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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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Form 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO

SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


|  |  |                                                                                             
|- |  | --------------------------------------------------------------------------------------------
|þ |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
| 
|  |  | For the Fiscal Year Ended December 31,
    2003                                             
| 
|o |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| 
|  |  | For the transition period
    from           to                                             

Commission File Number: 000-32057



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American Physicians Capital, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Michigan                                                           |  | 38-3543910                              
|(State or other jurisdiction of
    incorporation or organization) |  | (IRS employer
    identification number)

1301 North Hagadorn Road, East Lansing,
Michigan 48823

(Address of principal executive offices)(Zip
Code)


Registrants telephone number, including
area code: (517) 351-1150

Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock, no par value


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

Indicate by check
mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrants
knowledge, in a definitive proxy or information statement
incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.

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

The aggregate
market value of the Common Stock held by non-affiliates of the
Registrant as of June 30, 2003 based on $24.48 per share
(the last sale price for the Common Stock on such date as
reported on the Nasdaq Stock Markets National Market), was
approximately $176.3 million. For purposes of this
computation only, all executive officers, directors and 10%
beneficial owners of the Registrant are assumed to be affiliates.

As of
February 24, 2004 the Registrant had 8,485,347 shares
of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the
Registrants definitive Proxy Statement pertaining to the
2004 Annual Meeting of Shareholders (the Proxy
Statement) to be filed pursuant to Regulation 14A are
incorporated by reference into Part III.



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|        |         
|------- | --------
|Item 1. | Business

General

American Physicians Capital, Inc., or
APCapital, is an insurance holding company which writes
primarily medical professional liability insurance through its
subsidiary American Physicians Assurance Corporation, or
American Physicians. We also provide, on a limited basis, health
coverage through American Physicians, workers compensation
insurance through our Insurance Corporation of America
subsidiary, and excess and surplus lines through our APSpecialty
Insurance Corporation subsidiary. Starting in late 2002, and
continuing throughout 2003, we made several changes to our
medical professional liability line of business, including
exiting the Florida market and discontinuing the issuance of
occurrence-based policies in Ohio and Kentucky. Late in 2003, we
made the decision to exit the health and workers
compensation insurance lines, and have de-emphasized our excess
and surplus lines. Exit activities related to health and
workers compensation insurance will continue into 2004,
and potentially beyond. APCapital also owns several financial
services companies. APCapital and its consolidated subsidiaries
are sometimes referred to in this report as we,
us, or the Company.

APCapital was incorporated in Michigan in July
2000 to facilitate the conversion of American Physicians from a
mutual insurance company to a publicly owned stock insurance
company. In connection with this conversion, APCapital offered
its common stock to policyholders of American Physicians, to
various other groups having specified relationships to American
Physicians and to the general public. APCapital stock began
trading on the Nasdaq Stock Markets National Market on
December 8, 2000. The conversion became effective, the
offerings were closed and American Physicians and its
subsidiaries became subsidiaries of APCapital on
December 13, 2000.

American Physicians, which is APCapitals
primary subsidiary, was formed in June 1975 under the
sponsorship of the Michigan State Medical Society in response to
a medical professional liability insurance crisis in Michigan.
By 1981, American Physicians insured more physicians than any
other insurer in the State of Michigan, a distinction it
maintains today.

Summary Premium Volume and Revenue By
Line

The following table sets forth, for the years
ended December 31, 2003, 2002 and 2001, the amount of
direct premiums written, net premiums written, and net premiums
earned for each of our insurance operating segments, as well as
investment income, net realized gains (losses), other income and
total revenues and other income.

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|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |       |        | 
|------------------------ | ------------------------------ | ------------------------------- | - | ------- | ------- |  |  | ------ | ------ |  | ----- | ------- | ------- | ------ |  | ----- | ------ |  | - | ------- | ------- |  |  | ----- | ------ | 
|                         |                                |                                
|                         |                                | Year Ended December 31,         |  
|                         |                                |                                 |  
|                         |                                |                                 |   |         |         | 
|                         |                                | 2003                            |   |         | 2002    |  |  | 2001   |       
|                         |                                |                                 |   |         |         |  |  |        |       
|                         |                                |                                 |   | % of    |         |  |  |        | % of   |  |       |         |         | % of   | 
|                         |                                | Amount                          |   |         | Total   |  |  | Amount |        |  | Total |         |         | Amount |  |       | Total  | 
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                |                                
|                         |                                | (Dollars in thousands)          |  
|Direct premiums written: |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|                         | Medical professional liability |                                 | $ | 195,742 |         |  |  | 76.4%  |        |  | $     | 177,253 |         |        |  | 66.6% |        |  | $ | 149,253 |         |  |  | 64.7% |       
|                         | Workers compensation          |                                 |   | 37,337  |         |  |  | 14.6%  |        |  |       | 64,194  |         |        |  | 24.1% |        |  |   | 63,977  |         |  |  | 27.7% |       
|                         | Health                         |                                 |   | 23,156  |         |  |  | 9.0%   |        |  |       | 24,433  |         |        |  | 9.2%  |        |  |   | 18,001  |         |  |  | 7.8%  |       
|                         | Personal and commercial        |                                 |   |        |         |  |  | 0.0%   |        |  |       | 380     |         |        |  | 0.1%  |        |  |   | (466    | )       |  |  | -0.2% |       
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total                           |   | $       | 256,235 |  |  |        | 100.0% |  |       | $       | 266,260 |        |  |       | 100.0% |  |   | $       | 230,765 |  |  |       | 100.0% | 
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|Net premiums written:    |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|                         | Medical professional liability |                                 | $ | 164,157 |         |  |  | 73.1%  |        |  | $     | 154,583 |         |        |  | 64.8% |        |  | $ | 126,830 |         |  |  | 60.8% |       
|                         | Workers compensation          |                                 |   | 38,521  |         |  |  | 17.1%  |        |  |       | 60,446  |         |        |  | 25.4% |        |  |   | 64,754  |         |  |  | 31.0% |       
|                         | Health                         |                                 |   | 22,208  |         |  |  | 9.9%   |        |  |       | 23,820  |         |        |  | 10.0% |        |  |   | 18,668  |         |  |  | 8.9%  |       
|                         | Personal and commercial        |                                 |   | (239    | )       |  |  | -0.1%  |        |  |       | (432    | )       |        |  | -0.2% |        |  |   | (1,473  | )       |  |  | -0.7% |       
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total                           |   | $       | 224,647 |  |  |        | 100.0% |  |       | $       | 238,417 |        |  |       | 100.0% |  |   | $       | 208,779 |  |  |       | 100.0% | 
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|Total revenue:           |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|Net premiums earned:     |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|                         | Medical professional liability |                                 | $ | 158,777 |         |  |  | 58.5%  |        |  | $     | 148,646 |         |        |  | 53.0% |        |  | $ | 119,659 |         |  |  | 48.8% |       
|                         | Workers compensation          |                                 |   | 43,844  |         |  |  | 16.2%  |        |  |       | 63,517  |         |        |  | 22.6% |        |  |   | 58,377  |         |  |  | 23.8% |       
|                         | Health                         |                                 |   | 22,208  |         |  |  | 8.2%   |        |  |       | 23,820  |         |        |  | 8.5%  |        |  |   | 18,668  |         |  |  | 7.6%  |       
|                         | Personal and commercial        |                                 |   | (239    | )       |  |  | -0.1%  |        |  |       | (432    | )       |        |  | -0.2% |        |  |   | 5,667   |         |  |  | 2.3%  |       
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total                           |   |         | 224,590 |  |  |        | 82.8%  |  |       |         | 235,551 |        |  |       | 84.0%  |  |   |         | 202,371 |  |  |       | 82.6%  | 
|                         | Investment income              |                                 |   | 43,294  |         |  |  | 16.0%  |        |  |       | 44,775  |         |        |  | 16.0% |        |  |   | 47,883  |         |  |  | 19.5% |       
|                         | Net realized gains (losses)    |                                 |   | 2,403   |         |  |  | 0.9%   |        |  |       | (163    | )       |        |  | -0.1% |        |  |   | (5,651  | )       |  |  | -2.3% |       
|                         | Other income                   |                                 |   | 1,104   |         |  |  | 0.4%   |        |  |       | 376     |         |        |  | 0.1%  |        |  |   | 546     |         |  |  | 0.2%  |       
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total revenues and other income |   | $       | 271,391 |  |  |        | 100.0% |  |       | $       | 280,539 |        |  |       | 100.0% |  |   | $       | 245,149 |  |  |       | 100.0% | 
|                         |                                |                                 |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 

Medical Professional Liability

Products and
Services.We underwrite medical
professional liability coverage for physicians, their
corporations, medical groups, clinics and ancillary healthcare
providers. Medical professional liability insurance protects
physicians and other health care providers against liabilities
arising from the rendering of, or failure to render,
professional medical services. We offer claims-made coverage in
all states in which we write business, with the exception of New
Mexico, and occurrence policies in a limited number of states.
Our policies include coverage for the cost of defending claims.
Claims-made policies provide coverage to the policyholder for
claims reported during the period of coverage. Policyholders are
insured continuously while their claims-made policy is in force.
We offer extended reporting endorsements (tails) to
cover claims reported after the policy expires. Occurrence
policies provide coverage to the policyholders for all losses
incurred during the policy coverage year regardless of when the
claims are reported. Although we generate a majority of our
premiums from individual and small group practices, we also
insure several major physician groups as well as two hospitals.
We also have an excess and surplus lines company, APSpecialty,
to provide coverage on a limited basis in select states to
physicians that are part of a group practice who do not meet
standard underwriting criteria. As a non-admitted company in
most states, we can charge higher premiums for APSpecialty
policies and issue more restricted policy terms and conditions.

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We offer separate policy forms for physicians who
are sole practitioners and for those who practice as part of a
medical group or clinic. The policy issued to sole practitioners
includes coverage for professional liability that arises from
the medical practice. The medical professional insurance for
sole practitioners and for medical groups provides protection
against the legal liability of the insureds for injury caused by
or as a result of the performance of patient treatment, failure
to treat, failure to diagnose and related types of malpractice.
We offer two types of policies for medical groups or clinics.
Under the first policy type, both the individual physician and
the group share the same set of policy limits. Under the second
group policy type, the individual physician and the group or
clinic each purchase separate policy limits. At
December 31, 2003, we insured approximately 10,500
physicians in 12 states, with a concentration in our core
Midwestern states of Michigan, Ohio, Illinois and Indiana,
as well as Kentucky and New Mexico. The Company has withdrawn
from Florida and is in the process of exiting Nevada.

Marketing.Our
marketing philosophy is to sell profitable business in our core
states, using a focused, multi-channeled, cost-effective
distribution system as follows: In 2003, our captive agents
generated 42% of our premiums, independent agents generated 48%
and we produced 10% of premiums on a direct basis without agent
involvement. In addition to our agency force, we have built our
sales and marketing efforts around several strategic business
alliances. These alliances include medical society endorsements,
purchasing group programs and other marketing alliances.

Our medical professional liability product line
is marketed through approximately 50 agents in 10 states,
with one strategic partner, SCW Agency Group, Inc. and its
wholly owned subsidiary, Kentucky Medical Agency
(SCW), accounting for approximately 38% of medical
professional liability direct premiums written during 2003. The
vast majority of our remaining agents who write our medical
professional liability insurance are independent agents. Due to
the highly specialized nature of medical professional liability
insurance, we are working to build a controlled distribution
system to increase the percentage of our business that is
produced through captive agents, which protects the company and
makes us less vulnerable to changes in market conditions. We
also work with financially sound agencies that focus on this
line in targeted geographic areas. Our top ten agencies produced
$131.9 million of direct premiums written, or 67% of total
premium writings in 2003.

The Michigan State Medical Society
(MSMS), has endorsed American Physicians as its
exclusive professional liability carrier of choice for
28 years. We renewed our exclusive strategic partnership
through December 2006, in which we compensate MSMS for marketing
our professional medical liability products to MSMS members.
American Physicians is endorsed by the Michigan Osteopathic
Association, the New Mexico Medical Society, several specialty
societies and numerous physician organizations.

Underwriting and
Pricing.Most of our initial
underwriting work and customer contact is performed through a
centralized process based in our home office. The home office
underwriting department has final responsibility for the
issuance, establishment and implementation of underwriting
standards for all of our underwritten coverages. The local
office underwriting staff have the authority to evaluate,
approve and issue medical professional liability coverage for
individual providers and medical groups with annual premiums
that do not exceed present threshold amounts or guidelines
imposed by the home office.

Through our management and actuarial staff, we
regularly establish rates and rating classifications for our
physician and medical group insureds based on the loss and loss
adjustment expense, or LAE, experience we have developed over
the past 28 years, and the loss and LAE experience for the
entire medical professional liability market. We have various
rating classifications based on practice location, medical
specialty and other liability factors. We also utilize various
discounts, such as claim-free credits, to encourage low risk,
high profit physicians to insure with American Physicians.

The nature of our business requires that we
remain sensitive to the marketplace and the pricing strategies
of our competitors. Using the market information as our
background, we normally set our prices based on our estimated
future costs. From time to time, we may reduce our discounts or
apply a premium surcharge to achieve an appropriate return.
Pricing flexibility allows us to provide a fair rate
commensurate with the assumed liability. If our pricing strategy
cannot yield sufficient premium to cover our costs on a
particular type

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of risk, we may determine not to underwrite that
risk. It is our philosophy not to sacrifice profitability for
premium growth.


Claims Management.Our strategy for handling medical professional liability claims
combines a basic philosophy of vigorously defending against
non-meritorious claims with an overall commitment to providing
outstanding service to our insured physicians and hospitals. Our
claims department is responsible for claims investigation,
establishment of appropriate case reserves for loss and loss
adjustment expenses, defense planning and coordination, working
closely with attorneys engaged by us to defend a claim and
negotiation of the settlement or other disposition of a claim. A
part of our overall claims strategy is to establish regional
claims departments in our major markets. This local presence
helps to facilitate better defense attorney coordination, as
well as develop claims staff that have experience with the
regions legal environment, which enables us to more
accurately establish case reserves. Our policies require us to
provide a defense for our insureds in any suit involving a
medical incident covered by the policy. The defense costs we
incur are in addition to the limit of liability under the
policy. Medical professional liability claims often involve the
evaluation of highly technical medical issues, severe injuries
and conflicting expert opinions.

We emphasize early evaluation and aggressive
management of claims. When a claim is reported, a claims
department professional completes an initial evaluation and sets
the initial reserve. As the discovery process continues, the
reserve may be adjusted. We have established different levels of
authority within the claims department for settlement of claims.

Workers Compensation

In 2003, we wrote workers compensation
insurance to small and mid-level accounts throughout the
Midwest. Starting in the fourth quarter of 2003, we began to
exit the workers compensation line. We are currently in
the process of non-renewing all policies. The process of
non-renewing policies should be substantially complete by
June 30, 2004; however, premiums will continue to be earned
into 2005 on policies which were written during the first half
of 2004.

Distribution, Underwriting and
Pricing.Our workers
compensation book of business had been marketed by independent
agents. Underwriting and claims services were provided through
our offices in the Midwest. In conjunction with exiting this
line, all underwriting and policy processing functions have been
centralized to our East Lansing, Michigan home office, which is
responsible for all aspects of underwriting standards for all of
our underwritten coverages, including pricing.

Using a variety of data, we set our prices based
on estimated futures costs. From time to time, we have reduced
our discounts or applied premium surcharges to achieve an
appropriate return. Pricing flexibility allows us to provide a
fair rate commensurate with the ultimate assumed liability. If
our pricing strategy cannot yield sufficient premium to cover
costs on a particular type of risk, we do not write that risk.

Claims Management.Our claims processing has been centralized in our Louisville,
Kentucky office where we have an experienced claims staff who
will oversee the run-off of the claims associated with this line
of business. We intend to maintain our commitment to exceptional
service, aggressive claims management, quality medical care,
timely payment and claims settlement throughout the run-off
process. We apply numerous techniques to reduce medical and
indemnity costs and, as allowed by statute, we provide medical
direction for injured workers. We encourage development of
alternative work for those employees who can re-enter the
workforce on a limited basis.

We apply an aggressive defense for all
non-compensable claims. We encourage participation from the
insured and maintain open communications with the policyholder
and defense counsel throughout the life of the case. In defense
contested workers compensation claims, our claims
representatives work with pre-approved counsel who specialize in
workers compensation defense practice. Our claims
representatives are accountable for the outcome of each claim.
All of these practices assist us in reducing the cost of
workers compensation claims.

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Health Insurance

We currently write small business employee health
insurance through a single preferred provider organization
located in western Michigan. However, in late 2003, we have made
the decision to exit this line. We can begin non-renewing
policies July 1, 2004. Thus, we will continue to have
written and earned premiums through the first half of 2005.

Other Insurance

We previously sold personal and commercial
insurance. We are no longer accepting new business in this line
of business and have not renewed business previously written by
us in this line.

On a selective basis, we continue to offer
alternative risk transfer programs.

A.M. Best Company Rating

The financial strength and ability to meet
policyholder obligations of our insurance subsidiaries are rated
by A.M. Best Company (A.M. Best). Our American
Physicians and APSpecialty subsidiaries have a B+ (Very Good)
rating, which is the sixth highest of 15 rating levels.
According to A.M. Best, companies rated B+ are deemed
secure and are assigned to insurers that have, on
balance, very good balance sheet strength, operating performance
and business profiles when compared to the standards established
by A.M. Best, and in A.M. Bests opinion, have a good
ability to meet their ongoing obligations to policyholders. Our
Insurance Corporation of America subsidiary is rated B- by A.M.
Best. According to A.M. Best, companies rated B- (Fair) are
deemed vulnerable and are assigned to insurers which
have, on balance, fair balance sheet strength, operating
performance and business profiles when compared to the standards
established by A.M. Best, and in A.M. Bests opinion, have
an ability to meet their ongoing obligations to policyholders.

In November 2003, A.M. Best reduced the financial
strength rating of the APCapital Group of Companies from A- to
B++. This downgrade was directly attributable to our third
quarter 2003 loss announced November 6, 2003. At that time,
A.M. Best put our rating under further review with a negative
outlook pending completion of their analysis. In January 2004,
A.M. Best reduced the financial strength rating of American
Physicians and APSpecialty to B+, based on their lower
capitalization. Our Insurance Corporation of America subsidiary
was given a B- rating due to its change in status to a
workers compensation run-off company. All of these ratings
remain under review with a negative outlook.

An insurance companys rating, and
particularly its A.M. Best rating, is a potential source of
competitive advantage or disadvantage in the marketplace.
Although any rating downgrade is a negative, the reduction of
our A.M. Best rating has not had a material adverse impact on
our business to date and we do not anticipate any significant
decline in business as a result of the recent downgrades.
However, any further downgrade could have a material adverse
impact on our business.

Rating agencies such as A.M. Best evaluate
insurance companies based on their financial strength and
ability to pay claims, factors which are more relevant to
policyholders and potential customers who are purchasing
insurance, and agents who are advising customers, than
investors. Financial strength ratings by rating agencies are not
ratings of securities or recommendations to buy, hold, or sell
any security.

Other Financial Subsidiaries

We have developed and acquired a variety of other
organizations to offer financial services and consulting to its
customers. These services include captive insurance company
arrangements, loss control consulting, risk management and
investment management. Revenues from these sources are not
material.

Reinsurance

In accordance with industry practice, we cede to
other insurance companies some of the potential liability under
insurance policies we have underwritten. This practice, called
reinsurance, helps us reduce our net liability on individual
risks, stabilize our underwriting results and increase our
underwriting capacity. However,

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if the reinsurer fails to meet its obligations,
we remain liable for policyholder obligations. As payment for
sharing a portion of our risk, we are also required to share a
part of the premium we receive on the related policies. We
determine the amount and scope of reinsurance coverage to
purchase each year based upon an evaluation of the risks
accepted, consultations with reinsurance brokers and a review of
market conditions, including the availability and pricing of
reinsurance. Our reinsurance arrangements are generally
renegotiated annually.


Under our primary professional liability
reinsurance contract, the portion of the policyholder premium
ceded to the reinsurers is swing-rated, or
experience rated on a retrospective basis. This swing-rated
contract is subject to a minimum and maximum premium range to be
paid to the reinsurers in the future, depending upon the extent
of losses actually paid by the reinsurers. We pay a provisional
premium during the initial policy year. A liability is recorded
to represent an estimate of net additional payments to be made
to the reinsurers under the program, based on the level of loss
and LAE reserves recorded. Our largest net insured amount on any
medical professional liability risk is $500,000.

Our net retention in workers compensation,
in states other than Minnesota, is $1 million. In
Minnesota, insurers are required to obtain reinsurance from a
state facility called the Workers Compensation Reinsurance
Association, or WCRA. Our current net retention on any one claim
with respect to the WCRA is $720,000. To take advantage of
emerging markets, we have also utilized quota share reinsurance
in the recent past, where we proportionately share the premium
and losses with the reinsurer.

The following table identifies our principal
reinsurers, their percentage participation in our aggregate
reinsured risk based upon amounts recoverable and their
respective A.M. Best ratings as of December 31, 2003. A.M.
Best classifies an A rating as Excellent
and A++ and A+ ratings as
Superior. The NR-3 rating for Gerling Global
Reinsurance Corporation (Gerling Global) indicates
that A.M. Bests rating procedures are inapplicable,
primarily due to the fact that Gerling Globals United
States subsidiary is in run-off. Other than the entities listed
below, no single reinsurers percentage participation in
2003 exceeded 5% of total amounts recoverable from reinsurers.

|                                       |  |                        |      |         |                  |   |                  |           |  |         |                  |  |  |  |       | 
|-------------------------------------- |  | ---------------------- | ---- | ------- | ---------------- | - | ---------------- | --------- |  | ------- | ---------------- |  |  |  | ----- | 
|                                       |  |                        |      |         |                  |   |                  | % of 2003 | 
|                                       |  |                        |      | Amounts |                  |   | 2003 Total Ceded |           |  | Amounts |                 
|                                       |  | A.M. Best              |      |         | Recoverable From |   |                  | Premiums  |  |         | Recoverable From | 
|Reinsurer                              |  | Rating                 |      |         | Reinsurers       |   |                  | Written   |  |         | Reinsurers       | 
|                                       |  |                        |      |         |                  |   |                  |           |  |         |                  | 
|                                       |  |                       
|                                       |  | (Dollars in thousands) |     
|Hannover Ruckversicherungs             |  |                        | A    |         |                  | $ | 34,348           |           |  | $       | 11,125           |  |  |  | 30.2% | 
|Gerling Global Reinsurance Corporation |  |                        | NR-3 |         |                  |   | 17,528           |           |  |         | 1,860            |  |  |  | 15.4% | 
|American Re-Insurance Company          |  |                        | A+   |         |                  |   | 13,507           |           |  |         | 8,722            |  |  |  | 11.9% | 
|Transatlantic Reinsurance Company      |  |                        | A++  |         |                  |   | 11,284           |           |  |         | 4,271            |  |  |  | 9.9%  | 

We annually review the financial stability of all
of our reinsurers. This review includes a ratings analysis of
each reinsurer participating in a reinsurance contract. On the
basis of this review, as of December 31, 2003, we concluded
that there was no material risk of not being paid by our
reinsurers. We performed additional analysis on Gerling Global
given the fact that the United States subsidiary is in run-off.
Our review indicates that Gerling Global still has adequate
surplus and cash flow, and we have not experienced any
difficulties in collecting amounts due from Gerling Global, or
any other reinsurers. However, we will continue to monitor the
Gerling Global situation carefully, and may pursue an economic
settlement or commutation if we determine this is the best
long-term course of action. We believe that our reinsurance is
maintained with financially stable reinsurers and that any
reinsurance security we have is adequate to protect our
interests. However, our inability to collect on our reinsurance,
or the inability of our reinsurers to make payments under the
terms of reinsurance, due to insolvency or otherwise, could have
a material adverse effect on our future results of operations
and financial condition.

6



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##### 



Loss and Loss Adjustment Expense
Reserves

Our insurance subsidiaries are required by
applicable insurance laws and regulations to maintain reserves
for payment of losses and loss adjustment expenses for reported
claims and for claims incurred but not reported, arising from
policies that have been issued. Generally, these laws and
regulations require that we provide for the ultimate cost of
those claims without regard to how long it takes to settle them
or the time value of money. We are also required to maintain
reserves on a physicians death, disability and retirement,
or DD&R reserves, which are included in our loss reserves.
The determination of reserves involves actuarial and statistical
projections of what we expect to be the cost of the ultimate
settlement and administration of such claims based on facts and
circumstances then known, estimates of future trends in claims
severity, and other variable factors such as inflation and
changing judicial theories of liability. We do not discount our
reserves to recognize for the time value of money.

When a claim is reported to us, claims personnel
establish a case reserve for the estimated amount of
the ultimate payment. This estimate reflects an informed
judgment based upon insurance reserving practices appropriate
for the relevant line of business and on the experience and
knowledge of the estimator regarding the nature and value of the
specific claim, the severity of injury or damage, and the policy
provisions relating to the type of loss. Case reserves are
periodically adjusted by the claims staff, as more information
becomes available. The estimation of ultimate liability for
losses and loss adjustment expenses is an inherently uncertain
process and does not represent an exact calculation of that
liability. We maintain reserves for claims incurred but not
reported to provide for future reporting of already incurred
claims and developments on reported claims. The reserve for
claims incurred but not reported is determined based on
historical loss trends.

We have three actuaries on our staff that analyze
and develop projections of ultimate losses which are used to
establish recorded reserves. Our actuaries utilized standard
actuarial techniques to project ultimate losses based on our
paid and incurred loss information, as well as drawing from
industry data. These projections are done using actual loss
dollars and claim counts. We analyze loss trends and claims
frequency and severity to determine our best
estimate of the required reserves. We then record this
best estimate in the Companys financial statements. As
required by insurance regulatory authorities, we receive an
annual statement of opinion by an independent consulting actuary
concerning the adequacy of our reserves. Typically, as of the
end of the third quarter of each year, our independent actuary
performs an initial analysis of our reserves and provides us
with a preliminary indication of what they believe is the
appropriate level for our recorded reserves. After year end, the
independent actuary performs a much more in-depth analysis on
the basis of which they render their opinion regarding the
adequacy of our reserves. As part of this year end analysis, the
independent actuary determines a range of reserve estimates,
based on its projection methodologies, and a select
amount within the range. If our recorded reserves are materially
different than the independent actuarys select amount, we
adjust reserves so that they are near or above their select
amount. This independent review of our reserves is one of the
key factors that we rely on in our overall assessment of the
adequacy of our reserves. To the extent that the independent
actuarys projections produce results similar to those we
have developed internally, we can be reasonably assured that our
assumptions and methodologies used to project ultimate losses
are adequate.

There can be no assurance that ultimate losses
will not exceed our actuarially determined best estimate of loss
reserves at December 31, 2003. While management does not
explicitly calculate an acceptable range of probable
reserves, historical results have shown ultimate losses have
varied from our initial estimates in a range of plus or minus
8%. Adjustments in aggregate reserves, if any, are reflected in
the operating results of the period during which we become aware
that such adjustments are necessary.

7



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##### 



The following table provides a reconciliation,
prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP), of
beginning and ending loss and loss adjustment expense reserve
balances for the years ended December 31, 2003, 2002 and
2001.

|                               |                                |                        |         |         |         |   |         |         |         |   |         |         |         | 
|------------------------------ | ------------------------------ | ---------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                               |                                | 2003                   |         |         | 2002    |   |         | 2001    |        
|                               |                                |                        |         |         |         |   |         |         |        
|                               |                                |                       
|                               |                                | (Dollars in thousands) |        
|Balance, beginning of year     |                                | $                      | 637,494 |         |         | $ | 597,046 |         |         | $ | 483,273 |        
|                               | Less, reinsurance recoverables |                        |         | (95,468 | )       |   |         | (91,491 | )       |   |         | (69,319 | )      
|                               |                                |                        |         |         |         |   |         |         |        
|Net balance, beginning of year |                                |                        | 542,026 |         |         |   | 505,555 |         |         |   | 413,954 |        
|Incurred related to:           |                                |                        |         |         |         |   |         |         |         |   |         |        
|                               | Current year                   |                        |         | 209,299 |         |   |         | 236,398 |         |   |         | 228,848 |        
|                               | Prior years                    |                        |         | 43,443  |         |   |         | 5,630   |         |   |         | 29,000  |        
|                               |                                |                        |         |         |         |   |         |         |        
|                               |                                | Total incurred         |         |         | 252,742 |   |         |         | 242,028 |   |         |         | 257,848 | 
|                               |                                |                        |         |         |         |   |         |         |        
|Paid related to:               |                                |                        |         |         |         |   |         |         |         |   |         |        
|                               | Current year                   |                        |         | 38,464  |         |   |         | 43,867  |         |   |         | 41,693  |        
|                               | Prior years                    |                        |         | 181,657 |         |   |         | 161,690 |         |   |         | 124,554 |        
|                               |                                |                        |         |         |         |   |         |         |        
|                               |                                | Total paid             |         |         | 220,121 |   |         |         | 205,557 |   |         |         | 166,247 | 
|                               |                                |                        |         |         |         |   |         |         |        
|Net balance, end of year       |                                |                        | 574,647 |         |         |   | 542,026 |         |         |   | 505,555 |        
|                               | Plus, reinsurance recoverables |                        |         | 98,958  |         |   |         | 95,468  |         |   |         | 91,491  |        
|                               |                                |                        |         |         |         |   |         |         |        
|Balance, end of period         |                                | $                      | 673,605 |         |         | $ | 637,494 |         |         | $ | 597,046 |        
|                               |                                |                        |         |         |         |   |         |         |        

During 2003, 2002, and 2001, management made
adjustments to prior year reserves. These adverse adjustments
totaled $43.4 million, $5.6 million, and
$29.0 million for the years ended December 31, 2003,
2002, and 2001, respectively. As a percentage of net reserves as
of the beginning of the year, these adjustments were 8%, 1.1%,
and 7%, respectively.

In the second half of 2001, the Company
encountered a large increase in reported losses, primarily in
its Florida, Ohio and Kentucky professional liability markets.
This increase in reported losses was the result of an over 20%
increase in the average severity of claims reported in 2001. The
2001 adjustment was also unusually large because the Ohio and
Florida markets were relatively new for the Company, making
initial reserve estimates very difficult to predict. These
higher than expected loss trends continued into 2002, but at a
much lower level. As a result, the Company also increased prior
year loss reserves in 2002, primarily in its Ohio and Florida
markets.

During the third quarter of 2003, the Company
experienced a sharp increase in the severity of paid losses in
our medical professional liability segment, which indicated a
much higher trend in claims severity. As a result, actuarial
projections resulted in higher ultimate severities of loss on
currently existing claims related to the 1999 through
2002 accident years, which resulted in management
increasing its estimate of incurred but not reported claims
related to the 1999 through 2002 accident years by
approximately $43.0 million in the third quarter of 2003.

The unfavorable development in the third quarter
of 2003 was primarily related to the Companys Ohio
($16.4 million), Florida ($16.0 million) and Kentucky
($15.0 million) markets, partially offset by positive
development of $7.8 million in the Michigan market. The
Company announced its exit from the Florida market in 2002 and
also discontinued writing occurrence-based policies in the Ohio
and Kentucky markets in 2002. There was no significant
unfavorable development noted on prior year medical professional
liability loss reserves during the fourth quarter of 2003.

The following table shows the development of the
net liability for unpaid loss and loss adjustment expenses from
1994 through 2003. The top line of the table shows the original
estimated liabilities at the balance sheet date, including
losses incurred but not yet reported. The upper portion of the
table shows the cumulative amounts subsequently paid as of
successive year ends with respect to the liability. The lower

8



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##### 



portion of the table shows the re-estimated
amount of the previously recorded liability based on experience
as of the end of each succeeding year. The estimates change as
claims settle and more information becomes known about the
ultimate frequency and severity of claims for individual years.
The (deficiency) or redundancy exists when the re-estimated
liability at each December 31 is greater (or less) than the
prior liability estimate. The cumulative
(deficiency) or redundancy depicted in the table, for any
particular calendar year, represents the aggregate change in the
initial estimates over all subsequent calendar years.


The volatility of professional liability claim
frequency and severity makes the prediction of the ultimate loss
very difficult. Likewise, the long time frame for professional
liability claims to develop and be paid further complicates the
reserving process.

|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|------------------------------------------------------------------------------------------- | ----------------- | ---- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- |  | ---- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- |  | ---- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- |  | 
|                                                                                            |                   | 1994 |         |         | 1995 |   |         | 1996    |  |   | 1997    |         |  | 1998 |         |         | 1999 |   |         | 2000    |  |   | 2001    |         |  | 2002 |         |         | 2003 |  
|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Liability for unpaid losses and loss adjustment
    expenses net of reinsurance recoverable |                   | $    | 341,254 |         |      | $ | 334,264 |         |  | $ | 346,455 |         |  | $    | 352,836 |         |      | $ | 371,982 |         |  | $ | 393,582 |         |  | $    | 413,954 |         |      | $ | 505,555 |         |  | $ | 542,026 |         |  | $ | 574,647 | 
|Cumulative net paid as of:                                                                  |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         | 
|                                                                                            | End of year       |      |         | 59,982  |      |   |         | 47,113  |  |   |         | 69,750  |  |      |         | 86,703  |      |   |         | 85,290  |  |   |         | 95,471  |  |      |         | 124,479 |      |   |         | 161,770 |  |   |         | 181,658 |  |   |         |  | 
|                                                                                            | Two years later   |      |         | 93,724  |      |   |         | 89,260  |  |   |         | 134,184 |  |      |         | 152,656 |      |   |         | 146,497 |  |   |         | 182,541 |  |      |         | 236,653 |      |   |         | 293,852 |  |   |         |         |  |   |         |  | 
|                                                                                            | Three Years later |      |         | 122,509 |      |   |         | 122,734 |  |   |         | 181,144 |  |      |         | 188,665 |      |   |         | 198,774 |  |   |         | 251,448 |  |      |         | 322,226 |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Four years later  |      |         | 142,127 |      |   |         | 148,000 |  |   |         | 205,824 |  |      |         | 215,426 |      |   |         | 231,748 |  |   |         | 292,766 |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Five Years later  |      |         | 154,716 |      |   |         | 158,041 |  |   |         | 219,944 |  |      |         | 232,323 |      |   |         | 251,810 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Six years later   |      |         | 160,204 |      |   |         | 165,250 |  |   |         | 227,840 |  |      |         | 243,012 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Seven Years later |      |         | 165,133 |      |   |         | 170,750 |  |   |         | 234,429 |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Eight years later |      |         | 169,316 |      |   |         | 175,597 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Nine Years later  |      |         | 172,854 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|Re-estimated Net Liability as of:                                                           |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         | 
|                                                                                            | End of year       |      |         | 300,626 |      |   |         | 273,025 |  |   |         | 324,233 |  |      |         | 327,542 |      |   |         | 350,114 |  |   |         | 383,004 |  |      |         | 435,069 |      |   |         | 511,185 |  |   |         | 585,469 |  |   |         |  | 
|                                                                                            | Two years later   |      |         | 251,083 |      |   |         | 259,103 |  |   |         | 302,696 |  |      |         | 314,613 |      |   |         | 334,827 |  |   |         | 373,400 |  |      |         | 449,871 |      |   |         | 538,980 |  |   |         |         |  |   |         |  | 
|                                                                                            | Three Years later |      |         | 239,185 |      |   |         | 238,572 |  |   |         | 291,406 |  |      |         | 290,490 |      |   |         | 313,248 |  |   |         | 374,729 |  |      |         | 458,846 |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Four years later  |      |         | 221,973 |      |   |         | 221,226 |  |   |         | 267,788 |  |      |         | 273,982 |      |   |         | 303,540 |  |   |         | 366,818 |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Five Years later  |      |         | 207,930 |      |   |         | 196,949 |  |   |         | 258,838 |  |      |         | 268,754 |      |   |         | 296,834 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Six years later   |      |         | 187,451 |      |   |         | 192,521 |  |   |         | 254,272 |  |      |         | 266,546 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Seven Years later |      |         | 185,398 |      |   |         | 189,708 |  |   |         | 251,718 |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Eight years later |      |         | 184,033 |      |   |         | 188,400 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Nine Years later  |      |         | 183,996 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|Net cumulative (deficiency) redundancy                                                      |                   |      |         |         |      |   | 145,864 |         |  |   | 94,737  |         |  |      | 86,290  |         |      |   | 75,148  |         |  |   | 26,764  |         |  |      | (44,892 | )       |      |   | (33,425 | )       |  |   | (43,443 | )       |  |   |         | 
|Gross liability  end of year                                                               |                   |      |         |         |      |   | 359,330 |         |  |   | 392,626 |         |  |      | 407,746 |         |      |   | 422,987 |         |  |   | 457,072 |         |  |      | 483,273 |         |      |   | 597,046 |         |  |   | 637,494 |         |  |   | 673,605 | 
|Reinsurance Recoverables                                                                    |                   |      |         |         |      |   | 25,066  |         |  |   | 46,171  |         |  |      | 54,910  |         |      |   | 51,005  |         |  |   | 63,490  |         |  |      | 69,319  |         |      |   | 91,491  |         |  |   | 95,468  |         |  |   | 98,958  | 
|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Net Liability  end of year                                                                 |                   |      |         |         |      |   | 334,264 |         |  |   | 346,455 |         |  |      | 352,836 |         |      |   | 371,982 |         |  |   | 393,582 |         |  |      | 413,954 |         |      |   | 505,555 |         |  |   | 542,026 |         |  |   | 574,647 | 
|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Gross re-estimated liability  latest                                                       |                   |      |         |         |      |   | 199,017 |         |  |   | 297,890 |         |  |      | 325,185 |         |      |   | 377,493 |         |  |   | 446,645 |         |  |      | 540,752 |         |      |   | 633,114 |         |  |   | 685,817 |         |  |   |         | 
|Re-estimated reinsurance recoverables 
    latest                                          |                   |      |         |         |      |   | 10,617  |         |  |   | 46,172  |         |  |      | 58,639  |         |      |   | 80,659  |         |  |   | 79,827  |         |  |      | 81,906  |         |      |   | 94,134  |         |  |   | 100,348 |         |  |   |         | 
|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Net re-estimated liability  latest                                                         |                   |      |         |         |      |   | 188,400 |         |  |   | 251,718 |         |  |      | 266,546 |         |      |   | 296,834 |         |  |   | 366,818 |         |  |      | 458,846 |         |      |   | 538,980 |         |  |   | 585,469 |         |  |   |         | 
|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Gross cumulative (deficiency) redundancy                                                    |                   |      |         |         |      |   | 160,313 |         |  |   | 94,736  |         |  |      | 82,561  |         |      |   | 45,494  |         |  |   | 10,427  |         |  |      | (57,479 | )       |      |   | (36,068 | )       |  |   | (48,323 | )       |  |   |         | 
|                                                                                            |                   |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  

In evaluating the information in the table above,
it should be noted that each column includes the effects of
changes in amounts for prior periods. The table does not present
accident year or policy year development data. Conditions and
trends that have affected the development of liabilities in the
past may not necessarily

9



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occur in the future. Accordingly, it may not be
appropriate to extrapolate future redundancies or deficiencies
based on this table.


Statutory accounting principles require reserves
to be reported on a net basis, i.e., after reinsurance.
Accounting principles generally accepted in the United States of
America (GAAP) require reserves to be reported on a
gross basis, i.e., before reinsurance, with a corresponding
asset established for the reinsurance recoverable. When compared
on either a gross or net basis, our statutory and GAAP reserves
are identical.

Investments

An important component of our operating results
has been the total return on invested assets. Our investment
objectives are primarily to maximize current returns, in
addition to generating long-term capital appreciation that can
ultimately be converted to current income. We are pursuing these
objectives, while maintaining safety of capital, with an
emphasis on adequate liquidity for our insurance operations. All
of our investment securities are classified as
available-for-sale in accordance with Statement of Financial
Accounting Standards No. 115. As of December 31, 2003,
91.5% of our fixed-income investment portfolio, which consisted
of fixed-income securities and short-term investments, was
investment grade. The majority of our fixed-income portfolio is
managed by one of our subsidiaries. For additional information
regarding our investment results, see Note 5 of the Notes
to Consolidated Financial Statements, which information is
incorporated herein by reference. Other invested assets include
investment real estate and investment real estate limited
partnerships.

Competition

The insurance industry is highly competitive. We
compete with numerous insurance companies and various
self-insurance mechanisms. Many of our competitors have
considerably greater financial resources and higher
A.M. Best Company ratings than we have. We believe that the
principal competitive factors in all of our insurance segments
are service quality, name recognition, breadth and flexibility
of coverages, financial stability and, to a lesser degree,
price. We believe we compare favorably to many of our
competitors based on our excellent service to customers, our
close relationship with the medical community, primarily through
various medical societies, which affords us a high degree of
name recognition, our ability to customize product features and
programs to fit the needs of our customers and our long history
of financial stability. These factors will vary by state based
on the relative strength of our competitors in each market.

An insurance companys rating, and in
particular its A.M. Best rating, is a potential source of
competitive advantage or disadvantage in the marketplace.
Although our recent rating downgrades are a negative factor in
our ability to compete, the reduction of our A.M. Best
rating has not had a material adverse impact on our business to
date and we do not anticipate any significant decline in
business as a result of the recent downgrades.

Segment Information

See Note 21 of the Notes to Consolidated
Financial Statements contained elsewhere in this report for
information regarding our business segments. Such information is
incorporated herein by reference.

Insurance Regulatory Matters

General.Insurance
companies are subject to supervision and regulation relating to
numerous aspects of their business and financial condition in
the states in which they transact business. The nature and
extent of such regulation varies from jurisdiction to
jurisdiction. Our Michigan insurance companies, for example, are
subject to supervision and regulation by the Office of Financial
and Insurance Services for the State of Michigan, or OFIS, which
establishes standards of solvency, licenses insurers and agents,
establishes guidelines for investments by insurers, reviews
premium rates, reviews the provisions which insurers must make
for current losses and future liabilities, reviews transactions
involving a change in control and requires the filing of
periodic reports relating to financial condition. In addition,
state regulatory examiners, including

10



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##### 



the OFIS, perform periodic examinations of
insurance companies. Such regulation is generally intended for
the protection of policyholders rather than shareholders.


Our insurance subsidiaries together are licensed
to write insurance in a total of 36 states and are eligible
to write excess and surplus lines in 19 states. However, we
currently write business in only 14 of the states where we are
licensed or eligible to write excess and surplus lines, with
approximately 95% of that business coming from 8 states.
Our current focus of operations is on our existing states.

Holding Company
Regulation.Most states, including
Michigan, have enacted legislation that regulates insurance
holding company systems such as ours. Each insurance company in
a holding company system is required to register with the
insurance supervisory agency of its state of domicile and
furnish information concerning the operations of companies
within the holding company system that may materially affect the
operations, management or financial condition of the insurers
within the system. These laws permit the OFIS or any other
relevant insurance departments to examine APCapital and its
insurance subsidiaries at any time, to require disclosure of
material transactions between APCapital and its insurance
subsidiaries, and to require prior approval of sales or
purchases of a material amount of assets and the payment of
extraordinary dividends.

Holding company laws also limit the amount of
dividends payable by insurance subsidiaries to the parent
company. Under Michigan law, the maximum dividend that may be
paid to APCapital from its insurance subsidiaries during any
twelve-month period, without prior approval of the OFIS, is the
greater of 10% of each insurance companys statutory
surplus, as reported on the most recent annual statement filed
with the OFIS, or the statutory net income, excluding realized
gains, for the period covered by such annual statement. At
December 31, 2003, the amount available for payment of
dividends without the prior approval of the OFIS was
approximately $14.8 million.

Change of Control.The Michigan Insurance Code requires that the OFIS receive prior
notice of and approve a change of control for either American
Physicians or APCapital. The Michigan Insurance Code contains a
complete definition of control. In simplified terms,
a person, corporation, or other entity would obtain
control of American Physicians or APCapital if they
possessed, had a right to acquire possession, or had the power
to direct any other person acquiring possession, directly or
indirectly, of 10% or more of the voting securities of either
company. In addition, our plan of conversion provides that no
one may acquire more than 5% of the common shares outstanding of
APCapital before December 13, 2005 without OFIS approval.
To obtain approval for a change of control, the proposed
acquirer must file an application with the OFIS containing
detailed information such as the identity and background of the
acquirer and its affiliates, the sources of and amount of funds
to be used to effect the acquisition, and financial information
regarding the proposed acquirer. Insurance laws of other states
applicable to our insurance subsidiaries have similar
requirements.

