998 from
63.0%  for the year  ended  December  31,  1997.  The  statutory  expense  ratio
increased to 35.0% from 32.3% for the year ended December 31, 1997. The increase
in the statutory expense ratio is attributable mainly to the decrease in the net
premiums written primarily in the non-standard personal automobile lines as well
as the increase in the commercial lines commission rate. The statutory  combined
ratio  increased to 97.3% for the year ended December 31, 1998 compared to 95.3%
for the year ended December 31, 1997.

As a result of the factors described above, the Company's net operating earnings
before realized  investment gains for the year ended December 31, 1998 increased
1.0% to $8.9  million or $0.91 per share  (basic) and $0.90 per share  (diluted)
from $8.8 million or $1.08 per share  (basic) and $1.07 per share  (diluted) for
the year ended December 31, 1997.

Net earnings for the year ended December 31, 1998 were $8.9 million or $0.91 per
share  (basic) and $0.90 per share  (diluted)  as compared  with $9.6 million or
$1.19 per share (basic) and $1.17 per share (diluted) in 1997.

Year ended December 31, 1997 compared to year ended December 31, 1996

Gross  written  premiums  increased  30.1% to $104.7  million for the year ended
December 31, 1997,  from $80.5 million for the year ended December 31, 1996. The
increase  resulted  from 64.8% growth in the  non-standard  personal  automobile
line's  gross  written  premiums  to  $35.9  million  and  17.2%  growth  in the
commercial lines gross written premiums to
                                                                              12

<PAGE>
$68.8  million.  These  increases in gross written  premiums  were  attributable
primarily to increased volume; rate changes were not significant.

Net  written  premiums  increased  31.4% to  $96.6  million  for the year  ended
December 31, 1997,  from $73.5  million,  for the year ended  December 31, 1996.
During the same periods,  net premiums  earned  increased 32.7% to $91.6 million
from $69.1 million.  Net premiums earned  increased due to the increase in gross
written  premiums,  partially  offset  by  an  increase  in  premiums  ceded  to
reinsurers.

Net  investment  income  increased  37.5% to $9.2  million  for the  year  ended
December 31, 1997, from $6.7 million,  for the year ended December 31, 1996. The
increase  resulted  principally  from  the  growth  in  invested  assets  funded
primarily by net proceeds from the  secondary  offering and from cash flows from
operations.  The average  investment yield of the fixed- maturity  portfolio for
the year ended December 31, 1997 was 6.70%, compared to 6.84% for the year ended
December 31, 1996.

Net realized  investment  gains after taxes for the year ended December 31, 1997
were  $864,000  or $0.11 per share  (basic)  and $0.10 per share  (diluted),  as
compared to $598,000 or $0.09 per share  (basic and  diluted) for the year ended
December 31, 1996.

[GRAPHIC OMITTED - BAR CHART ENTITLED "STOCKHOLDERS' EQUITY"]

Losses and loss  adjustment  expenses  increased  33.3% to $57.7 million for the
year ended  December 31, 1997,  from $43.3 million in 1996,  due primarily to an
increase in net premiums earned.

Amortization of deferred  acquisition costs increased 40.5% to $25.0 million for
the year ended December 31, 1997, from $17.8 million for the year ended December
31, 1996. The increase was  attributable  to an increase in net premiums  earned
and to the higher  percentage of net premiums  earned in  non-standard  personal
automobile  lines  relative to commercial  lines for the year ended December 31,
1997 compared to the same period ended December 31, 1996.  Commission  rates for
non-standard  personal  automobile  lines are generally  higher than  commission
rates for commercial lines.

Other  underwriting  expenses increased 34.3% to $5.8 million for the year ended
December  31,  1997,  from $4.3  million for the year ended  December  31, 1996,
primarily due to the increase in gross written premiums.

The loss ratio increased  slightly to 63.0% for the year ended December 31,1997,
from 62.7% for the year ended  December 31, 1996.  The  statutory  expense ratio
increased to 32.3% from 31.6% for the year ended December 31, 1996. The increase
in the statutory expense ratio is attributable to the increase in the percentage
of net premiums  written in non-standard  personal  automobile lines relative to
commercial  lines. The statutory  combined ratio increased to 95.3% for the year
ended December 31, 1997, compared to 94.3% for the year ended December 31, 1996.

As a result of the factors  described  above, the Company's net earnings for the
year ended December 31, 1997 increased  37.9% to $9.6 million or $1.19 per share
(basic)  and $1.17 per share  (diluted),  from $7.0  million  or $1.05 per share
(basic) and $1.04 (diluted) for the year ended December 31, 1996.

Liquidity and Capital Resources 

PAGI is a holding  company,  the principal asset of which is the common stock of
Penn-America Insurance Company.  PAGI's cash flows depend primarily on dividends
and other payments from  Penn-America  and its subsidiary  Penn-Star.  PAGI uses
these funds to pay (i)  operating  expenses,  (ii) taxes and other  payments and
(iii) dividends to PAGI  stockholders.  Penn-America's  source of funds consists
primarily of premiums, investment income and proceeds from sales and redemptions
of investments.  Funds are used by Penn-America and Penn-Star principally to pay
claims and operating expenses,  to purchase investments and to make dividend and
other payments to PAGI.

The  principal  source of cash to use for the  payment  of  dividends  to PAGI's
stockholders  is  dividends  from  Penn-America  and its  subsidiary  Penn-Star.
Penn-America  is  required  by law to  maintain a certain  minimum  surplus on a
statutory  basis  and  is  subject  to  risk-based   capital   requirements  and
regulations  under which payment of dividends from statutory surplus may require
prior approval of the Pennsylvania regulatory authorities.  The maximum dividend
that may be paid in 1999 by  Penn-America  to PAGI  without  prior  approval  of
regulatory authorities is $9,455,000. Penn-America's statutory surplus increased
2.3% to $85.4 million as of December 31, 1998, from $83.5 million as of December
31, 1997, primarily due to the consolidated statutory net income of $9.8 million
from Penn-America offset by dividends of $8.0 million to

13
<PAGE>

PAGI which were used  primarily  to  purchase  stock under the  corporate  stock
buy-back  program of $5.6 million and to pay dividends to PAGI  stockholders  of
$1.9 million.

Net cash provided by operating  activities  decreased 57.4% to $10.6 million for
the year ended  December 31, 1998 from $25.0 million for the year ended December
31, 1997. The decrease in net cash provided by operations  resulted  principally
from the decrease in net premiums  written during the year. Net cash provided by
investing  activities  was $18.2  million for the year ended  December 31, 1998,
compared  to $60.9  million  used by  investing  activities  for the year  ended
December 31, 1997.  This  increase in cash  provided by investing  activities in
1998 was due to the Company's  decision to remain liquid through year-end as the
Company evaluated  interest rates and the financial  markets.  During 1997, cash
flow was used by investing  activities  due to the  investment of funds from the
proceeds of the Company's secondary stock offering.

[GRAPHIC OMITTED - PIE CHART ENTITLED "INVESTMENT PORTFOLIO MIX"]

Net cash  used by  financing  activities  was $6.9  million  for the year  ended
December 31, 1998 as compared to $35.1 million provided by financing  activities
for the same period in 1997.  The cash used by financing  activities in 1998 was
$5.6 million used by the Company to repurchase  542,325  shares of Company stock
through the stock  buy-back  program and $1.9 million used for PAGI  stockholder
dividends.  The cash provided by financing activities in 1997 resulted primarily
from  $45.6  million in  proceeds  from the  secondary  stock  offering  and the
exercise of stock options, partially offset by the principal repayment of the $9
million  on the term  loan  and  $1.3  million  of the  cash  dividends  paid to
stockholders.

[GRAPHIC OMITTED - PIE CHART ENTITLED "HIGH-QUALITY FIXED-INCOME 
SECURITIES PORTFOLIO"]

The Company  believes that it has sufficient  liquidity to meet its  anticipated
insurance obligations and operating and capital expenditure needs. The Company's
investment strategy emphasizes quality,  liquidity and diversification,  as well
as total return.  With respect to  liquidity,  the Company  considers  liability
durations,  specifically  related to loss  reserves,  when  determining  desired
investment  maturities.  In addition,  maturities have been staggered to produce
cash  flows  for loss  payments  and  reinvestment  opportunities.  The  average
duration  of  the   fixed-maturity   portfolio  as  of  December  31,  1998  was
approximately 3.0 years.

The Company's  fixed-maturity  portfolio  represented $132.6 million or 83.5% of
the total investment  portfolio as of December 31, 1998.  Approximately 98.0% of
these  securities  were  rated "A" or better by  Standard  & Poor's or  Moody's.
Equity securities,  the majority of which consist of preferred stocks, represent
$25.2 million or 15.9% of total investments as of December 31, 1998.

As of December 31, 1998, the  investment  portfolio  contained  $31.0 million of
mortgage- and asset-backed obligations. All of these securities were "AAA" rated
securities issued by government or  government-related  agencies,  were publicly
traded and had market  values  obtained  from an  independent  pricing  service.
Changes in estimated  cash flows due to changes in prepayment  assumptions  from
the original  purchase  assumptions are revised based on current  interest rates
and the  economic  environment.  The Company had no other  derivative  financial
instruments, real estate or mortgages in the investment portfolio as of December
31, 1998.

In September  1998, the Company  completed a revolving  credit  facility for $25
million with First Union National Bank.  This facility  provides for an interest
rate tied to LIBOR plus a variable  factor to be charged on borrowed funds based
on the Company's  debt-to-equity  ratio at the time of borrowing.  This variable
interest  factor ranges from 75 to 150 basis  points.  The facility is available
until the year 2004 with a  structured  step-down in the  available  credit line
over that period.

14
<PAGE>
Market Risk 

The Company is subject to market risk  principally  arising  from the  potential
change in the value of its investment portfolio.

