[LOGO] Penn-America Group, Inc.

The mission of Penn-America is to
produce a superior return to
shareholders by being the first-choice
insurance carrier for a select group of
wholesale general agents who serve the
small business marketplace.

Annual Report
 2001

<PAGE>

Stock Price
Exchange/Symbol         NYSE/PNG
Closing Price           $ 10.55
52-Week Range           $ 7.19 - $ 10.55
Market Capitalization   $ 80.7 million
Price/Book Ratio        1.00
Dividends Per Share     $ .21
Dividend Yield          2.0%

Balance Sheet
Cash And Investments    $ 188.6 million
Total Assets            $ 248.1 million
Stockholders' Equity    $ 80.4 million
Shares Outstanding      7,652,234
Book Value Per Share    $ 10.51

Operating Data
Total Revenues          $ 99.7 million
Operating Income        $ 5.7 million
Operating Income
   Per Diluted Share    $ 0.75
Net Income
   Per Diluted Share    $ 0.70
Comprehensive Income
   Per Diluted Share    $ 0.95
Net Cash Provided
   By Operations        $ 8.4 million
As of December 31, 2001

                              Book Value Per Share
                    [BAR GRAPH OMITTED see Data Points below]
                                  (In dollars)
                               1997             9.85
                               1998            10.71
                               1999            10.00
                               2000             9.77
                               2001            10.51

                    Core Commercial Gross Written Premioums*
                    [BAR GRAPH OMITTED see Data Points below]
                            (In millions of dollars)
                               1997            68.6
                               1998            69.3
                               1999            77.4
                               2000            95.5
                               2001            97.3

                    * Excludes personal and commercial
                      automobile lines of business

Penn-America Group At A Glance

Penn-America Group, Inc. (NYSE: PNG) is an insurance holding company that
underwrites commercial property, general liability and commercial multi-peril
insurance, for small businesses in small cities and towns, through its
subsidiaries Penn-America Insurance Company and Penn-Star Insurance Company.

Penn-America distributes insurance products through a small network of about 60
wholesale general agents who live and work in the small cities and towns that
the company targets. These general agents, in turn, serve the needs of more than
25,000 retail insurance brokers who represent some 60 percent of the 42,000 in
the United States. This distribution system is suited ideally to the insurance
requirements of small business owners for whom "getting it right" depends on the
consulting relationship that only a professional insurance broker can provide.

Because this efficient distribution system is supported from a central location
with only about 100 employees, Penn-America has a national reach without the
costly bricks and mortar overhead typically associated with nationwide insurance
distribution. Further, because the company is focused in "non-standard" (excess
and surplus lines) insurance markets, it provides for the routine insurance
needs of tens of thousands of small businesses at rates that are typically
higher than those of standard markets. Yet the average annual $2,000 premium
size makes the same market unattractive to most standard companies, which do not
have distribution systems outside of major metropolitan areas.

Penn-America is traded on the New York Stock Exchange under the symbol "PNG." In
2001, the company paid quarterly dividends of $.0525. Rated A- (Excellent) by
A.M. Best Company, it is located in Hatboro, Pennsylvania, a small town near
Philadelphia.



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[PHOTOS OMITTED]


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[PHOTOS OMITTED]

[PHOTO CAPTION]

In this annual report to shareholders, five of Penn-America's employees speak
about the business strategies that support the company mission shown on the
front cover. They are five among more than 100 talented, dedicated people who
build enduring relationships, every day, with all of Penn-America's customers.
Just a few of them are pictured here.



<PAGE>

Dear Shareholder:

In the past year, every insurance management team in the world, including this
one, evaluated every aspect of its operations and strategies. When any industry
goes through the chaotic change that has occurred in the insurance industry, you
must challenge every assumption.

In 2001 we re-examined Penn-America at every level. In the process we
re-discovered that our mission and business strategies are as sound today as
they were twenty-five years ago when Penn-America was founded. It is our dogged
adherence to the "old-fashioned" fundamentals of this company that produced five
consecutive quarters of increased operating earnings by the end of 2001. In
short, I couldn't be more enthusiastic about our present condition and prospects
for the future.

There are about 100 people who work with me here. It is their focus, resolve and
commitment to execute on each and every transaction that differentiate us in the
end. This 2001 annual report tells the story, in the words of our agents and our
employees, of the business strategies that are producing growth and
profitability for Penn-America. That leaves me with the pleasure of recounting
some of our collective accomplishments during 2001:

* We increased our core commercial gross written premiums, excluding the
residential contractor business we exited, by 10 percent. Investment income grew
by 9 percent. Comprehensive income, which includes net income and the net
appreciation in the value of our investment portfolio, was $7.3 million.
Shareholders' equity increased to $80.4 million and book value per share grew
from $9.77 to $10.51. We made significant progress toward our goal of producing
a 12 to 15 percent return on equity (ROE) over the long term;

* We restructured our Binding Authority Unit into three regional teams, each
responsible for developing the relationships and franchise value with our
general agents in each territory. We strengthened our growing Submit Unit, which
underwrites the larger risks that fall outside our agents' binding authority,
with the addition of three underwriters. Overall, our underwriters accomplished
a 15 percent across the board rate increase, while successfully exiting a $12
million commercial automobile book of business and selected residential
contractors;

* We also restructured our Claims Department in significant ways, including
adding a new litigation unit. We have implemented faster investigation
practices, have reduced the number of outside attorneys and claims adjusters we
employ, have more strongly emphasized salvage and subrogation opportunities and
have aligned a higher level of claim technicians with more complex and severe
losses;

* The regionalization of our Underwriting Department demonstrates a core
principle at Penn-America, listening to our agents. At our 25th anniversary
celebration, we invited our agents to spend an entire day with us conducting an
analysis of Penn-America's strengths, weaknesses, opportunities and challenges.
They asked for regionalization and we delivered. It is this continuous back and
forth process with our now 57 agents that accounts for their collective and
individual growth in core commercial gross written premiums. With price
increases still to be implemented and other steps that we and our agents are
taking to strengthen franchise value, we believe that we will increase written
premiums during the next several years;

* It is worth noting and celebrating the fact that we have these 57 strong,
enduring agency relationships-and that all of our agents are shareholders. That
very fact speaks volumes given the chaos in the industry and the difficult
changes we have asked our agents to make. We continue to expand our distribution
network in ways that preserve the value of our existing agents' franchises with
us and expand our revenue potential in new areas of the country. In 2001 we
welcomed American Management Corporation, Granite Insurance Services, Inc.,
Continental Special Risks, Inc., Johannes/ Stoermer Company and M.J. Kelly
Company. Each was granted 100 shares of Penn-America common stock upon
appointment;

* Finally, we strengthened our board of directors with the addition of two
experienced insurance industry executives, one of whom is another member of the
Saltzman family, my brother, Tony. He has more than 20 years of experience in
the excess and surplus lines industry. Martin Sheffield, CPCU, with 29 years of
property/casualty insurance background, is chief operating officer of Ward
Financial Group, a management consulting firm. Since their appointments in May,
all of us have benefited from their insights and contributions.

We operate in the exciting yet volatile excess and surplus lines insurance
marketplace. There is no doubt that our market will continue to change. We
welcome it. In this business, "change" frequently means that hundreds or
thousands of the small businesses of the kind we serve have been dislocated from
standard insurance markets. We thrive in the chaos this creates. We won't forget
that we must shift with the markets, stay on our toes and practice the kind of
responsiveness and flexibility that only small, nimble companies like ours can
deliver and did deliver in 2001. We are extremely well-positioned to take
advantage of the turmoil and chaos that will mark our industry in 2002.

At the end of last year, I said that 2001 would be a "put-up or shut-up" year
for Penn-America. The results speak for themselves. It is always difficult for
me to shut-up when I am feeling great about the company. But it's time to do so
and allow our agents and employees to speak for themselves and deliver the news
we believe our shareholders want most to hear: the mission and business
strategies of Penn-America are sound, they are producing results and they are
providing the strong foundation on which we are actively building long-term
shareholder value. Our future is extraordinarily bright and we eagerly look
forward to 2002 with great enthusiasm.

We appreciate the confidence you share with us in the future of Penn-America.

Sincerely,

/s/ Jon S. Saltzman

Jon S. Saltzman
President and Chief Executive Officer



<PAGE>

Strategy #1: Small businesses in small cities and towns


[PHOTO OMITTED]

[PHOTO CAPTION]
Jackie Zimmerman
Assistant Underwriter
Underwriting Department

The company philosophy has always been to
provide insurance for mainstream America. We
target small entrepreneurial businesses like
restaurants and merchants in small towns and
suburban areas. That's where we've made our
bread and butter, in places just like the
town where we're located, Hatboro,
Pennsylvania. We focus on smaller risks that
bring in premiums that fit our niche in the
marketplace in which we do business. Our
general agents market to small and rural
retail brokers who don't have many options in
the standard markets. We have appointed
general agents who are located across the
country so we are able to access these
smaller businesses in all 50 states.

It's the American way. An entrepreneur starts
out small in a little shop somewhere and
hopes it grows and makes a little profit for
her family. Hopefully we are helping small
businesses to start up and keep going and
making it a little better out there, helping
people to achieve the American dream. If
someone starts a small business and doesn't
have insurance and something happens and it
burns to the ground, how are they going to
feed their family? Start the next business?
Build a bigger and better business?




     "The small business and small town strategy makes a lot of sense,
particularly for a company the size of Penn-America. We see it day in and day
out. Our average binding market premium is $2,500 to $3,000. If you can even
reach an underwriter at another company, getting them to talk to you about a
premium of that size just doesn't happen. It's a perfect strategy for writing
the smaller business.

     You get franchise value for your agency with Penn-America as a brand name.
Our retailers know that one of our main markets is Penn-America and that we are
able to get things done just because of the good relationship we have. It's a
meaningful relationship not just because it is warm and friendly but because we
make money with them and they make money with us. They have created
relationships with some very high-quality wholesale agencies across the country
that are the cream of the crop in the wholesale business.

     Albuquerque is what we call 'a big small town.' You know your neighbors and
what they are doing. The same small business customers keep coming back to us. I
have a feel for what they do and, quite honestly, I patronize their businesses.
I can count on the retail brokers to be in the same close situation, to know if
it's a good business, whether it's clean and safe, whether they pay their bills
or not.

     The best way to describe Penn-America is 'service, service, service.' Their
service is the best in the business. The people are incredibly responsive. They
actually seem to like their jobs. If we call them with a risk or ideas or a
problem, we get a response back the same day. We don't have to hunt them down as
we do with other carriers. It comes down to corporate culture. The employees are
very satisfied and I think they feel that they are in a position to grow. At
carriers of the same size, it is just a job for those people. At Penn-America, I
think the people feel as if they are really a part of something."


2
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[PHOTO OMITTED]

[PHOTO CAPTION]
Tim Neff, President
E & S Brokerage Services, Inc., Albuquerque, New Mexico

                                                                               3
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Strategy #2: Selective general agency distribution network

[PHOTO OMITTED]

[PHOTO CAPTION]
Gary Peterson, President
Chris-Leef General Agency, Inc., Shawnee Mission, Kansas

     "When Penn-America gives me a contract, gives me binding authority, I take
that as a responsibility that I have to write business for them that produces a
profit. As an individual I take a great deal of pride in that. Our job is to
obtain as many premium dollars as we can because it increases our return as
shareholders.

     We understand the local market and the local pricing better than you can in
Pennsylvania. In Kansas and Missouri you are dealing with towns of only five,
ten, maybe fifteen thousand



4
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people. Joe is very hesitant to sue Bob who he has to drink coffee with every
morning so the legal environment is so much better. We understand that because
we understand the population of the towns. For example Garden City suffered the
loss of a major employer. The economy was devastated. We knew that, but the
people in Pennsylvania wouldn't. When you know that the local economy is bad and
you're writing small businesses, you look very carefully at what you do. We know
to keep an eye on it.

     Penn-America gives me guide rates. But we can use higher rates because we
know the market. I have one carrier with which I have 13 competitors in the same
two states. When I have to quote something from that carrier, I have to use
their rates as gospel, not as guides. If I don't sell it, somebody else will. By
not having to compete against a dozen other general agents in our two-state
area, Penn-America adds value to our agency from a marketing standpoint. We can
write accounts with a retail broker that we might not otherwise by releasing a
Penn-America quote because there are so few of us who have the ability to offer
it.

     Their 57 general agents have an average tenure of about 10 years. That
means they are not turning them over. One of my other carriers has only two
general agents in two states. However they have appointed 26 agents in about the
same time that we have been with Penn-America. They appoint and cancel because
they are trying to find somebody who can produce business for them that turns a
profit. Rather than screening them up-front like Penn-America does, they just
appoint everybody and then cancel them when they don't work out.

     Penn-America is a company that should produce an underwriting profit and
provide a return better than any other insurance company I have in my office
because of their ability to deliver responsive service and to listen to me. When
we talk to them, they always listen and do it if it makes business sense. They
really have an ability to think outside the box. I've invested in Penn-America
myself because I believe in the company, the management and the direction."