Risk-Based Capital
Requirements.In addition to
state-imposed insurance laws and regulations, the OFIS
administers the requirements adopted by the National Association
of Insurance Commissioners, or NAIC, that require insurance
companies to calculate and report information under a risk-based
formula that attempts to measure capital and surplus needs based
on the risks in a companys mix of products and investment
portfolio. Under the formula, we first determine our risk-based
capital base level by taking into account risks with respect to
our assets and underwriting risks relating to our liabilities
and obligations. We then compare our total adjusted
capital to the base level. Our total adjusted
capital is determined by subtracting our liabilities from
our assets in accordance with rules established by the OFIS. A
ratio of total adjusted capital to risk-based capital of less
than 2.0 may give rise to enhanced regulatory scrutiny or even a
regulatory takeover of the insurer, depending on the extent to
which the ratio is less than 2.0.

The ratio for our primary insurance subsidiary,
American Physicians, has always exceeded 2.0 in the past, but
there can be no assurance that the requirements applicable to
American Physicians will not increase in the future. As of
December 31, 2003, American Physicians risk-based
capital base level was $45.0 million and its total adjusted
capital was $113.3 million, for a ratio of 2.5. The ratio
of risk-based capital to total adjusted capital for our other
two insurance subsidiaries, APSpecialty and Insurance
Corporation of America, was 51.6 and 4.5 respectively, at
December 31, 2003. In January 2004, APCapital contributed
$25 million to American Physicians to strengthen their
statutory capital and surplus.

11



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##### 



IRIS Requirements.The NAIC has also developed a set of financial ratios, referred
to as the Insurance Regulatory Information System, or IRIS, for
use by state insurance regulators in monitoring the financial
condition of insurance companies. The NAIC has established an
acceptable range of values for each of the IRIS financial
ratios. Generally, an insurance company will become the subject
of increased scrutiny when four or more of its IRIS ratio
results fall outside the range deemed acceptable by the NAIC.
The nature of increased regulatory scrutiny resulting from IRIS
ratio results outside the acceptable range is subject to the
judgment of the applicable state insurance department, but
generally will result in accelerated reviews of annual and
quarterly filings.

In 2003, our insurance company subsidiaries
generated certain ratios that varied from values within the
NAICs acceptable range. The variations and reasons for the
variations are set forth in the table below:

|                                                       |                                                            |             |               |       |  |         |     
|------------------------------------------------------ | ---------------------------------------------------------- | ----------- | ------------- | ----- |  | ------- | ----
|Ratios by Company                                      |                                                            | Usual Range |               | Value | 
|                                                       |                                                            |             |               |       | 
|Company: APSpecialty Insurance
    Corporation         |                                                            |             |               |       |  |        
|                                                       | Change in net writings                                     |             | <33% or> -33% |       |  | -130.4% | (1) 
|Company: Insurance Corporation of
    America          |                                                            |             |               |       |  |        
|                                                       | Net premium to policyholders surplus                      |             | <300%         |       |  | 613.1%  | (2) 
|                                                       | Change in net writings                                     |             | <33% or> -33% |       |  | 2250.6% | (3) 
|                                                       | Two-year overall operating ratio                           |             | <100%         |       |  | 108.3%  | (4) 
|                                                       | Investment yield                                           |             | <10% or> 4.5% |       |  | 3.9%    | (5) 
|                                                       | Change in policyholders surplus                           |             | <50% or> -10% |       |  | 99.9%   | (6) 
|                                                       | Two-year reserve development to
    policyholders surplus |             | <20%          |       |  | 21.7%   | (7) 
|                                                      
|Company: American Physicians Assurance
    Corporation |                                                            |             |               |       |  |        
|                                                       | Change in net writings                                     |             | <33% or> -33% |       |  | -43.1%  | (8) 
|                                                       | Two-year overall operating ratio                           |             | <100%         |       |  | 114.7%  | (9) 
|                                                       | Change in policyholders surplus                           |             | <50% or> -10% |       |  | -23.9%  | (10)
|                                                       | One-year reserve development to
    policyholders surplus |             | <20%          |       |  | 28.4%   | (11)
|                                                       | Two-year reserve development to
    policyholders surplus |             | <20%          |       |  | 22.7%   | (11)



---



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | The reduction in APSpecialtys net premiums
    written is primarily the result of a novation that resulted in
    certain reserve and unearned premium balances being transferred
    to its sister companies, Insurance Corporation of America
    (ICA) and American Physicians. The novation, which
    is an outright transfer of the rights and obligations associated
    with the policies affected, was completed to align the
    Companys major lines of business within specific insurance
    companies. In connection with the novation, written and earned
    premiums equal to the novated reserve and unearned premium
    balances were also transferred, which resulted in a reduction of
    net premiums written of $1.8 million. Without the effects
    of the novation, the results of this ratio would have been
    -59.9%, which is still outside the usual range and can be
    attributed to the transfer of premiums previously written by
    APSpecialty prior to the novation, which was effective
    August 1, 2003, that are now being written on American
    Physicians and ICA.
|
| | (2) | As a result of the novation described
    above, ICAs net premiums written were increased by
    approximately $79.0 million, which resulted in this ratio
    being outside of the usual range. Without the effects of the
    novation, the results of this ratio would have been 87.6%, which
    is within the acceptable range.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| | (3) | This ratio is outside of the acceptable range
    primarily as a result of the additional $79.0 million in
    net premiums written recorded as a result of the novation
    described above; however, even without the additional
    $79.0 million of net premiums written, the increase in net
    premiums written would have been 236.1%, which is still outside
    of the NAICs usual range. The increase in the ratio is
    primarily due to an increase in writings related to the business
    transferred to ICA as a result of the novation, as well as the                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

12



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##### 



| |     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |     | discontinuance, also effective on August 1,
    2003, of an intercompany quota share reinsurance treaty under
    which ICA ceded 80% of its direct premiums written to American
    Physicians. With the discontinuance of the reinsurance
    treaty, ICA is retaining significantly more net premiums
    written.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | (4) | ICAs two year operating ratio is slightly
    skewed as a result of the novation. When the balances were
    novated, losses equal to the reserves transferred were incurred
    along with an equal amount of earned premiums, which resulted in
    a loss ratio of 100% on a significant portion of ICAs
    business recorded during 2003. This, combined with an increase
    in underwriting costs associated with the salaries, employee
    benefits and severance of the workers compensation
    management team that was hired in 2002, are the primary reasons
    for the unusual ratio value.                                                                                                                                                                                                                                                                                                                                                                                     
|
| | (5) | The investment yield is calculated using a simple
    average of beginning and ending invested assets plus accrued
    investment income. During 2003, ICA saw a dramatic increase
    in its invested assets as a result of payments received for
    liabilities accepted in connection with the novation. However,
    this increase did not occur until August 1, 2003, which
    skews the simple average slightly. Using a weighted average of
    invested asset balances, the yield on the investment portfolio
    was approximately 4.4%, which is still slightly less than the
    NAICs usual value, due primarily to the percentage of
    ICAs portfolio that was invested in cash and short-term
    investments, which produce lower yields. See
    Item 7  Managements Discussion and
    Analysis  Results of Operations, Consolidated 2003
    Compared to 2002 for further discussion regarding the
    larger than normal position in cash and short-term investments.
|
| | (6) | The increase in ICAs statutory surplus was
    primarily the result of a $15 million surplus contribution
    from its sister company, American Physicians, offset by a net
    loss of approximately $7.4 million. This surplus
    contribution was made simultaneously with the novation to
    support the increase in ICAs net premium writings as a
    result of the business transferred, and the discontinuance of
    the intercompany quota share reinsurance treaty.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| | (7) | The two year reserve development ratio of 21.7%
    is primarily the result of the novation. Because almost all of
    the Companys workers compensation reserves are now
    reported on ICA, development attributed to this line is also
    reported on ICA. The two year reserve development compares
    reserves for accident years 2001 and prior to surplus as of
    December 31, 2001. ICAs December 31, 2001
    surplus, which was used as the denominator in the calculation,
    was not proportionate to the December 31, 2001
    workers compensation reserves, and the corresponding
    potential for adverse development, which was one of the primary
    reasons an additional $15 million of surplus was
    contributed to ICA in 2003. If ICAs December 31, 2003
    surplus were used as the denominator in the calculation, the
    resulting ratio would have been 11.9%, within the NAICs
    usual value range.                                                
|
| | (8) | The change in net writings ratio value of -43.1%
    is primarily the result of the novation discussed above, which
    resulted in a reduction of American Physicians net premium
    writings related to novated balances of approximately
    $77.3 million. Had net premiums written not been reduced as
    a result of the novation, the ratio would have been -9.8%, which
    is within the NAICs usual range.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| | (9) | The two year overall operating result ratio value
    of 114.7% is primarily the result of a two year loss ratio of
    approximately 110.4%. The unusually high loss ratio is a factor
    of (a) adverse development on prior year loss reserves of
    approximately $46.4 million and $6.4 million in 2003
    and 2002, respectively, and (b) a decrease in net premiums
    earned during 2003 of approximately $57.4 million related
    to the intercompany novation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      



|     |                                                                                                                                                                                                                                                                                                      
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | The decrease in American Physicians
    statutory surplus during 2003 was primarily the result of a
    $32.2 million statutory net loss for the year ended
    December 31, 2003, which was due in large part to the
    adverse development on prior year loss reserves.                          
|    
|(11) | The one and two year reserve development to
    surplus ratio values are outside of the usual range as a result
    of the significant adverse development on prior year loss
    reserves related to the medical professional liability line of
    business, as discussed elsewhere in this report.

Guaranty Fund.We
participate in various guaranty associations in the states in
which we write business that protect policyholders and claimants
against losses due to insolvency of insurers. When an insolvency
occurs, the associations are authorized to assess member
companies up to the amount of the shortfall of funds,

13



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##### 



including expenses. Member companies are assessed
based on the type and amount of insurance written during the
previous calendar year.


We make accruals for our portion of assessments
when we become aware of any possible assessments by the
associations.

Employees

As of December 31, 2003, we had 224
employees. None of the employees are covered by a collective
bargaining unit and we believe that employee relations are good.

Filings Under the Securities Exchange Act of
1934

Our website address is www.apcapital.com. All of
our reports filed under the Securities Exchange Act of 1934 are
available free of charge at our website promptly after they are
filed. In addition, the Companys code of ethics covering
directors, officers and other employees is also available on our
website.

Uncertainties Relating To Forward-Looking
Statements

We make forward-looking statements in this report
and may make such statements in future filings with the
Securities and Exchange Commission. We may also make
forward-looking statements in our press releases or other public
or shareholder communications. Our forward-looking statements
are subject to risks and uncertainties and include information
about our expectations and possible or assumed future results of
our operations. When we use any of the words
believes, expects,
anticipates, estimates or similar
expressions, we are making forward-looking statements.

We claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995 for all of our forward-looking
statements. While we believe that our forward-looking statements
are reasonable, you should not place undue reliance on any such
forward-looking statements, which speak only as of the date
made. Because these forward-looking statements are based on
estimates and assumptions that are subject to significant
business, economic and competitive uncertainties, many of which
are beyond our control or are subject to change, actual results
could be materially different. Factors that might cause such a
difference include the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | If we establish inadequate loss and loss
    adjustment expense reserves, or if they develop less favorably
    than in the past, our profitability may decline.                                                                                                                                                                                                 
|
| |  | A deterioration in the current accident year
    experience could result in a portion or all of our deferred
    policy acquisition costs not being recoverable, which would
    result in a charge to income.                                                                                                                                                   
|
| |  | We may be unable to collect the full amount of
    reinsurance recoverable from Gerling Global, a significant
    reinsurer, if their cash flow or surplus levels are inadequate
    to make claim payments, which could result in a future charge to
    income.                                                                                                
|
| |  | Our exit from various markets and lines of
    business, including without limitation our exit from, the
    workers compensation, health and personal and commercial
    lines of business, as well as various geographic markets, could
    result in future charges to income due to unforeseen costs or
    the need for unanticipated reserve enhancements.
|
| |  | An adverse outcome in the putative shareholder
    class action lawsuits against us may result in a charge to
    income that could have a material adverse effect on our
    financial condition, liquidity and results of operations.                                                                                                                          
|
| |  | Substantial jury awards against our insureds
    could impose liability on us exceeding our policy limits or the
    funds we have reserved for the payment of claims.                                                                                                                                                                                           
|
| |  | If the marketplace puts pressure on pricing
    increases, we may not be able to obtain expected rate increases.                                                                                                                                                                                                                                                 

14



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##### 





| |   |                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | If competitive or other conditions change, our
    revenues may decrease or our expenses may increase.                                                                                                                                                                                                                                                       
|
| |  | If we experience substantial changes in claims
    frequency or severity patterns, our profitability may decline.                                                                                                                                                                                                                                            
|
| |  | If reinsurance rates rise significantly or
    reinsurance becomes unavailable or reinsurers are unable to pay
    our claims, our results of operations and financial condition
    may be adversely affected.                                                                                                                                              
|
| |  | The concentration of our business in Michigan and
    Illinois leaves us vulnerable to various factors specific to
    those states.                                                                                                                                                                                                                         
|
| |  | If our current relationship with medical
    associations and physicians does not continue, our ability to
    market our products and compete successfully may be harmed.                                                                                                                                                                                   
|
| |  | An interruption or change in our relationship
    with SCW Agency Group, an insurance sales agency, which is
    principally owned by our former President and CEO, could reduce
    our insurance premiums and net income. This agency accounts for
    substantially more of our medical professional liability
    premiums written than any other agency.
|
| |  | If any of the member companies in the various
    guaranty associations in which we participate were to become
    insolvent, we could be assessed by the relevant association in
    an amount that could materially affect the financial condition
    or results of operations of the Company.                                                            
|
| |  | We may not be able to obtain regulatory approval
    for rate increases, which may negatively affect our
    profitability.                                                                                                                                                                                                                                  
|
| |  | If we fail to comply with insurance industry
    regulations, or if those regulations become more burdensome to
    us, we may not be able to operate profitably.                                                                                                                                                                                            
|
| |  | A further reduction in our A.M. Best Company
    rating could make it more difficult for us to sell our products.                                                                                                                                                                                                                                            
|
| |  | Changes in prevailing interest rates and other
    negative changes in financial market conditions may reduce our
    revenues, cash flows or assets.                                                                                                                                                                                                        
|
| |  | A downturn in general economic conditions or
    significant increase in inflation in the markets in which we
    compete could negatively affect our profitability.                                                                                                                                                                                         

Other factors not currently anticipated by
management may also materially and adversely affect our
financial condition, liquidity or results of operations. Except
as required by applicable law, we do not undertake any
obligation to publicly update or alter any forward-looking
statements whether as a result of new information, events or
circumstances occurring after the date of this report or
otherwise.



|        |           
|------- | ----------
|Item 2. | Properties

We own our home office in East Lansing, Michigan
which comprises approximately 89,000 square feet. In
addition, we lease office space as needed in our major markets
to provide a local presence. Our leases tend to be five to ten
years in length. We currently lease a total of approximately
70,000 square feet of space in East Lansing, Michigan;
Chicago, Illinois; Louisville, Kentucky; Boca Raton,
Florida; Eden Prairie, Minnesota; and Albuquerque, New Mexico.
We also own various real estate investment properties as part of
our investment portfolio. We are currently in the process of
trying to sublease our office space in Chicago, Boca Raton and
Eden Prairie.



|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

With the exception of the following, we are not
currently subject to any material litigation. Though we have
many routine litigation matters in the ordinary course of our
insurance business, we do not expect these cases to have a
material adverse effect on our financial condition and results
of operations.

15



---



##### 



On both December 30, 2003, and
February 20, 2004, separate putative shareholder class
action complaints were filed in the United States District Court
for the Western District of Michigan against the Company, its
former President and Chief Executive Officer, and its Chief
Financial Officer. The complaints allege violations of federal
securities laws for certain disclosures made by the Company
between February 13, 2003 and November 6, 2003,
regarding its operating results and the adequacy of its
reserves, and each seeks money damages in an unspecified amount.
The Company denies the allegations and intends to vigorously
defend the lawsuits. On each of March 2, 2004 and
March 3, 2004, motions were filed by various shareholders
seeking orders consolidating the two lawsuits, naming the moving
shareholders as lead plaintiff and naming lead counsel. On
March 9, 2004, the parties filed a stipulation and proposed
order consolidating the two cases by dismissing the first suit
with prejudice and appointing a lead plaintiff and lead counsel.
The Company has preserved its right to challenge the propriety
of certifying the case as a class action. The Court has not
acted on this filing. While management believes that meritorious
defenses to the allegations exist, the ultimate disposition of
this litigation could have a material adverse impact on the
Companys financial position, liquidity and results of
operations.



|        |                                                        
|------- | -------------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security
    Holders

No matters were submitted to a vote of
shareholders during the three months ended December 31,
2003.



PART II




|        |                                                                                                                           
|------- | --------------------------------------------------------------------------------------------------------------------------
|Item 5. | Market Price for Registrants Common
    Equity, Related Stockholder Matters and Issuer Purchases of
    Equity Securities

The following table sets forth the high and low
sale price per share of the common stock as reported on the
Nasdaq Stock Markets National Market for the periods
indicated.

|                              |  |            |       |  |     |   |       | 
|----------------------------- |  | ---------- | ----- |  | --- | - | ----- | 
|                              |  |           
|                              |  | Sale Price |      
|                              |  |            |      
|                              |  | High       |       |  | Low |  
|                              |  |            |       |  |     |  
|2003                          |  |            |       |  |     |   |       | 
|October 1  December 31, 2003 |  | $          | 28.95 |  |     | $ | 15.44 | 
|July 1  September 30, 2003   |  |            | 29.22 |  |     |   | 23.92 | 
|April 1  June 30, 2003       |  |            | 25.79 |  |     |   | 20.59 | 
|January 1  March 31, 2003    |  |            | 22.88 |  |     |   | 18.30 | 
|2002                          |  |            |       |  |     |   |       | 
|October 1  December 31, 2002 |  | $          | 19.30 |  |     | $ | 15.03 | 
|July 1  September 30, 2002   |  |            | 19.16 |  |     |   | 15.60 | 
|April 1  June 30, 2002       |  |            | 20.57 |  |     |   | 15.02 | 
|January 1  March 31, 2002    |  |            | 21.85 |  |     |   | 17.35 | 

We have never paid a cash dividend and currently
do not intend to pay cash dividends in the future. Our ability
to pay dividends may be contingent on the receipt of cash
dividends from our subsidiaries. The payment of any dividends
from our insurance subsidiaries to APCapital is subject to a
number of regulatory conditions described above under
Item 1. Business  Insurance Regulatory
Matters.

As of January 31, 2004, there were
251 shareholders of record and approximately 2,500
beneficial shareholders of our common stock, based on the
records of our transfer agent and securities listing information.

The Company has a Stock Compensation Plan
pursuant to which it grants stock options and other stock-based
compensation to employees, officers and directors. The Stock
Compensation Plan was approved by the shareholder in 2000 prior
to the Companys initial public offering. The following
table sets forth, with respect to the Stock Compensation Plan,
as of December 31, 2003, (a) the number of shares of
common stock to be

16



---



##### 



issued upon the exercise of outstanding options,
(b) the weighted average exercise price of outstanding
options, and (c) the number of shares remaining available
for future issuance.


|                                                           |  |                         |         |  |                     |   |                       |                          |  |  |         | 
|---------------------------------------------------------- |  | ----------------------- | ------- |  | ------------------- | - | --------------------- | ------------------------ |  |  | ------- | 
|                                                          
|Equity Compensation Plans                                  | 
|                                                           | 
|                                                           |  | Number of shares        |        
|                                                           |  | remaining available for |        
|                                                           |  | Number of shares to     |         |  |                     |   | future issuance under |                         
|                                                           |  | be issued upon          |         |  | Weighted-average    |   |                       | equity compensation      | 
|                                                           |  | exercise of             |         |  | exercise price of   |   |                       | plans (excluding shares  | 
|Plan Category                                              |  | outstanding options     |         |  | outstanding options |   |                       | reflected in column (a)) | 
|                                                           |  |                         |         |  |                     |   |                       |                          | 
|                                                           |  | (a)                     |         |  | (b)                 |   |                       | (c)                      | 
|Equity compensation plans approved by shareholders         |  |                         | 873,200 |  |                     | $ | 18.01                 |                          |  |  | 123,303 | 
|Equity compensation plans not approved by
    shareholders |  |                         |        |  |                     |   |                      |                          |  |  |        | 

The Company may from time to time repurchase
shares of its outstanding common stock. The Companys
repurchase of any of its shares is subject to limitations that
may be imposed by applicable laws and regulations and rules of
the Nasdaq stock market. The timing of the purchase and the
number of shares to be bought at any one time depend on market
conditions and the Companys capital requirements. The
following table sets forth (a) the number of shares
repurchased, (b) the average price paid per share,
(c) the total number of shares purchased as part of
publicly announced plans, and (d) the maximum number of
shares that may yet be purchased under the plans.

|                                             |  |           |         |  |            |   |                 |                     |  |                |                    |  |  |  |         | 
|-------------------------------------------- |  | --------- | ------- |  | ---------- | - | --------------- | ------------------- |  | -------------- | ------------------ |  |  |  | ------- | 
|                                             |  | Total     |         |  |            |   | Total Number of |                     |  | Maximum Number |                   
|                                             |  | Number of |         |  | Average    |   |                 | Shares Purchased    |  |                | of Shares that May | 
|                                             |  | Shares    |         |  | Price Paid |   |                 | as Part of Publicly |  |                | Yet Be Purchased   | 
|                                             |  | Purchased |         |  | per Share  |   |                 | Announced Plans     |  |                | Under the Plans(1) | 
|                                             |  |           |         |  |            |   |                 |                     |  |                |                    | 
|                                             |  | (a)       |         |  | (b)        |   |                 | (c)                 |  |                | (d)                | 
|For the month ended
    October 31, 2003     |  |           | 21,500  |  |            | $ | 28.26           |                     |  |                | 21,500             |  |  |  | 418,369 | 
|For the month ended November 30, 2003        |  |           |        |  |            |   |                |                     |  |                |                   |  |  |  | 418,369 | 
|For the month ended December 31, 2003        |  |           |        |  |            |   |                |                     |  |                |                   |  |  |  | 418,369 | 
|For the three months ended December 31, 2003 |  |           | 21,500  |  |            | $ | 28.26           |                     |  |                | 21,500             |  |  |  | 418,369 | 
|For the year ended
    December 31, 2003     |  |           | 272,800 |  |            | $ | 28.14           |                     |  |                | 272,800            |  |  |  | 418,369 | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On September 11, 2003, APCapitals
    Board of Directors authorized the Company to purchase an
    additional 500,000 shares of its outstanding common stock.
    There is no expiration date with respect to this authorization.
    This brings the total number of shares authorized to be
    repurchased under publicly announced plans to 3,615,439, of
    which, 3,197,070 have been purchased at an average price per
    share of $18.89. The Company does not intend to make further
    repurchases of its outstanding common stock in the near future.

17



---



##### 





|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The following selected financial data, other than
the selected statutory data, are derived from our consolidated
financial statements which were prepared in accordance with
GAAP. The data should be read in conjunction with the
consolidated financial statements, related notes and other
financial information included elsewhere in this report. The
selected statutory data are derived from our annual statements
which were prepared in accordance with statutory accounting
practices as required by insurance regulatory authorities. See
Note 20 of the Notes to Consolidated Financial Statements
for a discussion of the principal differences between GAAP and
statutory accounting practices. Such information is incorporated
herein by reference.

|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |         |         |         |   |         |         |         | 
|------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------- | -------------------------------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | - | ------- | ------- | ------- | ------- | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                                                                                                                                  |                             |                                             
|                                                                                                                                                  |                             | For the Year Ended December 31,              |        
|                                                                                                                                                  |                             |                                              |        
|                                                                                                                                                  |                             | 2003                                         |         |         | 2002(a) |   |         | 2001    |         |   | 2000    |         |         | 1999(b) |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|Revenue:                                                                                                                                          |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |         |         |         |   |         |        
|                                                                                                                                                  | Direct premiums written     |                                              | $       | 256,235 |         |   | $       | 266,260 |         |   | $       | 230,765 |         |         | $       | 203,169 |         |   | $       | 189,647 |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|                                                                                                                                                  | Net premiums written        |                                              | $       | 224,647 |         |   | $       | 238,417 |         |   | $       | 208,779 |         |         | $       | 187,076 |         |   | $       | 158,028 |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|                                                                                                                                                  | Net premiums earned         |                                              | $       | 224,590 |         |   | $       | 235,551 |         |   | $       | 202,371 |         |         | $       | 180,342 |         |   | $       | 148,656 |        
|                                                                                                                                                  | Investment income           |                                              |         | 43,294  |         |   |         | 44,775  |         |   |         | 47,883  |         |         |         | 36,784  |         |   |         | 30,539  |        
|                                                                                                                                                  | Net realized gains (losses) |                                              |         | 2,403   |         |   |         | (163    | )       |   |         | (5,651  | )       |         |         | 1,164   |         |   |         | 1,849   |        
|                                                                                                                                                  | Other income                |                                              |         | 1,104   |         |   |         | 376     |         |   |         | 546     |         |         |         | 2,428   |         |   |         | 6,676   |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|                                                                                                                                                  |                             | Total revenues and other income              |         |         | 271,391 |   |         |         | 280,539 |   |         |         | 245,149 |         |         |         | 220,718 |   |         |         | 187,720 | 
|Losses and expenses:                                                                                                                              |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |         |         |         |   |         |        
|Losses and loss adjustment expenses                                                                                                               |                             |                                              | 252,742 |         |         |   | 242,028 |         |         |   | 257,848 |         |         |         | 153,518 |         |         |   | 130,949 |        
|Underwriting expenses                                                                                                                             |                             |                                              | 51,104  |         |         |   | 48,593  |         |         |   | 45,111  |         |         |         | 42,158  |         |         |   | 40,037  |        
|Investment expenses                                                                                                                               |                             |                                              | 2,940   |         |         |   | 2,515   |         |         |   | 1,788   |         |         |         | 2,978   |         |         |   | 3,283   |        
|Interest expense                                                                                                                                  |                             |                                              | 1,370   |         |         |   | 373     |         |         |   | 400     |         |         |         | 716     |         |         |   | 565     |        
|Amortization expense                                                                                                                              |                             |                                              | 389     |         |         |   |        |         |         |   | 2,514   |         |         |         | 2,328   |         |         |   | 1,177   |        
|Other expense                                                                                                                                     |                             |                                              | 3,729   |         |         |   | 1,971   |         |         |   | 4,718   |         |         |         | 2,275   |         |         |   | 1,739   |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|                                                                                                                                                  |                             | Total losses and expenses                    |         |         | 312,274 |   |         |         | 295,480 |   |         |         | 312,379 |         |         |         | 203,973 |   |         |         | 177,750 | 
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|(Loss) income before federal income tax (benefit)
    expense and minority interest and cumulative effect of a change
    in accounting principle |                             |                                              | (40,883 | )       |         |   | (14,941 | )       |         |   | (67,230 | )       |         |         | 16,745  |         |         |   | 9,970   |        
|Federal income tax expense (benefit)                                                                                                              |                             |                                              | 36,296  |         |         |   | (5,529  | )       |         |   | (23,450 | )       |         |         | 4,800   |         |         |   | (23,759 | )      
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|(Loss) income before minority interest and
    cumulative effect of a change in accounting principle                                              |                             |                                              | (77,179 | )       |         |   | (9,412  | )       |         |   | (43,780 | )       |         |         | 11,945  |         |         |   | 33,729  |        
|                                                                                                                                                  |                             | Minority interest in consolidated subsidiary |         |         | 348     |   |         |         |        |   |         |         |        |         |         |         |        |   |         |         |        | 
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|(Loss) income before cumulative effect of a
    change in accounting principle                                                                    |                             |                                              | (76,831 | )       |         |   | (9,412  | )       |         |   | (43,780 | )       |         |         | 11,945  |         |         |   | 33,729  |        
|Cumulative effect of a change in accounting
    principle                                                                                         |                             |                                              |        |         |         |   | (9,079  | )       |         |   |        |         |         |         |        |         |         |   |        |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|Net (loss) income                                                                                                                                 |                             | $                                            | (76,831 | )       |         | $ | (18,491 | )       |         | $ | (43,780 | )       |         | $       | 11,945  |         |         | $ | 33,729  |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|Net (loss) income per share  basic(c)                                                                                                            |                             | $                                            | (9.02   | )       |         | $ | (1.98   | )       |         | $ | (3.95   | )       |         | $       | 0.07    |         |         |   |         |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        
|Net (loss) income per share  diluted(c)                                                                                                          |                             | $                                            | (9.02   | )       |         | $ | (1.98   | )       |         | $ | (3.95   | )       |         | $       | 0.07    |         |         |   |         |        
|                                                                                                                                                  |                             |                                              |         |         |         |   |         |         |         |   |         |         |         |         |        



---



|    |  |                                                                                                                                                                                                                                                                                                                         
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | Net loss for the year ended December 31,
    2002 includes a $9.1 million charge, net of tax, for the
    write-off of goodwill related to the adoption of Statement of
    Financial Accounting Standards No. 142
    (SFAS No. 142), Goodwill and Other
    Intangible Assets. In accordance with the transitional

18



---



##### 



|    |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |  | guidance given in SFAS No. 142, this
    write-off, related to the adoption of the standard, was treated
    as a cumulative effect of a change in accounting principle.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|(b) |  | Net income for the year ended December 31,
    1999 includes the effects of a large settlement with the
    Internal Revenue Service. Without this settlement, net income
    for the year ended December 31, 1999 would have been
    approximately $4.6 million.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(c) |  | The weighted average shares outstanding for the
    years ended December 31, 2003, 2002 and 2001, were
    8,520,335, 9,339,739 and 11,071,529 basic common shares,
    respectively. As the Company was in a net loss position for the
    years ended December 31, 2003, 2002 and 2001, no effect of
    awards or options were calculated as the impact would have been
    anti-dilutive. The weighted average shares outstanding for the
    period from December 13, 2000, the date of the conversion,
    to December 31, 2000 were 11,134,981 basic common
    shares and 11,260,797 common shares assuming dilution.
    There were no cash dividends declared during the periods
    presented.

|                    |                                                    |                                       |   |           |      |  |   |           |   |  |      |           |   |      |   |         |   |  |   |         |  
|------------------- | -------------------------------------------------- | ------------------------------------- | - | --------- | ---- |  | - | --------- | - |  | ---- | --------- | - | ---- | - | ------- | - |  | - | ------- | -
|                    |                                                    |                                      
|                    |                                                    | At or For the Year Ended December 31, |  
|                    |                                                    |                                       |  
|                    |                                                    | 2003                                  |   |           | 2002 |  |   | 2001      |   |  | 2000 |           |   | 1999 |  
|                    |                                                    |                                       |   |           |      |  |   |           |   |  |      |           |   |      |  
|Balance Sheet Data: |                                                    |                                       |   |           |      |  |   |           |   |  |      |           |   |      |   |         |   |  |   |        
|                    | Total cash and investments                         |                                       | $ | 834,005   |      |  | $ | 801,556   |   |  | $    | 752,508   |   |      | $ | 762,023 |   |  | $ | 541,894 |  
|                    | Total assets                                       |                                       |   | 1,063,046 |      |  |   | 1,058,918 |   |  |      | 1,038,917 |   |      |   | 977,976 |   |  |   | 794,390 |  
|                    | Total liabilities                                  |                                       |   | 859,037   |      |  |   | 778,629   |   |  |      | 731,952   |   |      |   | 608,551 |   |  |   | 585,604 |  
|                    | Total GAAP shareholders equity(a)                 |                                       |   | 201,808   |      |  |   | 280,289   |   |  |      | 306,965   |   |      |   | 369,425 |   |  |   | 208,786 |  
|GAAP Ratios:        |                                                    |                                       |   |           |      |  |   |           |   |  |      |           |   |      |   |         |   |  |   |        
|                    | Loss ratio                                         |                                       |   | 112.5     | %    |  |   | 102.7     | % |  |      | 127.4     | % |      |   | 85.1    | % |  |   | 88.1    | %
|                    | Underwriting expense ratio                         |                                       |   | 22.8      |      |  |   | 20.6      |   |  |      | 22.3      |   |      |   | 23.4    |   |  |   | 26.9    |  
|                    | Combined ratio                                     |                                       |   | 135.3     |      |  |   | 123.3     |   |  |      | 149.7     |   |      |   | 108.5   |   |  |   | 115.0   |  
|Statutory Data      |                                                    |                                       |   |           |      |  |   |           |   |  |      |           |   |      |   |         |   |  |   |        
|                    | Loss ratio                                         |                                       |   | 112.5     | %    |  |   | 103.2     | % |  |      | 131.1     | % |      |   | 85.2    | % |  |   | 88.0    | %
|                    | Underwriting expense ratio(b)                      |                                       |   | 23.3      |      |  |   | 20.9      |   |  |      | 24.3      |   |      |   | 24.7    |   |  |   | 29.2    |  
|                    | Combined ratio                                     |                                       |   | 135.8     |      |  |   | 124.1     |   |  |      | 155.4     |   |      |   | 109.9   |   |  |   | 117.2   |  
|                    | Surplus                                            |                                       | $ | 150,270   |      |  | $ | 190,216   |   |  | $    | 203,069   |   |      | $ | 246,089 |   |  | $ | 179,829 |  
|                    | Ratio of statutory net premiums written to surplus |                                       |   | 1.49      | x    |  |   | 1.25      | x |  |      | 1.03      | x |      |   | 0.76    | x |  |   | 0.88    | x



---



|    |  |                                                                                                                                                                                                                                             
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | No dividends were paid during the periods
    presented.                                                                                                                                                                                    
|   
|(b) |  | The statutory underwriting expense ratio is
    calculated by dividing statutory underwriting expenses by net
    premiums written as opposed to the GAAP underwriting expense
    ratio, which uses net premiums earned as the denominator.



|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

The following discussion and analysis should be
read in conjunction with the consolidated financial statements
and the notes thereto included elsewhere in this report. The
discussion that follows contains certain forward-looking
statements relating to our anticipated future financial
condition, operating results, cash flows and our current
business plans. When we use any of the words
believes, expects,
anticipates, estimates or similar
expressions, we are making forward looking statements. These
forward-looking statements represent our outlook only as of the
date of this report. While we believe any forward-looking
statements we have made are reasonable, actual results could
differ materially since the statements are based on our current
expectations and are subject to risks and uncertainties. These
risks and uncertainties are detailed under
Item 1  Business  Uncertainties
Relating to Forward Looking Statements and elsewhere in
this report and from time to time in other reports filed by the
Company with the Securities and Exchange Commission. The
cross-referenced information is incorporated herein by reference.

19



---



##### 



Overview of APCapitals
Operations

We are a leading provider of medical professional
liability insurance coverage, writing this coverage in
12 states throughout the country. This insurance coverage
protects physicians and other health providers from claims filed
against them for alleged acts of medical malpractice. Medical
professional liability insurance represented 76% of our direct
premiums written in 2003. In addition, during 2003, we wrote
workers compensation insurance in 11 states, insuring
a variety of business classes. During 2003, we also participated
in a health insurance program, writing small business employee
health insurance through a single preferred provider
organization located in Western Michigan. In the fourth quarter
of 2003, the Company began to implement plans to exit the
workers compensation and health insurance lines of
business. In late 2003 and early 2004, we received downgrades in
our financial strength rating from A.M. Best. These downgrades,
and their potential impact on our business, are discussed more
fully in Item 1  Business  A.M.
Best Company Rating, which information is incorporated herein by
reference.

The Economics of Property & Casualty
Insurance

As a property and casualty insurer, our results
of operations are primarily driven by our underwriting results,
which are measured by subtracting incurred loss and loss
adjustment expenses and underwriting expenses from net premiums
earned. While this measure is a key performance indicator of an
insurance companys operations, it is not uncommon for a
property and casualty insurance company to generate an
underwriting loss, yet earn a profit overall, because of the
availability of investment income to offset the underwriting
loss.

An insurance company earns investment income on
what is commonly referred to as the float. The float
is money that we hold, in the form of investments, from premiums
that we have collected. Although most of these premiums will
ultimately be used to make claim payments and to pay for claims
adjustment expenses, the period of time that we hold the float
prior to paying losses can extend over several years. The key
factors that determine the amount of investment income we are
able to generate are: 1) the rate of return, or yield, on
the float, and 2) the amount of time we able to hold the
float.

Most of the insurance policies we write have a
one year policy term. The written premiums associated with
policies we write are earned ratably over the year in which we
provide insurance coverage. This means that rate increases that
we implement will not be fully earned for up to 24 months
as policyholders who renewed immediately prior to the rate
increase will not be charged the higher rate for up to
12 months, and then those premiums will take another
12 months to be fully earned.

Our loss experience is a major component of our
results of operations. When we receive notice of a claim that is
covered under a policy we have issued, our claims adjusters
establish a reserve for the expected cost to settle the claim,
including estimates of any related legal or other expenses
associated with resolving the claim. These reserves are referred
to as case basis reserves. In addition, at the end
of each reporting period, certain losses will have occurred that
have not been reported to us. Accordingly, we establish reserves
for such incurred but not reported (IBNR) losses and
related loss adjustment expenses. Our incurred loss and loss
adjustment expenses represent any payments made to settle
losses, including related loss adjustment expense payments, as
well as any change in our case basis and IBNR reserves.

Paid and incurred losses give different pictures
of our loss experience, and examining both can help provide a
better understanding of our losses. Paid losses are the cash
payments we make in a given year, irrespective of the year in
which the claim giving rise to the payment occurred or was
reported. Most payments made in a given year are for claims that
were reported in previous years because of the extended amount
of time required to resolve a claim through litigation or
settlement. Incurred losses in any given year reflect our
expectations of the amount that will ultimately be paid on
claims reported in that year. Incurred losses in a single year,
will also reflect any adjustment we make to the expected amounts
that must be paid on claims reported during previous years, as
well as any changes in our estimates for IBNR.

Underwriting expenses represent costs associated
with issuing new and renewal business as well as ongoing policy
maintenance expenses. Some of these costs, such as commissions
and premium taxes, as well

20



---



##### 



as a portion of the salaries related to our
underwriting staff, vary with and are primarily related to the
production of new and renewal business. These costs are deferred
and amortized over the related period in which we earn the
premiums associated with the business written. Other costs that
do not vary with the production of new and renewal business are
charged to income as incurred.


To ensure the security of our policyholders, we
must maintain assets in excess of total liabilities. This
excess, or surplus, is the principal measure used by
state insurance regulators, and rating agencies such as
A.M. Best, to evaluate the Companys financial
strength. Medical professional liability insurers generally
attempt to keep this surplus level approximately equal to their
annual net premiums written.

The Medical Professional Liability Insurance
Market

The medical professional liability insurance
business, like all other property and casualty insurance
markets, tends to cycle through what are often referred to as
hard and soft markets. A hard market is
generally characterized as a period of rapidly rising premium
rates, tightened underwriting standards, narrowed coverage, and
the withdrawal of insurers from certain markets. Soft markets,
are usually characterized by relatively flat or slow-rising
premium rates, less stringent underwriting standards, expanded
coverage and strong competition among insurers. In the mid to
late 1990s, the medical professional liability insurance
industry was generally viewed as being in a soft market.
However, since approximately 2001, the trend in medical
professional liability insurance has been towards a harder
market. Hard and soft market cycles tend to be more extreme in
the medical professional liability business than in other
insurance businesses because of the longer period of time
required to resolve medical malpractice claims.

The rising cost of medical professional liability
insurance has been prominent in the media in recent years.
Several factors have contributed to the recent premium rate
increases such as, an increase in paid losses, decreased
investment income due to lower prevailing interest rates,
reduced competition, and increased reinsurance rates.

The most significant factor contributing to the
increase in medical professional liability premiums in recent
years is the increase in paid losses. To combat rising loss
costs, we have initiated several actions including:



| |   |                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------
| |  | Exiting unprofitable markets such as Florida and
    Nevada;                                                           
|
| |  | Ceased writing occurrence-based policies in all
    markets with the exception of Michigan, Indiana and
    New Mexico.
|
| |  | Discontinued writing certain high-risk
    specialties;                                                                
|
| |  | Implemented on-site risk management assessments
    on all new business in Ohio, Kentucky and Illinois;                
|
| |  | Implemented a unique communication skills
    assessment in targeted markets; and                                      
|
| |  | Reduced policy limits.                                                                                                 

Tort reform is another factor that affects our
business. Tort reform encompasses a variety of subject matters;
however, the one most critical to the medical professional
liability insurance market is limits on non-economic damages and
punitive damages. Historically tort reform has occurred on a
state by state basis. Accordingly, losses can vary dramatically
by state depending on the level of tort reform the state has
enacted. We monitor state tort reform closely and evaluate any
changes for impacts on our current business strategies and
estimated loss reserves.

Anticipated losses will generally be the primary
determinant of premium rates. We establish medical professional
liability premium base rates for particular medical specialties
within a given state and sometimes for a specific geographic
region within a state. We also offer discounts or add surcharges
for particular policyholder characteristics, such as claims
history or participation in any risk-management programs. Our
premium rates are based on anticipated losses on claims and
related expenses, expected investment income, our surplus needs,
and the desire to earn a reasonable profit for shareholders. In
most states, however, insurance regulators have the authority to
approve or deny proposed premium rate changes.

21



---



##### 



Medical professional liability insurance can be
written on both a claims-made and an occurrence basis.
Claims-made policies, which are the most common, cover claims
reported during the year in which the policy is in effect.
Occurrence-based policies cover claims arising out of events
that have occurred during the year in which the policy was in
effect, regardless of when they are reported. During the last
three years, approximately 70% of our medical professional
liability direct premiums represented claims-made policies, with
the remainder representing occurrence-based policies. Although
we have discontinued writing occurrence based policies in
certain states and markets, we have not seen an overall decrease
in occurrence based premiums as a result of premium rate
increases in New Mexico, where we are required to write
occurrence based policies by law, and in other states such as
Michigan.

Accurately predicting losses on medical
professional liability claims is difficult for several reasons.
First, most medical professional liability claims take several
years to resolve. This often lengthy resolution period reflects
the time needed for the discovery of the medical malpractice,
which is often not reported to the insured immediately, the
filing of a claim, determining, through settlement or trial, the
payment responsibilities, if any, associated with the claim, and
the payment of the claim. As a result, we often must estimate
the ultimate cost to settle a claim, including related expenses,
several years in advance of payment. Second, the range of the
ultimate potential loss can vary significantly for individual
claims with similar characteristics, making it difficult to
predict the ultimate loss associated with any single claim.
Third, the ultimate projected loss is based, in part, on
actuarial methodologies using relevant historical data, which in
some cases may be limited. We review our estimates quarterly,
and as facts and patterns emerge that provide us with more
relevant information related to projection of ultimate expected
loss costs, we adjust our estimates related to the liability for
unpaid loss and loss adjustment expenses, with the change in
estimates resulting in either an increase or decrease in
incurred loss and loss adjustment expenses for the current
period.

As with other types of property and casualty
insurance, medical professional liability insurance policies are
subject to policy limits. The limits of liability purchased by
our medical professional liability policyholders differ by
state. In Michigan and New Mexico, the most common limits
purchased are $200,000 of coverage per claim and $600,000 of
aggregate coverage per year. In all other states in which we
write business, the most common policy limits purchased are
$1 million/ $3 million. We may write higher limits and
excess coverage in conjunction with special reinsurance
arrangements.

Important Agency Relationship

The principal agency through which we write
medical professional liability insurance is SCW Agency
Group, Inc. and its wholly owned subsidiaries. SCW is 91.1%
owned by William B. Cheeseman, one of our directors and our
former president and chief executive officer. Bridget Cheeseman,
Mr. Cheesemans adult daughter, is a vice president of
SCW and owns approximately 2.5% of SCW. During the
three years ended December 31, 2003,
Mr. Cheeseman has received no cash or other compensation,
dividends or other distributions from SCW and his only benefit
from SCW from this relationship is the potential appreciation of
his ownership interest in that company. If SCW increases the
amount of business it writes for us, SCW will earn more
commission revenue from us. To the extent the increase in
commission revenue we pay SCW increases SCWs profits,
Mr. Cheesemans ownership interest may appreciate.

SCW has been a significant agent for us for many
years. The commission rates we have paid to SCW have been either
the same or less than the commission rates we paid to our other
agents. In addition, with limited exceptions, the only medical
professional liability insurance sold by SCW in Michigan was
written by the Company. We are not required to sell insurance
solely through SCW. We believe these factors have created a more
favorable agency relationship for us than we have with our other
agents.

SCW sells insurance written by several companies.
However, the commissions it receives on premiums it writes for
the Company typically account for 65% to 75% of its revenues.
Direct premiums written for us by SCW during 2003, 2002 and 2001
totaled $75,270,000, $70,810,000 and $68,896,000, respectively,
representing 29.4%, 26.6% and 29.9% of direct premiums written
during such years. Commission expense we incurred related to SCW
approximated $5,962,000, $5,560,000 and $4,660,000 in 2003, 2002
and 2001, respectively.