The major  components of market risk affecting the Company are interest rate and
equity risk. The Company has a fixed-maturities investment portfolio with a fair
value of $132.9 million at December 31, 1998 that is subject to changes in value
principally  due to  changes  in  market  interest  rates.  A  component  of the
fixed-maturities  portfolio includes mortgage-backed and asset-backed securities
($31.1  million  in fair  value at  December  31,  1998)  which are  exposed  to
accelerated  prepayment  risk generally  caused by decreases in interest  rates.
Acceleration of repayments could adversely effect future  investment  income, if
reinvestment  of  the  cash  received  from  repayments  is  in   lower-yielding
securities.

The Company's  preferred  equity portfolio of $17.1 million at December 31, 1998
is subject  primarily  to interest  rate risk,  similar to the  fixed-maturities
portfolio described above.

In addition to interest rate risk, the Company's common equity portfolio of $8.1
million at December  31, 1998 is subject to changes in value based on changes in
equity prices in United States markets.

The  Company   manages  its  exposure  to  market  risk  through  a  disciplined
asset/liability  matching and capital management  process.  In the management of
market risk, the  characteristics  of duration,  credit and  variability of cash
flows are critical  elements.  These risks  constantly are assessed and balanced
within the context of the liability and capital position of the Company.

The following is a tabular  presentation of the Company's  investment  portfolio
(dollars are presented in millions) at December 31, 1998.
<TABLE>
<CAPTION>
                                           Expected Maturity Date
                                 ---------------------------------------------
                                                                                             Fair
                                                                        There-              Value
                                  1999    2000    2001   2002    2003    after     Total    Total
--------------------------------------------------------------------------------------------------
<S>                             <C>     <C>     <C>     <C>     <C>     <C>       <C>      <C>
Fixed-Maturities Portfolio
        Principal amount        $ 33.4  $ 18.9  $ 16.3  $ 4.5   $ 3.3   $ 50.0    $126.4
        Average interest rate     6.67%   6.23%   6.46%  6.59%   5.30%    5.21%     5.94%
        Fair value                                                                         $132.9
        Yield on fair value                                                                  5.10%
          Preferred Stock
        Principal amount                                                 $16.6    $ 16.6
        Average interest rate                                             6.52%     6.52%
        Fair value                                                                         $ 17.1
        Yield on fair value                                                                  6.40%
Common Stock
        Fair value                                                                          $ 8.1
</TABLE>

The average  interest  rate  presented  above is the yield on amortized  cost of
fixed maturities and the cost of preferred stocks. The principal amounts are the
par values or the cash flow at maturity.  The expected maturity date anticipates
calls and prepayments.

Impact of Inflation 

Inflation  can have a  significant  impact on  property  and  casualty  insurers
because  premium  rates are  established  before  the  amounts  of loss and loss
adjustment expenses are known. The Company attempts to anticipate increases from
inflation in establishing rates,  subject to limitations imposed for competitive
pricing.  The Company does not believe that inflation has had a material  impact
on the Company's business, results of operations or financial condition to date.
The Company also considers inflation when estimating  liabilities for losses and
loss adjustment  expenses,  particularly for claims having a long period between
occurrence  and  settlement.  The  liabilities  for losses  and loss  adjustment
expenses are  management's  estimates  of the  ultimate  net cost of  underlying
claims and expenses and are not discounted for the time value of money. In times
of high  inflation,  the normally  higher  yields on  investments  may be offset
partially by higher claims and expenses.

New Accounting Standard 

In June 1998,  Statement  of  Financial  Accounting  Standards  (SFAS) No.  133,
"Accounting for Derivatives  Instruments and Hedging Activities," was issued and
established standards for accounting and reporting of derivative instruments and
hedging activities. The statement is effective for all fiscal quarters of fiscal
years  beginning  after  June  15,  1999.  The  Company  is in  the  process  of
determining the effect, if any, on its financial statements.

Other 

The National Association of Insurance  Commissioners  adopted risk-based capital
standards  with which  property and casualty  insurers must comply.  In concept,
risk-based  capital is designed to measure the  acceptable  amount of capital an
insurer  should  have  based on the  inherent  specific  risks of each  insurer.
Insurers failing to meet this benchmark capital level may be subject to scrutiny
by the insurer's domiciled insurance department.  Based on the currently adopted
standards,  Penn-America's  and Penn-Star's  capital and surplus is in excess of
the prescribed risk-based capital requirements for 1998.

The Year 2000 

Introduction 

The "Year 2000," or Y2K,  refers to the problems  that  automated  systems could
encounter as the year 2000  approaches  due to  computers'  or other  electronic
devices' inability to register the year 2000 correctly,  rather than as the year
1900. In this regard, the Company relies on its existing information  technology
systems  ("IT  systems")  to  operate  and to monitor  all major  aspects of the
Company's business, including

15
<PAGE>
underwriting,  claims and various financial systems. The Company also relies, to
a lesser  extent,  on the IT systems of its general agents and,  indirectly,  on
those of the producing retail insurance brokers.  Finally, the Company relies on
certain critical  non-information  technology systems ("non-IT systems") such as
electricity,  telephones,  facsimile machines,  heating and air-conditioning and
fire  protection  systems.  Any disruption in the operation of the IT and non-IT
systems  of either  the  Company or any of its  critical  customers,  vendors or
suppliers  could  have a  material  adverse  effect on the  Company's  business,
results of operations or financial condition.

State of Readiness 

IT systems:  In an effort to  remediate  the problems  associated  with the Year
2000,  the Company,  in 1996,  evaluated all of its computer  codes to determine
which software programs would be affected by date-sensitive  fields.  After this
identification  process was  completed,  the Company hired an outside  vendor to
implement the recoding that was required.  In July 1997 the Company successfully
ran its first trial of all the revised programs. Based upon testing to date, the
Company  believes  that its  programs  are Year  2000  compliant.  The  Company,
however, continues to run tests on a semi-annual basis to make sure the programs
will function properly. The next test is scheduled in March 1999.

The Company's IT systems also have been tested against hypothetical  information
supplied  by its  general  agents.  The IT  systems  currently  are able to read
properly the information provided. Assuming the general agents don't alter their
records,  the Company  reasonably  believes  that its IT systems  will  function
properly. To the extent the general agents' records change, the Company requires
that the agents provide notice.

The Company's  management  information  systems rely  primarily on an integrated
property-casualty  software  package that is processed on an IBM AS/400 computer
system.  The system is leased from IBM and kept  current or near current in both
hardware and operating systems.  The IBM AS/400 model was upgraded in the fourth
quarter of 1998 to Version 4,  which is  reported  by IBM to be fully  compliant
with Year 2000.

The Company uses a Novell Local Area Network  (LAN) to connect all  employees to
the computer system.  The LAN is reported to be Year 2000 compliant.  The LAN is
used   primarily   for   "service"   applications   including   word-processing,
spreadsheets  and  e-mail.  The  majority  of  the  LAN-based  applications  are
Microsoft products and are current or near current in their software releases.

The LAN also  consists  of personal  computers  ("PCs")  that are  attached to a
series of servers.  All PCs have been tested and  correctly  recognize  the Year
2000. The IT Department of the Company supports an Internet web site and various
standalone  third-party PC software  applications.  These packages were assessed
for any Year 2000  problems.  The  Company is in the  process  of testing  these
packages to ensure their  compliance.  Testing  should be complete by June 1999.
The IT  Department  also  supports  FormMaker,  a document  management  software
package developed by DocuCorp which is used by the majority of general agents to
produce  Penn-America  policies.  FormMaker  has been tested and, in its current
release, is reported by DocuCorp to be Year 2000 compliant.

Non-IT systems: The Company has identified,  and relies on, the following non-IT
systems in its daily  operations:  telephones,  voicemail,  facsimile  machines,
heating and air conditioning and fire protection  systems.  The telephone system
was tested as compliant.  The voicemail  system was identified as  non-compliant
and was replaced with a compliant  system in September 1998. The heating and air
conditioning  systems have been tested and are  compliant.  The Company has been
informed that all of the remaining systems will not be effected by the year 2000
and the Company has received written confirmations to this effect.

Key Customers, Suppliers and Vendors

As part of its  remediation  plan,  the  Company  is  analyzing  the  Year  2000
readiness  of  the  Company's  critical  outside  customers  (including  general
agents),  vendors and  suppliers.  Each  department  of the Company was asked to
identify  key  customers,  suppliers  and  vendors  with whom the Company has an
interdependent,  material  business  relationship.  In  September  of 1998,  the
Company    sent     approximately    188    surveys    to    those    identified
customers/suppliers/vendors  to ask them: to provide the current status of their
Y2K plan;  whether they will be compliant;  and what contingency plans they have
in place in the event they will not be compliant.  Of the 188 surveys  sent-out,
100 were returned with responses indicating that the recipients were or would be
compliant;  88 did not  respond.  In  December of 1998,  the Company  sent-out a
second request for  information to those who had not yet responded and for newly
identified  customers,  suppliers  and  vendors.  As of January  21,  1999,  the
responses were as follows: 49 indicated that they were compliant;  105 indicated
that they would be compliant before January 1, 2000; and 38 have yet to respond.
The Company is going to send-out one more  request.  Thereafter,  for those that
have not yet  responded,  the Company will deem them  non-compliant  and find an
alternative  source  for that  information  or  service.  For  those  that  have
responded  that they will be  compliant,  the Company plans to issue a follow-up
letter on or about the dates on which they  indicated  they will be compliant in
order to confirm that status.

16
<PAGE>
Despite all the procedures  the Company has in place,  there can be no guarantee
that the systems of other companies on which the Company's  business relies will
be converted in a timely  fashion or that failure to convert by another  company
or a conversion that is incompatible  with the Company's systems will not have a
materially adverse effect on the Company and its operations.