[PHOTO OMITTED]

[PHOTO CAPTION]
John Gibbons, CPCU
Regional Underwriting Manager
Underwriting Department

We purposely limit our agency distribution
network to a small size and as a result we
have one-half the number of agents as our
nearest competitor. We set out to appoint the
right agents, both geographically and
professionally. They have to know their local
markets and have top-notch business
standards. There just isn't a very large
population of general agents in this whole
country who write in our small town, small
business market and meet those standards. For
these reasons we have practically no agency
turnover.

Agents come to us by referral from existing
agents or through several years of
interviewing at industry events. We often
have agents in the bullpen for years before
we appoint them. The chemistry has to be
right and the business has to be right.

Once an agent is appointed, we provide them
with a lot of support -- automation support,
ways to issue policies, personal
communications. We talk to them, write to
them, E-mail them and visit them frequently.
Our underwriters are on the phone with their
underwriters every day. They call us for
advice and we call them for competitive
information. There's a strong personal and
social bond between our underwriters and
theirs and you can't fake that. That's a
large contribution to the strong franchise
value we provide.

I worked a lot of years at other insurance
companies and I often say that I couldn't
work anywhere other than Penn-America. As a
flat, non-hierarchical company it's very
un-political. Before I started working here
everything else was just rehearsal, paying
dues. This is showtime.


                                                                               5
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Strategy #3: Disciplined underwriting practices


[PHOTO OMITTED]

[PHOTO CAPTION]
Nancy Rankin, CPCU
Vice President - Underwriting
Underwriting Department

Our agents have binding authority to write
business on our behalf. But we have to
support and enforce adherence to our
guidelines. Most important, we tailor our
underwriting approach to each agent. This was
the key motivation behind reorganizing our
Binding Authority Unit into three regional
teams during 2001.

There is a real discipline to what we do
here. There are a number of things going on
behind the scenes that speak to that
discipline. Our technology is very important.
We receive much of our information from
agents electronically and this reduces
potential errors and increases speed.
Everything we receive electronically or on
paper enters our optical imaging system, so
everyone who needs to see a file has
immediate access to it. We have several
automated systems that enable us to confirm
certain things without having to ask the
agent, such as the financial condition of our
insureds, sales, payroll and building values.

We also conduct agency audits. Many of these
audits are done in the agents' offices. That
gives us the opportunity to strengthen the
personal relationships that are so important.
It goes beyond just seeing if they are
following our guidelines. There's a real
collaborative, sharing process. A lot of
people here make agency visits, from our CEO
to underwriters. That really cements the
relationships. We have known many of our
agents for years. We have people ask us to
arrange our visits around weekends because
they are really looking forward to seeing us.

The agents working on our behalf across the
nation are of really high quality. I see them
and the people I work with working hard every
day to get to the place we want to be. We
have a clear vision and a defined mission. I
see commitment every day.







     "When I started out in the early 70s agents and companies were partners.
They were in it together. You always knew the company would back you up. Over
the years that has gone away a great deal. Some companies act like the agents
are their enemies. In the surplus lines area you still have more of that
agent/company relationship and Penn-America is especially good at it. You really
feel that they are there for you. You don't always feel that way with the other
companies. Sometimes underwriters at other companies can be completely
unreasonable and there is no talking to them about it. It is so important to
have a give and take.

     Penn-America's underwriting is very cautious but at the same time they are
willing to hear your reasons why a particular risk may be a good account. They
are always willing to look at things and to discuss it. Discipline doesn't have
to be hard and rigid all the time. You start out with your basis - this is what
we are and this is what we do - but if you have something that doesn't fit these
guidelines they look at it. And when they come down with a new guideline like
rate increases, they will work with you. Everybody doesn't wear the same size
shirt.

     The standard insurance markets operate on a set of rules and regulations
and there is no varying from those. In the surplus lines market you only have
guidelines by which to operate. Penn-America is more specific than some of the
other E&S companies, but their underwriters are always flexible and willing to
listen to a unique situation. You get to use your mind, you get to think about
what you have. It may have a sharp edge on it that may not fit down in a little
hole.

     They have an excellent manual and 99% of the time you can get what you want
there because it is laid-out so well. Strength-ening the Submit Unit was a great
idea, too. It has been a great avenue to look at the things that are slightly
more risky. They have a group of people who are concentrating just on that and
they are very experienced. When you have a very confident, knowledgeable,
experienced underwriter, he or she may see what


6
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[PHOTO OMITTED]

[PHOTO CAPTION]
Melanie Hosford, President
Specialty Insurance Services, Inc., Jacksonville, Florida

at first glance appears to be a risky account and then realize it is not quite
so. The unit has been a great move and we have used it frequently. We have
written several accounts as a result of it.

     Penn-America has laid-out its goals, they know their mission and they know
what they are. At the same time, they realize that things change all the time
and they are willing to look at changes while still staying true to their core
integrity. They move forward without losing sight of who they are."


                                                                               9
<PAGE>

Strategy #4: People


[PHOTO OMITTED]

[PHOTO CAPTION]
Leonard T. LoVullo, President
LoVullo Associates, Inc., Depew, New York



8
<PAGE>

     "Jon Saltzman's dad and my dad are contemporaries and the relationship goes
back 30 years. This whole business is a family thing. Jon and I are the same age
and we grew up together in this business. We're friends, we've been friends for
years and will be for many more years.

     Insurance is an intangible product. We're selling protection. You can't
feel it or touch it. So the relationship an insurance company has with its
agency is critical. It has to be very close. As Penn-America's agent we have to
be able to put the answer out to our customers immediately. We can't do that
without a good relationship. Life is wonderful because our underwriting staff
clicks with theirs and we can respond without being second-guessed by the people
in Hatboro. They hire people who are flexible and courteous. Our people like
dealing with them because they are responsive. You can spend millions on
advertising. But if you don't walk the talk it won't do anything for you. As
long as we are performing, they will trust us and give us the authority to make
decisions. That's what the relationship thing is all about.

     When you work for customers in small towns, Penn-America's product lines
and way of doing business work perfectly for us. Upstate New York is filled with
many, many small towns and that's where our bread and butter comes from. That
fits perfectly with their strategy. We come from a small town and we have a
small-town mentality. Many of our people are born and raised in small towns,
including the 1,000 retail brokers we do business with.

     Penn-America's best years are ahead of it, in the near future and the
long-range future. They have made some tough decisions over the last 12 - 15
months that have significantly improved their bottom line and their share
price."





[PHOTO OMITTED]

[PHOTO CAPTION]
Angela Furino
Senior Claims Examiner
Claims Department

Focusing on people is a very good working
philosophy. Many companies forget that the
whole reason for being in business is the
individual customer. We are acutely aware
that each and every one of our customers
contributes to our success regardless of
their size.

Being located in a small town we can identify
more with the people at the "mom and pop"
restaurant who just had a fire that shut down
their business. We patronize numerous small
businesses in our hometown every day. We have
a good sense of how they would be affected if
that were to happen to them.

Penn-America has always treated its employees
as equal partners. I have worked for
companies where I was nothing more than a
mouthpiece and the managers decided what was
to be done and my job was just to pass that
on. Here, we are given more opportunities for
input, more opportunity to use our own
discretion, our own minds, our own thoughts
to come to the proper conclusions.

This company is like a home to many of us and
we take the business personally. For most of
us it's a very big part of our lives; it's
not just a job, not just a place to go to
work. We're much more personally invested in
the company than a lot of the employees of
larger companies who just go to work and go
home and forget about it.

We are always striving to improve, always
looking for ways to make our product better,
with better programs, improving customer
relations. Penn-America just never stops
trying to get better.



                                                                               9
<PAGE>

Strategy #5: Innovative technology


[PHOTO OMITTED]

[PHOTO CAPTION]
Chris Jamison
Network Systems Manager
Information Technology Department

Technology gives our company the ability to
work with the data everyone needs to insure
that the relationships with our agents are
strong. Strong relationships allow us to
provide the support the agents want and this
is the contribution we make to enhance their
franchise value. In very real terms, we have
become consultants to our agents. Did you
know that we designed 18 of our 57 agents'
web sites?

Here's another example. Just two weeks ago an
agent gave me a call. His computer system was
having multiple problems. He walked us
through his problems and we spent two days
with him correcting them. Then we spent
another whole day working with his technical
people. We gave them complete instructions on
what technical things they can do in their
office to improve their computer operations.
He was extremely excited and happy. The
agencies are smaller and their primary
function is not information technology. So
helping them with technology is just a
natural extension of everything we do to
build those relationships. We tell them that
when they have a problem, they should call us
before they call a support company.

Penn-America is a company that is getting
stronger every day, putting its priorities in
place. We are setting ourselves up to succeed
because we keep out the red tape and the
bureaucracy. I know what this company is
building for the future and I am proud to be
a part of it.




     "Penn-America's technology surpasses anything in the industry. They have
really done a good job with automation, with systems like PennLink, the EZ
raters, the automated forms and manuals and policy submission and issuance
systems. These things have enabled us to become more efficient in our operation
and we appreciate the efforts that Penn-America has put into them. It's an area
that other companies don't really recognize as a service area in which they
could really help their general agencies. Many companies don't have the
background within the general agency business as Penn-America does because they
were an outgrowth of a general agency. They understand the high value a general
agent puts on service. They have defined their method of operations around the
knowledge they have of our service needs.

     They have effectively addressed the areas where they interface with us and
they have concentrated on those pieces that make it easy for us to do business
with them. That has helped us to be more efficient within our operation and it
has saved us money and time. The more electronic things are, the less paper we
have to shuffle. We can look up the manual on the Internet. We don't have to
find it, keep it up with pages that are mailed to us. A paper manual might be
lost or I might be working at home and want to look something up with an
Internet connection. The little things are the things that add up. Yet we still
get pages to add to our manuals from other companies.

     One of the smart things they have done is to create a value for their
franchise for us as agents. Technology is an important part of that. Timing of
information is critical to our ability to manage our business and to make a
profit for everyone. If we have growing loss problems in a particular line of
business, the quicker we have access to that information the quicker we can
react to changing prices or coverages to try to prevent future losses. Many
companies that aren't as automated may take so long getting the data to us that
we may not be able to react quickly enough to turn it around.

     These guys have a lot on the ball. They are doing a lot of good things. The
relationships that they develop with their customers and their use of technology
make them far superior to many companies."

10
<PAGE>

[PHOTO OMITTED]

[PHOTO CAPTION]
Bobby Owens, President
Equity Insurance Managers, Lexington, Kentucky



                                                                              11
<PAGE>

Strategy #6: Strong financial results

Penn-America Group, Inc. and Subsidiaries
Selected Five Year Financial Data
<TABLE>
<CAPTION>
                                                                        As of or for the year ended December 31,
(In thousands, except ratios and per share data)
------------------------------------------------------------------------------------------------------------------------------------
                                             2001                2000                 1999                1998                1997
------------------------------------------------------------------------------------------------------------------------------------
Operating Data
<S>                                      <C>                  <C>                 <C>                 <C>                 <C>
Premiums earned                          $  88,934            $  91,449           $  85,677           $  89,493           $  91,649
Net investment income                       11,339               10,454               9,537              10,763               9,218
Net realized investment
        gain (loss)                           (555)              (1,331)                841                  18               1,314
Other revenue                                                                                                                   672
                                        --------------------------------------------------------------------------------------------
        Total revenues                      99,718              100,572              96,055             100,274             102,853
Operating income (loss)                      5,717               (2,978)              1,483               8,869               8,781
Net income (loss)                            5,351               (3,856)              2,038               8,881               9,645
Comprehensive income (loss)                  7,254                 (343)             (5,000)              9,946              10,301
Diluted earnings per share:
        Operating income (loss)               0.75                (0.39)               0.17                0.90                1.07
        Net income (loss)                     0.70                (0.50)               0.24                0.90                1.17
        Comprehensive income
                (loss)                        0.95                (0.04)              (0.58)               1.01                1.25
Comprehensive return on
        average equity                         9.4%                -0.4%               -5.5%               10.0%               14.8%
Cash dividends per share                 $    0.21            $    0.21           $  0.2075           $    0.20           $    0.16
Cash flow from operations                    8,423               14,991               8,602              10,644              24,988

Insurance Performance Data
Gross written premiums                   $  98,412            $ 109,791           $  95,983           $  95,097           $ 104,694
Net written premiums                        87,123               97,250              87,036              87,829              96,561
GAAP basis:
        Loss ratio                            68.5                 82.4                73.8                62.3                63.0
        Expense ratio                         34.6                 34.0                34.5                33.9                33.2
                                        --------------------------------------------------------------------------------------------
        Combined ratio                       103.1                116.4               108.3                96.2                96.2
Statutory basis:
        Loss ratio                            68.5                 82.4                73.8                62.3                63.0
        Expense ratio                         33.6                 33.2                34.9                35.0                32.3
                                        --------------------------------------------------------------------------------------------
        Combined ratio                       102.1                115.6               108.7                97.3                95.3
Balance Sheet Data
Cash and investments                     $ 188,615            $ 178,675           $ 166,227           $ 182,866           $ 177,819
Total assets                               248,115              239,486             217,782             230,504             225,157
Total stockholders' equity                  80,391               74,051              80,618             100,630              97,307
Total stockholders'
        equity per share                     10.51                 9.77               10.00               10.71                9.85
Statutory policyholders'
        surplus                          $  64,733            $  55,531           $  69,515           $  85,358           $  83,459
</TABLE>


12
<PAGE>

Penn-America Group, Inc. and Subsidiaries
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 subsidiary, Penn-America Insurance Company
and its subsidiary Penn-Star Insurance Company (collectively "Penn-America" or
the "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. Penn-America can write business in all fifty
states and the District of Columbia. The Company writes business on both an
admitted and non-admitted (excess and surplus lines) basis in thirty-six states,
on only an admitted basis in two states and on only a non-admitted basis in
twelve states and the District of Columbia.