22



---



##### 



Based on financial information made available to
us, we estimate SCWs net profits on the commission revenue
earned from us in 2003 to be approximately $1.2 million. We
have not attempted to independently audit or verify the
information SCW has furnished, although we have no reason to
believe it is inaccurate. For purposes of this disclosure, we
have estimated the net profits that SCW earned on the revenue
received from us by calculating the profit percentage that
SCWs net profits bears to its total revenue in 2003 and
applying that percentage to the revenue earned from us.

Prior to Mr. Cheesemans retirement,
there were various safeguards to protect the Company from actual
or potential conflicts of interest arising from this
relationship. Mr. Cheeseman was prohibited from acting as a
director, officer or employee of SCW and, pursuant to Company
policy, did not participate in day-to-day discussions between
the Company and SCW or in decisions about whether to underwrite
business proposed to be written by SCW prior to his retirement.
Moreover, we applied and continue to apply the same underwriting
rules to business written by SCW as we apply to business written
by other agencies. These underwriting rules are generally filed
with the regulatory agencies in the various states in which we
do business and are established solely by the Company in order
to control the quality of business submitted by all agents,
including SCW. We also monitor our loss experience on the
business written by our agents, including SCW. Since his
retirement from APCapital, Mr. Cheeseman has taken a more
active role in the activities of SCW.

In January 2004, we completed a new 5-year
contract with SCW. The agreement provides for American
Physicians to be the exclusive medical professional liability
carrier SCW represents in the state of Michigan, subject to
limited exceptions, such as a further downgrade of our
A.M. Best rating. However, we continue to have the right to
appoint other agents. SCW may continue to represent other
insurance companies in other states. The contract provides for
SCW to be paid commissions consistent with the marketplace. The
terms of the new agency agreement were determined by
negotiations between our management staff, SCWs
management, and under the review of independent consultants, and
ultimately approved by our board of directors. In rendering its
approval, the board of directors considered the fairness of the
agreed rates and determined that they were fair to the Company
based, upon other things, an evaluation of market rates and
agreements between the Company and its other agents.

Significant Accounting Policies

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires us to make estimates and
assumptions that affect amounts reported in the accompanying
consolidated financial statements and related footnotes. These
estimates and assumptions are evaluated on an on-going basis
based on historical developments, market conditions, industry
trends and other information we believe to be reasonable under
the circumstances. There can be no assurance that actual results
will conform to our estimates and assumptions, and that reported
results of operations will not be materially adversely affected
by the need to make accounting adjustments to reflect changes in
these estimates and assumptions from time to time. Adjustments
related to changes in estimates are reflected in the
Companys earnings in the period those estimates changed.
The following policies are those we believe to be the most
sensitive to estimates and judgments. Our significant accounting
policies are more fully described in Note 1 to our
Consolidated Financial Statements. Such information is
incorporated herein by reference.



| |                                               
| | ----------------------------------------------
| | Unpaid Losses and Loss Adjustment
    Expenses

Our Consolidated Financial Statements include
estimated reserves for unpaid losses and loss adjustment
expenses related to our various insurance lines of business. We
have actuaries on our staff that analyze and develop projections
of ultimate payments that will be made to settle all losses
incurred as of each balance sheet date, and the related loss
adjustment expenses. Our actuaries utilize standard actuarial
techniques to project ultimate losses based on our paid and
incurred loss information and claim count, as well as industry
data. These projections are done using the Companys data,
including the number of claims reported and paid, and the
average severity of reported and paid claims, as well as
industry data. This process assumes that past experience,
adjusted for the effects of current developments and anticipated
trends, is an appropriate basis for predicting future events. A
key projection used in the actuarial estimation of ultimate
losses takes an average payment (severity) times a projected
total number of claims (frequency). Accordingly, any changes in
the

23



---



##### 



frequency or severity of claims reported to us
can have a significant impact on actuarial estimates of ultimate
losses and recorded reserves. Based on these quantitative as
well as other qualitative factors, such as a review of current
pricing and underwriting initiatives, an evaluation of
reinsurance costs and retention levels, and the current
reserving practices of the Companys claims department, we
select a best estimate of ultimate future losses,
and then record this best estimate in the Companys
Consolidated Financial Statements. As required by insurance
regulatory authorities, we receive an annual statement of
opinion by an independent consulting actuary concerning the
adequacy of our reserves.


When a claim is reported to us, claims personnel
establish a case reserve for the estimated amount of
the ultimate payment. This estimate reflects an informed
judgment based upon insurance reserving practices appropriate
for the relevant line of business, and on the experience and
knowledge of the estimator regarding the nature and value of the
specific claim, the severity of injury or damage, and the policy
provisions relating to the type of loss. Case reserves are
periodically reviewed and adjusted as necessary by the claims
staff as more information becomes available. Reserves for claims
incurred but not reported provide for the future
reporting of claims already incurred, and development on claims
already reported. The reserve for claims incurred but not
reported is determined based on historical loss trends.

It often takes several years for medical
professional liability claims to be resolved, three to six years
on average from the time the loss is reported. As a result, the
ultimate payment can be difficult to project due to changes in
legal and other economic environmental factors during the
intervening period. In addition, changes in the Companys
case reserving philosophy, such as those executed by the Company
over the last two years, can introduce additional uncertainty
into the actuarial estimation process, as a strengthening of
case reserves results in higher reported losses, which increases
the average severity of claims used in actuarial projections.
Therefore, careful consideration must be made when evaluating
the strengthening of case reserves to ensure that the impact on
ultimate projected losses is not under or overstated.

The process of estimating the reserves for unpaid
losses and loss adjustment expenses involves significant
judgment and is complex and imprecise due to the number of
variables and assumptions inherent in the estimation process.
These variables include the effects on ultimate loss payments of
internal factors such as changes in claims handling practices
and changes in the mix of our products, as well as external
factors such as changes in loss severity trends, economic
inflation, judicial trends and legislative and regulatory
changes. In addition, medical professional liability claims may
take several years to resolve due to typical delays in reporting
claims to us, the often lengthy discovery process, and the time
necessary to defend the claim. In addition, claims with similar
characteristics may result in very different ultimate losses
depending on the state or region where the claim occurred. All
of these factors contribute to the variability in estimating
ultimate loss payments, especially since the affects of many of
these variables cannot be directly quantified, particularly on a
prospective basis.

Although considerable variability is inherent in
such estimates, we believe that the reserve for unpaid losses
and loss adjustment expenses is adequate. However, there can be
no assurance that losses will not exceed the reserve for unpaid
losses and loss adjustment expenses, as future trends related to
the frequency and severity of claims, and other factors, may
develop differently than management has projected.

The assumptions and methodologies used in
estimating and establishing the reserve for unpaid losses and
loss adjustment expenses are continually reviewed and any
adjustments are reflected as income or expense in the period in
which the adjustment is made. Historically, such adjustments
have not exceeded 8% of our recorded net reserves as of the
beginning of the period, but can materially and adversely affect
our results of operations when an adjustment is made. Due to the
current volatility of losses in the medical professional
liability industry, adjustments have occurred in each of the
last several years.

With the exception of reserves for extended
reporting period claims discussed below, we do not discount our
reserves to recognize the time value of money.

24



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##### 





| |            
| | -----------
| | Investments

Investments represent our largest asset and are
the primary source of funds to pay insurance claims. All of our
fixed maturity securities are classified as available-for-sale,
which are those securities that would be available to be sold in
the future in response to our liquidity needs, changes in market
interest rates and asset-liability management strategies.
Available-for-sale securities are reported at their estimated
fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of other
comprehensive income, net of deferred taxes. Investment income
includes amortization of premium and accrual of discount on the
yield-to-maturity method relating to investments acquired at
other than par value.

Equity securities are carried at quoted market
values. The fair value of fixed maturity securities is based on
market quotations provided to us by our third-party custodian
who engages independent third party pricing sources that use
valuation models. The valuation models used by the independent
third party pricing sources use indicative information such as
ratings, industry, coupon, and maturity along with publicly
traded bond prices to determine security specific spreads, and
the ultimate fair value of the non-publicly traded fixed
maturity securities. Real estate is carried at the lesser of
historical cost, less accumulated depreciation or estimated fair
value as determined by recent appraisals, offers from
prospective independent third-party buyers, or the undiscounted
future cash flows associated with the property. Realized gains
or losses on sales or maturities of investments are determined
on a specific identification basis and are credited or charged
to income.

We periodically review our investment portfolio
for any potential credit quality or collection issues and for
any securities with respect to which we consider any decline in
market value to be other than temporary. Investments which are
considered to be other than temporarily impaired
(OTTI) are written down to their estimated net
realizable value as of the end of the period in which the OTTI
was noted. Subsequent recoveries in the fair value of impaired
securities are not reported in income, but rather as unrealized
gains, net of tax, in comprehensive income. Inherent in our
evaluation of a particular security are assumptions and
estimates about the operations of the issuer, and its future
liquidity and earnings potential. Some of the factors considered
in evaluating whether a decline in market value is other than
temporary are:



| |   |                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our ability and intent to retain the investment
    for a period of time sufficient to allow for an anticipated
    recovery in value;                                                                        
|
| |  | The recoverability of principal and interest
    related to the security;                                                                                                                                     
|
| |  | The duration and extent to which the fair value
    has been less than cost for equity securities, or amortized cost
    for fixed maturity securities;                                                       
|
| |  | The financial condition, near-term and long-term
    earnings and cash flow prospects of the issuer, including
    relevant industry conditions and trends, and implications of
    rating agency actions; and
|
| |  | The specific reasons that a security is in a
    significant unrealized loss position, including market
    conditions that could affect access to liquidity.                                                 

The following table shows the aging of unrealized
losses included in our investment portfolio as of
December 31, 2003:

|               |       |                |      |      |            |   |      |            |   |   |             |      |            |   |   |   |  |   |   |   | 
|-------------- | ----- | -------------- | ---- | ---- | ---------- | - | ---- | ---------- | - | - | ----------- | ---- | ---------- | - | - | - |  | - | - | - | 
|Security Type  |       | <3 Months      |      |      | 3-6 Months |   |      | 6-9 Months |   |   | 9-12 Months |      | >12 Months
|               |       |                |      |      |            |   |      |            |   |   |             |      |           
|               |       |               
|               |       | (In thousands)
|Fixed maturity |       | $              | (74  | )    |            | $ | (249 | )          |   | $ | (319        | )    |            | $ |  |   |  | $ |  |  
|Equity         |       |                | (106 | )    |            |   |     |            |   |   |            |      |            |   |  |   |  |   |  |  
|               |       |                |      |      |            |   |      |            |   |   |             |      |            |   |  
|               | Total |                | $    | (180 | )          |   | $    | (249       | ) |   | $           | (319 | )          |   | $ |  |  |   | $ |  | 
|               |       |                |      |      |            |   |      |            |   |   |             |      |            |   |  

During the year ended December 31, 2003, we
recorded an impairment charge of $1.3 million on enhanced
equipment trust certificates that were issued by Delta Airlines.
During the years ended December 31, 2002 and 2001 we
recorded an impairment charge of $520,000 and $5.9 million,
respectively related to bonds issued by Frontier Corporation, a
subsidiary of Global Crossings. At December 31, 2003, the

25



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##### 



Companys investment in Delta enhanced
equipment trust certificates is carried in the Consolidated
Balance Sheets, included elsewhere in this report, at a value of
$5.4 million. In December of 2003, the Frontier bonds, as
part of bankruptcy proceedings, were converted to equity
securities of Frontiers parent company, Global Crossings.
We received a total of 15,865 shares of Global Crossing
common stock based on the amount of bonds held by the Company.
These shares had an initial fair value of $35 per share,
which resulted in a realized gain of approximately $245,000 upon
the conversion.




| |                                                 
| | ------------------------------------------------
| | Reserve for Extended Reporting Period
    Claims

A portion of the coverage that physicians
purchase under claims-made policies is for an additional death,
disability and retirement (DDR) insurance benefit.
This DDR coverage provides coverage to the physician for any
prior incidents occurring during the coverage period that are
reported after their death, disability or retirement. The loss
exposure associated with this product is known as extended
reporting period claims. The reserve for extended reporting
period claims coverage is recorded during the term of the
original claims-made policy, based on the present value of
future estimated benefits, including morbidity and mortality
assumptions, less the present value of expected future premiums
associated with this DDR coverage. The reserves for these claims
fluctuate based on the number of physicians who are eligible for
this coverage and their age. Any changes in the DDR reserves are
reflected as an expense in the period in which we become aware
that an adjustment is necessary. At December 31, 2003 and
2002, our recorded DDR reserves were $14.0 million.



| |            
| | -----------
| | Reinsurance

In accordance with industry practice, we cede to
other insurance companies some of the potential liability under
insurance policies we have underwritten. This practice, called
reinsurance, helps us reduce our net liability on individual
risks, stabilize our underwriting results and increase our
underwriting capacity. As payment for sharing a portion of our
risk, we are also required to share a part of the premium we
receive on the related policies. We determine the amount and
scope of reinsurance coverage to purchase each year based upon
an evaluation of the risks accepted, consultations with
reinsurance brokers and a review of market conditions, including
the availability and pricing of reinsurance. Our reinsurance
arrangements are generally renegotiated annually.

Reinsurance premiums and losses related to
reinsured business are accounted for on bases consistent with
those used in accounting for the original policies issued and
the terms of the reinsurance contracts. Premiums ceded to other
companies are reported as a reduction of premium income.
Reinsured losses incurred are reported as a reduction of gross
losses incurred.

Under our primary professional liability
reinsurance contract, the portion of the policyholder premium
ceded to the reinsurers is swing-rated, or
experience rated on a retrospective basis. This swing-rated
contract is subject to a minimum and maximum premium range to be
paid to the reinsurers in the future, depending upon the extent
of losses actually paid by the reinsurers. We pay a provisional
premium during the initial policy year. A liability is recorded
to represent an estimate of net additional payments to be made
to the reinsurers under the program, based on the level of loss
and LAE reserves recorded. To the extent that our estimate for
unpaid losses and loss adjustment expenses changes, the amount
of swing rated reinsurance premiums may also change.

We annually review the financial stability of all
of our reinsurers. This review includes a ratings analysis of
each reinsurer participating in a reinsurance contract. On the
basis of this review, as of December 31, 2003, we concluded
that an allowance for uncollectible reinsurance recoverables was
unnecessary. We do, however, have a reinsurance recoverable from
Gerling Global (Gerling) of approximately
$17.5 million ($13.3 million net of ceded premiums
payable of $4.2 million), at December 31, 2003. In
2002, Gerlings parent company put Gerlings United
States subsidiary into run off resulting in a series of A.M.
Best rating downgrades for Gerling. We have discussed the
possibility of a settlement with Gerling, but have not received
an offer that we deem financially adequate. We continue to
believe that Gerling has adequate surplus and cash flow to
satisfy its obligations to us and we have not experienced any
difficulties in collecting amounts due from Gerling; however,
there can be no assurance that amounts currently recoverable
from Gerling will ultimately

26



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##### 



be collected. Because the Company has not
experienced any difficulties in collecting amounts from Gerling,
and in light of Gerlings current surplus levels and cash
flows, we determined not to accept the settlement offer because
we do not believe that it is in the Companys best
long-term economic interest. We will continue to monitor
Gerlings financial strength and liquidity and may pursue a
settlement in the future if circumstances change. The periodic
analysis of Gerling includes reviews of Gerlings publicly
available financial information, as well as monitoring of trade
publications and press releases. Should there be a material
change in the financial condition of Gerling, our assessment of
its ability to meet its obligations to us may also change. Our
assessment of the financial strength and liquidity of Gerling is
the primary basis by which we have determined not to record a
valuation allowance against this recoverable.




| |             
| | ------------
| | Income Taxes

Deferred federal income tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to the differences between financial
statement carrying amounts of existing assets and liabilities,
and their respective tax bases. Accounting for deferred taxes in
accordance with GAAP requires us to make a qualitative analysis
of our deductible temporary differences, past financial history
and future earnings projections to determine how much of a
deferred tax asset can be recognized. The standard for measuring
whether or not a gross deferred tax asset can be recognized is
more likely than not based on all available
evidence. In making this evaluation, historical losses weigh
more heavily than future earnings projections due to
uncertainties inherent in making such projections. Accordingly
based on our recent loss experience, we have determined that
sufficient taxable income may not exist in the periods of
reversal, and have recorded a deferred tax asset valuation
allowance for the entire net deferred tax asset as, under the
accounting guidance, there is no reasonable basis to support
carrying some of the individual deferred tax assets and not
others. The establishment of the valuation allowance is recorded
as federal income tax expense in the accompanying Consolidated
Statements of Income, included elsewhere in this report. Once
the Company has re-established a pattern of profitability, the
deferred tax asset valuation allowance may be reduced upon
evaluation of the availability of future taxable income. See
Note 11 of the Notes to Consolidated Financial Statements
for further discussion of the deferred tax valuation allowance
and its impact on our financial condition and results of
operations. Such information is incorporated herein by reference.



| |                             
| | ----------------------------
| | Earned But Unbilled Premiums

In addition to premiums earned on written
premiums, the Company also recognizes premium income for any
changes in estimated earned but unbilled premiums in
connection with future audit premium billings on workers
compensation insurance policies. Audit premiums are retroactive
adjustments made after the policys expiration that result
in either additional premium billings or premium refunds based
on the insureds actual employee head count and other
factors. Earned but unbilled premiums represent the portion of
estimated future audit premiums that will be billed in future
periods, but have been earned during the period based on the
effective dates of the policies that are expected to generate
the future audit premium billings. Estimated future audit
premium billings are based on historical audit premium billings,
adjusted for factors related to the current economic
environment. To the extent that there are changes in the classes
of businesses that we insure, or that the headcount at insured
businesses changes based on the overall economic environment,
our use of historical data to estimate future earned but
unbilled premiums may result in amounts that differ from actual
billings. The estimate for earned but unbilled premiums at
December 31, 2003 and 2002 was $339,000 and $945,000,
respectively.



| |                                      
| | -------------------------------------
| | Deferred Policy Acquisition
    Costs

Deferred policy acquisition costs
(DAC) are those costs that vary with and are
primarily related to the production of new, or renewal, business
and include such costs as commissions, premium taxes and other
costs incurred in connection with writing business. These costs
are deferred and amortized over the period in which the related
premiums are earned. Under GAAP, the premiums that will be
earned in future periods, to which these deferred costs relate,
must produce sufficient profits to offset the future expense
that will be recognized from the amortization of the DAC, that
is, the DAC must be recoverable. In evaluating the
recoverability of

27



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##### 



DAC, we have made certain assumptions regarding
future costs associated with the business written, such as costs
to maintain the policies and the ultimate projected loss and
loss adjustment expense payments associated with these policies.
In addition, we have considered future investment income in
determining the recoverability of DAC, which requires certain
assumptions regarding the timing of payments of future loss and
loss adjustment expenses, as well as the yield on our investment
portfolio. Based on our analysis as of December 31, 2003,
the DAC carried on the Consolidated Balance Sheets, included
elsewhere in this report, of $10.4 million, was deemed to
be fully recoverable. While we believe that our assumptions and
estimates related to the recoverability of DAC are reasonable,
historically, our accident year loss ratios have developed
unfavorably. In the event that future unfavorable adjustments to
loss reserves occur, the likelihood of our being able to recover
these deferred costs will diminish, and the possibility of a
write-off of a portion or all of our DAC in future periods will
increase.


Description of Ratios Analyzed

In the analysis of our operating results that
follows, we refer to various financial ratios that management
uses to analyze and compare the underwriting results of our
insurance operations. These ratios are calculated on a GAAP
basis and include:



| |           
| | ----------
| | Loss Ratio

This ratio compares our losses and loss
adjustment expenses incurred, net of reinsurance, to our net
premiums earned, and indicates how much we expect to pay
policyholders for claims and related settlement expenses
compared to the amount of premiums we earn. The calendar year
loss ratio uses all losses and loss adjustment expenses incurred
in the current calendar year (i.e., related to all accident
years). The accident year loss ratio uses only those loss and
loss adjustment expenses that relate to the current accident
year (i.e., excludes the effect of development on prior year
loss reserves). The lower the percentage, the more profitable
our insurance business is, all other things being equal.



| |                           
| | --------------------------
| | Underwriting Expense Ratio

This ratio compares our expenses to obtain new
business and renew existing business, plus normal operating
expenses, to our net premiums earned. The ratio is used to
measure how efficient we are at obtaining business and operating
the insurance segments. The lower the percentage, the more
efficient we are, all else being equal. Sometimes, however, a
higher underwriting expense ratio can result in better business
and improve our loss ratio, and overall profitability.



| |               
| | --------------
| | Combined Ratio

This ratio equals the sum of our loss ratio and
underwriting expense ratio. The lower the percentage, the more
profitable our insurance business is. This ratio excludes the
effects of investment income.

The statutory ratios will differ from GAAP ratios
as a result of differences in accounting between the statutory
basis of accounting and GAAP. Additionally, the denominator for
the underwriting expense ratio for GAAP is net premiums earned,
versus net premiums written for the statutory underwriting
expense ratio.

28



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##### 



Results of Operations



| |                                       
| | --------------------------------------
| | Consolidated Results of
    Operations

The following table sets forth our results of
operations for the years ended December 31, 2003, 2002 and
2001 on a consolidated basis. The discussion that follows should
be read in connection with the Consolidated Financial
Statements, and Notes thereto, included elsewhere in this report.

|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |         |   |         |        |         |   |         |         |       | 
|------------------------------------------------------------ | ------------------------------ | --------------------------------------------------------------------------------------------------------------------- | ------- | ------- | ------- | - | ------- | ---------- | ------- | - | ------ | ------- | ------- | ---- | ---------- | ------ | ------- |  | ------- | ------- | ------- | - | ------- | ------ | ------- | - | ------- | ------- | ----- | 
|                                                             |                                |                                                                                                                       |         |         |         |   |         | Percentage |         |   |        |         |         |      | Percentage |       
|                                                             |                                | 2003                                                                                                                  |         |         | 2002    |   |         | Change     |         |   | Change |         |         | 2001 |            |        | Change  |  |         | Change  |        
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                |                                                                                                                      
|                                                             |                                | (Dollars in thousands)                                                                                                |        
|Net premiums earned by insurance segment:                    |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |         |   |         |        |         |   |         |        
|                                                             | Medical professional liability |                                                                                                                       | $       | 158,777 |         |   | $       | 148,646    |         |   | $      | 10,131  |         |      |            | 6.8%   |         |  | $       | 119,659 |         |   | $       | 28,987 |         |   |         | 24.2%   |      
|                                                             | Workers compensation          |                                                                                                                       |         | 43,844  |         |   |         | 63,517     |         |   |        | (19,673 | )       |      |            | -31.0% |         |  |         | 58,377  |         |   |         | 5,140  |         |   |         | 8.8%    |      
|                                                             | Health                         |                                                                                                                       |         | 22,208  |         |   |         | 23,820     |         |   |        | (1,612  | )       |      |            | -6.8%  |         |  |         | 18,668  |         |   |         | 5,152  |         |   |         | 27.6%   |      
|                                                             | Personal and commercial        |                                                                                                                       |         | (239    | )       |   |         | (432       | )       |   |        | 193     |         |      |            | -44.7% |         |  |         | 5,667   |         |   |         | (6,099 | )       |   |         | -107.6% |      
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Total net premiums earned                                                                                             |         |         | 224,590 |   |         |            | 235,551 |   |        |         | (10,961 | )    |            |        | -4.7%   |  |         |         | 202,371 |   |         |        | 33,180  |   |         |         | 16.4% | 
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|Investment income                                            |                                |                                                                                                                       | 43,294  |         |         |   | 44,775  |            |         |   | (1,481 | )       |         |      | -3.3%      |        |         |  | 47,883  |         |         |   | (3,108  | )      |         |   | -6.5%   |        
|Net realized gains (losses)                                  |                                |                                                                                                                       | 2,403   |         |         |   | (163    | )          |         |   | 2,566  |         |         |      | 1574.2%    |        |         |  | (5,651  | )       |         |   | 5,488   |        |         |   | 97.1%   |        
|Other income                                                 |                                |                                                                                                                       | 1,104   |         |         |   | 376     |            |         |   | 728    |         |         |      | 193.6%     |        |         |  | 546     |         |         |   | (170    | )      |         |   | -31.1%  |        
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Total revenues and other income                                                                                       |         |         | 271,391 |   |         |            | 280,539 |   |        |         | (9,148  | )    |            |        | -3.3%   |  |         |         | 245,149 |   |         |        | 35,390  |   |         |         | 14.4% | 
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|Losses and loss adjustment expenses                          |                                |                                                                                                                       | 252,742 |         |         |   | 242,028 |            |         |   | 10,714 |         |         |      | 4.4%       |        |         |  | 257,848 |         |         |   | (15,820 | )      |         |   | -6.1%   |        
|Underwriting expenses                                        |                                |                                                                                                                       | 51,104  |         |         |   | 48,593  |            |         |   | 2,511  |         |         |      | 5.2%       |        |         |  | 45,111  |         |         |   | 3,482   |        |         |   | 7.7%    |        
|Investment expenses                                          |                                |                                                                                                                       | 2,940   |         |         |   | 3,091   |            |         |   | (151   | )       |         |      | -4.9%      |        |         |  | 2,518   |         |         |   | 573     |        |         |   | 22.8%   |        
|Interest expense                                             |                                |                                                                                                                       | 1,370   |         |         |   | 373     |            |         |   | 997    |         |         |      | 267.3%     |        |         |  | 400     |         |         |   | (27     | )      |         |   | -6.8%   |        
|Amortization expense                                         |                                |                                                                                                                       | 389     |         |         |   |        |            |         |   | 389    |         |         |      |            |        |         |  | 2,514   |         |         |   | (2,514  | )      |         |   | -100.0% |        
|General and administrative expenses                          |                                |                                                                                                                       | 2,921   |         |         |   | 1,395   |            |         |   | 1,526  |         |         |      | 109.4%     |        |         |  | 1,504   |         |         |   | (109    | )      |         |   | -7.2%   |        
|Restructuring costs                                          |                                |                                                                                                                       | 808     |         |         |   |        |            |         |   | 808    |         |         |      |            |        |         |  | 2,484   |         |         |   | (2,484  | )      |         |   | -100.0% |        
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Total expenses                                                                                                        |         |         | 312,274 |   |         |            | 295,480 |   |        |         | 16,794  |      |            |        | 5.7%    |  |         |         | 312,379 |   |         |        | (16,899 | ) |         |         | -5.4% | 
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Loss before federal income taxes, minority
    interest and cumulative effect of a change in accounting
    principle |         |         | (40,883 | ) |         |            | (14,941 | ) |        |         | (25,942 | )    |            |        | -173.6% |  |         |         | (67,230 | ) |         |        | 52,289  |   |         |         | 77.8% | 
|Federal income tax expense (benefit)                         |                                |                                                                                                                       | 36,296  |         |         |   | (5,529  | )          |         |   | 41,825 |         |         |      | 756.5%     |        |         |  | (23,450 | )       |         |   | 17,921  |        |         |   | 76.4%   |        
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Loss before minority interest and cumulative
    effect of a change in accounting principle                           |         |         | (77,179 | ) |         |            | (9,412  | ) |        |         | (67,767 | )    |            |        | -720.0% |  |         |         | (43,780 | ) |         |        | 34,368  |   |         |         | 78.5% | 
|Minority interest in net loss of consolidated
    subsidiary |                                |                                                                                                                       | 348     |         |         |   |        |            |         |   | 348    |         |         |      |            |        |         |  |        |         |         |   |        |        |         |   |         |        
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Loss before cumulative effect of a change in
    accounting principle                                                 |         |         | (76,831 | ) |         |            | (9,412  | ) |        |         | (67,419 | )    |            |        | -716.3% |  |         |         | (43,780 | ) |         |        | 34,368  |   |         |         | 78.5% | 
|Cumulative effect of a change in accounting
    principle    |                                |                                                                                                                       |        |         |         |   | (9,079  | )          |         |   | 9,079  |         |         |      |            |        |         |  |        |         |         |   | (9,079  | )      |         |   |         |        
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|                                                             |                                | Net loss                                                                                                              |         | $       | (76,831 | ) |         | $          | (18,491 | ) |        | $       | (58,340 | )    |            |        | -315.5% |  |         | $       | (43,780 | ) |         | $      | 25,289  |   |         |         | 57.8% | 
|                                                             |                                |                                                                                                                       |         |         |         |   |         |            |         |   |        |         |         |      |            |        |         |  |         |         |        
|Loss ratio                                                   |                                |                                                                                                                       | 112.5   | %       |         |   | 102.7   | %          |         |   | 9.8    | %       |         |      |            |        |         |  | 127.4   | %       |         |   | -24.7   | %      |         |   |         |        
|Underwriting ratio                                           |                                |                                                                                                                       | 22.8    | %       |         |   | 20.6    | %          |         |   | 2.2    | %       |         |      |            |        |         |  | 22.3    | %       |         |   | -1.7    | %      |         |   |         |        
|Combined ratio                                               |                                |                                                                                                                       | 135.3   | %       |         |   | 123.3   | %          |         |   | 12.0   | %       |         |      |            |        |         |  | 149.7   | %       |         |   | -26.4   | %      |         |   |         |        

2003 Compared to
2002.The net loss reported for 2003
was primarily attributable to unfavorable development on prior
year loss reserves of $43.4 million and the establishment
of a deferred tax valuation allowance of $50.6 million. The
unfavorable development on prior year loss reserves was
primarily related to our medical professional liability segment,
and was the result of an increase in paid loss severity noted
during

29



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the third quarter, particularly in our Florida,
Ohio and Kentucky markets. We also established the deferred tax
valuation allowance in the third quarter of 2003, as there was
not adequate support regarding the availability of future
taxable income based on our recent loss history. Our net loss in
2002 was primarily the result of a $55.1 million
underwriting loss, and a $9.1 million charge, net of tax,
for the write-off of goodwill, which was recorded as a
cumulative effect of a change in accounting principle, partially
offset by $44.8 million of investment income.


Net premiums earned decreased during 2003, as
compared to 2002, primarily as a result of the restructuring of
our workers compensation book of business that began in
2002. In the fourth quarter of 2003, we announced our intention
to exit the workers compensation and health insurance
lines of business, which is anticipated to cause a decrease in
our net premiums earned in 2004.

The yield on our investment portfolio was 5.55%
for 2003 compared to 5.98% for 2002. The lower yield in 2003 was
the result of a general decline in interest rates combined with
a higher cash balance during the first part of the year, which
produces a significantly lower yield than longer-term more
productive assets. We delayed investing a portion of the cash
flow generated during the first half of 2003 due to the very low
interest rate environment and our reluctance to lock-in
longer-term interest rates at prevailing levels.

Incurred loss and loss adjustment expenses
increased during 2003 as a result of the $43.4 million of
unfavorable development on prior year loss reserves mentioned
above. Prior year unfavorable loss reserve development in 2002
was $5.6 million. The consolidated calendar year loss ratio
for the 2003 year was 112.5%, consisting of 19.3% on prior
accident years and 93.2% on the current accident year. In 2002,
the current year accident loss ratio was 100.3%, with a prior
year loss ratio of 2.4%, for a total calendar year loss ratio of
102.7%. Our incurred loss and loss adjustment expenses are
analyzed more fully in the discussions of our individual
operating segment results.

Underwriting expenses increased during 2003 as a
result of increased salary and employee relation costs,
amortization of our deferred policy acquisition costs, and the
inclusion of Physicians Insurance Company (PIC) in
our consolidated results during 2003. Physicians Insurance
Company is a start up medical professional liability insurance
company in Florida in which the Company has a 49% ownership
interest. As a result of recent changes in accounting rules, we
are required to consolidate Physicians Insurance Company despite
not having a controlling financial interest. See
 Effects of New Accounting
Pronouncements, for further discussion regarding our
investment in PIC.

The increase in interest expense during 2003 was
the result of the issuance of $30.9 million of debentures
in May of 2003.

Amortization expense during 2003 relates to a
definite-lived intangible asset acquired in connection with our
investment in PIC. See Note 4 of the Notes to Consolidated
Financial Statements for further information regarding this and
other intangible assets. Such information is incorporated herein
by reference.

Our general and administrative expenses increased
during 2003 primarily as a result of increased legal, audit, and
other professional fees pertaining to compliance with the new
Sarbanes-Oxley legislation, and related SEC rules, and legal and
investment banking fees incurred in the fourth quarter pursuant
to the Board of Directors evaluation of alternatives to
maximize shareholder value after the loss reported in the third
quarter.

Restructuring expenses incurred during 2003 were
recorded during the fourth quarter and relate to employee
separation costs as a result of terminations in connection with
the initiation of our exit from the workers compensation
segment. As we continue our exit from workers compensation
in 2004 and beyond, we anticipate incurring approximately
$300,000 of additional employee separation costs in future
periods in accordance with the guidance given in Statement of
Financial Accounting Standards SFAS No. 146.
See  Effects of New Accounting
Pronouncements for further discussion of the impact of the
adoption of SFAS No. 146.

The federal income tax expense recorded in 2003,
as compared to the benefit recorded in 2002, was the result of
the establishment of the deferred tax valuation allowance as
described above. Once we have

30



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##### 



re-established a pattern of profitability, and
can demonstrate the availability of future taxable income, the
deferred tax valuation allowance may be reduced, which will
create a federal income tax benefit in the period of reduction.


2002 Compared to
2001.The net loss reported in 2002
was primarily the result of a $55.1 million underwriting
loss, partially offset by investment income of
$44.8 million. Other significant items included the
write-off of goodwill, which totaled $9.1 million net of
tax, and was recorded as a cumulative effect of a change in
accounting principle as a result of the adoption of
SFAS No. 142. The 2002 loss ratio decreased to 102.7%
from 127.4% in 2001, primarily as a result of rate increases,
tighter underwriting standards and less development on prior
year loss and loss adjustment expense reserves. Loss and loss
adjustment expenses incurred during 2001 included
$29.0 million of unfavorable development on prior year loss
reserves, which were recorded in the third and fourth quarter as
a result of emerging loss trends. Rate increases initiated in
2001 began to be earned in 2002, which resulted in a
$33.2 million increase in net premiums earned from 2001 to
2002. The prior year unfavorable development, combined with the
lower net premiums earned were the primary factors contributing
to the recorded net loss of $43.8 million in 2001.

The increase in net premiums earned was the
result of rate increases initiated in 2001 on our medical
professional liability line, and is discussed more fully in that
segments results of operations.

The decline in investment income was primarily
the result of a lower interest rate environment in 2002,
compared to 2001. In addition, the Company spent
$27.5 million to fund its share repurchase program during
the year ended December 31, 2002, which reduced the amount
of invested assets during 2002 as compared to 2001. The average
yield on the Companys investment portfolio was 5.98% for
the year ended December 31, 2002 compared to 6.36% for 2001.

The decrease in net realized losses in 2002 was
the result of a charge for other than temporarily impaired
securities in 2001 of $5.9 million related to bonds issued
by Frontier Corporation. These same bonds were written down an
additional $520,000 during 2002.

The decrease in incurred loss and loss adjustment
expenses was the result of the $29.0 million of unfavorable
development on prior year loss reserves recorded in 2001.
Unfavorable development on prior year loss reserves in 2002 was
$5.6 million. Our incurred loss and loss adjustment
expenses are analyzed more fully in the discussions of our
individual operating segments.

The increase in underwriting expenses was the
result of additional commissions and premium taxes on higher
premium volumes in 2002 as compared to 2001.

In accordance with the provisions of
SFAS No. 142, the Company did not record any
amortization expense during the year ended December 31,
2002. Amortization expense for the year ended December 31,
2001 was $2.5 million and related primarily to goodwill
acquired in connection with the purchase of the
Stratton-Cheeseman Management Company in 1999. See Note 4
to the Consolidated Financial Statements for further discussion
regarding amortization expense and the effect of
SFAS No. 142 on the Companys operating results.
Such information is incorporated herein by reference.

Restructuring costs in 2001 were incurred in
connection with a reduction of personnel in our Information
Systems department and our senior management team as the Company
evaluated the impact of recently becoming a publicly traded
company and made certain organization changes to obtain
expertise in its core lines of business.

The Company recorded $5.5 million in federal
income tax benefit for the year ended December 31, 2002,
compared to a benefit of $23.5 million during 2001. The
income tax benefit recorded was a result of net losses in those
periods. The effective tax rate was 37.0% for the year ended
December 31, 2002, compared to 34.9% for 2001.

31



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| |                                                        
| | -------------------------------------------------------
| | Medical Professional Liability Insurance
    Operations

The following table sets forth summary premium,
loss and expense information regarding the underwriting results
of our medical professional liability insurance operations for
the years ended December 31, 2003, 2002 and 2001.

|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |         |   |        |         |        |   |        |        |       | 
|--------------------------------------------------------------------------------------------------------------------- | ------------- | ---------------------- | ------- | ------- | ------- | - | ------- | ---------- | ------- | - | ------- | ------- | ------ | ---- | ---------- | ------ | ------ | - | ------- | ------- | ------- | - | ------ | ------- | ------ | - | ------ | ------ | ----- | 
|                                                                                                                      |               |                        |         |         |         |   |         | Percentage |         |   |         |         |        |      | Percentage |       
|                                                                                                                      |               | 2003                   |         |         | 2002    |   |         | Change     |         |   | Change  |         |        | 2001 |            |        | Change |   |         | Change  |        
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|                                                                                                                      |               |                       
|                                                                                                                      |               | (Dollars in thousands) |        
|Direct premiums written:                                                                                              |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |         |   |        |         |        |   |        |       
|                                                                                                                      | Michigan      |                        | $       | 54,629  |         |   | $       | 50,077     |         |   | $       | 4,552   |        |      |            | 9.1%   |        |   | $       | 44,927  |         |   | $      | 5,150   |        |   |        | 11.5%  |      
|                                                                                                                      | Illinois      |                        |         | 54,108  |         |   |         | 35,429     |         |   |         | 18,679  |        |      |            | 52.7%  |        |   |         | 22,006  |         |   |        | 13,423  |        |   |        | 61.0%  |      
|                                                                                                                      | Ohio          |                        |         | 35,793  |         |   |         | 33,731     |         |   |         | 2,062   |        |      |            | 6.1%   |        |   |         | 24,864  |         |   |        | 8,867   |        |   |        | 35.7%  |      
|                                                                                                                      | New Mexico    |                        |         | 16,268  |         |   |         | 11,448     |         |   |         | 4,820   |        |      |            | 42.1%  |        |   |         | 9,236   |         |   |        | 2,212   |        |   |        | 23.9%  |      
|                                                                                                                      | Kentucky      |                        |         | 15,747  |         |   |         | 15,742     |         |   |         | 5       |        |      |            | 0.0%   |        |   |         | 15,738  |         |   |        | 4       |        |   |        | 0.0%   |      
|                                                                                                                      | Florida       |                        |         | 10,683  |         |   |         | 23,637     |         |   |         | (12,954 | )      |      |            | -54.8% |        |   |         | 26,690  |         |   |        | (3,053  | )      |   |        | -11.4% |      
|                                                                                                                      | Nevada        |                        |         | 4,833   |         |   |         | 4,595      |         |   |         | 238     |        |      |            | 5.2%   |        |   |         | 2,945   |         |   |        | 1,650   |        |   |        | 56.0%  |      
|                                                                                                                      | Other         |                        |         | 3,681   |         |   |         | 2,594      |         |   |         | 1,087   |        |      |            | 41.9%  |        |   |         | 2,847   |         |   |        | (253    | )      |   |        | -8.9%  |      
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|                                                                                                                      |               | Total                  |         | $       | 195,742 |   |         | $          | 177,253 |   |         | $       | 18,489 |      |            |        | 10.4%  |   |         | $       | 149,253 |   |        | $       | 28,000 |   |        |        | 18.8% | 
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|Net premiums written                                                                                                  |               | $                      | 164,157 |         |         | $ | 154,583 |            |         | $ | 9,574   |         |        |      | 6.2%       |        |        | $ | 126,830 |         |         | $ | 27,753 |         |        |   | 21.9%  |       
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|Net premiums earned                                                                                                   |               | $                      | 158,777 |         |         | $ | 148,646 |            |         | $ | 10,131  |         |        |      | 6.8%       |        |        | $ | 119,659 |         |         | $ | 28,987 |         |        |   | 24.2%  |       
|Incurred loss and loss adjustment expenses:                                                                           |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |         |   |        |         |        |   |        |       
|                                                                                                                      | Current year  |                        |         | 153,180 |         |   |         | 157,750    |         |   |         | (4,570  | )      |      |            | -2.9%  |        |   |         | 145,890 |         |   |        | 11,860  |        |   |        | 8.1%   |      
|                                                                                                                      | Prior years   |                        |         | 44,250  |         |   |         | 4,500      |         |   |         | 39,750  |        |      |            | 883.3% |        |   |         | 22,700  |         |   |        | (18,200 | )      |   |        | -80.2% |      
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|                                                                                                                      |               | Total                  |         |         | 197,430 |   |         |            | 162,250 |   |         |         | 35,180 |      |            |        | 21.7%  |   |         |         | 168,590 |   |        |         | (6,340 | ) |        |        | -3.8% | 
|Underwriting expenses                                                                                                 |               |                        | 31,315  |         |         |   | 27,157  |            |         |   | 4,158   |         |        |      | 15.3%      |        |        |   | 23,281  |         |         |   | 3,876  |         |        |   | 16.6%  |       
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|Underwriting loss                                                                                                     |               | $                      | (69,968 | )       |         | $ | (40,761 | )          |         | $ | (29,207 | )       |        |      | 71.7%      |        |        | $ | (72,212 | )       |         | $ | 31,451 |         |        |   | -43.6% |       
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|Loss before federal income taxes, minority
    interest and cumulative effect of a change in accounting
    principle |               | $                      | (33,821 | )       |         | $ | (5,219  | )          |         | $ | (28,602 | )       |        |      | 548.0%     |        |        | $ | (41,943 | )       |         | $ | 36,724 |         |        |   | -87.6% |       
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|Loss ratio:                                                                                                           |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |         |   |        |         |        |   |        |       
|                                                                                                                      | Accident year |                        |         | 96.5%   |         |   |         | 106.1%     |         |   |         | -9.6%   |        |      |            |        |        |   |         | 121.9%  |         |   |        | -15.8%  |        |   |        |        |      
|                                                                                                                      | Prior years   |                        |         | 27.8%   |         |   |         | 3.1%       |         |   |         | 24.7%   |        |      |            |        |        |   |         | 19.0%   |         |   |        | -15.9%  |        |   |        |        |      
|                                                                                                                      |               |                        |         |         |         |   |         |            |         |   |         |         |        |      |            |        |        |   |         |         |        
|                                                                                                                      | Calendar year |                        |         | 124.3%  |         |   |         | 109.2%     |         |   |         | 15.1%   |        |      |            |        |        |   |         | 140.9%  |         |   |        | -31.7%  |        |   |        |        |      
|Underwriting expense ratio                                                                                            |               |                        | 19.7%   |         |         |   | 18.3%   |            |         |   | 1.4%    |         |        |      |            |        |        |   | 19.5%   |         |         |   | -1.2%  |         |        |   |        |       
|Combined ratio                                                                                                        |               |                        | 144.0%  |         |         |   | 127.5%  |            |         |   | 16.5%   |         |        |      |            |        |        |   | 160.4%  |         |         |   | -32.9% |         |        |   |        |       

2003 Compared to
2002.Direct premiums written for the
medical professional liability segment increased in 2003
primarily as a result of rate increases in virtually all
markets, partially offset by our exit from the Florida market.
Our insured physician count at December 31, 2003 has
decreased approximately 12% from December 31, 2002 due to
our exit from the Florida market, the discontinuance of Ohio
occurrence-based policies and the elimination of poor risks in
other markets. The average premium per policy in-force has
increased from approximately $13,400 at December 31, 2002
to approximately $16,300 at December 31, 2003, an increase
of 21.6%. The decrease in direct premiums written in Florida, as
a result of our exit from that state was partially offset by
direct premiums written of approximately $3.8 million by
Physicians Insurance Company (PIC), a newly
consolidated entity. See  Effects of New
Accounting Pronouncements for further discussion regarding
our investment in PIC.

32



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##### 



We believe that the current pricing environment
for medical professional liability insurance is favorable. We
expect medical professional liability direct premiums written to
increase moderately in the future as the Company is granted
additional rate increases by regulatory authorities. However,
this growth may be limited by our ability to allocate
appropriate levels of statutory capital and surplus to the
medical professional liability segment. The decrease in premiums
related to our exit from the Florida and other markets is
expected to be offset by rate increases in other states. While
we do not anticipate any significant decline in business as a
result of our recent A.M. Best downgrades, the downgrades could
adversely impact our competitive position within the
marketplace, making it more difficult to retain or attract new
policyholders.

Our net premiums written and earned during 2003
did not increase as much as direct premiums written primarily
due to an increase in the cost of reinsurance, which resulted in
additional ceded written and earned premiums.