Cost 

The  Company  incurred  costs of  approximately  $60,000 to recode its  internal
programs.  The costs were incurred by the Company to test significant  insurance
hardware and software that the Company  believes are compliant.  These costs are
and will be  minimal  as these  costs  are  built  into the  Company's  standard
disaster   recovery  testing   program.   The  current  standard  testing  costs
approximately  $28,000  per year.  The  Company  does not  separately  track the
internal costs incurred for the Y2K project. Such costs are related primarily to
payroll costs for the Company's information services personnel. The Company also
incurred an  additional  $13,000 to upgrade  its  voicemail  system.  Additional
expenses may arise in the upcoming year.  Management  believes that at this time
these costs will be approximately $10,000.

Risks 

The risks  associated  with the  Company's  inability  to resolve  all Year 2000
issues include the  possibility of system  failures or  miscalculations  causing
disruption in operations including,  among other things, an inability to process
transactions, to send invoices, to send or to receive e-mail and voicemail or to
conduct   similar  normal   business   activities.   Additionally,   failure  of
third-parties  upon whom the Company's  business  relies to remediate their Year
2000 problems in a timely  fashion could result in disruption in the receipt and
processing of insurance  policies,  claims,  payment of receivables  and general
problems   related  to  the  Company's  daily   operations.   If  any  of  these
contingencies  were to occur,  the  disruption in business could be temporary or
permanent,  depending  on the  degree of  failure.  Until the  Company  receives
responses  from all of the  Company's  agents and  suppliers,  the overall risks
associated  with the Year 2000 remain  difficult to describe  accurately  and to
quantify; and there can be no guarantee that the Year 2000 issue will not have a
material adverse effect on the Company and its operations.

If the Year 2000 problem is not solved by the Company and its business partners,
the Company  could face business  disruption,  operational  problems,  financial
losses,  legal  liability and similar  risks to the business.  These risks could
have a material adverse impact on the Company.

Additionally, the Company may be exposed to insurance risk related to Y2K
exposures of its insureds. In order to mitigate this risk, the Company generally
began endorsing applicable new and renewal policies with effective dates after
November 1, 1998, with an exclusion endorsement. This endorsement excludes Y2K
computer and related electronic exposures by using the standard industry
exclusion. Certain states, however, may not accept this exclusion in all cases.

Contingency Plan 

The Company has not, to date, finalized its Year 2000 Contingency Plan. However,
the Company has completed a first draft of a plan and anticipates having a final
draft of the plan in place by the fourth  quarter of 1999. In the meantime,  the
Company maintains a Disaster Recovery Plan to address various potential business
interruptions.

The current Disaster  Recovery Plan addresses the availability and compatibility
of hardware offsite that could be placed into action immediately by the Company.
In September 1998, the Company tested the offsite  facility and the operation of
significant  insurance software that had been made Year 2000 compliant,  as well
as the operation of the offsite hardware. Under these test conditions, all dates
were  rolled-forward  to January 1, 2000.  The test results  indicated  that the
Company's significant insurance related software would be compliant.

The  testing  facility  has  indicated  that the  majority of its  hardware  and
equipment  would be fully  compliant  by December  1998.  The  testing  facility
further  noted that it will not upgrade  certain of its systems  until the first
quarter of 1999 so as to afford all  subscribers an opportunity to upgrade their
systems.  The Company will follow-up with the testing facility at the end of the
first quarter to ensure that it has achieved  compliance.  The testing  facility
also is available if electric, heat, water, telephones or office space should be
required.

The foregoing is a "Year 2000  Readiness  Disclosure"  pursuant to the Year 2000
Readiness Disclosure Act.

Readers  are  cautioned  that  forward-looking   statements  in  the  Year  2000
disclosure  contained  herein should be read in  conjunction  with the Company's
disclosure titled "Safe Harbor Provisions of the Private  Securities  Litigation
Reform Act of 1995." Forward-looking statements include, but are not limited to,
whether  the  Company  will  complete  its  remediation  and testing in a timely
fashion,  whether  remediation  will cost more than  anticipated,  the impact of
redeploying  staff and the effect of third-parties  on the Company's  ability to
function after the century date change.

17
<PAGE>
Penn-America Group, Inc. and Subsidiaries Consolidated Balance Sheets
<TABLE>
<CAPTION>
        
(In thousands except share and per share data)                                                 December 31,
                                                                                         1998            1997
<S>                                                                                     <C>            <C>    
Assets
Investments:
     Fixed maturities:
       Available for sale, at fair value
        (amortized cost 1998, $103,365: 1997, $89,185)                                 $105,598        $89,979
       Held to maturity, at amortized cost (fair value 1998,
         $27,270: 1997, $47,034)                                                         26,956         46,842
     Equity securities, at fair value (cost 1998,
         $23,358: 1997, $25,662)                                                         25,238         27,380
     Short-term investments, at cost, which approximates fair value                         997         11,455
                                                                                       -----------------------
         Total investments                                                              158,789        175,656
Cash                                                                                     24,077          2,163
Receivables:
     Accrued investment income                                                            1,871          1,973
     Premiums receivable, net                                                            10,349         12,414
     Reinsurance recoverable                                                             18,766         16,605
                                                                                       -----------------------
         Total receivables                                                               30,986         30,992
Prepaid reinsurance premiums                                                              2,809          3,065
Deferred policy acquisition costs                                                         8,728          8,563
Capital lease                                                                             2,051          1,865
Deferred income taxes                                                                     1,598          2,302
Income tax recoverable                                                                      884             40
Other assets                                                                                582            511
                                                                                       -----------------------
         Total assets                                                                  $230,504       $225,157
                                                                                       =======================

Liabilities and Stockholders' Equity
Liabilities:
     Unpaid losses and loss adjustment expenses                                         $88,937        $84,566
     Unearned premiums                                                                   34,253         36,173
     Accounts payable and accrued expenses                                                1,179          2,338
     Capitalized lease obligation                                                         2,080          1,920
     Other liabilities                                                                    3,425          2,853
                                                                                       -----------------------
         Total liabilities                                                              129,874        127,850
                                                                                       =======================

Stockholders' equity:
     Preferred stock, $ .01 par value; authorized 2,000,000 shares;
         none issued                                                                         --             --
     Common stock, $ .01 par value; authorized 1998 and 1997, 20,000,000
         shares; issued 1998, 9,938,179 and 1997, 9,883,384 shares, outstanding 
         1998, 9,395,854 and 1997, 9,883,384 (note 2)                                        99             99
     Additional paid-in capital                                                          69,035         68,221
     Accumulated other comprehensive income                                               2,714          1,649
     Retained earnings                                                                   34,779         27,849
     Treasury stock, 1998, 542,325 shares, at cost                                       (5,643)            --
                                                                                       -----------------------
                                                                                        100,984         97,818
     Unearned compensation from restricted stock awards                                    (354)          (511)
                                                                                       -----------------------
         Total stockholders' equity                                                     100,630         97,307
                                                                                       -----------------------
         Total liabilities and stockholders' equity                                    $230,504       $225,157
                                                                                       =======================
</TABLE>
See accompanying notes to consolidated financial statements.

18
<PAGE>
Penn-America Group, Inc. and Subsidiaries Consolidated Statements of Earnings
<TABLE>
<CAPTION>
                                                            For the years ended December 31,
(In thousands except per share data)                         1998          1997        1996
<S>                                                         <C>          <C>          <C>    
Revenues
     Premiums earned                                        $89,493      $91,649      $69,081
     Net investment income                                   10,763        9,218        6,705
     Net realized investment gains                               18        1,314          906
     Other income                                                --          672           --
                                                            ---------------------------------
         Total revenues                                     100,274      102,853       76,692
                                                            ---------------------------------

Losses and expenses
     Losses and loss adjustment expenses                     55,733       57,728       43,292
     Amortization of deferred policy acquisition costs       25,452       24,984       17,785
     Other underwriting expenses                              6,389        5,840        4,349
     Interest expense                                           177          520          884
                                                            ---------------------------------
         Total losses and expenses                           87,751       89,072       66,310
                                                            ---------------------------------

     Earnings before income tax                              12,523       13,781       10,382
     Income tax                                               3,642        4,136        3,389
                                                            ---------------------------------
Net earnings                                                 $8,881       $9,645       $6,993
                                                            =================================

Net earnings per share (note 2)
     Basic                                                    $0.91        $1.19        $1.05
     Diluted $                                                 0.90        $1.17        $1.04
                                                            =================================
Weighted average number of shares used in
 calculating per share data (note 2)
     Basic                                                    9,766        8,126        6,663
     Diluted                                                  9,873        8,228        6,743
                                                            =================================
Cash dividends per share (note 2)                             $0.20        $0.16        $0.11
                                                            =================================
</TABLE>
See accompanying notes to consolidated financial statements.