Penn-America's commercial insureds consist primarily of small, "Main Street"
businesses including restaurants, mercantiles and non-residential service
contractors. 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 benefited 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 selects only insurance lines of business and industry segments for
which it reasonably can evaluate the probability of future loss exposure.
Therefore, the Company avoids high-hazard risks and high-hazard lines of
business such as medical malpractice and environmental liability.

Penn-America markets its products through fifty-seven 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 businesses in small towns and rural areas that are
serviced by retail insurance brokers with limited access to larger, standard
lines insurers. The Company believes that larger, standard lines insurers, which
often limit their underwriting to larger policies and to certain risk classes,
generally underserve these markets. Penn-America believes that its distribution
network enables it to effectively access these numerous small markets at a
relatively low fixed-cost through the marketing, underwriting and administrative
support of its general agents. This access also is enabled by the local market
knowledge and expertise of its general agents and their retail insurance
brokers.

Penn-America's distribution strategy is to maintain strong relationships with a
select group of high-quality general agents. The Company believes that its
network comprises a smaller, higher-quality group of agents than its
competitors. The Company carefully selects a limited number of general agents
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 to develop strong, long-standing relationships by
providing a high level of service and support. The success of the Company's
strategy is demonstrated by its strong and consistent growth. From 1992 to 2001,
commercial gross written premiums grew at an 18% compound annual rate from $22.6
million to $98.4 million while the number of general agents rose from 38 to 57.

Commercial Gross Written Premiums
Per General Agent
(Same Store Sales)
                                                              Compound
                                                                Annual
(Dollars in millions)                1992           2001       Growth %
-------------------------------------------------------------------------
Commercial gross
        written premiums           $  22.6        $  98.4        18%
Number of general
        agents                          38             57         5%
Commercial gross
        written premiums
        per general agent          $   0.6        $   1.7        13%
-------------------------------------------------------------------------

Core Commercial Business

The Company underwrites its core commercial business (excluding the Company's
exited commercial automobile business - see Exited Lines, below) through three
underwriting units: the Binding Authority Unit, the Submit Unit and the
Specialty Lines Unit.

                                                                              13
<PAGE>


The Binding Authority Unit accounted for approximately 88% of the Company's core
commercial gross written premiums in 2001. Of this amount, approximately 85% is
bound by general agents in accordance with the Company's underwriting manual.
The Binding Authority Unit reviews, on a continuous basis, the new and renewal
policies issued by the general agents to ensure that the Company's underwriting
guidelines are followed. The Company provides its general agents with a
comprehensive, regularly updated underwriting manual, which also is available
online through a private intranet site called Pennlink. This manual clearly
outlines the Company's risk eligibility, pricing, underwriting guidelines and
policy issuance instructions. Penn-America closely monitors the underwriting
quality of its business through online system edits and in-force account
reviews. The Company also periodically audits each agent's office to determine
if the Company's underwriting guidelines are followed in all aspects of risk
selection, underwriting compliance, policy issuance and pricing. In addition to
standard commissions, the Company provides strong incentives to its general
agents to produce profitable business through a contingent profit commission
structure that is tied directly to underwriting profitability. Payments of these
contingent profit commissions have been through the issuance of shares of PAGI
common stock and cash. Since 1996, the Company has awarded agents approximately
184,000 shares of PAGI common stock through its contingent profit commission
structure.

The Submit Unit was formed in 1999 in response to general agents who had risks
similar to the Company's risk profile but were outside of their underwriting
authority. The unit provides a market to the Company's general agents for
approximately fifty classes of business. One hundred percent of the business is
quoted and bound by Penn-America underwriters; general agents have no binding
authority for risks considered by this unit. This unit accounted for
approximately 5% of core commercial gross written premiums in 2001.

The Specialty Lines Unit, which accounted for 7% of the Company's core
commercial gross written premiums in 2001, creates specialized underwriting and
marketing programs for individual general agents based upon specific territorial
needs and opportunities. An individual general agent typically is given
exclusive marketing authority for a special program subject to territorial
limitations. The Company believes it can achieve superior underwriting results
and expense savings on these programs. The Company continuously is developing
specialized programs for certain industry segments to meet the needs of insureds
in these segments. For example, Penn-America has developed programs for cargo
and Alaskan dwellings. Collectively, these programs are a significant benefit to
Penn-America's marketing efforts.

Exited Lines

The Company offered commercial automobile coverage from 1998 through the first
quarter of 2001. In late 2000, the Company announced that it was exiting this
line of business due to unsatisfactory underwriting results. No new policies
have been written since the first quarter of 2001 and all policies are being
non-renewed. Gross written premiums for commercial automobile business decreased
to $1.1 million in 2001 from $11.5 million in 2000 and $7.0 million in 1999.

The Company exited the non-standard personal automobile business in 1999 and, as
a result, gross written premiums declined to $2,000 in 2001 from $2.8 million in
2000 and $11.5 million in 1999.

Competition

The property and casualty insurance industry is highly competitive. Penn-America
competes with domestic and international insurers, some of which have greater
financial, marketing and management resources and experience than the Company.
The Company also 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
Penn-Star currently have a pooled rating from A.M. Best of "A-" (Excellent).

Insurance Loss Reserves

The Company is liable directly for losses and loss adjustment expenses under the
terms of the insurance policies that it writes. In many cases, several years may
lapse between the occurrence of an insured loss, the reporting of the loss to
the Company and the Company's payment of that loss. The Company reflects its
liability for the ultimate payment of all incurred losses and loss adjustment
expenses by establishing loss and loss adjustment


14
<PAGE>

expense reserves as balance sheet liabilities for both reported and unreported
claims.

The establishment of loss and loss adjustment expense reserves requires an
estimate of the ultimate liability based primarily on past experience. The
Company applies a variety of traditional actuarial techniques to determine its
estimate of ultimate liability. The techniques recognize, among other factors,
the Company's and the industry's experience, historical trends in reserving
patterns and loss payments, the pending level of unpaid claims, the cost of
claim settlements, the line of business mix and the economic environment in
which property and casualty insurance companies operate. Estimates continually
are reviewed and, based on subsequent developments and new information,
adjustments of the probable ultimate liability are included in operating results
for the periods in which the adjustments are made. In general, reserves are
established initially based upon the actuarial and underwriting data utilized to
set pricing levels and are reviewed as additional information, including claims
experience, becomes available. The establishment of loss and loss adjustment
expense reserves makes no provision for the broadening of coverage by
legislative action or judicial interpretation or for the extraordinary future
emergence of new types of losses not sufficiently represented in the Company's
historical experience, or which cannot yet be quantified. The Company regularly
analyzes its reserves and reviews its pricing and reserving methodologies so
that future adjustments to prior year reserves can be minimized. However, given
the complexity of this process, reserves will require continual updates and the
ultimate liability may be higher or lower than previously indicated.

The table below illustrates the sensitivity to a hypothetical change in the
Company's net loss and loss adjustment expense reserves as of December 31, 2001.
The selected scenarios are not predictions of future events, but rather
illustrative of the effect that such events may have on stockholders' equity.

<TABLE>
<CAPTION>
                                                                                                   Hypothetical
                                                                                                     Percentage
(Dollars in thousands)                          Balance of Net            Change in Net                Increase
                                                 Loss and Loss            Loss and Loss           (Decrease) in
Hypothetical Change in Net Loss                     Adjustment               Adjustment           Stockholders'
  and Loss Adjustment Expense Reserve         Expense Reserves          Expense Reserve                  Equity
-------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>                      <C>                         <C>
3% increase                                           $ 96,867                 $  2,821                    (2.3)%
2% increase                                             95,927                    1,881                    (1.5)
1% increase                                             94,986                      940                    (0.8)
No change                                               94,046                       --                      --
1% decrease                                             93,106                     (940)                    0.8
2% decrease                                             92,165                   (1,881)                    1.5
3% decrease                                             91,225                   (2,821)                    2.3
-------------------------------------------------------------------------------------------------------------------
</TABLE>

Reinsurance

The Company purchases reinsurance in order to lower its retention for individual
risks, enable it to underwrite policies with higher limits of liability and to
protect against catastrophic losses. Reinsurance does not discharge the Company
from its primary liability for the full amount of insured claims. The Company
carefully examines the financial condition of its reinsurers and places its
coverage only with financially sound companies.

The Company has a multiple-line excess-of-loss reinsurance treaty currently in
place that provides the following reinsurance coverage:

<TABLE>
<CAPTION>
Line of Business        Company Policy Limit            Reinsurance Coverage / Company Retention
-------------------------------------------------------------------------------------------------------------------
Property                $2.0 million per risk           $1.7 million per risk in excess of $300,000 per risk
<S>                     <C>                             <C>
Commercial automobile   $1.0 million per occurrence     $750,000 per occurrence in excess of $250,000
                                                        per occurrence
General liability       $3.0 million per occurrence     $2.5 million per occurrence in excess of $500,000
                                                        per occurrence
-------------------------------------------------------------------------------------------------------------------
</TABLE>


                                                                              15
<PAGE>

Umbrella liability coverages are provided up to $5.0 million per occurrence and
are reinsured for 90% of policy limits up to $1.0 million per occurrence and
100% of policy limits to $4.0 million in excess of $1.0 million per occurrence.

The Company may write individual policies with limits of liability greater than
the aforementioned Company policy limits. These limits of liability are 100%
reinsured on a facultative reinsurance basis.

The Company maintains a catastrophic loss reinsurance program, the terms of
which provide for 100% retention of the first $1.0 million per occurrence,
reinsurance of 90.0% of $1.0 million per occurrence in excess of $1.0 million
per occurrence and reinsurance of 100% of $23.0 million per occurrence in excess
of $2.0 million per occurrence.

Results of Operations

Year ended December 31, 2001 compared with year ended December 31, 2000

Gross written premiums decreased 10.4% to $98.4 million for the year ended
December 31, 2001 from $109.8 million for the year ended December 31, 2000. The
decrease was due to the decline of $13.2 million in gross written premiums for
the exited commercial and non-standard personal automobile lines. Core
commercial gross written premiums increased 1.9% in 2001 to $97.3 million from
$95.5 million in the prior year. This increase is attributable mainly to rate
increases implemented during the year as well as growth in new business, which
were offset partially by a decline in the renewal ratio due to the Company's
decision to exit the residential contractors industry segment.

Net written premiums decreased 10.4% to $87.1 million for the year ended
December 31, 2001 from $97.3 million for the year ended December 31, 2000. This
decline is consistent with the drop in gross written premiums. Net premiums
earned decreased 2.8% to $88.9 million for the year ended December 31, 2001 from
$91.5 million for the year ended December 31, 2000.

Net investment income increased 8.5% to $11.3 million for the year ended
December 31, 2001 from $10.5 million for the year ended December 31, 2000. The
increase resulted principally from an increase in the investment yield of the
fixed-income investment portfolio and the growth in invested assets, partially
offset by a decline in interest rates on overnight cash balances.

Net realized investment loss for the year ended December 31, 2001 was $0.6
million as compared with $1.3 million for the year ended December 31, 2000. Net
realized investment loss for the year ended December 31, 2001 included an
other-than-temporary impairment on the Company's equity investments of $0.6
million.

Losses and loss adjustment expenses decreased 19.2% to $60.9 million in 2001 as
compared with $75.4 million in 2000. The 2000 operating results included
strengthening of prior year loss reserves of $9.2. This prior year reserve
increase related principally to the commercial automobile liability, CMP
liability and other liability lines of business.

The September 11, 2001 tragedies in New York, Washington and Pennsylvania
resulted in no property or casualty losses to the Company.

Amortization of deferred acquisition costs decreased 9.9% to $22.7 million for
the year ended December 31, 2001 from $25.2 million for the year ended December
31, 2000. The decrease is due to lower commission rates to general agents that
were implemented in the third quarter of 2000 and lower premium taxes as a
result of the Company writing a larger portion of its business in its
non-admitted company. Also contributing to the decrease were lower commissions
related to the exited lines of business. Non-standard personal automobile
commission rates were higher than commercial rates.