The increase in incurred loss and loss adjustment
expenses was primarily the result of $43 million of adverse
development on prior year loss and loss adjustment expense
reserves in the third quarter of 2003. This unfavorable
development is discussed more fully under
Item 1  Business  Loss and Loss
Adjustment Expense Reserves. The cross-referenced
information is incorporated herein by reference.

The loss ratio, on an accident year basis, was
96.5% for the year ended December 31, 2003 compared to
106.1% for the year ended December 31, 2002. The decrease
in the accident year loss ratio was primarily the result of rate
increases taken in all markets.

The increase in underwriting expenses was the
result of increased salaries and employee relations costs as we
added to our claims and underwriting personnel. In addition,
higher premium volumes resulted in increased commissions and
premium taxes. We anticipate that the medical professional
liability underwriting ratio may increase in the near future due
to the increased allocation of corporate and other overhead
expense to this segment as we exit the workers
compensation and health lines.

2002 Compared to
2001.The increase in direct premiums
written was primarily the result of premium rate increases and
reduced discounts instituted by the Company in late 2001 and
continued through 2002, partially offset by our exit from the
Florida market, which began in December of 2002. Insured
physician counts were relatively flat from December 31,
2001 to December 31, 2002.

During 2002 and 2001, we experienced adverse
development on prior year loss reserves. The 2002 adverse
development, approximately $4.5 million, emerged primarily
in our Florida and Ohio markets where loss frequency and
severity have both exceeded our original expectations. The 2001
adverse development on prior year loss reserves, approximately
$22.7 million, was the result of a significant increase in
reported losses in the second half of 2001. Losses on prior
accident years increased in our Ohio, Florida and Kentucky
markets and were caused primarily by a dramatic increase in loss
severity. The accident year loss ratio was 106.1% for the year
ended December 31, 2002, compared to 121.9% for 2001. The
decrease in the accident year loss ratio is the direct result of
premium rate increases, and reduced discounts taken in 2002.

The increase in underwriting expenses from 2001
to 2002 was primarily the result of increased commissions and
premium taxes on the higher premium volume.

33



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##### 





| |                                               
| | ----------------------------------------------
| | Workers Compensation Insurance
    Operations

The following table sets forth summary premium,
loss and expense information regarding the underwriting results
of our workers compensation insurance operations for the
years ended December 31, 2003, 2002 and 2001.

|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |        |   |        |        |        |   |        |        |        | 
|--------------------------------------------------------------------------------------------------------------------- | ------------- | ---------------------- | ------ | ------ | ------ | - | ------ | ---------- | ------ | - | ------- | ------- | ------- | ---- | ---------- | ------- | ------ | - | ------- | ------ | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                                                                                      |               |                        |        |        |        |   |        | Percentage |        |   |         |         |         |      | Percentage |        
|                                                                                                                      |               | 2003                   |        |        | 2002   |   |        | Change     |        |   | Change  |         |         | 2001 |            |         | Change |   |         | Change |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|                                                                                                                      |               |                       
|                                                                                                                      |               | (Dollars in thousands) |       
|Direct premiums written:                                                                                              |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |        |   |        |        |        |   |        |       
|                                                                                                                      | Minnesota     |                        | $      | 14,685 |        |   | $      | 29,811     |        |   | $       | (15,126 | )       |      |            | -50.7%  |        |   | $       | 30,069 |        |   | $      | (258   | )      |   |        | -0.9%  |       
|                                                                                                                      | Michigan      |                        |        | 9,196  |        |   |        | 11,639     |        |   |         | (2,443  | )       |      |            | -21.0%  |        |   |         | 9,803  |        |   |        | 1,836  |        |   |        | 18.7%  |       
|                                                                                                                      | Illinois      |                        |        | 6,513  |        |   |        | 9,104      |        |   |         | (2,591  | )       |      |            | -28.5%  |        |   |         | 8,957  |        |   |        | 147    |        |   |        | 1.6%   |       
|                                                                                                                      | Indiana       |                        |        | 4,769  |        |   |        | 7,118      |        |   |         | (2,349  | )       |      |            | -33.0%  |        |   |         | 6,787  |        |   |        | 331    |        |   |        | 4.9%   |       
|                                                                                                                      | Wisconsin     |                        |        | 1,678  |        |   |        | 488        |        |   |         | 1,190   |         |      |            | 243.9%  |        |   |         | 688    |        |   |        | (200   | )      |   |        | -29.1% |       
|                                                                                                                      | Iowa          |                        |        | 141    |        |   |        | 1,375      |        |   |         | (1,234  | )       |      |            | -89.7%  |        |   |         | 4,000  |        |   |        | (2,625 | )      |   |        | -65.6% |       
|                                                                                                                      | Kentucky      |                        |        | (9     | )      |   |        | 3,912      |        |   |         | (3,921  | )       |      |            | -100.2% |        |   |         | 3,197  |        |   |        | 715    |        |   |        | 22.4%  |       
|                                                                                                                      | Other         |                        |        | 364    |        |   |        | 747        |        |   |         | (383    | )       |      |            | -51.3%  |        |   |         | 476    |        |   |        | 271    |        |   |        | 56.9%  |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|                                                                                                                      |               | Total                  |        | $      | 37,337 |   |        | $          | 64,194 |   |         | $       | (26,857 | )    |            |         | -41.8% |   |         | $      | 63,977 |   |        | $      | 217    |   |        |        | 0.3%   | 
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|Net premiums written                                                                                                  |               | $                      | 38,521 |        |        | $ | 60,446 |            |        | $ | (21,925 | )       |         |      | -36.3%     |         |        | $ | 64,754  |        |        | $ | (4,308 | )      |        |   | -6.7%  |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|Net premiums earned                                                                                                   |               | $                      | 43,844 |        |        | $ | 63,517 |            |        | $ | (19,673 | )       |         |      | -31.0%     |         |        | $ | 58,377  |        |        | $ | 5,140  |        |        |   | 8.8%   |       
|Incurred loss and loss adjustment expenses:                                                                           |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |        |   |        |        |        |   |        |       
|                                                                                                                      | Current year  |                        |        | 37,032 |        |   |        | 55,157     |        |   |         | (18,125 | )       |      |            | -32.9%  |        |   |         | 57,112 |        |   |        | (1,955 | )      |   |        | -3.4%  |       
|                                                                                                                      | Prior years   |                        |        | (1,400 | )      |   |        |           |        |   |         | (1,400  | )       |      |            |         |        |   |         | 5,600  |        |   |        | (5,600 | )      |   |        | 100%   |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|                                                                                                                      |               | Total                  |        |        | 35,632 |   |        |            | 55,157 |   |         |         | (19,525 | )    |            |         | -35.4% |   |         |        | 62,712 |   |        |        | (7,555 | ) |        |        | -12.0% | 
|Underwriting expenses                                                                                                 |               |                        | 15,698 |        |        |   | 16,222 |            |        |   | (524    | )       |         |      | -3.2%      |         |        |   | 16,402  |        |        |   | (180   | )      |        |   | -1.1%  |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|Underwriting loss                                                                                                     |               | $                      | (7,486 | )      |        | $ | (7,862 | )          |        | $ | 376     |         |         |      | -4.8%      |         |        | $ | (20,737 | )      |        | $ | 12,875 |        |        |   | -62.1% |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|Loss before federal income taxes, minority
    interest and cumulative effect of a change in accounting
    principle |               | $                      | (2,680 | )      |        | $ | (2,520 | )          |        | $ | (160    | )       |         |      | 6.3%       |         |        | $ | (14,974 | )      |        | $ | 12,454 |        |        |   | -83.2% |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|Loss ratio:                                                                                                           |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |        |   |        |        |        |   |        |       
|                                                                                                                      | Accident year |                        |        | 84.5%  |        |   |        | 86.8%      |        |   |         | -2.3%   |         |      |            |         |        |   |         | 97.8%  |        |   |        | -11.0% |        |   |        |        |       
|                                                                                                                      | Prior years   |                        |        | -3.2%  |        |   |        | 0.0%       |        |   |         | -3.2%   |         |      |            |         |        |   |         | 9.6%   |        |   |        | -9.6%  |        |   |        |        |       
|                                                                                                                      |               |                        |        |        |        |   |        |            |        |   |         |         |         |      |            |         |        |   |         |        |       
|                                                                                                                      | Calendar year |                        |        | 81.3%  |        |   |        | 86.8%      |        |   |         | -5.5%   |         |      |            |         |        |   |         | 107.4% |        |   |        | -20.6% |        |   |        |        |       
|Underwriting expense ratio                                                                                            |               |                        | 35.8%  |        |        |   | 25.5%  |            |        |   | 10.3%   |         |         |      |            |         |        |   | 28.1%   |        |        |   | -2.6%  |        |        |   |        |       
|Combined ratio                                                                                                        |               |                        | 117.1% |        |        |   | 112.3% |            |        |   | 4.8%    |         |         |      |            |         |        |   | 135.5%  |        |        |   | -23.2% |        |        |   |        |       

2003 Compared to
2002.Workers compensation
direct premiums written decreased during 2003 as a result of the
restructuring of this book of business initiated in 2002 and the
subsequent decision to exit this line completely in 2003. We
expect direct premiums written related to this line to decrease
further in 2004 as we complete our exit from this line.

In June 2002, the Company filled several
executive and management positions in its workers
compensation segment. These positions were filled to improve the
overall performance of this segment, reduce risk exposures and
improve profitability. However, during 2003, the workers
compensation market remained very competitive and the growth of
this line did not keep pace with expectations. As a result, in
the third quarter of 2003, management made the decision to exit
this line of business.

Management has determined that non-renewing our
workers compensation policies is the most effective way to
achieve the exit of this line of business. As a result,
APCapital ceased discussions to sell its workers

34



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##### 



compensation policy renewals under the terms of a
previously announced non-binding letter of intent. We are
required by various state regulatory authorities to provide a
notification period, typically 30 to 90 days, to insureds
prior to non-renewing their policies to provide them time to
find alternative coverage. We began mailing non-renewal notices
in February 2004, which means that additional written premiums
may continue into the second quarter of 2004.


Net premiums earned did not decrease as much as
direct premiums written as we continued to earn in 2003 the
premiums that were written in 2002.

The restructuring of this book of business,
combined with rate increases and improved claims management,
have translated into lower calendar year and accident year loss
ratios, which were 81.3% and 84.5%, respectively, for the year
ended December 31, 2003 compared to 86.8% and 86.8%,
respectively, for the same period of 2002. The benefits of the
improved claims management and rate increases, however, were
partially offset by an increase in loss adjustment expenses
related primarily to salaries, in the first half of 2003, of the
executives and managers the Company hired to restructure the
workers compensation book of business, as well as
assessments related to workers compensation business in
the state of Minnesota.

Salary and employee relations costs related to
the management team during the first half of 2003, combined with
the decreases in net premiums earned, were the primary reasons
for the increases in the underwriting expense ratios.

Management is continuing to pursue a loss
portfolio transfer of our existing workers compensation
reserves for unpaid losses and loss adjustment expenses. As of
December 31, 2003 workers compensation reserves
totaled $62.3 million, $60.6 million net of
reinsurance.

2002 Compared to
2001.Workers compensation net
premiums earned increased for the year ended December 31,
2002 compared to 2001, primarily as a result of continuing to
earn premiums written in 2001, which exceeded those written in
2000 due to policy growth in 2001, primarily in our Minnesota,
Illinois and Indiana markets.

The decrease in the loss ratio from 2001 to 2002
was due to an overall pattern of increasing premium rates and
reduced discounts in all markets, as well as a $5.0 million
reserve enhancement related to prior accident years in 2001.
There was no reserve development related to prior accident years
in 2002.

The decrease in the workers compensation
underwriting expense ratio resulted primarily from the 8.8%
growth in net premiums earned for the year ended
December 31, 2002 as compared with 2001, as underwriting
expenses remained relatively flat.

35



---



##### 





| |                            
| | ---------------------------
| | Health Insurance Operations

The following table sets forth summary premium,
loss and expense information regarding the underwriting results
of our health insurance operations for the years ended
December 31, 2003, 2002 and 2001.

|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |        |   |       |       |       |  |       |       |       | 
|------------------------------------------------------------------------------------------------------------------------------ | ------------- | ---------------------- | ------ | ------ | ------ | - | ------ | ---------- | ------ | - | ------ | ------ | ------ | ---- | ---------- | ----- | ------ | - | ------ | ------ | ------ | - | ----- | ----- | ----- |  | ----- | ----- | ----- | 
|                                                                                                                               |               |                        |        |        |        |   |        | Percentage |        |   |        |        |        |      | Percentage |      
|                                                                                                                               |               | 2003                   |        |        | 2002   |   |        | Change     |        |   | Change |        |        | 2001 |            |       | Change |   |        | Change |       
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|                                                                                                                               |               |                       
|                                                                                                                               |               | (Dollars in thousands) |       
|Direct premiums written                                                                                                        |               | $                      | 23,156 |        |        | $ | 24,433 |            |        | $ | (1,277 | )      |        |      | -5.2       | %     |        | $ | 18,001 |        |        | $ | 6,432 |       |       |  | 35.7% |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|Net premiums written                                                                                                           |               | $                      | 22,208 |        |        | $ | 23,820 |            |        | $ | (1,612 | )      |        |      | -6.8       | %     |        | $ | 18,668 |        |        | $ | 5,152 |       |       |  | 27.6% |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|Net premiums earned                                                                                                            |               | $                      | 22,208 |        |        | $ | 23,820 |            |        | $ | (1,612 | )      |        |      | -6.8       | %     |        | $ | 18,668 |        |        | $ | 5,152 |       |       |  | 27.6% |      
|Incurred loss and loss adjustment expenses:                                                                                    |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |        |   |       |       |       |  |       |      
|                                                                                                                               | Current year  |                        |        | 19,087 |        |   |        | 23,254     |        |   |        | (4,167 | )      |      |            | -17.9 | %      |   |        | 18,430 |        |   |       | 4,824 |       |  |       | 26.2% |      
|                                                                                                                               | Prior years   |                        |        | (468   | )      |   |        |           |        |   |        | (468   | )      |      |            |       |        |   |        |       |        |   |       |      |       |  |       |       |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|                                                                                                                               |               | Total                  |        |        | 18,619 |   |        |            | 23,254 |   |        |        | (4,635 | )    |            |       | -19.9  | % |        |        | 18,430 |   |       |       | 4,824 |  |       |       | 26.2% | 
|Underwriting expenses                                                                                                          |               |                        | 3,875  |        |        |   | 4,849  |            |        |   | (974   | )      |        |      | -20.1      | %     |        |   | 4,193  |        |        |   | 656   |       |       |  | 15.6% |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|Underwriting loss                                                                                                              |               | $                      | (286   | )      |        | $ | (4,283 | )          |        | $ | 3,997  |        |        |      | -93.3      | %     |        | $ | (3,955 | )      |        | $ | (328  | )     |       |  | 8.3%  |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|Income (loss) before federal income taxes,
    minority interest and cumulative effect of a change in
    accounting principle |               | $                      | 490    |        |        | $ | (3,572 | )          |        | $ | 4,062  |        |        |      | -113.7     | %     |        | $ | (3,750 | )      |        | $ | 178   |       |       |  | -4.7% |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|Loss ratio:                                                                                                                    |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |        |   |       |       |       |  |       |      
|                                                                                                                               | Accident year |                        |        | 85.9   | %      |   |        | 97.6       | %      |   |        | -11.7  | %      |      |            |       |        |   |        | 98.7   | %      |   |       | -1.1  | %     |  |       |       |      
|                                                                                                                               | Prior years   |                        |        | -2.1   | %      |   |        | 0.0        | %      |   |        | -2.1   | %      |      |            |       |        |   |        | 0.0    | %      |   |       | 0.0   | %     |  |       |       |      
|                                                                                                                               |               |                        |        |        |        |   |        |            |        |   |        |        |        |      |            |       |        |   |        |        |       
|                                                                                                                               | Calendar year |                        |        | 83.8   | %      |   |        | 97.6       | %      |   |        | -13.8  | %      |      |            |       |        |   |        | 98.7   | %      |   |       | -1.1  | %     |  |       |       |      
|Underwriting expense ratio                                                                                                     |               |                        | 17.4   | %      |        |   | 20.4   | %          |        |   | -3.0   | %      |        |      |            |       |        |   | 22.5   | %      |        |   | -2.1  | %     |       |  |       |      
|Combined ratio                                                                                                                 |               |                        | 101.2  | %      |        |   | 118.0  | %          |        |   | -16.8  | %      |        |      |            |       |        |   | 121.2  | %      |        |   | -3.2  | %     |       |  |       |      

2003 Compared to
2002.Health direct premiums written
decreased in 2003 as a result of a reduction in the number of
covered lives, partially offset by an increase in the average
per member per month premium. The number of covered lives at
December 31, 2003 was 6,554 compared to 12,898 at
December 31, 2002, a decrease of approximately 49%. Over
the same period, the average per member per month premium
increased $60 from $188 at December 31, 2002 to $248 at
December 31, 2003. We expect to see premiums for this
segment continue to decrease due to a further decline in the
number of covered lives as we tighten underwriting standards and
raise rates during the first half of 2004, after which we will
discontinue issuing new health insurance policies.

Effective December 31, 2003, we gave notice
to the third-party that administers our health plan of our
intent to exit the health insurance market. In accordance with
the contract between the Company and the third-party
administrator (TPA), we are required to give a
180 day notice of our intent to terminate the agreement
between us and the TPA. Therefore, we will continue to write
health policies through June 30, 2004; however, we intend
to follow strict underwriting and pricing guidelines during this
period.

The decrease in the incurred loss and loss
adjustment expense ratio was primarily the result of improved
underwriting and premium rate increases.

The decreases in underwriting expenses and the
underwriting expense ratio were primarily due to the reduction
of certain corporate overhead expenses related to the health
insurance segment as well as a reduction in fees charged by a
TPA who handles policy administration and premium collections on
behalf of the Company.

2002 Compared to
2001.The increase in direct premiums
written was the result of rate increases, of up to 25%,
implemented in 2002, as well as moderate membership growth in
the fourth quarter of 2002.

36



---



##### 



Health net premiums earned increased less than
direct premiums written as, in June 2002, we discontinued
assuming health premiums from a pool that we had previously
participated in.

The increase in incurred losses and loss
adjustment expenses was primarily the result of increased health
care costs and membership growth during the fourth quarter of
2002. These increases were mostly offset by an increase in net
premiums earned, causing the loss ratio to remain relatively
flat.

The increase in underwriting expenses was
primarily the result of additional commissions and premium taxes
on higher premium volumes. The decrease in the health
underwriting ratio was primarily the result of holding
underwriting salaries and employee benefit costs relatively
constant, while net premiums earned increased 27.6% during the
year ended December 31, 2002.



| |                        
| | -----------------------
| | Personal and Commercial

Beginning January 1, 2001, we began
non-renewing all personal and commercial lines policies. The
negative net premiums earned for 2003 and 2002, $(239,000) and
$(432,000), respectively, primarily represent retrospective
premium adjustments related to certain personal and commercial
reinsurance treaties. Net premiums earned in 2001 were
$5.7 million as a result of continuing to earn premiums on
policies written in 2000, prior to non-renewing all policies.



| |                    
| | -------------------
| | Corporate and Other

2003 Compared to
2002.The Corporate and Other segment
consists of the operations of our holding company and its
non-insurance subsidiaries. For this segment, loss before
federal income taxes, minority interests and cumulative effect
of a change in accounting principle for the year ended
December 31, 2003 was $3.4 million compared to
$1.0 million for the same period of 2002. The increase was
primarily attributable to higher general and administrative
expenses as a result of increased legal, audit, and other
professional fees pertaining to compliance with the new
Sarbanes-Oxley legislation and related SEC rules. As well as
legal and investment banking fees incurred in the fourth quarter
pursuant to the Board of Directors evaluation of
alternatives to maximize shareholder value after the loss
reported in the third quarter, as well as interest expense as a
result of the issuance of floating rate junior subordinated
deferrable interest debentures discussed in Note 9 of the
Notes to Consolidated Financial Statements. Such information is
incorporated herein by reference. The increase in these expenses
was partially offset by an increase in other income.

2002 Compared to
2001.Loss before federal income
taxes, minority interests and cumulative effect of a change in
accounting principle for the year ended December 31, 2002
was $1.0 million compared to $2.8 million for the same
period of 2001. The decrease in net loss was primarily
attributable to the restructuring charges incurred in 2001.

Liquidity and Capital Resources

The primary sources of our liquidity, on both a
short- and long-term basis, are funds provided by insurance
premiums collected, net investment income, recoveries from
reinsurers and proceeds from the maturity or sale of invested
assets. We also enter into financing transactions from time to
time to acquire additional capital. The primary uses of cash, on
both a short and long-term basis, are losses, loss adjustment
expenses, operating expenses, the acquisition of invested assets
and fixed assets, reinsurance premiums, interest payments,
taxes, and the repurchase of the Companys stock.

Our holding companys only material assets
are the capital stock of American Physicians and its other
subsidiaries, and a portion of the proceeds from recently issued
junior subordinated deferrable interest debentures
(debentures). APCapitals ongoing cash flow
will consist primarily of dividends and other permissible
payments from its subsidiaries and investment earnings on funds
held. The payment of dividends to APCapital by its insurance
subsidiaries is subject to limitations imposed by applicable
law. APCapitals primary uses of cash, on both a short and
long-term bases include periodic interest payments, operating
expenses, and the repayment of the debentures. In January 2004,
APCapital made a $25 million surplus contribution to its
subsidiary American Physicians. The purpose of the contribution
was to increase American

37



---



##### 



Physicians statutory capital and surplus,
which is a critical factor in the financial stability rating
process by insurance rating agencies such as A.M. Best. After
the contribution, APCapitals cash and cash equivalent
resources totaled approximately $2.8 million, which will be
held at the holding company for future debt service costs. The
$2.8 million of cash and cash equivalents held at the
holding company is adequate to service interest payments on the
debentures for approximately one and a half years.


At December 31, 2003, the Company was
indebted is to its former President and Chief Executive Officer
in the amount of $6.0 million in connection with the
purchase of Stratton-Cheeseman Management Company. As a result
of his retirement, effective December 31, 2003, the note
payable became due, and was paid in its entirety in January 2004.

In May 2003, the Company issued debentures
totaling $30.9 million. These debentures bear interest at a
variable rate based on the London Interbank Offered Rate
(LIBOR), payable quarterly, and mature in
30 years. Substantially all of the proceeds from the
debenture issuance were contributed to American Physicians. See
Note 9 of the Notes to Consolidated Financial Statements
for a description of the debentures and the transactions in
which they were issued. Such information is incorporated herein
by reference.

The Company also completed an additional
debenture issuance in the fourth quarter of 2003 that was
subsequently unwound prior to year end with such debentures
being redeemed at par. The net effect of the issuance and
redemption did not have a material effect on our results of
operations, financial condition or liquidity.

At December 31, 2003, we had no material
planned expenditures for the acquisition of assets, or other
expenditures, other than expenses incurred in the normal course
of operations.

In September 2003, the Board of Directors
authorized the Company to purchase an additional
500,000 shares of its outstanding common stock. This brings
the total number of shares authorized to be repurchased under
publicly announced plans to 3,615,439. The Company repurchased
272,800, 1,555,100 and 1,369,170 shares, at a cost of
$7.7 million, $27.5 million and $25.2 million,
during 2003, 2002 and 2001, respectively, bringing the total
number of shares purchased pursuant to these authorizations to
3,197,070, at a total cost of $60,382,000, or an average price
per share of $18.89. The Companys repurchase of any of its
shares is subject to limitations that may be imposed by
applicable laws and regulations and the rules of the Nasdaq
Stock Market. The timing of the purchases and the number of
shares to be bought at any one time depend on market conditions
and the Companys capital requirements. As of
December 31, 2003, the Company has approximately
418,369 shares of its September 11, 2003 stock
repurchase program remaining to be purchased. The Company does
not anticipate repurchasing any of its shares in the near future.

Our net cash flow generated by operations was
approximately $9.1 million for the year ended
December 31, 2003, compared to $52.1 million provided
by operations for 2002. The cash generated by operations in 2003
was primarily the result of premiums collected, net of
reinsurance premiums paid, of approximately $231.0 million
in excess of losses paid of approximately $220.1 million.
Premiums collected in excess of losses paid in 2002 were
approximately $36.4 million. In general, our investment
income offsets cash paid for underwriting and general and
administrative expenses. A large portion of our investment
expense is related to depreciation on investment in real estate,
which is a non-cash charge. Anticipated premium rate increases
are expected to have a positive impact on our cash flows from
operations in 2004.

At December 31, 2003, the Company had
$102.1 million of cash and cash equivalents available and
an investment portfolio of $732.0 million. The portfolio
includes $35.0 million of bonds maturing in the next year
to meet short-term cash flow needs. On a long-term basis, fixed
income securities are purchased on a basis intended to provide
adequate cash flows from future maturities to meet future
policyholder obligations and ongoing cash needs to fund
operations. As of December 31, 2003, our fixed maturity
portfolio included $372.0 million of bonds that mature in
the next one to five years and $138.5 million that mature
in the next five to ten years. In addition, at December 31,
2003, we have $62.5 million of mortgage-backed securities
that provide periodic principal repayments. See Note 5 of
the Notes to Consolidated Financial Statements for further
information regarding the anticipated maturities of our fixed
maturity securities. Such information is incorporated herein by
reference.

38



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Based on historical trends, market conditions and
our business plans, we believe that our existing resources and
sources of funds will be sufficient to meet our short and
long-term liquidity needs. However, economic, market and
regulatory conditions may change, and there can be no assurance
that our funds will be sufficient to meet these liquidity needs.
In addition, in order to support future premium growth as a
result of planned rate increases, or to support our A.M. Best
rating, our insurance subsidiaries may require additional
capital. Accordingly, we are exploring options with respect to
raising future capital.

Financial Condition

In evaluating our financial condition, two
factors are the most critical. First, the availability of
adequate statutory capital and surplus to satisfy state
regulators and to support our current A.M. Best rating, and
second, the adequacy of our reserves for unpaid loss and loss
adjustment expenses.



| |                              
| | -----------------------------
| | Statutory Capital and Surplus

Our statutory capital and surplus
(surplus) at December 31, 2003 was
approximately $150.3 million, which results in a net
premiums written to surplus ratio of 1.49:1. Statutory surplus
at December 31, 2002 was approximately $190.2 million,
for a net premiums written to surplus ratio of 1.25:1. The
increase in our ratio of net premiums written to surplus was
primarily the result of the third quarter charge for unfavorable
development on prior year loss reserves related to our medical
professional liability segment, which reduced our statutory
surplus by approximately $43 million. The exit from the
workers compensation and health insurance lines of
business in 2004 is expected to make additional surplus
available to support future medical professional liability
premiums. However, as approximately $35 million of our
statutory surplus is related to our APSpecialty and ICA
insurance subsidiaries, we are considering alternatives on how
to maximize our use of that surplus to support the medical
professional liability premium writings in American Physicians.
These alternatives include a pooling arrangement between
APSpecialty and American Physicians, and/or a statutory merger
among our various insurance subsidiaries. In January 2004,
APCapital contributed $25 million to American Physicians.
We are also considering various options with respect to raising
additional capital at the holding company level, which could
then be contributed to American Physicians.



| |                                                            
| | -----------------------------------------------------------
| | Reserves for Unpaid Losses and Loss
    Adjustment Expenses

The adequacy of our reserves for unpaid loss and
loss adjustment expenses is another critical factor in
evaluating our financial condition.

For the year ended December 31, 2003, we
recorded an increase in ultimate loss estimates, net of
reinsurance, for accident years 2002 and prior of
$43.4 million, or 8.0% of $542.0 million of net loss
and loss adjustment expense reserves as of December 31,
2002. The increase in net ultimate loss estimates reflected
revisions in the estimated reserves as a result of actual claims
activity in calendar year 2003 that differed from projected
activity. Specifically, in the third quarter of 2003, a pattern
of increasing paid severity emerged on our medical professional
liability losses related to the 1999 through 2002 accident
years. In light of this higher than expected trend of average
paid severity, our internal and independent actuaries made
significant upward revisions to their estimated ultimate
severities on all claims incurred in those accident years, which
had the effect of significantly increasing the projected
ultimate losses on those years. Accordingly, recorded reserves
on those years were adjusted to match these ultimate loss
projections.

39



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The following table shows reported claim counts,
open claim counts, the average net case reserve per open claim,
and the average claim payment on claims that were closed with a
payment for our medical professional liability segment at or for
the years ended December 31, 2003, 2002 and 2001.

|                         |  |             |       |  |         |          |       |          |              |   |              |  |  |   |        | 
|------------------------ |  | ----------- | ----- |  | ------- | -------- | ----- | -------- | ------------ | - | ------------ |  |  | - | ------ | 
|                         |  |             |       |  |         | Average  |       |          |             
|                         |  |             |       |  |         | Net Case |       |          | Average Paid |  
|                         |  | Number      |       |  | Number  |          |       | Reserve  |              |   | Claim per    | 
|At or For the Year Ended |  | of Reported |       |  | of Open |          |       | Per Open |              |   | Claim Closed | 
|December 31,             |  | Claims      |       |  | Claims  |          |       | Claim    |              |   | With Payment | 
|                         |  |             |       |  |         |          |       |          |              |   |              | 
|2003                     |  |             | 2,657 |  |         |          | 4,447 |          |              | $ | 87,592       |  |  | $ | 66,279 | 
|2002                     |  |             | 3,018 |  |         |          | 4,863 |          |              |   | 70,905       |  |  |   | 65,645 | 
|2001                     |  |             | 2,869 |  |         |          | 4,620 |          |              |   | 61,975       |  |  |   | 46,811 | 

Due to the long-tailed nature of the medical
professional liability line of insurance, changes in the
actuarially projected ultimate loss severity can have an even
greater impact on the balance of recorded reserves than with
most other property and casualty insurance lines. While we
believe that our estimate for ultimate projected losses related
to our medical professional liability segment is adequate based
on our open and reported claim counts, there can be no assurance
that additional significant reserve enhancements will not be
necessary in the future given the many variables inherent in
such estimates and the extended period of time that it can take
for claim patterns to emerge.

Activity in the liability for unpaid loss and
loss adjustment expenses by insurance segment for the year ended
December 31, 2003 was as follows:

|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |       |        |   |   |         |         |  
|-------------------------------------------------------- | ------------------------------ | -------------- | ------- | ------- | ------------ | - | ------ | ------ | -------- | --- | ---------- | ------ | --- | -------- | ----- | ------ | - | - | ------- | ------- | -
|                                                         |                                | Medical        |         |         |              |   |        |        | Personal |     |            |       
|                                                         |                                | Professional   |         |         | Workers     |   |        |        |          | and |            |        | All |         
|                                                         |                                | Liability      |         |         | Compensation |   |        | Health |          |     | Commercial |        |     | Segments |      
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|                                                         |                                |               
|                                                         |                                | (In thousands) |        
|Balance, December 31, 2002                               |                                | $              | 545,256 |         |              | $ | 80,274 |        |          | $   | 8,350      |        |     | $        | 3,614 |        |   | $ | 637,494 |        
|                                                         | Less, reinsurance recoverables |                |         | (86,296 | )            |   |        | (7,282 | )        |     |            | (280   | )   |          |       | (1,610 | ) |   |         | (95,468 | )
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|Net reserves, December 31, 2002                          |                                |                | 458,960 |         |              |   | 72,992 |        |          |     | 8,070      |        |     |          | 2,004 |        |   |   | 542,026 |        
|Incurred related to                                      |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |       |        |   |   |         |        
|                                                         | Current year                   |                |         | 153,179 |              |   |        | 37,033 |          |     |            | 19,088 |     |          |       |       |   |   |         | 209,300 |  
|                                                         | Prior years                    |                |         | 44,250  |              |   |        | (1,400 | )        |     |            | (468   | )   |          |       | 1,061  |   |   |         | 43,443  |  
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|                                                         |                                |                | 197,429 |         |              |   | 35,633 |        |          |     | 18,620     |        |     |          | 1,061 |        |   |   | 252,743 |        
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|Paid related to                                          |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |       |        |   |   |         |        
|                                                         | Current year                   |                |         | 5,935   |              |   |        | 14,502 |          |     |            | 18,027 |     |          |       |       |   |   |         | 38,464  |  
|                                                         | Prior years                    |                |         | 143,127 |              |   |        | 33,571 |          |     |            | 3,208  |     |          |       | 1,752  |   |   |         | 181,658 |  
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|                                                         |                                |                | 149,062 |         |              |   | 48,073 |        |          |     | 21,235     |        |     |          | 1,752 |        |   |   | 220,122 |        
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|Net reserves, December 31, 2003                          |                                |                | 507,327 |         |              |   | 60,552 |        |          |     | 5,455      |        |     |          | 1,313 |        |   |   | 574,647 |        
|                                                         | Plus, reinsurance recoverables |                |         | 91,002  |              |   |        | 5,957  |          |     |            | 170    |     |          |       | 1,829  |   |   |         | 98,958  |  
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|Balance, December 31, 2003                               |                                | $              | 598,329 |         |              | $ | 66,509 |        |          | $   | 5,625      |        |     | $        | 3,142 |        |   | $ | 673,605 |        
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      
|Development as a % of December 31,
    2002 net reserves |                                |                | 9.6     | %       |              |   | -1.9   | %      |          |     | -5.8       | %      |     |          | 52.9  | %      |   |   | 8.0     | %      
|                                                         |                                |                |         |         |              |   |        |        |          |     |            |        |     |          |      

Also see Part I 
Item 1. Business  Loss and Loss Adjustment
Expense Reserves for a longer-term view on the development
of our prior year loss reserves. The cross-referenced
information is included herein by reference.



| |                                          
| | -----------------------------------------
| | Other Significant Balance Sheet
    Items

Our invested assets consist primarily of fixed
maturity and equity securities, which are carried in the
Consolidated Balance Sheets, included elsewhere in this report,
at their estimated fair value, and investment

40



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real estate and real estate limited partnerships.
At December 31, 2003, our investment portfolio included net
unrealized gains of approximately $45.5 million, an
increase of $7.6 million as compared to December 31,
2002. Net unrealized gains are reported, net of tax, in the
shareholders equity section of the Consolidated Balance
Sheets, included elsewhere in this report, and represented
approximately 14.7% and 8.8% of consolidated shareholders
equity at December 31, 2003 and 2002, respectively.
Generally, the estimated fair value of our fixed maturity
securities is inversely related to current interest rates.
Therefore, as interest rates rise or fall, our net unrealized
gains will change accordingly. See
Item 7A  Quantitative and Qualitative
Disclosure About Market Risk, for further information
regarding the potential impact of changes in prevailing interest
rates on the fair value of our fixed maturity portfolio. Also
see Note 5 of the Notes to Consolidated Financial
Statements for more detail regarding our invested assets. The
cross-referenced information is incorporated herein by reference.


Reinsurance recoverables increased
$5.5 million, or 5.6%, to $103.7 million at
December 31, 2003. Reinsurance recoverables, on a GAAP
basis, represent reserves for unpaid losses and loss adjustment
expenses ceded under the various reinsurance treaties we have in
place, as well as receivables from reinsurers for loss payments
we have made and are entitled to recover under the terms of the
treaties. The 5.6% increase in reinsurance recoverables is
relatively consistent with the 5.7% increase in the liability
for direct and assumed unpaid loss and loss adjustment expenses.
Included in reinsurance recoverables are $17.5 million of
reserves and paid losses ceded to Gerling Global.
Managements assessment of the ultimate collectibility of
this recoverable is discussed more fully in the reinsurance
section under  Significant Accounting
Policies.

At December 31, 2003, we have no recorded
deferred federal income tax assets due to the establishment of a
valuation allowance during 2003. The valuation allowance was
established in the third quarter of 2003. Based on the
Companys recent loss experience, it is uncertain that
sufficient taxable income will exist in the periods of when the
deductible temporary differences that gave rise to the deferred
tax assets are expected to reverse. The establishment of the
valuation allowance is recorded as federal income tax expense in
the accompanying Consolidated Statements of Income, included
elsewhere in this report. Once the Company has re-established a
pattern of profitability, the deferred tax asset valuation
allowance may be reduced in whole or in part upon evaluation of
the availability of future taxable income.

During 2003, we acquired intangible assets with
respects to certain covenants not to compete in connection with
our investment in Physicians Insurance Company and the
retirement of our former President and CEO. These assets are
discussed more fully in Note 4 of the Notes to Consolidated
Financial Statements. Such information is incorporated herein by
reference.

As previously mentioned, in May 2003, we issued
$30.9 million of Debentures. See Note 9 of the Notes
to the Consolidated Financial Statements. Such information is
incorporated herein by reference.

Accrued expenses and other liabilities at
December 31, 2003 were $44.7 million, an increase of
$13.6 million compared to December 31, 2002. This
increase was primarily attributable to a $9.2 million
increase in ceded reinsurance premiums payable, primarily
related to our medical professional liability reinsurance
treaties, and a $4.3 million increase in accrued expenses.
Our medical professional liability reinsurance treaties are
swing rated, on a retrospective basis. In accordance
with the treaties, we pay a provisional premium to the
reinsurer, and after three years, the provisional premium is
either increased or decreased depending on the actual loss
experience on the business written during a given treaty year.
In light of our recent loss experience, especially related to
accident years 2001 and 2002, we have recorded the maximum
liability for premiums due under the treaties for the 2001 and
2002 accident years. For the 2003 accident year, we have
recorded an additional liability for future premiums due;
however, we have not recorded the maximum liability due to the
improved loss ratio for that accident year. Accordingly, our
exposure for additional ceded premiums on the 2003 accident year
is approximately $250,000. The increase in accrued expenses was
primarily the result of a change in the way certain
workers compensation surcharges were assessed during 2003.
This change caused us to have to record an additional liability
of approximately $1.6 million.

Shareholders equity at December 31,
2003 was $201.8 million, a decrease of $78.5 million
from $280.3 million at December 31, 2002. The decrease
in shareholders equity was primarily attributable to the

41



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reported net loss of $76.8 million for the
year ended December 31, 2003, stock repurchases of
$7.7 million, offset by an increase in unrealized gains,
net of tax, of $5.0 million. The Companys book value
per common share outstanding at December 31, 2003 was
$23.87 per share, based on 8,452,778 shares
outstanding, compared to $32.24 per common share
outstanding at December 31, 2002. Total shares outstanding
at December 31, 2002 were 8,695,492.


Off-Balance Sheet Arrangements

In May 2003, we formed two subsidiary statutory
trusts for the purpose of issuing mandatorily redeemable trust
preferred securities (trust preferred securities).
The proceeds from the trust preferred securities that were
issued were used by the trusts to purchase debentures issued by
APCapital. APCapital used the amounts borrowed pursuant to these
debentures to increase its available capital and has
subsequently contributed substantially all of the proceeds to
American Physicians to increase its statutory surplus. The
debentures and the trust preferred securities have terms and
maturities that mirror each other. In accordance with the
guidance given in Financial Accounting Standards Board
(FASB) Interpretation No. 46, Variable
Interest Entities, (FIN No. 46), we have
not consolidated these subsidiary trusts. APCapital has issued
guarantees, that amounts paid to the trusts related to the
debentures, will subsequently be remitted to the holders of the
trust preferred securities. In accordance with the nature of the
transactions, the amounts guaranteed by APCapital, are also
recorded as liabilities in the Consolidated Financial
Statements, as they represent obligations to the trusts, which
are in turn obligated to the holders of the trust preferred
securities.

Contractual Obligations

We are contractually obligated in accordance with
various loan or borrowing agreements and operating leases. The
following table shows the nature and the timing of our
contractual obligations as of December 31, 2003:

|                           |       |                        |        |           |        |   |       |       |  |     |       |       |           |         |     |     |  |   |        |        | 
|-------------------------- | ----- | ---------------------- | ------ | --------- | ------ | - | ----- | ----- |  | --- | ----- | ----- | --------- | ------- | --- | --- |  | - | ------ | ------ | 
|                           |       |                       
|                           |       | Payments Due by Period |       
|                           |       |                        |       
|                           |       |                        |        | Less Than |        |   | 1-3   |       |  | 3-5 |       |       | More Than |        
|Contractual Obligations(1) |       | Total                  |        |           | 1 Year |   |       | Years |  |     | Years |       |           | 5 Years |    
|                           |       |                        |        |           |        |   |       |       |  |     |       |       |           |         |    
|                           |       |                       
|                           |       | (In thousands)         |       
|Note payable to officer(2) |       | $                      | 6,000  |           |        | $ | 6,000 |       |  | $   |      |       |           | $       |    |     |  | $ |       |       
|Operating leases           |       |                        | 5,812  |           |        |   | 1,336 |       |  |     | 1,650 |       |           |         | 857 |     |  |   | 1,969  |       
|Long-term debt(3)          |       |                        | 30,928 |           |        |   |      |       |  |     |      |       |           |         |    |     |  |   | 30,928 |       
|                           |       |                        |        |           |        |   |       |       |  |     |       |       |           |         |    
|                           | Total |                        | $      | 42,740    |        |   | $     | 7,336 |  |     | $     | 1,650 |           |         | $   | 857 |  |   | $      | 32,897 | 
|                           |       |                        |        |           |        |   |       |       |  |     |       |       |           |         |    



---



|    |                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Companys reserves for unpaid loss and
    loss adjustment expenses are an estimate of future cash flows
    necessary to fulfill insurance obligations based on insured
    events that have already occurred but the amount and timing of
    the cash outflow is uncertain. In light of these uncertainties,
    these liabilities have been excluded from the table above.
|   
|(2) | The note payable to officer was paid in its
    entirety in January 2004.                                                                                                                                                                                                                                                                                                         
|   
|(3) | The long-term debt is more fully described in
    Note 9 of the Notes to Consolidated Financial Statements.                                                                                                                                                                                                                                                                       

Effects of New Accounting
Pronouncements

In June 2002, the Financial Accounting Standards
Board issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. With the
adoption of SFAS No. 146, effective for exit or
disposal activities initiated after December 31, 2002, a
liability for a cost associated with an exit or disposal
activity should be recognized and measured initially at fair
value only when the liability is incurred. Under the previous
restructuring accounting guidance, companies were permitted to
record a liability for costs associated with exit or disposal
activities at the date that management had formally committed to
the activity and announced its plan. As a result of this change
in accounting practices, approximately $300,000 of estimated
future employee separation costs associated with the exit of our
workers compensation line of business were

42



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not recorded as a liability at December 31,
2003, but rather will be accrued prospectively over the
remaining future minimum service period required of the
employees affected. See Notes 2 and 14 of the Notes to
Consolidated Financial Statements for further discussion
regarding the impact of the adoption of SFAS No. 146.
Such information is incorporated herein by reference.


In November 2002, the FASB issued FASB
Interpretation No. 45. Guarantors Accounting
and Disclosure Requirements for Guarantees of Indebtedness of
Others (FIN No. 45). This interpretation
clarifies disclosures required to be made by a guarantor in its
interim and annual financial statements and requires a guarantor
to recognize, at the inception of the guarantee, a liability for
the fair value of the obligation undertaken in issuing the
guarantee. The provisions of FIN No. 45 pertaining to the
recording of a liability are effective for all guarantees
entered into, or modified, after December 31, 2002. The
disclosure requirements of FIN No. 45 are effective for
financial statements of interim or annual periods ending after
December 31, 2002. APCapital has issued guarantees in
connection with its establishment of trusts and issuance of
debentures. The amounts due under the guarantees are also
recorded as liabilities in the Companys Consolidated
Financial Statements in accordance with the structure of the
transaction. See Note 9 of the Notes to the Consolidated
Financial Statements, included elsewhere in this report, for
further details on the nature of the guarantees and the
transactions that gave rise to the guarantees. We have also
issued certain guarantees in connection with real estate limited
partnerships in which we have invested. The disclosures
pertaining to these guarantees are included in Note 19 of
the Notes to Consolidated Financial Statements. Such information
is incorporated herein by reference.

In January 2003, the FASB issued FIN No. 46,
which was revised in December 2003 by FASB FIN No. 46R.
These interpretations address consolidation by business
enterprises of variable interest entities and are effective
during the first interim or annual period ending after
December 15, 2003. Management has evaluated certain
investments, as required by FIN No. 46, and has determined
that its investments in subsidiary trusts used to issue
mandatorily redeemable trust preferred securities should not be
consolidated. Accordingly, we have not consolidated the trusts
in the Consolidated Financial Statements, included elsewhere in
this report. Also, during 2003, we invested $2,450,000 for 49%
of the outstanding common stock of a start-up insurance company
in the state of Florida, PIC. We have evaluated our investment
in PIC, and based on the guidance given in FIN No. 46, have
determined that PIC should be consolidated because, among other
factors, we financed a portion of the other investors
capital contribution at PICs inception. The amount
financed was repaid in full prior to December 31, 2003.
Minority interest in the Consolidated Statements of Income and
Consolidated Balance Sheets represents the remaining 51% of the
net loss and shareholders equity of PIC.



|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

General

Market risk is the risk of loss due to adverse
changes in market rates and prices. We invest primarily in fixed
maturity securities, which are interest-sensitive assets.
Accordingly, our primary market risk is exposure to changes in
interest rates.

