##### Table of Contents









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,
    2002                                             
|                                                                                                                
|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 28, 2002,
based on $18.46 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 $113.3 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 March 10, 2003 the Registrant had
8,701,533 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrants definitive
Proxy Statement pertaining to the 2003 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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TABLE OF CONTENTS



|                                                                         |  |  |  |  |  |  |  | 
|------------------------------------------------------------------------ |  |  |  |  |  |  |  | 
|PART II                                                                 
|REPORT OF INDEPENDENT ACCOUNTANTS                                       
|CONSOLIDATED BALANCE SHEETS                                             
|CONSOLIDATED STATEMENTS OF INCOME                                       
|CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
|CONSOLIDATED STATEMENTS OF CASH FLOWS                                   
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                              
|SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT            
|CONDENSED BALANCE SHEET                                                 
|CONDENSED STATEMENTS OF OPERATIONS                                      
|CONDENSED STATEMENTS OF CASH FLOW                                       
|NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT                  
|PART III                                                                
|PART IV                                                                 
|SIGNATURES                                                              
|CERTIFICATION OF DISCLOSURE                                             
|CERTIFICATION OF DISCLOSURE                                             
|EXHIBIT INDEX                                                           
|Executive Employment Agreement                                          
|Executive Employment Agreement                                          
|Agency Agreement                                                        
|Consent of PricewaterhouseCoopers LLP                                   
|Certification of CEO Pursuant to Section 906                            
|Certification of CFO Pursuant to Section 906                            



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##### Table of Contents



Item 1.     Business

General

American Physicians Capital, Inc., or APCapital,
is an insurance holding company which writes primarily medical
professional liability and workers compensation insurance
through its subsidiaries American Physicians Assurance
Corporation, or APAssurance (formerly Mutual Insurance
Corporation Of America, or MICOA), Insurance Corporation of
America and APSpecialty Insurance Corporation (formerly RML
Insurance Company). It also provides, on a limited basis, health
coverage. 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 APAssurance 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 APAssurance, to various other groups
having specified relationships to APAssurance 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
APAssurance and its subsidiaries became subsidiaries of
APCapital on December 13, 2000.

APAssurance, 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,
APAssurance insured more physicians than any other insurer in
the State of Michigan, a distinction it maintains today.

Summary Premium Volume By Line

The following table sets forth, for the years
ended December 31, 2002, 2001 and 2000, the amount of
direct premiums written, net premiums written, and net premiums
earned for each of our lines of insurance.

|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |       |        | 
|------------------------ | ------------------------------ | ----------------------- | - | ------- | ------- |  |  | ------ | ------ |  | ----- | ------- | ------- | ------ |  | ----- | ------ |  | - | ------- | ------- |  |  | ----- | ------ | 
|                         |                                |                        
|                         |                                | Year Ended December 31, |  
|                         |                                |                         |  
|                         |                                |                         |   |         |         | 
|                         |                                | 2002                    |   |         | 2001    |  |  | 2000   |       
|                         |                                |                         |   |         |         |  |  |        |       
|                         |                                |                         |   | % of    |         |  |  |        | % of   |  |       |         |         | % of   | 
|                         |                                | Amount                  |   |         | Total   |  |  | Amount |        |  | Total |         |         | Amount |  |       | Total  | 
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                |                        
|                         |                                | (dollars in thousands)  |  
|Direct premiums written: |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|                         | Medical professional liability |                         | $ | 177,253 |         |  |  | 66.6%  |        |  | $     | 149,253 |         |        |  | 64.7% |        |  | $ | 123,916 |         |  |  | 61.0% |       
|                         | Workers compensation          |                         |   | 64,194  |         |  |  | 24.1%  |        |  |       | 63,977  |         |        |  | 27.7% |        |  |   | 50,738  |         |  |  | 25.0% |       
|                         | Health                         |                         |   | 24,433  |         |  |  | 9.2%   |        |  |       | 18,001  |         |        |  | 7.8%  |        |  |   | 13,214  |         |  |  | 6.5%  |       
|                         | Other                          |                         |   | 380     |         |  |  | 0.1%   |        |  |       | (466    | )       |        |  | -0.2% |        |  |   | 15,299  |         |  |  | 7.5%  |       
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total                   |   | $       | 266,260 |  |  |        | 100.0% |  |       | $       | 230,765 |        |  |       | 100.0% |  |   | $       | 203,167 |  |  |       | 100.0% | 
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|Net premiums written:    |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|                         | Medical professional liability |                         | $ | 154,583 |         |  |  | 64.8%  |        |  | $     | 126,830 |         |        |  | 60.8% |        |  | $ | 114,541 |         |  |  | 61.2% |       
|                         | Workers compensation          |                         |   | 60,446  |         |  |  | 25.4%  |        |  |       | 64,754  |         |        |  | 31.0% |        |  |   | 48,184  |         |  |  | 25.8% |       
|                         | Health                         |                         |   | 23,820  |         |  |  | 10.0%  |        |  |       | 18,668  |         |        |  | 8.9%  |        |  |   | 11,066  |         |  |  | 5.9%  |       
|                         | Other                          |                         |   | (432    | )       |  |  | -0.2%  |        |  |       | (1,473  | )       |        |  | -0.7% |        |  |   | 13,285  |         |  |  | 7.1%  |       
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total                   |   | $       | 238,417 |  |  |        | 100.0% |  |       | $       | 208,779 |        |  |       | 100.0% |  |   | $       | 187,076 |  |  |       | 100.0% | 
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|Net premiums earned:     |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        |  |   |         |         |  |  |      
|                         | Medical professional liability |                         | $ | 148,646 |         |  |  | 63.1%  |        |  | $     | 119,659 |         |        |  | 59.2% |        |  | $ | 109,492 |         |  |  | 60.7% |       
|                         | Workers compensation          |                         |   | 63,517  |         |  |  | 27.0%  |        |  |       | 58,377  |         |        |  | 28.8% |        |  |   | 46,980  |         |  |  | 26.1% |       
|                         | Health                         |                         |   | 23,820  |         |  |  | 10.1%  |        |  |       | 18,668  |         |        |  | 9.2%  |        |  |   | 11,066  |         |  |  | 6.1%  |       
|                         | Other                          |                         |   | (432    | )       |  |  | -0.2%  |        |  |       | 5,667   |         |        |  | 2.8%  |        |  |   | 12,804  |         |  |  | 7.1%  |       
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 
|                         |                                | Total                   |   | $       | 235,551 |  |  |        | 100.0% |  |       | $       | 202,371 |        |  |       | 100.0% |  |   | $       | 180,342 |  |  |       | 100.0% | 
|                         |                                |                         |   |         |         |  |  |        |        |  |       |         |         |        |  |       |        | 

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Medical Professional Liability

Products and
Services.We underwrite medical
professional and hospital professional liability policy
coverages for physicians and physician medical groups, clinics
and other providers in the health care industry. Medical
professional liability insurance insures physicians and other
health care providers against liabilities arising from the
rendering of, or failure to render, professional medical
services. We offer both claims-made and occurrence policies, and
include legal defense against asserted medical professional
liability 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. 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 a few hospitals.

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 in 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. At
December 31, 2002, we insured approximately 13,000
physicians in 14 states throughout the United States, with a
concentration in the Midwest.

Marketing.Our
marketing philosophy is to sell profitable business in our core
lines of insurance through a broad, multi-channeled,
cost-effective distribution system. 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 subsidiaries (SCW), accounting for
approximately 40% of medical professional liability premiums
written during 2002. The 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, or work with financially sound
agencies that focus on this line in targeted geographic areas.
Of the 50 agencies that write medical professional liability, 27
wrote over $1 million in premiums with us in 2002.

The Michigan State Medical Society, or MSMS, has
endorsed APAssurance as its exclusive professional liability
carrier of choice for 27 years and currently endorses
APAssurance in accordance with an agreement pursuant to which we
compensate MSMS for marketing our professional medical liability
products to MSMS members. APAssurance has also received a
similar marketing endorsement agreement from the Michigan
Osteopathic Association, the Kentucky Medical Association, and
the New Mexico Medical Association.

Underwriting and
Pricing.Most of our underwriting work
and customer contact is performed through our local offices
under the supervision of the home office. The home office
underwriting department is responsible 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 25 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 APAssurance.

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

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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 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 expense, 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.
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

Products and
Services.We focus our workers
compensation efforts on two approaches to the marketplace.
First, we provide coverage to smaller accounts (under $75,000 in
annual premiums) in several markets in the Midwest. These
accounts are in exposure to loss hazard classes within
industries that have low probability of severity claims. Second,
we focus on mid-level accounts ($75,000 to $750,000 in annual
premium) in underserved markets where we can add value to the
relationship with expert accident prevention and assertive
claims management services, reducing the clients cost of
risk.

Distribution.Our
workers compensation sales and marketing philosophy is to
utilize primarily independent agencies. However, it is our goal
with these agencies to develop long-term strategic
relationships. The premium volume for an individual agency is
normally minor in relation to the total premiums. Only 37
workers compensation agencies exceeded $500,000 in premium
volume in 2002, and only eight of these exceeded $1 million
in premium volume.

Underwriting and
Pricing.Most of our underwriting work
and customer contact is performed through our local offices
under the supervision of the home office. The home office
underwriting department is responsible for all aspects of
underwriting standards for all of our underwritten coverages,
including pricing. Local underwriting staff have the authority
to evaluate, approve and issue workers compensation
coverage for businesses with annual premiums that do not exceed
present threshold amounts or guidelines established by the home
office.

The nature of our business requires that we
monitor the marketplace and the pricing strategies of our
competitors. Using a variety of data, we set our prices based on
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 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. It is our
approach not to sacrifice profitability for premium growth.

Claims Management.Our claims professionals are committed to exceptional service,
aggressive claims management, quality medical care, timely
payment and claims settlement. We perform on-site reviews with
customers who need special attention in claims reporting,
accident investigation and job analysis for a successful return
of injured employees to productive work. We apply numerous
techniques to reduce medical and indemnity costs and, as allowed
by statute, we provide medical direction for injured workers. We

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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
of 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 this activity assists us in reducing the cost of
workers compensation claims.

Accident Prevention.We invest in accident prevention resources and pre-underwriting
analysis of past losses and inherent hazards within the risk to
reduce our exposure to loss. We have developed a unique business
plan for each account exceeding $75,000 in annual premium that
provides a focus for the reduction of accidents and injuries.

Health Insurance

We currently write small business employee health
insurance through a single preferred provider organization
located in western Michigan. This coverage is provided as part
of our long-term strategic relationship with the physician
organization which sponsors this plan. We also provide medical
professional liability coverage to many of the physician members
of this organization. All other health programs have been
discontinued.

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.

We have reduced efforts to write business through
our APDirect Internet sales channel, choosing to focus on
improving customer and agent communication via the internet. On
a selective basis, we continue to offer alternative risk
transfer programs.

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. 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.

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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, 2002. A.M.
Best classifies an A rating as Excellent
and A++ and A+ ratings as
Superior and a B- rating as
Fair. Other than the entities listed below, no
single reinsurers percentage participation in 2002
exceeded 5% of total amounts recoverable from reinsurers.

|                                       |  |                        |     |         |                  |   |                  |           |  |         |                  |  |  |  |       | 
|-------------------------------------- |  | ---------------------- | --- | ------- | ---------------- | - | ---------------- | --------- |  | ------- | ---------------- |  |  |  | ----- | 
|                                       |  |                        |     |         |                  |   |                  | % of 2002 | 
|                                       |  |                        |     | Amounts |                  |   | 2002 Total Ceded |           |  | Amounts |                 
|                                       |  | A.M. Best              |     |         | Recoverable From |   |                  | Premiums  |  |         | Recoverable From | 
|Reinsurer                              |  | Rating                 |     |         | Reinsurers       |   |                  | Written   |  |         | Reinsurers       | 
|                                       |  |                        |     |         |                  |   |                  |           |  |         |                  | 
|                                       |  |                       
|                                       |  | (dollars in thousands) |    
|Hannover Ruckversicherungs             |  |                        | A+  |         |                  | $ | 27,065           |           |  | $       | 9,412            |  |  |  | 26.0% | 
|Gerling Global Reinsurance Corporation |  |                        | B-  |         |                  |   | 17,202           |           |  |         | 7,908            |  |  |  | 16.6% | 
|General Reinsurance Corporation        |  |                        | A++ |         |                  |   | 11,716           |           |  |         | 34               |  |  |  | 11.3% | 
|Transatlantic Reinsurance Company      |  |                        | A++ |         |                  |   | 11,626           |           |  |         | 341              |  |  |  | 11.2% | 
|American Re-Insurance Company          |  |                        | A+  |         |                  |   | 5,990            |           |  |         | 4,319            |  |  |  | 5.8%  | 
|Employers Reinsurance                  |  |                        | A+  |         |                  |   | 5,831            |           |  |         | 222              |  |  |  | 5.6%  | 

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, 2002, we concluded
that there was no material risk of not being paid by our
reinsurers. We performed additional analysis on Gerling Global
given its recent downgrade to B- and actions by its parent
company to put United States subsidiary into run-off. Despite
Gerling Globals B- A.M. Best rating at December 31,
2002, 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.

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

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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 a team of 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. Management then records
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.

There can be no assurance that ultimate losses
will not exceed our actuarially determined best estimate of loss
reserves at December 31, 2002. While management does not
explicitly calculate an acceptable range of probable
reserves, historical results have shown ultimate losses can vary
from our initial estimates in a range of plus or minus 7%.
Adjustments in aggregate reserves, if any, are reflected in the
operating results of the period during which such adjustments
are made.

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 expenses reserve
balances for the years ended December 31, 2002, 2001 and
2000.

|                               |                                |                        |         |         |         |   |         |         |         |   |         |         |         | 
|------------------------------ | ------------------------------ | ---------------------- | ------- | ------- | ------- | - | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                               |                                | 2002                   |         |         | 2001    |   |         | 2000    |        
|                               |                                |                        |         |         |         |   |         |         |        
|                               |                                |                       
|                               |                                | (dollars in thousands) |        
|Balance, beginning of year     |                                | $                      | 597,046 |         |         | $ | 483,273 |         |         | $ | 457,072 |        
|                               | Less, reinsurance recoverables |                        |         | (91,491 | )       |   |         | (69,319 | )       |   |         | (63,490 | )      
|                               |                                |                        |         |         |         |   |         |         |        
|Net balance, beginning of year |                                |                        | 505,555 |         |         |   | 413,954 |         |         |   | 393,582 |        
|Incurred related to:           |                                |                        |         |         |         |   |         |         |         |   |         |        
|                               | Current year                   |                        |         | 236,398 |         |   |         | 228,848 |         |   |         | 164,997 |        
|                               | Prior years                    |                        |         | 5,630   |         |   |         | 29,000  |         |   |         | (11,479 | )      
|                               |                                |                        |         |         |         |   |         |         |        
|                               |                                | Total incurred         |         |         | 242,028 |   |         |         | 257,848 |   |         |         | 153,518 | 
|                               |                                |                        |         |         |         |   |         |         |        
|Paid related to:               |                                |                        |         |         |         |   |         |         |         |   |         |        
|                               | Current year                   |                        |         | 43,867  |         |   |         | 41,693  |         |   |         | 49,243  |        
|                               | Prior years                    |                        |         | 161,690 |         |   |         | 124,554 |         |   |         | 83,903  |        
|                               |                                |                        |         |         |         |   |         |         |        
|                               |                                | Total paid             |         |         | 205,557 |   |         |         | 166,247 |   |         |         | 133,146 | 
|                               |                                |                        |         |         |         |   |         |         |        
|Net balance, end of year       |                                |                        | 542,026 |         |         |   | 505,555 |         |         |   | 413,954 |        
|                               | Plus, reinsurance recoverables |                        |         | 95,468  |         |   |         | 91,491  |         |   |         | 69,319  |        
|                               |                                |                        |         |         |         |   |         |         |        
|Balance, end of period         |                                | $                      | 637,494 |         |         | $ | 597,046 |         |         | $ | 483,273 |        
|                               |                                |                        |         |         |         |   |         |         |        

During 2002, 2001, and 2000, management made
adjustments to prior year reserves. These adverse/ (positive)
adjustments totaled $5.6 million, $29.0 million, and
($11.5) million for the years ended December 31, 2002,
2001, and 2000, respectively. As a percentage of net reserves as
of the beginning of the year, these adjustments were 1.1%, 7%,
and (2.9%), respectively.

The positive development recognized in 2000 was
the result of continued favorable claims settlement experience
in the Michigan market. In 2001, we encountered a large increase
in reported losses, primarily in our 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 Ohio and Florida markets were relatively
new for the Company making our initial reserve estimates very
difficult to predict. These higher than expected loss trends
continued into 2002, but at a

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much lower level. As a result, we also added to
prior year reserves in 2002, primarily in our Ohio and Florida
markets.


The following table shows the development of the
net liability for unpaid loss and loss adjustment expenses from
1993 through 2002. 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 years with respect to the liability. The lower
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.

|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|------------------------------------------------------------------------------------------- | ----------------- | -------------------------- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- |  | ---- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- |  | ---- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- |  | - | ------- |  | 
|                                                                                            |                   |                           
|                                                                                            |                   | At Year Ended December 31, |        
|                                                                                            |                   |                            |        
|                                                                                            |                   | 1993                       |         |         | 1994 |   |         | 1995    |  |   | 1996    |         |  | 1997 |         |         | 1998 |   |         | 1999    |  |   | 2000    |         |  | 2001 |         |         | 2002 |  
|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|                                                                                            |                   |                           
|                                                                                            |                   | (dollars in thousands)     |        
|Liability for unpaid losses and loss adjustment
    expenses net of reinsurance recoverable |                   | $                          | 328,436 |         |      | $ | 341,254 |         |  | $ | 334,264 |         |  | $    | 346,455 |         |      | $ | 352,836 |         |  | $ | 371,982 |         |  | $    | 393,582 |         |      | $ | 413,954 |         |  | $ | 505,555 |         |  | $ | 542,026 | 
|Cumulative net paid as of:                                                                  |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         | 
|                                                                                            | End of year       |                            |         | 57,110  |      |   |         | 59,982  |  |   |         | 47,113  |  |      |         | 69,750  |      |   |         | 86,703  |  |   |         | 85,290  |  |      |         | 95,471  |      |   |         | 124,479 |  |   |         | 161,770 |  |   |         |  | 
|                                                                                            | Two years later   |                            |         | 97,424  |      |   |         | 93,724  |  |   |         | 89,260  |  |      |         | 134,184 |      |   |         | 152,656 |  |   |         | 146,497 |  |      |         | 182,541 |      |   |         | 236,653 |  |   |         |         |  |   |         |  | 
|                                                                                            | Three years later |                            |         | 126,220 |      |   |         | 122,509 |  |   |         | 122,734 |  |      |         | 181,144 |      |   |         | 188,665 |  |   |         | 198,774 |  |      |         | 251,448 |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Four years later  |                            |         | 137,667 |      |   |         | 142,127 |  |   |         | 148,000 |  |      |         | 205,824 |      |   |         | 215,426 |  |   |         | 231,748 |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Five years later  |                            |         | 149,443 |      |   |         | 154,716 |  |   |         | 158,041 |  |      |         | 219,944 |      |   |         | 232,323 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Six years later   |                            |         | 155,556 |      |   |         | 160,204 |  |   |         | 165,250 |  |      |         | 227,840 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Seven years later |                            |         | 159,325 |      |   |         | 165,133 |  |   |         | 170,750 |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Eight years later |                            |         | 161,385 |      |   |         | 169,316 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Nine years later  |                            |         | 164,819 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|Re-estimated net liability as of:                                                           |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         | 
|                                                                                            | End of year       |                            |         | 304,888 |      |   |         | 300,626 |  |   |         | 273,025 |  |      |         | 324,233 |      |   |         | 327,542 |  |   |         | 350,114 |  |      |         | 383,004 |      |   |         | 435,069 |  |   |         | 511,185 |  |   |         |  | 
|                                                                                            | Two years later   |                            |         | 269,571 |      |   |         | 251,083 |  |   |         | 259,103 |  |      |         | 302,696 |      |   |         | 314,613 |  |   |         | 334,827 |  |      |         | 373,400 |      |   |         | 449,871 |  |   |         |         |  |   |         |  | 
|                                                                                            | Three years later |                            |         | 235,507 |      |   |         | 239,185 |  |   |         | 238,572 |  |      |         | 291,406 |      |   |         | 290,490 |  |   |         | 313,248 |  |      |         | 374,729 |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Four years later  |                            |         | 221,633 |      |   |         | 221,973 |  |   |         | 221,226 |  |      |         | 267,788 |      |   |         | 273,982 |  |   |         | 303,540 |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Five years later  |                            |         | 207,074 |      |   |         | 207,930 |  |   |         | 196,949 |  |      |         | 258,838 |      |   |         | 268,754 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Six years later   |                            |         | 194,432 |      |   |         | 187,451 |  |   |         | 192,521 |  |      |         | 254,272 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Seven years later |                            |         | 178,551 |      |   |         | 185,398 |  |   |         | 189,708 |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Eight years later |                            |         | 176,827 |      |   |         | 184,033 |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|                                                                                            | Nine years later  |                            |         | 175,852 |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |   |         |  | 
|Net cumulative (deficiency) redundancy                                                      |                   |                            |         |         |      |   | 157,221 |         |  |   | 144,556 |         |  |      | 92,183  |         |      |   | 84,082  |         |  |   | 68,442  |         |  |      | 18,853  |         |      |   | (35,917 | )       |  |   | (5,630  | )       |  |   |         | 
|Gross liability  end of year                                                               |                   |                            |         |         |      |   | 367,332 |         |  |   | 359,330 |         |  |      | 392,626 |         |      |   | 407,746 |         |  |   | 422,987 |         |  |      | 457,072 |         |      |   | 483,273 |         |  |   | 597,046 |         |  |   | 637,494 | 
|Reinsurance recoverables                                                                    |                   |                            |         |         |      |   | 26,078  |         |  |   | 25,066  |         |  |      | 46,171  |         |      |   | 54,910  |         |  |   | 51,005  |         |  |      | 63,490  |         |      |   | 69,319  |         |  |   | 91,491  |         |  |   | 95,468  | 
|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Net liability  end of year                                                                 |                   |                            |         |         |      | $ | 341,254 |         |  | $ | 334,264 |         |  | $    | 346,455 |         |      | $ | 352,836 |         |  | $ | 371,982 |         |  | $    | 393,582 |         |      | $ | 413,954 |         |  | $ | 505,555 |         |  | $ | 542,026 | 
|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Gross re-estimated
    liability  latest                                                   |                   |                            |         |         |      | $ | 193,505 |         |  | $ | 197,998 |         |  | $    | 298,148 |         |      | $ | 324,140 |         |  | $ | 381,281 |         |  | $    | 455,504 |         |      | $ | 539,804 |         |  | $ | 601,821 |         |  |   |         | 
|Re-estimated reinsurance recoverables 
    latest                                          |                   |                            |         |         |      |   | 9,473   |         |  |   | 8,290   |         |  |      | 43,875  |         |      |   | 55,386  |         |  |   | 77,741  |         |  |      | 80,775  |         |      |   | 89,933  |         |  |   | 90,637  |         |  |   |         | 
|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Net re-estimated liability  latest                                                         |                   |                            |         |         |      | $ | 184,032 |         |  | $ | 189,708 |         |  | $    | 254,273 |         |      | $ | 268,754 |         |  | $ | 303,540 |         |  | $    | 374,729 |         |      | $ | 449,871 |         |  | $ | 511,186 |         |  |   |         | 
|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  
|Gross cumulative (deficiency) redundancy                                                    |                   |                            |         |         |      | $ | 173,827 |         |  | $ | 161,332 |         |  | $    | 94,478  |         |      | $ | 83,606  |         |  | $ | 41,706  |         |  | $    | 1,568   |         |      | $ | (56,531 | )       |  | $ | (4,775  | )       |  |   |         | 
|                                                                                            |                   |                            |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |   |         |         |  |   |         |         |  |      |         |         |      |  

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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 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, 2002,
97.6% of our fixed-income investment portfolio, which consisted
of fixed-income securities and short-term investments, was
investment grade. The fixed-income portfolio is managed by one
of our subsidiaries. For additional information regarding our
investment results, see Managements Discussion and
Analysis and Note 5 of the Notes to Consolidated Financial
Statements contained elsewhere in this report. Other invested
assets include investment real estate at December 31, 2002
and 2001, and mortgage loans at December 31, 2001.

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, particularly our competitors
in the workers compensation segments. 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.

Segment Information

See Note 20 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 the OFIS, perform periodic
examinations of insurance companies. Such regulation is
generally intended for the protection of policyholders rather
than shareholders.

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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 25 states. However, we
currently write business in only 18 of the states where we are
licensed or eligible to write excess and surplus lines. Our
current focus of operations is on our existing states. However,
we continue to expand our geographic capabilities beyond the
states where we currently write coverage, by adding licenses
when appropriate to allow for future growth.

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, 2002, the amount available for payment of
dividends without the prior approval of the OFIS was
approximately $18.8 million.