Other underwriting and corporate expenses increased 29.2% to $8.6 million for
the year ended December 31, 2001 from $6.6 million for the year ended December
31, 2000. This increase was due to the recording of additional expenses related
to guarantee fund assessments and an increase in the allowance for doubtful
accounts. Costs related to audits of assureds' records and salary expenses also
were higher in 2001 than in the prior year.

The GAAP combined ratio decreased to 103.1 for the year ended December 31, 2001
compared with 116.4 for the year ended December 31, 2000. The loss ratio
decreased to 68.5 for the year ended December 31, 2001 from 82.4 for the year
ended December 31, 2000. As noted above, 2000 operating results included the
strengthening of prior year loss reserves by $9.2 million. This strengthening
added approximately 10.0 points to the 2000 loss and combined ratios. The GAAP
expense ratio for the year ended December 31, 2001, which compris-


16
<PAGE>

es amortization of deferred policy acquisition costs and other underwriting
expenses, increased slightly to 34.6 from 34.0 for the year ended December 31,
2000.

As a result of the factors described above, the Company's operating income,
before net realized investment loss, for the year ended December 31, 2001
increased to $5.7 million or $0.75 per share (basic and diluted) compared with
an operating loss, before net realized investment loss, of $3.0 million or $0.39
per share (basic and diluted) for the year ended December 31, 2000.

Net income for the year ended December 31, 2001 was $5.4 million or $0.70 per
share (basic and diluted) as compared with a net loss of $3.9 million or $0.50
per share (basic and diluted) for the year ended December 31, 2000.

Results of Operations

Year ended December 31, 2000 compared with year ended December 31, 1999

Gross written premiums increased 14.4% to $109.8 million for the year ended
December 31, 2000 from $96.0 million for the year ended December 31, 1999. This
increase resulted from a 26.7% increase in commercial lines gross written
premiums to $107.0 million, partially offset by a 75.8% decline in gross written
premiums for the non-standard personal automobile lines of business to $2.8
million.

Net written premiums increased 11.7% to $97.3 million for the year ended
December 31, 2000 from $87.0 million for the year ended December 31, 1999.
During the same period, net premiums earned increased 6.7% to $91.5 from $85.7
million. The increase in net premiums earned corresponds to the increase in
gross and net written premiums.

Net investment income increased 9.6% to $10.5 million for the year ended
December 31, 2000 from $9.5 million for the year ended December 31, 1999. The
increase resulted principally from an increase in yields on fixed-income
investments and an increase in cash flows from operations due principally to the
growth in written premiums and a reduction in paid losses.

Net realized investment loss for the year ended December 31, 2000 was $1.3
million as compared with a net realized investment gain of $0.8 million for the
year ended December 31, 1999. Realized investment losses were generated in 2000
due to the Company's decision to sell selected securities and reinvest the
proceeds into higher-yielding securities.

Losses and loss adjustment expenses increased 19.3% to $75.4 million in 2000 as
compared with $63.2 million in 1999. The 2000 operating results included
strengthening of prior year loss reserves of $9.2 million relating principally
to the Company's commercial automobile liability, CMP liability and other
liability lines of business. Operating results in 1999 included adverse loss
development of $8.4 million in the Company's discontinued non-standard personal
automobile, other liability and property lines of business. Property results in
1999 also were affected by losses related to Hurricanes Floyd and Irene and
other windstorm damage.

Amortization of deferred acquisition costs increased 1.7% to $25.2 million for
the year ended December 31, 2000 from $24.8 million for the year ended December
31, 1999. The increase was attributable primarily to the growth in commercial
gross written premiums.

Other underwriting and corporate expenses increased 10.0% to $6.6 million for
the year ended December 31, 2000 from $6.0 million for the year ended December
31, 1999.

The GAAP combined ratio increased to 116.4 for the year ended December 31, 2000
compared with 108.3 for the year ended December 31, 1999. The loss ratio
increased to 82.4 for the year ended December 31, 2000 from 73.8 for the year
ended December 31, 1999. The GAAP expense ratio decreased to 34.0 for the year
ended December 31, 2000 from 34.5 for the year ended December 31, 1999.

As a result of the factors described above, the Company's operating loss, before
net realized investment loss, for the year ended December 31, 2000 was $3.0
million or $0.39 per share (basic and diluted) compared with operating income,
before net realized investment gain, of $1.5 million or $0.17 per share (basic
and diluted) for the year ended December 31, 1999.

Net loss for the year ended December 31, 2000 was $3.9 million or $0.50 per
share (basic and diluted) as compared with net income of $2.0 million or $0.24
per share (basic and diluted) for the year ended December 31, 1999.


                                                                              17
<PAGE>

                   Net Cash Provided by Operating Activities

                    [BAR GRAPH OMITTED see data points below]


                               Dollars in millions

                               1997    25.0
                               1998    10.6
                               1999     8.6
                               2000    15.0
                               2002     8.4


Liquidity and Capital Resources

PAGI is a holding company, the principal asset of which is the common stock of
Penn-America. The principal source of cash for the payment of dividends to
PAGI's stockholders, PAGI operating expenses and the repurchase of PAGI common
stock is dividends from Penn-America. Penn-America's principal sources of funds
are underwriting operations, 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 payments to PAGI.

The Company's insurance subsidiaries are restricted by statute as to the amount
of dividends that they may pay without the prior approval of regulatory
authorities. Penn-America may pay dividends to PAGI without advance regulatory
approval only from unassigned surplus and only to the extent that all dividends
in the past twelve months do not exceed the greater of 10% of total statutory
surplus, or statutory net income for the prior year. Using these criteria, the
available ordinary dividend for 2002 is $6,473,325. Ordinary dividends paid by
Penn-America to PAGI in 2001 were $1.6 million. No ordinary dividends were paid
to PAGI in 2000. Rather, after receiving approval from the Pennsylvania
Insurance Department, Penn-America paid a $6.4 million return of capital to PAGI
in 2000, which PAGI used to repurchase common stock and to pay common stock
dividends and PAGI operating expenses.

Penn-America and Penn-Star are required by law to maintain a certain minimum
level of policyholders' surplus on a statutory basis. The National Association
of Insurance Commissioners adopted risk-based capital standards designed to
identify property and casualty insurers that may be inadequately capitalized
based on inherent risks of each insurer's assets and liabilities and its mix of
net written premiums. Insurers falling below a calculated threshold may be
subject to varying degrees of regulatory action. Based on the currently adopted
standards, Penn-America's and Penn-Star's capital and surplus are in excess of
the prescribed risk-based capital requirements as of December 31, 2001.

Net cash provided by operating activities decreased to $8.4 million for the year
ended December 31, 2001 from $15.0 million for the year ended December 31, 2000.
The decrease in net cash provided by operations resulted principally from the
decrease in net written premiums during 2001, partially offset by a decrease in
paid losses. Net cash used by investing activities was $5.5 million for the year
ended December 31, 2001, compared with $9.1 million for the year ended December
31, 2000.

Net cash used by financing activities was $1.2 million for the year ended
December 31, 2001 as compared with $6.5 million for the same period in 2000. In
2000, $4.7 million was used by the Company to repurchase 572,425 shares of PAGI
common stock through a stock buy-back program, which was discontinued in the
third quarter of 2000.

The Company seeks to maintain a sufficient level of liquidity from operations,
investing and financing activities 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. At December 31, 2001, the Company held a total
of $188.6 million in cash and investments. Of this amount, $15.1 million was

18
<PAGE>
                         Cash and Investments Portfolio Mix
                         [PIE CHART OMITTED]
                         Fixed income            80%
                         Cash and short-term      7%
                         Non-redeemable
                          preferred stock         9%
                         Common stock             4%



                         Quality of Fixed-Income Portfolio
                         [PIE CHART OMITTED]
                         AAA                    50%
                         AA                     18%
                         A                      25%
                         BBB                     6%
                         Below BBB               1%



classified as held-to-maturity. Approximately $14.1 million of investments
classified as held-to-maturity will mature in 2002. Upon maturity, the Company
intends to reinvest the proceeds in fixed-income securities classified as
available for sale. As of December 31, 2001, cash represented $13.1 million,
equity securities represented $25.1 million, and fixed maturities classified as
available-for-sale represented $135.3 million.

The Company's fixed-income portfolio of $150.4 million represents 79.7% of the
carrying value of the total of cash and investments as of December 31, 2001.
Approximately 93% 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, represented $25.1 million or 14.3% of total invested assets as of
December 31, 2001.

As of December 31, 2001, the investment portfolio contained $48.8 million of
mortgage-backed, asset-backed and collateralized mortgage obligations. All of
these securities were "AA-"-rated or better and 75% were "AAA"-rated by Standard
& Poor's or Moody's. These securities 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 derivative financial instruments, real estate or mortgages in its
investment portfolio as of December 31, 2001.

The Company regularly evaluates its investment portfolio to identify
other-than-temporary impairments of individual securities. The Company considers
many factors in determining if an other-than-temporary impairment exists,
including the length of time and extent to which the market value of the
security has been less than cost, the financial condition and near-term
prospects of the issuer of the security and the ability and willingness of the
Company to hold the security until the market value is expected to recover.

Market Risk

Market risk is the potential economic loss principally arising from adverse
changes in the market value of financial instruments.

The major components of market risk affecting the Company are interest rate risk
and equity price risk.

Interest Rate Risk

The Company had fixed-income and preferred stock investments with a market value
of $167.7 million at December 31, 2001 that are subject to interest rate risk.
The Company manages its exposure to interest rate risk through a disciplined
asset/liability matching and capital management process. In the management of
this 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 table below summarizes the Company's interest rate risk. The table
illustrates the sensitivity of the market value of fixed-income and preferred
stock investments to selected hypothetical changes in interest rates as of
December 31, 2001. The selected scenarios are not predictions of future events,
but rather illustrative of the effect that such events may have on the market
value of the fixed-income and preferred stock portfolio and stockholders'
equity.

                                                                              19
<PAGE>

<TABLE>
<CAPTION>
                                               Estimated Market                               Hypothetical Percentage
                                                Value of Fixed-                                Increase (Decrease) in
(Dollars in thousands)                               Income and           Estimated        ------------------------------
                                                Preferred Stock           Change in                         Stockholders'
Hypothetical Change in Interest Rates               Investments        Market Value         Market Value       Equity
------------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>                <C>                    <C>            <C>
200 basis point increase                              $ 153,680          $ (14,062)             (8.4)%         (11.4)%
100 basis point increase                                160,460             (7,282)             (4.3)           (5.9)
No change                                               167,742                 --                --              --
100 basis point decrease                                175,463              7,721               4.6             6.3
200 basis point decrease                                183,532             15,790               9.4            12.8
------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Equity Price Risk

Equity price risk is the underlying exposure of the Company to an economic loss
from the decline of common stock prices. The Company's common equity portfolio
was $8.0 million at December 31, 2001.

The Company attempts to mitigate equity price risk to its common stock portfolio
by investing exclusively in exchange-traded funds ("ETFs"). ETFs are securities
that represent an interest in a trust that owns and holds a basket of common
stocks that replicate a major market index (such as the S&P 500 or the Dow Jones
Industrial Average) or a portion of a major market index (such as the Value
Component of the S&P). Since these securities represent an interest in the
equity capital markets as a whole, or a sub-sector thereof, they are a
diversified, index-based exposure to common stocks. As such, the value of these
ETFs will be determined by the performance of the equity capital markets in
general or of a particular sub-sector and reduces equity price risk to a single
issuer of stock.

The table below summarizes the Company's common equity price risk. The table
illustrates the sensitivity of the market value of common stock investments to
selected hypothetical changes in market prices as of December 31, 2001. The
selected scenarios are not predictions of future events, but rather illustrative
of the effect that such events may have on the fair value of the common stock
investment portfolio and stockholders' equity.

<TABLE>
<CAPTION>
                                                                                           Hypothetical
                                                                                             Percentage
                                                                                               Increase
(Dollars in thousands)                               Estimated Market        Estimated    (Decrease) in
                                                      Value of Common        Change in    Shareholders'
Hypothetical Change in Market Price                Equity Investments     Market Value           Equity
----------------------------------------------------------------------------------------------------------
<S>                                                          <C>              <C>                  <C>
20% price increase                                           $  9,572         $  1,595             1.3%
10% price increase                                              8,775              798             0.7
No change                                                       7,977               --              --
10% price decrease                                              7,179             (798)           (0.7)
20% price decrease                                              6,382           (1,595)           (1.3)
----------------------------------------------------------------------------------------------------------
</TABLE>



20
<PAGE>

Impact of Inflation
Inflation can have a significant impact on property and casualty insurers
because premium rates are established before the amounts of losses 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 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 best 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.