As of December 31, 2003, the majority of our
investment portfolio was invested in fixed maturity securities
and short-term investments. The fixed maturity securities
primarily consisted of U.S. government and agency bonds,
high-quality corporate bonds, high-yield corporate bonds,
mortgage-backed securities and tax-exempt U.S. municipal
bonds.

Qualitative Information About Market
Risk

Investments in our portfolio have varying degrees
of risk. The primary market risk exposure to the fixed maturity
portfolio is interest rate risk, which is limited somewhat by
our management of duration. The distribution of maturities and
sector concentrations are monitored on a regular basis.

Equity securities are carried at quoted market
values. The fair value of publicly traded fixed maturity
securities is based upon independent market quotations. The fair
value of non-publicly traded securities is

43



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##### 



based on independent third party pricing sources
that use valuation models. The valuation models used by the
independent third party pricing sources use indicative
information such as ratings, industry, coupon, and maturity
along with publicly traded bond prices to determine security
specific spreads, and the ultimate fair value of the
non-publicly traded fixed maturity securities. Realized gains or
losses on sales or maturities of investments are determined on a
specific identification basis and are credited or charged to
income.


At December 31, 2003, approximately 91.5% of
our fixed maturity portfolio (excluding approximately
$22.4 million of private placement issues) was considered
investment grade. We define investment grade securities as those
that have a Standards & Poors credit rating of
BBB and above. Non-investment grade securities typically bear
more credit risk than those of investment grade quality. Credit
risk is the risk that amounts due the Company by creditors may
not ultimately be collected.

We periodically review our investment portfolio
for any potential credit quality or collection issues and for
any securities with respect to which we consider any decline in
market value to be other than temporary. Our policy for
recording OTTI write-downs is more fully discussed in
Item 7  Managements Discussion and
Analysis  Significant Accounting
Policies, Investments. The cross-referenced
information is included herein by reference.

In June 2003, the Company invested approximately
$20 million in mortgage-backed securities and allocated an
additional $50 million for high-yield corporate bonds and
$6 million for equity security investments. High-yield
corporate bonds are typically not investment grade.

Approximately $13.5 million of the
mortgage-backed securities purchased are interest-only
certificates. Unlike traditional fixed-maturity securities, the
fair value of these investments is not inversely related to
interest rates, but rather, moves in the same direction as
interest rates as the underlying financial instruments are
mortgage-backed securities. With mortgage-backed securities, as
interest rates rise, prepayments will decrease, which means that
the interest-only certificates will generate interest for a
longer period of time than originally anticipated, which in turn
will increase the fair value of these investments.

Approximately $7.4 million of these
interest-only certificates have an inverse floating rate of
interest tied to LIBOR. The Company has determined that these
inverse floating interest-only certificates contain
an embedded derivative as defined by SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities. Because the Company cannot readily segregate
the fair value of the embedded derivative from the host debt
instrument, the entire change in the fair value of these inverse
floating interest-only certificates is reported in earnings as
investment income. For the year ended December 31, 2003,
approximately $432,000 was included in investment income for the
change in fair value of the inverse floating interest-only
certificates.

Quantitative Information About Market
Risk

At December 31, 2003, our fixed income
security portfolio was valued at $694.6 million and had an
average modified duration of 2.89 years, compared to a
portfolio valued at $618.9 million with an average modified
duration of 3.20 years at December 31, 2002. Of the
$694.6 million at December 31, 2003,
$13.5 million were interest only certificates that had a
modified duration of 1.02 years. The following tables show
the effects of a change in interest rates on the fair value and
duration of our entire fixed maturity portfolio at
December 31, 2003 and 2002, and then separately for our
interest only certificates. We have

44



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##### 



assumed an immediate increase or decrease of 1%
or 2% in interest rate for illustrative purposes. You should not
consider this assumption or the values shown in the table to be
a prediction of actual future results.


Entire Fixed Maturity Portfolio (Including
Interest Only Certificates)

|                |  |                        |         |  |                        |   |         |          |  |  |           |  |  |           |         |  |          |   |         |   |  |  |      | 
|--------------- |  | ---------------------- | ------- |  | ---------------------- | - | ------- | -------- |  |  | --------- |  |  | --------- | ------- |  | -------- | - | ------- | - |  |  | ---- | 
|                |  |                        |         | 
|                |  | December 31, 2003      |         |  | December 31, 2002      |  
|                |  |                        |         |  |                        |  
|                |  | Portfolio              |         |  | Change in              |   |         | Modified |  |  | Portfolio |  |  | Change in |         |  | Modified |  
|Change in Rates |  | Value                  |         |  | Value                  |   |         | Duration |  |  | Value     |  |  | Value     |         |  | Duration |  
|                |  |                        |         |  |                        |   |         |          |  |  |           |  |  |           |         |  |          |  
|                |  |                        |         | 
|                |  | (Dollars in thousands) |         |  | (Dollars in thousands) |  
|+2%             |  | $                      | 664,072 |  |                        | $ | (30,561 | )        |  |  | 3.07      |  |  | $         | 581,066 |  |          | $ | (37,833 | ) |  |  | 2.94 | 
|+1%             |  |                        | 680,389 |  |                        |   | (14,244 | )        |  |  | 2.81      |  |  |           | 599,244 |  |          |   | (19,655 | ) |  |  | 2.97 | 
|0               |  |                        | 694,633 |  |                        |   |         |          |  |  | 2.89      |  |  |           | 618,899 |  |          |   |         |   |  |  | 3.20 | 
|-1%             |  |                        | 708,257 |  |                        |   | 13,624  |          |  |  | 2.80      |  |  |           | 639,729 |  |          |   | 20,830  |   |  |  | 3.26 | 
|-2%             |  |                        | 726,316 |  |                        |   | 31,683  |          |  |  | 2.87      |  |  |           | 661,713 |  |          |   | 42,814  |   |  |  | 3.37 | 

Interest Only Certificates

|                |  |                        |        |  |           |   |        |          |  |  |      |  |  |  |  |  |  |  |  |  |  |  |  | 
|--------------- |  | ---------------------- | ------ |  | --------- | - | ------ | -------- |  |  | ---- |  |  |  |  |  |  |  |  |  |  |  |  | 
|                |  |                        |        |  |           |   |        |         
|                |  | December 31, 2003      |        |  |           |   |        |          | 
|                |  |                        |        |  |           |   |        |          | 
|                |  | Portfolio              |        |  | Change in |   |        | Modified |  |  |      |  |  |  | 
|Change in Rates |  | Value                  |        |  | Value     |   |        | Duration |  |  |      |  |  |  | 
|                |  |                        |        |  |           |   |        |          |  |  |      |  |  |  | 
|                |  |                        |        |  |           |   |        |         
|                |  | (Dollars in thousands) |        |  |           |   |        |          | 
|+2%             |  | $                      | 19,217 |  |           | $ | 5,751  |          |  |  | 1.57 |  |  |  |  |  |  |  |  |  |  |  |  | 
|+1%             |  |                        | 17,792 |  |           |   | 4,326  |          |  |  | 1.44 |  |  |  |  |  |  |  |  |  |  |  |  | 
|0               |  |                        | 13,466 |  |           |   |        |          |  |  | 1.02 |  |  |  |  |  |  |  |  |  |  |  |  | 
|-1%             |  |                        | 7,136  |  |           |   | (6,330 | )        |  |  | 1.03 |  |  |  |  |  |  |  |  |  |  |  |  | 
|-2%             |  |                        | 5,536  |  |           |   | (7,930 | )        |  |  | 0.42 |  |  |  |  |  |  |  |  |  |  |  |  | 

45



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##### 





|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of

American Physicians Capital, Inc.:


In our opinion, the consolidated financial
statements listed in the accompanying index under
Item 15(a)(1) and (2), present fairly, in all material
respects, the financial position of American Physicians
Capital, Inc. and its subsidiaries at December 31,
2003 and 2002, and the results of their operations and their
cash flows for each of the three years in the period ended
December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. In addition,
in our opinion, the financial statement schedules listed in the
accompanying index under Item 15(a)(1) and (2), present
fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial
statement schedules are the responsibility of the Companys
management; our responsibility is to express an opinion on these
financial statements and financial statement schedules based on
our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.

As discussed in Note 2 to the consolidated
financial statements, during 2003 the Company adopted the
provisions of Statement of Financial Accounting Standards
No. 146, Accounting for Costs Associated with Exit or
Disposal Activities, and FASB Interpretation No. 46,
Consolidation of Variable Interest Entities. As
discussed in Note 4 to the consolidated financial
statements, the Company changed its method of accounting for
goodwill to be in conformity with Statement of Financial
Accounting Standards No. 142 Goodwill and Other
Intangible Assets, which was adopted as of January 1,
2002.

PricewaterhouseCoopers LLP

Grand Rapids, Michigan

February 12, 2004


46



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS


DECEMBER 31, 2003 AND 2002


|                                                                                                                                                             |                                                                                      |                                            |         |         |           |   |         |         |           | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------------------------------------------------ | ------------------------------------------ | ------- | ------- | --------- | - | ------- | ------- | --------- | 
|                                                                                                                                                             |                                                                                      | 2003                                       |         |         | 2002      |  
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                             |                                                                                      |                                           
|                                                                                                                                                             |                                                                                      | (In thousands,                             |        
|                                                                                                                                                             |                                                                                      | except share data)                         |        
|ASSETS                                                                                                                                                      
|Investments:                                                                                                                                                 |                                                                                      |                                            |         |         |           |   |         |        
|                                                                                                                                                             | Fixed maturities, at fair value                                                      |                                            | $       | 694,633 |           |   | $       | 618,899 |          
|                                                                                                                                                             | Equity securities, at fair value                                                     |                                            |         | 7,545   |           |   |         | 44      |          
|                                                                                                                                                             | Other investments                                                                    |                                            |         | 29,776  |           |   |         | 30,788  |          
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                             |                                                                                      | Total investments                          |         |         | 731,954   |   |         |         | 649,731   | 
|Cash and cash equivalents                                                                                                                                    |                                                                                      |                                            | 102,051 |         |           |   | 151,825 |        
|Premiums receivable                                                                                                                                          |                                                                                      |                                            | 65,362  |         |           |   | 62,531  |        
|Reinsurance recoverable                                                                                                                                      |                                                                                      |                                            | 103,652 |         |           |   | 98,128  |        
|Federal income taxes recoverable                                                                                                                             |                                                                                      |                                            | 973     |         |           |   | 1,100   |        
|Deferred federal income taxes                                                                                                                                |                                                                                      |                                            |        |         |           |   | 42,542  |        
|Property and equipment, net                                                                                                                                  |                                                                                      |                                            | 16,490  |         |           |   | 14,352  |        
|Intangible assets, net                                                                                                                                       |                                                                                      |                                            | 1,539   |         |           |   |        |        
|Other assets                                                                                                                                                 |                                                                                      |                                            | 41,025  |         |           |   | 38,709  |        
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                             |                                                                                      | Total assets                               |         | $       | 1,063,046 |   |         | $       | 1,058,918 | 
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                            
|LIABILITIES                                                                                                                                                 
|Unpaid losses and loss adjustment expenses                                                                                                                   |                                                                                      | $                                          | 673,605 |         |           | $ | 637,494 |        
|Unearned premiums                                                                                                                                            |                                                                                      |                                            | 103,806 |         |           |   | 103,420 |        
|Note payable, officer                                                                                                                                        |                                                                                      |                                            | 6,000   |         |           |   | 6,567   |        
|Long-term debt                                                                                                                                               |                                                                                      |                                            | 30,928  |         |           |   |        |        
|Accrued expenses and other liabilities                                                                                                                       |                                                                                      |                                            | 44,698  |         |           |   | 31,148  |        
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                             |                                                                                      | Total liabilities                          |         |         | 859,037   |   |         |         | 778,629   | 
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|Commitments and Contingencies
    (Note 19)                                                                                                                  |                                                                                      |                                            |         |         |           |   |         |        
|Minority Interest in Consolidated
    Subsidiary                                                                                                             |                                                                                      |                                            | 2,201   |         |           |   |        |        
|Shareholders Equity                                                                                                                                         |                                                                                      |                                            |         |         |           |   |         |        
|Common stock, no par value,
    50,000,000 shares authorized:
    8,445,807 and 8,695,492 shares outstanding at
    December 31, 2003 and 2002, respectively |                                                                                      |                                            |         |         |           |   |         |        
|Additional paid-in-capital                                                                                                                                   |                                                                                      |                                            | 85,137  |         |           |   | 92,148  |        
|Retained earnings                                                                                                                                            |                                                                                      |                                            | 87,352  |         |           |   | 164,183 |        
|Unearned stock compensation                                                                                                                                  |                                                                                      |                                            | (288    | )       |           |   | (678    | )      
|Accumulated other comprehensive income:                                                                                                                      |                                                                                      |                                            |         |         |           |   |         |        
|                                                                                                                                                             | Net unrealized appreciation on investments, net
    of deferred federal income taxes |                                            |         | 29,607  |           |   |         | 24,636  |          
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                             |                                                                                      | Total shareholders equity                 |         |         | 201,808   |   |         |         | 280,289   | 
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  
|                                                                                                                                                             |                                                                                      | Total liabilities and shareholders equity |         | $       | 1,063,046 |   |         | $       | 1,058,918 | 
|                                                                                                                                                             |                                                                                      |                                            |         |         |           |  

The accompanying notes are an integral part of
the consolidated financial statements.

47



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONSOLIDATED STATEMENTS OF INCOME


For the Years Ended December 31, 2003,
2002, and 2001


|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |   |   |         |         |  
|--------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------- | ------------------------------------- | ------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                                                                                                          |                                                                       | 2003                                  |         |         | 2002 |   |         | 2001    |  
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|                                                                                                          |                                                                       |                                      
|                                                                                                          |                                                                       | (In thousands, except per share data) |        
|Revenues and Other Income                                                                                 |                                                                       |                                       |         |         |      |   |         |         |   |   |         |        
|Net premiums written                                                                                      |                                                                       | $                                     | 224,647 |         |      | $ | 238,417 |         |   | $ | 208,779 |        
|Change in unearned premiums                                                                               |                                                                       |                                       | (57     | )       |      |   | (2,866  | )       |   |   | (6,408  | )      
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|Net premiums earned                                                                                       |                                                                       |                                       | 224,590 |         |      |   | 235,551 |         |   |   | 202,371 |        
|Investment income                                                                                         |                                                                       |                                       | 43,294  |         |      |   | 44,775  |         |   |   | 47,883  |        
|Net realized gains (losses)                                                                               |                                                                       |                                       | 2,403   |         |      |   | (163    | )       |   |   | (5,651  | )      
|Other income, net                                                                                         |                                                                       |                                       | 1,104   |         |      |   | 376     |         |   |   | 546     |        
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|                                                                                                          | Total revenues and other income                                       |                                       |         | 271,391 |      |   |         | 280,539 |   |   |         | 245,149 |  
|Expenses                                                                                                  |                                                                       |                                       |         |         |      |   |         |         |   |   |         |        
|Losses and loss adjustment expenses                                                                       |                                                                       |                                       | 252,742 |         |      |   | 242,028 |         |   |   | 257,848 |        
|Underwriting expenses                                                                                     |                                                                       |                                       | 51,104  |         |      |   | 48,593  |         |   |   | 45,111  |        
|Investment expenses                                                                                       |                                                                       |                                       | 2,940   |         |      |   | 3,091   |         |   |   | 2,518   |        
|Interest expense                                                                                          |                                                                       |                                       | 1,370   |         |      |   | 373     |         |   |   | 400     |        
|Amortization expense                                                                                      |                                                                       |                                       | 389     |         |      |   |        |         |   |   | 2,514   |        
|General and administrative expenses                                                                       |                                                                       |                                       | 2,921   |         |      |   | 1,395   |         |   |   | 1,504   |        
|Restructuring expenses                                                                                    |                                                                       |                                       | 808     |         |      |   |        |         |   |   | 2,484   |        
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|                                                                                                          | Total expenses                                                        |                                       |         | 312,274 |      |   |         | 295,480 |   |   |         | 312,379 |  
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|Loss before income taxes, minority interest and
    cumulative effect of a change in accounting principle |                                                                       |                                       | (40,883 | )       |      |   | (14,941 | )       |   |   | (67,230 | )      
|Federal income tax expense (benefit)                                                                      |                                                                       |                                       | 36,296  |         |      |   | (5,529  | )       |   |   | (23,450 | )      
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|Loss before minority interest and cumulative
    effect of a change in accounting principle               |                                                                       |                                       | (77,179 | )       |      |   | (9,412  | )       |   |   | (43,780 | )      
|Minority interest in net loss of consolidated
    subsidiary                                              |                                                                       |                                       | 348     |         |      |   |        |         |   |   |        |        
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|                                                                                                          | Loss before cumulative effect of a change in
    accounting principle |                                       |         | (76,831 | )    |   |         | (9,412  | ) |   |         | (43,780 | )
|Cumulative effect of a change in accounting
    principle, net of tax (Note 4)                            |                                                                       |                                       |        |         |      |   | (9,079  | )       |   |   |        |        
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|                                                                                                          | Net loss                                                              |                                       | $       | (76,831 | )    |   | $       | (18,491 | ) |   | $       | (43,780 | )
|                                                                                                          |                                                                       |                                       |         |         |      |   |         |         |  
|Earnings Per Share:                                                                                       |                                                                       |                                       |         |         |      |   |         |         |   |   |         |        
|Loss before cumulative effect of a change in
    accounting principle                                     |                                                                       |                                       |         |         |      |   |         |         |   |   |         |        
|                                                                                                          | Basic                                                                 |                                       | $       | (9.02   | )    |   | $       | (1.01   | ) |   | $       | (3.95   | )
|                                                                                                          | Diluted                                                               |                                       | $       | (9.02   | )    |   | $       | (1.01   | ) |   | $       | (3.95   | )
|Cumulative effect of a change in accounting
    principle                                                 |                                                                       |                                       |         |         |      |   |         |         |   |   |         |        
|                                                                                                          | Basic                                                                 |                                       | $       |        |      |   | $       | (0.97   | ) |   | $       |        |  
|                                                                                                          | Diluted                                                               |                                       | $       |        |      |   | $       | (0.97   | ) |   | $       |        |  
|Net loss                                                                                                  |                                                                       |                                       |         |         |      |   |         |         |   |   |         |        
|                                                                                                          | Basic                                                                 |                                       | $       | (9.02   | )    |   | $       | (1.98   | ) |   | $       | (3.95   | )
|                                                                                                          | Diluted                                                               |                                       | $       | (9.02   | )    |   | $       | (1.98   | ) |   | $       | (3.95   | )

The accompanying notes are an integral part of
the consolidated financial statements.

48



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY


AND COMPREHENSIVE INCOME


For the Years Ended December 31, 2003,
2002 and 2001


|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |         |  
|----------------------------------------------------------- | ----------------------------------------------------------------------------- | --------------------------------- | ---------- | ---------- | ------- | - | ------- | -------- | -------- | ----------- | ------------ | ------- | - | ------------- | ------ | - | ----- | - | ------ | ------ |  | - | ------- | ------- | -
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          | Accumulated |              |         |  
|                                                            |                                                                               |                                   |            | Additional |         |   |         |          | Unearned |             |              | Other   |   |               |       
|                                                            |                                                                               | Shares                            |            |            | Paid-in |   |         | Retained |          |             | Stock        |         |   | Comprehensive |        |   |      
|                                                            |                                                                               | Outstanding                       |            |            | Capital |   |         | Earnings |          |             | Compensation |         |   | Income        |        |   | Total |  
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|                                                            |                                                                               |                                  
|                                                            |                                                                               | (In thousands, except share data) |           
|Balance, January 1, 2001                                    |                                                                               |                                   | 11,625,055 |            |         | $ | 144,940 |          |          | $           | 226,454      |         |   | $             | (1,450 | ) |       | $ | (519   | )      |  | $ | 369,425 |        
|Comprehensive loss                                          |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |        
|                                                            | Net loss                                                                      |                                   |            |            |         |   |         |          |          |             |              | (43,780 | ) |               |        |   |       |   |        |        |  |   |         | (43,780 | )
|                                                            | Unrealized appreciation on investment securities,
    net of taxes of $3,417  |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        | 6,348  |  |   |         | 6,348   |  
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Total comprehensive loss, net of taxes                      |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | (37,432 | )      
|Purchase and retirement of common stock                     |                                                                               |                                   | (1,369,170 | )          |         |   | (25,225 | )        |          |             |              |         |   |               |        |   |       |   |        |        |  |   | (25,225 | )      
|Unrestricted stock grants                                   |                                                                               |                                   | 3,937      |            |         |   | 50      |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 50      |        
|Amortization of unearned stock compensation                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               | 217    |   |       |   |        |        |  |   | 217     |        
|Forfeiture of unearned stock compensation                   |                                                                               |                                   | (21,700    | )          |         |   | (302    | )        |          |             |              |         |   |               | 232    |   |       |   |        |        |  |   | (70     | )      
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Balance, December 31, 2001                                  |                                                                               |                                   | 10,238,122 |            |         |   | 119,463 |          |          |             | 182,674      |         |   |               | (1,001 | ) |       |   | 5,829  |        |  |   | 306,965 |        
|Comprehensive income                                        |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |        
|                                                            | Net loss                                                                      |                                   |            |            |         |   |         |          |          |             |              | (18,491 | ) |               |        |   |       |   |        |        |  |   |         | (18,491 | )
|                                                            | Unrealized appreciation on investment securities,
    net of taxes of $10,125 |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        | 18,807 |  |   |         | 18,807  |  
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Total comprehensive income, net of taxes                    |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 316     |        
|Purchase and retirement of common stock                     |                                                                               |                                   | (1,555,100 | )          |         |   | (27,483 | )        |          |             |              |         |   |               |        |   |       |   |        |        |  |   | (27,483 | )      
|Options exercised                                           |                                                                               |                                   | 18,000     |            |         |   | 243     |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 243     |        
|Amortization of unearned stock compensation                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               | 301    |   |       |   |        |        |  |   | 301     |        
|Forfeiture of unearned stock compensation                   |                                                                               |                                   | (5,530     | )          |         |   | (75     | )        |          |             |              |         |   |               | 22     |   |       |   |        |        |  |   | (53     | )      
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Balance, December 31, 2002                                  |                                                                               |                                   | 8,695,492  |            |         |   | 92,148  |          |          |             | 164,183      |         |   |               | (678   | ) |       |   | 24,636 |        |  |   | 280,289 |        
|Comprehensive loss                                          |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |        
|                                                            | Net loss                                                                      |                                   |            |            |         |   |         |          |          |             |              | (76,831 | ) |               |        |   |       |   |        |        |  |   |         | (76,831 | )
|                                                            | Unrealized appreciation on investment securities,
    net of taxes of $2,678  |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        | 4,971  |  |   |         | 4,971   |  
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Total comprehensive loss, net of taxes                      |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | (71,860 | )      
|Options exercised                                           |                                                                               |                                   | 25,800     |            |         |   | 440     |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 440     |        
|Amortization of unearned stock compensation, net
    of tax |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               | 300    |   |       |   |        |        |  |   | 300     |        
|Tax benefit of vested restricted stock                      |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |        
|and exercised stock options                                 |                                                                               |                                   |            |            |         |   | 261     |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 261     |        
|Purchase and retirement of common stock                     |                                                                               |                                   | (272,800   | )          |         |   | (7,676  | )        |          |             |              |         |   |               |        |   |       |   |        |        |  |   | (7,676  | )      
|Forfeiture of unearned stock compensation                   |                                                                               |                                   | (2,685     | )          |         |   | (36     | )        |          |             |              |         |   |               | 90     |   |       |   |        |        |  |   | 54      |        
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Balance, December 31, 2003                                  |                                                                               |                                   | 8,445,807  |            |         | $ | 85,137  |          |          | $           | 87,352       |         |   | $             | (288   | ) |       | $ | 29,607 |        |  | $ | 201,808 |        
|                                                            |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  

The accompanying notes are an integral part of
the consolidated financial statements.

49



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH
FLOWS


For the Years Ended December 31, 2003,
2002, and 2001


|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |         |          |          |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------------------------- | ------------------------------------------------------------ | -------------------------------------------------------- | ------------------------------------------------------- | -------- | ------- | ------- | ------- | ------- | ------ | ------- | ------- | -------- | -------- | -------- | -
|                                                                                                                                                 |                                                                                    | 2003                                                         |                                                          |                                                         | 2002     |         |         | 2001    |        
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|                                                                                                                                                 |                                                                                    |                                                             
|                                                                                                                                                 |                                                                                    | (In thousands)                                               |                                                         
|Cash flows from operating activities                                                                                                             |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |        
|                                                                                                                                                 | Net loss                                                                           |                                                              | $                                                        | (76,831                                                 | )        |         | $       | (18,491 | )       |        | $       | (43,780 | )       
|                                                                                                                                                 | Adjustments to reconcile net loss to net cash
    provided by operating activities |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |         |         
|                                                                                                                                                 |                                                                                    | Depreciation and amortization                                |                                                          |                                                         | 7,058    |         |         |         | 4,056   |        |         |         | 4,184    |         
|                                                                                                                                                 |                                                                                    | Net realized (gains) losses                                  |                                                          |                                                         | (2,403   | )       |         |         | 163     |        |         |         | 5,651    |         
|                                                                                                                                                 |                                                                                    | Loss on equity method investees                              |                                                          |                                                         | 1,775    |         |         |         | 750     |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Change in fair value of derivatives                          |                                                          |                                                         | (432     | )       |         |         |        |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Deferred federal income taxes                                |                                                          |                                                         | 39,865   |         |         |         | (6,903  | )      |         |         | (16,918  | )       
|                                                                                                                                                 |                                                                                    | Goodwill impairment                                          |                                                          |                                                         |         |         |         |         | 13,968  |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Minority interest in net loss of consolidated
    subsidiary |                                                          |                                                         | (348     | )       |         |         |        |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Other                                                        |                                                          |                                                         |         |         |         |         |        |        |         |         | 1,105    |         
|                                                                                                                                                 |                                                                                    | Changes in:                                                  |                                                          |                                                         |          |         |         |         |         |        |         |         |          |         
|                                                                                                                                                 |                                                                                    |                                                              | Premiums receivable                                      |                                                         |          | (2,831  | )       |         |         | 1,663  |         |         |          | (12,840  | )       
|                                                                                                                                                 |                                                                                    |                                                              | Reinsurance recoverable                                  |                                                         |          | (5,524  | )       |         |         | (2,241 | )       |         |          | (23,885  | )       
|                                                                                                                                                 |                                                                                    |                                                              | Federal income taxes recoverable/payable                 |                                                         |          | 127     |         |         |         | 10,166 |         |         |          | (15,053  | )       
|                                                                                                                                                 |                                                                                    |                                                              | Unpaid losses and loss adjustment expenses               |                                                         |          | 36,111  |         |         |         | 40,448 |         |         |          | 113,773  |         
|                                                                                                                                                 |                                                                                    |                                                              | Unearned premiums                                        |                                                         |          | 386     |         |         |         | 3,364  |         |         |          | 12,009   |         
|                                                                                                                                                 |                                                                                    |                                                              | Accrued expenses and other liabilities                   |                                                         |          | 13,550  |         |         |         | 3,492  |         |         |          | 2,029    |         
|                                                                                                                                                 |                                                                                    |                                                              | Other assets                                             |                                                         |          | (1,410  | )       |         |         | 1,703  |         |         |          | (13,264  | )       
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|                                                                                                                                                 |                                                                                    |                                                              |                                                          | Net cash provided by operating
    activities           |          |         | 9,093   |         |         |        | 52,138  |         |          |          | 13,011   |  
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|Cash flows from investing activities                                                                                                             |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |        
|                                                                                                                                                 | Purchases                                                                          |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |         |         
|                                                                                                                                                 |                                                                                    | Available-for-sale  fixed maturities                        |                                                          |                                                         | (254,421 | )       |         |         | (85,765 | )      |         |         | (267,537 | )       
|                                                                                                                                                 |                                                                                    | Available-for-sale  equity securities                       |                                                          |                                                         | (19,030  | )       |         |         |        |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Other investments                                            |                                                          |                                                         | (1,407   | )       |         |         | (270    | )      |         |         |         |         
|                                                                                                                                                 |                                                                                    | Physicians Insurance Company, net of cash acquired           |                                                          |                                                         | 2,550    |         |         |         |        |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Intangible assets                                            |                                                          |                                                         | (1,800   | )       |         |         |        |        |         |         |         |         
|                                                                                                                                                 |                                                                                    | Property and equipment                                       |                                                          |                                                         | (4,111   | )       |         |         | (1,668  | )      |         |         | (2,951   | )       
|                                                                                                                                                 | Sales and maturities                                                               |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |         |         
|                                                                                                                                                 |                                                                                    | Available-for-sale  fixed maturities                        |                                                          |                                                         | 187,629  |         |         |         | 101,997 |        |         |         | 131,711  |         
|                                                                                                                                                 |                                                                                    | Available-for-sale  equity securities                       |                                                          |                                                         | 9,700    |         |         |         | 347     |        |         |         | 180      |         
|                                                                                                                                                 |                                                                                    | Other investments                                            |                                                          |                                                         | 4        |         |         |         | 6,842   |        |         |         | 419      |         
|                                                                                                                                                 |                                                                                    | Property and equipment                                       |                                                          |                                                         | 8        |         |         |         |        |        |         |         | 1,958    |         
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|                                                                                                                                                 |                                                                                    |                                                              |                                                          | Net cash (used in) provided by investing
    activities |          |         | (80,878 | )       |         |        | 21,483  |         |          |          | (136,220 | )
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|Cash flows from financing activities                                                                                                             |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |         |        |         |        
|                                                                                                                                                 | Principal payment on note payable                                                  |                                                              |                                                          | (1,000                                                  | )        |         |         | (1,000  | )       |        |         | (1,000  | )       
|                                                                                                                                                 | Common stock repurchased                                                           |                                                              |                                                          | (7,676                                                  | )        |         |         | (27,483 | )       |        |         | (25,225 | )       
|                                                                                                                                                 | Debt issue costs                                                                   |                                                              |                                                          | (906                                                    | )        |         |         |        |         |        |         |        |         
|                                                                                                                                                 | Issuance of long-term debt                                                         |                                                              |                                                          | 30,928                                                  |          |         |         |        |         |        |         |        |         
|                                                                                                                                                 | Proceeds from stock options exercised                                              |                                                              |                                                          | 440                                                     |          |         |         | 243     |         |        |         |        |         
|                                                                                                                                                 | Other                                                                              |                                                              |                                                          | 225                                                     |          |         |         |        |         |        |         |        |         
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|                                                                                                                                                 |                                                                                    |                                                              |                                                          | Net cash provided by (used in) financing
    activities |          |         | 22,011  |         |         |        | (28,240 | )       |          |          | (26,225  | )
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|                                                                                                                                                 |                                                                                    |                                                              | Net (decrease) increase in cash and cash
    equivalents |                                                         |          | (49,774 | )       |         |         | 45,381 |         |         |          | (149,434 | )       
|                                                                                                                                                 |                                                                                    |                                                              |                                                          | Cash and cash equivalents, beginning of period          |          |         | 151,825 |         |         |        | 106,444 |         |          |          | 255,878  |  
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|                                                                                                                                                 |                                                                                    |                                                              |                                                          | Cash and cash equivalents, end of period                |          | $       | 102,051 |         |         | $      | 151,825 |         |          | $        | 106,444  |  
|                                                                                                                                                 |                                                                                    |                                                              |                                                          |                                                         |          |         |         |         |        
|Supplemental disclosures of cash flow
    information                                                                                           
|Federal income taxes of $(3,752,000),
    $(13,619,000), and $8,481,000, net, were (received) paid
    during 2003, 2002 and 2001, respectively.
|Interest payments of $822,000, $0 and $0 were
    made during 2003, 2002 and 2001, respectively.                                                
|The Company purchased 49% of the outstanding
    common stock of Physicians Insurance Company for $2,450,000.                                   
|Cash acquired in connection with the purchase was
    $5,000,000.                                                                               

The accompanying notes are an integral part of
the consolidated financial statements.

50



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS




|   |                                
|-- | -------------------------------
|1. | Significant Accounting Policies



| |                                         
| | ----------------------------------------
| | Basis of consolidation and
    reporting

The accompanying consolidated financial
statements have been prepared in accordance with accounting
principles generally accepted in the United States of America
(GAAP) and include the accounts of American
Physicians Capital, Inc. (APCapital), its
wholly owned subsidiaries, Insurance Corporation of America
(ICA), APSpecialty Insurance Corporation
(APS), APConsulting LLC, APDirect Sales, LLC, Alpha
Advisors, Inc., APIndemnity (Bermuda) Ltd., APManagement
Ltd. and American Physicians Assurance Corporation
(American Physicians). In accordance with the
guidance given in Financial Accounting Standards Board
(FASB) Interpretation No. 46 (FIN
No. 46), the accounts of two wholly owned subsidiary
trusts used to issue mandatorily redeemable trust preferred
securities have been included on the equity method in the
accompanying Consolidated Financial Statements, and the accounts
of Physicians Insurance Company (PIC) have been
included in the accompanying Consolidated Financial Statements.
See Note 2 for further discussion regarding the impact of
FIN No. 46. All significant intercompany accounts and
transactions are eliminated in consolidation.



| |                   
| | ------------------
| | Nature of business

The Company is principally engaged in the
business of providing medical professional liability insurance
to physicians and other health care providers. In addition, the
Company has historically provided workers compensation and
health insurance; however, in 2003 the Company initiated plans
to exit these lines. Medical professional liability,
workers compensation and health insurance direct premiums
written accounted for approximately 76%, 15% and 9% of the
Companys total direct premiums written.

We write business throughout the United States of
America, with an emphasis on markets in the Midwest. During
2003, approximately 67% of direct premiums written by the
Company occurred in Midwestern states.



| |            
| | -----------
| | Investments

All of the Companys fixed maturity and
equity securities are classified as available-for-sale, which
are those securities that would be available to be sold in the
future in response to the Companys liquidity needs,
changes in market interest rates and asset-liability management
strategies. Available-for-sale securities are reported at
estimated fair value, with unrealized gains and losses excluded
from earnings and reported as a separate component of other
comprehensive income, net of deferred taxes.

Investment income includes amortization of
premium and accrual of discount on the yield-to-maturity method
relating to investments acquired at other than par value.
Realized gains or losses on sales or maturities of investments
are determined on a specific identification basis and are
credited or charged to income.

Equity securities are carried at quoted market
values. Fair values of fixed maturities and equity securities
are determined on the basis of dealer or market quotations or
comparable securities on which quotations are available.

Investments are evaluated for other than
temporary impairment (OTTI) using both quantitative
and qualitative methods that include, but are not limited to
(a) an evaluation of the Companys ability and intent
to retain the investment for a period of time sufficient to
allow for an anticipated recovery in value, (b) the
recoverability of principal and interest related to the
security, (c) the duration and extent to which the fair
value has been less than cost for equity securities, or
amortized cost for fixed maturity securities, (d) the
financial condition, near-term and long-term earnings and cash
flow prospects of the issuer, including relevant industry
conditions and trends, and implications of rating agency
actions, and (e) the specific reasons that a

51



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                
|-- | -----------------------------------------------
|1. | Significant Accounting Policies
    (continued)

security is in a significant unrealized loss
position, including market conditions that could affect access
to liquidity.

Write-downs for OTTI are recorded as realized
losses in the period the security is considered impaired.
Subsequent declines in market value of an impaired security are
recorded as realized losses in the period of decline. The
Company does not record realized gains for subsequent recoveries
in the market value of an impaired security until the security
is sold or otherwise disposed of.

Real estate is carried at the lower of historical
cost, less accumulated depreciation, or fair value, based on
estimated undiscounted future cash flows. Real estate of
$27,105,000, net of accumulated depreciation of $2,444,000, and
$27,380,000, net of accumulated depreciation of $1,839,000, in
2003 and 2002, respectively, is included in other investments on
the balance sheet. At December 31, 2003 and 2002,
$8,008,000 of real estate was non-income producing.

Real estate limited partnerships are accounted
for based on the cost method, or the equity method for
partnerships where the Company is able to exercise significant
influence over the operating and financial policies of the
partnership. Real estate limited partnerships are included in
other investments on the balance sheet and had a carrying value
of $1,164,000 and $1,901,000 at December 31, 2003 and 2002,
respectively.



| |                                     
| | ------------------------------------
| | Derivative Financial
    Instruments

During 2003, the Company purchased interest-only
certificates that may not allow for the recovery of
substantially all of its investment. These certificates pay a
variable rate of interest that is inversely related to the
London Interbank Offered Rate (LIBOR). The Company
has determined that these certificates contain an embedded
derivative instrument as defined by Statement of Financial
Accounting Standard (SFAS) No. 133,
Accounting for Derivative Instruments and Hedging
Activities.

All interest-only certificates with an inverse
floating rate of interest are carried on the balance sheet at
fair value as a fixed maturity security. These certificates are
not linked to specific assets or liabilities on the balance
sheet or to a forecasted transaction and, therefore, do not
qualify for hedge accounting. In addition, the Company does not
feel that it can reliably identify and separately measure the
embedded derivative instrument. Accordingly, any changes in the
fair value of the interest-only certificates, based on quoted
market prices, are recorded in current period earnings as
investment income.

At December 31, 2003 the Company had such
certificates with a fair value of approximately
$7.4 million. The fair value of these certificates
increased by approximately $432,000 during the year ended
December 31, 2003.

The Company uses these certificates as a part of
its overall interest rate risk-management strategy related to
its investment portfolio.



| |                          
| | -------------------------
| | Cash and cash equivalents

Cash equivalents consist principally of
commercial paper and money market funds. They are stated at
cost, which approximates fair value, and have original
maturities of three months or less.



| |                                    
| | -----------------------------------
| | Premiums written and
    receivable

Premiums written are earned using the daily pro
rata method over the period of risk. Premiums receivable include
$58,694,000 at December 31, 2003 and $57,013,000 at
December 31, 2002 of premium installments. Receivable
balances consist principally of written premiums from physicians
and employers in the states of Michigan, Ohio, Illinois,
Minnesota and New Mexico. The Companys exposure to credit
risk associated with

52



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                
|-- | -----------------------------------------------
|1. | Significant Accounting Policies
    (continued)

receivables is generally offset by the liability
for unearned premiums; however, an allowance for doubtful
accounts of approximately $550,000 and $1.0 million at
December 31, 2003 and 2002, respectively, is included in
the premium receivable balance, primarily for receivable
balances that may not be collectable and have no associated
unearned premiums.



| |                                      
| | -------------------------------------
| | Deferred policy acquisition
    costs

Deferred policy acquisition costs
(DAC) (carried on the accompanying Consolidated
Balance Sheets in other assets) include commissions, premium
taxes and other costs incurred in connection with writing
business. These costs are deferred and amortized over the period
in which the related premiums are earned. Future investment
income has been considered in determining the recoverability of
deferred costs.



| |                                         
| | ----------------------------------------
| | Property, equipment and
    depreciation

Property and equipment are recorded at cost.
Depreciation is computed for assets on a straight-line basis
over the following periods: building  40 years,
furniture  10 years, and computer equipment and
software  5 years. Upon the sale or retirement
of property and equipment, balances are removed from the
respective accounts and any gain or loss is included in income,
as a realized gain or loss.



| |                                               
| | ----------------------------------------------
| | Unpaid losses and loss adjustment
    expenses

The reserves for unpaid losses and loss
adjustment expenses are estimated using the Companys claim
experience. These estimates are subject to the effects of trends
in loss severity and frequency. When a claim is reported to the
Company, a case reserve is established for the
estimated amount of the ultimate payment. This estimate reflects
an informed judgment based upon insurance reserving practices
appropriate for the relevant type of insurance, and based on the
experience and knowledge of the estimator regarding the nature
and value of the specific claim, the severity of injury or
damage, and the policy provisions relating to the type of loss.
Case reserves are periodically reviewed and adjusted as
necessary as more information becomes available. Reserves for
claims incurred but not reported provide for the
future reporting of claims already incurred, and development on
claims already reported. The reserve for claims incurred but not
reported is actuarially estimated based on historical loss
trends. With the exception of reserves for extended reporting
period claims, the Company does not discount reserves to
recognize the time value of money.

The Companys internal actuaries develop
projections of ultimate losses that are used to establish
recorded reserves. Management utilizes these actuarial
projections, as well as qualitative considerations, to establish
a best estimate recorded reserve amount. Although
considerable variability is inherent in such estimates,
management believes that the reserve for unpaid losses and loss
adjustment expenses is adequate.

The assumptions and methodologies used in
estimating and establishing the reserve for unpaid losses and
loss adjustment expenses are continually reviewed and any
adjustments are reflected as income or expense in the period in
which the adjustments are made.



| |                                                 
| | ------------------------------------------------
| | Reserve for extended reporting period
    claims

The reserve for extended reporting period claims
coverage is recorded during the term of the original claims-made
policy, utilizing the pure-premium approach, in amounts believed
to be adequate to pay for estimated future claims reported
subsequent to a current policyholders death, disability or
retirement. The amount of this reserve is $14.0 million at
December 31, 2003 and 2002, and is included in unpaid loss
and loss adjustment expenses on the balance sheet. Changes in
this reserve are charged or credited to income.

53



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                
|-- | -----------------------------------------------
|1. | Significant Accounting Policies
    (continued)



| |                    
| | -------------------
| | Revenue recognition

Insurance premium income is recognized on a daily
pro rata basis over the respective terms of the policies
in-force, generally one month for health insurance policies and
one year for all other policies. Unearned premiums represent the
portion of premiums written which are applicable to the
unexpired terms of policies in-force.

The Company also recognizes premium income for
any changes in its estimate for earned but unbilled
premiums. Earned but unbilled premiums represent the
portion of estimated future audit premiums, associated with
workers compensation insurance policies, that will be
billed in future periods, but have been earned during the period
based on the effective dates of the policies that are expected
to generate the future audit premium billings. Earned premiums
included approximately $339,000, $945,000 and $0 of earned but
unbilled premiums for the years ended December 31, 2003,
2002 and 2001, respectively. Estimated future audit premium
billings are based on historical audit premium billings,
adjusted for factors related to the current economic
environment. Although considerable variability is inherent in
such estimates, management believes that its estimate of future
audit premium billings and earned but unbilled premiums is
reasonable.



| |            
| | -----------
| | Reinsurance

Reinsurance premiums and losses related to
reinsured business are accounted for on bases consistent with
those used in accounting for the original policies issued and
the terms of the reinsurance contracts. Reinsurance recoverables
and prepaid reinsurance premiums are accounted for in accordance
with SFAS No. 113, Accounting and Reporting for
Reinsurance. Premiums ceded to other companies have been
reported as a reduction of premium income. Reinsured losses
incurred are reported as a reduction of gross losses incurred.
The reserve for unpaid losses and loss adjustment expenses is
presented gross of recoverables from reinsurers, which are
included in the amounts recoverable from reinsurers.

The Companys reinsurers are reviewed for
financial solvency, at least quarterly. This review includes,
among other quantitative and qualitative factors, a ratings
analysis of each reinsurer participating in a reinsurance
contract. Included in reinsurance recoverables on the accompany
Balance Sheets is a $17.5 million recoverable from Gerling
Global Reinsurance Corporation (Gerling Global) at
December 31, 2003. In 2002, Gerling Globals parent
company put Gerling Globals United States subsidiary into
run off resulting in a series of A.M. Best rating downgrades for
Gerling. The Company has not experienced delays in payments from
Gerling Global and believes that Gerling Globals surplus
and cash flow are adequate to meet its current obligations to
the Company. Based on the assessment of the financial strength
and liquidity of Gerling Global, the Company has determined that
a valuation allowance against this recoverable is not needed at
December 31, 2003.



| |             
| | ------------
| | Income taxes

Deferred federal income tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to the differences between financial
statement carrying amounts of existing assets and liabilities,
and their respective tax bases. The Company has reviewed its
deferred federal income tax assets for recoverability based on
the availability of future taxable income when the deductible
temporary differences are expected to reverse, and has
determined, based on its recent loss experience, that sufficient
taxable income may not exist in the periods of reversal.
Accordingly, the Company has recorded a deferred tax asset
valuation allowance for the entire net deferred tax asset. The
establishment of a valuation allowance in 2003 is recorded as
federal income tax expense in the accompanying Consolidated
Statements of Income. Once the Company has re-established a
pattern of profitability, the deferred tax asset valuation
allowance may be reduced upon evaluation of the availability of
future taxable income.

54



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                
|-- | -----------------------------------------------
|1. | Significant Accounting Policies
    (continued)



| |         
| | --------
| | Goodwill

Goodwill consists of the excess of cost over fair
market value of the net assets of acquired businesses. Prior to
2002, goodwill was amortized on a straight-line basis over a
period of ten years.