19
<PAGE>
Penn-America Group, Inc. and Subsidiaries Consolidated Statements of
Stockholders' Equity
<TABLE>
<CAPTION>
                                                                                                                  Unearned
                                                                              Accumulated                     Compensation
                                                                 Additional         Other                             From
(In thousands except share                      Common Stock        Paid-In Comprehensive  Retained  Treasury   Restricted
  and per share data)                         Shares      Amount    Capital        Income  Earnings     Stock  Stock Awards  Total
<S>                                       <C>             <C>      <C>         <C>       <C>                    <C>      <C>    
Balance, at December 31, 1995               4,430,000       $44      $21,608     $1,501    $13,251       --       $(154)   $36,250
Net earnings                                                                                 6,993                           6,993
Other comprehensive income,
     net of tax:
Unrealized losses on investments,
     net of reclassification adjustment                                            (508)                                      (508)
                                                                                                                           --------
Comprehensive income                                                                                                         6,485
                                                                                                                           --------
Retroactive effect of   
     3-for-2 stock split,    
     January 1997 (note 2)                  2,225,377        22          (22)
Issuance of common stock                       20,754         1          258                                                   259
Cash dividends paid     
     ($0.11 per share)                                                                        (711)                           (711)
Amortization of compensation
     expense from restricted stock                                                                                   54         54
                                        -------------------------------------------------------------------------------------------


Balance, at December 31, 1996               6,676,131        67       21,844        993     19,533                 (100)    42,337
Net earnings                                                                                 9,645                           9,645
Other comprehensive income,
     net of tax:
Unrealized gains on investments,
     net of reclassification adjustment                                             656                                        656
                                                                                                                           --------
Comprehensive income                                                                                                        10,301
                                                                                                                           --------

Issuance of common stock                    3,207,253        32       46,377                                                46,409
Unearned compensation from
     restricted stock awards                                                                                       (512)      (512)
Cash dividends paid
     ($0.16 per share)                                                                      (1,329)                         (1,329)
Amortization of compensation    
     expense from restricted stock                                                                                  101        101
                                        -------------------------------------------------------------------------------------------


Balance, at December 31, 1997               9,883,384        99       68,221      1,649     27,849                 (511)    97,307
Net earnings                                                                                 8,881                           8,881
Other comprehensive income,
     net of tax:
Unrealized gains on
     investments, net of
     reclassification adjustment                                                  1,065                                      1,065
                                                                                                                           --------
Comprehensive income                                                                                                         9,946
                                                                                                                           --------
Issuance of common stock                       54,795                    814                                                   814
Amortization of compensation
     expense from restricted
     stock awards                                                                                                   157        157
Cash dividends paid ($0.20 per share)                                                       (1,951)                         (1,951)
Purchase of treasury stock, at cost                                                                  (5,643)                (5,643)
                                        -------------------------------------------------------------------------------------------
Balance at December 31, 1998                9,938,179       $99      $69,035     $2,714    $34,779  $(5,643)      $(354)  $100,630
                                        ===========================================================================================
</TABLE>
See accompanying notes to consolidated financial statements.

20
<PAGE>
Penn-America Group, Inc. and Subsidiaries Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
<S>                                                                      <C>           <C>           <C>     
                                                                             For the years ended December 31,
(In thousands)                                                              1998          1997           1996
Cash flows from operating activities:
     Net earnings                                                        $  8,881      $  9,645      $  6,993
     Adjustments to reconcile net earnings to net cash provided by
     operating activities:
       Amortization and depreciation expense                                  720           449           331
       Net realized investment gains                                          (18)       (1,314)         (906)
       Deferred tax expense (benefit)                                         159          (434)           (2)
       Net increase in premiums and note receivable, prepaid
         reinsurance premiums and unearned premiums                           401         3,266         3,001
       Net increase in unpaid losses and loss adjustment expenses
         and reinsurance recoverable                                        2,210        12,951         8,822
    (Increase) decrease in:
       Accrued investment income                                              102          (302)         (286)
       Deferred policy acquisition costs                                     (165)       (1,332)       (1,515)
       Income tax recoverable                                                (844)          562           281
       Other assets                                                          (215)          (50)         (454)
     Increase (decrease) in:
       Accounts payable and accrued expenses                               (1,159)          565           (68)
       Other liabilities                                                      572           982           624
                                                                         ------------------------------------
     Net cash provided by operating activities                             10,644        24,988        16,821
                                                                         ------------------------------------

Cash flows from investing activities:
     Purchases of equity securities                                       (17,388)      (19,258)       (8,636)
     Purchases of fixed maturities available for sale                     (45,533)      (61,966)      (21,611)
     Purchases of fixed maturities held to maturity                        (1,015)      (13,082)      (24,084)
     Proceeds from sales of equity securities                              19,633         5,459         8,147
     Proceeds from sales of fixed maturities available for sale            23,037            --         9,825
     Proceeds from maturities of fixed maturities available for sale        7,997        13,604         5,000
     Proceeds from maturities of fixed maturities held to maturity         20,988        18,789        14,008
     Change in short-term investments                                      10,458        (4,455)           --
     Other                                                                     --            --             9
                                                                         ------------------------------------
     Net cash provided (used) by investing activities                      18,177       (60,909)      (17,342)
                                                                         ------------------------------------

Cash flows from financing activities:
     Issuance of common stock                                                 814        45,544           259
     Purchase of treasury stock                                            (5,643)           --            --
     Principal payments on notes payable                                       --        (9,000)       (1,150)
     Principal payments on capital lease obligations                         (127)         (110)         (102)
     Dividends paid                                                        (1,951)       (1,329)         (711)
     Net cash (used) provided by financing activities                      (6,907)       35,105        (1,704)

Increase (decrease) in cash                                                21,914          (816)       (2,225)
Cash, beginning of period                                                   2,163         2,979         5,204
                                                                         ------------------------------------
Cash, end of period                                                      $ 24,077      $  2,163      $  2,979
                                                                         ====================================
Supplemental disclosure of cash flow information
     Cash paid during the period for:
       Income tax                                                        $  4,248      $  4,009      $  3,111
       Interest                                                               177           576           857
     Non-cash transaction:
       Cost of securities transferred from available for
       sale to held to maturity                                                --      $  8,002            --
</TABLE>
See accompanying notes to consolidated financial statements.

21
<PAGE>
Penn-America Group, Inc. and Subsidiaries Notes to Consolidated Financial
Statements

Note 1 
Summary of Significant Accounting Policies

Basis of Presentation and Description of Business

Penn-America  Group, Inc. (the "Company") is an insurance holding company.  Penn
Independent   Corporation  ("Penn  Independent")  at  December  31,  1998,  owns
approximately  32.9%  of  the  outstanding  common  stock  of the  Company.  The
accompanying  financial  statements  include the accounts of the Company and its
wholly owned subsidiary, Penn-America Insurance Company ("Penn-America") and its
wholly  owned  subsidiary   Penn-Star  Insurance  Company   ("Penn-Star").   All
significant  intercompany  accounts and  transactions  have been  eliminated  in
consolidation.  These  financial  statements  are  prepared in  conformity  with
generally  accepted  accounting  principles,  which differ in some respects from
those followed in reports to insurance regulatory authorities.

The preparation of financial  statements  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.

Penn-America underwrites commercial property and general liability insurance and
non-standard personal automobile  insurance,  generally referred to as "property
and casualty"  insurance,  on an excess and surplus lines or non-standard basis.
Penn-America and Penn-Star  combined are licensed admitted insurers in 34 states
and are approved  non-admitted  (excess and surplus lines) insurers in 16 states
and the District of Columbia.

Investments

At the  time of  purchase  of  fixed-maturity  investments,  management  makes a
determination as to the investment classification ("Available for Sale" or "Held
to Maturity"). Factors taken into consideration by management in determining the
appropriate investment category are: maturity, yield, cash flow requirements and
anticipated changes in interest rates. Fixed maturities classified as "Available
for Sale" are carried at fair value with unrealized  investment gains or losses,
net of  deferred  income  taxes,  and are  included as a separate  component  of
accumulated  other  comprehensive  income  in  stockholders'  equity.  "Held  to
Maturity" investments are carried at amortized cost.

Investments  in fixed  maturity  securities  are  adjusted for  amortization  of
premium and accretion of discounts to maturity  date using the interest  method.
Income is recognized on the accrual basis.  Realized investment gains and losses
are  recorded  as  income  when the  securities  are  sold  using  the  specific
identification basis.

The amortized cost of mortgage- and asset-backed  securities  iscalculated using
the interest method including  consideration  of anticipated  prepayments at the
date of purchase.  Significant changes in estimated cash flows from the original
assumptions are accounted for using the composite method.

Equity  securities  are  carried at fair  value  with the  change in  unrealized
investment gains or losses credited or charged directly to stockholders' equity,
net of deferred  income  taxes,  and are included as a component of  accumulated
other comprehensive  income.  Short-term  investments are carried at cost, which
approximates fair value.

Premiums and Other Receivables

Premiums are  recognized  as revenue  ratably  over the terms of the  respective
policies.  Unearned  premiums are  calculated  using the  semi-monthly  pro rata
basis. Management has established an allowance for doubtful accounts of $522,000
at December 31, 1998 and 1997, on premium receivables, which management believes
is adequate to cover uncollectable accounts.

Policy Acquisition Costs 

Policy  acquisition  costs  such as  commissions,  salaries,  premium  taxes and
certain other underwriting expenses, which vary with and are directly related to
the production of business, are deferred and amortized over the effective period
of the related  insurance  policies.  The method followed in computing  deferred
policy  acquisition  costs  limits  the amount of such  deferred  costs to their
estimated  realizable  values,  which gives  effect to the premium to be earned,
related investment income, losses and loss adjustment expenses and certain other
costs expected to be incurred as the premium is earned.

Losses and Loss Adjustment Expenses 

The  liability  for losses and loss  adjustment  expenses  (LAE)  represents  an
estimate of the ultimate  unpaid net cost of all losses  incurred.  Estimates of
unpaid  reported  losses and related  allocated  loss  adjustment  expenses  are
determined on the basis of claims adjusters'  evaluations of individual  claims.
Estimates of losses and loss  adjustment  expenses  arising from losses incurred
but not yet reported are based on selected  historical and industry  data.  Such
estimates are not discounted and may be more or less than the amounts ultimately
paid when the claims are settled.  These estimates are reviewed periodically and
adjusted as necessary; such adjustments are reflected in current operations.

Fair Values of Financial Instruments 

The Company uses the following  methods or assumptions in estimating  fair value
disclosures:

Investment  Securities:  Fair  values  are based on quoted  market  prices or on
quoted  market  prices  of  comparable   instruments  or  values  obtained  from
independent pricing services.

Premium and Reinsurance  Receivables and Payables: The carrying amounts reported
in the balance sheet for these instruments approximate their fair values.

Capitalized Lease Obligation:  Fair value is based upon the present value of the
underlying cash flows discounted at the Company's  incremental borrowing rate at
year end. The carrying  amounts  reported in the balance sheet  approximate fair
value.