Change of Control.The Michigan Insurance Code requires that the OFIS receive prior
notice of and approve a change of control for either APAssurance
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 APAssurance 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,
APAssurance, has always exceeded 2.0 in the past, but there can
be no assurance that the requirements applicable to APAssurance
will not increase in the future. As of December 31, 2002,
APAssurances risk-based capital base level was
$42.6 million and its total adjusted capital was
$163.5 million, for a ratio of 3.8. The ratio of risk-based
capital to total adjusted capital for our other two insurance
subsidiaries, APSpecialty and Insurance Corporation of America,
was 25.0 and 36.0, respectively, at December 31, 2002.

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

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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 review of annual and quarterly filings. The NAIC
does not compute IRIS ratios on a consolidated basis. However,
none of our insurance subsidiaries had more than two ratios
outside the acceptable range for 2002.


Guaranty Fund.We
participate in various guaranty associations in the states in
which we write business, which protects 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 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, 2002, we had 244
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.

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.      
|
| |  | 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.                                                      
|
| |  | If competitive or other conditions change, our
    revenues may decrease or our expenses may increase so that our
    business is no longer profitable.               
|
| |  | If we experience substantial change in claims
    frequency or severity patterns, our profitability may decline.                                                      

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Changes in the health care industry could reduce
    the size of our premiums and the number of customers buying our
    insurance.                                                                                                                                                                                                                                                                                                                                     
|
| |  | We may be unable to obtain adequate and
    affordable reinsurance coverage from creditworthy reinsurers,
    which would increase our risk and restrict our ability to offer
    insurance at competitive rates and coverage limits.                                                                                                                                                                                                                                   
|
| |  | The concentration of our business in Michigan
    leaves us vulnerable to various factors specific to that state.                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Although our strategy for growth includes
    expansion and diversification of our insurance products, there
    is no assurance that this strategy will be successful.                                                                                                                                                                                                                                                                                                 
|
| |  | 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, an insurance sales agency, which is principally owned
    by our 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. However, the commission rates we pay to this
    agency are substantially the same, or lower, than we pay to
    other agents.
|
| |  | 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 which could materially affect the financial condition
    of the Company.                                                                                                                                                                                               
|
| |  | If our President and Chief Executive Officer does
    not continue in that role, our financial performance may decline.                                                                                                                                                                                                                                                                                                                                                 
|
| |  | We may not be able to obtain regulatory approval
    for rate increases, which may negatively affect our
    profitability.                                                                                                                                                                                                                                                                                                                                             
|
| |  | We may experience unanticipated losses and loss
    adjustment expenses and other unforeseen expenses associated
    with our exit from the Florida medical professional liability
    insurance market and the Kentucky workers compensation
    market as well as workers compensation construction
    policies in all states.                                                                                                                                     
|
| |  | 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 reduction in our A.M. Best Company rating could
    make it more difficult for us to sell our products.                                                                                                                                                                                                                                                                                                                                                               
|
| |  | We may be unable to obtain anticipated processing
    efficiencies, which may negatively affect our profitability.                                                                                                                                                                                                                                                                                                                                                      
|
| |  | 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 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 approximately five years
in length. We currently lease a total of approximately 70,000
square feet of

12



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##### Table of Contents



space in East Lansing, Michigan; Chicago,
Illinois; Louisville, Kentucky; Boca Raton, Florida; Eden
Prairie, Minnesota; Las Vegas, Nevada; and Albuquerque, New
Mexico. We also own various real estate investment properties as
part of our investment portfolio.


Item 3.     Legal
Proceedings

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.

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,
2002.






PART II


Item 5.     Market
Price for Registrants Common Equity and Related
Stockholder Matters

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 |  
|                              |  |            |       |  |     |  
|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 | 
|2001                          |  |            |       |  |     |   |       | 
|October 1  December 31, 2001 |  | $          | 23.60 |  |     | $ | 14.70 | 
|July 1  September 30, 2001   |  |            | 22.95 |  |     |   | 18.02 | 
|April 1  June 30, 2001       |  |            | 20.69 |  |     |   | 16.50 | 
|January 1  March 31, 2001    |  |            | 20.44 |  |     |   | 15.63 | 

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 March 10, 2003, there were
approximately 1,800 beneficial owners of our common stock, based
on the records of our transfer agent and securities position
listings 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,
(i) the number of shares of common stock to be issued upon
the exercise of

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##### Table of Contents



outstanding options, (ii) the weighted
average exercise price of outstanding options, and
(iii) the number of shares remaining available for future
issuance, as of December 31, 2002.


Equity Compensation Plans

|                                                            |  |                         |         |  |                     |                         |       |                             |  |  |        | 
|----------------------------------------------------------- |  | ----------------------- | ------- |  | ------------------- | ----------------------- | ----- | --------------------------- |  |  | ------ | 
|                                                            |  |                         |         |  |                     | Number of shares        |      
|                                                            |  |                         |         |  |                     | remaining available for |      
|                                                            |  |                         |         |  |                     | future issuance under   |      
|                                                            |  | Number of shares to be  |         |  | Weighted-average    |                         |       | equity compensation plans   | 
|                                                            |  | issued upon exercise of |         |  | exercise price of   |                         |       | (excluding shares reflected | 
|Plan Category                                               |  | outstanding options     |         |  | outstanding options |                         |       | in column (a))              | 
|                                                            |  |                         |         |  |                     |                         |       |                             | 
|                                                            |  | (a)                     |         |  | (b)                 |                         |       | (c)                         | 
|Equity compensation plans approved by
    shareholders:     |  |                         | 987,500 |  |                     | $                       | 18.39 |                             |  |  | 44,993 | 
|Equity compensation plans not approved by
    shareholders: |  |                         |        |  |                     |                         |      |                             |  |  |       | 

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 19 of the Notes to Consolidated Financial Statements
included elsewhere in this report for a discussion of the
principal differences between GAAP and statutory accounting
practices.

|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |       |         |         |  |        |         |         | 
|------------------------------------------------------------- | ------------------------------------ | ------------------------------- | ------- | ------- | ------- |  | ------- | ------- | ------- |  | ------- | ------- | ------- | ---- | ----- | ------- | ------- |  | ------ | ------- | ------- | 
|                                                              |                                      |                                
|                                                              |                                      | For the Year Ended December 31, |        
|                                                              |                                      |                                 |        
|                                                              |                                      | 2002(a)                         |         |         | 2001    |  |         | 2000    |         |  | 1999(b) |         |         | 1998 |      
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      
|Revenue:                                                      |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |       |         |         |  |        |        
|                                                              | Direct premiums written              |                                 | $       | 266,260 |         |  | $       | 230,765 |         |  | $       | 203,169 |         |      | $     | 189,647 |         |  | $      | 160,305 |        
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      
|                                                              | Net premiums written                 |                                 | $       | 238,417 |         |  | $       | 208,779 |         |  | $       | 187,076 |         |      | $     | 158,028 |         |  | $      | 147,801 |        
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      
|                                                              | Net premiums earned                  |                                 | $       | 235,551 |         |  | $       | 202,371 |         |  | $       | 180,342 |         |      | $     | 148,656 |         |  | $      | 136,995 |        
|                                                              | Investment income                    |                                 |         | 45,525  |         |  |         | 47,883  |         |  |         | 36,784  |         |      |       | 30,539  |         |  |        | 29,451  |        
|                                                              | Net realized (losses) gains          |                                 |         | (913    | )       |  |         | (5,651  | )       |  |         | 1,164   |         |      |       | 1,849   |         |  |        | 9,540   |        
|                                                              | Other income                         |                                 |         | 376     |         |  |         | 546     |         |  |         | 2,428   |         |      |       | 6,676   |         |  |        | 2,832   |        
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      
|                                                              |                                      | Total revenues and other income |         |         | 280,539 |  |         |         | 245,149 |  |         |         | 220,718 |      |       |         | 187,720 |  |        |         | 178,818 | 
|Losses and expenses:                                          |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |       |         |         |  |        |        
|                                                              | Losses and loss adjustment expenses  |                                 |         | 242,028 |         |  |         | 257,848 |         |  |         | 153,518 |         |      |       | 130,949 |         |  |        | 122,053 |        
|                                                              | Underwriting expenses                |                                 |         | 48,593  |         |  |         | 45,111  |         |  |         | 42,158  |         |      |       | 40,037  |         |  |        | 38,455  |        
|                                                              | Investment expense                   |                                 |         | 2,515   |         |  |         | 1,788   |         |  |         | 2,978   |         |      |       | 3,283   |         |  |        | 2,943   |        
|                                                              | Interest expense                     |                                 |         | 373     |         |  |         | 400     |         |  |         | 716     |         |      |       | 565     |         |  |        | 791     |        
|                                                              | Amortization expense                 |                                 |         |         |         |  |         | 2,514   |         |  |         | 2,328   |         |      |       | 1,177   |         |  |        | 906     |        
|                                                              | Other expense                        |                                 |         | 1,971   |         |  |         | 4,718   |         |  |         | 2,275   |         |      |       | 1,739   |         |  |        | 1,206   |        
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      
|                                                              |                                      | Total losses and expenses       |         |         | 295,480 |  |         |         | 312,379 |  |         |         | 203,973 |      |       |         | 177,750 |  |        |         | 166,354 | 
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      
|(Loss) income before federal income tax (benefit)
    expense |                                      |                                 | (14,941 | )       |         |  | (67,230 | )       |         |  | 16,745  |         |         |      | 9,970 |         |         |  | 12,464 |        
|                                                              | Federal income tax (benefit) expense |                                 |         | (5,529  | )       |  |         | (23,450 | )       |  |         | 4,800   |         |      |       | (23,759 | )       |  |        | 3,400   |        
|                                                              |                                      |                                 |         |         |         |  |         |         |         |  |         |         |         |      |      

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|                                                                               |  |                                 |         |   |      |   |         |      |  |   |         |  |  |      |        |  |  |   |       | 
|------------------------------------------------------------------------------ |  | ------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- |  |  | ---- | ------ |  |  | - | ----- | 
|                                                                               |  |                                
|                                                                               |  | For the Year Ended December 31, |        
|                                                                               |  |                                 |        
|                                                                               |  | 2002(a)                         |         |   | 2001 |   |         | 2000 |  |   | 1999(b) |  |  | 1998 |       
|                                                                               |  |                                 |         |   |      |   |         |      |  |   |         |  |  |      |       
|(Loss) income before cumulative effect of a
    change in accounting principle |  |                                 | (9,412  | ) |      |   | (43,780 | )    |  |   | 11,945  |  |  |      | 33,729 |  |  |   | 9,064 | 
|Cumulative effect of a change in accounting
    principle                      |  |                                 | (9,079  | ) |      |   |         |      |  |   |         |  |  |      |        |  |  |   |       | 
|                                                                               |  |                                 |         |   |      |   |         |      |  |   |         |  |  |      |       
|Net (loss) income                                                              |  | $                               | (18,491 | ) |      | $ | (43,780 | )    |  | $ | 11,945  |  |  | $    | 33,729 |  |  | $ | 9,064 | 
|                                                                               |  |                                 |         |   |      |   |         |      |  |   |         |  |  |      |       
|Net (loss) income per share 
    basic(c)                                     |  | $                               | (1.98   | ) |      | $ | (3.95   | )    |  | $ | 0.07    |  |  |      |        |  |  |   |       | 
|                                                                               |  |                                 |         |   |      |   |         |      |  |   |         |  |  |      |       
|Net (loss) income per share 
    diluted(c)                                   |  | $                               | (1.98   | ) |      | $ | (3.95   | )    |  | $ | 0.07    |  |  |      |        |  |  |   |       | 
|                                                                               |  |                                 |         |   |      |   |         |      |  |   |         |  |  |      |       



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | Net income 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 Standard No. 142 (SFAS
    No. 142), Goodwill and Other Intangible
    Assets. In accordance with the transitional 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, 2002 and 2001, were 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,
    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, |  
|                    |                                                    |                                       |  
|                    |                                                    | 2002                                  |   |           | 2001 |  |   | 2000      |   |  | 1999 |         |   | 1998 |  
|                    |                                                    |                                       |   |           |      |  |   |           |   |  |      |         |   |      |  
|Balance Sheet Data: |                                                    |                                       |   |           |      |  |   |           |   |  |      |         |   |      |   |         |   |  |   |        
|                    | Total cash and investments                         |                                       | $ | 801,556   |      |  | $ | 752,508   |   |  | $    | 762,023 |   |      | $ | 541,894 |   |  | $ | 548,665 |  
|                    | Total assets                                       |                                       |   | 1,058,918 |      |  |   | 1,038,917 |   |  |      | 977,976 |   |      |   | 794,390 |   |  |   | 715,596 |  
|                    | Total liabilities                                  |                                       |   | 778,629   |      |  |   | 731,952   |   |  |      | 608,551 |   |      |   | 585,604 |   |  |   | 526,844 |  
|                    | Total GAAP shareholders equity                    |                                       |   | 280,289   |      |  |   | 306,965   |   |  |      | 369,425 |   |      |   | 208,786 |   |  |   | 188,752 |  
|GAAP Ratios:        |                                                    |                                       |   |           |      |  |   |           |   |  |      |         |   |      |   |         |   |  |   |        
|                    | Loss ratio                                         |                                       |   | 102.7     | %    |  |   | 127.4     | % |  |      | 85.1    | % |      |   | 88.1    | % |  |   | 89.1    | %
|                    | Underwriting expense ratio                         |                                       |   | 20.6      |      |  |   | 22.3      |   |  |      | 23.4    |   |      |   | 26.9    |   |  |   | 28.1    |  
|                    | Combined ratio                                     |                                       |   | 123.3     |      |  |   | 149.7     |   |  |      | 108.5   |   |      |   | 115.0   |   |  |   | 117.2   |  
|                    | Operating ratio                                    |                                       |   | 105.1     |      |  |   | 126.9     |   |  |      | 89.8    |   |      |   | 96.7    |   |  |   | 97.8    |  
|Statutory Data:     |                                                    |                                       |   |           |      |  |   |           |   |  |      |         |   |      |   |         |   |  |   |        
|                    | Loss ratio                                         |                                       |   | 103.2     | %    |  |   | 131.1     | % |  |      | 85.2    | % |      |   | 88.0    | % |  |   | 89.4    | %
|                    | Underwriting expense ratio                         |                                       |   | 20.9      |      |  |   | 24.3      |   |  |      | 24.7    |   |      |   | 29.2    |   |  |   | 27.0    |  
|                    | Combined ratio                                     |                                       |   | 124.1     |      |  |   | 155.4     |   |  |      | 109.9   |   |      |   | 117.2   |   |  |   | 116.4   |  
|                    | Surplus                                            |                                       | $ | 190,216   |      |  | $ | 203,069   |   |  | $    | 246,089 |   |      | $ | 179,829 |   |  | $ | 144,541 |  
|                    | Ratio of statutory net premiums written to surplus |                                       |   | 1.25      | x    |  |   | 1.03      | x |  |      | 0.76    | x |      |   | 0.88    | x |  |   | 1.02    | x

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|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|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
following discussion contains certain forward-looking statements
relating to our anticipated future financial condition,
operating results, cash flows and our current business plans.
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 elsewhere in this report
and from time to time in other reports filed by the Company with
the Securities and Exchange Commission. See the disclosures
under Item 1  Business 
Uncertainties Relating to Forward-Looking Statements.

Overview

We are a leading provider of medical professional
liability insurance coverage, writing this coverage in 17 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 66.6% of our direct
premiums written in 2002. In addition, we write workers
compensation insurance in 11 states, insuring a variety of
business classes. During 2002, we also provided a limited amount
of general personal and commercial coverage and participated in
a health insurance program.

Our policy liability limits vary by line and
state. In workers compensation insurance, state statutes
dictate the coverage we offer our policyholders. For medical
professional liability insurance, most states allow physicians
to choose their own coverage 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 by our policyholders are $200,000 per
claim, with a $600,000 annual aggregate ($200,000/$600,000). In
Florida, the most common limits purchased are $250,000/$750,000.
In all other states, the most common limit purchased is $1
million per claim, with a $3 million annual aggregate.
Higher limits and excess coverage may be written in conjunction
with special reinsurance arrangements.

We purchase reinsurance to limit risk on our
individual exposures, stabilize underwriting results and
increase our capacity to write insurance. By purchasing
reinsurance, we transfer a portion of our loss exposure to a
reinsurer. Purchasing reinsurance does not discharge us from our
obligation to our insureds. If the reinsurer fails to meet its
obligations, we remain liable to pay the insured. We have
various reinsurance agreements in place. In general, we retain
the first $500,000 of a medical professional liability claim and
$1,000,000 of a workers compensation claim; and reinsurers
pay the portion of the claim in excess of those amounts.

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 Cheeseman, our 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 last three years, 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. Also, to the extent our financial performance as
a whole improves or deteriorates, whether due to the business
relationship with SCW or otherwise, the Compensation Committee
is likely to consider such improvement or deterioration in
Company performance when determining Mr. Cheesemans
compensation.

SCW has been a significant agent for us for many
years. The commission rates we pay to SCW are either the same or
less than the commission rates we pay to our other agents. In
addition, SCW has agreed that, with limited exceptions, the only
medical professional liability insurance it will sell will be
written by the Company.

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The Company is not required to sell insurance
solely through SCW. We believe these factors create 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 2002, 2001 and 2000
totaled $70,810,000, $68,896,000 and $67,758,000, respectively,
representing 26.6%, 29.9% and 33.4% of our direct premiums
written during such years. Commission expense we incurred and
paid to SCW approximated $5,560,000, $4,660,000 and $4,633,000
in 2002, 2001 and 2000, respectively.

Based on financial information made available to
us, we estimate SCWs net profits on the commission revenue
earned from us in 2002 to be approximately $1.1 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 profit bears to its total revenue in 2002 and
applying that percentage to the revenue earned from us.

We have put in place various safeguards to
protect the Company from actual or potential conflicts of
interest arising from this relationship. The commission rates we
currently pay to SCW were determined by negotiations between our
marketing staff and SCWs management and approved by our
board of directors without involvement by Mr. Cheeseman. In
rendering its approval, the board of directors considered the
fairness of the agreed rates and determined they were fair to
the Company based upon, among other things, an evaluation of
market rates and other Company agency agreements. A new agency
contract is currently being negotiated by a special committee of
our board of directors and SCW management without involvement by
Mr. Cheeseman. The new contract is expected to have an
extended term and to provide for payment of commission rates
which are at least as favorable to the Company as those paid
under the prior contract. Mr. Cheeseman is prohibited from
acting as a director, officer or employee of SCW and, pursuant
to Company policy, does 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.
Moreover, we 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.

An interruption in our relationship with SCW,
whether due to Mr. Cheesemans sale of his ownership
interest in SCW or otherwise, could significantly reduce our
premiums written because SCW represents such a significant
portion of our premiums written. In addition, because the
commission rates we pay to SCW are sometimes less than we pay to
other agents, an interruption in our relationship could result
in an increase in the commission rates we must pay and a
decrease in our net income.

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. 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.

Unpaid losses and loss adjustment
expenses.The reserves for unpaid
losses and loss adjustment expenses are actuarially 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 us, claims personnel establish a

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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. We do
not discount our reserves to recognize the time value of money.


We currently have a staff of internal actuaries
who develop projections of ultimate losses that are used to
establish recorded reserves. Management utilizes these actuarial
projections, as well as qualitative input from the actuarial
staff, and an independent actuarial firm, to establish a
best estimate recorded reserve amount. While
management does not explicitly calculate an acceptable
range of probable reserves, historical results have
shown ultimate losses can vary from our initial estimates in a
range of plus or minus 7%.

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 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.

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. 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.
Mortgage loans at December 31, 2001 were carried at the
unpaid principal balance, which approximated the fair market
value as they bore current market interest rates at that date.
There were no mortgage loans at December 31, 2002. Real
estate is carried at historical cost, less accumulated
depreciation. 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. We
specifically reviewed for any securities that we considered to
have any decline in market value to be other than temporary.
Investments which are considered impaired are written down to
their estimated net realizable value. We utilize both
quantitative and qualitative evaluation methods to evaluate the
potential for other than temporary impairment
(OTTI). At December 31, 2002, we established a
reserve of $1.0 million on investment real estate primarily
due to depressed real estate prices and lower than expected cash
flows. Additionally, we wrote down our investment in Frontier
bonds $520,000 in 2002 and $5.9 million in 2001. We noted
no other investments that required a write down for OTTI. We did
analyze $6.5 million of enhanced equipment trust
certificates we owned that were issued by Delta Airlines. These
certificates traded at 75.53% of par at December 31, 2002.
However, based on the economic performance of Delta, its strong
balance sheet position, and the fact that the certificates are
collateralized by newer, fuel-efficient aircraft, no impairment
was deemed necessary.

During the year ended December 31, 2002, we
generated approximately $2.3 million of realized losses on
the sales of securities. The sale of one security in particular,
United Airlines bonds, generated approximately

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$1.7 million of this loss. Management
analyzed the United Airlines bonds at September 30, 2002
and concluded that the decline in fair market value as of that
date was temporary. In the fourth quarter, United Airlines filed
for bankruptcy. As a result of that event, management believed
that the impairment was now other than temporary, and management
made the decision to sell the security at a loss.


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. Amounts are
estimated on a basis similar to the estimates made in respect of
the reserve for unpaid losses and loss adjustment expenses.
Changes in this reserve are reflected as an expense in the
period in which the adjustment is made.

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.

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, 2002, we concluded
that there was no material risk of not being paid by our
reinsurers. We performed additional analysis on Gerling Global
given its recent downgrade to B- and actions by its parent
company to put its United States subsidiary into run-off.
Despite Gerling Globals B- A.M. Best rating at
December 31, 2002, 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 Gerling Global situation carefully, and may
pursue an economic settlement or commutation if we determine
that 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.

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. We review our deferred federal income tax
asset on a quarterly basis for recoverability based on the
availability of future taxable income in the years when the
deductible temporary differences are expected to reverse. Our
deferred tax assets primarily relate to deductible temporary
differences (DTDs) for unpaid loss and loss
adjustment expenses and unearned premiums, as well as minimum
tax credit carryforwards. Most of our DTDs reverse in the
next three years and will more likely than not be realized as
management has taken premium rate increases and other
underwriting actions that are anticipated to generate taxable
income in those years.

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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.

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Results of Operations  2002
Compared to 2001

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, 2002 and 2001.

|                                            |               |                        |         |        |         |         |         |            |         |         |        |        |         |        |        |        |        |       | 
|------------------------------------------- | ------------- | ---------------------- | ------- | ------ | ------- | ------- | ------- | ---------- | ------- | ------- | ------ | ------ | ------- | ------ | ------ | ------ | ------ | ----- | 
|                                            |               |                        |         |        |         |         |         | Percentage |        
|                                            |               | 2002                   |         |        | 2001    |         |         | Change     |         |         | Change |       
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|                                            |               |                       
|                                            |               | (dollars in thousands) |        
|Direct premiums written:                    |               |                        |         |        |         |         |         |            |         |         |        |        |         |        |        |       
|                                            | Michigan      |                        | $       | 50,077 |         |         | $       | 44,927     |         |         | $      | 5,150  |         |        |        | 11.5%  |       
|                                            | Ohio          |                        |         | 33,731 |         |         |         | 24,864     |         |         |        | 8,867  |         |        |        | 35.7%  |       
|                                            | Illinois      |                        |         | 35,429 |         |         |         | 22,006     |         |         |        | 13,423 |         |        |        | 61.0%  |       
|                                            | Florida       |                        |         | 23,637 |         |         |         | 26,690     |         |         |        | (3,053 | )       |        |        | -11.4% |       
|                                            | Kentucky      |                        |         | 15,742 |         |         |         | 15,738     |         |         |        | 4      |         |        |        | 0.0%   |       
|                                            | New Mexico    |                        |         | 11,448 |         |         |         | 9,236      |         |         |        | 2,212  |         |        |        | 23.9%  |       
|                                            | Nevada        |                        |         | 4,595  |         |         |         | 2,945      |         |         |        | 1,650  |         |        |        | 56.0%  |       
|                                            | Other         |                        |         | 2,594  |         |         |         | 2,847      |         |         |        | (253   | )       |        |        | -8.9%  |       
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|                                            |               |                        | Total   |        | $       | 177,253 |         |            | $       | 149,253 |        |        | $       | 28,000 |        |        |        | 18.8% | 
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|Net premiums written                        |               | $                      | 154,583 |        |         | $       | 126,830 |            |         | $       | 27,753 |        |         |        | 21.9%  |       
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|Net premiums earned                         |               | $                      | 148,646 |        |         | $       | 119,659 |            |         | $       | 28,987 |        |         |        | 24.2%  |       
|Incurred loss and loss adjustment expenses: |               |                        |         |        |         |         |         |            |         |         |        |        |         |        |        |       
|                                            |               | Current year losses    |         |        | 157,750 |         |         |            | 145,890 |         |        |        | 11,860  |        |        |        | 8.1%   |      
|                                            |               | Prior year losses      |         |        | 4,500   |         |         |            | 22,700  |         |        |        | (18,200 | )      |        |        | -80.2% |      
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|                                            |               |                        | Total   |        |         | 162,250 |         |            |         | 168,590 |        |        |         | (6,340 | )      |        |        | -3.8% | 
|Underwriting expenses                       |               |                        | 27,157  |        |         |         | 23,281  |            |         |         | 3,876  |        |         |        | 16.6%  |       
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|Underwriting loss                           |               | $                      | (40,761 | )      |         | $       | (72,212 | )          |         | $       | 31,451 |        |         |        | -43.6% |       
|                                            |               |                        |         |        |         |         |         |            |         |         |        |       
|Loss ratio:                                 |               |                        |         |        |         |         |         |            |         |         |        |        |         |        |        |       
|                                            | Calendar year |                        |         | 109.2  | %       |         |         | 140.9      | %       |         |        | -31.7  | %       |        |        |        |       
|                                            | Accident year |                        |         | 106.1  | %       |         |         | 121.9      | %       |         |        | -15.8  | %       |        |        |        |       

Medical professional liability direct premiums
written were $177.3 million for the year ended
December 31, 2002, an increase of $28.0 million, or
18.8% 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 2002. The Company is
seeking regulatory approval of additional rate increases in 2003.