Cautionary Statements
Certain information included in Management's Discussion and Analysis and
elsewhere in this annual report are not historical facts but are forward-looking
statements including, but not limited to, such matters as anticipated financial
performance, business prospects, technological developments, new and existing
products, expectations for market segment growth and similar matters. In
connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company provides the following cautionary
remarks regarding important factors which, among others, could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's
forward-looking statements. The risks and uncertainties that may affect the
operations, performance, development, results of the Company's business and the
other matters referred to above include, but are not limited to: (1) changes in
the business environment in which the Company operates, including inflation and
interest rates; (2) changes in taxes, governmental laws and regulations; (3)
competitive product and pricing activity; and (4) difficulties of managing
growth profitably. For additional disclosure regarding potential risk factors,
please refer to the Company's 2001 10-K and other documents filed with the
Securities and Exchange Commission.


                                                                              21
<PAGE>

Report of Management

Management is responsible for the financial information included in this annual
report and for determining that the information presents fairly the financial
position and operating results of the Company. The accompanying consolidated
financial statements have been prepared in conformity with accounting principles
generally accepted in the United States. Such statements include informed
estimates and judgments of management for those transactions that are not yet
complete or for which the ultimate effects cannot be determined precisely,
including provisions for unpaid losses and loss adjustment expenses and asset
valuation reserves. Financial information presented elsewhere in this annual
report is consistent with that in the consolidated financial statements.

The Company maintains a system of internal accounting controls designed to
provide reasonable assurance that assets are safeguarded against losses from
unauthorized use or disposition and that transactions are executed in accordance
with management's authorization and are recorded properly. Qualified personnel
maintain and monitor these internal accounting controls on an ongoing basis.

The Company engages Ernst & Young, LLP as independent auditors to audit its
financial statements and express their opinion thereon. They have full access to
each member of management in conducting their audits. Such audits are conducted
in accordance with auditing standards generally accepted in the United States
and include a review and evaluation of the system of internal accounting
controls, tests of the accounting records and other auditing procedures they
consider necessary to express their opinion on the consolidated financial
statements.

The Audit Committee of the board of directors comprises outside directors and is
responsible for over-seeing and monitoring the quality of the Company's
accounting practices and internal controls. Management, and the independent
auditors meet periodically with the Committee to review the accounting practices
employed by the Company and to discuss auditing, internal control, financial
reporting matters and any other matters they believe should be brought to the
Committee's attention. The independent auditors have unrestricted access to the
Audit Committee, without members of management present. The Committee also
reviews Ernst & Young's statement regarding its independence.



Jon S. Saltzman             Joseph F. Morris               John A. Smith
President and               Senior Vice President,         Vice President and
Chief Executive Officer     Chief Financial Officer        Controller
                            and Treasurer

22
<PAGE>

Report of Independent Auditors

The Board of Directors
Penn-America Group, Inc.

We have audited the accompanying consolidated balance sheets of Penn-America
Group, Inc. (the "Company") as of December 31, 2001 and 2000, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the three years then ended. 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Penn-America Group, Inc. at December 31, 2001 and 2000, and the consolidated
results of its operations and its cash flows for the three years then ended in
conformity with accounting principles generally accepted in the United States.


/s/ Ernst & Young LLP

Philadelphia, Pennsylvania
January 18, 2002


                                                                              23
<PAGE>

Penn-America Group, Inc. and Subsidiaries
Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                                    -----------------------------------
(In thousands, except per share data)                                                     2001               2000
-----------------------------------------------------------------------------------------------------------------------
<S>                                                                                   <C>                 <C>
Assets
Investments:
  Fixed maturities:
     Available for sale, at fair value (amortized cost 2001, $130,976;
             2000, $123,873)                                                          $ 135,253           $ 125,477
     Held to maturity, at amortized cost (fair value 2001, $15,317;
             2000, $17,441)                                                              15,084              17,282
  Equity securities, at fair value (cost 2001, $27,770; 2000, $27,324)                   25,149              24,491
                                                                                    -----------------------------------
     Total investments                                                                  175,486             167,250
Cash                                                                                     13,129              11,425
Accrued investment income                                                                 2,199               2,181
Premiums receivable (net of allowances of $972 in 2001 and $422 in 2000)                 12,285               9,695
Reinsurance recoverable                                                                  25,804              24,447
Prepaid reinsurance premiums                                                              4,241               4,635
Deferred policy acquisition costs                                                         9,083              10,317
Capital lease                                                                             1,666               1,753
Deferred income taxes                                                                     3,790               4,272
Income tax recoverable                                                                       66               2,982
Other assets                                                                                366                 529
                                                                                    -----------------------------------
     Total assets                                                                     $ 248,115           $ 239,486
                                                                                    ===================================

Liabilities and Stockholders' Equity
Liabilities:
  Unpaid losses and loss adjustment expenses                                          $ 119,598           $ 115,314
  Unearned premiums                                                                      41,034              43,239
  Accounts payable and accrued expenses                                                   3,800               2,353
  Capitalized lease obligation                                                            1,570               1,701
  Other liabilities                                                                       1,722               2,828
                                                                                    -----------------------------------
     Total liabilities                                                                  167,724             165,435
                                                                                    -----------------------------------

Stockholders' equity:
  Preferred stock, $.01 par value; authorized 2,000,000 shares;
     None issued                                                                             --                  --
  Common stock, $.01 par value; authorized 20,000,000 shares;
     issued 2001 and 2000, 10,152,234 and 10,076,025 shares, respectively;
     outstanding 2001 and 2000, 7,652,234 and 7,576,025 shares, respectively                101                 101
  Additional paid-in capital                                                             70,786              70,164
  Accumulated other comprehensive income (loss)                                           1,092                (811)
  Retained earnings                                                                      33,334              29,583
  Treasury stock, 2,500,000 shares, at cost                                             (24,161)            (24,161)
  Officers' stock loans                                                                    (629)               (546)
  Unearned compensation from restricted stock awards                                       (132)               (279)
                                                                                    -----------------------------------
     Total stockholders' equity                                                          80,391              74,051
                                                                                    -----------------------------------
     Total liabilities and stockholders' equity                                       $ 248,115           $ 239,486
                                                                                    ===================================
</TABLE>
See accompanying notes to Consolidated Financial Statements.


24
<PAGE>

Penn-America Group, Inc. and Subsidiaries
Consolidated Statements of Operations
<TABLE>
<CAPTION>
                                                                           Year ended December 31,
                                                         -----------------------------------------------------------
(In thousands, except per share data)                            2001                 2000                  1999
--------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>                   <C>                   <C>
Revenues
Premiums earned                                            $    88,934           $    91,449           $    85,677
Net investment income                                           11,339                10,454                 9,537
Net realized investment gain (loss)                               (555)               (1,331)                  841
                                                         -----------------------------------------------------------
        Total revenues                                          99,718               100,572                96,055
                                                         -----------------------------------------------------------

Losses and expenses
Losses and loss adjustment expenses                             60,921                75,378                63,187
Amortization of deferred policy acquisition costs               22,715                25,219                24,802
Other underwriting expenses                                      8,030                 5,850                 4,733
Corporate expenses                                                 548                   791                 1,306
Interest expense                                                   160                   161                   145
                                                         -----------------------------------------------------------
        Total losses and expenses                               92,374               107,399                94,173
                                                         -----------------------------------------------------------

Income (loss) before income tax                                  7,344                (6,827)                1,882
Income tax expense (benefit)                                     1,993                (2,971)                 (156)
                                                         -----------------------------------------------------------

Net income (loss)                                          $     5,351           $    (3,856)          $     2,038
                                                         -----------------------------------------------------------

Net income (loss) per share
        Basic                                              $      0.70           $     (0.50)          $      0.24
        Diluted                                            $      0.70           $     (0.50)          $      0.24

Weighted average shares outstanding
        Basic                                                7,613,475             7,679,312             8,591,767
        Diluted                                              7,667,802             7,679,312             8,657,735

</TABLE>

See accompanying notes to Consolidated Financial Statements.

                                                                              25
<PAGE>

Penn-America Group, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
                                                                                                               Unearned
                                                               Accumulated                                   Compensation     Total
                                                Additional           Other                        Officers'      From         Stock-
                                         Common    Paid-In   Comprehensive    Retained  Treasury     Stock     Restricted   holders'
(In thousands, except per share amounts)  Stock    Capital    Income (Loss)   Earnings     Stock     Loans   Stock Awards    Equity
------------------------------------------------------------------------------------------------------------------------------------
<S>                                        <C>    <C>              <C>        <C>       <C>           <C>        <C>      <C>
Balance at December 31, 1998                $99    $69,035          $2,714     $34,779   $(5,643)      $ 0        $(354)   $100,630
Net income                                   --         --              --       2,038        --        --           --       2,038
Other comprehensive loss:
        Unrealized loss on investments,
        net of tax and reclassification
        adjustment                           --         --          (7,038)         --        --        --           --      (7,038)
                                                                                                                           ---------
Comprehensive loss                                                                                                           (5,000)
                                                                                                                           ---------
Issuance of common stock                      1        556              --          --        --        --           --         557
Unearned compensation from
         restricted stock awards issued      --         --              --          --        --        --          (91)        (91)
Amortization of compensation
        expense from restricted stock
        awards issued                        --         --              --          --        --        --          120         120
Cash dividends paid
        ($ 0.2075 per share)                 --         --              --      (1,767)       --        --           --      (1,767)
Purchase of treasury stock, at cost          --         --              --          --   (13,831)       --           --     (13,831)
                                        --------------------------------------------------------------------------------------------
Balance at December 31, 1999               $100    $69,591        $ (4,324)   $ 35,050  $(19,474)      $ 0        $(325)   $ 80,618
                                        --------------------------------------------------------------------------------------------
Net loss                                     --         --              --      (3,856)       --        --           --      (3,856)
Other comprehensive income:
        Unrealized gain on investments,
        net of tax and reclassification
        adjustment                           --         --           3,513          --        --        --           --       3,513
                                                                                                                           ---------
Comprehensive loss                                                                                                             (343)
                                                                                                                           ---------
Issuance of common stock                      1        573              --          --        --        --           --         574
Officers' stock loans                        --         --              --          --        --      (546)          --        (546)
Unearned compensation from
        restricted stock awards issued       --         --              --          --        --        --          (74)        (74)
Amortization of compensation
        expense from restricted stock
        awards issued                        --         --              --          --        --        --          120         120
Cash dividends paid
         ($ 0.21 per share)                  --         --              --      (1,611)       --        --           --      (1,611)
Purchase of treasury stock, at cost          --         --              --          --    (4,687)       --           --      (4,687)
                                        --------------------------------------------------------------------------------------------
Balance at December 31,2000                $101    $70,164           $(811)    $29,583  $(24,161)    $(546)       $(279)    $74,051
                                        --------------------------------------------------------------------------------------------
Net income                                   --         --              --       5,351        --        --           --       5,351
Other comprehensive income:
        Unrealized gain on investments,
        net of tax and reclassification
        adjustment                           --         --           1,903          --        --        --           --       1,903
                                                                                                                           ---------
Comprehensive income                                                                                                          7,254
                                                                                                                           ---------
Issuance of common stock                     --        622              --          --        --        --           --         622
Officers' stock loans                        --         --              --          --        --       (83)          --         (83)
Forfeiture of restricted stock awards                                                                                32          32
Amortization of compensation
        expense from restricted stock
        awards issued                        --         --              --          --        --        --          115         115
Cash dividends paid
        ($ 0.21 per share)                   --         --              --      (1,600)       --        --           --      (1,600)
                                        --------------------------------------------------------------------------------------------
Balance at December 31, 2001              $ 101   $ 70,786         $ 1,092    $ 33,334  $(24,161)   $ (629)       $(132)   $ 80,391
                                        ============================================================================================
</TABLE>

See accompanying notes to Consolidated Financial Statements.