22
<PAGE>

The fair value of options is estimated on the grant date using the Black-Scholes
option pricing model.  The model assumes the following for 1998,  1997 and 1996,
respectively:  expected annual dividend rates of 1.1%, 1.2% and 1.5%;  risk-free
interest rates of 6.0%,  6.8% and 6.8%;  weighted  average  expected life of the
options of 2.5 years for all years;  and expected stock price  volatility of 30%
for all years.

Reinsurance 

In the  ordinary  course of  business,  the  Company  reinsures  certain  risks,
generally  on an excess of loss  basis  with  other  insurance  companies  which
principally are rated A+ or higher by A.M. Best. Such  reinsurance  arrangements
serve to limit the Company's maximum loss.  Amounts  recoverable from reinsurers
are estimated in a manner consistent with the claim liabilities arising from the
reinsured policies and incurred but not reported losses.

Capitalized Lease 

The  capitalized  lease  is  carried  at  cost  less  accumulated  amortization.
Amortization  is  calculated  using the  interest  method  over 20 years,  which
represents  the term of the mortgage on the office space which the Company rents
from a related party (see note 3).

Income Tax 

Deferred  income taxes are accounted  for under the asset and liability  method.
Deferred  tax  assets  and   liabilities  are  recognized  for  the  future  tax
consequences   attributable  to  differences  between  the  financial  statement
carrying  amounts of existing assets and  liabilities  and their  respective tax
bases.  Deferred tax assets and liabilities are measured using enacted tax rates
expected  to apply to  taxable  income  in the  years in which  those  temporary
differences are expected to be recovered or settled.  The effect on deferred tax
assets and  liabilities  of a change in tax rates is recognized in income in the
period that includes the enactment date.

Note 2 Basic and Diluted Earnings Per Share and Retroactive Adjustment for Stock
Split

Basic  earnings  per share is computed by dividing  income  available  to common
stockholders  by the  weighted-average  number of common shares  outstanding for
each period. Diluted EPS reflects the potential dilution that could occur if the
securities or other  contracts to issue common stock were exercised or converted
into common  stock.  All per share  calculations  and stock  option  disclosures
presented  have been adjusted  retroactively  to reflect a  three-for-two  stock
split declared in January 1997.  Shares  outstanding  also have been restated to
reflect the stock split.

The following is a  reconciliation  of the  numerators and  denominators  of the
basic and diluted EPS computations:

                                             Years ended December 31,
                                          ----------------------------
(In thousands except per share data)       1998       1997       1996
                                          ----------------------------

Basic EPS:

Net earnings                              $8,881     $9,645     $6,993
Weighted average common
     shares outstanding                    9,766      8,126      6,663
                                          ----------------------------
Basic EPS                                 $ 0.91     $ 1.19     $ 1.05
                                          ----------------------------

Diluted EPS:

Net Earnings                              $8,881     $9,645     $6,993
                                          ----------------------------
Weighted average common
     shares outstanding                    9,766      8,126      6,663
Additional shares outstanding
     after the assumed exercise of
     options by applying the treasury
     stock method                            107        102         80
                                          ----------------------------
Total Shares                               9,873      8,228      6,743
                                          ----------------------------
Diluted EPS                               $ 0.90     $ 1.17     $ 1.04
                                          ============================

Note 3 Transactions with Affiliates

Penn-America  leases its home office  facility from a stockholder.  The lease is
accounted  for as a  capitalized  lease.  The  amount of  property  capitalized,
$2,727,000  and  $2,440,000  is presented  net of  accumulated  amortization  of
$676,000  and  $575,000 as of December  31,  1998 and 1997,  respectively.  Penn
Independent and its  subsidiaries  also lease a portion of the building in which
Penn-America's  home office  facility is located.  Management  believes that the
lease terms are at market rates.

Penn  Independent  provides the Company with management and other services.  The
Company  paid  $225,000,   $296,000  and  $342,000  in  1998,   1997  and  1996,
respectively,  for such  services.  Such  amounts  are based on  allocations  of
estimated costs.

All costs  incurred  by Penn  Independent  on behalf of  Penn-America  have been
allocated  to  Penn-America  and  are  reflected  in the  financial  statements.
Management  believes that the methods used to allocate such costs are reasonable
and that Penn-America's  expenses on a stand-alone basis would not be materially
different.

Premiums written resulting from transactions with insurance agency affiliates of
Penn Independent  were $1,279,000 in 1998,  $1,597,000 in 1997 and $3,880,000 in
1996.  Commissions  paid to such affiliates  were $294,000 in 1998,  $359,000 in
1997 and $888,000 in 1996.

23
<PAGE>

Note 4 Investments 

The  Company   invests   primarily  in   investment   grade  fixed   maturities,
substantially  all of  which  are  rated  "A" or  higher  by  Standard  & Poor's
Corporation.  The cost,  gross  unrealized  gains and losses and fair  values of
investments are as follows:
<TABLE>
<CAPTION>
                                                     December 31, 1998
                                    ------------------------------------------------
                                                    Gross         Gross
                                               Unrealized    Unrealized        Fair
(In thousands)                         Cost         Gains        Losses       Value
                                    ------------------------------------------------
<S>                                 <C>          <C>          <C>           <C>     
Fixed maturities

Available for sale

U.S. Treasury securities
    and obligations of U.S.
    government agencies             $  5,512     $    149     $     --      $  5,661
Corporate securities                  28,725        1,024           (1)       29,748
Mortgage-backed securities            10,074           96           (3)       10,167
Other structured securities           15,668           69           --        15,737
Municipal                             35,295          624           --        35,919
Public utilities                       8,091          275           --         8,366
                                    ------------------------------------------------
Total                               $103,365     $  2,237     $     (4)     $105,598
                                    ------------------------------------------------


Held to maturity

U.S. Treasury securities and
    obligations of U.S. 
    government agencies             $ 11,046     $    148     $     --      $ 11,194
Corporate securities                   9,396          101           (1)        9,496
Mortgage-backed securities             5,123           37           (2)        5,158
Municipal                                399            4           --           403
Public utilities                         992           27           --         1,019
                                    ------------------------------------------------
Total                                 26,956          317           (3)       27,270
                                    ------------------------------------------------
Total fixed-maturity securities      130,321        2,554           (7)      132,868
                                    ------------------------------------------------

Equity securities                     23,358        2,348         (468)       25,238
Short-term investments                   997           --           --           997
                                    ------------------------------------------------
Total investments                   $154,676     $  4,902     $   (475)     $159,103
                                    ================================================


                                                     December 31, 1997
                                    ------------------------------------------------
                                                    Gross         Gross
                                               Unrealized    Unrealized        Fair
(In thousands)                         Cost         Gains        Losses       Value
                                    ------------------------------------------------

Fixed maturities

Available for sale

U.S. Treasury securities and
    obligations of U.S. 
    government agencies             $ 22,730     $    132     $    (31)     $ 22,831
Corporate securities                  30,053          486           (2)       30,537
Mortgage-backed securities            11,751           41           --        11,792
Asset-backed securities               18,602           92           --        18,694
Public utilities                       6,049           76           --         6,125
                                    ------------------------------------------------
Total                               $ 89,185     $    827     $    (33)     $ 89,979
                                    ================================================


Held to maturity

U.S. Treasury securities and
    obligations of U.S. 
    government agencies             $ 21,466     $     75     $     (6)     $ 21,535
Corporate securities                  11,284           57          (15)       11,326
Mortgage-backed securities             7,901          114          (50)        7,965
Public utilities                       6,041           19           (2)        6,058
Other securities                         150           --           --           150
                                    ------------------------------------------------
Total                                 46,842          265          (73)       47,034
                                    ------------------------------------------------
Total fixed-maturity securities      136,027        1,092         (106)      137,013
                                    ------------------------------------------------

Equity securities                     25,662        1,957         (239)       27,380
Short-term investments                11,455           --           --        11,455
                                    ------------------------------------------------
Total investments                   $173,144     $  3,049     $   (345)     $175,848
                                    ================================================
</TABLE>

Fixed maturities at December 31, 1998, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.

                                   Available for Sale         Held to Maturity
                                 -----------------------------------------------
                                  Amortized      Fair       Amortized     Fair
(In thousands)                      Cost         Value         Cost       Value
                                 -----------------------------------------------

Due in one year or less          $  8,245     $  8,312     $  8,283     $  8,336
Due after one year through
    five years                     18,312       19,025       12,550       12,757
Due after five years through
    ten years                      39,425       40,562           --           --
Due after ten years                11,641       11,795        1,000        1,019
Asset- and mortgage-backed
    securities                     25,742       25,904        5,123        5,158
                                 -----------------------------------------------
Total                            $103,365     $105,598     $ 26,956     $ 27,270
                                 -----------------------------------------------

A summary of net investment income is as follows: 

                                          Years ended December 31,
                                   ------------------------------------
(In thousands)                        1998          1997           1996
                                   ------------------------------------

Interest on fixed maturities       $  8,921      $  7,506      $  6,108
Dividends on equity securities        1,528         1,123           691
Interest on short-term
    investments and cash                732           852           380
Other                                     2            42            61
                                   ------------------------------------
Total investment income              11,183         9,523         7,240

Less investment expense                (420)         (305)         (535)
                                   ------------------------------------
Net investment income              $ 10,763      $  9,218      $  6,705
                                   ------------------------------------

24
<PAGE>
All investments in fixed-maturity securities have been income-producing during
1998, 1997 and 1996. Realized pre-tax gains (losses) on the sale of investments
are as follows:

                                         Years ended December 31,
                                  ---------------------------------
(In thousands)                       1998         1997         1996
                                  ---------------------------------
Fixed maturities:
Gross realized gains              $    87      $    77      $    32
Gross realized losses                 (11)         (30)        (529)
                                  ---------------------------------
Net gains (losses)                     76           47         (497)
                                  ---------------------------------
Equity securities:
Gross realized gains                  724        1,321        1,460
Gross realized losses                (782)         (54)         (57)
                                  ---------------------------------
Net (losses) gains                    (58)       1,267        1,403
                                  ---------------------------------
Total net realized investment
        gains                     $    18      $ 1,314      $   906
                                  =================================

Income taxes on net realized investment gains were $6,000, $450,000 and $308,000
in 1998, 1997 and 1996, respectively.