In the second quarter of 2002, the Company
announced its intention to discontinue writing medical
professional liability insurance in Florida. Medical
professional liability direct premiums written in the state of
Florida for the year ended December 31, 2002 were
$23.6 million and the Company reported net loss and loss
adjustment expenses for that period of $35.2 million in
Florida. The Florida Department of Insurance has approved the
Companys plan to exit this market and in October 2002, the
Company began mailing non-renewal notices to medical
professional liability policyholders in Florida whose renewals
would have been effective in December 2002. Florida law requires
the Company to offer extended reporting coverage, commonly
referred to as tail policies, at the time of
non-renewal. Tail policies typically have written premiums of
approximately two times the last annual policy premium. The
Company expects that some physicians will opt for this extended
reporting coverage, which will result in additional direct
premiums written in 2003. The amount of these future premiums
cannot be reasonably estimated due to the uncertainty regarding
the number of physicians who will opt for the coverage. The
Company is exploring various

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reinsurance options with respect to the premiums
and risks associated with these extended reporting coverages. In
January 2003, the Company invested $3 million in a start up
insurance company managed by the Companys former
third-party-administrator who underwrote its Florida medical
professional liability business. This start up insurance
company, Physicians Insurance Company, would seek to write as
many of the tail policies as its capital and surplus levels
would permit, thereby limiting APCapitals direct exposure
to future losses associated with underwriting Florida medical
professional liability extended reporting period coverages.


Net premiums earned were $148.6 million for
the year ended December 31, 2002, an increase of
$29.0 million, or 24.2% compared to 2001. As with the
increases in direct premiums written, the increase in net
premiums earned was primarily due to premium rate increases and
reduced discounts instituted in 2002, as policy counts were
relatively flat.

Incurred loss and loss adjustment expenses
totaled $162.3 million for the year ended December 31,
2002, a decrease of $6.3 million, or 3.8% compared to 2001.
The incurred loss and loss adjustment expense ratio decreased to
109.2% for 2002 from 140.9% for 2001.

During 2002 and 2001, we experienced adverse
development on prior year loss reserves. In the second half of
2001, we encountered a large increase in reported losses,
primarily in our Florida, Ohio and Kentucky markets. This
increase in reported losses was the result of an over 20%
increase in the average severity of claims in these markets. The
2001 prior year development of $22.7 million was also
unusually large because the Florida and Ohio markets were
relatively new to us, making our initial reserve estimates
difficult to predict. These higher than expected reported losses
continued into 2002, but at a much lower level than in 2001. As
a result, we also increased prior year reserves in 2002 by
approximately $4.5 million. 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 granted in 2002.

Underwriting expenses were $27.2 million for
the year ended December 31, 2002, an increase of
$3.9 million, or 16.6% compared to 2001. The underwriting
expense ratio was 18.3% for the year ended December 31,
2002, compared to 19.5% for 2001. Commission expense, a
component of overall underwriting expense, for the year ended
December 31, 2002 was $12.8 million compared with
$8.9 million for 2001. The decrease in the medical
professional liability underwriting expense ratio was primarily
the result of holding underwriting salaries and other 2002
employee costs relatively constant with 2001, while net premiums
earned increased 24.2% during the year ended December 31,
2002, as compared to 2001.

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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, 2002 and 2001.

|                                            |                     |                        |        |        |        |   |         |            |        |   |        |        |        |   |        |         |        | 
|------------------------------------------- | ------------------- | ---------------------- | ------ | ------ | ------ | - | ------- | ---------- | ------ | - | ------ | ------ | ------ | - | ------ | ------- | ------ | 
|                                            |                     |                        |        |        |        |   |         | Percentage |       
|                                            |                     | 2002                   |        |        | 2001   |   |         | Change     |        |   | Change |       
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|                                            |                     |                       
|                                            |                     | (dollars in thousands) |       
|Direct premiums written:                    |                     |                        |        |        |        |   |         |            |        |   |        |        |        |   |        |        
|                                            | Minnesota           |                        | $      | 29,811 |        |   | $       | 30,069     |        |   | $      | (258   | )      |   |        | -0.9%   |       
|                                            | Michigan            |                        |        | 11,639 |        |   |         | 9,803      |        |   |        | 1,836  |        |   |        | 18.7%   |       
|                                            | Illinois            |                        |        | 9,104  |        |   |         | 8,957      |        |   |        | 147    |        |   |        | 1.6%    |       
|                                            | Indiana             |                        |        | 7,118  |        |   |         | 6,787      |        |   |        | 331    |        |   |        | 4.9%    |       
|                                            | Kentucky            |                        |        | 3,912  |        |   |         | 3,197      |        |   |        | 715    |        |   |        | 22.4%   |       
|                                            | Iowa                |                        |        | 1,375  |        |   |         | 4,000      |        |   |        | (2,625 | )      |   |        | -65.6%  |       
|                                            | Other               |                        |        | 1,235  |        |   |         | 1,164      |        |   |        | 71     |        |   |        | 6.1%    |       
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|                                            |                     | Total                  |        | $      | 64,194 |   |         | $          | 63,977 |   |        | $      | 217    |   |        |         | 0.3%   | 
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|Net premiums written                        |                     | $                      | 60,446 |        |        | $ | 64,754  |            |        | $ | (4,308 | )      |        |   | -6.7%  |        
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|Net premiums earned                         |                     | $                      | 63,517 |        |        | $ | 58,377  |            |        | $ | 5,140  |        |        |   | 8.8%   |        
|Incurred loss and loss adjustment expenses: |                     |                        |        |        |        |   |         |            |        |   |        |        |        |   |        |        
|                                            | Current year losses |                        |        | 55,157 |        |   |         | 57,112     |        |   |        | (1,955 | )      |   |        | -3.4%   |       
|                                            | Prior year losses   |                        |        |       |        |   |         | 5,600      |        |   |        | (5,600 | )      |   |        | -100.0% |       
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|                                            |                     | Total                  |        |        | 55,157 |   |         |            | 62,712 |   |        |        | (7,555 | ) |        |         | -12.0% | 
|Underwriting expenses                       |                     |                        | 16,222 |        |        |   | 16,402  |            |        |   | (180   | )      |        |   | -1.1%  |        
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|Underwriting loss                           |                     | $                      | (7,862 | )      |        | $ | (20,737 | )          |        | $ | 12,875 |        |        |   | -62.1% |        
|                                            |                     |                        |        |        |        |   |         |            |        |   |        |       
|Loss ratio:                                 |                     |                        |        |        |        |   |         |            |        |   |        |        |        |   |        |        
|                                            | Calendar year       |                        |        | 86.8%  |        |   |         | 107.4%     |        |   |        | -20.6% |        |   |        |         |       
|                                            | Accident year       |                        |        | 86.8%  |        |   |         | 97.8%      |        |   |        | -11.0% |        |   |        |         |       
|Underwriting expense ratio                  |                     |                        | 25.5%  |        |        |   | 28.1%   |            |        |   | -2.6%  |        |        |   |        |        
|Combined ratio:                             |                     |                        |        |        |        |   |         |            |        |   |        |        |        |   |        |        
|                                            | Calendar year       |                        |        | 112.3% |        |   |         | 135.5%     |        |   |        | -23.2% |        |   |        |         |       
|                                            | Accident year       |                        |        | 112.3% |        |   |         | 125.9%     |        |   |        | -13.6% |        |   |        |         |       

Workers compensation direct premiums
written were $64.2 million for the year ended
December 31, 2002, an increase of $217,000, or 0.3%
compared to 2001. The increase in direct premiums written was
primarily the result of premium rate increases and reduced
discounts, offset by our exit of certain markets as described
below. The Company is seeking regulatory approval of additional
rate increases in 2003.

In the fourth quarter of 2002, the Company began
to exit the Kentucky workers compensation market, as well
as non-renew certain higher-risk construction policies in all
markets. These actions had the effect of decreasing
workers compensation direct premiums written for the three
months ended December 31, 2002, to $9.5 million from
$13.4 million for the same period of 2001. Management
expects the trend of decreasing direct premiums written to
continue into the near future as it implements its business
plans to replace the Kentucky and construction policy premiums
as discussed below.

In June 2002, the Company filled several
executive and management positions in its workers
compensation segment to improve the overall performance of this
segment, reduce risk exposures and improve profitability. We
expect to see growth in our workers compensation segment,
but not until the second half of 2003, as management is still
implementing its business plans for this segment. These business
plans include

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exiting certain high-risk specialties (e.g.,
construction policies) and poor performing markets, and
replacing this business with lower risk, more profitable
accounts as described more fully in
Item 1  Business.


Net premiums earned were $63.5 million for
the year ended December 31, 2002, an increase of
$5.1 million, or 8.8% compared to 2001. Net premiums earned
increased more than direct premiums written due to a change in
one of the Companys reinsurance treaties that resulted in
decreased ceded premiums in 2002.

Incurred loss and loss adjustment expenses
totaled $55.2 million for the year ended December 31,
2002, a decrease of $7.6 million, or 12.0 % compared to
2001. The workers compensation incurred loss and loss
adjustment expense ratio decreased to 86.8% for the year ended
December 31, 2002, from 107.4 % for 2001. The decrease in
the loss ratio 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
recorded in 2001. Without the adverse development related to
prior accident years the 2001 loss ratio, on an accident year
basis, was 97.8%. There was no reserve development related to
prior accident years in 2002.

Underwriting expenses were $16.2 million for
the year ended December 31, 2002, a decrease of $180,000,
or 1.1% compared to 2001. The underwriting expense ratio
decreased to 25.5% for the year ended December 31, 2002,
from 28.1% for 2001. Commission expense for the year ended
December 31, 2002 was $5.5 million, compared to
$7.7 million during 2001. 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. Management expects
that the workers compensation underwriting expense ratio
will increase in the near future due to the hiring of several
workers compensation executives and managers as described
above. However, the addition of these executives and managers is
expected to have a positive impact on premium growth, and the
underwriting expense ratio should eventually return,
approximately, to its present level.

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, 2002 and 2001.

|                                            |                     |                        |        |        |        |   |        |            |        |   |        |       |       |  |      |      |      |  
|------------------------------------------- | ------------------- | ---------------------- | ------ | ------ | ------ | - | ------ | ---------- | ------ | - | ------ | ----- | ----- |  | ---- | ---- | ---- | -
|                                            |                     |                        |        |        |        |   |        | Percentage |       
|                                            |                     | 2002                   |        |        | 2001   |   |        | Change     |        |   | Change |      
|                                            |                     |                        |        |        |        |   |        |            |        |   |        |      
|                                            |                     |                       
|                                            |                     | (dollars in thousands) |       
|Direct premiums written                     |                     | $                      | 24,433 |        |        | $ | 18,001 |            |        | $ | 6,432  |       |       |  | 35.7 | %   
|                                            |                     |                        |        |        |        |   |        |            |        |   |        |      
|Net premiums written                        |                     | $                      | 23,820 |        |        | $ | 18,668 |            |        | $ | 5,152  |       |       |  | 27.6 | %   
|                                            |                     |                        |        |        |        |   |        |            |        |   |        |      
|Net premiums earned                         |                     | $                      | 23,820 |        |        | $ | 18,668 |            |        | $ | 5,152  |       |       |  | 27.6 | %   
|Incurred loss and loss adjustment expenses: |                     |                        |        |        |        |   |        |            |        |   |        |       |       |  |      |     
|                                            | Current year losses |                        |        | 23,254 |        |   |        | 18,430     |        |   |        | 4,824 |       |  |      | 26.2 | %   
|                                            | Prior year losses   |                        |        |        |        |   |        |            |        |   |        |       |       |  |      |      |     
|                                            |                     |                        |        |        |        |   |        |            |        |   |        |      
|                                            |                     | Total                  |        |        | 23,254 |   |        |            | 18,430 |   |        |       | 4,824 |  |      |      | 26.2 | %
|Underwriting expenses                       |                     |                        | 4,849  |        |        |   | 4,193  |            |        |   | 656    |       |       |  | 15.6 | %   
|                                            |                     |                        |        |        |        |   |        |            |        |   |        |      
|Underwriting loss                           |                     | $                      | (4,283 | )      |        | $ | (3,955 | )          |        | $ | (328   | )     |       |  | 8.3  | %   
|                                            |                     |                        |        |        |        |   |        |            |        |   |        |      
|Loss ratio:                                 |                     |                        |        |        |        |   |        |            |        |   |        |       |       |  |      |     
|                                            | Calendar year       |                        |        | 97.6   | %      |   |        | 98.7       | %      |   |        | -1.1  | %     |  |      |      |     
|                                            | Accident year       |                        |        | 97.6   | %      |   |        | 98.7       | %      |   |        | -1.1  | %     |  |      |      |     
|Underwriting expense ratio                  |                     |                        | 20.4   | %      |        |   | 22.5   | %          |        |   | -2.1   | %     |       |  |      |     
|Combined ratio:                             |                     |                        |        |        |        |   |        |            |        |   |        |       |       |  |      |     
|                                            | Calendar year       |                        |        | 118.0  | %      |   |        | 121.2      | %      |   |        | -3.2  | %     |  |      |      |     
|                                            | Accident year       |                        |        | 118.0  | %      |   |        | 121.2      | %      |   |        | -3.2  | %     |  |      |      |     

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Health direct premiums written were
$24.4 million for the year ended December 31, 2002, an
increase of $6.4 million, or 35.7% compared to 2001. All
health direct premiums written were related to our involvement
with a single preferred provider organization located in Western
Michigan. This coverage is provided as part of our long-term
strategic relationship with the physician organization that
sponsors this plan. The increase in direct premiums written was
the result of rate increases implemented in 2002, of up to 25%,
as well as moderate membership growth in the fourth quarter of
2002. Working with the plan sponsor, we are continuing to
implement rate increases and tighten underwriting standards.

Net premiums earned were $23.8 million for
the year ended December 31, 2002, an increase of
$5.2 million, or 27.6% compared to 2001. Health net
premiums earned increased less than direct premiums written due
to a change in reinsurance treaties that resulted in increased
ceded health premiums in 2002.

Incurred loss and loss adjustment expenses
totaled $23.3 million for the year ended December 31,
2002, an increase of $4.8 million, or 26.2% compared to
2001. The incurred loss and loss adjustment expense ratio
decreased to 97.6% for 2002, from 98.7% for 2001.

Underwriting expenses were $4.8 million for
the year ended December 31, 2002, an increase of $656,000,
or 15.6% compared to 2001. The health underwriting expense ratio
decreased to 20.4% for 2002 from 22.5% for the year ended
December 31, 2001. Health commission expense for the year
ended December 31, 2002 was $2.5 million, compared to
$2.3 million during 2001. 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 Lines Insurance
Operations

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

|                                            |                     |                        |        |       |       |   |        |            |       |   |        |        |        |   |        |       |       |  
|------------------------------------------- | ------------------- | ---------------------- | ------ | ----- | ----- | - | ------ | ---------- | ----- | - | ------ | ------ | ------ | - | ------ | ----- | ----- | -
|                                            |                     |                        |        |       |       |   |        | Percentage |      
|                                            |                     | 2002                   |        |       | 2001  |   |        | Change     |       |   | Change |       
|                                            |                     |                        |        |       |       |   |        |            |       |   |        |       
|                                            |                     |                       
|                                            |                     | (dollars in thousands) |       
|Direct premiums written                     |                     | $                      | 380    |       |       | $ | (466   | )          |       | $ | 846    |        |        |   | -181.5 | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |        |       
|Net premiums written                        |                     | $                      | (432   | )     |       | $ | (1,473 | )          |       | $ | 1,041  |        |        |   | -70.7  | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |        |       
|Net premiums earned                         |                     | $                      | (432   | )     |       | $ | 5,667  |            |       | $ | (6,099 | )      |        |   | -107.6 | %    
|Incurred loss and loss adjustment expenses: |                     |                        |        |       |       |   |        |            |       |   |        |        |        |   |        |      
|                                            | Current year losses |                        |        | 237   |       |   |        | 7,416      |       |   |        | (7,179 | )      |   |        | -96.8 | %    
|                                            | Prior year losses   |                        |        | 1,130 |       |   |        | 700        |       |   |        | 430    |        |   |        |       |      
|                                            |                     |                        |        |       |       |   |        |            |       |   |        |       
|                                            |                     | Total                  |        |       | 1,367 |   |        |            | 8,116 |   |        |        | (6,749 | ) |        |       | -83.2 | %
|Underwriting expenses                       |                     |                        | 365    |       |       |   | 1,235  |            |       |   | (870   | )      |        |   | -70.4  | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |        |       
|Underwriting loss                           |                     | $                      | (2,164 | )     |       | $ | (3,684 | )          |       | $ | 1,520  |        |        |   | -41.3  | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |        |       
|Loss ratio:                                 |                     |                        |        |       |       |   |        |            |       |   |        |        |        |   |        |      
|                                            | Calendar year       |                        |        |       | (a)   |   |        | 143.2      | %     |   |        |        |        |   |        |       |      
|                                            | Accident year       |                        |        |       | (a)   |   |        | 130.9      | %     |   |        |        |        |   |        |       |      
|Underwriting expense ratio                  |                     |                        |        | (a)   |       |   | 21.8   | %          |       |   |        |        |        |   |        |      
|Combined ratio:                             |                     |                        |        |       |       |   |        |            |       |   |        |        |        |   |        |      
|                                            | Calendar year       |                        |        |       | (a)   |   |        | 165.0      | %     |   |        |        |        |   |        |       |      
|                                            | Accident year       |                        |        |       | (a)   |   |        | 152.7      | %     |   |        |        |        |   |        |       |      



---



|    |                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------
|(a) | Because net premiums earned in 2002 were a
    negative amount, calculated ratios are not meaningful.

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Effective December 31, 2001, the Company
exited the personal and commercial lines of business with the
exception of a single alternative-risk-transfer program. Direct
premiums written associated with this program were $380,000 for
the year ended December 31, 2002. Direct written premiums
for the year ended December 31, 2001, represent premiums
returned to insureds of ($466,000).

During the year ended December 31, 2002, the
Company recorded net premiums earned of $(432,000). This amount
represents additional ceded premiums earned of $(590,000) in
connection with one of the Companys reinsurance treaties
and $158,000 of net premiums earned related to the
alternative-risk-transfer program mentioned above. The premiums
and risk related to this alternative-risk-transfer program were
originally 100% ceded; however, in the fourth quarter of 2002,
the Company began to participate in a portion of this program
and will continue to earn premiums associated with the program
into 2003. Personal and commercial net premiums earned were
$5.7 million for the year ended December 31, 2001.

Incurred loss and loss adjustment expenses
totaled $1.4 million for the year ended December 31,
2002, a decrease of $6.7 million, or 83.2% compared to
2001. Incurred loss and loss adjustment expenses for the year
ended December 31, 2002 represent unfavorable development
on December 31, 2001 unpaid loss and loss adjustment
expenses of $1.1 million, and current year incurred losses
of $237,000 related to the alternative-risk-transfer program
mentioned above.

Net underwriting expenses during the year ended
December 31, 2002 were $365,000, a decrease of $870,000, or
70.4%, compared to 2001.

Investments and Corporate and Other

Investment income, excluding realized investment
losses, was $45.5 million for the year ended
December 31, 2002, a decrease of $2.4 million, or 4.9
% compared to 2001. Net realized losses were $913,000 and
$5.7 million during the years ended December 31, 2002
and 2001, respectively. 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 funds available for investment in 2002. The Company maintains
a portfolio of cash and short-term investments to meet operating
cash needs, and to fund the Companys share repurchase
program.

The average yield on the Companys
investment portfolio was 6.09% for the year ended
December 31, 2002 compared to 6.36 % for 2001. The market
value of the Companys fixed income security portfolio is
inversely related to interest rates; therefore, as interest
rates have declined, the market value of the Companys
fixed income security portfolio has increased. Unrealized gains,
net of deferred income taxes, on the Companys investments
were $24.6 million at December 31, 2002, an increase
of $18.8 million compared to December 31, 2001.

Investment expenses were $2.5 million during
the year ended December 31, 2002. This represents an
increase of $727,000, or 40.7%, compared to the year ended
December 31, 2001. The increase in investment expenses was
primarily due to increased depreciation expense on several of
the Companys investment real estate properties.

The Companys general and administrative
expenses decreased $263,000, or 11.8%, to $1.9 million during
the year ended December 31, 2002 compared to 2001. The
decrease in general and administrative expenses was primarily
the result of the elimination of positions at the Companys
non-insurance subsidiaries.

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. See Effects of New Accounting
Pronouncements and Note 4 to the Consolidated
Financial Statements for further discussion regarding
amortization expense and the effect of SFAS No. 142 on the
Companys future operating results.

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##### Table of Contents



In 2001, the Company recorded a restructuring
charge of $2.5 million. There were no restructuring
activities initiated in 2002. See Note 13 to the
Consolidated Financial Statement, included elsewhere in this
report, for a further discussion of our restructuring activities.

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.

The net loss for the year ended December 31,
2002 was $18.5 million on revenues of $280.5 million,
compared to a net loss of $43.8 million on revenues of
$245.1 million for 2001. The net loss for the year ended
December 31, 2002 included a $9.1 million charge, net
of tax, for the cumulative effect of a change in accounting
principle. The 2002 net loss before the cumulative effect of a
change in accounting principle was $9.4 million. The
decrease in net loss was due primarily to increases in net
premiums earned, which decreased the incurred loss and loss
adjustment expense and underwriting expense ratios for the year
ended December 31, 2002, compared to 2001. Unfavorable
development on prior year loss reserves decreased
$23.4 million to $5.6 million for the year ended
December 31, 2002 from $29.0 million for the year
ended December 31, 2001. This decrease in unfavorable prior
year development also had the effect of decreasing the net loss
for the year ended December 31, 2002 as compared to 2001.

Results of Operations  2001
Compared to 2000

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, 2001 and 2000.

|                                            |                     |                        |         |         |         |   |         |            |         |   |         |        |        |  |       |        |      |  
|------------------------------------------- | ------------------- | ---------------------- | ------- | ------- | ------- | - | ------- | ---------- | ------- | - | ------- | ------ | ------ |  | ----- | ------ | ---- | -
|                                            |                     |                        |         |         |         |   |         | Percentage |        
|                                            |                     | 2001                   |         |         | 2000    |   |         | Change     |         |   | Change  |       
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       
|                                            |                     |                       
|                                            |                     | (dollars in thousands) |        
|Direct premiums written:                    |                     |                        |         |         |         |   |         |            |         |   |         |        |        |  |       |       
|                                            | Michigan            |                        | $       | 44,927  |         |   | $       | 41,771     |         |   | $       | 3,156  |        |  |       | 7.6    | %   
|                                            | Ohio                |                        |         | 24,864  |         |   |         | 17,123     |         |   |         | 7,741  |        |  |       | 45.2   | %   
|                                            | Illinois            |                        |         | 22,006  |         |   |         | 15,924     |         |   |         | 6,082  |        |  |       | 38.2   | %   
|                                            | Florida             |                        |         | 26,690  |         |   |         | 20,182     |         |   |         | 6,508  |        |  |       | 32.2   | %   
|                                            | Kentucky            |                        |         | 15,738  |         |   |         | 17,817     |         |   |         | (2,079 | )      |  |       | -11.7  | %   
|                                            | New Mexico          |                        |         | 9,236   |         |   |         | 8,438      |         |   |         | 798    |        |  |       | 9.5    | %   
|                                            | Nevada              |                        |         | 2,945   |         |   |         | 1,790      |         |   |         | 1,155  |        |  |       | 64.5   | %   
|                                            | Other               |                        |         | 2,847   |         |   |         | 871        |         |   |         | 1,976  |        |  |       | 226.9  | %   
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       
|                                            |                     | Total                  |         | $       | 149,253 |   |         | $          | 123,916 |   |         | $      | 25,337 |  |       |        | 20.4 | %
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       
|Net premiums written                        |                     | $                      | 126,830 |         |         | $ | 114,541 |            |         | $ | 12,289  |        |        |  | 10.7  | %     
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       
|Net premiums earned                         |                     | $                      | 119,659 |         |         | $ | 109,492 |            |         | $ | 10,167  |        |        |  | 9.3   | %     
|Incurred loss and loss adjustment expenses: |                     |                        |         |         |         |   |         |            |         |   |         |        |        |  |       |       
|                                            | Current year losses |                        |         | 145,890 |         |   |         | 104,662    |         |   |         | 41,228 |        |  |       | 39.4   | %   
|                                            | Prior year losses   |                        |         | 22,700  |         |   |         | (8,700     | )       |   |         | 31,400 |        |  |       | -360.9 | %   
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       
|                                            |                     | Total                  |         |         | 168,590 |   |         |            | 95,962  |   |         |        | 72,628 |  |       |        | 75.7 | %
|Underwriting expenses                       |                     |                        | 23,281  |         |         |   | 20,629  |            |         |   | 2,652   |        |        |  | 12.9  | %     
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       
|Underwriting loss                           |                     | $                      | (72,212 | )       |         | $ | (7,099  | )          |         | $ | (65,113 | )      |        |  | 917.2 | %     
|                                            |                     |                        |         |         |         |   |         |            |         |   |         |       

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|                           |               |                        |      |       |      |  |      |            |   |  |        |      |   |  |  |  | 
|-------------------------- | ------------- | ---------------------- | ---- | ----- | ---- |  | ---- | ---------- | - |  | ------ | ---- | - |  |  |  | 
|                           |               |                        |      |       |      |  |      | Percentage |  
|                           |               | 2001                   |      |       | 2000 |  |      | Change     |   |  | Change |     
|                           |               |                        |      |       |      |  |      |            |   |  |        |     
|                           |               |                       
|                           |               | (dollars in thousands) |     
|Loss ratio:                |               |                        |      |       |      |  |      |            |   |  |        |      |   |  |  | 
|                           | Calendar year |                        |      | 140.9 | %    |  |      | 87.6       | % |  |        | 53.3 | % |  |  |  | 
|                           | Accident year |                        |      | 121.9 | %    |  |      | 95.6       | % |  |        | 26.3 | % |  |  |  | 
|Underwriting expense ratio |               |                        | 19.5 | %     |      |  | 18.8 | %          |   |  | 0.7    | %    |   |  |  | 
|Combined ratio:            |               |                        |      |       |      |  |      |            |   |  |        |      |   |  |  | 
|                           | Calendar year |                        |      | 160.4 | %    |  |      | 106.4      | % |  |        | 54.0 | % |  |  |  | 
|                           | Accident year |                        |      | 141.4 | %    |  |      | 114.4      | % |  |        | 27.0 | % |  |  |  | 

Medical professional liability direct premiums
written were $149.3 million for the year ended
December 31, 2001, an increase of $25.3 million, or
20.4% compared to 2000. The increase in direct premiums written
was primarily the result of premium rate increases, reduced
discounts, and policy growth in our Florida and Illinois
markets; however, these factors were offset by the reduction in
the number of insured physicians in Ohio and Kentucky as a
result of our re-underwriting efforts.