26
<PAGE>

Penn-America Group, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                                Year ended December 31,
                                                                                  -------------------------------------------------
(In thousands)                                                                        2001               2000               1999
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>                <C>                <C>
Cash flows from operating activities:
        Net income (loss)                                                          $  5,351           $  (3,856)         $  2,038
        Adjustments to reconcile net income (loss) to
                net cash provided by operating activities:
                        Bond amortization (accretion) and
                                depreciation expense, net                                (5)               393                493
                        Net realized investment loss (gain)                             555              1,331               (841)
                        Deferred income tax benefit                                    (499)              (594)              (263)
                        Net (increase) decrease in premiums receivable,
                                prepaid reinsurance premiums and
                                unearned premiums                                    (4,401)             5,087              2,727
                        Net increase in unpaid losses and loss adjustment
                                expenses and reinsurance recoverable                  2,927             15,432              5,264
                        Accrued investment income                                       (18)              (216)               (94)
                        Deferred policy acquisition costs                             1,234             (1,011)              (578)
                        Income tax recoverable                                        2,915             (1,330)              (768)
                        Other assets                                                     23               (134)               (64)
                        Accounts payable and accrued expenses                         1,447                598                576
                        Other liabilities                                            (1,106)              (709)               112
                                                                                  -------------------------------------------------
                                Net cash provided by operating activities             8,423             14,991              8,602
                                                                                  -------------------------------------------------

Cash flows from investing activities:
        Purchases of equity securities                                               (4,162)           (10,405)            (8,320)
        Purchases of fixed maturities available for sale                            (28,672)           (87,573)           (38,521)
        Purchases of fixed maturities held to maturity                                   --             (9,974)            (2,785)
        Proceeds from sales of equity securities                                      3,146             11,202              4,462
        Proceeds from sales and maturities of fixed maturities
                available for sale                                                   21,911             78,154             25,995
        Proceeds from maturities and calls of fixed maturities
                held to maturity                                                      2,250              9,000             13,256
        Change in short-term investments                                                 --                449                548
                                                                                  -------------------------------------------------
                                Net cash used by investing activities                (5,527)            (9,147)            (5,365)
                                                                                  -------------------------------------------------

Cash flows from financing activities:
        Issuance of common stock                                                        622                500                465
        Purchase of treasury stock                                                       --             (4,687)           (13,831)
        Officers' stock loans                                                           (83)              (546)                --
        Principal payments on capital lease obligations                                (131)              (120)              (136)
        Dividends paid                                                               (1,600)            (1,611)            (1,767)
                                                                                  -------------------------------------------------
                                Net cash used by financing activities                (1,192)            (6,464)           (15,269)
                                                                                  -------------------------------------------------

Increase (decrease) in cash                                                           1,704               (620)           (12,032)
Cash, beginning of period                                                            11,425             12,045             24,077
                                                                                  -------------------------------------------------
Cash, end of period                                                                $ 13,129           $ 11,425           $ 12,045
                                                                                  -------------------------------------------------

Supplemental disclosure of cash flow information:
                Interest paid                                                      $    160           $    161           $    145
                Taxes (recovered) paid                                                 (492)              (950)               875

</TABLE>
See accompanying notes to Consolidated Financial Statements.

                                                                              27
<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. ("PAGI") is an insurance holding company. Penn
Independent Corporation ("Penn Independent") owned approximately 40% of the
outstanding common stock of PAGI at December 31, 2001. The accompanying
financial statements include the accounts of PAGI and its wholly owned
subsidiary, Penn-America Insurance Company ("Penn-America") and its wholly owned
subsidiary Penn-Star Insurance Company ("Penn-Star"), (collectively the
"Company"). All significant inter-company accounts and transactions have been
eliminated in consolidation. These financial statements are prepared in
conformity with accounting principles generally accepted in the United States,
which differ in some respects from those required by 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.

The Company underwrites commercial property, general liability and multi-peril
insurance for small businesses located primarily in small towns and suburban and
rural areas. The Company can write business in all fifty states and the District
of Columbia. The Company writes business on both an admitted and non-admitted
basis in thirty-six states, on only an admitted basis in two states and on only
a non-admitted basis in twelve states and the District of Columbia.

Revenue Recognition

Premiums written are recognized as earned ratably over the terms of the
respective policies and include estimates for premiums earned but not yet
billed. Unearned premiums represent the portion of premiums written applicable
to the unexpired terms of policies in force and are calculated on a semi-monthly
pro-rata basis.

Valuation of Premiums Receivable

The Company evaluates the collectibility of premiums receivable based on a
combination of factors. In circumstances in which the Company is aware of a
specific customer's inability to meet its financial obligations to the Company,
a specific reserve for bad debts against amounts due is recorded to reduce the
net receivable to the amount reasonably believed to be collectible. No such
instances occurred in 2001. For all remaining balances, reserves are recognized
for bad debts based on the length of time the receivables are past due based on
historical statistics.

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, 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.
Interest income is recognized on the accrual basis.

The amortized cost of mortgage-backed and asset-backed securities is calculated
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.



28
<PAGE>

Equity securities are carried at fair value with the change in unrealized
investment gains or losses, net of deferred income taxes, included as a separate
component of accumulated other comprehensive income in stockholders' equity.

Realized gains or losses represent the difference between the book value of
securities sold and the proceeds realized upon sale. The cost of securities is
adjusted where appropriate to include a provision for a decline in value that is
considered to be other-than-temporary. The Company uses the specific
identification method to determine the cost of securities sold. Realized gains
or losses, including any provision for other-than-temporary declines in value,
are included in the statement of operations.

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
periods 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 represents estimates of
amounts needed to pay reported and unreported claims and related expenses. These
estimates are based on certain actuarial and other assumptions related to the
ultimate cost to pay such claims. All estimates are reviewed periodically and as
experience develops and new information becomes known, the reserves are adjusted
as necessary. Such adjustments are reflected in the results of operations in the
period in which they are determined.

Fair Values of Financial Instruments

The Company uses the following methods or assumptions in determining fair
values:

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.

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 Company. 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 that the Company rents
from a related party.


29
<PAGE>

Income Tax

Deferred income taxes are accounted for under the 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.

Comprehensive Income (Loss)

Comprehensive income (loss) encompasses all changes in stockholders' equity
(except those arising from transactions with stockholders) and includes net
income and net unrealized investment gains and losses on fixed-income
investments classified as "available-for-sale" and equity securities, net of
deferred income tax.

Reclassification

Certain prior year amounts have been restated to conform to 2001
classifications.

Note 2 Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing income available to
common stockholders by the weighted-average number of common shares outstanding
for each period. Diluted net income (loss) per share includes the potential
dilution that could occur if the contracts to issue common stock were exercised
and converted into common stock.

The following is a reconciliation of the basic and diluted net income (loss) per
share computations:

<TABLE>
<CAPTION>
                                                                                Year ended December 31,
                                                              ----------------------------------------------------------
(In thousands, except per share data)                                 2001                2000                  1999
------------------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                  <C>                   <C>
Basic per share computation:
        Net income (loss)                                        $     5,351          $    (3,856)          $     2,038
        Weighted average common shares outstanding                 7,613,475            7,679,312             8,591,767
                                                              ----------------------------------------------------------
        Basic net income (loss) per share                        $      0.70          $     (0.50)          $      0.24
                                                              ----------------------------------------------------------

Diluted per share computation:
        Net income (loss)                                        $     5,351          $    (3,856)          $     2,038
        Weighted average common shares outstanding                 7,613,475            7,679,312             8,591,767
        Additional shares outstanding after the assumed
                exercise of options by applying the
                treasury stock method                                 54,327                    *                65,968
                                                              ----------------------------------------------------------
Total shares                                                       7,667,802            7,679,312             8,657,735
                                                              ----------------------------------------------------------
Diluted net income (loss) per share                              $      0.70          $     (0.50)          $      0.24
                                                              ==========================================================
</TABLE>


* As of December 31, 2000 the Company had issued options to purchase 359,250
shares of common stock to employees and directors at prices ranging from $5.42
to $19.00. These options were not considered in the 2000 computation, as the
impact was anti-dilutive.

Note 3 Transactions with Affiliates

Penn-America leases its home office facility from a stockholder and the lease is
accounted for as a capital lease. The amount of property capitalized of
$2,227,000 is presented net of accumulated depreciation of $561,000 and $474,000
as of December 31, 2001 and 2000, respectively. Capitalized lease obligations of
$1,570,000 and $1,701,000 were recorded at December 31, 2001 and 2000,
respectively, representing the


30
<PAGE>

lease obligation arising from this lease, which carries an 8.5% interest rate.
Penn Independent and its subsidiaries also lease a portion of the building in
which the Company's home office facility is located. Management believes that
the lease terms are at market rates.

At December 31, 2001, the future minimum lease payments for the capitalized
lease obligation are $281,000 per year in 2002 through 2006 and the total
minimum lease payments are $2,262,000, of which $692,000 is the amount
representing interest.

Penn Independent provides the Company with human resource management and other
services. The Company paid $212,000, $200,000 and $200,000 in 2001, 2000 and
1999, respectively, for such services. Such amounts are based on allocations of
estimated costs. All costs incurred by Penn Independent on behalf of the Company
have been allocated to the Company and are reflected in the financial
statements. Management believes that the methods used to allocate such costs are
reasonable and that the Company's expenses on a stand-alone basis would not be
materially different.

Gross written premiums with insurance agency affiliates of Penn Independent were
$3,888,000, $3,282,000 and $1,732,000 in 2001, 2000 and 1999, respectively.
Commissions paid to such affiliates were $857,000, $740,000 and $441,000 in
2001, 2000 and 1999 respectively. Premiums receivable includes receivables from
affiliates of $454,000 and $535,000 as of December 31, 2001 and 2000,
respectively.

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 or
Moody's. The cost, gross unrealized gains and losses and fair values of
investments are as follows:

<TABLE>
<CAPTION>
                                                                           December 31, 2001
                                                   --------------------------------------------------------------------
                                                                           Gross             Gross
                                                     Amortized        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                                $  4,013          $    182          $     --          $  4,195
      Corporate securities                              49,981             2,091                51            52,021
      Mortgage-backed securities                        26,483               863                30            27,316
      Other structured securities                       20,758               725                21            21,462
      Municipal securities                              20,569               457                22            21,004
      Public utilities                                   9,172               259               176             9,255
                                                   --------------------------------------------------------------------
   Total available for sale                            130,976             4,577               300           135,253
                                                   --------------------------------------------------------------------

   Held to maturity:
      U.S. Treasury securities and
              obligations of U.S. government
              agencies                                  13,812               213                --            14,025
      Corporate securities                                 276                14                --               290
      Public utilities                                     996                 6                --             1,002
                                                   --------------------------------------------------------------------
   Total held to maturity                               15,084               233                --            15,317
                                                   --------------------------------------------------------------------

Total fixed-maturity securities                        146,060             4,810               300           150,570

Equity securities                                       27,770               269             2,890            25,149
                                                   --------------------------------------------------------------------
Total investments                                     $173,830          $  5,079          $  3,190          $175,719
                                                   ===================================================================
</TABLE>


                                                                              31
<PAGE>

<TABLE>
<CAPTION>
                                                                      December 31, 2000
                                          -------------------------------------------------------------------
                                                                 Gross             Gross
                                           Amortized        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           $  4,015          $    107          $     --          $  4,122
      Corporate securities                    52,084               668               387            52,365
      Mortgage-backed securities              23,321               629                 6            23,944
      Other structured securities             21,381               497                 6            21,872
      Municipal securities                    15,882               537                --            16,419
      Public utilities                         7,190                44               479             6,755
                                          -------------------------------------------------------------------
   Total available for sale                  123,873             2,482               878           125,477
                                          -------------------------------------------------------------------

   Held to maturity:
      U.S. Treasury securities and
              obligations of U.S.
              government agencies             13,760               162                14            13,908
      Corporate securities                     2,378                --                 4             2,374
      Municipal securities                       150                --                --               150
      Public utilities                           994                15                --             1,009
                                          -------------------------------------------------------------------
   Total held to maturity                     17,282               177                18            17,441
                                          -------------------------------------------------------------------

Total fixed-maturity securities              141,155             2,659               896           142,918

Equity securities                             27,324               300             3,133            24,491
                                          -------------------------------------------------------------------
Total investments                           $168,479          $  2,959          $  4,029          $167,409
                                          ===================================================================
</TABLE>


Fixed maturities at December 31, 2001, by contractual maturity, are shown below.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or to prepay obligations with or without call or
prepayment penalties.
<TABLE>
<CAPTION>
                                             Available for Sale                 Held to Maturity
                                     -----------------------------        -----------------------------
                                      Amortized                           Amortized
(In thousands)                             Cost         Fair Value             Cost        Fair Value
------------------------------------------------------------------        -----------------------------
<S>                                    <C>               <C>               <C>               <C>
Due in one year or less                $  3,055          $  3,132          $ 12,118          $ 12,261
Due after one year through
        five years                       45,659            47,565             2,966             3,056
Due after five years through
        ten years                        27,198            27,585                --                --
Due after ten years                       7,823             8,193                --                --
Mortgage-backed and other
        structured securities            47,241            48,778                --                --
                                     -----------------------------        -----------------------------
Total                                  $130,976          $135,253          $ 15,084          $ 15,317
                                     -----------------------------        -----------------------------
</TABLE>



32
<PAGE>


A summary of net investment income is as follows:
<TABLE>
<CAPTION>
                                                             Year ended December 31,
                                                --------------------------------------------------
(In thousands)                                       2001               2000               1999
--------------------------------------------------------------------------------------------------
<S>                                               <C>                <C>                <C>
Interest on fixed maturities                      $  9,835           $  8,508           $  7,629
Dividends on equity securities                       1,421              1,422              1,492
Interest on short-term investments and cash            377                815                787
Other                                                   37                 26                  4
                                                --------------------------------------------------
Total investment income                             11,670             10,771              9,912
Less investment expense                               (331)              (317)              (375)
                                                --------------------------------------------------
Net investment income                             $ 11,339           $ 10,454           $  9,537
                                                --------------------------------------------------
</TABLE>


All investments in fixed-maturity securities were income-producing during 2001,
2000 and 1999. Realized pre-tax gains (losses) on the sale of investments are as
follows:

<TABLE>
<CAPTION>
                                                                Year ended December 31,
                                                --------------------------------------------------
(In thousands)                                       2001              2000              1999
--------------------------------------------------------------------------------------------------
Fixed maturities:
<S>                                                <C>               <C>               <C>
        Gross realized gains                       $   218           $    24           $    66
        Gross realized losses                         (203)           (1,461)              (23)
                                                --------------------------------------------------
Net realized investment gain (loss)                     15            (1,437)               43

Equity securities:
        Gross realized gains                           240             1,128             1,266
        Gross realized losses                         (810)           (1,022)             (468)
                                                --------------------------------------------------
Net realized investment gain (loss)                   (570)              106               798
                                                --------------------------------------------------

Total net realized investment gain (loss)          $  (555)          $(1,331)          $   841
                                                --------------------------------------------------
</TABLE>

Income tax benefit on net realized losses was $189,000 and $453,000 in 2001 and
2000, respectively. Income tax expense on net realized investment gain was
$286,000 in 1999. Gross realized losses on equity securities for the year ended
December 31, 2001 included an other-than-temporary impairment of $603,000.