The  amortized  cost of fixed  maturities  on deposit  with  various  regulatory
authorities  at  December  31,  1998  and  1997,   amounted  to  $7,341,000  and
$7,328,000, respectively.

Note 5 Reinsurance 

In the normal  course of business,  the Company  seeks to reduce the losses that
may arise from catastrophes or other events that cause unfavorable  underwriting
results by reinsuring  certain levels of risks in various areas of exposure with
other insurance enterprises or reinsurers.

Reinsurance  contracts  do  not  relieve  the  Company  of  its  obligations  to
policyholders.  Failure of reinsurers to honor their obligations could result in
losses to the  Company.  Allowances  have been  established  for amounts  deemed
uncollectible.  The Company evaluates the financial  condition of its reinsurers
and monitors  concentrations  of credit risk  arising  from  similar  geographic
regions,  activities or economic  characteristics  of the reinsurers to minimize
its exposure to significant losses from reinsurer insolvencies.  At December 31,
1998, reinsurance  recoverables and prepaid reinsurance premiums associated with
one major reinsurer, General Reinsurance Corporation (Gen Re), was $17,799,000.

Premiums written and earned consisted of the following:

                            Years ended December 31,
                       ----------------------------------
(In thousands)            1998         1997         1996
                       ----------------------------------

Premiums written:

Gross                  $ 95,097     $104,694     $ 80,496
Ceded                     7,268        8,133        7,027
                       ----------------------------------
Net of reinsurance     $ 87,829     $ 96,561     $ 73,469
                       ----------------------------------
Premiums earned:

Gross                  $ 97,017     $ 99,385     $ 75,876
Ceded                  $  7,524        7,736        6,795
                       ----------------------------------
Net of reinsurance     $ 89,493     $ 91,649     $ 69,081
                       ----------------------------------

Recoveries recognized under reinsurance contracts were as follows:

                        1998            $ 6,081,000
                        1997            $ 5,132,000
                        1996            $ 8,530,000

Note 6 Capitalized Lease Obligation

Capitalized  lease  obligation of $2,080,000 and $1,920,000 at December 31, 1998
and 1997, respectively,  represented the lease obligation arising under the home
office  facility  lease  (see  note  3).  Interest  is  payable  at  8.5% on the
outstanding principal balance.

Note 7 Unpaid Losses and Loss Adjustment Expenses

Activity in the  liability  for unpaid  losses and loss  adjustment  expenses is
summarized as follows:


(In thousands)                       1998         1997         1996
                                  ----------------------------------

Balance as of January 1           $ 84,566     $ 70,728     $ 60,139
Less reinsurance recoverables       15,703       15,072       13,627
                                  ----------------------------------
Net balance at January 1            68,863       55,656       46,512
                                  ----------------------------------

Incurred related to:
Current year                        55,647       57,387       44,096
Prior years                             86          341         (804)
                                  ----------------------------------
Total incurred                      55,733       57,728       43,292
                                  ----------------------------------

Paid related to:
Current year                        21,903       20,861       16,940
Prior years                         30,258       23,660       17,208
                                  ----------------------------------
Total paid                          52,161       44,521       34,148
                                  ----------------------------------

Net balance at December 31          72,435       68,863       55,656
Plus reinsurance recoverables       16,502       15,703       15,072
                                  ----------------------------------

Balance as of December 31         $ 88,937     $ 84,566     $ 70,728
                                  ----------------------------------

As a result of  changes  in  estimates  of insured  events in prior  years,  the
provision for losses and loss  adjustment  expenses  increased  $86,000 in 1998,
$341,000 in 1997 and  decreased  $804,000 in 1996.  The increase in prior years'
incurred  losses  in 1998  and  1997 is due  primarily  to loss  development  in
automobile liability partially offset by favorable development in the commercial
lines.  The decrease in incurred  losses of prior years incurred in 1996 was due
to favorable development in commercial lines.

25
<PAGE>
Note 8 Income Tax 
The components of income tax expense are as follows:

                      Years ended December 31,
                 --------------------------------
(In thousands)      1998        1997         1996
                 --------------------------------

Current          $ 3,483     $ 4,570      $ 3,391
Deferred             159        (434)          (2)
                 --------------------------------
Total            $ 3,642     $ 4,136      $ 3,389
                 --------------------------------

The actual income tax rate differed from the statutory income tax rate
applicable to income before income taxes as follows:

                                        1998       1997       1996

Statutory income tax rate               34.0%      34.2%      34.0%
Tax-exempt interest and dividends
    received deduction                  (5.4)      (1.6)      (1.4)
Life insurance proceeds                   --       (2.5)        --
Other                                    0.5       (0.1)        --
                                       ----------------------------
                                        29.1%      30.0%      32.6%
                                       ----------------------------

The tax effects of temporary differences that result in a net deferred tax asset
as of December 31, are summarized as follows:

(In thousands)                            1998       1997
                                         -----------------

Assets

Effect of discounting unpaid losses
    and loss adjustment expenses         $3,530     $3,379
Excess of tax over financial
    reporting of earned premium           2,138      2,267
Other, net                                  476        577

Total deferred assets                     6,144      6,223

Liabilities

Deferred policy acquisition costs        $3,024     $2,932
Unrealized investment gains               1,398        863
Other, net                                  124        126
                                         -----------------
Total deferred liabilities                4,546      3,921
                                         -----------------
Net deferred tax asset                   $1,598     $2,302
                                         -----------------

The Company is required to  establish a valuation  allowance  for any portion of
the deferred tax asset that  management  believes  will not be realized.  In the
opinion of management,  it is more likely than not that the Company will realize
the  benefit  of the  deferred  tax  asset  and,  therefore,  no such  valuation
allowance has been established.

Note 9 Segment Information 

In 1998, the Company implemented Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information" which
establishes standards about a company's operating segments.

The Company has two reportable  segments:  personal lines and commercial  lines.
These segments are managed  separately  because they have  different  customers,
pricing and expense  structures.  The Company does not allocate  assets  between
segments because assets are reviewed in total by management for  decision-making
purposes.

The accounting  policies of the segments are the same as those  described in the
summary of significant accounting policies. The Company evaluates segment profit
based on profit or loss from operating  activities.  Segment profit or loss from
operations is pre-tax and does not include unallocated expenses but does include
investment income attributable to insurance transactions. Segment profit or loss
therefore  excludes  Federal income taxes,  unallocated  expenses and investment
income  attributable to equity as opposed to investment  income  attributable to
insurance transaction.

The Company currently has one major customer accounting for more than 10% of the
Company's revenue. In 1998 and 1997, the Company derived approximately 18.4% and
21.3% of its  revenues  from this  agent.  In 1996,  the  Company  had two major
customers and derived 24.7% of its revenue from these two agents.

The  following  is a summary of the  Company's  segment  revenues,  expenses and
profit for the years ended December 31, 1998, 1997 and 1996:

(In thousands)                                         1998
                                      ------------------------------------
                                     Commercial      Personal        Total
                                      ------------------------------------

Premiums earned                       $ 62,949      $ 26,544      $ 89,493
Net investment income from
    insurance operations                 4,126           945         5,071
                                      ------------------------------------
Total segment revenues                  67,075        27,489        94,564
                                      ------------------------------------
Segment losses and LAE                  37,121        18,612        55,733
Segment expenses                        18,687         8,547        27,234
                                      ------------------------------------
Total segment expenses                  55,808        27,159        82,967
                                      ------------------------------------
Segment profit                        $ 11,267      $    330      $ 11,597
                                      ====================================

Plus unallocated items:
Net investment income from equity                                    5,710
Unallocated expenses                                                (4,784)
Income taxes                                                        (3,642)
                                                                  --------
Net earnings                                                      $  8,881
                                                                  --------

26
<PAGE>

(In thousands)                                          1997
                                      ------------------------------------
                                     Commercial      Personal        Total
                                      ------------------------------------

Premiums earned                       $ 57,189      $ 34,460      $ 91,649
Net investment income from
        insurance operations             4,764           934         5,698
Other income                               442           230           672
                                      ------------------------------------

Total segment revenues                  62,395        35,624        98,019
                                      ------------------------------------

Segment losses and LAE                  32,723        25,005        57,728
Segment expenses                        15,822        11,004        26,826
                                      ------------------------------------
Total segment expenses                  48,545        36,009        84,554
                                      ------------------------------------
Segment profit (loss)                 $ 13,850      $   (385)     $ 13,465
                                      ====================================

Plus unallocated items:
Net investment income from equity                                    4,834
Unallocated expenses                                                (4,518)
Income taxes                                                        (4,136)
                                                                  --------
Net earnings                                                      $  9,645
                                                                  --------

(In thousands)                                          1996
                                      ------------------------------------
                                     Commercial      Personal        Total
                                      ------------------------------------

Premiums earned                       $ 49,667      $ 19,414      $ 69,081
Net investment income from
        insurance operations             3,832           433         4,265
                                      ------------------------------------
Total segment revenues                  53,499        19,847        73,346
                                      ------------------------------------
Segment losses and LAE                  30,887        12,405        43,292
Segment expenses                        13,026         6,147        19,173
                                      ------------------------------------
Total segment expenses                  43,913        18,552        62,465
                                      ------------------------------------
Segment profit                        $  9,586      $  1,295      $ 10,881
                                      ====================================

Plus unallocated items:
Net investment income from equity                                    3,346
Unallocated expenses                                                (3,845)
                                                                  --------
Income taxes                                                        (3,389)
                                                                  --------
Net earnings                                                      $  6,993
                                                                  --------

Total segment  revenues of $94.6  million,  $98.0 million and $73.3 million plus
unallocated net investment income from equity of $5.7 million,  $4.8 million and
$3.3 million equals total Company revenues of $100.3 million, $102.9 million and
$76.7  million  for  the  years  ended   December  31,  1998,   1997  and  1996,
respectively.