Net premiums earned were $119.7 million for
the year ended December 31, 2001, an increase of
$10.2 million, or 9.3%, compared to 2000. Net premiums
earned did not increase as much as direct premiums written in
2001 as many of the premium rate increases and reduced discounts
were instituted in the second half of the year, and remained to
be earned at December 31, 2001. In addition, we recorded
additional ceded premium on all affected swing-rated reinsurance
treaties due to the higher losses, which amounted to a
$6.3 million increase in ceded premiums.

Incurred loss and loss adjustment expenses
totaled $168.6 million for the year ended December 31,
2001, an increase of $72.6 million, or 75.7%, compared to
2000. The incurred loss and loss adjustment expense ratio
increased to 140.9% for the year ended December 31, 2001
from 87.6% for 2000. The increase in the loss ratio was due
primarily to reserve adjustments taken in the third and fourth
quarters of 2001 that related to prior accident years, and
revisions made to current year, expected losses. Due to the
unexpected significant increase in reported losses and claim
severity primarily in our newer markets in the third quarter of
2001, including an unusually high frequency of large claims, we
undertook and completed a comprehensive internal actuarial
study. As a result of this study, we revised the actuarial
assumptions that loss reserves are based upon, and adjusted loss
reserves accordingly.

The reserve adjustments included a total of
approximately $22.7 million increase on prior accident
years, primarily the 2000 and 1999 years. In addition, the
current accident year loss estimates were increased to
approximately $145.9 million to reflect our revised
assumptions regarding loss development patterns. The adjustments
were made primarily as a result of losses in our Ohio, Florida
and Kentucky medical professional liability markets. Ohio and
Florida were relatively new markets for us and had higher policy
limits. Thus, actual loss development was volatile and difficult
to predict. With these revised loss assumptions, the 2001
accident year net loss and loss adjustment expense ratio is
121.9%. We discontinued offering higher policy limits in Ohio
and Florida in the third quarter of 2001.

Underwriting expenses were $23.3 million for
the year ended December 31, 2001, an increase of
$2.7 million, or 12.9%, compared to 2000. The underwriting
expense ratio was 19.5% for the year ended December 31,
2001, compared to 18.8% for 2000. This increase was due
primarily to the growth of premiums in states where we pay
higher commissions than we pay in Michigan, where we have an
arrangement with SCW, which results in commissions at rates that
are substantially the same or lower than we pay to other agents.

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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, 2001 and 2000.

|                                            |                     |                        |         |        |        |   |        |            |        |   |         |        |        |  |       |         |      |  
|------------------------------------------- | ------------------- | ---------------------- | ------- | ------ | ------ | - | ------ | ---------- | ------ | - | ------- | ------ | ------ |  | ----- | ------- | ---- | -
|                                            |                     |                        |         |        |        |   |        | Percentage |       
|                                            |                     | 2001                   |         |        | 2000   |   |        | Change     |        |   | Change  |       
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|                                            |                     |                       
|                                            |                     | (dollars in thousands) |        
|Direct premiums written:                    |                     |                        |         |        |        |   |        |            |        |   |         |        |        |  |       |        
|                                            | Minnesota           |                        | $       | 30,069 |        |   | $      | 21,933     |        |   | $       | 8,136  |        |  |       | 37.1    | %   
|                                            | Michigan            |                        |         | 9,803  |        |   |        | 8,589      |        |   |         | 1,214  |        |  |       | 14.1    | %   
|                                            | Illinois            |                        |         | 8,957  |        |   |        | 4,489      |        |   |         | 4,468  |        |  |       | 99.5    | %   
|                                            | Indiana             |                        |         | 6,787  |        |   |        | 6,709      |        |   |         | 78     |        |  |       | 1.2     | %   
|                                            | Kentucky            |                        |         | 3,197  |        |   |        | 3,204      |        |   |         | (7     | )      |  |       | -0.2    | %   
|                                            | Iowa                |                        |         | 4,000  |        |   |        | 4,285      |        |   |         | (285   | )      |  |       | -6.7    | %   
|                                            | Other               |                        |         | 1,164  |        |   |        | 1,529      |        |   |         | (365   | )      |  |       | -23.9   | %   
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|                                            |                     | Total                  |         | $      | 63,977 |   |        | $          | 50,738 |   |         | $      | 13,239 |  |       |         | 26.1 | %
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|Net premiums written                        |                     | $                      | 64,754  |        |        | $ | 48,184 |            |        | $ | 16,570  |        |        |  | 34.4  | %      
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|Net premiums earned                         |                     | $                      | 58,377  |        |        | $ | 46,980 |            |        | $ | 11,397  |        |        |  | 24.3  | %      
|Incurred loss and loss adjustment expenses: |                     |                        |         |        |        |   |        |            |        |   |         |        |        |  |       |        
|                                            | Current year losses |                        |         | 57,112 |        |   |        | 37,920     |        |   |         | 19,192 |        |  |       | 50.6    | %   
|                                            | Prior year losses   |                        |         | 5,600  |        |   |        | (300       | )      |   |         | 5,900  |        |  |       | -1966.7 | %   
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|                                            |                     | Total                  |         |        | 62,712 |   |        |            | 37,620 |   |         |        | 25,092 |  |       |         | 66.7 | %
|Underwriting expenses                       |                     |                        | 16,402  |        |        |   | 13,275 |            |        |   | 3,127   |        |        |  | 23.6  | %      
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|Underwriting loss                           |                     | $                      | (20,737 | )      |        | $ | (3,915 | )          |        | $ | (16,822 | )      |        |  | 429.7 | %      
|                                            |                     |                        |         |        |        |   |        |            |        |   |         |       
|Loss ratio:                                 |                     |                        |         |        |        |   |        |            |        |   |         |        |        |  |       |        
|                                            | Calendar year       |                        |         | 107.4  | %      |   |        | 80.1       | %      |   |         | 27.3   | %      |  |       |         |     
|                                            | Accident year       |                        |         | 97.8   | %      |   |        | 80.7       | %      |   |         | 17.1   | %      |  |       |         |     
|Underwriting expense ratio                  |                     |                        | 28.1    | %      |        |   | 28.3   | %          |        |   | -0.2    | %      |        |  |       |        
|Combined ratio:                             |                     |                        |         |        |        |   |        |            |        |   |         |        |        |  |       |        
|                                            | Calendar year       |                        |         | 135.5  | %      |   |        | 108.4      | %      |   |         | 27.1   | %      |  |       |         |     
|                                            | Accident year       |                        |         | 125.9  | %      |   |        | 109.0      | %      |   |         | 16.9   | %      |  |       |         |     

Workers compensation direct premiums
written were $64.0 million for the year ended
December 31, 2001, an increase of $13.2 million, or
26.1% compared to 2000. The increase in direct premiums written
was primarily due to retroactive premium adjustments and reduced
credits following audits, as well as growth in the number of
policies written in Minnesota, Illinois, and Indiana.

Net premiums earned were $58.4 million for
the year ended December 31, 2001, an increase of
$11.4 million, or 24.3%, compared to 2000. The increase in
net premiums earned approximated the increase in direct premiums
written in 2001.

Incurred loss and loss adjustment expenses
totaled $62.7 million for the year ended December 31,
2001, an increase of $25.1 million, or 66.7%, compared to
2000. The incurred loss and loss adjustment expense ratio
increased to 107.4% for the year ended December 31, 2001
from 80.1% for 2000. The increasing loss ratio was due to an
overall pattern of increasing losses, especially in our newer
states, Illinois, Iowa and Kentucky, where we have less
historical data on which to base our estimates. As a result of
these high loss patterns, we increased our prior year reserves
in almost all markets by a total of $5.6 million. The
current accident year loss

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estimates were increased to $57.1 million,
primarily in the markets noted above. After these adjustments,
the 2001 accident year net loss and loss adjustment expense
ratio is 97.8%.


Workers compensation underwriting expenses
were $16.4 million for the year ended December 31,
2001, an increase of $3.1 million, or 23.6%, compared to
2000. The underwriting expense ratio decreased to 28.1% for the
year ended December 31, 2001, from 28.3% for 2000. The
decrease resulted primarily from our expense reduction
initiatives, lower assessments and fees, and premium increases.

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, 2001 and 2000.

|                                            |               |                        |        |       |        |        |        |            |        |        |        |      |       |       |      |   |      |      |  
|------------------------------------------- | ------------- | ---------------------- | ------ | ----- | ------ | ------ | ------ | ---------- | ------ | ------ | ------ | ---- | ----- | ----- | ---- | - | ---- | ---- | -
|                                            |               |                        |        |       |        |        |        | Percentage |       
|                                            |               | 2001                   |        |       | 2000   |        |        | Change     |        |        | Change |     
|                                            |               |                        |        |       |        |        |        |            |        |        |        |     
|                                            |               |                       
|                                            |               | (dollars in thousands) |       
|Direct premiums written                     |               | $                      | 18,001 |       |        | $      | 13,214 |            |        | $      | 4,787  |      |       |       | 36.2 | %
|                                            |               |                        |        |       |        |        |        |            |        |        |        |     
|Net premiums written                        |               | $                      | 18,668 |       |        | $      | 11,066 |            |        | $      | 7,602  |      |       |       | 68.7 | %
|                                            |               |                        |        |       |        |        |        |            |        |        |        |     
|Net premiums earned                         |               | $                      | 18,668 |       |        | $      | 11,066 |            |        | $      | 7,602  |      |       |       | 68.7 | %
|Incurred loss and loss adjustment expenses: |               |                        |        |       |        |        |        |            |        |        |        |      |       |       |      |  
|                                            |               | Current year losses    |        |       | 18,430 |        |        |            | 10,020 |        |        |      | 8,410 |       |      |   | 83.9 | %   
|                                            |               | Prior year losses      |        |       |       |        |        |            |       |        |        |      |      |       |      |   |      |     
|                                            |               |                        |        |       |        |        |        |            |        |        |        |     
|                                            |               |                        | Total  |       |        | 18,430 |        |            |        | 10,020 |        |      |       | 8,410 |      |   |      | 83.9 | %
|Underwriting expenses                       |               |                        | 4,193  |       |        |        | 3,676  |            |        |        | 517    |      |       |       | 14.1 | %
|                                            |               |                        |        |       |        |        |        |            |        |        |        |     
|Underwriting loss                           |               | $                      | (3,955 | )     |        | $      | (2,630 | )          |        | $      | (1,325 | )    |       |       | 50.4 | %
|                                            |               |                        |        |       |        |        |        |            |        |        |        |     
|Loss ratio:                                 |               |                        |        |       |        |        |        |            |        |        |        |      |       |       |      |  
|                                            | Calendar year |                        |        | 98.7  | %      |        |        | 90.5       | %      |        |        | 8.2  | %     |       |      |   |     
|                                            | Accident year |                        |        | 98.7  | %      |        |        | 90.5       | %      |        |        | 8.2  | %     |       |      |   |     
|Underwriting expense ratio                  |               |                        | 22.5   | %     |        |        | 33.2   | %          |        |        | -10.7  | %    |       |       |      |  
|Combined ratio:                             |               |                        |        |       |        |        |        |            |        |        |        |      |       |       |      |  
|                                            | Calendar year |                        |        | 121.2 | %      |        |        | 123.7      | %      |        |        | -2.5 | %     |       |      |   |     
|                                            | Accident year |                        |        | 121.2 | %      |        |        | 123.7      | %      |        |        | -2.5 | %     |       |      |   |     

Health direct premiums written were
$18.0 million for the year ended December 31, 2001, an
increase of $4.8 million, or 36.2% compared to 2000. The
increase in direct premiums written was due to a single health
insurance program through a preferred provider organization in
West Michigan. We discontinued all other health programs in 2001.

Net premiums earned were $18.7 million for
the year ended December 31, 2001, an increase of
$7.6 million, or 68.7% compared to 2000. Health net
premiums earned increased more dramatically than direct premiums
written in 2001 due to a change in reinsurance treaties that
resulted in decreased ceded premiums in 2001.

Incurred loss and loss adjustment expenses
totaled $18.4 million for the year ended December 31,
2001, an increase of $8.4 million or 83.9%, compared to
2000. The incurred loss and loss adjustment expense ratio
increased to 98.7% for the year ended December 31, 2001,
from 90.5% for 2000. The increase in the loss ratio was due to
overall increases in health care costs, primarily in the state
of Michigan. We increased health insurance premium rates in 2002
to offset these higher health loss costs.

Underwriting expenses were $4.2 million for
the year ended December 31, 2001, an increase of $517,000,
or 14.1%, compared to 2000. The underwriting expense ratio
decreased to 22.5% for the year ended

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December 31, 2001 from 33.2% for 2000. The
reduction was directly related to our expense reduction
initiatives and premium increases.


Personal and Commercial Lines Insurance
Operations

The following table sets forth summary premium,
loss and expense information regarding the underwriting results
of our personal and commercial insurance operations for the
years ended December 31, 2001 and 2000.

|                                            |                     |                        |        |       |       |   |        |            |       |   |         |        |        |   |        |       |       |  
|------------------------------------------- | ------------------- | ---------------------- | ------ | ----- | ----- | - | ------ | ---------- | ----- | - | ------- | ------ | ------ | - | ------ | ----- | ----- | -
|                                            |                     |                        |        |       |       |   |        | Percentage |      
|                                            |                     | 2001                   |        |       | 2000  |   |        | Change     |       |   | Change  |       
|                                            |                     |                        |        |       |       |   |        |            |       |   |         |       
|                                            |                     |                       
|                                            |                     | (dollars in thousands) |       
|Direct premiums written                     |                     | $                      | (466   | )     |       | $ | 15,299 |            |       | $ | (15,765 | )      |        |   | -103.0 | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |         |       
|Net premiums written                        |                     | $                      | (1,473 | )     |       | $ | 13,285 |            |       | $ | (14,758 | )      |        |   | -111.1 | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |         |       
|Net premiums earned                         |                     | $                      | 5,667  |       |       | $ | 12,804 |            |       | $ | (7,137  | )      |        |   | -55.7  | %    
|Incurred loss and loss adjustment expenses: |                     |                        |        |       |       |   |        |            |       |   |         |        |        |   |        |      
|                                            | Current year losses |                        |        | 7,416 |       |   |        | 12,295     |       |   |         | (4,879 | )      |   |        | -39.7 | %    
|                                            | Prior year losses   |                        |        | 700   |       |   |        | (2,479     | )     |   |         | 3,179  |        |   |        |       |      
|                                            |                     |                        |        |       |       |   |        |            |       |   |         |       
|                                            |                     | Total                  |        |       | 8,116 |   |        |            | 9,816 |   |         |        | (1,700 | ) |        |       | -17.3 | %
|Underwriting expenses                       |                     |                        | 1,235  |       |       |   | 4,578  |            |       |   | (3,343  | )      |        |   | -73.0  | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |         |       
|Underwriting loss                           |                     | $                      | (3,684 | )     |       | $ | (1,590 | )          |       | $ | (2,094  | )      |        |   | 131.7  | %    
|                                            |                     |                        |        |       |       |   |        |            |       |   |         |       
|Loss ratio:                                 |                     |                        |        |       |       |   |        |            |       |   |         |        |        |   |        |      
|                                            | Calendar year       |                        |        | 143.2 | %     |   |        | 76.7       | %     |   |         | 66.5   | %      |   |        |       |      
|                                            | Accident year       |                        |        | 130.9 | %     |   |        | 96.0       | %     |   |         | 34.9   | %      |   |        |       |      
|Underwriting expense ratio                  |                     |                        | 21.8   | %     |       |   | 35.8   | %          |       |   | -14.0   | %      |        |   |        |      
|Combined ratio:                             |                     |                        |        |       |       |   |        |            |       |   |         |        |        |   |        |      
|                                            | Calendar year       |                        |        | 165.0 | %     |   |        | 112.5      | %     |   |         | 52.5   | %      |   |        |       |      
|                                            | Accident year       |                        |        | 152.7 | %     |   |        | 131.8      | %     |   |         | 20.9   | %      |   |        |       |      

Personal and commercial direct premiums written
were $(466,000) for the year ended December 31, 2001, a
decrease of $15.8 million, or 103.0% compared to 2000. In
the fourth quarter of 2000, we announced our plan to exit the
personal and commercial lines of business. As a result, no new
premiums were written during 2001 and the negative direct
written premiums were the result of premiums returned to
policyholders.

Net premiums earned were $5.7 million for
the year ended December 31, 2001, a decrease of
$7.1 million, or 55.7% compared to 2000. Personal and
commercial net premiums earned did not decrease as dramatically
as direct premiums written in 2001 as premiums written in 2000
continued to be earned in 2001.

Incurred loss and loss adjustment expenses
totaled $8.1 million for the year ended December 31,
2001, a decrease of $1.7 million or 17.3%, compared to
2000. The incurred loss and loss adjustment expense ratio
increased to 143.2% for the year ended December 31, 2001,
from 76.7% for 2000. The increasing loss ratio was due primarily
to a higher amount of winter storm-related losses in 2001, and
the adverse effect on premium of discontinuing this line of
business.

Underwriting expenses were $1.2 million for
the year ended December 31, 2001, a decrease of
$3.3 million, or 73.0%, compared to 2000. The underwriting
expense ratio decreased to 21.8% for the year ended
December 31, 2001 from 35.8% for 2000. The reduction was
directly related to our exit from this line of business
beginning in the fourth quarter of 2000.

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Investments and Corporate and Other

Net investment income, excluding realized losses,
was $47.9 million for the year ended December 31,
2001, an increase of $11.1 million, or 30.2%, compared to
2000. Approximately $7.8 million of the increase was
attributable to the investment of the proceeds of our initial
public offering received in December 2000. In addition, in 2000
we liquidated approximately $35.0 million in equity
securities, invested the proceeds in interest income producing
government and corporate bonds, and shifted some of our
portfolio from tax-exempt securities to higher yielding taxable
corporate securities. Net realized (losses) and gains were
($5.6) million and $1.2 million during the years ended
December 31, 2001 and 2000, respectively. Approximately
$6.0 million of the 2001 loss was attributable to a
security whose decline in market value in 2001 we considered to
be other than temporary. Reductions in short-term interest rates
in 2001 reduced the yields generated by this portfolio.

Our general and administrative expenses increased
$1.4 million, to $2.2 million, during the year ended
December 31, 2001, compared to the prior year. The increase
was primarily due to new costs incurred by the holding company,
which became publicly traded in December 2000. These costs
included stock market listing fees, investor relations fees,
shareholder meeting costs and securities reporting expenses.

We incurred a restructuring charge of
$2.5 million in 2001, compared to $919,000 in 2000. See
Note 13 to the Consolidated Financial Statements, included
elsewhere in this report, for further discussion regarding our
restructuring initiatives.

We recorded $23.5 million in federal income
tax benefit for the year ended December 31, 2001, compared
to a $4.8 million expense during 2000, due to the loss for
2001. The effective tax rate was 34.9% for the year ended
December 31, 2001, compared to 28.7% for 2000. The 2000
effective tax rate was lower due to the greater impact of tax
exempt interest.

On March 9, 2002, new tax laws extended the
net operating loss (NOL) carryback period from two
years to five years. As a result, approximately
$9.3 million of the Companys NOL carryforward at
December 31, 2001 was utilized to recover taxes previously
paid in tax years 1996, 1997, and 1998. In addition, the
carryback of the 2001 NOL generated approximately
$6.9 million of minimum tax credit that can be used to
reduce taxable income in the future. This additional loss
carryback resulted in an increase to the reported federal income
taxes recoverable with a corresponding decrease in deferred
federal income taxes in the first quarter of 2002.

Liquidity, Capital Resources and Financial
Condition

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. The primary uses of cash, on both a short and long-term
basis, are losses, loss adjustment expenses, operating expenses,
reinsurance premiums and taxes.

APCapital itself is a holding company whose only
material assets are the capital stock of APAssurance and its
other subsidiaries, and a portion of the net proceeds from the
stock offering. 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.

The Companys only indebtedness is to its
President and Chief Executive Officer (the CEO) in
the amount of $8.0 million, (reflected on the balance sheet
at its present value of $6.6 million) in connection with the
purchase of Stratton-Cheeseman Management Company. The
indebtedness is due in annual installments, with the final
installment due in April 2008. The amount of the annual payments
will increase or decrease by $200,000 for each corresponding
half-grade level increase or decrease in the Companys A.M.
Best Company, Inc. rating. Certain events, such as the
termination, death or disability of the President and CEO or a
change in control of the Company, could accelerate these
payments.

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At December 31, 2002, the Company had
planned expenditures of approximately $3.4 million related
to various information technology initiatives.

The Companys net cash flow generated by
operations was approximately $52.2 million for the year
ended December 31, 2002, compared to $13.0 million
provided by operations for 2001. The improvement in cash flows
generated from operations was primarily the result of premium
rate increases.

At December 31, 2002, the Company had
$151.8 million of cash available and an investment
portfolio of $649.7 million. The portfolio includes
$20.1 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. As of December 31, 2002,
$318 million of bonds mature in the next one to five years
and $199 million mature in the next five to ten years. In
addition, the Company has $2.1 million of mortgage-backed
securities that provide periodic principal repayments.

Total assets increased $20.0 million to
$1.059 billion at December 31, 2002, compared to
$1.039 billion at December 31, 2001. The increase was
primarily attributable to cash flow generated from operations
and the increase in the market value of our fixed income
securities.

Loss and loss adjustment expense reserves
increased $40.5 million, or 6.8%, to $637.5 million at
December 31, 2002, from $597.0 million at
December 31, 2001. This increase was due to increased
writings, primarily in our medical professional liability
segment, and adverse development on prior year estimates.

The unearned premium reserve increased
$3.4 million, or 3.4%, to $103.4 million at
December 31, 2002, from $100.1 million at
December 31, 2001. The increase was primarily due to
premium rate increases in 2002.

In March, July and November 2001, May 2002 and
twice in August 2002, APCapitals Board of Directors
authorized six separate programs to purchase 5% of its
outstanding common stock, representing a total of approximately
3,115,000 shares. The Companys purchase of any of its
shares is subject to limitations that may be imposed by
applicable securities 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. During
the year ended December 31, 2002, the Company purchased
1,555,100 shares pursuant to these authorizations, bringing the
total number of shares purchased pursuant to these
authorizations to 2,924,270, at a total cost of $52,707,000. As
of December 31, 2002, the Company has approximately 191,000
shares of its August 28, 2002 stock repurchase program
remaining to be purchased. There can be no assurance that the
Company will repurchase the remaining shares authorized to be
purchased, or that any additional repurchases will be authorized
by the Companys Board of Directors.

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-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 our short-term liquidity needs.

The Company is exploring various options with
respect to financing to meet its long-term liquidity needs.
While we believe that our exiting sources of funds will be
sufficient to meet our long-term liquidity needs, planned
premium rate increases may require that we obtain additional
funds to bolster surplus so that we maintain an acceptable ratio
of net premiums written to surplus.