Effective January 1, 2002, the Company
completed the transitional impairment testing required by
SFAS No. 142, Goodwill and Other Intangible
Assets (SFAS No. 142). Based on the
results of the impairment testing, net goodwill of
$13.9 million, $9.1 million net of tax, was written
off as a cumulative effect of a change in accounting principle.
See Note 4 for additional information regarding the effects
of the adoption of SFAS No. 142.

Prior to January 1, 2002, the Company
measured the potential impairment of recorded goodwill based on
the estimated undiscounted cash flows of the entity acquired
over the remaining amortization period. During 2001, it was
determined that the goodwill associated with the purchase of
Alpha Advisors, Inc. and ICA was impaired based on changes
in organizational structure and ongoing operating losses. This
resulted in additional amortization expense of $380,000.



| |                         
| | ------------------------
| | Stock-based compensation

The Company uses the intrinsic value-based method
to account for all stock-based employee compensation plans and
has adopted the disclosure alternative of SFAS No. 123
Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure
(SFAS No. 148). The Companys policy
regarding stock options is to issue options with an exercise
price equal to the market price on the date of grant.
Accordingly, no compensation expense has been recognized for
options granted in 2003, 2002, and 2001. The Company, however,
does recognize compensation expense related to restricted stock
grants, equal to the fair market value as of the date of grant,
as there is no consideration due from employees for these awards
at the date they vest. This expense is recognized on a
straight-line basis over the period of vesting, with future
compensation expense reflected as a reduction of
shareholders equity in the accompanying Consolidated
Balance Sheets.

In accordance with SFAS No. 123, as
amended by SFAS No. 148, the Company is required to
disclose the pro forma effects on operating results as if the
Company had elected the fair value approach to account for its
stock-based employee compensation plans.

55



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                
|-- | -----------------------------------------------
|1. | Significant Accounting Policies
    (continued)

Had compensation expense been determined based on
the fair value at the grant date, consistent with the provisions
of SFAS No. 123, our net loss and net loss per share
would have been as follows for the years ended December 31,
2003, 2002 and 2001:

|                                                                                                                                                                       |             |                                       |         |       |      |   |         |       |   |   |         |       |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | ------------------------------------- | ------- | ----- | ---- | - | ------- | ----- | - | - | ------- | ----- | -
|                                                                                                                                                                       |             | 2003                                  |         |       | 2002 |   |         | 2001  |  
|                                                                                                                                                                       |             |                                       |         |       |      |   |         |       |  
|                                                                                                                                                                       |             |                                      
|                                                                                                                                                                       |             | (In thousands, except per share data) |        
|Net loss, as reported                                                                                                                                                  |             | $                                     | (76,831 | )     |      | $ | (18,491 | )     |   | $ | (43,780 | )    
|Add: Stock-based employee compensation expense
    included in reported net loss, net of related tax effects                                                           |             |                                       | 367     |       |      |   | 275     |       |   |   | 175     |      
|Deduct: Total stock-based employee compensation
    expense determined under fair value based method for all awards
    granted since 2000, net of related tax effects |             |                                       | (1,455  | )     |      |   | (2,318  | )     |   |   | (647    | )    
|                                                                                                                                                                       |             |                                       |         |       |      |   |         |       |  
|Pro forma net loss                                                                                                                                                     |             | $                                     | (77,919 | )     |      | $ | (20,534 | )     |   | $ | (44,252 | )    
|                                                                                                                                                                       |             |                                       |         |       |      |   |         |       |  
|Basic net loss per share                                                                                                                                               |             |                                       |         |       |      |   |         |       |   |   |         |      
|                                                                                                                                                                       | As reported |                                       | $       | (9.02 | )    |   | $       | (1.98 | ) |   | $       | (3.95 | )
|                                                                                                                                                                       | Pro forma   |                                       | $       | (9.15 | )    |   | $       | (2.20 | ) |   | $       | (4.00 | )
|Diluted net loss per share(1)                                                                                                                                          |             |                                       |         |       |      |   |         |       |   |   |         |      
|                                                                                                                                                                       | As reported |                                       | $       | (9.02 | )    |   | $       | (1.98 | ) |   | $       | (3.95 | )
|                                                                                                                                                                       | Pro forma   |                                       | $       | (9.15 | )    |   | $       | (2.20 | ) |   | $       | (4.00 | )
|Basic Weighted Average Shares                                                                                                                                          |             |                                       | 8,520   |       |      |   | 9,340   |       |   |   | 11,072  |      
|Diluted Weighted Average Shares(1)                                                                                                                                     |             |                                       | 8,520   |       |      |   | 9,340   |       |   |   | 11,072  |      



---



|    |                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | As the Company was in a net loss position for the
    years ended December 31, 2003, 2002 and 2001, no effect of
    options or other stock awards was calculated as the impact would
    be anti-dilutive.

For pro forma disclosure purposes, the fair value
of stock options was estimated at the date of grant using a
Black-Scholes option pricing model using the following
assumptions:

|                                         |  |      |       |   |      |  |       |      |  |  |       |  
|---------------------------------------- |  | ---- | ----- | - | ---- |  | ----- | ---- |  |  | ----- | -
|                                         |  | 2003 |       |   | 2002 |  |       | 2001 | 
|                                         |  |      |       |   |      |  |       |      | 
|Risk-free interest rate                  |  |      | 2.79  | % |      |  | 4.09  | %    |  |  | 5.48  | %
|Dividend yield                           |  |      | 0.00  | % |      |  | 0.00  | %    |  |  | 0.00  | %
|Weighted average volatility assumption   |  |      | 35.00 | % |      |  | 35.00 | %    |  |  | 30.00 | %
|Weighted average life of options (years) |  |      | 5.00  |   |      |  | 5.00  |      |  |  | 5.00  |  

In managements opinion, existing stock
option valuation models do not provide an entirely reliable
measure of the fair value of non-transferable employee stock
options with vesting restrictions. In addition, such pro forma
disclosures may not be representative of future compensation
costs as options may vest over several years and additional
grants may be made.

See Note 17 for further information
regarding the Companys stock-based compensation plans.



| |                   
| | ------------------
| | Net loss per share

Net loss per share is computed by dividing net
loss by the weighted average number of shares of common stock
and common stock equivalents (stock options and stock grants)
outstanding during each year. As the Company was in a net loss
position for the years ended December 31, 2003, 2002 and
2001, no effect of options or other stock awards was calculated
as the impact would have been anti-dilutive (See Note 18).

56



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                
|-- | -----------------------------------------------
|1. | Significant Accounting Policies
    (continued)



| |                 
| | ----------------
| | Reclassification

Certain prior year amounts have been reclassified
to conform to the current year presentation.



| |                 
| | ----------------
| | Use of estimates

The preparation of financial statements in
conformity with GAAP 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 most significant estimates that are
susceptible to significant change in the near-term relate to the
determination of loss and loss adjustment expense reserves,
investments, taxes, reinsurance, and the reserve for extended
reporting period claims. Although considerable variability is
inherent in these estimates, management believes that the
current estimates are reasonable in all material respects. The
estimates are reviewed regularly and adjusted as necessary. Such
adjustments are reflected in current operations.



|   |                                             
|-- | --------------------------------------------
|2. | Effects of New Accounting
    Pronouncements

In June 2002, the Financial Accounting Standards
Board (FASB) issued SFAS No. 146,
Accounting for Costs Associated with Exit or Disposal
Activities (SFAS No, 146). With the
adoption of SFAS No. 146, effective for exit or
disposal activities initiated after December 31, 2002, a
liability for a cost associated with an exit or disposal
activity should be recognized and measured initially at fair
value only when the liability is incurred. See Note 14 for
further discussion regarding costs associated with exit
activities and the impact of SFAS No. 146.

In November 2002, the FASB issued FASB
Interpretation (FIN) No. 45.
Guarantors Accounting and Disclosure Requirements
for Guarantees of Indebtedness of Others (FIN
No. 45). This interpretation clarifies disclosures
required to be made by a guarantor in its interim and annual
financial statements and requires a guarantor to recognize, at
the inception of the guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. The
provisions of FIN No. 45 pertaining to the recording of a
liability are effective for all guarantees entered into, or
modified, after December 31, 2002. The disclosure
requirements of FIN No. 45 are effective for financial
statements of interim or annual periods ending after
December 31, 2002. APCapital has issued guarantees in
connection with its establishment of non-consolidated subsidiary
trusts and issuance of debentures. The amounts due under the
guarantees are also recorded as liabilities in the
Companys Consolidated Financial Statements in accordance
with the structure of the transaction. See Note 9 for
further details on the nature of the guarantees and the
transactions that gave rise to the guarantees. Also see
Note 19 for disclosures regarding other guarantees the
Company has issued.

In January 2003, the FASB issued FIN No. 46,
which was revised in December 2003 by FASB FIN No. 46R.
These interpretations address consolidation by business
enterprises of variable interest entities and are effective
during the first interim or annual period ending after
December 15, 2003. The Company has evaluated certain
investments, as required by FIN No. 46, and has determined
that its investments in subsidiary trusts used to issue
mandatorily redeemable trust preferred securities should not be
consolidated. Accordingly, the Company has not consolidated the
trusts in the accompanying Consolidated Financial Statements.
Also, during 2003, the Company invested $2,450,000 for 49% of
the outstanding common stock of a start-up insurance company in
the state of Florida, PIC. The Company has evaluated our
investment in PIC, and based on the guidance given in FIN
No. 46, have determined that PIC should be consolidated
because, among other factors, the Company financed a portion of
the other investors capital contribution at PICs
inception. The amount financed was repaid in full prior to
December 31, 2003. Minority interest in the

57



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                         
|-- | --------------------------------------------------------
|2. | Effects of New Accounting Pronouncements
    (continued)

accompanying Consolidated Statements of Income
and Consolidated Balance Sheets represents the remaining 51% of
the net loss and shareholders equity of PIC.

PIC was formed in March of 2003 with the intent
of writing as much medical professional liability insurance as
PICs capital and surplus levels could reasonably support.
At December 31, 2003, PICs total assets were
approximately $8.6 million and direct premiums written by
PIC were approximately $3.8 million for the year ended
December 31, 2003. The Company has no future obligations
with respect to its investment in PIC, nor do creditors of PIC
have any recourse to the general credit of the Company.
Accordingly, the maximum exposure to loss as a result of the
Companys involvement with PIC, is approximately
$2.7 million, which represents the initial pro-rata equity
contribution of $2,450,000 plus the remaining unamortized
balance of an intangible asset of $289,000 related to a covenant
not to compete.



|   |                     
|-- | --------------------
|3. | Comprehensive Income

SFAS No. 130, Reporting
Comprehensive Income, requires unrealized gains or losses
on the Companys available-for-sale securities to be
included in other comprehensive income, net of tax. Net realized
investment gains (losses) on securities held as of the beginning
of the year totaling $3,109,000 in 2003, $459,000 in 2002, and
$(4,103,000) in 2001 had net unrealized appreciation of
$2,106,000 at the beginning of 2003, $620,000 at the beginning
of 2002, and $100,000 at the beginning of 2001.



|   |                               
|-- | ------------------------------
|4. | Goodwill and Intangible Assets

Effective January 1, 2002, the Company
adopted SFAS No. 142. In accordance with the guidance
given in SFAS No. 142, the Company completed its
transitional impairment testing of all goodwill and other
intangible assets as of January 1, 2002. At that date, the
only goodwill or other intangible asset recorded by the Company
was $13.9 million of net goodwill associated with the
purchase of Stratton-Cheeseman Management Company in 1999. Based
on the results of the impairment testing, the recorded net
goodwill of $13.9 million was written off as the fair
value, as determined by various fair value estimation
approaches, including multiples of projected future net income
and market capitalization of the Companys reporting units,
did not support the carrying value of previously recorded
goodwill. The goodwill impairment was recorded as a cumulative
effect of a change in accounting principle, net of a deferred
income tax benefit of $4.9 million.

58



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                               
|-- | ----------------------------------------------
|4. | Goodwill and Intangible Assets
    (continued)

The adoption of SFAS No. 142 had a
significant impact on the Companys operating results, as
effective January 1, 2002 goodwill is no longer being
amortized. The Companys net loss per share for the years
ended December 31, 2003, 2002 and 2001, in the Consolidated
Statements of Income, exclusive of amortization expense
recognized in those periods related to goodwill, would have been
as follows:

|                      |                                   |                                       |   |         |      |  |   |         |   |  |   |         |  
|--------------------- | --------------------------------- | ------------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                      |                                   | 2003                                  |   |         | 2002 |  |   | 2001    |  
|                      |                                   |                                       |   |         |      |  |   |         |  
|                      |                                   |                                      
|                      |                                   | (In thousands, except per share data) |  
|Net loss:             |                                   |                                       |   |         |      |  |   |         |   |  |   |        
|                      | Reported net loss                 |                                       | $ | (76,831 | )    |  | $ | (18,491 | ) |  | $ | (43,780 | )
|                      | Add back:                         |                                       |   |         |      |  |   |         |   |  |   |         |  
|                      | Goodwill amortization, net of tax |                                       |   |        |      |  |   |        |   |  |   | 1,634   |  
|                      |                                   |                                       |   |         |      |  |   |         |  
|                      | Adjusted net loss                 |                                       | $ | (76,831 | )    |  | $ | (18,491 | ) |  | $ | (42,146 | )
|                      |                                   |                                       |   |         |      |  |   |         |  
|Basic loss per share: |                                   |                                       |   |         |      |  |   |         |   |  |   |        
|                      | Reported net loss                 |                                       | $ | (9.02   | )    |  | $ | (1.98   | ) |  | $ | (3.95   | )
|                      | Add back:                         |                                       |   |         |      |  |   |         |   |  |   |         |  
|                      | Goodwill amortization, net of tax |                                       |   |        |      |  |   |        |   |  |   | 0.15    |  
|                      |                                   |                                       |   |         |      |  |   |         |  
|                      | Adjusted net loss per share       |                                       | $ | (9.02   | )    |  | $ | (1.98   | ) |  | $ | (3.80   | )
|                      |                                   |                                       |   |         |      |  |   |         |  

As the Company was in a net loss position for the
years ended December 31, 2003, 2002 and 2001, diluted loss
per share is not presented as the effect of awards or options
would be anti-dilutive.

The changes in the carrying amount of goodwill
for the years ended December 31, 2003 and 2002 were as
follows:

|                                  |                                   |                |       |        |              |   |       |        |   |              |            |      |           |           |       |        |   |   |   |   |  |   |        |         |  
|--------------------------------- | --------------------------------- | -------------- | ----- | ------ | ------------ | - | ----- | ------ | - | ------------ | ---------- | ---- | --------- | --------- | ----- | ------ | - | - | - | - |  | - | ------ | ------- | -
|                                  |                                   | Medical        |       |        |              |   |       |        |   |              |            |      |          
|                                  |                                   | Professional   |       |        | Workers     |   |       |        |   | Personal and |            |      | Corporate |           |      
|                                  |                                   | Liability      |       |        | Compensation |   |       | Health |   |              | Commercial |      |           | and Other |       | Total  |  
|                                  |                                   |                |       |        |              |   |       |        |   |              |            |      |           |           |       |        |  
|                                  |                                   |               
|                                  |                                   | (In thousands) |      
|Balance at January 1, 2002        |                                   | $              | 8,229 |        |              | $ | 3,611 |        |   | $            | 206        |      |           | $         | 1,922 |        |   | $ |  |   |  | $ | 13,968 |        
|                                  | Goodwill acquired during the year |                |       |       |              |   |       |       |   |              |            |     |           |           |       |       |   |   |   |  |  |   |        |        |  
|                                  | Amortization                      |                |       |       |              |   |       |       |   |              |            |     |           |           |       |       |   |   |   |  |  |   |        |        |  
|                                  | Impairment losses                 |                |       | (8,229 | )            |   |       | (3,611 | ) |              |            | (206 | )         |           |       | (1,922 | ) |   |   |  |  |   |        | (13,968 | )
|                                  |                                   |                |       |        |              |   |       |        |   |              |            |      |           |           |       |        |   |  
|Net goodwill at December 31, 2002 |                                   | $              |      |        |              | $ |      |        |   | $            |           |      |           | $         |      |        |   | $ |  |   |  | $ |       |        
|                                  |                                   |                |       |        |              |   |       |        |   |              |            |      |           |           |       |        |   |  

There was no goodwill acquired, amortized or
impaired during 2003.

In 2003, the Company acquired intangible assets
related to certain non-compete agreements in connection with its
investment in PIC and a covenant not to compete from the former
President and Chief Executive Officer (CEO) of the
Company. The gross carrying amount and accumulated amortization
of these intangible assets for the year ended December 31,
2003 was $1.8 million and $261,000, respectively.
Amortization expense related to intangible assets was $261,000
for the year ended December 31, 2003. The estimated
amortization expense related to these intangible assets is
expected to be $914,000 and $625,000 for the years ended
December 31, 2004 and 2005, respectively. There will be no
amortization expense related to these intangible assets beyond
December 31, 2005.

59



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |            
|-- | -----------
|5. | Investments

The composition of the investment portfolio
including unrealized gains and losses at December 31, 2003
and 2002 was:

|                   |                                   |                          |   |         |            |  |       |            |        |  |            |      |      |   |   |         |         | 
|------------------ | --------------------------------- | ------------------------ | - | ------- | ---------- |  | ----- | ---------- | ------ |  | ---------- | ---- | ---- | - | - | ------- | ------- | 
|                   |                                   |                         
|                   |                                   | 2003                     |  
|                   |                                   |                          |  
|                   |                                   |                          |   | Gross   |            |  | Gross |            |        | 
|                   |                                   | Amortized                |   |         | Unrealized |  |       | Unrealized |        |  | Estimated  |     
|                   |                                   | Cost/Cost                |   |         | Gains      |  |       | Losses     |        |  | Fair Value |     
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     
|                   |                                   |                         
|                   |                                   | (In thousands)           |  
|Available-for-sale |                                   |                          |   |         |            |  |       |            |        |  |            |      |      |   |   |        
|                   | U.S. government obligations       |                          | $ | 54,168  |            |  | $     | 1,927      |        |  | $          | (4   | )    |   | $ | 56,091  |        
|                   | States and political subdivisions |                          |   | 32,932  |            |  |       | 1,404      |        |  | $          | (18  | )    |   |   | 34,318  |        
|                   | Corporate securities              |                          |   | 475,866 |            |  |       | 37,896     |        |  |            | (75  | )    |   |   | 513,687 |        
|                   | Mortgage-backed securities        |                          |   | 60,440  |            |  |       | 2,546      |        |  |            | (557 | )    |   |   | 62,429  |        
|                   | Other debt securities             |                          |   | 25,706  |            |  |       | 2,402      |        |  |            |     |      |   |   | 28,108  |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     
|                   |                                   | Fixed maturities         |   |         | 649,112    |  |       |            | 46,175 |  |            |      | (654 | ) |   |         | 694,633 | 
|                   | Equity securities                 |                          |   | 7,083   |            |  |       | 567        |        |  |            | (107 | )    |   |   | 7,543   |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     
|                   |                                   | Total available-for-sale |   | $       | 656,195    |  |       | $          | 46,742 |  |            | $    | (761 | ) |   | $       | 702,176 | 
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |     

|                   |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |         |         | 
|------------------ | --------------------------------- | ------------------------ | - | ------- | ---------- |  | ----- | ---------- | ------ |  | ---------- | ------ | ------ | - | - | ------- | ------- | 
|                   |                                   |                         
|                   |                                   | 2002                     |  
|                   |                                   |                          |  
|                   |                                   |                          |   | Gross   |            |  | Gross |            |        | 
|                   |                                   | Amortized                |   |         | Unrealized |  |       | Unrealized |        |  | Estimated  |       
|                   |                                   | Cost/Cost                |   |         | Gains      |  |       | Losses     |        |  | Fair Value |       
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   |                         
|                   |                                   | (In thousands)           |  
|Available-for-sale |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |        
|                   | U.S. government obligations       |                          | $ | 77,306  |            |  | $     | 1,959      |        |  | $          |       |        |   | $ | 79,265  |        
|                   | States and political subdivisions |                          |   | 13,118  |            |  |       | 394        |        |  |            | (43    | )      |   |   | 13,469  |        
|                   | Corporate securities              |                          |   | 440,309 |            |  |       | 33,820     |        |  |            | (2,567 | )      |   |   | 471,562 |        
|                   | Mortgage-backed securities        |                          |   | 2,081   |            |  |       | 105        |        |  |            |       |        |   |   | 2,186   |        
|                   | Other debt securities             |                          |   | 48,208  |            |  |       | 4,231      |        |  |            | (22    | )      |   |   | 52,417  |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   | Fixed maturities         |   |         | 581,022    |  |       |            | 40,509 |  |            |        | (2,632 | ) |   |         | 618,899 | 
|                   | Equity securities                 |                          |   | 21      |            |  |       | 23         |        |  |            |       |        |   |   | 44      |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   | Total available-for-sale |   | $       | 581,043    |  |       | $          | 40,532 |  |            | $      | (2,632 | ) |   | $       | 618,943 | 
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       

For the year ended December 31, 2003, gross
unrealized gains include $432,000 of gains that relate to
securities that contain an embedded derivative instrument. These
gains have been included in investment income for the period in
accordance with SFAS No. 133. See Note 1 for
further discussion of these securities and the embedded
derivative instruments.

60



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                        
|-- | -----------------------
|5. | Investments (continued)

The following table shows the Companys
gross unrealized investment losses and fair value, aggregated by
investment category and length of time that individual
securities have been in a continuous unrealized loss position,
at December 31, 2003.

|                                  |                                       |                     |       |        |                   |   |       |       |   |            |   |       |  |   |            |   |  |   |       |        |  |   |      |      |  
|--------------------------------- | ------------------------------------- | ------------------- | ----- | ------ | ----------------- | - | ----- | ----- | - | ---------- | - | ----- |  | - | ---------- | - |  | - | ----- | ------ |  | - | ---- | ---- | -
|                                  |                                       |                     |       |        |                   |  
|                                  |                                       | Less Than 12 Months |       |        | 12 Months or More |   | Total |      
|                                  |                                       |                     |       |        |                   |   |       |      
|                                  |                                       | Fair                |       |        | Unrealized        |   |       | Fair  |   | Unrealized |   | Fair  |  |   | Unrealized |  
|Description of Securities         |                                       | Value               |       |        | Losses            |   |       | Value |   | Losses     |   | Value |  |   | Losses     |  
|                                  |                                       |                     |       |        |                   |   |       |       |   |            |   |       |  |   |            |  
|                                  |                                       |                    
|                                  |                                       | (In thousands)      |      
|U.S. government obligations       |                                       | $                   | 948   |        |                   | $ | (4    | )     |   | $          |  |       |  | $ |           |   |  | $ | 948   |        |  | $ | (4   | )   
|States and political subdivisions |                                       |                     | 5,247 |        |                   |   | (18   | )     |   |            |  |       |  |   |           |   |  |   | 5,247 |        |  |   | (18  | )   
|Corporate securities              |                                       |                     | 9,774 |        |                   |   | (75   | )     |   |            |  |       |  |   |           |   |  |   | 9,774 |        |  |   | (75  | )   
|Mortgage-backed securities        |                                       |                     | 5,852 |        |                   |   | (557  | )     |   |            |  |       |  |   |           |   |  |   | 5,852 |        |  |   | (557 | )   
|Other debt securities             |                                       |                     |      |        |                   |   |      |       |   |            |  |       |  |   |           |   |  |   |      |        |  |   |     |     
|                                  |                                       |                     |       |        |                   |   |       |       |   |            |   |       |  |   |            |   |  |  
|                                  | Subtotal fixed maturities             |                     |       | 21,821 |                   |   |       | (654  | ) |            |   |      |  |   |            |  |  |   |       | 21,821 |  |   |      | (654 | )
|Equity securities                 |                                       |                     | 1,587 |        |                   |   | (107  | )     |   |            |  |       |  |   |           |   |  |   | 1,587 |        |  |   | (107 | )   
|                                  |                                       |                     |       |        |                   |   |       |       |   |            |   |       |  |   |            |   |  |  
|                                  | Total temporarily impaired securities |                     | $     | 23,408 |                   |   | $     | (761  | ) |            | $ |      |  |   | $          |  |  |   | $     | 23,408 |  |   | $    | (761 | )
|                                  |                                       |                     |       |        |                   |   |       |       |   |            |   |       |  |   |            |   |  |  

Unrealized losses above are primarily related to
mortgage-backed securities, which are typically slightly more
sensitive to changes in prevailing interest rates than other
fixed-maturity securities due to pre-payment options. The
unrealized losses associated with mortgage-backed securities are
considered by the Company to be interest rate related and
temporary in nature.

The components of pretax investment income and
net realized investment gains (losses) for the years ended
December 31, 2003, 2002 and 2001 were:

|                               |                       |                                     |        |        |        |   |        |        |        |   |        |        |        |  
|------------------------------ | --------------------- | ----------------------------------- | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------ | -
|                               |                       | 2003                                |        |        | 2002   |   |        | 2001   |       
|                               |                       |                                     |        |        |        |   |        |        |       
|                               |                       |                                    
|                               |                       | (In thousands)                      |       
|Interest income                |                       | $                                   | 43,892 |        |        | $ | 44,435 |        |        | $ | 46,548 |       
|Dividend income                |                       |                                     | 37     |        |        |   |       |        |        |   | 2      |       
|Other investment (loss) income |                       |                                     | (635   | )      |        |   | 340    |        |        |   | 1,333  |       
|                               |                       |                                     |        |        |        |   |        |        |       
|                               | Investment income     |                                     | $      | 43,294 |        |   | $      | 44,775 |        |   | $      | 47,883 |       
|                               |                       |                                     |        |        |        |   |        |        |       
|Gross realized gains           |                       |                                     |        |        |        |   |        |        |        |   |        |       
|                               | Fixed maturities      |                                     | $      | 3,354  |        |   | $      | 2,575  |        |   | $      | 1,697  |       
|                               | Equity securities     |                                     |        | 647    |        |   |        | 48     |        |   |        | 121    |       
|                               | Other invested assets |                                     |        |       |        |   |        | 20     |        |   |        |       |       
|                               |                       |                                     |        |        |        |   |        |        |       
|                               |                       | Total gross realized gains          |        |        | 4,001  |   |        |        | 2,643  |   |        |        | 1,818  |  
|                               |                       |                                     |        |        |        |   |        |        |       
|Gross realized losses          |                       |                                     |        |        |        |   |        |        |        |   |        |       
|                               | Fixed maturities      |                                     |        | (1,554 | )      |   |        | (2,262 | )      |   |        | (5,978 | )     
|                               | Equity securities     |                                     |        | (6     | )      |   |        |       |        |   |        |       |       
|                               | Other invested assets |                                     |        | (31    | )      |   |        | (251   | )      |   |        | (963   | )     
|                               |                       |                                     |        |        |        |   |        |        |       
|                               |                       | Total gross realized losses         |        |        | (1,591 | ) |        |        | (2,513 | ) |        |        | (6,941 | )
|                               |                       |                                     |        |        |        |   |        |        |       
|                               |                       | Net realized investment gain (loss) |        | $      | 2,410  |   |        | $      | 130    |   |        | $      | (5,123 | )
|                               |                       |                                     |        |        |        |   |        |        |       

61



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                        
|-- | -----------------------
|5. | Investments (continued)

Net realized investment gains (losses) above
excludes approximately $7,000 in 2003, $293,000 in 2002, and
$528,000 in 2001 of realized losses on the sale or disposal of
fixed assets.

During the years ended December 31, 2003,
2002 and 2001, the Company recorded losses of $1.3 million,
$770,000 and $5.9 million, respectively, on investments
whose decline in market value was considered other than
temporary. Net realized gains for the year ended
December 31, 2003 are reduced by a $1.3 million charge
for an other than temporary impairment
(OTTI) on enhanced equipment trust certificates
issued by Delta Airlines. Net realized losses for the years
ended December 31, 2002 and 2001 include an OTTI charge of
$520,000 and $5.9 million, respectively for the write down
of Frontier bonds, as well as $250,000 impairment loss on
investment real estate in 2002. In December of 2003, the
Frontier bonds, as part of bankruptcy proceedings, were
converted to equity securities of Frontiers parent
company, Global Crossings. The Company received
15,865 shares of Global Crossing common stock based on the
amount of bonds held by the Company. These shares had an initial
fair value of $35 per share, which resulted in a realized
gain of approximately $245,000 upon the conversion.

Changes in unrealized gains (losses) on fixed
maturities and equity securities were:

|                      |                   |                |        |       |      |   |         |        |   |   |        |       |  
|--------------------- | ----------------- | -------------- | ------ | ----- | ---- | - | ------- | ------ | - | - | ------ | ----- | -
|                      |                   | 2003           |        |       | 2002 |   |         | 2001   |  
|                      |                   |                |        |       |      |   |         |        |  
|                      |                   |               
|                      |                   | (In thousands) |       
|Available-for-sale:   |                   |                |        |       |      |   |         |        |   |   |        |      
|                      | Fixed maturities  |                | $      | 7,212 |      |   | $       | 29,244 |   |   | $      | 9,780 |  
|                      | Equity securities |                |        | 437   |      |   |         | (312   | ) |   |        | (15   | )
|Deferred income taxes |                   |                | (2,678 | )     |      |   | (10,125 | )      |   |   | (3,417 | )    
|                      |                   |                |        |       |      |   |         |        |  
|                      |                   | $              | 4,971  |       |      | $ | 18,807  |        |   | $ | 6,348  |      
|                      |                   |                |        |       |      |   |         |        |  

The amortized cost and estimated fair value of
debt securities at December 31, 2003, by contractual
maturity, was:

|                   |                            |                |   |         |            |  |   |         |         | 
|------------------ | -------------------------- | -------------- | - | ------- | ---------- |  | - | ------- | ------- | 
|                   |                            | Amortized      |   |         | Estimated  | 
|                   |                            | Cost           |   |         | Fair Value | 
|                   |                            |                |   |         |            | 
|                   |                            |               
|                   |                            | (In thousands) |  
|Available-for-sale |                            |                |   |         |            |  |   |        
|                   | Less than one year         |                | $ | 34,021  |            |  | $ | 34,968  |        
|                   | One to five years          |                |   | 343,315 |            |  |   | 371,954 |        
|                   | Five to ten years          |                |   | 128,056 |            |  |   | 138,470 |        
|                   | More than ten years        |                |   | 83,280  |            |  |   | 86,722  |        
|                   | Mortgage-backed securities |                |   | 60,440  |            |  |   | 62,519  |        
|                   |                            |                |   |         |            | 
|                   |                            | Total          |   | $       | 649,112    |  |   | $       | 694,633 | 
|                   |                            |                |   |         |            | 

Expected maturities will differ from contractual
maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.

The carrying amount of bonds that were on deposit
with various state regulatory authorities as of
December 31, 2003 and 2002 was $8,311,000 and $8,541,000,
respectively.

Proceeds on the sales of investments in bonds
totaled $43,754,000 in 2003, $45,337,000 in 2002, and
$27,400,000 in 2001.

62



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                           
|-- | --------------------------
|6. | Deferred Acquisition Costs

Changes in deferred policy acquisition costs for
the years ended December 31, 2003, 2002, and 2001 are
summarized as follows:

|                     |  |                |         |   |      |   |         |      |  |   |         |  
|-------------------- |  | -------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                     |  | 2003           |         |   | 2002 |   |         | 2001 | 
|                     |  |                |         |   |      |   |         |      | 
|                     |  |               
|                     |  | (In thousands) |        
|Balance, January 1   |  | $              | 10,877  |   |      | $ | 10,712  |      |  | $ | 9,693   |  
|Additions            |  |                | 24,954  |   |      |   | 28,191  |      |  |   | 26,779  |  
|Amortization         |  |                | (25,370 | ) |      |   | (28,026 | )    |  |   | (25,760 | )
|                     |  |                |         |   |      |   |         |      | 
|Balance, December 31 |  | $              | 10,461  |   |      | $ | 10,877  |      |  | $ | 10,712  |  
|                     |  |                |         |   |      |   |         |      | 

Deferred acquisition costs are included in other
assets on the accompanying Consolidated Balance Sheets.



|   |                            
|-- | ---------------------------
|7. | Property and Equipment, Net

At December 31, 2003 and 2002, property and
equipment consisted of the following:

|                                     |  |                |         |   |      |   |         |  
|------------------------------------ |  | -------------- | ------- | - | ---- | - | ------- | -
|                                     |  | 2003           |         |   | 2002 |  
|                                     |  |                |         |   |      |  
|                                     |  |               
|                                     |  | (In thousands) |        
|Land                                 |  | $              | 571     |   |      | $ | 571     |  
|Building (occupied by the Company)   |  |                | 10,499  |   |      |   | 10,499  |  
|Computer equipment and software      |  |                | 14,198  |   |      |   | 11,352  |  
|Furniture and leasehold improvements |  |                | 4,901   |   |      |   | 3,683   |  
|                                     |  |                |         |   |      |  
|                                     |  |                | 30,169  |   |      |   | 26,105  |  
|Accumulated depreciation             |  |                | (13,679 | ) |      |   | (11,753 | )
|                                     |  |                |         |   |      |  
|                                     |  | $              | 16,490  |   |      | $ | 14,352  |  
|                                     |  |                |         |   |      |  

Depreciation expense associated with property and
equipment for the years ended December 31, 2003, 2002 and
2001 was $2.0 million, $1.5 million, and
$1.4 million, respectively. Net realized losses on the sale
or disposal of property and equipment for the years ended
December 31, 2003, 2002 and 2001 were $7,000, $293,000 and
$528,000, respectively.

During the years ended December 31, 2003 and
2002, the Company capitalized approximately $1.6 million
and $605,000, respectively, of costs incurred related to
computer software obtained and developed for internal use.
Accordingly, at December 31, 2003 and 2002, approximately
$2.2 million and $605,000, respectively, of costs related
to this software package have been capitalized. It is
anticipated that the software will be placed in use in the
second quarter of 2004, at which time these capitalized costs
will begin to be amortized on a straight-line basis over a
period of five years.

63



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                               
|-- | ----------------------------------------------
|8. | Unpaid Losses and Loss Adjustment
    Expenses

Activity in unpaid losses and loss adjustment
expenses for the years ended December 31, 2003, 2002, and
2001 was as follows:

|                               |                                |                |         |         |      |   |         |         |   |   |         |         |  
|------------------------------ | ------------------------------ | -------------- | ------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                               |                                | 2003           |         |         | 2002 |   |         | 2001    |  
|                               |                                |                |         |         |      |   |         |         |  
|                               |                                |               
|                               |                                | (In thousands) |        
|Balance, beginning of year     |                                | $              | 637,494 |         |      | $ | 597,046 |         |   | $ | 483,273 |        
|                               | Less, reinsurance recoverables |                |         | (95,468 | )    |   |         | (91,491 | ) |   |         | (69,319 | )
|                               |                                |                |         |         |      |   |         |         |  
|Net balance, beginning of year |                                |                | 542,026 |         |      |   | 505,555 |         |   |   | 413,954 |        
|Incurred related to            |                                |                |         |         |      |   |         |         |   |   |         |        
|                               | Current year                   |                |         | 209,299 |      |   |         | 236,398 |   |   |         | 228,848 |  
|                               | Prior years                    |                |         | 43,443  |      |   |         | 5,630   |   |   |         | 29,000  |  
|                               |                                |                |         |         |      |   |         |         |  
|                               | Total incurred                 |                |         | 252,742 |      |   |         | 242,028 |   |   |         | 257,848 |  
|                               |                                |                |         |         |      |   |         |         |  
|Paid related to                |                                |                |         |         |      |   |         |         |   |   |         |        
|                               | Current year                   |                |         | 38,464  |      |   |         | 43,867  |   |   |         | 41,693  |  
|                               | Prior years                    |                |         | 181,657 |      |   |         | 161,690 |   |   |         | 124,554 |  
|                               |                                |                |         |         |      |   |         |         |  
|                               | Total paid                     |                |         | 220,121 |      |   |         | 205,557 |   |   |         | 166,247 |  
|                               |                                |                |         |         |      |   |         |         |  
|Net balance, end of year       |                                |                | 574,647 |         |      |   | 542,026 |         |   |   | 505,555 |        
|                               | Plus, reinsurance recoverables |                |         | 98,958  |      |   |         | 95,468  |   |   |         | 91,491  |  
|                               |                                |                |         |         |      |   |         |         |  
|Balance, end of period         |                                | $              | 673,605 |         |      | $ | 637,494 |         |   | $ | 597,046 |        
|                               |                                |                |         |         |      |   |         |         |  

During the years ended December 31, 2003,
2002 and 2001, management made adjustments to prior years
loss reserves, specifically, accident years 1999 through 2002.
The unfavorable development totaled $43.4 million in 2003,
$5.6 million in 2002, and $29.0 million in 2001. As a
percentage of net reserves as of the beginning of the year,
these adjustments represented 8.0%, 1.1% and 7.0%, respectively.

In the second half of 2001, the Company
encountered a large increase in reported losses, primarily in
its Florida, Ohio and Kentucky professional liability markets.
This increase in reported losses was the result of an over 20%
increase in the average severity of claims reported in 2001. The
2001 adjustment was also unusually large because the Ohio and
Florida markets were relatively new for the Company, making
initial reserve estimates very difficult to predict. These
higher than expected loss trends continued into 2002, but at a
much lower level. As a result, the Company also increased prior
year loss reserves in 2002, primarily in its Ohio and Florida
markets.

During the third quarter of 2003, the Company
experienced a sharp increase in the severity of paid losses in
our medical professional liability segment, which indicated a
much higher trend in claims severity. As a result, actuarial
projections resulted in higher ultimate severities of loss on
currently existing claims related to the 1999 through 2002
accident years, which resulted in management increasing its
estimate of incurred but not reported claims related to the 1999
through 2002 accident years by approximately $43.0 million
in the third quarter of 2003.

The unfavorable development in the third quarter
of 2003 was primarily related to the Companys Ohio
($16.4 million), Florida ($16.0 million) and Kentucky
($15.0 million) markets, partially offset by positive
development in the Michigan market. The Company announced its
exit from the Florida market in 2002 and also discontinued
writing occurrence-based policies in the Ohio and Kentucky
markets in 2002. There was no significant unfavorable
development noted on prior year medical professional liability
loss reserves during the fourth quarter of 2003.

64



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##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                                                           
|-- | ----------------------------------------------------------
|8. | Unpaid Losses and Loss Adjustment Expenses
    (continued)

Management believes that the estimate of the
ultimate liability for losses and loss adjustment expenses at
December 31, 2003 is reasonable and reflects the
anticipated ultimate loss experience. However, it is possible
that the Companys actual incurred loss and losses and loss
adjustment expenses will not conform to the assumptions inherent
in the estimation of the liability. Accordingly, it is
reasonably possible that the ultimate settlement of losses and
the related loss adjustment expenses may vary significantly from
the estimated amounts included in the accompanying Consolidated
Balance Sheets.



|   |               
|-- | --------------
|9. | Long Term Debt

In May 2003, the Company formed American
Physicians Capital Statutory Trust I and APCapital
Trust II (the Trusts) by contributing equity of
$464,000 to each trust. The trusts were formed for the purpose
of issuing mandatorily redeemable trust preferred securities
(TPS). Each trust issued $15 million of TPS to
another trust formed by an institutional investor. The trusts
received a total of $29.1 million in net proceeds, after
the deduction of a total of approximately $906,000 of
commissions paid to the placement agents in the transactions.
These commissions were ultimately paid by APCapital, and have
been capitalized and are included in other assets on the
accompanying Consolidated Balance Sheet. Issuance costs will be
amortized over five years as a component of amortization expense.

The gross proceeds from the trust issuances, and
the cash from the equity contribution, were used by the trusts
to purchase Debentures issued by APCapital. The TPS issued by
the trusts have financial terms similar to the floating rate
junior subordinated deferrable interest debentures (the
Debentures) issued by APCapital. In accordance with
FIN No. 46, these trusts are not consolidated in the
Companys Consolidated Financial Statements. See
Note 2 for further discussion regarding the impact of FIN
No. 46.

The Debentures issued by APCapital mature in
30 years and bear interest at an annual rate equal to the
three-month LIBOR plus 4.10% for the first trust issuance, and
plus 4.20% for the second trust issuance, payable quarterly. The
interest rate is adjusted on a quarterly basis provided that
prior to May 2008, the interest rate shall not exceed 12.50%.
The weighted average interest rates of 5.31% (Trust I
issuance) and 5.40% (Trust II issuance) resulted in
interest expense of approximately $1.0 million for the year
ended December 31, 2003. At December 31, 2003, accrued
interest payable to the trusts was approximately $182,000. The
Debentures are callable by APCapital at par beginning in May
2008. APCapital has guaranteed that the payments made to the
Trusts will be distributed by the Trusts to the holders of the
TPS. As the amounts that could potentially be payable under the
guarantees are recorded as liabilities by the Company, no
additional liability related to these guarantees has been
accrued.

The Debentures are unsecured obligations of the
Company and are junior in the right of payment to all future
senior indebtedness of the Company. The Company estimates that
the fair value of the debentures approximates the gross proceeds
of cash received at the time of issuance.



|    |            
|--- | -----------
|10. | Reinsurance

Reinsurance arises from the Company seeking to
reduce its loss exposure on its higher limit policies. The
Company has mainly entered into excess of loss contracts for
medical malpractice and workers compensation.

65



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                        
|--- | -----------------------
|10. | Reinsurance (continued)

A reconciliation of direct premiums to net
premiums, on both a written and earned basis, for the years
ended December 31, 2003, 2002, and 2001 is as follows:

|                               |     |                |         |         |                |   |         |                |  |   |         |         |  |         |         |         |        |   |         |         |  |   |         |         | 
|------------------------------ | --- | -------------- | ------- | ------- | -------------- | - | ------- | -------------- |  | - | ------- | ------- |  | ------- | ------- | ------- | ------ | - | ------- | ------- |  | - | ------- | ------- | 
|                               |     |                |         |         |                |  
|                               |     | 2003           |         |         | 2002           |   |         | 2001           | 
|                               |     |                |         |         |                |   |         |                | 
|                               |     | Written        |         |         | Earned         |   |         | Written        |  |   | Earned  |         |  | Written |         |         | Earned |  
|                               |     |                |         |         |                |   |         |                |  |   |         |         |  |         |         |         |        |  
|                               |     |                |         |         |                |  
|                               |     | (In thousands) |         |         | (In thousands) |   |         | (In thousands) | 
|Direct                         |     | $              | 256,236 |         |                | $ | 256,458 |                |  | $ | 266,260 |         |  | $       | 262,847 |         |        | $ | 230,765 |         |  | $ | 219,035 |        
|Ceded                          |     |                | (36,343 | )       |                |   | (36,014 | )              |  |   | (29,769 | )       |  |         | (29,271 | )       |        |   | (24,933 | )       |  |   | (19,333 | )      
|Assumed                        |     |                | 4,754   |         |                |   | 4,146   |                |  |   | 1,926   |         |  |         | 1,975   |         |        |   | 2,947   |         |  |   | 2,669   |        
|                               |     |                |         |         |                |   |         |                |  |   |         |         |  |         |         |         |        |  
|                               | Net |                | $       | 224,647 |                |   | $       | 224,590        |  |   | $       | 238,417 |  |         | $       | 235,551 |        |   | $       | 208,779 |  |   | $       | 202,371 | 
|                               |     |                |         |         |                |   |         |                |  |   |         |         |  |         |         |         |        |  
|Assumed as a percentage of net |     |                | 2.1     | %       |                |   | 1.8     | %              |  |   | 0.8     | %       |  |         | 0.8     | %       |        |   | 1.4     | %       |  |   | 1.3     | %      
|                               |     |                |         |         |                |   |         |                |  |   |         |         |  |         |         |         |        |  

Losses and loss adjustment expenses incurred are
net of ceded losses of $33,497,000 for 2003, $31,725,000 for
2002, and $46,721,000 for 2001.

The Companys policy is to enter into
reinsurance contracts only with highly rated reinsurers.
Reinsurance contracts do not relieve the Company from its
obligations to policyholders. If the reinsurance company is
unable to meet its obligations under existing reinsurance
agreements, the Company remains liable for ceded reserves for
unpaid losses, loss adjustment expenses and unearned premiums.