Note 10 Stockholders' Equity 

A  source  of  cash  to use  for  the  payment  of  dividends  to the  Company's
stockholders is dividends from Penn-America.  Penn-America is required by law to
maintain  a certain  minimum  surplus  on a  statutory  basis and is  subject to
risk-based  capital  requirements  and  regulations  under  which  payment  of a
dividend from statutory  surplus may require prior approval of the  Pennsylvania
regulatory authorities. The maximum dividend that may be paid by Penn-America to
the  Company  without  prior  approval  of  regulatory  authorit  ies in 1999 is
$9,455,000.

The National  Association  of  Insurance  Commissioners  has adopted  risk-based
capital (RBC) requirements for property and casualty insurance  companies.  This
requirement  may have a  further  impact  on the  payment  of  dividends  to the
stockholders.  At December 31, 1998 and 1997 the  Company's  actual RBC exceeded
minimum  requirements.  Therefore,  there  are no  further  restrictions  on the
payment of dividends.

The  following  tables  reconcile  surplus and net earnings of  Penn-America  as
determined in accordance with accounting  procedures  prescribed or permitted by
the insurance regulatory authorities to stockholders' equity and net earnings of
the  Company  calculated  in  accordance  with  generally  accepted   accounting
principles (GAAP) as reported herein:
<TABLE>
<CAPTION>
                                                               At December 31,
                                                 ---------------------------------------
(In thousands)                                        1998           1997           1996
                                                 ---------------------------------------
<S>                                              <C>            <C>            <C>      
Statutory surplus as regards
        policyholders                            $  85,358      $  83,459      $  41,665
Deferred policy acquisition costs                    8,728          8,563          7,231
Deferred income taxes                                1,576          2,302          2,214
Unrealized investment gains
       (losses) on fixed maturities
        available for sale                           2,233            794           (289)
Capital lease, net                                     (29)           (55)           (80)
Provision for unauthorized
        reinsurance                                    184             65             57
Non-admitted assets                                    889            889            589
Other assets (liabilities)                              38             15            (95)
Provision for uncollectible
        accounts                                      (622)          (622)          (622)
Holding company                                      2,275          1,897         (8,333)
                                                 ---------------------------------------
GAAP stockholders' equity                        $ 100,630      $  97,307      $  42,337
                                                 =======================================


                                                          Years ended December 31,
                                                 ---------------------------------------
(In thousands)                                        1998           1997           1996
                                                 ---------------------------------------

Statutory net income                             $   9,805      $   8,075      $   6,262
Deferred acquisition costs                             165          1,332          1,515
Deferred income tax                                   (169)           418             (2)
Allowance for uncollectable accounts                    --             --             84
Capital lease                                           25             25             24
Life insurance proceeds                                 --            672             --
Other, net                                              23             99            201
Holding company                                       (968)          (976)        (1,091)
                                                 ---------------------------------------
GAAP net earnings                                $   8,881      $   9,645      $   6,993
                                                 =======================================
</TABLE>

Note 11 Profit-Sharing Plans

Penn-America  participates  in  a  profit-sharing  and  401(k)  plan  with  Penn
Independent that covers qualified employees.  Penn-America's contributions under
the 401(k) plan were  $114,000,  $74,000  and  $51,000 for 1998,  1997 and 1996,
respectively. There were no profit-sharing distributions in 1998, 1997 and 1996.

Note 12 Stock Incentive Plans 

Stock options:  In August 1993, the Company  adopted a Stock Incentive Plan (the
"Plan").  The  purpose  of  the  Plan  is to  enable  officers,  key  employees,
directors,  consultants,  advisors and service  providers of the Company and its
affiliates (as defined in the Plan)

27
<PAGE>
to participate in the Company's  future and to enable the Company to attract and
retain these persons by offering them proprietary  interests in the Company. The
Plan authorizes the issuance of up to 525,000 shares of common stock pursuant to
the exercise of stock options or the award of restricted stock.

Options are  exercisable  according  to the various  terms under which they were
granted varying from one year to ten years after the date of grant.  All options
are subject in general to earlier  termination if the optionee leaves the employ
of the Company.

The Company applies APB opinion No. 25 and related interpretations in accounting
for its Plan.  Accordingly,  no  compensation  cost has been  recognized for the
Plan. Had compensation  cost for the Plan been determined based on fair value at
the grant  date  consistent  with FASB  Statement  No.  123,  the  effect on the
Company's net earnings and earnings per share would have been:
<TABLE>
<CAPTION>
                                                       Years ended December 31,
                                                ------------------------------------------
                                                1998               1997               1996
                                                ------------------------------------------
Net earnings (in thousands):
<S>                                            <C>                <C>                <C>   
As reported                                    $8,881             $9,645             $6,993
Pro forma                                       8,845              9,610              6,958

Basic net earnings per share:

As reported                                     $0.91              $1.19              $1.05
Pro forma                                        0.91               1.18               1.04

Diluted net earnings per share:

As reported                                     $0.90              $1.17              $1.04
Pro forma                                        0.90               1.17               1.03
</TABLE>

A summary of the status of the Company's stock option plan as of December 31,
1998, 1997, 1996 and the changes during the years ended on those dates is
presented below:
<TABLE>
<CAPTION>
(Options in thousands)                           1998          1997           1996
                                              ---------------------------------------
<S>                                           <C>            <C>            <C>
Outstanding at beginning of year
   (average price of $6.40, $6.07,
   and $5.86, in 1998, 1997 and
   1996 respectively)                            313            405            382
Granted
   (average price of $19.00, $13.99,
   and $8.83 per share)                           16             22             30
Exercised
   (average price of $6.00, $6.19 and
   $6.00 per share)                              (29)          (114)            (7)
Forfeited (average price of
   $15.13 per share)                              (2)            --             --
                                               -----------------------------------
Outstanding at end of year
   (average price of $6.98, $6.40, and
   $6.07 per share in 1998, 1997
   and 1996 respectively)                        298            313            405
                                               -----------------------------------
Options exercisable at end of year               286            250            279
                                               -----------------------------------
Weighted average fair value
     of options granted
      during the year                          $4.43          $2.45          $2.11
                                               -----------------------------------
</TABLE>


The following table summarizes information about stock options outstanding at
December 31, 1998:
                           Options Outstanding           Options Exercisable
                                Weighted
                     Number      Average    Weighted    Number       Weighted
                  Outstanding   Remaining    Average  Exercisable     Average
                    12/31/98   Contractual  Exercise   12/31/98      Exercise
Exercise Prices     (in 000's) Life (Years)   Price   (in 000's)       Price
-----------------------------------------------------------------------------
$ 4.33 - $ 5.42          30        1.9       $ 4.88         30        $ 4.88 
$ 6.00                  225        4.8       $ 6.00        225        $ 6.00 
$ 8.83 - $19.00          43        4.4       $13.50         31        $11.41 
-----------------------------------------------------------------------------
$ 4.33 - $19.00         298        4.4       $ 6.98        286        $ 6.48
-----------------------------------------------------------------------------

Restricted  Stock:  The Company awarded to certain  employees  45,000 and 32,500
shares of  restricted  stock having a value on the date of the award of $270,000
and $512,000  respectively.  Such shares are held by the Company and released to
each  grantee  at the rate of 20% per year  provided  that the  grantee is still
employed  by the  Company  or its  affiliates.  The  Company  charged  $157,000,
$101,000 and $54,000 to  compensation  expense  relating to these awards for the
years ended  1998,  1997 and 1996,  respectively.  During  1998,  1997 and 1996,
14,600,  9,900 and 9,000  shares,  respectively,  of the  restricted  stock were
released to the applicable employees as allowed by the provisions of the grant.

Executive  Incentive  Compensation  Plan: During 1995, the Board of Directors of
the Company adopted an executive  incentive  compensation plan which provides up
to 75,000  shares,  over the life of the plan,  to be granted  to key  officers,
executives and employees of the Company and its  subsidiaries.  In January 1998,
5,629 shares were  distributed in accordance with the plan's  provisions for the
year 1997. In January 1997, 7,535 shares were distributed for the year 1996. The
shares  issued  under this plan are valued at the fair value of the stock at the
close of business at the end of each year and are issued in the subsequent year,
subject to the Board's approval and attainment of corporate objectives.

Agents'  Contingent   Commission  Plan:  During  1995,  the  Agents'  Contingent
Commission  Plan  was  modified  to  provide  that  at  least  one-third  of the
contingent  commission award to the Company's agents each year would be given in
stock of the Company. Up to 75,000 shares of the Company's stock were authorized
for issuance under this plan.  Agents' stock awards for the 1997,  1996 and 1995
years,  which were  issued in May of 1998,  1997 and 1996,  amounted  to 20,437,
27,746 and 16,403 shares respectively.  The awards for the 1998 year will not be
determined until March 1999.

28
<PAGE>

Note 13 Commitments and Contingencies 

The Company's insurance subsidiaries are subject to routine legal proceedings in
connection  with their  property and casualty  insurance  business.  Neither the
Company nor its  subsidiaries is involved in any pending or threatened  legal or
administrative  proceedings  which  management  believes  might  have a material
adverse effect on the Company's financial condition or results of operations.