Effects of New Accounting
Pronouncements

In June 2001, the Financial Accounting Standards
Board issued SFAS No. 142, Goodwill and Other
Intangible Assets. With the adoption of SFAS No. 142,
goodwill is no longer amortized, but rather, is reviewed at
least annually for impairment in accordance with the provisions
set forth in the statement. In addition, SFAS No. 142
introduced the concept of definite and indefinite lived
intangible assets. Definite lived intangible assets are
amortized over their useful life, unless circumstances indicate
that the asset has been impaired. Indefinite lived intangible
assets, similar to goodwill, are no longer amortized, but rather
reviewed annually for impairment. See Notes 2 and 4 to the
Consolidated Financial Statements, included elsewhere in this
report, for a discussion on the impact of the adoption of SFAS
No. 142.

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The Company is exploring various options with
respect to financing to meet its long-term liquidity needs.
While we believe, that our exiting sources of funds will be
sufficient to meet our long-term liquidity needs, planned
premium rate increases may require that we obtain additional
funds to bolster surplus so that we maintain an acceptable ratio
of net premiums written to surplus.

In August 2001, the Financial Accounting
Standards Board issued SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, effective
for fiscal years beginning after December 15, 2001. This
Statement supersedes SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of, and the accounting and reporting provisions
of Accounting Principles Board Opinion No. 30
Reporting the Results of Operations  Reporting
the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB No. 30). SFAS No. 144
generally retains the basic accounting model for the
identification and measurement of impairments to long-lived
assets to be held, and long-lived assets to be disposed. SFAS
No. 144 broadens the definition of discontinued
operations, as previously defined by APB No. 30, but
does not allow for the accrual of future operating losses, as
was previously permitted under that standard. SFAS No. 144
also addresses several implementation and financial statement
presentation issues not previously addressed under GAAP. SFAS
No. 144 excludes from its scope financial accounting and
reporting for the impairment of goodwill and other intangible
assets. The implementation of SFAS No. 144 did not have an
effect on the Companys consolidated financial position or
results of operations for the year ended December 31, 2002.

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, 2002, 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, 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. 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.
Mortgage loans at December 31, 2001 were carried at the
unpaid principal balance, which approximated the fair market
value as they bore current market interest rates at that date.
There were no mortgage loans at December 31, 2002. Real
estate is carried at historical cost, less accumulated
depreciation. Realized gains or losses on sales or maturities of
investments are determined on a specific identification basis
and are credited or charged to income.

Quantitative Information About Market
Risk

At December 31, 2002, our fixed income
security portfolio was valued at $618.9 million and had an
average modified duration of 3.20 years, compared to a
portfolio valued at $605.9 million with an average modified
duration of 3.65 years at December 31, 2001. The
following tables show the effects of a change in interest rates
on the fair value and duration of our portfolio at
December 31, 2002 and 2001. We have assumed

34



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##### Table of Contents



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.


|                |  |                        |         |  |                        |   |         |          |  |  |           |  |  |           |         |  |          |   |         |   |  |  |      | 
|--------------- |  | ---------------------- | ------- |  | ---------------------- | - | ------- | -------- |  |  | --------- |  |  | --------- | ------- |  | -------- | - | ------- | - |  |  | ---- | 
|                |  |                        |         | 
|                |  | December 31, 2002      |         |  | December 31, 2001      |  
|                |  |                        |         |  |                        |  
|                |  | Portfolio              |         |  | Change in              |   |         | Modified |  |  | Portfolio |  |  | Change in |         |  | Modified |  
|Change in Rates |  | Value                  |         |  | Value                  |   |         | Duration |  |  | Value     |  |  | Value     |         |  | Duration |  
|                |  |                        |         |  |                        |   |         |          |  |  |           |  |  |           |         |  |          |  
|                |  |                        |         | 
|                |  | (dollars in thousands) |         |  | (dollars in thousands) |  
|+2%             |  | $                      | 581,066 |  |                        | $ | (37,833 | )        |  |  | 2.94      |  |  | $         | 558,361 |  |          | $ | (47,506 | ) |  |  | 3.96 | 
|+1%             |  |                        | 599,244 |  |                        |   | (19,655 | )        |  |  | 2.97      |  |  |           | 581,746 |  |          |   | (24,121 | ) |  |  | 3.83 | 
|0               |  |                        | 618,899 |  |                        |   |         |          |  |  | 3.20      |  |  |           | 605,867 |  |          |   |         |   |  |  | 3.65 | 
|-1%             |  |                        | 639,729 |  |                        |   | 20,830  |          |  |  | 3.26      |  |  |           | 629,512 |  |          |   | 23,645  |   |  |  | 3.67 | 
|-2%             |  |                        | 661,713 |  |                        |   | 42,814  |          |  |  | 3.37      |  |  |           | 654,405 |  |          |   | 48,538  |   |  |  | 3.77 | 

35



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##### Table of Contents



Item 8.     Financial
Statements and Supplementary Data






REPORT OF INDEPENDENT ACCOUNTANTS


To the Board of Directors and Shareholders of

American Physicians Capital, Inc.:


In our opinion, the consolidated financial
statements listed in the index appearing under Item 15,
present fairly, in all material respects, the financial position
of American Physicians Capital, Inc. and its subsidiaries at
December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 2002 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 index appearing under Item 15
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 audits 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 4 to the consolidated
financial statements, the Company changed its method of
accounting for goodwill 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

March 12, 2003


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AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES






CONSOLIDATED BALANCE SHEETS


December 31, 2002 and 2001


|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |           |         |         |           |           | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------ | ------------------ | ------------------------------------------ | ------- | --------- | --------- | ------- | ------- | --------- | --------- | 
|                                                                                                                                                              |                                                                                      | 2002               |                                            |         | 2001      |          
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|                                                                                                                                                              |                                                                                      |                   
|                                                                                                                                                              |                                                                                      | (In thousands,     |                                           
|                                                                                                                                                              |                                                                                      | except share data) |                                           
|Assets                                                                                                                                                       
|Investments:                                                                                                                                                  |                                                                                      |                    |                                            |         |           |           |         |        
|                                                                                                                                                              | Fixed maturities, at fair value                                                      |                    | $                                          | 618,899 |           |           | $       | 605,867 |          
|                                                                                                                                                              | Equity securities, at fair value                                                     |                    |                                            | 44      |           |           |         | 656     |          
|                                                                                                                                                              | Other investments                                                                    |                    |                                            | 30,788  |           |           |         | 39,541  |          
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|                                                                                                                                                              |                                                                                      | Total investments  |                                            |         | 649,731   |           |         |         | 646,064   |          
|Cash and cash equivalents                                                                                                                                     |                                                                                      |                    | 151,825                                    |         |           |           | 106,444 |        
|Premiums receivable                                                                                                                                           |                                                                                      |                    | 62,531                                     |         |           |           | 64,194  |        
|Reinsurance recoverable                                                                                                                                       |                                                                                      |                    | 98,128                                     |         |           |           | 95,887  |        
|Federal income taxes recoverable                                                                                                                              |                                                                                      |                    | 1,100                                      |         |           |           | 11,266  |        
|Deferred federal income taxes                                                                                                                                 |                                                                                      |                    | 42,542                                     |         |           |           | 45,940  |        
|Property and equipment, net                                                                                                                                   |                                                                                      |                    | 14,352                                     |         |           |           | 14,742  |        
|Goodwill, net                                                                                                                                                 |                                                                                      |                    |                                            |         |           |           | 13,968  |        
|Other assets                                                                                                                                                  |                                                                                      |                    | 38,709                                     |         |           |           | 40,412  |        
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|                                                                                                                                                              |                                                                                      | Total assets       |                                            | $       | 1,058,918 |           |         | $       | 1,038,917 |          
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|Liabilities                                                                                                                                                  
|Unpaid losses and loss adjustment expenses                                                                                                                    |                                                                                      | $                  | 637,494                                    |         |           | $         | 597,046 |        
|Unearned premiums                                                                                                                                             |                                                                                      |                    | 103,420                                    |         |           |           | 100,056 |        
|Note payable, officer                                                                                                                                         |                                                                                      |                    | 6,567                                      |         |           |           | 7,194   |        
|Accrued expenses and other liabilities                                                                                                                        |                                                                                      |                    | 31,148                                     |         |           |           | 27,656  |        
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|                                                                                                                                                              |                                                                                      | Total liabilities  |                                            |         | 778,629   |           |         |         | 731,952   |          
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|Commitments and Contingencies
    (Note 18)                                                                                                                   |                                                                                      |                    |                                            |         |           |           |         |        
|Shareholders Equity                                                                                                                                          |                                                                                      |                    |                                            |         |           |           |         |        
|Common stock, no par value, 50,000,000 shares
    authorized:
    8,695,492 and 10,238,122 shares outstanding at December 31,
    2002 and 2001, respectively |                                                                                      |                    |                                            |         |           |           |         |        
|Additional paid-in-capital                                                                                                                                    |                                                                                      |                    | 92,148                                     |         |           |           | 119,463 |        
|Retained earnings                                                                                                                                             |                                                                                      |                    | 164,183                                    |         |           |           | 182,674 |        
|Unearned stock compensation                                                                                                                                   |                                                                                      |                    | (678                                       | )       |           |           | (1,001  | )      
|Accumulated other comprehensive income:                                                                                                                       |                                                                                      |                    |                                            |         |           |           |         |        
|                                                                                                                                                              | Net unrealized appreciation on investments, net
    of deferred federal income taxes |                    |                                            | 24,636  |           |           |         | 5,829   |          
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|                                                                                                                                                              |                                                                                      |                    | Total shareholders equity                 |         |           | 280,289   |         |         |           | 306,965   | 
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          
|                                                                                                                                                              |                                                                                      |                    | Total liabilities and shareholders equity |         | $         | 1,058,918 |         |         | $         | 1,038,917 | 
|                                                                                                                                                              |                                                                                      |                    |                                            |         |           |          

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

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AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF INCOME


For the Years Ended December 31, 2002,
2001, and 2000


|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |         | 
|------------------------------------------------------------------------------ | ----------------------------------------------------------------------------------------------- | ------------------------------------- | ------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | 
|                                                                               |                                                                                                 | 2002                                  |         |         | 2001 |   |         | 2000    |  
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|                                                                               |                                                                                                 |                                      
|                                                                               |                                                                                                 | (In thousands, except per share data) |        
|Revenues and Other Income                                                      |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |        
|Net premiums written                                                           |                                                                                                 | $                                     | 238,417 |         |      | $ | 208,779 |         |   | $ | 187,076 |        
|Change in unearned premiums                                                    |                                                                                                 |                                       | (2,866  | )       |      |   | (6,408  | )       |   |   | (6,734  | )      
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|                                                                               | Net premiums earned                                                                             |                                       |         | 235,551 |      |   |         | 202,371 |   |   |         | 180,342 | 
|Investment income                                                              |                                                                                                 |                                       | 45,525  |         |      |   | 47,883  |         |   |   | 36,784  |        
|Net realized (losses) gains                                                    |                                                                                                 |                                       | (913    | )       |      |   | (5,651  | )       |   |   | 1,164   |        
|Other income                                                                   |                                                                                                 |                                       | 376     |         |      |   | 546     |         |   |   | 2,428   |        
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|                                                                               | Total revenues and other income                                                                 |                                       |         | 280,539 |      |   |         | 245,149 |   |   |         | 220,718 | 
|Expenses                                                                       |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |        
|Losses and loss adjustment expenses                                            |                                                                                                 |                                       | 242,028 |         |      |   | 257,848 |         |   |   | 153,518 |        
|Underwriting expenses                                                          |                                                                                                 |                                       | 48,593  |         |      |   | 45,111  |         |   |   | 42,158  |        
|Investment expenses                                                            |                                                                                                 |                                       | 2,515   |         |      |   | 1,788   |         |   |   | 2,978   |        
|Interest expense                                                               |                                                                                                 |                                       | 373     |         |      |   | 400     |         |   |   | 716     |        
|Amortization expense                                                           |                                                                                                 |                                       |         |         |      |   | 2,514   |         |   |   | 2,328   |        
|General and administrative expenses                                            |                                                                                                 |                                       | 1,971   |         |      |   | 2,234   |         |   |   | 855     |        
|Demutualization costs                                                          |                                                                                                 |                                       |         |         |      |   |         |         |   |   | 501     |        
|Restructuring costs (Note 13)                                                  |                                                                                                 |                                       |         |         |      |   | 2,484   |         |   |   | 919     |        
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|                                                                               | Total expenses                                                                                  |                                       |         | 295,480 |      |   |         | 312,379 |   |   |         | 203,973 | 
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|                                                                               | (Loss) income before income taxes and cumulative
    effect of a change in accounting principle |                                       |         | (14,941 | )    |   |         | (67,230 | ) |   |         | 16,745  | 
|Federal income tax (benefit) expense                                           |                                                                                                 |                                       | (5,529  | )       |      |   | (23,450 | )       |   |   | 4,800   |        
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|                                                                               | (Loss) income before cumulative effect of a
    change in accounting principle                  |                                       |         | (9,412  | )    |   |         | (43,780 | ) |   |         | 11,945  | 
|Cumulative effect of a change in accounting
    principle (Note 2)             |                                                                                                 |                                       | (9,079  | )       |      |   |         |         |   |   |         |        
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|Net (loss) income                                                              |                                                                                                 | $                                     | (18,491 | )       |      | $ | (43,780 | )       |   | $ | 11,945  |        
|                                                                               |                                                                                                 |                                       |         |         |      |   |         |         |  
|Earnings Per Share:                                                            |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |        
|(Loss) income before cumulative effect of a
    change in accounting principle |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |        
|                                                                               | Basic*                                                                                          |                                       | $       | (1.01   | )    |   | $       | (3.95   | ) |   | $       | 0.07    | 
|                                                                               | Diluted*                                                                                        |                                       | $       | (1.01   | )    |   | $       | (3.95   | ) |   | $       | 0.07    | 
|Cumulative effect of a change in accounting
    principle                      |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |        
|                                                                               | Basic*                                                                                          |                                       | $       | (0.97   | )    |   | $       |        |   |   | $       |        | 
|                                                                               | Diluted*                                                                                        |                                       | $       | (0.97   | )    |   | $       |        |   |   | $       |        | 
|Net (loss) income                                                              |                                                                                                 |                                       |         |         |      |   |         |         |   |   |         |        
|                                                                               | Basic*                                                                                          |                                       | $       | (1.98   | )    |   | $       | (3.95   | ) |   | $       | 0.07    | 
|                                                                               | Diluted*                                                                                        |                                       | $       | (1.98   | )    |   | $       | (3.95   | ) |   | $       | 0.07    | 



---



|  |                                                          
|- | ---------------------------------------------------------
|* | For periods subsequent to conversion
    (Notes 1 and 17)

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

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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY


AND COMPREHENSIVE INCOME


For the Years Ended December 31, 2002,
2001 and 2000


|                                                                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |         |  
|---------------------------------------------------------------- | ----------------------------------------------------------------------------- | --------------------------------- | ---------- | ---------- | ------- | - | ------- | -------- | -------- | ----------- | ------------ | ------- | - | ------------- | ------ | - | ----- | - | ------ | ------ |  | - | ------- | ------- | -
|                                                                 |                                                                               |                                   |            |            |         |   |         |          |          | Accumulated |              |         |  
|                                                                 |                                                                               |                                   |            | Additional |         |   |         |          | Unearned |             |              | Other   |   |               |       
|                                                                 |                                                                               | Shares                            |            |            | Paid-in |   |         | Retained |          |             | Stock        |         |   | Comprehensive |        |   |      
|                                                                 |                                                                               | Outstanding                       |            |            | Capital |   |         | Earnings |          |             | Compensation |         |   | Income        |        |   | Total |  
|                                                                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|                                                                 |                                                                               |                                  
|                                                                 |                                                                               | (In thousands, except share data) |           
|Balance, January 1, 2000                                         |                                                                               |                                   |            |            |         |   |         |          |          | $           | 214,509      |         |   |               |        |   |       | $ | (5,723 | )      |  | $ | 208,786 |        
|Comprehensive income                                             |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   |         |        
|                                                                 | Net income                                                                    |                                   |            |            |         |   |         |          |          |             |              | 11,945  |   |               |        |   |       |   |        |        |  |   |         | 11,945  |  
|                                                                 | Unrealized appreciation on investment securities,
    net of taxes of $2,802  |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        | 5,204  |  |   |         | 5,204   |  
|                                                                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Total comprehensive income, net of taxes                         |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 17,149  |        
|Proceeds from subscription rights and best
    efforts offerings |                                                                               |                                   | 331,639    |            |         | $ | 4,475   |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 4,475   |        
|Proceeds from initial public offering, net of
    expenses       |                                                                               |                                   | 11,118,616 |            |         |   | 138,106 |          |          |             |              |         |   |               |        |   |       |   |        |        |  |   | 138,106 |        
|Restricted stock grants and unearned stock
    compensation      |                                                                               |                                   | 174,800    |            |         |   | 2,359   |          |          |             |              |         |   | $             | (1,533 | ) |       |   |        |        |  |   | 826     |        
|Amortization of unearned stock compensation                      |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               | 83     |   |       |   |        |        |  |   | 83      |        
|                                                                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  
|Balance, December 31, 2000                                       |                                                                               |                                   | 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 $3,418  |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        | 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 $10,217 |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |   |        | 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 |        
|                                                                 |                                                                               |                                   |            |            |         |   |         |          |          |             |              |         |   |               |        |   |       |  

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

39



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES






CONSOLIDATED STATEMENTS OF CASH
FLOWS


For the Years Ended December 31, 2002,
2001, and 2000


|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |          |          |        |         |          |         |        | 
|----------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ------------------------------------------------------- | --------------------------------------------- | ------- | ------- | ------ | ------- | -------- | -------- | ------ | ------- | -------- | ------- | ------ | 
|                                                      |                                                                                                                                                     | 2002                                                     |                                                         |                                               | 2001    |         |        | 2000    |         
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|                                                      |                                                                                                                                                     |                                                         
|                                                      |                                                                                                                                                     | (In thousands)                                           |                                                        
|Cash flows from operating activities                  |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |          |          |        |        
|                                                      | Net (loss) income                                                                                                                                   |                                                          | $                                                       | (18,491                                       | )       |         | $      | (43,780 | )        |          | $      | 11,945  |         
|                                                      | Adjustments to reconcile net (loss) income
    to net cash provided by operating activities                                                         |                                                          |                                                         |                                               |         |         |        |         |          |          |        |         |         
|                                                      |                                                                                                                                                     | Depreciation and amortization                            |                                                         |                                               | 4,056   |         |        |         | 4,184    |          |        |         | 3,709    |        
|                                                      |                                                                                                                                                     | Net realized losses (gains)                              |                                                         |                                               | 913     |         |        |         | 5,651    |          |        |         | (1,164   | )      
|                                                      |                                                                                                                                                     | Deferred federal income taxes                            |                                                         |                                               | (6,903  | )       |        |         | (16,918  | )        |        |         | (153     | )      
|                                                      |                                                                                                                                                     | Goodwill impairment                                      |                                                         |                                               | 13,968  |         |        |         |          |          |        |         |          |        
|                                                      |                                                                                                                                                     | Other                                                    |                                                         |                                               |         |         |        |         | 1,105    |          |        |         | 951      |        
|                                                      |                                                                                                                                                     | Changes in:                                              |                                                         |                                               |         |         |        |         |          |          |        |         |          |        
|                                                      |                                                                                                                                                     |                                                          | Premiums receivable                                     |                                               |         | 1,663   |        |         |          | (12,840  | )      |         |          | (205    | )     
|                                                      |                                                                                                                                                     |                                                          | Reinsurance recoverable                                 |                                               |         | (2,241  | )      |         |          | (23,885  | )      |         |          | (6,105  | )     
|                                                      |                                                                                                                                                     |                                                          | Federal income taxes recoverable/payable                |                                               |         | 10,166  |        |         |          | (15,053  | )      |         |          | 39,273  |       
|                                                      |                                                                                                                                                     |                                                          | Unpaid losses and loss adjustment expenses              |                                               |         | 40,448  |        |         |          | 113,773  |        |         |          | 26,201  |       
|                                                      |                                                                                                                                                     |                                                          | Unearned premiums                                       |                                               |         | 3,364   |        |         |          | 12,009   |        |         |          | 2,457   |       
|                                                      |                                                                                                                                                     |                                                          | Accrued expenses and other liabilities                  |                                               |         | 3,492   |        |         |          | 2,029    |        |         |          | (9,942  | )     
|                                                      |                                                                                                                                                     |                                                          | Other assets                                            |                                               |         | 1,703   |        |         |          | (13,264  | )      |         |          | 3,074   |       
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|                                                      |                                                                                                                                                     |                                                          |                                                         | Net cash provided by operating
    activities |         |         | 52,138 |         |          |          | 13,011 |         |          |         | 70,041 | 
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|Cash flows from investing activities                  |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |          |          |        |        
|                                                      | Purchases                                                                                                                                           |                                                          |                                                         |                                               |         |         |        |         |          |          |        |         |         
|                                                      |                                                                                                                                                     | Available-for-sale  fixed maturities                    |                                                         |                                               | (85,765 | )       |        |         | (267,537 | )        |        |         | (248,909 | )      
|                                                      |                                                                                                                                                     | Available-for-sale  equity securities                   |                                                         |                                               |         |         |        |         |          |          |        |         | (44,717  | )      
|                                                      |                                                                                                                                                     | Other investments                                        |                                                         |                                               | (270    | )       |        |         |          |          |        |         |          |        
|                                                      |                                                                                                                                                     | Real estate                                              |                                                         |                                               |         |         |        |         |          |          |        |         | (5,200   | )      
|                                                      |                                                                                                                                                     | Property and equipment                                   |                                                         |                                               | (1,668  | )       |        |         | (2,951   | )        |        |         | (1,276   | )      
|                                                      | Sales and maturities                                                                                                                                |                                                          |                                                         |                                               |         |         |        |         |          |          |        |         |         
|                                                      |                                                                                                                                                     | Available-for-sale  fixed maturities                    |                                                         |                                               | 101,997 |         |        |         | 131,711  |          |        |         | 225,047  |        
|                                                      |                                                                                                                                                     | Available-for-sale  equity securities                   |                                                         |                                               | 347     |         |        |         | 180      |          |        |         | 80,776   |        
|                                                      |                                                                                                                                                     | Held-to-maturity                                         |                                                         |                                               |         |         |        |         |          |          |        |         | 980      |        
|                                                      |                                                                                                                                                     | Other investments                                        |                                                         |                                               | 6,842   |         |        |         | 419      |          |        |         | 3,426    |        
|                                                      |                                                                                                                                                     | Property and equipment                                   |                                                         |                                               |         |         |        |         | 1,958    |          |        |         | 36       |        
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|                                                      |                                                                                                                                                     |                                                          | Net cash provided by (used in) investing
    activities |                                               |         | 21,483  |        |         |          | (136,220 | )      |         |          | 10,163  |       
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|Cash flows from financing activities                  |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |          |          |        |        
|                                                      | Proceeds from issuance of common stock, net of
    expenses                                                                                         |                                                          |                                                         |                                               |         |         |        |         |          |          |        | 142,581 |         
|                                                      | Principle payment on note payable                                                                                                                   |                                                          |                                                         | (1,000                                        | )       |         |        | (1,000  | )        |          |        |         |         
|                                                      | Common stock repurchased                                                                                                                            |                                                          |                                                         | (27,483                                       | )       |         |        | (25,225 | )        |          |        |         |         
|                                                      | Proceeds from stock options exercised                                                                                                               |                                                          |                                                         | 243                                           |         |         |        |         |          |          |        |         |         
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|                                                      |                                                                                                                                                     |                                                          | Net cash (used in) provided by financing
    activities |                                               |         | (28,240 | )      |         |          | (26,225  | )      |         |          | 142,581 |       
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|                                                      |                                                                                                                                                     | Net increase (decrease) in cash and cash
    equivalents |                                                         |                                               | 45,381  |         |        |         | (149,434 | )        |        |         | 222,785  |        
|                                                      |                                                                                                                                                     |                                                          | Cash and cash equivalents, beginning of period          |                                               |         | 106,444 |        |         |          | 255,878  |        |         |          | 33,093  |       
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|                                                      |                                                                                                                                                     |                                                          | Cash and cash equivalents, end of period                |                                               | $       | 151,825 |        |         | $        | 106,444  |        |         | $        | 255,878 |       
|                                                      |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |         
|Supplemental disclosures of cash flow
    information |                                                                                                                                                     |                                                          |                                                         |                                               |         |         |        |         |          |          |        |        
|                                                      | Federal income tax refunds of $(13,619,000),
    $8,481,000 and $(28,104,000), net, were (received) paid in 2002,
    2001, and 2000, respectively. |                                                          |                                                         |                                               |         |         |        |         |          |          |        |         |         

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

40



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##### Table of Contents



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) and its wholly
owned subsidiaries, Insurance Corporation of America
(ICA), APSpecialty Insurance Corporation, formerly
RML Insurance Company, (APS), APConsulting LLC,
APDirect Sales, LLC, Alpha Advisors, Inc. and American
Physicians Assurance Corporation, formerly Mutual Insurance
Corporation Of America, (APAssurance), together
referred to as the Company. All significant
intercompany accounts and transactions are eliminated in
consolidation.

On December 13, 2000, the conversion of
APAssurance from a mutual company to a stock corporation was
consummated according to a Plan of Conversion adopted by the
Board of Directors of APAssurance on June 28, 2000, with
subsequent amendment on October 2, 2000. This plan was
approved by APAssurance policyholders at a special meeting held
on November 29, 2000 and by the State of Michigan Office of
Financial and Insurance Services. The Plan of Conversion
included several key components, including: formation of
APCapital to be the ultimate parent holding company; the
conversion of APAssurance from a mutual insurance company to a
stock company and wholly owned by APCapital; the transfer of
ICA, APS, APConsulting, APDirect Sales, and Alpha Advisors, Inc.
from APAssurance to wholly owned subsidiaries of APCapital.