The amortized cost of fixed maturities on deposit with various regulatory
authorities at December 31, 2001 and 2000 amounted to $10,998,000 and
$10,992,000, 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, 2001, reinsurance recoverable and prepaid
reinsurance premiums associated with two major reinsurers, General Reinsurance
Corporation and American Reinsurance Corporation, were $24.3 million and $5.0
million, respectively.

                                                                              33


<PAGE>

Written premiums and premiums earned consisted of the following:

<TABLE>
<CAPTION>
                                       Year ended December 31,
                          ------------------------------------------------
(In thousands)                 2001             2000               1999
--------------------------------------------------------------------------
<S>                         <C>               <C>               <C>
Written premiums:
        Gross               $ 98,412          $109,791          $ 95,983
        Ceded                 11,289            12,541             8,947
                          ------------------------------------------------
Net of reinsurance          $ 87,123          $ 97,250          $ 87,036
                          ------------------------------------------------

Premiums earned:
        Gross               $100,617          $102,883          $ 93,904
        Ceded                 11,683            11,434             8,227
                          ------------------------------------------------
Net of reinsurance          $ 88,934          $ 91,449          $ 85,677
                          ------------------------------------------------
</TABLE>

Loss and loss adjustment expenses are net of recoveries recognized under
reinsurance contracts as follows: $7,446,000, $9,438,000 and $7,182,000 in 2001,
2000 and 1999, respectively.

Note 6 Unpaid Losses and Loss Adjustment Expenses

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

<TABLE>
<CAPTION>
                                                    Year ended December 31,
                                     ------------------------------------------------
(In thousands)                             2001              2000              1999
-------------------------------------------------------------------------------------
<S>                                     <C>               <C>               <C>
Balance, beginning of year              $115,314          $ 93,719          $ 88,937
Less reinsurance recoverable              24,093            18,086            16,502
                                     ------------------------------------------------
Net balance, beginning of year            91,221            75,633            72,435
Incurred related to:
        Current year                      60,885            66,214            54,768
        Prior years                           36             9,164             8,419
                                     ------------------------------------------------
Total incurred                            60,921            75,378            63,187

Paid related to:
        Current year                      19,913            26,273            23,540
        Prior years                       38,183            33,517            36,449
                                     ------------------------------------------------
Total paid                                58,096            59,790            59,989

Net balance, end of year                  94,046            91,221            75,633
Plus reinsurance recoverable              25,552            24,093            18,086
                                     ------------------------------------------------
Balance, end of year                    $119,598          $115,314          $ 93,719
                                     ------------------------------------------------
</TABLE>

As a result of changes in estimates of insured events of prior years, the
provision for losses and loss adjustment expenses increased $36,000, $9,164,000,
and $8,419,000 in 2001, 2000, and 1999, respectively. The increase in prior year
incurred losses in 2000 was due principally to revised loss projections for the
Company's commercial automobile liability, CMP liability and other liability
lines of business. The increase in prior year incurred losses in 1999 was due
principally to loss reserve development in the non-standard personal automobile
line of business.




34
<PAGE>

Note 7 Income Tax

The components of income tax expense (benefit) are as follows:

                                            Year ended December 31,
                               ----------------------------------------------
(In thousands)                     2001               2000            1999
-----------------------------------------------------------------------------
Current                         $ 2,492           $ (2,377)         $  107
Deferred                           (499)              (594)           (263)
                               ----------------------------------------------
Total tax expense (benefit)     $ 1,993           $ (2,971)         $ (156)
                               ----------------------------------------------

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

<TABLE>
<CAPTION>
                                                                        Year ended December 31,
                                                           ----------------------------------------------
(In thousands)                                                  2001            2000            1999
----------------------------------------------------------------------------------------------------------
<S>                                                             <C>            <C>              <C>
Statutory income tax rate                                       34.0%          (34.0)%          34.0%
Tax-exempt interest and dividends received deduction            (7.7)          (10.2)          (44.5)
Other                                                            0.8             0.7             2.2
                                                           ----------------------------------------------
                                                                27.1%          (43.5)%          (8.3)%
                                                           ----------------------------------------------
</TABLE>

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

                                                   December 31,
                                        -------------------------------
(In thousands)                                 2001            2000
-----------------------------------------------------------------------
Assets
Effect of discounting unpaid losses
        and loss adjustment expenses          $4,490          $4,070
Excess of tax over financial
        reporting of earned premium            2,502           2,625
Net unrealized investment loss                    --             433
Other                                            814             748
                                        -------------------------------
Total deferred assets                          7,806           7,876
                                        -------------------------------

Liabilities
Deferred policy acquisition costs              3,088           3,508
Net unrealized investment gain                   564              --
Other                                            364              96
                                        -------------------------------
Total deferred liabilities                     4,016           3,604
                                        -------------------------------
Net deferred tax asset                        $3,790          $4,272
                                        -------------------------------


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 probable that the Company will realize the benefit
of the deferred tax asset and, therefore, no such valuation allowance has been
established.


                                                                              35
<PAGE>

Note 8 Segment Information

The Company had two reportable segments: personal lines and commercial lines.
These segments were managed separately because they have different customers,
pricing and expense structures. The Company exited the non-standard personal
automobile business in 1999 and announced that it would run-off its remaining
portfolio of such business. The Company will continue to report on this segment
separately until the amounts relating to the non-standard personal automobile
business become immaterial to the financial statements presented. 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 income taxes, unallocated expenses and investment income
attributable to equity.

The following is a summary of the Company's segment revenues, expenses and
profit:

<TABLE>
<CAPTION>
                                                                Year ended December 31, 2001
                                                         ---------------------------------------------
(In thousands)                                            Commercial        Personal            Total
-------------------------------------------------------------------------------------------------------
<S>                                                        <C>              <C>               <C>
Premiums earned                                            $88,912          $    22           $88,934
Net investment income and net realized
        investment loss from insurance operations            7,290               --             7,290
                                                         ---------------------------------------------
Total segment revenues                                      96,202               22            96,224
                                                         ---------------------------------------------

Segment losses and loss adjustment expenses                 62,414           (1,493)           60,921
Segment expenses                                            26,087                8            26,095
                                                         ---------------------------------------------
Total segment expenses                                      88,501           (1,485)           87,016
                                                         ---------------------------------------------

Segment profit                                             $ 7,701          $ 1,507             9,208
                                                         ---------------------------------------------

Plus unallocated items:
        Net investment income from equity                                                       3,494
        Unallocated expenses                                                                   (5,358)
        Income tax expense                                                                     (1,993)
                                                                                             ---------
Net income                                                                                     $5,351
                                                                                             =========
</TABLE>


36
<PAGE>

<TABLE>
<CAPTION>

                                                                 Year ended December 31, 2000
                                                          ---------------------------------------------
(In thousands)                                            Commercial         Personal            Total
-------------------------------------------------------------------------------------------------------
<S>                                                        <C>               <C>               <C>
Premiums earned                                            $ 87,556          $  3,893          $ 91,449
Net investment income and net realized
        investment loss from insurance operations             5,152               479             5,631
                                                          ---------------------------------------------
Total segment revenues                                       92,708             4,372            97,080
                                                          ---------------------------------------------

Segment losses and loss adjustment expenses                  72,893             2,485            75,378
Segment expenses                                             25,614             1,362            26,976
                                                          ---------------------------------------------
Total segment expenses                                       98,507             3,847           102,354
                                                          ---------------------------------------------

Segment profit (loss)                                      $ (5,799)         $    525           (5,274)
                                                          ---------------------------------------------

Plus unallocated items:
        Net investment income from equity                                                        3,492
        Unallocated expenses                                                                    (5,045)
        Income tax benefit                                                                       2,971
                                                                                             ---------
Net loss                                                                                       $(3,856)
                                                                                             =========
</TABLE>


<TABLE>
<CAPTION>
                                                                     Year ended December 31, 1999
                                                         ------------------------------------------------
(In thousands)                                            Commercial         Personal             Total
-------------------------------------------------------------------------------------------------------
<S>                                                        <C>               <C>                <C>
Premiums earned                                            $ 71,731          $ 13,946           $ 85,677
Net investment income and net realized
        investment gain from insurance operations             4,730               800              5,530
                                                         ------------------------------------------------
Total segment revenues                                       76,461            14,746             91,207

Segment losses and loss adjustment expenses                  49,744            13,443             63,187
Segment expenses                                             21,905             4,533             26,438
                                                         ------------------------------------------------
Total segment expenses                                       71,649            17,976             89,625
                                                         ------------------------------------------------

Segment profit (loss)                                      $  4,812          $ (3,230)             1,582
                                                         ------------------------------------------------
        Plus unallocated items:
        Net investment income from equity                                                          4,848
        Unallocated expenses                                                                      (4,548)
        Income tax benefit                                                                           156
                                                                                                ---------
Net income                                                                                      $  2,038
                                                                                                =========
</TABLE>

Total segment revenues of $96,224,000, $97,080,000 and $91,207,000, plus
unallocated net investment income from equity of $3,494,000, $3,492,000 and
$4,848,000, equals total Company revenues of $99,718,000, $100,572,000 and
$96,055,000 for the years ended December 31, 2001, 2000, and 1999, respectively.

In 2001, the Company had one general agency that accounted for approximately 11%
of gross premiums earned. In 2000 and 1999, no general agent accounted for more
than 10% of gross premiums earned.




                                                                              37
<PAGE>

Note 9 Dividends from Subsidiaries and Statutory Information

Penn-America and Penn-Star are highly regulated by the state in which they are
incorporated and the states in which they do business. Such regulations, among
other things, limit the amount of dividends, impose restrictions on the amount
and types of investments and regulate rates insurers may charge for various
products.

A source of cash for the payment of common stock dividends to PAGI'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. In 2001, the Company paid dividends of $1.6 million to
PAGI. No ordinary dividends were paid in 2000. In 2000, Penn-America paid a $6.4
million return of capital to PAGI, after receiving approval from the
Pennsylvania Insurance Department. The maximum dividend that may be paid by
Penn-America to PAGI without prior approval of regulatory authorities in 2002 is
$6,473,325.

The National Association of Insurance Commissioners ("NAIC") has developed
Property and Casualty Risk-Based Capital ("RBC") standards that relate an
insurer's reported statutory surplus to the risks inherent to overall
operations. The RBC formula uses the statutory annual statement to calculate the
minimum indicated capital level required to support asset risk and underwriting
risk. The NAIC model law calls for various levels of regulatory action based on
the magnitude of an indicated RBC capital deficiency, if any. The Company
regularly monitors capital requirements along with the NAIC's RBC developments.
The Company has determined that its capital levels are in excess of the minimum
capital requirements for all RBC action levels and that its capital levels are
sufficient to support the level of risk inherent in its operations.

The following tables reconcile statutory surplus and net income (loss) of the
Company as determined in accordance with accounting procedures prescribed by the
insurance regulatory authorities to stockholders' equity and net income (loss)
of the Company calculated in accordance with accounting principles generally
accepted in the United States as reported herein:

<TABLE>
<CAPTION>
                                                                     Year ended December 31,
                                                      ------------------------------------------------
(In thousands)                                            2001               2000               1999
------------------------------------------------------------------------------------------------------
<S>                                                    <C>                <C>                <C>
Statutory surplus as regards to policyholders          $ 64,733           $ 55,530           $ 69,515
Deferred policy acquisition costs                         9,083             10,317              9,306
Deferred income taxes                                      (574)             4,272              5,483
Net unrealized investment gain (loss)                     4,151              1,974             (5,027)
Non-admitted assets                                       2,171              1,175                896
Provision for uncollectible accounts                     (1,022)              (522)              (522)
Holding company assets                                    1,594              1,156                938
Other, net                                                  255                149                 29
                                                      ------------------------------------------------
GAAP stockholders' equity                              $ 80,391           $ 74,051           $ 80,618
                                                      ------------------------------------------------

                                                                     Year ended December 31,
                                                      ------------------------------------------------
(In thousands)                                            2001               2000               1999
------------------------------------------------------------------------------------------------------
Statutory net income (loss)                            $  6,827           $ (5,020)          $  1,869
Deferred policy acquisition costs                        (1,268)             1,010                578
Deferred income tax                                         499                594                281
Allowance for uncollectible accounts                       (500)                --                100
Holding company expenses, net of tax                       (345)              (500)              (825)
Other, net                                                  138                 60                 35
                                                      ------------------------------------------------
GAAP net income (loss)                                 $  5,351           $ (3,856)          $  2,038
                                                      ------------------------------------------------
</TABLE>


38
<PAGE>

The NAIC revised the Statutory Accounting Practices and Procedures Manual in a
process referred to as Codification. The objective of Codification is to
standardize the accounting practices prescribed by each State's Insurance
Department. The revised manual was effective January 1, 2001. Pennsylvania, the
domiciliary state for Penn-America and Penn-Star, has adopted the provisions for
the revised manual. The revised manual has changed, to some extent, prescribed
statutory accounting practices and has resulted in changes to the accounting
practices that Penn-America and Penn-Star use to prepare their statutory-basis
financial statements. These changes resulted in an increase in the
statutory-basis capital and surplus of the Company of $3.3 million at January 1,
2001.