The Company had reinsurance recoverables from the
following reinsurers at December 31, 2003 and 2002:

|                                             |  |                |         |  |      |   |         | 
|-------------------------------------------- |  | -------------- | ------- |  | ---- | - | ------- | 
|                                             |  | 2003           |         |  | 2002 |  
|                                             |  |                |         |  |      |  
|                                             |  |               
|                                             |  | (In thousands) |        
|Hannover Ruckversicherungs                   |  | $              | 34,348  |  |      | $ | 27,065  | 
|Gerling Global Reinsurance Corporation       |  |                | 17,528  |  |      |   | 17,202  | 
|American Re-Insurance Company                |  |                | 13,507  |  |      |   | 5,990   | 
|Transatlantic Reinsurance Company            |  |                | 11,284  |  |      |   | 11,626  | 
|General Reinsurance Corporation              |  |                | 5,250   |  |      |   | 11,716  | 
|PMA Capital Insurance Corporation            |  |                | 4,739   |  |      |   | 4,011   | 
|Lloyds of London                             |  |                | 4,515   |  |      |   | 2,237   | 
|Workers Compensation Reinsurance Association |  |                | 2,427   |  |      |   | 3,395   | 
|Medical Assurance Company                    |  |                | 2,363   |  |      |   | 2,056   | 
|Employers Reinsurance Corporation            |  |                | 1,762   |  |      |   | 5,831   | 
|Converium Reinsurance                        |  |                | 1,718   |  |      |   | 5,754   | 
|Others                                       |  |                | 15,730  |  |      |   | 12,434  | 
|                                             |  |                |         |  |      |  
|                                             |  | $              | 115,171 |  |      | $ | 109,317 | 
|                                             |  |                |         |  |      |  

Amounts due from reinsurers on the accompanying
balance sheet consisted of the following:

|                                                                                                           |                                     |                |         |         |      |   |        |         | 
|---------------------------------------------------------------------------------------------------------- | ----------------------------------- | -------------- | ------- | ------- | ---- | - | ------ | ------- | 
|                                                                                                           |                                     | 2003           |         |         | 2002 |  
|                                                                                                           |                                     |                |         |         |      |  
|                                                                                                           |                                     |               
|                                                                                                           |                                     | (In thousands) |        
|Reinsurance recoverable                                                                                    |                                     | $              | 103,652 |         |      | $ | 98,128 |        
|Prepaid reinsurance premium (included in other
    assets on the accompanying Consolidated Balance Sheets) |                                     |                | 11,519  |         |      |   | 11,189 |        
|                                                                                                           |                                     |                |         |         |      |  
|                                                                                                           | Amounts recoverable from reinsurers |                | $       | 115,171 |      |   | $      | 109,317 | 
|                                                                                                           |                                     |                |         |         |      |  

66



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |             
|--- | ------------
|11. | Income Taxes

The provision for income taxes for the years
ended December 31, 2003, 2002 and 2001 consists of:

|                                 |  |                |         |   |      |   |        |      |  |   |         |  
|-------------------------------- |  | -------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | -
|                                 |  | 2003           |         |   | 2002 |   |        | 2001 | 
|                                 |  |                |         |   |      |   |        |      | 
|                                 |  |               
|                                 |  | (In thousands) |        
|Current benefit                  |  | $              | (3,620  | ) |      | $ | (3,478 | )    |  | $ | (6,532  | )
|Deferred benefit                 |  |                | (10,756 | ) |      |   | (2,051 | )    |  |   | (16,918 | )
|Deferred tax valuation allowance |  |                | 50,672  |   |      |   |       |      |  |   |        |  
|                                 |  |                |         |   |      |   |        |      | 
|                                 |  | $              | 36,296  |   |      | $ | (5,529 | )    |  | $ | (23,450 | )
|                                 |  |                |         |   |      |   |        |      | 

Income taxes incurred do not bear the usual
relationship to income before income taxes for the years ended
December 31, 2003, 2002, and 2001 due to the following:

|                         |                     |                |         |        |      |  |        |         |  |   |         |      |   |  |       |       |  |   |         |      |   |  |       |       | 
|------------------------ | ------------------- | -------------- | ------- | ------ | ---- |  | ------ | ------- |  | - | ------- | ---- | - |  | ----- | ----- |  | - | ------- | ---- | - |  | ----- | ----- | 
|                         |                     |                |         |        |      | 
|                         |                     | 2003           |         |        | 2002 |  |        | 2001    | 
|                         |                     |                |         |        |      |  |        |         | 
|                         |                     |                |         |        |      |  |        |         |  |  
|                         |                     |               
|                         |                     | (In thousands) |        
|Loss before income taxes |                     | $              | (40,883 | )      |      |  |        |         |  | $ | (14,941 | )    |   |  |       |       |  | $ | (67,230 | )    |   |  |       |      
|                         |                     |                |         |        |      |  |        |         |  |   |         |      |   |  |       |       |  |  
|Tax at statutory rate    |                     |                | (14,309 | )      |      |  | 35.0%  |         |  |   | (5,229  | )    |   |  | 35.0% |       |  |   | (23,531 | )    |   |  | 35.0% |      
|Tax effect of:           |                     |                |         |        |      |  |        |         |  |   |         |      |   |  |       |       |  |   |         |      |   |  |       |      
|                         | Tax exempt interest |                |         | (486   | )    |  |        | 1.2%    |  |   |         | (525 | ) |  |       | 3.5%  |  |   |         | (617 | ) |  |       | 0.9%  | 
|                         | Other items, net    |                |         | 419    |      |  |        | -1.0%   |  |   |         | 225  |   |  |       | -1.5% |  |   |         | 698  |   |  |       | -1.0% | 
|                         | Valuation allowance |                |         | 50,672 |      |  |        | -123.9% |  |   |         |     |   |  |       | 0.0%  |  |   |         |     |   |  |       | 0.0%  | 
|                         |                     |                |         |        |      |  |        |         |  |   |         |      |   |  |       |       |  |  
|                         |                     | $              | 36,296  |        |      |  | -88.8% |         |  | $ | (5,529  | )    |   |  | 37.0% |       |  | $ | (23,450 | )    |   |  | 34.9% |      
|                         |                     |                |         |        |      |  |        |         |  |   |         |      |   |  |       |       |  |  

Deferred federal income tax assets and
liabilities are recognized for the estimated future tax
consequences attributable to the differences between financial
statement carrying amounts of existing assets and liabilities,
and their respective tax bases. The Company has reviewed its
deferred federal income tax assets for recoverability based on
the availability of future taxable income when the deductible
temporary differences are expected to reverse, and has
determined, based on its recent loss experience, that sufficient
taxable income may not exist in the periods of reversal.
Accordingly, the Company has recorded a deferred tax asset
valuation allowance for the entire net deferred tax asset. The
establishment of the valuation allowance during 2003 is recorded
as federal income tax expense in the accompanying Consolidated
Statements of Income. Once the Company has re-established a
pattern of profitability, the deferred tax asset valuation
allowance may be reduced upon evaluation of the availability of
future taxable income.

67



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                         
|--- | ------------------------
|11. | Income Taxes (continued)

At December 31, 2003 and 2002, the
components of the net deferred federal income tax asset were as
follows:

|                                      |                                     |                                                   |   |        |         |   |   |        |        | 
|------------------------------------- | ----------------------------------- | ------------------------------------------------- | - | ------ | ------- | - | - | ------ | ------ | 
|                                      |                                     | 2003                                              |   |        | 2002    |  
|                                      |                                     |                                                   |   |        |         |  
|                                      |                                     |                                                  
|                                      |                                     | (In thousands)                                    |  
|Deferred tax assets arising from      |                                     |                                                   |   |        |         |   |   |       
|                                      | Losses and loss adjustment expenses |                                                   | $ | 29,385 |         |   | $ | 31,072 |       
|                                      | Net operating loss carryforwards    |                                                   |   | 15,658 |         |   |   | 3,326  |       
|                                      | Unearned and audit premiums         |                                                   |   | 7,732  |         |   |   | 8,140  |       
|                                      | Minimum tax credits                 |                                                   |   | 8,242  |         |   |   | 9,101  |       
|                                      | Realized losses on investments      |                                                   |   | 4,257  |         |   |   | 2,893  |       
|                                      | Goodwill                            |                                                   |   | 4,827  |         |   |   | 5,485  |       
|                                      | Other                               |                                                   |   | 2,604  |         |   |   | 1,843  |       
|                                      |                                     |                                                   |   |        |         |  
|                                      |                                     | Total deferred tax assets                         |   |        | 72,705  |   |   |        | 61,860 | 
|                                      |                                     |                                                   |   |        |         |  
|Deferred tax liabilities arising from |                                     |                                                   |   |        |         |   |   |       
|                                      | Deferred policy acquisition costs   |                                                   |   | 3,656  |         |   |   | 3,807  |       
|                                      | Net unrealized gains on securities  |                                                   |   | 15,942 |         |   |   | 13,263 |       
|                                      | Other                               |                                                   |   | 2,435  |         |   |   | 2,248  |       
|                                      |                                     |                                                   |   |        |         |  
|                                      |                                     | Total deferred tax liabilities                    |   |        | 22,033  |   |   |        | 19,318 | 
|                                      |                                     |                                                   |   |        |         |  
|                                      |                                     | Net deferred tax asset before valuation allowance |   |        | 50,672  |   |   |        | 42,542 | 
|                                      |                                     |                                                   |   |        |         |  
|                                      |                                     | Valuation allowance                               |   |        | (50,672 | ) |   |        |       | 
|                                      |                                     |                                                   |   |        |         |  
|                                      | Net deferred tax asset              |                                                   | $ |       |         |   | $ | 42,542 |       
|                                      |                                     |                                                   |   |        |         |  

At December 31, 2003, the Company had the
following net operating loss carryforwards:

|                                                             |  |                |        |        |            |   |         |            |  |  |      | 
|------------------------------------------------------------ |  | -------------- | ------ | ------ | ---------- | - | ------- | ---------- |  |  | ---- | 
|                                                             |  |                |        | Annual |            |   | Year of |           
|                                                             |  | Amount         |        |        | Limitation |   |         | Expiration | 
|                                                             |  |                |        |        |            |   |         |            | 
|                                                             |  | (In thousands) |        |        |            |   |        
|New Mexico Physicians Mutual Liability Company
    merger(2) |  | $              | 5,720  |        |            | $ | 575     |            |  |  | 2010 | 
|State Mutual Insurance Company merger(2)                     |  | $              | 4,073  |        |            | $ | 340     |            |  |  | 2012 | 
|2003 net operating loss(1)                                   |  | $              | 34,222 |        |            |   |        |            |  |  | 2018 | 



---



|    |                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------
|(1) | There are no change in control limitations on the
    annual use of net operating losses related to the year ended
    December 31, 2003.
|   
|(2) | American Physicians merged with New Mexico
    Physicians Mutual Liability Company and State Mutual Insurance
    Company in 1997.       

In addition, the Company had approximately
$8.2 million of minimum tax credits which can be carried
forward indefinitely.



|    |                     
|--- | --------------------
|12. | Shareholders Equity

In September 2003, the Board of Directors
authorized the Company to purchase an additional
500,000 shares of its outstanding common stock. This brings
the total number of shares authorized to be repurchased under
publicly announced plans to 3,615,439. The following table
reflects the number of shares

68



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                     
|--- | ------------------------------------
|12. | Shareholders Equity
    (continued)

repurchased during the years ended
December 31, 2003, 2002 and 2001, the cost of shares
repurchased, the average price per share repurchased during
those periods, as well as the cumulative inception to date
totals.

|                                   |  |                                                  |           |  |                                 |   |         |      |  |   |           |  |  |   |           | 
|---------------------------------- |  | ------------------------------------------------ | --------- |  | ------------------------------- | - | ------- | ---- |  | - | --------- |  |  | - | --------- | 
|                                   |  |                                                  |           | 
|                                   |  | Inception                                        |           |  | For the Year Ended December 31, |  
|                                   |  | to Date                                          |           |  |                                 |  
|                                   |  | Totals                                           |           |  | 2003                            |   |         | 2002 |  |   | 2001      | 
|                                   |  |                                                  |           |  |                                 |   |         |      |  |   |           | 
|                                   |  |                                                 
|                                   |  | (Dollars in thousands, except per share amounts) |          
|Number of shares repurchased       |  |                                                  | 3,197,070 |  |                                 |   | 272,800 |      |  |   | 1,555,100 |  |  |   | 1,369,170 | 
|Cost of shares repurchased         |  | $                                                | 60,382    |  |                                 | $ | 7,676   |      |  | $ | 27,483    |  |  | $ | 25,225    | 
|Average cost per share repurchased |  | $                                                | 18.89     |  |                                 | $ | 28.14   |      |  | $ | 17.67     |  |  | $ | 18.42     | 

The Companys repurchase of any of its
shares is subject to limitations that may be imposed by
applicable laws and regulations and the rules of the Nasdaq
Stock Market. The timing of the purchases and the number of
shares to be bought at any one time depend on market conditions
and the Companys capital requirements. As of
December 31, 2003, the Company has 418,369 shares of
its September 11, 2003 stock repurchase program remaining
to be purchased.

Approximately $1.032 billion of consolidated
assets represents assets of the Companys insurance
operations that are subject to regulation and may not be
transferred to APCapital in the form of dividends, loans or
advances. The amount of dividends that the Companys
insurance subsidiaries can pay to APCapital in any 12-month
period is limited to the greater of statutory net income for the
preceding year, excluding realized gains (losses) on sales of
investments, or 10% of surplus as of the preceding year end. As
of January 1, 2004, approximately $14.8 million could
be paid by the Companys insurance subsidiaries without
prior regulatory approval.



|    |                                    
|--- | -----------------------------------
|13. | Fair Value of Financial Instruments

SFAS No. 107, Disclosures About
Fair Value of Financial Instruments, requires disclosures
of fair-value information about financial instruments, whether
or not recognized in the balance sheet, for which it is
practicable to estimate that value. In situations where quoted
market prices are not available, fair values are to be based on
estimates using present value or other valuation techniques.
SFAS No. 107 excludes certain financial instruments
and all non-financial instruments from its disclosure
requirements.

Under SFAS No. 107, the Companys
investment securities, cash and cash equivalents, premiums
receivable, reinsurance recoverable on paid losses, long-term
debt, and note payable constitute financial instruments. The
carrying amounts of all financial instruments approximated their
fair values at December 31, 2003 and 2002.



|    |                      
|--- | ---------------------
|14. | Restructuring Charges

In November, 2001, the Company reduced personnel
in its Information Systems department and its management team. A
total of eleven people were terminated resulting in $1,891,000
of severance costs and $26,000 of other costs. In December 2001,
the Company completed its phase out of the personal and
commercial lines and all policies have been non-renewed. A total
of nine people were terminated resulting in a charge of
$567,000. At December 31, 2002, substantially all
activities related to the restructuring initiatives were
substantially complete; however, structured severance packages
were not completely paid out until 2003.

In the fourth quarter of 2003, the Company began
to exit its workers compensation line of business. A total
of twelve employees were terminated resulting in $808,000 of
one-time employee severance costs. Approximately $81,000 of
these costs were paid prior to December 31, 2003, with the
remaining $727,000 expected to be paid out over the next
10 months in accordance with the structure of the severance
packages.

69



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                  
|--- | ---------------------------------
|14. | Restructuring Charges (continued)

These costs have been included in the loss before
taxes reported for the workers compensation segment for
the year ended December 31, 2003 (Note 21).

The remaining amounts to be paid for
restructuring charges are as follows:

|                     |  |                |      |   |      |  |       |      |  |   |        |  
|-------------------- |  | -------------- | ---- | - | ---- |  | ----- | ---- |  | - | ------ | -
|                     |  | 2003           |      |   | 2002 |  |       | 2001 | 
|                     |  |                |      |   |      |  |       |      | 
|                     |  |               
|                     |  | (In thousands) |     
|Balance, January 1   |  | $              | 216  |   |      |  | 1,130 |      |  |   | 454    |  
|Employee separations |  |                | 808  |   |      |  |      |      |  |   | 2,484  |  
|Payments             |  |                | (297 | ) |      |  | (914  | )    |  |   | (1,808 | )
|                     |  |                |      |   |      |  |       |      | 
|Balance, December 31 |  | $              | 727  |   |      |  | 216   |      |  | $ | 1,130  |  
|                     |  |                |      |   |      |  |       |      | 

In addition to the above amounts, certain
employees related to the workers compensation line of
business have been retained to manage the run-off of this line.
The employee separation costs related to these individuals will
be recognized prospectively over the future service period. At
December 31, 2003, total future employee separation costs
are estimated to be approximately $300,000.



|    |                           
|--- | --------------------------
|15. | Related Party Transactions

The note payable to an officer represents the
remaining annual installment payments due to the Companys
former President and CEO in connection with the purchase of
Stratton-Cheeseman Management Company in 1999. In accordance
with the original purchase agreement, the remaining annual
installments have been reduced by $200,000 each because of the
half-grade decrease in the Companys A.M. Best Company
rating during the fourth quarter of 2003. The note aggregated
$6,000,000 and $6,566,800 at December 31, 2003 and 2002
respectively. As specified in the original purchase agreement,
the note was paid in its entirety in January 2004 upon the
retirement of the former President and CEO, effective
December 31, 2003.

The former President and CEO of the Company is a
majority owner of SCW Agency Group, Inc., formerly Stratton
Cheeseman & Walsh, Inc. (SCW), an
agency that sells the Companys medical professional
liability insurance in Michigan, Illinois, Kentucky,
Florida and Nevada and workers compensation insurance in
Michigan, Kentucky and other states. Direct premiums written by
the agency during 2003, 2002, and 2001 totaled $75,270,000,
$70,810,000, and $68,896,000, respectively, representing, 29.4%,
26.6%, and 29.9% of direct premiums written during such years.
Commission expense incurred related to SCW approximated
$5,962,000, $5,560,000, and $4,660,000 in 2003, 2002, and 2001,
respectively.

SCW leased approximately 10,000 square feet
of office space from the Company in 2003, approximately
13,000 square feet in 2002 and approximately 10,000 sq.
feet in 2001. The Company received $214,000, $283,000, and
$216,000 in rental income in 2003, 2002, and 2001, respectively,
from the agency related to the leased office space.

The Company also has a non-interest bearing note
receivable from SCW related to the establishment of a sales
force in the state of Nevada. This note is to be repaid through
a reduced commission rate on premium written by SCW in the state
of Nevada over a period of time not to exceed ten years. Any
unpaid amounts at the end of ten years will be forgiven. At
December 31, 2003 and 2002 the Companys non-interest
bearing receivable from SCW was approximately $286,000 and
$310,000, respectively. At December 31, 2003 and 2002, the
Company has established an allowance in the amount of $286,000
and $300,000, respectively, in the event that the receivable
balance owed by SCW is not repaid as a result of a reduction or
elimination of premiums written in Nevada. Accordingly, the net
receivable at December 31, 2003 and 2002 was $0 and
$10,000, respectively.

70



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                           
|--- | ------------------------------------------
|15. | Related Party Transactions
    (continued)

In 2001, a representative from a law firm
providing legal services to the Company was appointed an officer
of the Company. Legal services provided by this firm to the
Company during 2003, 2002 and 2001 were $390,000, $410,000 and
$370,000, respectively.



|    |                       
|--- | ----------------------
|16. | Employee Benefit Plans

The Company offers benefits under certain defined
contribution plans. In 2003, 2002 and 2001, the defined
contribution plans provide for Company contributions of 5% of
employee compensation, as defined in the plan, and a 100% match
of employee contributions on the first 3% of contributions and
50% match on the next 2% of contributions. Employer
contributions to the plans were approximately $986,000,
$995,000, and $1,672,000, for 2003, 2002, and 2001, respectively.



|    |                         
|--- | ------------------------
|17. | Stock Based Compensation

In December 2000, the Board of Directors adopted
the American Physicians Capital, Inc. Stock Compensation
Plan (the Plan). The Plan provides for the award of
stock options and stock awards for officers, directors and
employees of the Company. These awards must be approved by the
compensation committee of the board of directors. The total
number of shares of the Companys common stock which shall
be available for options and stock awards is
1,200,000 shares.

Certain executive officers, board members and
employees have been granted options to purchase shares of
APCapital common stock. Options granted during 2003, 2002 and
2001 vest in annual installments of 33%, 33%, and 34% on the
first through the third anniversaries, respectively, of the date
of grant. All options expire on the tenth anniversary of the
grant date.

A summary of the Companys stock option
activity is as follows:

|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                |  |          |   |  |   |       | 
|---------------------------------------- |  | ------- | ------- | - | -------------- | - | ----- | ------- |  |  | -------------- | - |  | ------- | ----- |  | -------------- |  | -------- | - |  | - | ----- | 
|                                         |  |         |         |   |                |  
|                                         |  | 2003    |         |   | 2002           |   |       | 2001    | 
|                                         |  |         |         |   |                |   |       |         | 
|                                         |  | Number  |         |   | Weighted       |   |       | Number  |  |  | Weighted       |   |  | Number  |       |  | Weighted       | 
|                                         |  | of      |         |   | Average        |   |       | of      |  |  | Average        |   |  | of      |       |  | Average        | 
|                                         |  | Options |         |   | Exercise Price |   |       | Options |  |  | Exercise Price |   |  | Options |       |  | Exercise Price | 
|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                | 
|Options outstanding at beginning of year |  |         | 987,500 |   |                | $ | 18.39 |         |  |  | 792,500        |   |  | $       | 17.80 |  |                |  | 410,000  |   |  | $ | 13.50 | 
|Granted during year                      |  |         | 5,000   |   |                | $ | 18.48 |         |  |  | 263,000        |   |  | $       | 18.72 |  |                |  | 490,500  |   |  | $ | 20.44 | 
|Exercised during year                    |  |         | (25,800 | ) |                | $ | 16.55 |         |  |  | (18,000        | ) |  | $       | 13.50 |  |                |  |          |   |  |   |       | 
|Canceled during year                     |  |         | (93,500 | ) |                | $ | 17.88 |         |  |  | (50,000        | ) |  | $       | 20.58 |  |                |  | (108,000 | ) |  | $ | 13.50 | 
|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                | 
|Options outstanding at end of year       |  |         | 873,200 |   |                | $ | 18.01 |         |  |  | 987,500        |   |  | $       | 18.39 |  |                |  | 792,500  |   |  | $ | 17.80 | 
|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                | 

|                                           |  |             |                     |  |           |  |      |       |  |           |        |  |  |       |         |  |  |   |       | 
|------------------------------------------ |  | ----------- | ------------------- |  | --------- |  | ---- | ----- |  | --------- | ------ |  |  | ----- | ------- |  |  | - | ----- | 
|                                           |  |            
|Options Outstanding                        |  |             | Options Exercisable | 
|                                           |  |             |                     | 
|                                           |  | Wtd. Avg.   |                     |  |           |  |     
|                                           |  | Remaining   |                     |  | Wtd. Avg. |  |      |       |  | Wtd. Avg. |       
|                                           |  | Contractual |                     |  | Exercise  |  |      |       |  | Exercise  |       
|Range of Exercise Prices                   |  | Number      |                     |  | Life      |  |      | Price |  |           | Number |  |  | Price |        
|                                           |  |             |                     |  |           |  |      |       |  |           |        |  |  |       |        
|$13.50 - $13.50                            |  |             | 278,000             |  |           |  | 6.93 |       |  | $         | 13.50  |  |  |       | 118,500 |  |  | $ | 13.50 | 
|$13.51 - $20.00                            |  |             | 69,000              |  |           |  | 8.76 |       |  | $         | 17.41  |  |  |       | 21,120  |  |  | $ | 17.33 | 
|$20.01 - $20.68                            |  |             | 526,200             |  |           |  | 7.95 |       |  | $         | 20.47  |  |  |       | 326,700 |  |  | $ | 20.45 | 
|Options available for grant at end of year |  |             | 123,303             |  |           |  |      |       |  |           |        |  |  |       |         |  |  |   |       | 
|                                           |  |             |                     |  |           |  |      |       |  |           |        |  |  |       |        

71



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                     
|--- | ------------------------------------
|17. | Stock Based Compensation (continued)

In December 2000, the Company granted 135,200
restricted shares of APCapital common stock, having a per share
market value of $13.50, to certain officers, board members and
employees. The restricted shares vest in annual installments of
10%, 15%, 20%, 25% and 30% on the first through fifth
anniversaries, respectively, of the date of grant.

In December 2000, the Company also granted
200 shares of restricted stock to each full-time employee
for a total grant of 39,600 shares at $13.50 per
share. These shares vested at a rate of 20%, 35% and 45%, in
2001, 2002, and 2003, respectively. During 2003, a total of
51,210 shares vested under the terms of the stock award
programs, including 17,600 shares that were vested in
connection with the retirement of the Companys former
President and CEO, effective December 31, 2003. During 2002
and 2001, a total of 26,580 and 18,110 shares,
respectively, vested under terms of these stock award programs.
A total of 2,685, 5,530 and 21,700 shares were forfeited as
a result of employee terminations prior to vesting during 2003,
2002 and 2001, respectively. The vesting of stock awarded to
officers, directors and employees resulted in a total
compensation expense of $565,000, $421,000 and $265,000 in 2003,
2002, and 2001, respectively.

In 2003, the Company recognized a tax benefit of
$261,000 related to the incremental tax benefit of restricted
stock that vested during the year and stock options that were
exercised during the year. This incremental tax benefit was
credited to additional paid-in-capital.



|    |                   
|--- | ------------------
|18. | Earnings Per Share

Basic and diluted earnings per share are
calculated in accordance with SFAS Statement No. 128,
Earnings per Share.

72



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                               
|--- | ------------------------------
|18. | Earnings Per Share (continued)

The following table sets forth the computation of
basic and diluted earnings per share for the years ended
December 31, 2003, 2002 and 2001:

|                                                           |                                                                                                  |                                 |   |         |       |   |   |         |       |   |   |         |       |  
|---------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ------------------------------- | - | ------- | ----- | - | - | ------- | ----- | - | - | ------- | ----- | -
|                                                           |                                                                                                  | 2003                            |   |         | 2002  |   |   | 2001    |      
|                                                           |                                                                                                  |                                 |   |         |       |   |   |         |      
|                                                           |                                                                                                  |                                
|                                                           |                                                                                                  | (In thousands, except per share |  
|                                                           |                                                                                                  | amounts)                        |  
|Numerator for basic and diluted loss per
    common share: |                                                                                                  |                                 |   |         |       |   |   |         |       |   |   |        
|                                                           | Loss before cumulative effect of a change in
    accounting principal                            |                                 | $ | (76,831 | )     |   | $ | (9,412  | )     |   | $ | (43,780 | )    
|                                                           | Cumulative effect of a change in accounting
    principal                                        |                                 |   |        |       |   |   | (9,079  | )     |   |   |        |      
|                                                           |                                                                                                  |                                 |   |         |       |   |   |         |      
|                                                           | Net loss                                                                                         |                                 | $ | (76,831 | )     |   | $ | (18,491 | )     |   | $ | (43,780 | )    
|                                                           |                                                                                                  |                                 |   |         |       |   |   |         |      
|Denominator:                                               |                                                                                                  |                                 |   |         |       |   |   |         |       |   |   |        
|                                                           | Denominator for basic loss per common
    share  weighted average shares outstanding            |                                 |   | 8,520   |       |   |   | 9,340   |       |   |   | 11,072  |      
|                                                           | Effect of dilutive stock options and awards(1)                                                   |                                 |   |        |       |   |   |        |       |   |   |        |      
|                                                           |                                                                                                  |                                 |   |         |       |   |   |         |      
|                                                           | Denominator for diluted loss per common
    share  adjusted weighted average shares outstanding |                                 |   | 8,520   |       |   |   | 9,340   |       |   |   | 11,072  |      
|                                                           |                                                                                                  |                                 |   |         |       |   |   |         |      
|Loss per common share:                                     |                                                                                                  |                                 |   |         |       |   |   |         |       |   |   |        
|                                                           | Loss before cumulative effect of a change in
    accounting principle                            |                                 |   |         |       |   |   |         |       |   |   |         |      
|                                                           |                                                                                                  | Basic                           |   | $       | (9.02 | ) |   | $       | (1.01 | ) |   | $       | (3.95 | )
|                                                           |                                                                                                  | Diluted                         |   | $       | (9.02 | ) |   | $       | (1.01 | ) |   | $       | (3.95 | )
|                                                           | Cumulative effect of a change in accounting
    principle                                        |                                 |   |         |       |   |   |         |       |   |   |         |      
|                                                           |                                                                                                  | Basic                           |   | $       |      |   |   | $       | (0.97 | ) |   | $       |      |  
|                                                           |                                                                                                  | Diluted                         |   | $       |      |   |   | $       | (0.97 | ) |   | $       |      |  
|                                                           | Net loss                                                                                         |                                 |   |         |       |   |   |         |       |   |   |         |      
|                                                           |                                                                                                  | Basic                           |   | $       | (9.02 | ) |   | $       | (1.98 | ) |   | $       | (3.95 | )
|                                                           |                                                                                                  | Diluted                         |   | $       | (9.02 | ) |   | $       | (1.98 | ) |   | $       | (3.95 | )



---



|    |                                                                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | As the Company was in a net loss position for the
    years ended December 31, 2003, 2002 and 2001, no effect of
    awards or options were calculated as the impact would be
    anti-dilutive.



|    |                              
|--- | -----------------------------
|19. | Commitments and Contingencies

The Company participates in various guaranty
associations in the states in which it writes business, which
protect policyholders and claimants against losses due to
insolvency of insurers. When an insolvency occurs, the
associations are authorized to assess member companies up to the
amount of the shortfall of funds, including expenses. Member
companies are assessed based on the type and amount of insurance
written during the previous calendar years. The Company accrues
for its portion of assessments in accordance with American
Institute of Certified Public Accountants Statement of
Position 97-3, Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments. Assessments
to date are not significant; however, the ultimate liability for
future assessments is not known. Accordingly, the Company is
unable to predict whether such future assessments will
materially affect the financial condition or results of
operations of the Company.

73



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                              
|--- | ---------------------------------------------
|19. | Commitments and Contingencies
    (continued)

APCapital has issued guarantees in connection
with the formation of non-consolidated subsidiary trusts that
were formed during 2003 for the purpose of issuing mandatorily
redeemable TPS. In accordance with the structure and nature of
the transactions, APCapital has guaranteed that amounts paid to
the trusts, related to the debentures issued by APCapital that
the trusts hold, will be distributed to the holders of the TPS.
The amounts payable to the holders of the TPS are recorded as
liabilities on the Companys Consolidated Balance Sheets.
See Note 9 for further information on the trusts, the TPS,
and the debentures issued by APCapital.

The Company is obligated under operating leases,
which have various expiration dates through December 2008.
Minimum future lease payments are as follows: 2004 
$1,336,000; 2005  $924,000; 2006 
$726,000, 2007  $469,000 and 2008 and
thereafter  $2,357,000. Rental expense was $1,615,000
in 2003, $1,900,000 in 2002, and $2,177,000 in 2001.

The Company is the first and second guarantor of
approximately $1.6 million and $4.9 million,
respectively, of debt owed by one of the Companys real
estate partnership investments. The debt matures in 2005, at
which time, if the partnership is not able to refinance the
loan, the Company has committed to provide temporary financing
in an amount not to exceed the amount of the loan that matured
for a period not to exceed nine months. Upon the failure to
perform of the other parties to the guarantee, the Company has
certain remedies that include suing to seek enforcement of the
Companys right of contribution to the partnership, remove
the other parties as managers of the partnership, or force the
sale of the partnership to recover damages. At December 31,
2003 and 2002, the Company has not recorded any liability
related to these guarantees, as the probability of being called
upon to make payment under the guarantees is considered by
management to be remote.

With the exception of the following, the Company
is not currently subject to any material litigation. Though
routine litigation matters may arise in the ordinary course of
the Companys insurance business, management does not
expect these cases to have a material adverse effect on the
Companys financial condition or results of operations.

On both December 30, 2003, and
February 20, 2004, separate putative shareholder class
action complaints were filed in the United States District Court
for the Western District of Michigan against the Company, its
former President and Chief Executive Officer, and its Chief
Financial Officer. The complaints allege violations of federal
securities laws for certain disclosures made by the Company
between February 13, 2003 and November 6, 2003,
regarding its operating results and the adequacy of its
reserves, and each seeks money damages in an unspecified amount.
The Company denies the allegations and intends to vigorously
defend the lawsuits. On each of March 2, 2004 and
March 3, 2004, motions were filed by various shareholders
seeking orders consolidating the two lawsuits, naming the moving
shareholders as lead plaintiff and naming lead counsel. On
March 9, 2004, the parties filed a stipulation and proposed
order consolidating the two cases by dismissing the first suit
with prejudice and appointing a lead plaintiff and lead counsel.
The Company has preserved its right to challenge the propriety
of certifying the case as a class action. The Court has not
acted on this filing. While management believes that meritorious
defenses to the allegations exist, the ultimate disposition of
this litigation could have a material adverse impact on the
Companys financial position, liquidity and results of
operations.



|    |                             
|--- | ----------------------------
|20. | GAAP and Statutory Reporting

American Physicians, APS and ICA, domiciled in
the State of Michigan, are included in the accompanying
Consolidated Financial Statements in accordance with GAAP. These
organizations are subject to regulation by the State of Michigan
Office of Financial and Insurance Services and file financial
statements using statutory accounting practices prescribed or
permitted by the state insurance regulators. Prescribed
statutory accounting practices include a variety of publications
of the National Association of Insurance Commissioners
(NAIC), as well as state laws, regulations and
general administrative rules. Permitted

74



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                             
|--- | --------------------------------------------
|20. | GAAP and Statutory Reporting
    (continued)

statutory accounting practices encompass all
accounting practices not so prescribed. Such practices vary in
certain respects from GAAP. The principal variances are as
follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Deferred policy acquisition costs are charged
    against operations as incurred for statutory accounting purposes.                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | Assets designated as nonadmitted
    assets are charged directly to surplus for statutory
    accounting purposes.                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | Bonds and U.S. government securities are
    generally carried at amortized cost for statutory accounting
    purposes.                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | Unpaid losses and loss adjustment expenses and
    unearned premiums are reported net of the impact of reinsurance
    for statutory accounting purposes.                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | A valuation allowance is required under GAAP when
    it is determined that gross deferred tax assets cannot be
    realized, in whole or in part. For statutory accounting
    purposes, the valuation allowance is replaced with a more
    objective admitted asset test, which is intended to serve the
    same purpose as the GAAP valuation allowance. This more
    quantitative approach under statutory accounting can sometimes
    result in differing amounts of deferred tax assets being carried
    for GAAP and statutory accounting purposes.
|
| |  | American Physicians investment in PIC is
    not consolidated, but rather, accounted for based on the equity
    method of accounting.                                                                                                                                                                                                                                                                                                                                                                                                                        

The following is statutory surplus at
December 31, 2003, 2002, and 2001 and net (loss) income for
the years then ended.

|                                                      |  |                |         |   |      |   |         |      |  |   |         |  
|----------------------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                      |  | 2003           |         |   | 2002 |   |         | 2001 | 
|                                                      |  |                |         |   |      |   |         |      | 
|                                                      |  |               
|                                                      |  | (In thousands) |        
|Statutory surplus, December 31                        |  | $              | 150,270 |   |      | $ | 190,216 |      |  | $ | 203,223 |  
|                                                      |  |                |         |   |      |   |         |      | 
|Statutory net loss for the year ended
    December 31 |  | $              | (36,434 | ) |      | $ | (10,117 | )    |  | $ | (63,535 | )
|                                                      |  |                |         |   |      |   |         |      | 

On January 1, 2001, significant changes to
the statutory basis of accounting became effective in all states
in which the Company is licensed. The cumulative effect of these
changes, known as Codification was recorded as a direct
adjustment to statutory surplus. The effect of adoption resulted
in an increase in statutory surplus of $16.7 million.



|    |                    
|--- | -------------------
|21. | Segment Information

The Company is organized and operates principally
in the property and casualty insurance industry and has five
reportable segments  medical professional liability,
workers compensation, health, personal and commercial and
corporate and other. The accounting policies of the segments are
the same as those described in the basis of presentation.

Expense allocations are based primarily on loss
and loss adjustment expenses by line of business and certain
other estimates for underwriting expenses. Investment income,
investment expense, amortization expense and interest expense
are allocated to the segments based on that segments
ownership percentage of the assets or liabilities
underlying the income or expense. General and administrative
expenses are all attributed to the holding company and are
included in corporate and other. Restructuring expenses are
allocated to the segments based on the nature of the
restructuring.

75



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                
|--- | -------------------------------
|21. | Segment Information (continued)

The financial information that management reviews
in making decisions about resources to be allocated to the
segments and assess their performance, is summarized as follows:

|              |      |                |   |         |              |  |  |         |  |              |            |        |           |           |  |              |              |  |  |              |  |  |  |          |   |  |   |           | 
|------------- | ---- | -------------- | - | ------- | ------------ |  |  | ------- |  | ------------ | ---------- | ------ | --------- | --------- |  | ------------ | ------------ |  |  | ------------ |  |  |  | -------- | - |  | - | --------- | 
|              |      | Medical        |   |         |              |  |  |         |  |              |            |        |           |           | 
|              |      | Professional   |   |         | Workers     |  |  |         |  | Personal and |            |        | Corporate |           |  | Intersegment |              |  | 
|Total assets: |      | Liability      |   |         | Compensation |  |  | Health  |  |              | Commercial |        |           | and Other |  |              | Eliminations |  |  | Consolidated | 
|              |      |                |   |         |              |  |  |         |  |              |            |        |           |           |  |              |              |  |  |              | 
|              |      |               
|              |      | (In thousands) |  
|December 31,  |      |                |   |         |              |  |  |         |  |              |            |        |           |           |  |              |              |  |  |              |  |  |  |          |   |  |   |          
|              | 2003 |                | $ | 909,372 |              |  |  | 113,123 |  |              |            | 5,839  |           |           |  | 4,102        |              |  |  | 234,326      |  |  |  | (203,716 | ) |  | $ | 1,063,046 | 
|              | 2002 |                | $ | 859,804 |              |  |  | 153,612 |  |              |            | 19,003 |           |           |  | 4,089        |              |  |  | 284,075      |  |  |  | (261,665 | ) |  | $ | 1,058,918 | 

|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |         |         | 
|---------------------------------------------------------------------------------------------------------- | ----------------------------------- | ------------------------------------ | ------- | ------- | ------------ | - | -------- | ------ | ------ | --------- | ---------- | ------ | ------ | ----- | ------ | ------------ | ------------ | - | ------ | ------------ | ----- | - | - | ---- | ---- | - | ------- | ------- | ------- | 
|                                                                                                           |                                     |                                     
|                                                                                                           |                                     | For the Year Ended December 31, 2003 |        
|                                                                                                           |                                     |                                      |        
|                                                                                                           |                                     | Medical                              |         |         |              |   | Personal |        |        | Corporate |            |        |       
|                                                                                                           |                                     | Professional                         |         |         | Workers     |   |          |        |        | and       |            |        | and    |       |        | Intersegment |              |   |       
|                                                                                                           |                                     | Liability                            |         |         | Compensation |   |          | Health |        |           | Commercial |        |        | Other |        |              | Eliminations |   |        | Consolidated |      
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     |                                     
|                                                                                                           |                                     | (In thousands)                       |        
|Revenues:                                                                                                  |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |        
|                                                                                                           | Net premiums earned                 |                                      | $       | 158,777 |              |   | $        | 43,844 |        |           | $          | 22,208 |        |       | $      | (239         | )            |   | $      |             |       |   | $ |     |      |   | $       | 224,590 |        
|                                                                                                           | Investment income                   |                                      |         | 36,282  |              |   |          | 5,855  |        |           |            | 741    |        |       |        | 54           |              |   |        | 362          |       |   |   |     |      |   |         | 43,294  |        
|                                                                                                           | Other revenue items                 |                                      |         | 4,649   |              |   |          | 241    |        |           |            | 89     |        |       |        |             |              |   |        | 881          |       |   |   | (578 | )    |   |         | 3,507   |        
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     | Total revenues                       |         |         | 197,933      |   |          |        | 49,940 |           |            |        | 23,038 |       |        |              | (185         | ) |        |              | 1,243 |   |   |      | (578 | ) |         | $       | 271,391 | 
|Expenses:                                                                                                  |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |        
|                                                                                                           | Loss and loss adjustment expenses   |                                      |         | 197,430 |              |   |          | 35,632 |        |           |            | 18,619 |        |       |        | 1,061        |              |   |        |             |       |   |   |     |      |   |         | 252,742 |        
|                                                                                                           | Underwriting expenses               |                                      |         | 31,315  |              |   |          | 15,698 |        |           |            | 3,875  |        |       |        | 216          |              |   |        |             |       |   |   |     |      |   |         | 51,104  |        
|                                                                                                           | General and administrative expenses |                                      |         |        |              |   |          |       |        |           |            |       |        |       |        |             |              |   |        | 2,921        |       |   |   |     |      |   |         | 2,921   |        
|                                                                                                           | Other expense items                 |                                      |         | 3,009   |              |   |          | 1,290  |        |           |            | 54     |        |       |        | 54           |              |   |        | 1,678        |       |   |   | (578 | )    |   |         | 5,507   |        
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     | Total expenses                       |         |         | 231,754      |   |          |        | 52,620 |           |            |        | 22,548 |       |        |              | 1,331        |   |        |              | 4,599 |   |   |      | (578 | ) |         |         | 312,274 | 
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|Loss before income taxes, minority interests and
    cumulative effect of a change in accounting principle |                                     | $                                    | (33,821 | )       |              | $ | (2,680   | )      |        | $         | 490        |        |        | $     | (1,516 | )            |              | $ | (3,356 | )            |       | $ |  |      |      | $ | (40,883 | )      
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      

76



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                
|--- | -------------------------------
|21. | Segment Information (continued)

|                                                                                                           |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |         |         | 
|---------------------------------------------------------------------------------------------------------- | ----------------------------------- | ------------------------------------ | ------ | ------- | ------------ | - | -------- | ------ | ------ | --------- | ---------- | ------ | ------ | ----- | ------ | ------------ | ------------ | - | ------ | ------------ | ----- | - | - | ---- | ---- | - | ------- | ------- | ------- | 
|                                                                                                           |                                     |                                     
|                                                                                                           |                                     | For the Year Ended December 31, 2002 |       
|                                                                                                           |                                     |                                      |       
|                                                                                                           |                                     | Medical                              |        |         |              |   | Personal |        |        | Corporate |            |        |       
|                                                                                                           |                                     | Professional                         |        |         | Workers     |   |          |        |        | and       |            |        | and    |       |        | Intersegment |              |   |       
|                                                                                                           |                                     | Liability                            |        |         | Compensation |   |          | Health |        |           | Commercial |        |        | Other |        |              | Eliminations |   |        | Consolidated |      
|                                                                                                           |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     |                                     
|                                                                                                           |                                     | (In thousands)                       |       
|Revenues:                                                                                                  |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |        
|                                                                                                           | Net premiums earned                 |                                      | $      | 148,646 |              |   | $        | 63,517 |        |           | $          | 23,820 |        |       | $      | (432         | )            |   | $      |             |       |   | $ |     |      |   | $       | 235,551 |        
|                                                                                                           | Investment income                   |                                      |        | 37,349  |              |   |          | 5,924  |        |           |            | 830    |        |       |        | 57           |              |   |        | 615          |       |   |   |     |      |   |         | 44,775  |        
|                                                                                                           | Other revenue items                 |                                      |        | 1,357   |              |   |          | (81    | )      |           |            | (11    | )      |       |        | (512         | )            |   |        | 770          |       |   |   | (560 | )    |   |         | 213     |        
|                                                                                                           |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     | Total revenues                       |        |         | 186,602      |   |          |        | 69,360 |           |            |        | 24,639 |       |        |              | (887         | ) |        |              | 1,385 |   |   |      | (560 | ) |         | $       | 280,539 | 
|Expenses:                                                                                                  |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |        
|                                                                                                           | Loss and loss adjustment expenses   |                                      |        | 162,250 |              |   |          | 55,157 |        |           |            | 23,254 |        |       |        | 1,367        |              |   |        |             |       |   |   |     |      |   |         | 242,028 |        
|                                                                                                           | Underwriting expenses               |                                      |        | 27,157  |              |   |          | 16,222 |        |           |            | 4,849  |        |       |        | 365          |              |   |        |             |       |   |   |     |      |   |         | 48,593  |        
|                                                                                                           | General and administrative expenses |                                      |        |        |              |   |          |       |        |           |            |       |        |       |        |             |              |   |        | 1,395        |       |   |   |     |      |   |         | 1,395   |        
|                                                                                                           | Other expense items                 |                                      |        | 2,414   |              |   |          | 501    |        |           |            | 108    |        |       |        | (6           | )            |   |        | 1,007        |       |   |   | (560 | )    |   |         | 3,464   |        
|                                                                                                           |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     | Total expenses                       |        |         | 191,821      |   |          |        | 71,880 |           |            |        | 28,211 |       |        |              | 1,726        |   |        |              | 2,402 |   |   |      | (560 | ) |         |         | 295,480 | 
|                                                                                                           |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|Loss before income taxes, minority interests and
    cumulative effect of a change in accounting principle |                                     | $                                    | (5,219 | )       |              | $ | (2,520   | )      |        | $         | (3,572     | )      |        | $     | (2,613 | )            |              | $ | (1,017 | )            |       | $ |  |      |      | $ | (14,941 | )      
|                                                                                                           |                                     |                                      |        |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      

|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |         |         | 
|---------------------------------------------------------------------------------------------------------- | ----------------------------------- | ------------------------------------ | ------- | ------- | ------------ | - | -------- | ------ | ------ | --------- | ---------- | ------ | ------ | ----- | ------ | ------------ | ------------ | - | ------ | ------------ | ----- | - | - | ---- | ---- | - | ------- | ------- | ------- | 
|                                                                                                           |                                     |                                     
|                                                                                                           |                                     | For the Year Ended December 31, 2001 |        
|                                                                                                           |                                     |                                      |        
|                                                                                                           |                                     | Medical                              |         |         |              |   | Personal |        |        | Corporate |            |        |       
|                                                                                                           |                                     | Professional                         |         |         | Workers     |   |          |        |        | and       |            |        | and    |       |        | Intersegment |              |   |       
|                                                                                                           |                                     | Liability                            |         |         | Compensation |   |          | Health |        |           | Commercial |        |        | Other |        |              | Eliminations |   |        | Consolidated |      
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     |                                     
|                                                                                                           |                                     | (In thousands)                       |        
|Revenues:                                                                                                  |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |        
|                                                                                                           | Net premiums earned                 |                                      | $       | 119,659 |              |   | $        | 58,377 |        |           | $          | 18,668 |        |       | $      | 5,667        |              |   | $      |             |       |   | $ |     |      |   | $       | 202,371 |        
|                                                                                                           | Investment income                   |                                      |         | 36,975  |              |   |          | 7,444  |        |           |            | 594    |        |       |        | 63           |              |   |        | 2,807        |       |   |   |     |      |   |         | 47,883  |        
|                                                                                                           | Other revenue items                 |                                      |         | (3,659  | )            |   |          | (734   | )      |           |            | (58    | )      |       |        | 9            |              |   |        | (125         | )     |   |   | (538 | )    |   |         | (5,105  | )      
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     | Total revenues                       |         |         | 152,975      |   |          |        | 65,087 |           |            |        | 19,204 |       |        |              | 5,739        |   |        |              | 2,682 |   |   |      | (538 | ) |         | $       | 245,149 | 
|Expenses:                                                                                                  |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |       |   |   |      |      |   |         |        
|                                                                                                           | Loss and loss adjustment expenses   |                                      |         | 168,590 |              |   |          | 62,712 |        |           |            | 18,430 |        |       |        | 8,116        |              |   |        |             |       |   |   |     |      |   |         | 257,848 |        
|                                                                                                           | Underwriting expenses               |                                      |         | 23,281  |              |   |          | 16,402 |        |           |            | 4,193  |        |       |        | 1,235        |              |   |        |             |       |   |   |     |      |   |         | 45,111  |        
|                                                                                                           | General and administrative expenses |                                      |         |        |              |   |          |       |        |           |            |       |        |       |        |             |              |   |        | 1,504        |       |   |   |     |      |   |         | 1,504   |        
|                                                                                                           | Other expense items                 |                                      |         | 3,047   |              |   |          | 947    |        |           |            | 331    |        |       |        | 174          |              |   |        | 3,955        |       |   |   | (538 | )    |   |         | 7,916   |        
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|                                                                                                           |                                     | Total expenses                       |         |         | 194,918      |   |          |        | 80,061 |           |            |        | 22,954 |       |        |              | 9,525        |   |        |              | 5,459 |   |   |      | (538 | ) |         |         | 312,379 | 
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      
|Loss before income taxes, minority interests and
    cumulative effect of a change in accounting principle |                                     | $                                    | (41,943 | )       |              | $ | (14,974  | )      |        | $         | (3,750     | )      |        | $     | (3,786 | )            |              | $ | (2,777 | )            |       | $ |  |      |      | $ | (67,230 | )      
|                                                                                                           |                                     |                                      |         |         |              |   |          |        |        |           |            |        |        |       |        |              |              |   |        |              |      