In connection with the conversion, 331,638 shares
of common stock of APCapital were sold at $13.50 per share under
a subscription rights and best efforts offering to APAssurance
policyholders, officers, directors, employees, and others.
APCapital then sold 9,668,362 shares of its common stock in an
underwritten public offering (the Offering) that
closed December 13, 2000. On December 13, 2000, an
additional 1,450,254 shares were sold to underwriters of the
Offering pursuant to an over-allotment option contained in the
underwriting agreement. The net proceeds of the Offering were
approximately $142.6 million, consisting of gross proceeds
of $154.6 million less conversion and offering expenses of
$12.0 million.

In March, July and November 2001, May, 2002 and
twice in August, 2002, APCapitals board of directors
authorized six separate programs to purchase 5% of its
outstanding common stock, representing approximately 3,115,000
shares. The Companys purchase of any of its shares is
subject to limitations that may be imposed by applicable
securities 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. APCapital
repurchased 1,555,100 and 1,369,170 shares, at a cost of $27.5
million and $25.2 million, during 2002 and 2001,
respectively. As of December 31, 2002, the Company has
approximately 191,000 shares of its August 28, 2002 stock
repurchase program remaining to be purchased.



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

The Company is principally engaged in the
business of providing medical professional liability,
workers compensation and health insurance throughout the
United States of America with a concentration of writings in the
Midwest.



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

All of the Companys fixed maturities 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.

41



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



1.     Significant
Accounting Policies  (Continued)


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. At
December 31, 2001, mortgage loans are carried at the unpaid
principal balance, which approximates the fair market value as
they bore current market interest rates at that date. There were
no mortgage loans at December 31, 2002. Real estate is carried
at historical cost, less accumulated depreciation. Real estate
of $27,380,000 and $33,411,000 in 2002 and 2001, respectively,
and mortgage loans of $4,474,000 in 2001 are included in other
investments on the balance sheet.

Investments are evaluated for other than
temporary impairment (OTTI) using both quantitative
and qualitative methods. At December 31, 2002, a reserve of
$1.0 million was established on investment real estate.
Additionally, the Company has written down its investment in
Frontier bonds by $520,000 during 2002 and by $5.9 million
in 2001. No other investments were noted that would require a
write down for OTTI. Changes 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 gains for subsequent recoveries in the
market value of an impaired security until the security is sold
or otherwise disposed of.



| |                          
| | -------------------------
| | 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 primarily using pro
rata methods over the period of risk. Premiums receivable
include $57,013,000 at December 31, 2002 and $56,679,000 at
December 31, 2001 of premium installments. Receivable
balances consist principally of written premiums from physicians
and employers in the states of Michigan, Ohio, Illinois,
Florida, Minnesota and New Mexico. The Companys exposure
to credit risk associated with receivables is generally offset
by the liability for unearned premiums.

Included in the premium receivable balance is an
allowance for doubtful accounts of approximately $1 million
and $1.3 million at December 31, 2002 and 2001,
respectively.



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

Deferred policy acquisition costs
(DAC) (carried on the accompanying balance sheet 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 using straight-line and
accelerated methods 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.

42



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



1.     Significant
Accounting Policies  (Continued)




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

The reserves for unpaid losses and loss
adjustment expenses are actuarially 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 determined
based on historical loss trends. 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 adjustment is 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 $14,000,000 and
$15,000,000 at December 31, 2002 and 2001, respectively,
and is included in unpaid losses on the balance sheet. Changes
in this reserve are charged or credited to income.



| |                    
| | -------------------
| | 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, and unearned premiums represent
the portion of premiums written which are applicable to the
unexpired terms of policies in-force.



| |            
| | -----------
| | 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 Statement of Financial Accounting Standards 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.

43



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



1.     Significant
Accounting Policies  (Continued)


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.



| |             
| | ------------
| | 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 reviews, at least
quarterly, deferred federal income tax assets for recoverability
based on the availability of future taxable income in the years
when the deductible temporary differences are expected to
reverse.



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

Goodwill consists of the excess of cost over fair
market value of net assets of acquired businesses. Prior to
2002, Goodwill is 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
Standard of Financial Accounting Standard No. 142,
Goodwill and Other Intangible Assets (SFAS
No. 142). 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

In accordance with APB Opinion No. 25, the
Company records compensation expense for stock options only if
the market price of the Companys stock, on the date of
grant, exceeds the amount an individual must pay to acquire the
stock.



| |                            
| | ---------------------------
| | Net (loss) income per share

Net (loss) income per share is computed by
dividing net (loss) income by the weighted average number of
shares of common stock and common stock equivalents (stock
options and stock grants) outstanding during each year (See
Note 17).



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

The preparation of financial statements in
conformity with accounting principals generally accepted in the
United States of America (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.

2.     Effects of New
Accounting Pronouncements

In June 2001, the Financial Accounting Standards
Board issued SFAS No. 142. With the adoption of SFAS
No. 142, goodwill is no longer amortized, but rather, is
reviewed at least annually for impairment in accordance with the
provisions set forth in the statement. In addition, SFAS
No. 142 introduced the concept

44



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

2.     Effects of New
Accounting Pronouncements  (Continued)

of definite and indefinite lived intangible
assets. Definite lived intangible assets are amortized over
their useful life, unless circumstances indicate that the asset
has been impaired. Indefinite lived intangible assets, similar
to goodwill, are no longer amortized, but rather reviewed
annually for impairment. Effective January 1, 2002, the
Company adopted SFAS No. 142. See Note 4 for further
discussion regarding the impact of SFAS No. 142.

The FASB issued SFAS No. 144
Accounting for Impairment or Disposal of Long-lived
Assets. This Standard was effective for the Company on a
prospective basis, beginning January 1, 2002. SFAS
No. 144 clarifies and revises existing guidance on
accounting for impairment of property, plant, and equipment,
amortized intangibles, and other long-lived assets not
specifically addressed in other accounting literature. The
adoption of this Standard did not have any impact on the
Companys 2002 financial results.

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. Realized investment
gains (losses) on securities held as of the beginning of the
year totaling $459,000 in 2002, $(4,103,000) in 2001, and
$3,686,000 in 2000 had unrealized appreciation of $620,000 at
the beginning of 2002, $100,000 at the beginning of 2001, and
$4,139,000 at the beginning of 2000.

4.     Goodwill

Effective January 1, 2002, the Company
adopted SFAS No. 142. In accordance with the guidance given
in SFAS No. 142, the Company has 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 the
$13.9 million 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 of the
Companys reporting units did not support the carrying
value of previously recorded goodwill. For purposes of the
impairment testing, fair value was estimated using various
methods, including multiples of projected net income and market
capitalization. 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.

45



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



4.     Goodwill 
(Continued)


The adoption of SFAS No. 142 has had a
significant impact on the Companys 2002 operating results,
as goodwill is no longer being amortized. The Companys net
(loss) income per share for the years ended
December 31, 2002 and 2001, and for the period
December 13, 2000 to December 31, 2000 (Notes 1
and 17), in the consolidated statements of income,
exclusive of amortization expense recognized in those periods
related to goodwill no longer being amortized, would have been
as follows:

|                                 |                                   |                        |   |         |      |  |   |         |   |  |   |      | 
|-------------------------------- | --------------------------------- | ---------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ---- | 
|                                 |                                   | 2002                   |   |         | 2001 |  |   | 2000    |  
|                                 |                                   |                        |   |         |      |  |   |         |  
|                                 |                                   |                       
|                                 |                                   | (In thousands,         |  
|                                 |                                   | except per share data) |  
|Net (loss) income:               |                                   |                        |   |         |      |  |   |         |   |  |   |     
|                                 | Reported net loss (income)        |                        | $ | (18,491 | )    |  | $ | (43,780 | ) |  | $ | 796  | 
|                                 | Add back:                         |                        |   |         |      |  |   |         |   |  |   |      | 
|                                 | Goodwill amortization, net of tax |                        |   |         |      |  |   | 1,634   |   |  |   | 113  | 
|                                 |                                   |                        |   |         |      |  |   |         |  
|                                 | Adjusted net (loss) income        |                        | $ | (18,491 | )    |  | $ | (42,146 | ) |  | $ | 909  | 
|                                 |                                   |                        |   |         |      |  |   |         |  
|Basic (loss) income per share:   |                                   |                        |   |         |      |  |   |         |   |  |   |     
|                                 | Reported net (loss) income        |                        | $ | (1.98   | )    |  | $ | (3.95   | ) |  | $ | 0.07 | 
|                                 | Add back:                         |                        |   |         |      |  |   |         |   |  |   |      | 
|                                 | Goodwill amortization, net of tax |                        |   |         |      |  |   | 0.15    |   |  |   | 0.01 | 
|                                 |                                   |                        |   |         |      |  |   |         |  
|                                 | Adjusted net (loss) income        |                        | $ | (1.98   | )    |  | $ | (3.81   | ) |  | $ | 0.08 | 
|                                 |                                   |                        |   |         |      |  |   |         |  
|Diluted (loss) income per share: |                                   |                        |   |         |      |  |   |         |   |  |   |     
|                                 | Reported net (loss) income        |                        | $ | (1.98   | )    |  | $ | (3.95   | ) |  | $ | 0.07 | 
|                                 | Add back:                         |                        |   |         |      |  |   |         |   |  |   |      | 
|                                 | Goodwill amortization, net of tax |                        |   |         |      |  |   | 0.15    |   |  |   | 0.01 | 
|                                 |                                   |                        |   |         |      |  |   |         |  
|                                 | Adjusted net (loss) income        |                        | $ | (1.98   | )    |  | $ | (3.81   | ) |  | $ | 0.08 | 
|                                 |                                   |                        |   |         |      |  |   |         |  



---



|    |                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------
|(a) | Net income and net income per share for 2000 are
    based on the period December 13, 2000 to December 31,
    2000 (Notes 1 and 17)

The changes in the carrying amount of goodwill
for the years ended December 31, 2002 and 2001, were as
follows:

|                                  |                   |                |       |        |              |   |       |        |   |              |            |      |     |       |       |        |       |   |     |      |   |   |        |         |  
|--------------------------------- | ----------------- | -------------- | ----- | ------ | ------------ | - | ----- | ------ | - | ------------ | ---------- | ---- | --- | ----- | ----- | ------ | ----- | - | --- | ---- | - | - | ------ | ------- | -
|                                  |                   | Medical        |       |        |              |   |       |        |   |              | Corporate  |      |     |      
|                                  |                   | Professional   |       |        | Workers     |   |       |        |   | Personal and |            |      | and |       |       |       
|                                  |                   | Liability      |       |        | Compensation |   |       | Health |   |              | Commercial |      |     | Other |       |        | Total |  
|                                  |                   |                |       |        |              |   |       |        |   |              |            |      |     |       |       |        |       |  
|                                  |                   |               
|                                  |                   | (In thousands) |      
|Balance at January 1, 2001        |                   | $              | 9,279 |        |              | $ | 4,192 |        |   | $            | 232        |      |     | $     | 2,168 |        |       | $ | 610 |      |   | $ | 16,481 |        
|                                  | Amortization      |                |       | (1,050 | )            |   |       | (518   | ) |              |            | (26  | )   |       |       | (246   | )     |   |     | (293 | ) |   |        | (2,133  | )
|                                  | Impairment losses |                |       |        |              |   |       | (63    | ) |              |            |      |     |       |       |        |       |   |     | (317 | ) |   |        | (380    | )
|                                  |                   |                |       |        |              |   |       |        |   |              |            |      |     |       |       |        |       |  
|Net goodwill at December 31, 2001 |                   |                | 8,229 |        |              |   | 3,611 |        |   |              | 206        |      |     |       | 1,922 |        |       |   |     |      |   |   | 13,968 |        
|                                  | Amortization      |                |       |        |              |   |       |        |   |              |            |      |     |       |       |        |       |   |     |      |   |   |        |         |  
|                                  | Impairment losses |                |       | (8,229 | )            |   |       | (3,611 | ) |              |            | (206 | )   |       |       | (1,922 | )     |   |     |      |   |   |        | (13,968 | )
|                                  |                   |                |       |        |              |   |       |        |   |              |            |      |     |       |       |        |       |  
|Net goodwill at December 31, 2002 |                   | $              |      |        |              | $ |      |        |   | $            |           |      |     | $     |      |        |       | $ |    |      |   | $ |       |        
|                                  |                   |                |       |        |              |   |       |        |   |              |            |      |     |       |       |        |       |  

46



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

5.     Investments

The composition of the investment portfolio at
December 31 was:

|                   |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |         |         | 
|------------------ | --------------------------------- | ------------------------ | - | ------- | ---------- |  | ----- | ---------- | ------ |  | ---------- | ------ | ------ | - | - | ------- | ------- | 
|                   |                                   |                         
|                   |                                   | 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 | 
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       

|                   |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |         |         | 
|------------------ | --------------------------------- | ------------------------ | - | ------- | ---------- |  | ----- | ---------- | ------ |  | ---------- | ------ | ------ | - | - | ------- | ------- | 
|                   |                                   |                         
|                   |                                   | 2001                     |  
|                   |                                   |                          |  
|                   |                                   |                          |   | Gross   |            |  | Gross |            |        | 
|                   |                                   | Amortized                |   |         | Unrealized |  |       | Unrealized |        |  | Estimated  |       
|                   |                                   | Cost/Cost                |   |         | Gains      |  |       | Losses     |        |  | Fair Value |       
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   |                         
|                   |                                   | (In thousands)           |  
|Available-for-sale |                                   |                          |   |         |            |  |       |            |        |  |            |        |        |   |   |        
|                   | U.S. government obligations       |                          | $ | 82,424  |            |  | $     | 1,389      |        |  | $          | (545   | )      |   | $ | 83,268  |        
|                   | States and political subdivisions |                          |   | 35,326  |            |  |       | 504        |        |  |            | (203   | )      |   |   | 35,627  |        
|                   | Corporate securities              |                          |   | 445,053 |            |  |       | 11,864     |        |  |            | (5,953 | )      |   |   | 450,964 |        
|                   | Mortgage-backed securities        |                          |   | 3,390   |            |  |       | 97         |        |  |            | (3     | )      |   |   | 3,484   |        
|                   | Other debt securities             |                          |   | 31,042  |            |  |       | 1,487      |        |  |            | (5     | )      |   |   | 32,524  |        
|                   |                                   | Fixed maturities         |   |         | 597,235    |  |       |            | 15,341 |  |            |        | (6,709 | ) |   |         | 605,867 | 
|                   | Equity securities                 |                          |   | 321     |            |  |       | 335        |        |  |            |        |        |   |   | 656     |        
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       
|                   |                                   | Total available-for-sale |   | $       | 597,556    |  |       | $          | 15,676 |  |            | $      | (6,709 | ) |   | $       | 606,523 | 
|                   |                                   |                          |   |         |            |  |       |            |        |  |            |       

47



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



5.     Investments 
(Continued)


The components of pretax investment income at
December 31 were:

|                        |                       |                                     |        |        |        |   |        |        |        |   |        |        |         |  
|----------------------- | --------------------- | ----------------------------------- | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------- | -
|                        |                       | 2002                                |        |        | 2001   |   |        | 2000   |       
|                        |                       |                                     |        |        |        |   |        |        |       
|                        |                       |                                    
|                        |                       | (In thousands)                      |       
|Interest income         |                       | $                                   | 44,435 |        |        | $ | 46,548 |        |        | $ | 34,372 |       
|Dividend income         |                       |                                     |        |        |        |   | 2      |        |        |   | 197    |       
|Other investment income |                       |                                     | 1,090  |        |        |   | 1,333  |        |        |   | 2,215  |       
|                        |                       |                                     |        |        |        |   |        |        |       
|                        | Investment income     |                                     | $      | 45,525 |        |   | $      | 47,883 |        |   | $      | 36,784 |        
|                        |                       |                                     |        |        |        |   |        |        |       
|Gross realized gains    |                       |                                     |        |        |        |   |        |        |        |   |        |       
|                        | Fixed maturities      |                                     | $      | 2,575  |        |   | $      | 1,697  |        |   | $      | 520    |        
|                        | Equity securities     |                                     |        | 48     |        |   |        | 121    |        |   |        | 16,243 |        
|                        | Other invested assets |                                     |        | 20     |        |   |        |        |        |   |        |        |        
|                        |                       |                                     |        |        |        |   |        |        |       
|                        |                       | Total gross realized gains          |        |        | 2,643  |   |        |        | 1,818  |   |        |        | 16,763  |  
|                        |                       |                                     |        |        |        |   |        |        |       
|Gross realized losses   |                       |                                     |        |        |        |   |        |        |        |   |        |       
|                        | Fixed maturities      |                                     |        | (2,262 | )      |   |        | (5,978 | )      |   |        | (6,556 | )      
|                        | Equity securities     |                                     |        |        |        |   |        |        |        |   |        | (9,039 | )      
|                        | Other invested assets |                                     |        | (1,001 | )      |   |        | (963   | )      |   |        |        |        
|                        |                       |                                     |        |        |        |   |        |        |       
|                        |                       | Total gross realized losses         |        |        | (3,263 | ) |        |        | (6,941 | ) |        |        | (15,595 | )
|                        |                       |                                     |        |        |        |   |        |        |       
|                        |                       | Net realized investment (loss) gain |        | $      | (620   | ) |        | $      | (5,123 | ) |        | $      | 1,168   |  
|                        |                       |                                     |        |        |        |   |        |        |       

Net investment (loss) gain in the above table
excludes approximately $293,000 in 2002, $528,000 in 2001, and
$4,000 in 2000 of realized losses on the sale of disposal of
fixed assets.

During 2002 and 2001, the Company recorded losses
of $520,000 and $5.9 million, respectively, on a security
whose decline in market value was considered other than
temporary.

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

|                                   |                   |                |         |        |      |   |        |       |   |   |        |         |  
|---------------------------------- | ----------------- | -------------- | ------- | ------ | ---- | - | ------ | ----- | - | - | ------ | ------- | -
|                                   |                   | 2002           |         |        | 2001 |   |        | 2000  |  
|                                   |                   |                |         |        |      |   |        |       |  
|                                   |                   |               
|                                   |                   | (In thousands) |        
|Held-to-maturity, fixed maturities |                   | $              |        |        |      | $ |       |       |   | $ | (8     | )      
|                                   |                   |                |         |        |      |   |        |       |  
|Available-for-sale                 |                   |                |         |        |      |   |        |       |   |   |        |        
|                                   | Fixed maturities  |                | $       | 29,244 |      |   | $      | 9,780 |   |   | $      | 20,152  |  
|                                   | Equity securities |                |         | (312   | )    |   |        | (15   | ) |   |        | (12,146 | )
|                                   |                   |                |         |        |      |   |        |       |  
|Deferred income taxes              |                   |                | (10,125 | )      |      |   | (3,417 | )     |   |   | (2,802 | )      
|                                   |                   |                |         |        |      |   |        |       |  
|                                   |                   | $              | 18,807  |        |      | $ | 6,348  |       |   | $ | 5,204  |        
|                                   |                   |                |         |        |      |   |        |       |  

48



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



5.     Investments 
(Continued)


The amortized cost and estimated fair value of
debt securities at December 31, 2002, by contractual
maturity, was:

|                   |                            |                |   |         |            |  |   |         |         | 
|------------------ | -------------------------- | -------------- | - | ------- | ---------- |  | - | ------- | ------- | 
|                   |                            | Amortized      |   |         | Estimated  | 
|                   |                            | Cost           |   |         | Fair Value | 
|                   |                            |                |   |         |            | 
|                   |                            |               
|                   |                            | (In thousands) |  
|Available-for-sale |                            |                |   |         |            |  |   |        
|                   | Less than one year         |                | $ | 20,116  |            |  | $ | 20,298  |        
|                   | One to five years          |                |   | 317,852 |            |  |   | 336,773 |        
|                   | Five to ten years          |                |   | 198,885 |            |  |   | 216,180 |        
|                   | More than ten years        |                |   | 42,088  |            |  |   | 43,462  |        
|                   | Mortgage-backed securities |                |   | 2,081   |            |  |   | 2,186   |        
|                   |                            |                |   |         |            | 
|                   |                            | Total          |   | $       | 581,022    |  |   | $       | 618,899 | 
|                   |                            |                |   |         |            | 

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.

Bonds with amortized costs of $8,541,000 and
$8,297,000 were on deposit with various states as of
December 31, 2002 and 2001, respectively.

Proceeds on the sales of investments in bonds
totaled $45,337,000 in 2002, $27,400,000 in 2001, and
$212,701,000 in 2000.

6.     Deferred
Acquisition Costs

Changes in deferred policy acquisition costs for
the years ended December 31, 2002, 2001, and 2000 are
summarized as follows:

|                  |                      |                |         |        |      |   |         |        |  |   |         |       | 
|----------------- | -------------------- | -------------- | ------- | ------ | ---- | - | ------- | ------ |  | - | ------- | ----- | 
|                  |                      | 2002           |         |        | 2001 |   |         | 2000   | 
|                  |                      |                |         |        |      |   |         |        | 
|                  |                      |               
|                  |                      | (In thousands) |        
|Beginning balance |                      | $              | 10,712  |        |      | $ | 9,693   |        |  | $ | 9,406   |      
|Additions         |                      |                | 28,191  |        |      |   | 26,779  |        |  |   | 24,232  |      
|Amortization      |                      |                | (28,026 | )      |      |   | (25,760 | )      |  |   | (23,945 | )    
|                  |                      |                |         |        |      |   |         |        | 
|                  | Balance, December 31 |                | $       | 10,877 |      |   | $       | 10,712 |  |   | $       | 9,693 | 
|                  |                      |                |         |        |      |   |         |        | 

Deferred acquisition costs are included in other
assets on the accompanying balance sheets.

49



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

7.     Property and
Equipment, Net

At December 31, 2002 and 2001, property and
equipment consisted of the following:

|                                   |  |                |         |   |      |   |        |  
|---------------------------------- |  | -------------- | ------- | - | ---- | - | ------ | -
|                                   |  | 2002           |         |   | 2001 |  
|                                   |  |                |         |   |      |  
|                                   |  |               
|                                   |  | (In thousands) |        
|Land                               |  | $              | 571     |   |      | $ | 571    |  
|Building (occupied by the Company) |  |                | 10,499  |   |      |   | 10,499 |  
|Computer equipment and software    |  |                | 11,352  |   |      |   | 9,917  |  
|Furniture                          |  |                | 3,683   |   |      |   | 3,596  |  
|                                   |  |                |         |   |      |  
|                                   |  |                | 26,105  |   |      |   | 24,583 |  
|Accumulated depreciation           |  |                | (11,753 | ) |      |   | (9,841 | )
|                                   |  |                |         |   |      |  
|                                   |  | $              | 14,352  |   |      | $ | 14,742 |  
|                                   |  |                |         |   |      |  

Depreciation expense associated with property and
equipment for the years ended December 31, 2002, 2001 and
2000 was $1.5 million, $1.4 million, and
$1.0 million, respectively.

8.     Unpaid Losses
and Loss Adjustment Expenses

Activity in unpaid losses and loss adjustment
expenses for the years ended December 31, 2002, 2001, and
2000 was as follows:

|                               |                                |                |         |         |      |   |         |         |   |   |         |         |  
|------------------------------ | ------------------------------ | -------------- | ------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                               |                                | 2002           |         |         | 2001 |   |         | 2000    |  
|                               |                                |                |         |         |      |   |         |         |  
|                               |                                |               
|                               |                                | (In thousands) |        
|Balance, beginning of year     |                                | $              | 597,046 |         |      | $ | 483,273 |         |   | $ | 457,072 |        
|                               | Less, reinsurance recoverables |                |         | (91,491 | )    |   |         | (69,319 | ) |   |         | (63,490 | )
|                               |                                |                |         |         |      |   |         |         |  
|Net balance, beginning of year |                                |                | 505,555 |         |      |   | 413,954 |         |   |   | 393,582 |        
|Incurred related to            |                                |                |         |         |      |   |         |         |   |   |         |        
|                               | Current year                   |                |         | 236,398 |      |   |         | 228,848 |   |   |         | 164,997 |  
|                               | Prior years                    |                |         | 5,630   |      |   |         | 29,000  |   |   |         | (11,479 | )
|                               |                                |                |         |         |      |   |         |         |  
|                               | Total incurred                 |                |         | 242,028 |      |   |         | 257,848 |   |   |         | 153,518 |  
|                               |                                |                |         |         |      |   |         |         |  
|Paid related to                |                                |                |         |         |      |   |         |         |   |   |         |        
|                               | Current year                   |                |         | 43,867  |      |   |         | 41,693  |   |   |         | 49,243  |  
|                               | Prior years                    |                |         | 161,690 |      |   |         | 124,554 |   |   |         | 83,903  |  
|                               |                                |                |         |         |      |   |         |         |  
|                               | Total paid                     |                |         | 205,557 |      |   |         | 166,247 |   |   |         | 133,146 |  
|                               |                                |                |         |         |      |   |         |         |  
|Net balance, end of year       |                                |                | 542,026 |         |      |   | 505,555 |         |   |   | 413,954 |        
|                               | Plus, reinsurance recoverables |                |         | 95,468  |      |   |         | 91,491  |   |   |         | 69,319  |  
|                               |                                |                |         |         |      |   |         |         |  
|Balance, end of period         |                                | $              | 637,494 |         |      | $ | 597,046 |         |   | $ | 483,273 |        
|                               |                                |                |         |         |      |   |         |         |  

During 2002, 2001, and 2000, management made
adjustments to prior year reserves. These adverse/ (positive)
adjustments totaled $5.6 million, $29.0 million, and
($11.5) million for the years ended December 31, 2002,
2001, and 2001, respectively. As a percentage of net reserves as
of the beginning of the year, these adjustments were 1.1%, 7%
and (2.9%), respectively.