Note 10 Incentive Savings and Retirement Plan

Penn-America participates in a profit-sharing and a 401(k) plan with Penn
Independent that covers qualified employees. Penn-America's contributions under
the 401(k) plan were $117,000, $72,000 and $105,000 for 2001, 2000, and 1999,
respectively. There were no profit-sharing distributions in 2001, 2000, and
1999.

Note 11 Stock Incentive Plans

Stock Options: In August 1993, the Company adopted a Stock Incentive Plan (the
"Plan"), which later was amended and restated in April of 1994 and amended in
April 2000. The purpose of the Plan is to enable officers, employees, directors,
consultants, advisors and service providers of the Company and its affiliates
(as defined in the Plan) 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 authorized the issuance of up to 825,000
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 fair value of options is estimated on the grant date using the Black-Scholes
option pricing model. The model assumes the following for 2001, 2000, and 1999,
respectively: expected annual dividend rates of 2.0%, 2.8% and 1.9%; risk-free
interest rates of 2.0% for 2001 and 6.0% for 2000 and 1999; weighted-average
expected life of the options of 4.8 years for 2001 and 2.5 years for 2000 and
1999; and expected stock price volatility of 22% for 2001 and 30% for 2000 and
1999.

The Company has elected to account for these stock options in accordance with
the provisions of Accounting Principles Board Opinion ("APB") #25, "Accounting
for Stock Issued to Employees" and accordingly, no compensation expense has been
recorded for such grants. Statement of Financial Accounting Standards ("SFAS")
#123 "Accounting for Stock-Based Compensation," effective in 1996, would require
that compensation expense be recorded for these option grants. Accounting for
such options using APB 25 and SFAS 123 are both acceptable alternatives under
GAAP. Had the Company elected to adopt SFAS 123, the effect on the Company's net
income and per share results would have been:

<TABLE>
<CAPTION>
                                                                   Year ended December 31,
                                                        ----------------------------------------
(In thousands)                                            2001            2000            1999
------------------------------------------------------------------------------------------------
<S>                                                     <C>             <C>             <C>
Net income (loss):
        As reported                                     $ 5,351         $ (3,856)       $ 2,038
        Pro forma                                         5,325           (3,998)         2,013

Diluted net income (loss) per share:
        As reported                                     $ 0.70          $ (0.50)        $ 0.24
        Pro forma                                         0.70            (0.52)          0.23
</TABLE>

                                                                              39
<PAGE>

A summary of the status of and changes in the Company's stock option plan is
presented below:

<TABLE>
<CAPTION>
                                                                              Year ended December 31,
                                                                    -----------------------------------------
(Options in thousands)                                                 2001            2000            1999
-------------------------------------------------------------------------------------------------------------
<S>                                                                  <C>             <C>            <C>
Outstanding at beginning of year
        (average price of $7.12, $7.09 and $6.98)                       359             307            298
Granted
        (average price of $7.75, $7.44 and $10.63 per share)             36              74              9
Exercised
        (average price of $6.18 and $4.43 per share)                    (54)            (16)             -
Forfeited
        (average price of $7.42 and $16.38 per share)                   (13)             (6)             -
                                                                    -----------------------------------------
Outstanding at end of year
        (average price of $7.31, $7.12 and $7.09)                       328             359            307
                                                                    -----------------------------------------

Options exercisable at end of year                                      279             295            298
                                                                    -----------------------------------------
Weighted average fair value of options
        granted during the year                                      $ 1.22          $ 2.91         $ 3.29
</TABLE>

The following table summarizes information about stock options outstanding at
December 31, 2001:

<TABLE>
<CAPTION>
                                 Options Outstanding                Options Exercisable
                  ----------------------------------------------------------------------------------
                                       Weighted
                         Number         Average          Weighted          Number          Weighted
                   Outstanding        Remaining           Average     Exercisable           Average
                      12/31/01      Contractual          Exercise        12/31/01          Exercise
Exercise Prices     (in 000's)     Life (Years)             Price       (in 000's)            Price
----------------------------------------------------------------------------------------------------
<S>                   <C>               <C>           <C>                 <C>            <C>
$ 5.40 - 5.70             8                 0.4           $  5.44             8              $ 5.44
$ 5.71 - 7.60           231                 2.8           $  6.25           215              $ 6.17
$ 7.61 - 9.50            36                 2.9           $  8.34            24              $ 8.64
$ 9.51 - 11.40           30                 3.4           $ 10.18             9              $10.63
$ 11.41 - 15.20          14                 1.4           $ 13.75            14              $13.75
$ 15.21 - 19.00           9                 2.4           $ 19.00             9              $19.00
</TABLE>


On January 2, 2002, the Company granted 174,890 stock options to employees at an
exercise price equal to the market price on the date of the grant. These stock
option grants vest over a five-year period beginning January 2, 2003.

Restricted Stock: The Company has awarded shares of restricted stock to certain
employees. 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 $115,000 in 2001 and $120,000 in
2000 and 1999 to compensation expense relating to these awards. During 2001,
2000 and 1999, 10,500, 6,500 and 6,500 shares, respectively, of the restricted
stock were released to the applicable employees as allowed by the provisions of
the grant.

Agents' Contingent Commission Plan: The Company's Agents' Contingent Commission
Plan allows its agents to receive up to 100% of their contingent profit
commission awards in PAGI common stock. Agents' common stock awards for the
2000, 1999 and 1998 years, which were issued in May of 2001, 2000 and 1999,
amounted to 23,459, 59,589 and 42,035 shares, respectively.


40
<PAGE>

Note 12 Commitments and Contingencies

The Company's insurance subsidiaries are subject to routine legal proceedings in
connection with their property and casualty insurance business. Penn-America has
been named as a defendant in litigation commenced in the Superior Court of
California, County of Los Angeles, on November 6, 2000 and in an identical suit
on December 18, 2000 in the County of Orange relating to its exited non-standard
personal automobile business. It is not possible at this time to evaluate the
probability of a favorable or unfavorable outcome, nor is it possible to
estimate the amount of loss, if any. Management believes that its position is
defensible as to such litigation and is of the opinion that the amount of loss,
if any, will not have a material affect on the Company's financial statements.
The Company is involved in no other 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.

The Company leases various computer equipment that have terms primarily expiring
in less than a three-year period. Rental expenses for these operating leases
were $391,000 $349,000 and $392,000 for the years ended December 31, 2001, 2000
and 1999, respectively.

At December 31, 2001, the future minimum rental payments required under
operating leases that have initial or remaining non-cancellable lease terms in
excess of one year were $341,000, $150,000 and $11,000 for 2002, 2003 and 2004,
respectively.

Note 13 Other Comprehensive Income

Accumulated other comprehensive income (loss) of the Company consists solely of
net unrealized investment gains and losses. The following table illustrates the
components of accumulated other comprehensive income:

<TABLE>
<CAPTION>
                                                                          Year ended December 31, 2001
                                                                -----------------------------------------------
                                                                  Pre-tax                Tax         Net of Tax
(In thousands)                                                     Amount            Expense             Amount
---------------------------------------------------------------------------------------------------------------
<S>                                                              <C>                <C>                <C>
Unrealized gains on investments:
        Unrealized holding gains arising during period           $  2,328           $   (792)          $  1,537
        Reclassification adjustments for
                losses realized in net income                         555               (189)               366
                                                                -----------------------------------------------
Other comprehensive income                                       $  2,883           $   (980)          $  1,903
                                                                -----------------------------------------------


                                                                          Year ended December 31, 2000
                                                                -----------------------------------------------
                                                                  Pre-tax                Tax         Net of Tax
(In thousands)                                                     Amount            Expense             Amount
---------------------------------------------------------------------------------------------------------------
Unrealized gains on investments:
        Unrealized holding gains arising during period           $  3,990           $ (1,355)          $  2,635
        Reclassification adjustments for losses
                realized in net income                              1,331               (453)               878
                                                                -----------------------------------------------
Other comprehensive income                                       $  5,321           $ (1,808)          $  3,513
                                                                -----------------------------------------------



                                                                          Year ended December 31, 1999
                                                                -----------------------------------------------
                                                                  Pre-tax                Tax         Net of Tax
(In thousands)                                                     Amount            Expense             Amount
---------------------------------------------------------------------------------------------------------------
Unrealized losses on investments:
        Unrealized holding losses arising during period          $ (9,823)          $  3,340           $ (6,483)
        Reclassification adjustments for gains
                realized in net income                               (841)               286               (555)
                                                                -----------------------------------------------
Other comprehensive loss                                         $(10,664)          $  3,626           $ (7,038)
                                                                -----------------------------------------------
</TABLE>



                                                                              41
<PAGE>

Note 14 Unaudited Quarterly Financial Information
<TABLE>
<CAPTION>
                                                                                  2001
                                        ----------------------------------------------------------------------------------------
(In thousands,
except per share data)                     First             Second               Third              Fourth              Total
--------------------------------------------------------------------------------------------------------------------------------
<S>                                     <C>                <C>                 <C>                 <C>                <C>
Revenues                                $  25,994          $  24,687           $  23,837           $  25,200          $  99,718
Net income                                    967                994               1,551               1,839              5,351

Basic and diluted
        net income per share                 0.13               0.13                0.20                0.24               0.70

                                                                                  2000
                                        ----------------------------------------------------------------------------------------
(In thousands,
except per share data)                     First             Second               Third              Fourth              Total
--------------------------------------------------------------------------------------------------------------------------------
Revenues                                $  23,933          $  24,923           $  24,971           $  26,745          $ 100,572
Net income (loss)                           1,583               (662)             (5,078)                301             (3,856)

Basic and diluted
        net income (loss) per share          0.20              (0.09)              (0.67)               0.04              (0.50)
</TABLE>


42
<PAGE>

Officers
Penn-America Group, Inc.

Jon S. Saltzman
President and Chief Executive Officer

Joseph F. Morris
Senior Vice President, Chief Financial Officer and Treasurer

Garland P. Pezzuolo
Vice President, Secretary and General Counsel

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

Jon S. Saltzman
President and Chief Executive Officer

Thomas P. Bowie
Senior Vice President, Claims

Joseph F. Morris
Senior Vice President, Chief Financial Officer and Treasurer

Thomas J. Cannon
Vice President, Marketing and Agency Relations

J. Ransley Lennon
Vice President, Information Technology

Garland P. Pezzuolo
Vice President, Secretary and General Counsel

Nancy M. Rankin
Vice President, Underwriting

John A. Smith
Vice President and Controller

Francis J. McKenna
Assistant Vice President, Claims


Independent Auditors
Ernst & Young, LLP
Two Commerce Square
Philadelphia PA 19103

Consulting Actuary
Ernst & Young, LLP
Two Commerce Square
Philadelphia PA 19103

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

Board of Directors
Penn-America Group, Inc.

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

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

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, Director,
        Penn Independent Corporation

Charles Ellman
Retired Insurance Executive
Paul Simon
Director, Public Policy Institute,
        Southern Illinois University

E. Anthony Saltzman
Vice President, Delaware Valley Underwriting Agency

Martin Sheffield, CPCU
Chief Operating Officer, Ward Financial Group, Inc.

Annual Meeting
The Annual Stockholders' Meeting will be held in the Company's home office on
May 15, 2002 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 an E-mail request to info@penn-america.com

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

Market and Common Stock Information
The Company's common stock trades on the New York Stock Exchange under the
symbol "PNG." As of February 1, 2002 there were 190 registered holders of record
and approximately 1,000 beneficial holders of record of the company's common
stock. The high and low sale prices of the common stock were as follows:

           2001
----------------------------
Quarter    High        Low
----------------------------
First     $10.45      $7.19
Second     10.50      10.00
Third      10.20       9.60
Fourth     10.55       9.00

           2000
----------------------------
Quarter    High        Low
----------------------------
First     $9.00       $6.63
Second     9.75        7.13
Third      7.88        6.88
Fourth     9.44        6.88