77



---



##### 



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                     
|--- | ------------------------------------
|22. | Quarterly Financial Data (Unaudited)

The unaudited operating results by quarter for
2003, 2002, and 2001 are summarized below:

|     |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |       |  
|---- | -------------- | ------------------------------------- | ------- | ------------------ | --------------------- | - | ------- | ------- | ----------------- | ---------- | -------------- | ------- | - |  | - | ----- | -
|     |                |                                       |         | (Loss) Income      |                       |   |         |         |                  
|     |                |                                       |         | Before Taxes,      |                       |   |         |         |                  
|     |                |                                       |         | Minority Interest, |                       |   |         |         | Net (Loss) Income |           
|     |                |                                       |         | and Cumulative     |                       |   | Net     |         |                   | Per Common |               
|     |                | Total                                 |         |                    | Effect of a Change in |   |         | (Loss)  |                   |            | Share Assuming |        
|     |                | Revenues                              |         |                    | Accounting Principle  |   |         | Income  |                   |            | Dilution*      |        
|     |                |                                       |         |                    |                       |   |         |         |                   |            |                |        
|     |                |                                      
|     |                | (In thousands, except per share data) |        
|2003 |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |      
|     | 1st Quarter    |                                       | $       | 68,979             |                       |   | $       | (1,515  | )                 |            | $              | (985    | ) |  | $ | (0.11 | )
|     | 2nd Quarter    |                                       |         | 66,267             |                       |   |         | 1,703   |                   |            |                | 1,107   |   |  |   | 0.12  |  
|     | 3rd Quarter*** |                                       |         | 68,292             |                       |   |         | (42,434 | )                 |            |                | (77,055 | ) |  |   | (9.03 | )
|     | 4th Quarter    |                                       |         | 67,853             |                       |   |         | 1,363   |                   |            |                | 102     |   |  |   | 0.01  |  
|     |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |      
|     |                | $                                     | 271,391 |                    |                       | $ | (40,883 | )       |                   | $          | (76,831        | )       |   |  |   |      
|     |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |      
|2002 |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |      
|     | 1st Quarter**  |                                       | $       | 64,595             |                       |   | $       | (5,429  | )                 |            | $              | (12,608 | ) |  | $ | (1.26 | )
|     | 2nd Quarter    |                                       |         | 67,466             |                       |   |         | (4,194  | )                 |            |                | (2,719  | ) |  |   | (0.28 | )
|     | 3rd Quarter    |                                       |         | 72,811             |                       |   |         | (2,996  | )                 |            |                | (1,948  | ) |  |   | (0.21 | )
|     | 4th Quarter**  |                                       |         | 75,667             |                       |   |         | (2,322  | )                 |            |                | (1,216  | ) |  |   | (0.14 | )
|     |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |      
|     |                | $                                     | 280,539 |                    |                       | $ | (14,941 | )       |                   | $          | (18,491        | )       |   |  |   |      
|     |                |                                       |         |                    |                       |   |         |         |                   |            |                |         |   |  |   |      



---



|    |  |                                                                                                                                                                                                                                                                                                         
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   |  | For periods where the Company incurred a loss, no
    effect of awards or options were calculated as the impact would
    be anti-dilutive).                                                                                                                                                            
|   
|**  |  | In accordance with the transition guidance given
    in SFAS No. 142, the goodwill impairment charge, net
    of tax, that was determined in the fourth quarter of 2002 has
    been recorded in the first quarter of 2002 as
    SFAS No. 142 was adopted effective January 1,
    2002 (Notes 2 and 4)
|   
|*** |  | The significant loss in the third quarter of
    2003, as compared to the first, second and fourth quarter of the
    same year, was primarily the result of adverse development on
    prior year loss reserves (Note 8) and the
    establishment of a deferred tax valuation allowance
    (Note 11).

78



---



##### 



SCHEDULE II  CONDENSED FINANCIAL
INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)




CONDENSED BALANCE SHEET


December 31, 2003 and 2002


|                                                                                                                                                             |                                                |                       |         |         |      |   |         |         | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---------------------------------------------- | --------------------- | ------- | ------- | ---- | - | ------- | ------- | 
|                                                                                                                                                             |                                                | 2003                  |         |         | 2002 |  
|                                                                                                                                                             |                                                |                       |         |         |      |  
|                                                                                                                                                             |                                                |                      
|                                                                                                                                                             |                                                | (In thousands, except |        
|                                                                                                                                                             |                                                | share data)           |        
|ASSETS                                                                                                                                                      
|Investments in subsidiaries                                                                                                                                  |                                                | $                     | 202,787 |         |      | $ | 260,664 |        
|Equity securities                                                                                                                                            |                                                |                       | 928     |         |      |   |        |        
|Cash and cash equivalents                                                                                                                                    |                                                |                       | 27,773  |         |      |   | 18,671  |        
|Deferred federal income taxes                                                                                                                                |                                                |                       |        |         |      |   | 942     |        
|Intangible asset                                                                                                                                             |                                                |                       | 625     |         |      |   |        |        
|Federal income taxes recoverable                                                                                                                             |                                                |                       |        |         |      |   | 207     |        
|Other assets                                                                                                                                                 |                                                |                       | 1,731   |         |      |   | 409     |        
|                                                                                                                                                             |                                                |                       |         |         |      |  
|                                                                                                                                                             | Total assets                                   |                       | $       | 233,844 |      |   | $       | 280,893 | 
|                                                                                                                                                             |                                                |                       |         |         |      |  
|LIABILITIES                                                                                                                                                 
|Long-term debt                                                                                                                                               |                                                | $                     | 30,928  |         |      | $ |        |        
|Accrued expenses and other liabilities                                                                                                                       |                                                |                       | 1,108   |         |      |   | 604     |        
|                                                                                                                                                             |                                                |                       |         |         |      |  
|                                                                                                                                                             | Total liabilities                              |                       |         | 32,036  |      |   |         | 604     | 
|                                                                                                                                                             |                                                |                       |         |         |      |  
|Shareholders Equity                                                                                                                                         |                                                |                       |         |         |      |   |         |        
|Common stock, no par value,
    50,000,000 shares authorized, 8,452,778 and
    8,695,492 shares outstanding at December 31, 2003 and
    2002, respectively |                                                |                       |         |         |      |   |         |        
|Additional paid-in capital                                                                                                                                   |                                                |                       | 85,137  |         |      |   | 92,148  |        
|Retained earnings                                                                                                                                            |                                                |                       | 87,352  |         |      |   | 164,183 |        
|Unearned stock compensation                                                                                                                                  |                                                |                       | (288    | )       |      |   | (678    | )      
|Accumulated other comprehensive income, net of
    deferred federal income taxes                                                                             |                                                |                       | 29,607  |         |      |   | 24,636  |        
|                                                                                                                                                             |                                                |                       |         |         |      |  
|                                                                                                                                                             | Total shareholders equity                     |                       |         | 201,808 |      |   |         | 280,289 | 
|                                                                                                                                                             |                                                |                       |         |         |      |  
|                                                                                                                                                             | Total liabilities and shareholders
    equity |                       | $       | 233,844 |      |   | $       | 280,893 | 
|                                                                                                                                                             |                                                |                       |         |         |      |  

These condensed financial statements should be
read in conjunction with the accompanying consolidated financial
statements and notes thereto of American Physicians Capital,
Inc. and Subsidiaries.

79



---



##### 



SCHEDULE II  CONDENSED FINANCIAL
INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)




CONDENSED STATEMENTS OF OPERATIONS


Years Ended December 31, 2003 and
2002


|                                             |                                                                               |                |         |         |      |   |         |         |  
|-------------------------------------------- | ----------------------------------------------------------------------------- | -------------- | ------- | ------- | ---- | - | ------- | ------- | -
|                                             |                                                                               | 2003           |         |         | 2002 |  
|                                             |                                                                               |                |         |         |      |  
|                                             |                                                                               |               
|                                             |                                                                               | (In thousands) |        
|Revenues                                     |                                                                               |                |         |         |      |   |         |        
|Investment income                            |                                                                               | $              | 344     |         |      | $ | 587     |        
|Other income                                 |                                                                               |                | 15      |         |      |   |        |        
|                                             |                                                                               |                |         |         |      |  
|                                             | Total revenues                                                                |                |         | 359     |      |   |         | 587     |  
|Expenses                                     |                                                                               |                |         |         |      |   |         |        
|Interest expense                             |                                                                               |                | 1,008   |         |      |   |        |        
|Amortization expense                         |                                                                               |                | 128     |         |      |   |        |        
|General and administrative expenses          |                                                                               |                | 2,813   |         |      |   | 1,178   |        
|                                             |                                                                               |                |         |         |      |  
|                                             | Total expenses                                                                |                |         | 3,949   |      |   |         | 1,178   |  
|                                             | Loss before income taxes and equity in
    undistributed loss of subsidiaries |                |         | (3,590  | )    |   |         | (591    | )
|Federal income tax expense (benefit)         |                                                                               |                | 393     |         |      |   | (209    | )      
|                                             |                                                                               |                |         |         |      |  
|                                             | Loss before equity in undistributed loss of
    subsidiaries                  |                |         | (3,983  | )    |   |         | (382    | )
|Equity in undistributed loss of subsidiaries |                                                                               |                | (72,848 | )       |      |   | (18,109 | )      
|                                             |                                                                               |                |         |         |      |  
|                                             | Net loss                                                                      |                | $       | (76,831 | )    |   | $       | (18,491 | )
|                                             |                                                                               |                |         |         |      |  

These condensed financial statements should be
read in conjunction with the accompanying consolidated financial
statements and notes thereto of American Physicians Capital,
Inc. and Subsidiaries.

80



---



##### 



SCHEDULE II  CONDENSED
FINANCIAL INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)




CONDENSED STATEMENTS OF CASH FLOW


Years Ended December 31, 2003 and
2002


|                                                                                              |                                          |                                                         |         |      |         |   |         |        |         |  
|--------------------------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------------------------- | ------- | ---- | ------- | - | ------- | ------ | ------- | -
|                                                                                              |                                          | 2003                                                    |         |      | 2002    |  
|                                                                                              |                                          |                                                         |         |      |         |  
|                                                                                              |                                          |                                                        
|                                                                                              |                                          | (In thousands)                                          |        
|Cash flows from operating activities                                                          |                                          |                                                         |         |      |         |   |         |       
|Net loss                                                                                      |                                          | $                                                       | (76,831 | )    |         | $ | (18,491 | )     
|Adjustments to reconcile net loss to net cash
    provided by (used in) operating activities: |                                          |                                                         |         |      |         |   |         |       
|Equity in undistributed loss of subsidiaries                                                  |                                          |                                                         | 72,848  |      |         |   | 18,109  |       
|Amortization                                                                                  |                                          |                                                         | 518     |      |         |   | 323     |       
|Deferred federal income taxes                                                                 |                                          |                                                         | 942     |      |         |   | (403    | )     
|Changes in:                                                                                   |                                          |                                                         |         |      |         |   |         |       
|                                                                                              | Federal income taxes recoverable/payable |                                                         |         | 207  |         |   |         | 580    |        
|                                                                                              | Accrued expenses and other liabilities   |                                                         |         | 504  |         |   |         | (1,014 | )      
|                                                                                              | Other assets                             |                                                         |         | (544 | )       |   |         | 3,672  |        
|                                                                                              |                                          |                                                         |         |      |         |  
|                                                                                              |                                          | Net cash provided by (used in) operating
    activities |         |      | (2,356  | ) |         |        | 2,776   |  
|                                                                                              |                                          |                                                         |         |      |         |  
|Cash flows from investing activities                                                          |                                          |                                                         |         |      |         |   |         |       
|Acquisition of intangible asset                                                               |                                          |                                                         | (625    | )    |         |   |        |       
|Net contributions to subsidiaries                                                             |                                          |                                                         | (10,928 | )    |         |   |        |       
|                                                                                              |                                          |                                                         |         |      |         |  
|                                                                                              |                                          | Net cash used in investing
    activities               |         |      | (11,553 | ) |         |        |        |  
|                                                                                              |                                          |                                                         |         |      |         |  
|Cash flows from financing activities                                                          |                                          |                                                         |         |      |         |   |         |       
|Common stock repurchased                                                                      |                                          |                                                         | (7,676  | )    |         |   | (27,483 | )     
|Debt issuance costs                                                                           |                                          |                                                         | (906    | )    |         |   |        |       
|Issuance of long-term debt                                                                    |                                          |                                                         | 30,928  |      |         |   |        |       
|Stock options exercised                                                                       |                                          |                                                         | 440     |      |         |   | 243     |       
|Other                                                                                         |                                          |                                                         | 225     |      |         |   | (75     | )     
|                                                                                              |                                          |                                                         |         |      |         |  
|                                                                                              |                                          | Net cash provided by (used in) financing
    activities |         |      | 23,011  |   |         |        | (27,315 | )
|                                                                                              |                                          |                                                         |         |      |         |  
|Net increase (decrease) in cash and cash
    equivalents                                      |                                          |                                                         | 9,102   |      |         |   | (24,539 | )     
|Cash and cash equivalents, beginning of year                                                  |                                          |                                                         | 18,671  |      |         |   | 43,210  |       
|                                                                                              |                                          |                                                         |         |      |         |  
|Cash and cash equivalents, end of year                                                        |                                          | $                                                       | 27,773  |      |         | $ | 18,671  |       
|                                                                                              |                                          |                                                         |         |      |         |  

These condensed financial statements should be
read in conjunction with the accompanying consolidated

financial statements and notes thereto of
American Physicians Capital, Inc. and Subsidiaries.


81



---



##### 



SCHEDULE II  CONDENSED
FINANCIAL INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)




NOTES TO CONDENSED FINANCIAL INFORMATION OF
REGISTRANT


Year Ended December 31, 2003




|    |                        
|--- | -----------------------
|(1) | Description of Business

American Physicians Capital, Inc. (APCapital) is
an insurance holding company incorporated under Michigan law on
July 6, 2000.

APCapital owns all of the issued and outstanding
common stock of the following entities:



| |                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | American Physicians Assurance
    Corporation  a stock insurance company incorporated
    under Michigan law (American Physicians), formerly Mutual
    Insurance Corporation Of America                 
|
| | Insurance Corporation of America  a
    stock insurance company incorporated under Michigan law (ICA).                                                                                                   
|
| | APSpecialty Insurance Corporation  a
    stock insurance company incorporated under Michigan law (APS),
    formerly RML Insurance Company.                                                              
|
| | APConsulting, LLC  a Michigan
    consulting company.                                                                                                                                                    
|
| | APDirect Sales, LLC  a Michigan
    corporation that serves as APCapitals direct sales channel.                                                                                                         
|
| | Alpha Advisors, Inc.  an Illinois
    corporation that provides investment management services.                                                                                                          
|
| | APIndemnity (Bermuda) Ltd.  a Bermuda
    company that provides a rent-a-captive vehicle for clients and
    prospects.                                                                                  
|
| | APManagement Ltd.  a Bermuda company
    that provides management and compliance services to APIndemnity
    and to clients and prospects of the financial group.                                        
|
| | American Physicians Capital Statutory
    Trust I  a trust formed in Connecticut for the
    purpose of issuing mandatorily redeemable trust preferred
    securities to institutional investors (Note 9)
|
| | APCapital Trust II  a trust
    formed in Delaware for the purpose of issuing mandatorily
    redeemable trust preferred securities to institutional investors
    (Note 9)                              



|    |                     
|--- | --------------------
|(2) | Federal Income Taxes

Income tax provisions for the individual
companies are computed on a separate company basis.



|    |                 
|--- | ----------------
|(3) | Subsequent Event

In January 2004, APCapital contributed
$25 million to its insurance subsidiary, American
Physicians.

82



---



##### 



SCHEDULE III  SUPPLEMENTARY
INSURANCE INFORMATION

AMERICAN PHYSICIANS CAPITAL, INC.


|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |   |        |        |  |   |        |        |  |   |         |         | 
|------------------------------ | ----- | ------------------------------------------ | ----- | ------------ | ------------- | - | ------- | -------- |  | ------------ | -------- | ------- | ------- | --- | --- | ---------- | ------ | -------- | ---------- | ----------- | ------ | ----------- | ------ | ------ | --------- | - | ------- | -------- |  | - | ------ | ------ |  | - | ------ | ------ |  | - | ------- | ------- | 
|                               |       |                                           
|                               |       | At or for the Year Ended December 31, 2003 |      
|                               |       |                                            |      
|                               |       |                                            |       | Amortization |               |   |        
|                               |       | Deferred                                   |       |              | Unpaid Losses |   |         |          |  | Other Policy |          |         |         | (1) |     |            | Losses |          |            | of Deferred |        |             |       
|                               |       | Policy                                     |       |              | and Loss      |   |         |          |  | Claims and   |          | Net     |         |     | Net |            |        | and Loss |            |             | Policy |             |        | Other  |           |   | Net     |         
|                               |       | Acquisition                                |       |              | Adjustment    |   |         | Unearned |  |              | Benefits |         | Premium |     |     | Investment |        |          | Adjustment |             |        | Acquisition |        |        | Operating |   |         | Premiums | 
|Segment                        |       | Costs                                      |       |              | Expenses      |   |         | Premiums |  |              | Payable  |         | Revenue |     |     | Income     |        |          | Expenses   |             |        | Costs       |        |        | Expenses  |   |         | Written  | 
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          | 
|                               |       |                                           
|                               |       | (In thousands)                             |      
|Medical professional liability |       | $                                          | 8,512 |              |               | $ | 598,329 |          |  | $            | 87,330   |         |         | $   |    |            |        | $        | 158,777    |             |        | $           | 33,748 |        |           | $ | 197,430 |          |  | $ | 19,376 |        |  | $ | 11,939 |        |  | $ | 164,157 |        
|Workers compensation          |       |                                            | 1,949 |              |               |   | 66,509  |          |  |              | 16,476   |         |         |     |    |            |        |          | 43,844     |             |        |             | 5,466  |        |           |   | 35,632  |          |  |   | 5,994  |        |  |   | 9,704  |        |  |   | 38,521  |        
|Health                         |       |                                            |      |              |               |   | 5,625   |          |  |              |         |         |         |     |    |            |        |          | 22,208     |             |        |             | 692    |        |           |   | 18,619  |          |  |   |       |        |  |   | 3,875  |        |  |   | 22,208  |        
|Personal and commercial        |       |                                            |      |              |               |   | 3,142   |          |  |              |         |         |         |     |    |            |        |          | (239       | )           |        |             | 50     |        |           |   | 1,061   |          |  |   |       |        |  |   | 216    |        |  |   | (239    | )      
|Corporate and other            |       |                                            |      |              |               |   |        |          |  |              |         |         |         |     |    |            |        |          |           |             |        |             | (180   | )      |           |   |        |          |  |   |       |        |  |   |       |        |  |   |        |        
|Intersegment eliminations      |       |                                            |      |              |               |   |        |          |  |              |         |         |         |     |    |            |        |          |           |             |        |             | 578    |        |           |   |        |          |  |   |       |        |  |   |       |        |  |   |        |        
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |  
|                               | Total |                                            | $     | 10,461       |               |   | $       | 673,605  |  |              | $        | 103,806 |         |     | $   |           |        |          | $          | 224,590     |        |             | $      | 40,354 |           |   | $       | 252,742  |  |   | $      | 25,370 |  |   | $      | 25,734 |  |   | $       | 224,647 | 
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |  

|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |   |        |        |  |   |       |        |  |   |         |         | 
|------------------------------ | ----- | ------------------------------------------ | ----- | ------------ | ------------- | - | ------- | -------- |  | ------------ | -------- | ------- | ------- | --- | --- | ---------- | ------ | -------- | ---------- | ----------- | ------ | ----------- | ------ | ------ | --------- | - | ------- | -------- |  | - | ------ | ------ |  | - | ----- | ------ |  | - | ------- | ------- | 
|                               |       |                                           
|                               |       | At or for the Year Ended December 31, 2002 |      
|                               |       |                                            |      
|                               |       |                                            |       | Amortization |               |   |        
|                               |       | Deferred                                   |       |              | Unpaid Losses |   |         |          |  | Other Policy |          |         |         | (1) |     |            | Losses |          |            | of Deferred |        |             |       
|                               |       | Policy                                     |       |              | and Loss      |   |         |          |  | Claims and   |          | Net     |         |     | Net |            |        | and Loss |            |             | Policy |             |        | Other  |           |   | Net     |         
|                               |       | Acquisition                                |       |              | Adjustment    |   |         | Unearned |  |              | Benefits |         | Premium |     |     | Investment |        |          | Adjustment |             |        | Acquisition |        |        | Operating |   |         | Premiums | 
|Segment                        |       | Costs                                      |       |              | Expenses      |   |         | Premiums |  |              | Payable  |         | Revenue |     |     | Income     |        |          | Expenses   |             |        | Costs       |        |        | Expenses  |   |         | Written  | 
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          | 
|                               |       |                                           
|                               |       | (In thousands)                             |      
|Medical professional liability |       | $                                          | 8,067 |              |               | $ | 542,456 |          |  | $            | 80,433   |         |         | $   |    |            |        | $        | 148,646    |             |        | $           | 35,156 |        |           | $ | 162,250 |          |  | $ | 19,284 |        |  | $ | 7,873 |        |  | $ | 154,583 |        
|Workers compensation          |       |                                            | 2,810 |              |               |   | 80,274  |          |  |              | 22,987   |         |         |     |    |            |        |          | 63,517     |             |        |             | 5,519  |        |           |   | 55,157  |          |  |   | 8,742  |        |  |   | 7,480 |        |  |   | 60,446  |        
|Health                         |       |                                            |      |              |               |   | 11,150  |          |  |              |         |         |         |     |    |            |        |          | 23,820     |             |        |             | 773    |        |           |   | 23,254  |          |  |   |        |        |  |   | 4,849 |        |  |   | 23,820  |        
|Personal and commercial        |       |                                            |      |              |               |   | 3,614   |          |  |              |         |         |         |     |    |            |        |          | (432       | )           |        |             | 68     |        |           |   | 1,367   |          |  |   |        |        |  |   | 365   |        |  |   | (432    | )      
|Corporate and other            |       |                                            |      |              |               |   |        |          |  |              |         |         |         |     |    |            |        |          |           |             |        |             | (392   | )      |           |   |        |          |  |   |        |        |  |   |       |        |  |   |        |        
|Intersegment eliminations      |       |                                            |      |              |               |   |        |          |  |              |         |         |         |     |    |            |        |          |           |             |        |             | 560    |        |           |   |        |          |  |   |        |        |  |   |       |        |  |   |        |        
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |  
|                               | Total |                                            | $     | 10,877       |               |   | $       | 637,494  |  |              | $        | 103,420 |         |     | $   |           |        |          | $          | 235,551     |        |             | $      | 41,684 |           |   | $       | 242,028  |  |   | $      | 28,026 |  |   | $     | 20,567 |  |   | $       | 238,417 | 
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |  

|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |   |        |        |  |   |       |        |  |   |         |         | 
|------------------------------ | ----- | ------------------------------------------ | ----- | ------------ | ------------- | - | ------- | -------- |  | ------------ | -------- | ------- | ------- | --- | --- | ---------- | ------ | -------- | ---------- | ----------- | ------ | ----------- | ------ | ------ | --------- | - | ------- | -------- |  | - | ------ | ------ |  | - | ----- | ------ |  | - | ------- | ------- | 
|                               |       |                                           
|                               |       | At or for the Year Ended December 31, 2001 |      
|                               |       |                                            |      
|                               |       |                                            |       | Amortization |               |   |        
|                               |       | Deferred                                   |       |              | Unpaid Losses |   |         |          |  | Other Policy |          |         |         | (1) |     |            | Losses |          |            | of Deferred |        |             |       
|                               |       | Policy                                     |       |              | and Loss      |   |         |          |  | Claims and   |          | Net     |         |     | Net |            |        | and Loss |            |             | Policy |             |        | Other  |           |   | Net     |         
|                               |       | Acquisition                                |       |              | Adjustment    |   |         | Unearned |  |              | Benefits |         | Premium |     |     | Investment |        |          | Adjustment |             |        | Acquisition |        |        | Operating |   |         | Premiums | 
|Segment                        |       | Costs                                      |       |              | Expenses      |   |         | Premiums |  |              | Payable  |         | Revenue |     |     | Income     |        |          | Expenses   |             |        | Costs       |        |        | Expenses  |   |         | Written  | 
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          | 
|                               |       |                                           
|                               |       | (In thousands)                             |      
|Medical professional liability |       | $                                          | 7,926 |              |               | $ | 510,397 |          |  | $            | 74,668   |         |         | $   |    |            |        | $        | 119,659    |             |        | $           | 35,069 |        |           | $ | 168,590 |          |  | $ | 17,728 |        |  | $ | 5,553 |        |  | $ | 126,830 |        
|Workers compensation          |       |                                            | 2,786 |              |               |   | 69,124  |          |  |              | 25,358   |         |         |     |    |            |        |          | 58,377     |             |        |             | 7,061  |        |           |   | 62,712  |          |  |   | 7,195  |        |  |   | 9,207 |        |  |   | 64,754  |        
|Health                         |       |                                            |      |              |               |   | 10,900  |          |  |              |         |         |         |     |    |            |        |          | 18,668     |             |        |             | 564    |        |           |   | 18,430  |          |  |   |        |        |  |   | 4,193 |        |  |   | 18,668  |        
|Personal and commercial        |       |                                            |      |              |               |   | 6,625   |          |  |              | 30       |         |         |     |    |            |        |          | 5,667      |             |        |             | 67     |        |           |   | 8,116   |          |  |   | 837    |        |  |   | 398   |        |  |   | (1,473  | )      
|Corporate and other            |       |                                            |      |              |               |   |        |          |  |              |         |         |         |     |    |            |        |          |           |             |        |             | 2,066  |        |           |   |        |          |  |   |        |        |  |   |      |        |  |   |         |        
|Intersegment eliminations      |       |                                            |      |              |               |   |        |          |  |              |         |         |         |     |    |            |        |          |           |             |        |             | 538    |        |           |   |        |          |  |   |        |        |  |   |      |        |  |   |         |        
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |  
|                               | Total |                                            | $     | 10,712       |               |   | $       | 597,046  |  |              | $        | 100,056 |         |     | $   |           |        |          | $          | 202,371     |        |             | $      | 45,365 |           |   | $       | 257,848  |  |   | $      | 25,760 |  |   | $     | 19,351 |  |   | $       | 208,779 | 
|                               |       |                                            |       |              |               |   |         |          |  |              |          |         |         |     |     |            |        |          |            |             |        |             |        |        |           |   |         |          |  |  



---



|    |                                                                                                                                                  
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Net investment income is allocated to each of the
    segments based on that segments ownership of
    the underlying income producing assets.

83



---



##### 





|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

Not applicable.



|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

As of the end of the period covered by this
report, the Company carried out an evaluation, under the
supervision and with the participation of the Companys
management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities
Exchange Act of 1934. Based upon that evaluation, the
Companys Chief Executive Officer and Chief Financial
Officer concluded that the Companys disclosure controls
and procedures are effective to cause the material information
required to be disclosed by the Company in the reports that it
files or submits under the Securities Exchange Act of 1934 to be
recorded, processed, summarized and reported within the time
periods specified in the SECs rules and forms. There have
been no changes in the Companys internal controls over
financial reporting during the quarter ended December 31,
2003 that have materially affected, or are reasonably likely to
materially affect the Companys internal controls over
financial reporting.



PART III




|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The required information will be contained in the
Proxy Statement under the captions Election of
Directors (excluding the Report of the Audit Committee)
and Section 16(a) Beneficial Ownership Reporting
Compliance and is incorporated herein by reference.



|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The required information will be contained in the
Proxy Statement under the caption Compensation of
Executive Officers (excluding the Compensation Committee
Report and the stock performance graph) and Election of
Directors  Director Compensation and is
incorporated herein by reference.



|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The required information will be contained in the
Proxy Statement under the caption Common Stock Ownership
of Certain Beneficial Owners and Management and is
incorporated herein by reference. In addition, the information
contained in the Equity Compensation Plan table under
Item 5 of this Report is incorporated herein by reference.



|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

The required information will be contained in the
Proxy Statement under the caption Certain Relationships
and Transactions and is incorporated herein by reference.



|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The required information will be contained in the
Proxy Statement under the caption Independent
Accountants, and is incorporated herein by reference.

84



---



##### 





PART IV




|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

(a)(1) and (2)

Financial Statements:



| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | Report of independent auditors                                                                                                       
|
| | Consolidated balance sheets as of
    December 31, 2003 and 2002                                                                     
|
| | Consolidated statements of income for the years
    ended December 31, 2003, 2002 and 2001                                           
|
| | Consolidated statements of shareholders
    equity and comprehensive income for the years ended
    December 31, 2003, 2002 and 2001
|
| | Consolidated statements of cash flows for the
    years ended December 31, 2003, 2002 and 2001                                       
|
| | Notes to consolidated financial statements                                                                                           

Financial Statement Schedules:



| |                                                      
| | -----------------------------------------------------
| | II. Condensed financial information of
    registrant
|
| | III. Supplementary insurance information             

All other schedules for which provision is made
in Regulation S-X either (i) are not required under
the related instructions or are inapplicable and, therefore,
have been omitted, or (ii) the information required is
included in the consolidated financial statements or the notes
thereto that are a part hereof.

(a)(3) The exhibits included as part of
this report are listed in the attached Exhibit Index, which
is incorporated herein by reference.

(b) Reports on Form 8-K

During the three months ended December 31,
2003, the following reports on Form 8-K were filed by the
Company.

Current Report on Form 8-K filed
October 30, 2003 disclosing under Items 5 and 7
completion of a trust preferred pool transaction.

Current Report on Form 8-K filed
November 7, 2003 disclosing under Items 7 and 12 the
issuance of a press release announcing a delay in the release of
financial results for the third quarter of 2003.

Current Report on Form 8-K filed
November 12, 2003 disclosing under Items 9 and 12 the
issuance of a press release announcing financial results for the
three and nine months ended September 30, 2003 and certain
other financial information.

Current Report on Form 8-K filed
November 13, 2003 disclosing under Items 9 and 12 the
issuance of a press release announcing financial results for the
three and nine months ended September 30, 2003 and certain
other financial information.

Current Report on Form 8-K/ A filed
November 14, 2003 disclosing under Item 12 the
issuance of a press release announcing financial results for the
three and nine months ended September 30, 2003 and certain
other financial information.

Current Report on Form 8-K filed
November 25, 2003 disclosing under Items 5 and 7 the
issuance of a press release announcing the engagement of a
financial advisor and the issuance of a press release announcing
the unwinding of a recent trust preferred securities issuance.

Current Report on Form 8-K filed
December 3, 2003 disclosing under Items 5 and 7 the
issuance of a press release announcing the intended retirement
of its Chief Executive Officer.

Current Report on Form 8-K filed
December 23, 2003 disclosing under Items 5 and 7 the
issuance of a press release announcing the appointment of a new
President and Chief Executive Officer.

There were no financial statements filed with
these Forms 8-K.

85



---



##### 



SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on March 12, 2004.



| |                                  
| | ---------------------------------
| | AMERICAN PHYSICIANS CAPITAL, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ R. KEVIN CLINTON

| |                                               
| | ----------------------------------------------
| |                                               
| | R. Kevin Clinton                              
| | Its: President and Chief Executive
    Officer

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed by the
following persons on March 12, 2004 on behalf of the
registrant and in the capacities indicated.

|                                                     |  |                                                                                                                             |  | 
|---------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | 
|                                                     |  |                                                                                                                            
|Signature                                            |  | Title                                                                                                                      
|                                                     |  |                                                                                                                            
|                                                    
|/s/ R. KEVIN CLINTONR. Kevin Clinton                 |  | President and Chief Executive Officer
    (principal executive officer)                                                    
|                                                    
|/s/ FRANK H. FREUNDFrank H. Freund                   |  | Executive Vice President, Treasurer,
    Chief Financial Officer
    (principal financial and principal accounting officer)
|                                                    
|/s/ THOMAS R. BERGLUND, M.D.Thomas R. Berglund, M.D. |  | Director and Chairman of the Board                                                                                         
|                                                    
|/s/ BILLY B. BAUMANN, M.D.Billy B. Baumann, M.D.     |  | Director                                                                                                                   
|                                                    
|William B. Cheeseman                                 |  | Director                                                                                                                   
|                                                    
|/s/ MYRON EMERICK, D.O.Myron Emerick, D.O.           |  | Director                                                                                                                   
|                                                    
|/s/ APPARAO MUKKAMALA, M.D.AppaRao Mukkamala, M.D.   |  | Director                                                                                                                   
|                                                    
|/s/ SPENCER L. SCHNEIDERSpencer L. Schneider         |  | Director                                                                                                                   
|                                                    
|/s/ LLOYD A. SCHWARTZLloyd A. Schwartz               |  | Director                                                                                                                   

86



---



##### 





EXHIBIT INDEX


The following documents are filed as part of this
report. Those exhibits previously filed and incorporated herein
by reference are identified below. Exhibits not required for
this report have been omitted. APCapitals commission file
number is 000-32057.

|        |        |  |             |                                                                                                                                                                                                           
|------- | ------ |  | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |  |            
|Number  |        |  | Description
|        |        |  |            
|        | 2.1    |  |             | Plan of Conversion, dated June 28, 2000, as
    amended September 22, 2000(2)                                                                                                                             
|        | 3.1    |  |             | Articles of Incorporation(2)                                                                                                                                                                              
|        | 3.2    |  |             | Amended and Restated Bylaws, as amended
    May 7, 2003(8)                                                                                                                                                
|        | 4.1    |  |             | Indenture relating to Floating Rate Junior
    Subordinated Deferrable Interest Debentures Dated as of
    May 15, 2003(8)                                                                                
|        | 4.2    |  |             | Indenture relating to Floating Rate Junior
    Subordinated Debt Securities Dated as of May 22, 2003(8)                                                                                                   
|        | *10.1  |  |             | American Physicians Capital, Inc. Stock
    Compensation Plan(3)                                                                                                                                          
|        | 10.2   |  |             | Stock Purchase Agreement, dated August 31,
    1999, by and among American Physicians and William B. Cheeseman
    and William J. Gaugier(2)                                                              
|        | 10.3   |  |             | First Amendment, dated October 9, 2000, to
    Stock Purchase Agreement, dated August 31, 1999, by and
    among American Physicians, William B. Cheeseman and William J.
    Gaugier(2)                  
|        | 10.4   |  |             | Stock Purchase Agreement between Kentucky Medical
    Insurance Company and Stratton, Cheeseman &
    Walsh, Inc., dated March 6, 1997(2)                                                                 
|        | 10.5   |  |             | American Physicians/SCW Sales Agency Agreement
    (Medical Professional Liability  Michigan Only),
    dated January 1, 2000(2)                                                                         
|        | 10.6   |  |             | KMIC Insurance Company Agency Agreement, dated
    October 13, 1998(2)                                                                                                                                    
|        | *10.7  |  |             | Employment Agreement between William B. Cheeseman
    and MICOA Management Company, Inc., dated October 27,
    1999(4)                                                                                   
|        | 10.10  |  |             | Agency Agreement between American Physicians and
    Stratton, Cheeseman, Walsh-Nevada, Inc., dated May 25,
    1999(2)                                                                                   
|        | 10.11  |  |             | Sub-Agent Agreement between SCW Agency
    Group, Inc. and Managed Insurance Services, Inc.,
    dated April 11, 2000(2)                                                                                  
|        | 10.12  |  |             | MSMS/American Physicians Marketing Support
    Agreement, effective January 1, 2000, and American
    Physicians(2)                                                                                       
|        | *10.14 |  |             | Executive Employment Agreement, dated as of
    October 11, 2000, between Frank H. Freund and American
    Physicians(4)                                                                                  
|        | *10.16 |  |             | Executive Employment Agreement, dated as of
    October 11, 2000, between Margo C. Runkle and American
    Physicians(4)                                                                                  
|        | *10.18 |  |             | Form of Stock Option Agreement with Directors,
    dated December 5, 2000(4)                                                                                                                              
|        | *10.19 |  |             | Form of Stock Option Agreement with Executives,
    dated December 5, 2000(4)                                                                                                                             
|        | *10.20 |  |             | Form of Restricted Stock Award with Directors,
    dated December 5, 2000(4)                                                                                                                              
|        | *10.21 |  |             | Form of Restricted Stock Award with Executives,
    dated December 5, 2000(4)                                                                                                                             
|        | 10.22  |  |             | Standstill Agreement, dated February 20,
    2002(5)                                                                                                                                                      
|        | 10.23  |  |             | Description of unwritten sublease arrangement
    between American Physicians and SCW Agency(6)                                                                                                           
|        | *10.24 |  |             | Executive Employment Agreement, dated as of
    May 13, 2002, between Annette Flood and American
    Physicians(7)                                                                                        
|        | *10.25 |  |             | Executive Employment Agreement, dated as of
    May 13, 2002, between R. Kevin Clinton and American
    Physicians(7)                                                                                     
|        | 10.26  |  |             | Amended And Restated Declaration Of Trust Dated
    As Of May 15, 2003 by and among U.S. Bank National
    Association, American Physicians Capital, Inc., William B.
    Cheeseman and Frank H. Freund(7)

87



---



##### 



|        |         |  |             |                                                                                                                                                                                            
|------- | ------- |  | ----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |         |  |            
|Number  |         |  | Description
|        |         |  |            
|        | 10.27   |  |             | Amended And Restated Declaration Of Trust Dated
    As Of May 22, 2003 of APCapital Trust II(8)                                                                                            
|        | 10.28   |  |             | Placement Agreement, dated April 25, 2003
    between the Company, American Physicians Capital Statutory
    Trust I, FTN Financial Capital Markets and Keefe
    Bruyette & Woods, Inc.(8)
|        | 10.29   |  |             | Placement Agreement, Dated As Of May 13,
    2003, with Sandler ONeill & Partners L.P.(8)                                                                                                 
|        | 10.30   |  |             | Guarantee Agreement Dated As Of May 15, 2003
    by and between U.S. Bank National Association and American
    Physicians Capital, Inc.(8)                                                
|        | 10.31   |  |             | Guarantee Agreement Dated As Of May 22, 2003
    by and between Wilmington Trust Company and American Physicians
    Capital, Inc.(8)                                                      
|        | *10.32  |  |             | Executive Employment Agreement, dated as of
    June 2, 2003, between Thomas Chase and American Physicians
    Assurance Corporation(8)                                                    
|        | *10.33  |  |             | Letter Agreement between William B. Cheeseman and
    American Physicians Capital, Inc., Dated As Of
    December 23, 2003(1)                                                              
|        | *10.34  |  |             | Consulting Agreement between William B. Cheeseman
    and American Physicians Capital, Inc., Dated As Of
    December 23, 2003(1)                                                          
|        | **10.35 |  |             | Master Agency Agreement between American
    Physicians Assurance Corporation and SCW Agency
    Group, Inc., effective January 1, 2004(1)                                                 
|        | 21.1    |  |             | Subsidiaries of APCapital(1)                                                                                                                                                               
|        | 23.1    |  |             | Consent of PricewaterhouseCoopers LLP(1)                                                                                                                                                   
|        | 31.1    |  |             | Certification of Chief Executive Officer pursuant
    to Rule 13a-14(a) under the Securities Exchange Act of 1934.(1)                                                                      
|        | 31.2    |  |             | Certification of Chief Financial Officer pursuant
    to Rule 13a-14(a) under the Securities Exchange Act of 1934.(1)                                                                      
|        | 32.1    |  |             | Certification of Chief Executive Officer and
    Chief Financial Officer pursuant to 18 U.S.C.
    Section 1350 and Rule 13a-14(b) under the Securities
    Exchange Act of 1934.(1)       



---



|    |                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Current management contracts or compensatory
    plans or arrangements.                                                                                                                                                                                       
|   
|**  | Portions of this exhibit have been omitted
    pursuant to APCapitals request to the Secretary of the
    Securities and Exchange Commission for confidential treatment
    pursuant to Rule 24b-2 under the Securities Exchange Act of
    1934, as amended.
|   
|(1) | Filed herewith.                                                                                                                                                                                                                                               
|   
|(2) | Filed as an exhibit to APCapitals
    Registration Statement on Form S-1 (no. 333-41136), as
    amended, and incorporated herein by reference.                                                                                                              
|   
|(3) | Filed as an exhibit to APCapitals
    Registration Statement on Form S-8 (no. 333-56428) and
    incorporated herein by reference.                                                                                                                           
|   
|(4) | Filed as an exhibit to APCapitals 2000
    Annual Report on Form 10-K and incorporated herein by
    reference.                                                                                                                                              
|   
|(5) | Filed as an exhibit to APCapitals Current
    Report on Form 8-K dated February 21, 2002 and
    incorporated herein by reference.                                                                                                                           
|   
|(6) | Filed as an exhibit to APCapitals 2001
    Annual Report on Form 10-K and incorporated herein by
    reference.                                                                                                                                              
|   
|(7) | Filed as an exhibit to APCapitals 2002
    Annual Report on Form 10-K and incorporated herein by
    reference.                                                                                                                                              
|   
|(8) | Filed as an exhibit to APCapitals Quarterly
    Report on Form 10-Q, as amended, for the quarterly period
    ended June 30, 2003 and incorporated herein by reference.                                                                                      

88