The positive development recognized in 2000 was
the result of continued favorable claims settlement experience
in the Michigan market. In the second half of 2001, we
encountered a large increase in reported losses, primarily in
our Florida, Ohio, and Kentucky professional liability markets.
This increase in reported

50



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



8.     Unpaid Losses
and Loss Adjustment Expenses  (Continued)


losses was the result of an over 20% increase in
an average severity of claims reported in 2001. The 2001
adjustment was also unusually large because Ohio and Florida
markets were relatively new for the Company, making our 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, we also added to prior year reserves in
2002, primarily in our Ohio and Florida markets.

Management believes the estimate of the ultimate
liability for losses and loss adjustment expenses at
December 31, 2002 is reasonable and reflective of
anticipated ultimate experience. However, it is possible that
the Companys actual incurred loss and loss adjustment
expenses will not conform to the assumptions inherent in the
determination 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 financial
statements.

9.     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. A
reconciliation of direct premiums to net premiums, on both a
written and earned basis, for the years ended December 31,
2002, 2001, and 2000 is as follows:

|        |     |                |         |         |        |   |         |         |  |   |         |         |  |         |         |         |        |   |         |         |  |   |         |         | 
|------- | --- | -------------- | ------- | ------- | ------ | - | ------- | ------- |  | - | ------- | ------- |  | ------- | ------- | ------- | ------ | - | ------- | ------- |  | - | ------- | ------- | 
|        |     |                |         |         |        |  
|        |     | 2002           |         |         | 2001   |   |         | 2000    | 
|        |     |                |         |         |        |   |         |         | 
|        |     | Written        |         |         | Earned |   |         | Written |  |   | Earned  |         |  | Written |         |         | Earned |  
|        |     |                |         |         |        |   |         |         |  |   |         |         |  |         |         |         |        |  
|        |     |               
|        |     | (In thousands) |        
|Direct  |     | $              | 266,260 |         |        | $ | 262,847 |         |  | $ | 230,765 |         |  | $       | 219,035 |         |        | $ | 203,167 |         |  | $ | 201,080 |        
|Ceded   |     |                | (29,769 | )       |        |   | (29,271 | )       |  |   | (24,933 | )       |  |         | (19,333 | )       |        |   | (21,098 | )       |  |   | (25,310 | )      
|Assumed |     |                | 1,926   |         |        |   | 1,975   |         |  |   | 2,947   |         |  |         | 2,669   |         |        |   | 5,005   |         |  |   | 4,572   |        
|        |     |                |         |         |        |   |         |         |  |   |         |         |  |         |         |         |        |  
|        | Net |                | $       | 238,417 |        |   | $       | 235,551 |  |   | $       | 208,779 |  |         | $       | 202,371 |        |   | $       | 187,074 |  |   | $       | 180,342 | 
|        |     |                |         |         |        |   |         |         |  |   |         |         |  |         |         |         |        |  

Losses and loss adjustment expenses incurred are
net of ceded losses of $31,725,000 for 2002, $46,721,000 for
2001, and $30,417,000 for 2000.

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.

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AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



9.     Reinsurance 
(Continued)


The Company had reinsurance recoverables from the
following reinsurers at December 31, 2002 and 2001:

|                                             |  |                |         |  |      |   |         | 
|-------------------------------------------- |  | -------------- | ------- |  | ---- | - | ------- | 
|                                             |  | 2002           |         |  | 2001 |  
|                                             |  |                |         |  |      |  
|                                             |  |               
|                                             |  | (In thousands) |        
|Hannover Ruckversicherungs                   |  | $              | 27,065  |  |      | $ | 19,332  | 
|Gerling Global Reinsurance Corporation       |  |                | 17,202  |  |      |   | 10,593  | 
|General Reinsurance Corporation              |  |                | 11,716  |  |      |   | 16,777  | 
|Transatlantic Reinsurance Company            |  |                | 11,626  |  |      |   | 12,737  | 
|American Re-Insurance Company                |  |                | 5,990   |  |      |   | 3,414   | 
|Employers Reinsurance Corporation            |  |                | 5,831   |  |      |   | 7,785   | 
|Converium Reinsurance                        |  |                | 5,754   |  |      |   | 7,438   | 
|PMA Capital Insurance Corporation            |  |                | 4,011   |  |      |   | 8,882   | 
|Workers Compensation Reinsurance Association |  |                | 3,395   |  |      |   | 322     | 
|Others                                       |  |                | 16,727  |  |      |   | 19,299  | 
|                                             |  |                |         |  |      |  
|                                             |  | $              | 109,317 |  |      | $ | 106,579 | 
|                                             |  |                |         |  |      |  

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

|                                                                                              |                                     |                |        |         |      |   |        |         | 
|--------------------------------------------------------------------------------------------- | ----------------------------------- | -------------- | ------ | ------- | ---- | - | ------ | ------- | 
|                                                                                              |                                     | 2002           |        |         | 2001 |  
|                                                                                              |                                     |                |        |         |      |  
|                                                                                              |                                     |               
|                                                                                              |                                     | (In thousands) |       
|Reinsurance recoverable                                                                       |                                     | $              | 98,128 |         |      | $ | 95,887 |        
|Prepaid reinsurance premium (included in other
    assets on the accompanying balance sheets) |                                     |                | 11,189 |         |      |   | 10,692 |        
|                                                                                              |                                     |                |        |         |      |  
|                                                                                              | Amounts recoverable from reinsurers |                | $      | 109,317 |      |   | $      | 106,579 | 
|                                                                                              |                                     |                |        |         |      |  

10.     Income
Taxes

The provision for income taxes for the years
ended December 31, 2002, 2001 and 2000 consists of:

|                          |  |                |        |   |      |   |         |      |  |   |       |  
|------------------------- |  | -------------- | ------ | - | ---- | - | ------- | ---- |  | - | ----- | -
|                          |  | 2002           |        |   | 2001 |   |         | 2000 | 
|                          |  |                |        |   |      |   |         |      | 
|                          |  |               
|                          |  | (In thousands) |       
|Current (benefit) expense |  | $              | (3,478 | ) |      | $ | (6,532  | )    |  | $ | 4,953 |  
|Deferred benefit          |  |                | (2,051 | ) |      |   | (16,918 | )    |  |   | (153  | )
|                          |  |                |        |   |      |   |         |      | 
|                          |  | $              | (5,529 | ) |      | $ | (23,450 | )    |  | $ | 4,800 |  
|                          |  |                |        |   |      |   |         |      | 

52



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



10.     Income
Taxes  (Continued)


Income taxes incurred do not bear the usual
relationship to income before income taxes for the years ended
December 31, 2002, 2001, and 2000 due to the following:

|                                  |                     |                |         |      |      |  |      |      |  |   |         |      |   |  |      |      |  |   |        |        |   |  |      |      | 
|--------------------------------- | ------------------- | -------------- | ------- | ---- | ---- |  | ---- | ---- |  | - | ------- | ---- | - |  | ---- | ---- |  | - | ------ | ------ | - |  | ---- | ---- | 
|                                  |                     |                |         |      |      | 
|                                  |                     | 2002           |         |      | 2001 |  |      | 2000 | 
|                                  |                     |                |         |      |      |  |      |      | 
|                                  |                     |                |         |      |      |  |      |      |  |  
|                                  |                     |               
|                                  |                     | (In thousands) |        
|(Loss) income before income taxes |                     | $              | (14,941 | )    |      |  |      |      |  | $ | (67,230 | )    |   |  |      |      |  | $ | 16,745 |        |   |  |      |     
|                                  |                     |                |         |      |      |  |      |      |  |   |         |      |   |  |      |      |  |  
|Tax at statutory rate             |                     |                | (5,229  | )    |      |  | 35.0 | %    |  |   | (23,531 | )    |   |  | 35.0 | %    |  | $ | 5,861  |        |   |  | 35.0 | %   
|Tax effect of:                    |                     |                |         |      |      |  |      |      |  |   |         |      |   |  |      |      |  |   |        |        |   |  |      |     
|                                  | Tax exempt interest |                |         | (525 | )    |  |      | 3.5  |  |   |         | (617 | ) |  |      | 0.9  |  |   |        | (1,330 | ) |  |      | -7.9 | 
|                                  | Other items, net    |                |         | 225  |      |  |      | -1.5 |  |   |         | 698  |   |  |      | -1.0 |  |   |        | 269    |   |  |      | 1.6  | 
|                                  |                     |                |         |      |      |  |      |      |  |   |         |      |   |  |      |      |  |  
|                                  |                     | $              | (5,529  | )    |      |  | 37.0 | %    |  | $ | (23,450 | )    |   |  | 34.9 | %    |  | $ | 4,800  |        |   |  | 28.7 | %   
|                                  |                     |                |         |      |      |  |      |      |  |   |         |      |   |  |      |      |  |  

At December 31, 2002 and 2001, the
components of the net deferred federal income tax asset were as
follows:

|                                      |                                     |                                |   |        |        |  |   |        |        | 
|------------------------------------- | ----------------------------------- | ------------------------------ | - | ------ | ------ |  | - | ------ | ------ | 
|                                      |                                     | 2002                           |   |        | 2001   | 
|                                      |                                     |                                |   |        |        | 
|                                      |                                     |                               
|                                      |                                     | (In thousands)                 |  
|Deferred tax assets arising from      |                                     |                                |   |        |        |  |   |       
|                                      | Losses and loss adjustment expenses |                                | $ | 31,072 |        |  | $ | 29,590 |       
|                                      | Net operating loss carryforwards    |                                |   | 3,326  |        |  |   | 13,010 |       
|                                      | Unearned and audit premiums         |                                |   | 8,140  |        |  |   | 8,780  |       
|                                      | Minimum tax credits                 |                                |   | 9,101  |        |  |   |        |       
|                                      | Realized losses on investments      |                                |   | 2,893  |        |  |   |        |       
|                                      | Goodwill                            |                                |   | 5,485  |        |  |   | 827    |       
|                                      | Other                               |                                |   | 1,843  |        |  |   | 1,583  |       
|                                      |                                     |                                |   |        |        | 
|                                      |                                     | Total deferred tax assets      |   |        | 61,860 |  |   |        | 53,790 | 
|                                      |                                     |                                |   |        |        | 
|Deferred tax liabilities arising from |                                     |                                |   |        |        |  |   |       
|                                      | Deferred policy acquisition costs   |                                |   | 3,807  |        |  |   | 3,749  |       
|                                      | Net unrealized gains on securities  |                                |   | 13,263 |        |  |   | 3,138  |       
|                                      | Other                               |                                |   | 2,248  |        |  |   | 963    |       
|                                      |                                     | Total deferred tax liabilities |   |        | 19,318 |  |   |        | 7,850  | 
|                                      |                                     |                                |   |        |        | 
|                                      |                                     | Net deferred tax asset         |   | $      | 42,542 |  |   | $      | 45,940 | 
|                                      |                                     |                                |   |        |        | 

At December 31, 2002, the Company had
approximately $9.5 million of net operating loss
carryforwards which expire in 2012 and are limited to
approximately $910,000 annually, and approximately
$9.1 million of minimum tax credits which can be carried
forward indefinitely.

11.     Shareholders
Equity

Approximately $1.037 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,

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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



11.     Shareholders
Equity  (Continued)


2003, approximately $18.8 million could be
paid by the Companys insurance subsidiaries without prior
regulatory approval.

12.     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
nonfinancial 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, and note
payable constitute financial instruments. The carrying amounts
of all financial instruments, other than investment securities,
which are presented in Note 5, approximated their fair
values at December 31, 2002 and 2001.

13.     Restructuring
Charges

In April 2000, the Company began de-emphasize its
health segment and restructure its New Mexico operations. A
total of six people were severanced at the time, resulting in
charges of $408,000 for severance costs and $105,000 of other
charges. In October 2000, the Company began to phase out its
personal and commercial lines in Lapeer, Michigan. A total of
14 people were terminated, resulting in a charge of
$406,000.

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
complete; however, structured severance packages will not be
completely paid out until the first quarter of 2003.

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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

13.     Restructuring
Charges  (Continued)

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

|                     |  |                |       |  |           |  |  |          |  |   |             |   |  |   |     | 
|-------------------- |  | -------------- | ----- |  | --------- |  |  | -------- |  | - | ----------- | - |  | - | --- | 
|                     |  |               
|                     |  | 2002           |      
|                     |  |                |      
|Type of Cost         |  | January 1      |       |  | Additions |  |  | Payments |  |   | December 31 |  
|                     |  |                |       |  |           |  |  |          |  |   |             |  
|                     |  |               
|                     |  | (In thousands) |      
|Employee separations |  | $              | 1,130 |  |           |  |  |          |  | $ | (914        | ) |  | $ | 216 | 
|                     |  |                |       |  |           |  |  |          |  |   |             |  

|                     |  |                |     |  |           |   |       |          |  |   |             |   |  |   |       | 
|-------------------- |  | -------------- | --- |  | --------- | - | ----- | -------- |  | - | ----------- | - |  | - | ----- | 
|                     |  |               
|                     |  | 2001           |    
|                     |  |                |    
|Type of Cost         |  | January 1      |     |  | Additions |   |       | Payments |  |   | December 31 |  
|                     |  |                |     |  |           |   |       |          |  |   |             |  
|                     |  |               
|                     |  | (In thousands) |    
|Employee separations |  | $              | 454 |  |           | $ | 2,458 |          |  | $ | (1,782      | ) |  | $ | 1,130 | 
|Other                |  |                |     |  |           |   | 26    |          |  |   | (26         | ) |  |   |       | 
|                     |  |                |     |  |           |   |       |          |  |   |             |  
|Total                |  | $              | 454 |  |           | $ | 2,484 |          |  | $ | (1,808      | ) |  | $ | 1,130 | 
|                     |  |                |     |  |           |   |       |          |  |   |             |  

|                     |  |                |     |  |           |   |     |          |  |   |             |   |  |   |     | 
|-------------------- |  | -------------- | --- |  | --------- | - | --- | -------- |  | - | ----------- | - |  | - | --- | 
|                     |  |               
|                     |  | 2000           |    
|                     |  |                |    
|Type of Cost         |  | January 1      |     |  | Additions |   |     | Payments |  |   | December 31 |  
|                     |  |                |     |  |           |   |     |          |  |   |             |  
|                     |  |               
|                     |  | (In thousands) |    
|Employee separations |  | $              | 418 |  |           | $ | 884 |          |  | $ | (848        | ) |  | $ | 454 | 
|Other                |  |                |     |  |           |   | 35  |          |  |   | (35         | ) |  |   |     | 
|                     |  |                |     |  |           |   |     |          |  |   |             |  
|Total                |  | $              | 418 |  |           | $ | 919 |          |  | $ | (883        | ) |  | $ | 454 | 
|                     |  |                |     |  |           |   |     |          |  |   |             |  

14.     Related Party
Transactions

The note payable to an officer represents the
remaining annual installment payments, discounted at
approximately 6%, due to the Companys President and CEO in
connection with the purchase of Stratton-Cheeseman Management
Company in 1999. The scheduled annual payments will increase or
decrease by $200,000 for each corresponding half-grade increase
or decrease in the Companys A.M. Best Company, Inc. rating
during the term of the payments. Any amounts paid or credited
for changes in the industry rating will be recorded as
compensation expense in the period earned. Certain events, such
as the termination, death or disability of the Companys
President and CEO or a change in control of the Company could
accelerate these payments. If the commitment is accelerated or
cancelled, any remaining discount or amounts forfeited will be
recorded as expense as the goodwill associated with the purchase
has been completely written off. This note aggregated $6,556,800
and $7,194,000, at December 31, 2002 and 2001, respectively.

The President and CEO of the Company is a
majority owner of SCW Agency Group, 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 Nevada. Direct premiums written by the agency
during 2002, 2001, and 2000 totaled $70,810,000, $68,896,000,
and $67,758,000, respectively, representing, 26.6%, 29.9%, and
33.4% of direct premiums written during such years. Commission
expense incurred related to SCW approximated $5,560,000,
$4,660,000, and $4,633,000 in 2002, 2001 and 2000, respectively.

In 1999, the Company asked SCW to help the
Company enter the Nevada medical professional liability market.
To help alleviate the cost of penetrating a new market, the
Company agreed to reimburse a portion of SCWs costs from
when it began its operations in Nevada in October 1997 through
October 1999. The amounts paid by the Company would then be
repaid through a reduced commission 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 by the Company. The Companys non-interest bearing
receivable balance related to

55



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AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

14.     Related Party
Transactions  (Continued)

the SCW Nevada start up costs was $310,000 and
$334,000 at December 31, 2002 and 2001, respectively. In
2002, the Company established an allowance in the amount of
$300,000 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, 2002 was $10,000.

SCW leased approximately 13,000 sq. feet of
office space from the Company in 2002 and approximately 10,000
sq. feet in 2001 and 2000. The Company received $283,000,
$216,000 and $192,000 in rental income in 2002, 2001 and 2000
respectively.

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 2002 and 2001 were $410,000 and $370,000,
respectively.

15.     Employee
Benefit Plans

The Company offers benefits under certain defined
contribution plans. In 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 (10% of employee
compensation and a 25% match of employee contributions on the
first 4% of contributions for the year 2000). Employer
contributions to the plans were approximately $575,000,
$1,654,000, and $1,401,000 for 2002, 2001, and 2000,
respectively.

16.     Stock Based
Compensation

In connection with the conversion, 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 2000 vest in
annual installments of 10%, 15%, 20%, 25% and 30% on the first
through the fifth anniversaries, respectively, of the date of
grant. Options granted during 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:

|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                |  |         |  |  |   |       | 
|---------------------------------------- |  | ------- | ------- | - | -------------- | - | ----- | ------- |  |  | -------------- | - |  | ------- | ----- |  | -------------- |  | ------- |  |  | - | ----- | 
|                                         |  |         |         |   |                |  
|                                         |  | 2002    |         |   | 2001           |   |       | 2000    | 
|                                         |  |         |         |   |                |   |       |         | 
|                                         |  | 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 |  |         | 792,500 |   |                | $ | 17.80 |         |  |  | 410,000        |   |  | $       | 13.50 |  |                |  |         |  |  |   |       | 
|Granted during year                      |  |         | 263,000 |   |                | $ | 18.72 |         |  |  | 490,500        |   |  | $       | 20.44 |  |                |  | 410,000 |  |  | $ | 13.50 | 
|Exercised during year                    |  |         | (18,000 | ) |                | $ | 13.50 |         |  |  |                |   |  |         |       |  |                |  |         |  |  |   |       | 
|Canceled during year                     |  |         | (50,000 | ) |                | $ | 20.58 |         |  |  | (108,000       | ) |  | $       | 13.50 |  |                |  |         |  |  |   |       | 
|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                | 
|Options outstanding at end of year       |  |         | 987,500 |   |                | $ | 18.39 |         |  |  | 792,500        |   |  | $       | 17.80 |  |                |  | 410,000 |  |  | $ | 13.50 | 
|                                         |  |         |         |   |                |   |       |         |  |  |                |   |  |         |       |  |                | 

56



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

16.     Stock Based
Compensation  (Continued)

|                                           |  |             |                     |  |           |  |      |       |  |           |        |  |  |       |         |  |  |   |       | 
|------------------------------------------ |  | ----------- | ------------------- |  | --------- |  | ---- | ----- |  | --------- | ------ |  |  | ----- | ------- |  |  | - | ----- | 
|                                           |  |            
|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                              |  |             | 284,000             |  |           |  | 7.93 |       |  | $         | 13.50  |  |  |       | 66,500  |  |  | $ | 13.50 | 
|$13.51-$20.00                              |  |             | 174,000             |  |           |  | 9.56 |       |  | $         | 17.72  |  |  |       |         |  |  |   |       | 
|$20.01-$20.68                              |  |             | 529,500             |  |           |  | 8.95 |       |  | $         | 20.47  |  |  |       | 161,865 |  |  | $ | 20.44 | 
|                                           |  |             |                     |  |           |  |      |       |  |           |        |  |  |       |        
|                                           |  |             | 987,500             |  |           |  | 8.76 |       |  | $         | 18.39  |  |  |       | 228,365 |  |  | $ | 18.28 | 
|                                           |  |             |                     |  |           |  |      |       |  |           |        |  |  |       |        
|Options available for grant at end of year |  |             | 44,993              |  |           |  |      |       |  |           |        |  |  |       |         |  |  |   |       | 

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 connection with the offering, the Company also
granted 200 shares of restricted stock to each employee for a
total grant of 39,600 shares at $13.50 per share. These shares
vest at a rate of 20%, 35% and 45%, in 2001, 2002, and 2003,
respectively. Upon issuance of the stock award, unearned
compensation is charged to shareholders equity and
amortized over the vesting periods. A total of 26,580 and 18,110
shares vested under terms of these stock award programs during
2002 and 2001, respectively. A total of 5,530 and 21,700 shares
were forfeited as a result of employee terminations prior to
vesting during 2002 and 2001, respectively. The vesting of stock
awarded to officers, directors and employees resulted in a total
compensation expense of $421,000, $435,000 and $83,000 in 2002,
2001 and 2000, respectively.

The Company accounts for its stock-based
compensation in accordance with Accounting Principles Bond
Opinion No. 25, Accounting for Stock Issued to
Employees and related interpretations. 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 2002, 2001, and 2000. Had compensation
expense for the options been recognized based on the fair value
at the grant date consistent with SFAS No. 123,
Accounting for Stock-Based Compensation, the
Companys net (loss) income and net (loss) income per
common share-assuming dilution would have been reduced to the
pro forma amounts below:

|                                  |             |      |   |         |      |  |   |         |   |  |   |        | 
|--------------------------------- | ----------- | ---- | - | ------- | ---- |  | - | ------- | - |  | - | ------ | 
|                                  |             | 2002 |   |         | 2001 |  |   | 2000    |  
|                                  |             |      |   |         |      |  |   |         |  
|Net (loss) income (in thousands): |             |      |   |         |      |  |   |         |   |  |   |       
|                                  | As reported |      | $ | (18,491 | )    |  | $ | (43,780 | ) |  | $ | 11,945 | 
|                                  | Pro forma   |      | $ | (20,534 | )    |  | $ | (44,252 | ) |  | $ | 11,918 | 
|Diluted EPS                       |             |      |   |         |      |  |   |         |   |  |   |       
|                                  | As reported |      | $ | (1.98   | )    |  | $ | (3.95   | ) |  | $ | 0.07   | 
|                                  | Pro forma   |      | $ | (2.20   | )    |  | $ | (3.99   | ) |  | $ | 0.07   | 

57



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AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

16.     Stock Based
Compensation  (Continued)

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:

|                                       |  |      |       |   |      |  |       |      |  |  |       |  
|-------------------------------------- |  | ---- | ----- | - | ---- |  | ----- | ---- |  |  | ----- | -
|                                       |  | 2002 |       |   | 2001 |  |       | 2000 | 
|                                       |  |      |       |   |      |  |       |      | 
|Risk-free interest rate                |  |      | 4.09  | % |      |  | 4.43  | %    |  |  | 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       |  |      | 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.

17.     Earnings Per
Share

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

The following table sets forth the computation of
basic and diluted earnings per share for the years ended
December 31, 2002 and 2001 and the period ended
December 31, 2000:

|                                                                              |               |               |             |   |               |  |            |        |  |   |       |   | 
|----------------------------------------------------------------------------- | ------------- | ------------- | ----------- | - | ------------- |  | ---------- | ------ |  | - | ----- | - | 
|                                                                              |               | (Loss)/Income |             |   | Shares        |  |            | Per    | 
|                                                                              |               | (Numerator)   |             |   | (Denominator) |  |            | Share  | 
|                                                                              |               |               |             |   |               |  |            |        | 
|For the Year Ended December 31,
    2002:                                     |               |               |             |   |               |  |            |        |  |   |       |  
|Loss before cumulative effect of a change in
    accounting principle  basic |               | $             | (9,412,000  | ) |               |  | 9,339,739  |        |  | $ | (1.01 | )
|Cumulative effect of a change in accounting
    principle  basic             |               | $             | (9,079,000  | ) |               |  | 9,339,739  |        |  | $ | (0.97 | )
|                                                                              |               |               |             |   |               |  |            |        | 
|Net loss  basic                                                              |               | $             | (18,491,000 | ) |               |  | 9,339,739  |        |  | $ | (1.98 | )
|                                                                              |               |               |             |   |               |  |            |        | 
|For the Year Ended December 31,
    2001:                                     |               |               |             |   |               |  |            |        |  |   |       |  
|Net loss per share  basic                                                    |               | $             | (43,780,000 | ) |               |  | 11,071,529 |        |  | $ | (3.95 | )
|                                                                              |               |               |             |   |               |  |            |        | 
|For the period from December 13, 2000 to
    December 31, 2000:               |               |               |             |   |               |  |            |        |  |   |       |  
|Net income per share  basic                                                  |               | $             | 796,000     |   |               |  | 11,134,981 |        |  | $ | 0.07  |  
|Effect of dilutive securities:                                                |               |               |             |   |               |  |            |        |  |   |       |  
|                                                                              | Stock awards  |               |             |   |               |  |            | 75,232 |  |   |       |   | 
|                                                                              | Stock options |               |             |   |               |  |            | 50,584 |  |   |       |   | 
|                                                                              |               |               |             |   |               |  |            |        | 
|Net income per share  diluted                                                |               | $             | 796,000     |   |               |  | 11,260,797 |        |  | $ | 0.07  |  
|                                                                              |               |               |             |   |               |  |            |        | 

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

18.     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

58



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AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



18.     Commitments
and Contingencies  (Continued)


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.