During 1998 the Company  secured a revolving  credit  facility  with First Union
National Bank for $25 million.  This facility  provides an interest rate tied to
libor  plus a  variable  factor to be charged  on  borrowed  funds  based on the
Company's debt-to-equity ratio at the time of borrowing.  This variable interest
factor ranges from 75 to 150 basis points.  This facility is available until the
year 2004 with a  structured  step-down  in the  available  credit line over the
period. The line also includes certain financial  covenants which must be met by
the Company.

The  Company  leases  various  computer  equipment  for  use  by  its  insurance
subsidiaries.  These  leases  have  terms  primarily  expiring  in  less  than a
three-year  period.  Rental expenses for these  operating  leases were $379,000,
$417,000  and $485,000  for the years ended  December  31, 1998,  1997 and 1996,
respectively.

At  December  31,  1998,  the future  minimum  rental  payments  required  under
operating  leases that have  initial or remaining  noncancelable  lease terms in
excess of one year were $421,000, $371,000 and $330,000 for 1999, 2000 and 2001,
respectively.

Note 14 Comprehensive Income 

In  1997,  the  Financial  Accounting  Standards  Board  issued  SFAS  No.  130,
"Comprehensive  Income." This  statement was  implemented  retroactively  by the
Company in 1998. The statement requires that an enterprise (a) classify items of
other  comprehensive  income by their  nature in a financial  statement  and (b)
display the accumulated  balance of other  comprehensive  income separately from
retained  earnings and additional  paid-in  capital in the equity section of the
statement of financial position.  Accumulated other comprehensive  income of the
Company consists solely of net unrealized gains on investment securities.

The following are components of other  comprehensive  income for the years ended
December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
(In thousands)                                                        1998
                                                   ------------------------------------------
                                                 Before Tax            Tax           Net of Tax
                                                   Amount            Expense           Amount
                                                   ------------------------------------------
<S>                                                <C>                <C>              <C>   
Unrealized gains on investments:
   Unrealized holding gains arising
     during the period                             $1,632             $(555)           $1,077
   Less: reclassification adjustment for
     gains realized in net income                     (18)                6               (12)
                                                   ------------------------------------------
Other comprehensive income                         $1,614             $(549)           $1,065
                                                   ------------------------------------------


                                                                      1997
                                                   ------------------------------------------
                                                 Before Tax            Tax           Net of Tax
                                                   Amount            Expense           Amount
                                                   ------------------------------------------
Unrealized gains on investments:
   Unrealized holding gains arising
     during period                                 $2,311             $(790)           $1,521
   Less: reclassification adjustment for
     gains realized in net income                  (1,314)              449              (865)
                                                   ------------------------------------------
Other comprehensive income                           $997             $(341)             $656
                                                   ------------------------------------------


                                                                      1996
                                                   ------------------------------------------
                                                 Before Tax            Tax           Net of Tax
                                                   Amount            Expense           Amount
                                                   ------------------------------------------
Unrealized losses on investments:
   Unrealized holding gains arising
     during period                                   $136              $(46)              $90
   Less: reclassification adjustment for
     gains realized in net income                    (906)              308              (598)
                                                   ------------------------------------------
Other comprehensive income (loss)                   $(770)             $262             $(508)
                                                   ------------------------------------------
</TABLE>

Note 15 Unaudited Quarterly Results of Operations for 1998 and 1997 
<TABLE>
<CAPTION>
(In thousands except per share data)
                                                                                1998
                                          --------------------------------------------------------------------------------
                                            First            Second             Third            Fourth            Total
                                          --------------------------------------------------------------------------------
<S>                                       <C>               <C>               <C>               <C>              <C>     
Revenues                                  $25,776           $25,300           $24,877           $24,321          $100,274
Losses and expenses                        22,099            21,733            22,426            21,493            87,751
Net earnings                                2,580             2,525             1,784             1,992             8,881

Net earnings per share:
Basic                                        0.26              0.25              0.18              0.21              0.91
Diluted                                      0.26              0.25              0.18              0.21              0.90


                                                                                1997
                                          --------------------------------------------------------------------------------
                                            First            Second             Third            Fourth            Total
                                          --------------------------------------------------------------------------------
Revenues                                  $22,840           $25,127           $26,950           $27,936          $102,853
Losses and expenses                        20,251            22,328            23,031            23,462            89,072
Net earnings                                1,750             2,019             2,587             3,289             9,645

Net earnings per share:
Basic                                        0.26              0.30              0.28              0.33              1.19
Diluted                                      0.26              0.30              0.28              0.33              1.17
</TABLE>

29
<PAGE>
Independent Auditors' Report


The Board of Directors and Stockholders

Penn-America Group, Inc.: 

We have audited the  accompanying  consolidated  balance sheets of  Penn-America
Group,  Inc. and  subsidiaries  as of December 31, 1998 and 1997 and the related
consolidated  statements of earnings,  stockholders'  equity, and cash flows for
each of the years in the  three-year  period  ended  December  31,  1998.  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  financialstatements 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 consolidated  financial statements referred to above present
fairly, in all material respects,  the financial position of Penn-America Group,
Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the  three-year  period
ended  December 31, 1998,  in  conformity  with  generally  accepted  accounting
principles.


/s/ KPMG LLP

January 22, 1999
Philadelphia, Pennsylvania

30
<PAGE>
Stockholders, Board of Directors and Management Information


Principal Officers 
Penn-America Group, Inc.

Jon S. Saltzman
President and Chief Executive Officer

Rosemary R. Ferrero, CPA
Vice President - Finance and Treasurer

Garland P. Pezzuolo
Secretary and General Counsel

Principal Officers
Penn-America Insurance Company and Penn-
Star Insurance Company

Jon S. Saltzman
President and Chief Executive Officer

John M. DiBiasi, CPCU
Executive Vice President Underwriting and Marketing

Rosemary R. Ferrero, CPA
Vice President - Finance, Secretary and Treasurer

Thomas P. Bowie
Senior Vice President, Claims

J.Ransley Lennon
Vice President Information Systems

Garland P. Pezzuolo
Secretary and General Counsel

Auditors

KPMG LLP
1600 Market Street
Philadelphia PA 19103

Consulting Actuary

Ronald T. Kuehn
Ernst & Young LLP
Two Commerce Square
STE 4000
2001 Market Street
Philadelphia PA 19103

Registrar and Transfer Agency

First Union National Bank
Corporate Trust Operations
1525 W. WT Harris Boulevard
Charlotte NC 28288-1153
Stockholder Inquiries: (800) 829-8432

Corporate Communication Consultant

David Kirk, APR
127 Gateshead Way
Phoenixville PA 19460-1048
(610) 792-3329 or davidkirk@theprguy.com

Graphic Design Firm
Malish & Pagonis
623 South 3rd Street
Philadelphia PA 19147
(215) 629-3699 or
info@malishandpagonis.com


Board of Directors
Penn-America Group, Inc.

Irvin Saltzman
Chairman of the Board of Directors, 
 Director, Penn Independent
 Corporation

Jon S. Saltzman
President and Chief Executive Officer,
 Penn-America Group
Director, Penn Independent
 Corporation

James E. Heerin, Jr.
Vice President, General Counsel and
 Director, Penn Independent
 Corporation
Senior Vice President and
 General Counsel, InterAg
 Technologies, Inc. 

Robert A. Lear
President and Director, Penn
 Independent Corporation 
Director, Dynasil Corporation of
 America 

M. Moshe Porat, Ph.D., CPCU 
Dean, Fox School of Business and
 Management, Temple University 

Jami Saltzman-Levy
Vice President, Human Resources,
 Director, Penn Independent
 Corporation 

Charles Ellman 
Retired Insurance Executive 

Paul Simon 
Director, Public Policy Institute,
 Southern Illinois University

Thomas M. Spiro
Managing General Partner,
 TMS Capital Partners, L.P.

Annual Meeting
The Annual Stockholders' Meeting will be held in our home office on May 19, 1999
at 10:00 A.M.

Stockholder Relations, Form 10-K
The  Company's  Form  10-K  has been  filed  with the  Securities  and  Exchange
Commission.  A copy of the Form  10-K  and  interim  reports  are  available  to
stockholders  without charge from the Investor Relations  Department.  Telephone
(215) 443-3656 or send your E-mail request to palumbo@penn-america.com

Corporate Headquarters
420 South York Road
Hatboro PA 19040-3949
(215) 443-3600 voice
(215) 443-3603 facsimile
http://www.penn-america.com

Market and Common Stock Information
Since  August 4, 1998,  the  Company's  common  stock has traded on the New York
Stock  Exchange  under the symbol "PNG."  Previously,  the  Company's  stock was
listed  on  NASDAQ.  As of  January  27,  1999  there  were  approximately  1400
beneficial  holders of record of the Company's  common  stock.  The high and low
sale prices of the common stock were as follows:

              1998 
------------------------------------
Quarter           High        Low  
------------------------------------
First           $ 23.00     $ 19.50 
Second            21.25       13.00 
Third             13.25        8.25 
Fourth            11.13        8.63

              1997
------------------------------------
Quarter           High        Low
------------------------------------
First           $ 14.50     $ 10.33
Second            15.50       11.25
Third             21.25       14.38
Fourth            21.75       17.25

Except  for  the  historical  information  contained  in  this  report,  matters
discussed herein may constitute "forward-looking statements" (within the meaning
of Section 27A of the  Securities Act and Section 21E of the Exchange Act.) Such
forward-looking  information  reflects  the  Company's  current  best  estimates
regarding  its future  operations.  The  Company's  actual  results could differ
materially from those estimated in the forward-looking statements as a result of
several factors, including those discussed below and elsewhere in this report.

A variety of factors may materially impact estimates of future operations.  Many
of such  factors  are  outside the  Company's  control and cannot be  accurately
predicted.  Important factors include,  but are not limited to, general economic
conditions,  interest rate levels,  financial  market  performance,  legislative
initiatives,  the adequacy of loss reserves, price competition impacting premium
levels,  relationships  with and capacity of the  Company's  general  agents and
changes in state insurance regulations.