The Company is the first and second guarantor of
approximately $1.8 million and $5.3 million, respectively,
of debt owed by one of the Companys real estate
partnership investments. At December 31, 2002 and 2001, the
Company has not recorded any liability related to these
guarantees.

The Company is obligated under operating leases,
which have various expiration dates through December 2007.
Minimum future lease payments are as follows: 2003 
$1,416,000; 2004  $920,000; 2005 
$579,000, 2006  $351,000 and 2007 
$269,000. Rental expense was $1,900,000 in 2002, $2,177,000 in
2001, and $2,419,000 in 2000.

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.

19.     GAAP and
Statutory Reporting

APAssurance, 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 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.
|
| |  | Deferred federal income taxes and were not
    recorded for statutory purposes prior to 2001.                                                            

59



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



19.     GAAP and
Statutory Reporting  (Continued)


The following is statutory surplus at
December 31, 2002, 2001, and 2000 and net (loss) income for
the years then ended.

|                                                               |  |                |         |   |      |   |         |      |  |   |         | 
|-------------------------------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | 
|                                                               |  | 2002           |         |   | 2001 |   |         | 2000 | 
|                                                               |  |                |         |   |      |   |         |      | 
|                                                               |  |               
|                                                               |  | (In thousands) |        
|Statutory surplus, December 31                                 |  | $              | 190,216 |   |      | $ | 203,223 |      |  | $ | 246,089 | 
|                                                               |  |                |         |   |      |   |         |      | 
|Statutory net (loss) income for the year ended
    December 31 |  | $              | (10,117 | ) |      | $ | (63,535 | )    |  | $ | 8,913   | 
|                                                               |  |                |         |   |      |   |         |      | 

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.

20.     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, restructuring expense and demutualization expense are
all attributed to the holding company and are included in
corporate and other, as is other income, which the Company does
not allocate to the insurance operating segments.

60



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

20.     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:

|                                                                                                     |                                |                                      |   |         |           |   |   |         |           |   |   |         |         | 
|---------------------------------------------------------------------------------------------------- | ------------------------------ | ------------------------------------ | - | ------- | --------- | - | - | ------- | --------- | - | - | ------- | ------- | 
|                                                                                                     |                                |                                     
|                                                                                                     |                                | At or For the Year Ended December 31 |  
|                                                                                                     |                                |                                      |  
|                                                                                                     |                                | 2002                                 |   |         | 2001      |   |   | 2000    |          
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          
|                                                                                                     |                                |                                     
|                                                                                                     |                                | (In thousands)                       |  
|Total assets:                                                                                        |                                |                                      |   |         |           |   |   |         |           |   |   |        
|                                                                                                     | Medical professional liability |                                      | $ | 859,804 |           |   | $ | 806,114 |           |   | $ | 756,162 |        
|                                                                                                     | Workers compensation          |                                      |   | 153,612 |           |   |   | 163,498 |           |   |   | 152,995 |        
|                                                                                                     | Health                         |                                      |   | 19,003  |           |   |   | 12,146  |           |   |   | 11,556  |        
|                                                                                                     | Personal and commercial        |                                      |   | 4,089   |           |   |   | 7,750   |           |   |   | 15,577  |        
|                                                                                                     | Corporate and other            |                                      |   | 22,410  |           |   |   | 49,409  |           |   |   | 41,686  |        
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          
|                                                                                                     |                                | Total                                |   | $       | 1,058,918 |   |   | $       | 1,038,917 |   |   | $       | 977,976 | 
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          
|Total revenue:                                                                                       |                                |                                      |   |         |           |   |   |         |           |   |   |        
|                                                                                                     | Medical professional liability |                                      | $ | 186,527 |           |   | $ | 152,680 |           |   | $ | 140,066 |        
|                                                                                                     | Workers compensation          |                                      |   | 69,278  |           |   |   | 64,999  |           |   |   | 53,336  |        
|                                                                                                     | Health                         |                                      |   | 24,627  |           |   |   | 19,196  |           |   |   | 11,493  |        
|                                                                                                     | Personal and commercial        |                                      |   | (884    | )         |   |   | 5,593   |           |   |   | 13,087  |        
|                                                                                                     | Corporate and other            |                                      |   | 991     |           |   |   | 2,681   |           |   |   | 2,736   |        
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          
|                                                                                                     |                                | Total                                |   | $       | 280,539   |   |   | $       | 245,149   |   |   | $       | 220,718 | 
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          
|(Loss) income before income taxes and
    cumulative effect
    of a change in accounting principle: |                                |                                      |   |         |           |   |   |         |           |   |   |        
|                                                                                                     | Medical professional liability |                                      | $ | (5,219  | )         |   | $ | (41,943 | )         |   | $ | 19,478  |        
|                                                                                                     | Workers compensation          |                                      |   | (2,520  | )         |   |   | (14,974 | )         |   |   | 1,265   |        
|                                                                                                     | Health                         |                                      |   | (3,572  | )         |   |   | (3,750  | )         |   |   | (2,542  | )      
|                                                                                                     | Personal and commercial        |                                      |   | (2,613  | )         |   |   | (3,786  | )         |   |   | (1,362  | )      
|                                                                                                     | Corporate and other            |                                      |   | (1,017  | )         |   |   | (2,777  | )         |   |   | (94     | )      
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          
|                                                                                                     |                                | Total                                |   | $       | (14,941   | ) |   | $       | (67,230   | ) |   | $       | 16,745  | 
|                                                                                                     |                                |                                      |   |         |           |   |   |         |          

61



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##### Table of Contents



AMERICAN PHYSICIANS CAPITAL, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

21.     Quarterly
Financial Data (Unaudited)

The unaudited operating results by quarter for
2002, 2001, and 2000 are summarized below:

|     |                |          |         |                |                         |   |         |            |                   |   |                |         |   |  |   |       |  
|---- | -------------- | -------- | ------- | -------------- | ----------------------- | - | ------- | ---------- | ----------------- | - | -------------- | ------- | - |  | - | ----- | -
|     |                |          |         | (Loss) Income  |                         |   |         |            |                  
|     |                |          |         | Before Taxes   |                         |   |         |            | Net (Loss) Income |  
|     |                |          |         | and cumulative |                         |   |         |            | Per Common        |  
|     |                | Total    |         |                | effect of a change      |   |         | Net (Loss) |                   |   | Share Assuming |        
|     |                | Revenues |         |                | in accounting principle |   |         | Income     |                   |   | Dilution*      |        
|     |                |          |         |                |                         |   |         |            |                   |   |                |        
|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  | ) |  |   | (0.13 | )
|     |                |          |         |                |                         |   |         |            |                   |   |                |        
|     |                | $        | 280,539 |                |                         | $ | (14,941 | )          |                   | $ | (18,491        | )       |   |  |   |      
|     |                |          |         |                |                         |   |         |            |                   |   |                |        
|2001 |                |          |         |                |                         |   |         |            |                   |   |                |         |   |  |   |      
|     | 1st Quarter    |          | $       | 61,889         |                         |   | $       | 6,050      |                   |   | $              | 4,137   |   |  | $ | 0.36  |  
|     | 2nd Quarter    |          |         | 61,821         |                         |   |         | 6,750      |                   |   |                | 4,424   |   |  |   | 0.38  |  
|     | 3rd Quarter*** |          |         | 58,230         |                         |   |         | (55,044    | )                 |   |                | (35,828 | ) |  |   | (3.26 | )
|     | 4th Quarter*** |          |         | 63,209         |                         |   |         | (24,986    | )                 |   |                | (16,513 | ) |  |   | (1.58 | )
|     |                |          |         |                |                         |   |         |            |                   |   |                |        
|     |                | $        | 245,149 |                |                         | $ | (67,230 | )          |                   | $ | (43,780        | )       |   |  |   |      
|     |                |          |         |                |                         |   |         |            |                   |   |                |        
|2000 |                |          |         |                |                         |   |         |            |                   |   |                |         |   |  |   |      
|     | 1st Quarter    |          | $       | 51,455         |                         |   | $       | 3,558      |                   |   | $              | 2,407   |   |  |   |       |  
|     | 2nd Quarter    |          |         | 56,157         |                         |   |         | 5,980      |                   |   |                | 4,021   |   |  |   |       |  
|     | 3rd Quarter    |          |         | 54,781         |                         |   |         | 2,612      |                   |   |                | 2,335   |   |  |   |       |  
|     | 4th Quarter    |          |         | 58,325         |                         |   |         | 4,595      |                   |   |                | 3,182   |   |  | $ | 0.07  |  
|     |                |          |         |                |                         |   |         |            |                   |   |                |        
|     |                | $        | 220,718 |                |                         | $ | 16,745  |            |                   | $ | 11,945         |         |   |  |   |      
|     |                |          |         |                |                         |   |         |            |                   |   |                |        



---



|    |                                                                                                                                                                                                                                                                                                      
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   | For periods subsequent to conversion; (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 losses in the third and fourth
    quarters of 2001, as compared to the first and second quarters
    of the same year, were primarily the result of adverse
    development on prior year loss reserves (Note 8).                                                                   

62



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##### Table of Contents








SCHEDULE II  CONDENSED FINANCIAL
INFORMATION OF REGISTRANT


AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)






CONDENSED BALANCE SHEET


December 31, 2002 and 2001


|                                                                                                                                                          |                                                |                    |         |         |      |   |         |         | 
|--------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------- | ------------------ | ------- | ------- | ---- | - | ------- | ------- | 
|                                                                                                                                                          |                                                | 2002               |         |         | 2001 |  
|                                                                                                                                                          |                                                |                    |         |         |      |  
|                                                                                                                                                          |                                                |                   
|                                                                                                                                                          |                                                | (In thousands,     |        
|                                                                                                                                                          |                                                | except share data) |        
|Assets                                                                                                                                                    |                                                |                    |         |         |      |   |         |        
|Investments in subsidiaries                                                                                                                               |                                                | $                  | 260,664 |         |      | $ | 260,121 |        
|Cash and cash equivalents                                                                                                                                 |                                                |                    | 18,671  |         |      |   | 43,210  |        
|Deferred federal income taxes                                                                                                                             |                                                |                    | 942     |         |      |   | 539     |        
|Federal income taxes recoverable                                                                                                                          |                                                |                    | 207     |         |      |   | 787     |        
|Other assets                                                                                                                                              |                                                |                    | 409     |         |      |   | 3,926   |        
|                                                                                                                                                          |                                                |                    |         |         |      |  
|                                                                                                                                                          | Total assets                                   |                    | $       | 280,893 |      |   | $       | 308,583 | 
|                                                                                                                                                          |                                                |                    |         |         |      |  
|                                                                                                                                                         
|Liabilities                                                                                                                                               |                                                |                    |         |         |      |   |         |        
|Accrued expenses and other liabilities                                                                                                                    |                                                | $                  | 604     |         |      | $ | 1,618   |        
|                                                                                                                                                          |                                                |                    |         |         |      |  
|                                                                                                                                                          | Total liabilities                              |                    |         | 604     |      |   |         | 1,618   | 
|                                                                                                                                                          |                                                |                    |         |         |      |  
|Shareholders Equity                                                                                                                                      |                                                |                    |         |         |      |   |         |        
|Common stock, no par value, 50,000,000 shares
    authorized, 8,695,492 and 10,238,122 shares outstanding at
    December 31, 2002 and 2001, respectively |                                                |                    |         |         |      |   |         |        
|Additional paid-in capital                                                                                                                                |                                                |                    | 92,148  |         |      |   | 119,463 |        
|Retained earnings                                                                                                                                         |                                                |                    | 164,183 |         |      |   | 182,674 |        
|Unearned stock compensation                                                                                                                               |                                                |                    | (678    | )       |      |   | (1,001  | )      
|Accumulated other comprehensive income, net of
    deferred federal income taxes                                                                          |                                                |                    | 24,636  |         |      |   | 5,829   |        
|                                                                                                                                                          |                                                |                    |         |         |      |  
|                                                                                                                                                          | Total shareholders equity                     |                    |         | 280,289 |      |   |         | 306,965 | 
|                                                                                                                                                          |                                                |                    |         |         |      |  
|                                                                                                                                                          | Total liabilities and shareholders
    equity |                    | $       | 280,893 |      |   | $       | 308,583 | 
|                                                                                                                                                          |                                                |                    |         |         |      |  

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.

63



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SCHEDULE II  CONDENSED FINANCIAL
INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)






CONDENSED STATEMENTS OF OPERATIONS


Years Ended December 31, 2002 and
2001


|                                             |                                                                                        |                |         |         |      |   |         |         |  
|-------------------------------------------- | -------------------------------------------------------------------------------------- | -------------- | ------- | ------- | ---- | - | ------- | ------- | -
|                                             |                                                                                        | 2002           |         |         | 2001 |  
|                                             |                                                                                        |                |         |         |      |  
|                                             |                                                                                        |               
|                                             |                                                                                        | (In thousands) |        
|Revenues                                     |                                                                                        |                |         |         |      |   |         |        
|Investment income                            |                                                                                        | $              | 587     |         |      | $ | 2,810   |        
|Net realized investment losses               |                                                                                        |                |         |         |      |   | (671    | )      
|                                             |                                                                                        |                |         |         |      |  
|                                             | Total revenues                                                                         |                |         | 587     |      |   |         | 2,139   |  
|Expenses                                     |                                                                                        |                |         |         |      |   |         |        
|General and administrative expenses          |                                                                                        |                | 1,178   |         |      |   | 1,700   |        
|                                             |                                                                                        |                |         |         |      |  
|                                             | (Loss) income before income taxes and equity in
    undistributed loss of subsidiaries |                |         | (591    | )    |   |         | 439     |  
|Federal income tax (benefit) expense         |                                                                                        |                | (209    | )       |      |   | 410     |        
|                                             | (Loss) income before equity in undistributed loss
    of subsidiaries                  |                |         | (382    | )    |   |         | 29      |  
|Equity in undistributed loss of subsidiaries |                                                                                        |                | (18,109 | )       |      |   | (43,809 | )      
|                                             |                                                                                        |                |         |         |      |  
|                                             | Net loss                                                                               |                | $       | (18,491 | )    |   | $       | (43,780 | )
|                                             |                                                                                        |                |         |         |      |  

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.

64



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SCHEDULE II  CONDENSED FINANCIAL
INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)






CONDENSED STATEMENTS OF CASH FLOW


Years Ended December 31, 2002 and
2001


|                                                                                              |                                          |                                                         |         |        |         |   |         |        |         |  
|--------------------------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------------------------- | ------- | ------ | ------- | - | ------- | ------ | ------- | -
|                                                                                              |                                          | 2002                                                    |         |        | 2001    |  
|                                                                                              |                                          |                                                         |         |        |         |  
|                                                                                              |                                          |                                                        
|                                                                                              |                                          | (In thousands)                                          |        
|Cash flows from operating activities                                                          |                                          |                                                         |         |        |         |   |         |       
|Net loss                                                                                      |                                          | $                                                       | (18,491 | )      |         | $ | (43,780 | )     
|Adjustments to reconcile net loss to net cash
    provided by (used in) operating activities: |                                          |                                                         |         |        |         |   |         |       
|Equity in undistributed loss of subsidiaries                                                  |                                          |                                                         | 18,109  |        |         |   | 43,809  |       
|Net realized losses                                                                           |                                          |                                                         |         |        |         |   | 671     |       
|Amortization of goodwill                                                                      |                                          |                                                         |         |        |         |   | 730     |       
|Changes in:                                                                                   |                                          |                                                         |         |        |         |   |         |       
|                                                                                              | Federal income taxes recoverable/payable |                                                         |         | 580    |         |   |         | (847   | )      
|                                                                                              | Accrued expenses and other liabilities   |                                                         |         | (1,014 | )       |   |         | (1,620 | )      
|                                                                                              | Other assets                             |                                                         |         | 3,517  |         |   |         | (3,165 | )      
|                                                                                              |                                          |                                                         |         |        |         |  
|                                                                                              |                                          | Net cash provided by (used in) operating
    activities |         |        | 2,701   |   |         |        | (4,202  | )
|                                                                                              |                                          |                                                         |         |        |         |  
|Cash flows from investing activities                                                          |                                          |                                                         |         |        |         |   |         |       
|Net contributions to subsidiaries                                                             |                                          |                                                         |         |        |         |   | (1,822  | )     
|                                                                                              |                                          |                                                         |         |        |         |  
|                                                                                              |                                          | Net cash used in investing
    activities               |         |        |         |   |         |        | (1,822  | )
|                                                                                              |                                          |                                                         |         |        |         |  
|Cash flows from financing activities                                                          |                                          |                                                         |         |        |         |   |         |       
|Common stock repurchased                                                                      |                                          |                                                         | (27,482 | )      |         |   | (25,225 | )     
|Stock options exercised                                                                       |                                          |                                                         | 243     |        |         |   |         |       
|                                                                                              |                                          |                                                         |         |        |         |  
|                                                                                              |                                          | Net cash used in financing
    activities               |         |        | (27,483 | ) |         |        | (25,225 | )
|                                                                                              |                                          |                                                         |         |        |         |  
|Net decrease in cash and cash
    equivalents                                                 |                                          |                                                         | (27,240 | )      |         |   | (31,249 | )     
|Cash and cash equivalents, beginning of year                                                  |                                          |                                                         | 43,210  |        |         |   | 74,459  |       
|                                                                                              |                                          |                                                         |         |        |         |  
|Cash and cash equivalents, end of year                                                        |                                          | $                                                       | 18,671  |        |         | $ | 43,210  |       
|                                                                                              |                                          |                                                         |         |        |         |  

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.

65



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SCHEDULE II  CONDENSED FINANCIAL
INFORMATION OF REGISTRANT

AMERICAN PHYSICIANS CAPITAL, INC. (PARENT
COMPANY)






NOTES TO CONDENSED FINANCIAL INFORMATION OF
REGISTRANT


Year Ended December 31, 2002


(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 (APAssurance), 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.               

(2)     Federal
Income Taxes

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

(3)     Conversion
and Initial Public Offering

On December 13, 2000, the conversion of
APAssurance from a mutual company to a stock corporation was
consummated according to a Plan of Conversion adopted by the
board of directors of APAssurance on June 28, 2000, with
subsequent amendment on October 2, 2000. This plan was
approved by APAssurance policyholders at a special meeting held
on November 29, 2000 and by the State of Michigan Office of
Financial and Insurance Services. The Plan of Conversion
included several key components, including: formation of
APCapital to be the ultimate parent holding company; the
conversion of APAssurance from a mutual insurance company to
stock company and wholly-owned by APCapital; the transfer of
ICA, APS, APConsulting, APDirect Sales, and Alpha Advisors, Inc.
from APAssurance to wholly-owned subsidiaries of APCapital.

In connection with the conversion,
331,638 shares of common stock of APCapital were sold at
$13.50 per share under a subscription rights and best
efforts offering to APAssurance policyholders, officers,
directors, employees, and others. APCapital then sold
9,668,362 shares of its common stock in an underwritten
public offering (the offering) that closed
December 13, 2000. On December 13, 2000, an additional
1,450,254 shares were sold to underwriters of the offering
pursuant to an over-allotment option contained in the offering
agreement. The net proceeds of the offering were approximately
$142.6 million, consisting of gross proceeds of
$154.6 million less conversion and offering expenses of
$12.0 million.

66



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##### Table of Contents



Item 9.     Changes
In and Disagreements with Accountants on Accounting and
Financial Disclosure

Not applicable.






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

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.     Controls
and Procedures

Within the 90 days prior to the date of 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 it files
or submits under the Securities Exchange Act of 1934, to be
recorded, processed, summarized and reported to the extent
applicable within the time periods specified in the Securities
and Exchange Commissions rules and forms. There have been
no significant changes in the Companys internal controls
or in other factors which could significantly affect internal
controls subsequent to the date the Company carried out its
evaluation.






PART IV


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

(a)(1) and (2)

Financial Statements:



| |                                                                                           
| | ------------------------------------------------------------------------------------------
| | Report of independent accountants                                                         
|
| | Consolidated balance sheets as of
    December 31, 2002 and 2001                          
|
| | Consolidated statements of income for the years
    ended December 31, 2002, 2001 and 2000

67



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| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | Consolidated statements of shareholders
    equity and comprehensive income for the years ended
    December 31, 2002, 2001 and 2000
|
| | Consolidated statements of cash flows for the
    years ended December 31, 2002, 2001 and 2000                                       
|
| | Notes to consolidated financial statements                                                                                           

Financial Statement Schedules:



| |                                                      
| | -----------------------------------------------------
| | II. Condensed financial information of
    registrant

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



| |                                                                                       
| | --------------------------------------------------------------------------------------
| | No reports on Form 8-K were filed during the
    three months ended December 31, 2002.

68



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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 28, 2003.



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



| |     |                         
| | --- | ------------------------
| | By: | /s/ WILLIAM B. CHEESEMAN

| |                                               
| | ----------------------------------------------
| |                                               
| | William B. Cheeseman                          
| | 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 28, 2003 on behalf of the
registrant and in the capacities indicated.

|                                                     |  |                                                                                                   |  | 
|---------------------------------------------------- |  | ------------------------------------------------------------------------------------------------- |  | 
|                                                     |  |                                                                                                  
|Signature                                            |  | Title                                                                                            
|                                                     |  |                                                                                                  
|                                                    
|/s/ WILLIAM B. CHEESEMANWilliam B. Cheeseman         |  | President, Chief Executive Officer and Director                                                  
|                                                    
|/s/ FRANK H. FREUNDFrank H. Freund                   |  | Executive Vice President, Treasurer,
    Chief Financial Officer 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                                                                                         
|                                                    
|/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                                                                                         

69



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CERTIFICATION OF DISCLOSURE


I, William B. Cheeseman certify that:

1. I have reviewed this annual report on
Form 10-K of American Physicians Capital, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b. evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c. presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officers and I have disclosed, based on our most recent
evaluation to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b. any fraud, whether material or not
    material, that involves management or other employees who have a
    significant role in the registrants internal
    controls and                                                                                                                                       

6. The registrants other certifying
officers and I have indicated in this annual report whether
there were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                                          
| | -----------------------------------------
| | /s/ WILLIAM B. CHEESEMAN                 
| |                                          
| | William B. Cheeseman                     
| | President and Chief Executive
    Officer
| | American Physicians Capital, Inc.        

Date: March 28, 2003

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CERTIFICATION OF DISCLOSURE


I, Frank H. Freund certify that:

1. I have reviewed this annual report on
Form 10-K of American Physicians Capital, Inc.;

2. Based on my knowledge, this annual report
does not contain any untrue statement of a material fact or omit
to state a material fact necessary to make the statements made,
in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this
annual report;

3. Based on my knowledge, the financial
statements, and other financial information included in this
annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual
report;

4. The registrants other certifying
officers and I are responsible for establishing and maintaining
disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and have:



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b. evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c. presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                

5. The registrants other certifying
officers and I have disclosed, based on our most recent
evaluation to the registrants auditors and the audit
committee of registrants board of directors (or persons
performing the equivalent functions):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a. all significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b. any fraud, whether material or not
    material, that involves management or other employees who have a
    significant role in the registrants internal
    controls and                                                                                                                                       

6. The registrants other certifying
officers and I have indicated in this annual report whether
there were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.



| |                                                             
| | ------------------------------------------------------------
| | /s/ FRANK H. FREUND                                         
| |                                                             
| | Frank H. Freund                                             
| | Executive Vice President, Treasurer,                        
| | Chief Financial Officer and Principal
    Accounting Officer
| | American Physicians Capital, Inc.                           

Date: March 28, 2003

71



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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
    March 9, 2002(6)                                                                                                                    
|        | *10.1  |  |             | American Physicians Capital, Inc. Stock
    Compensation Plan(3)                                                                                                                
|        | 10.2   |  |             | Stock Purchase Agreement, dated August 31,
    1999, by and among APAssurance 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 APAssurance, 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   |  |             | APAssurance/ 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 APAssurance 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/APAssurance Marketing Support Agreement,
    effective January 1, 2000, between the Michigan State
    Medical Society and APAssurance(2)                                  
|        | *10.14 |  |             | Executive Employment Agreement, dated as of
    October 11, 2000, between Frank H. Freund and
    APAssurance(4)                                                                
|        | *10.16 |  |             | Executive Employment Agreement, dated as of
    October 11, 2000, between Margo C. Runkle and
    APAssurance(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 APAssurance and SCW Agency(6)                                                                                         
|        | *10.24 |  |             | Executive Employment Agreement, dated as of
    May 13, 2002, between Annette Flood and APAssurance(1)                                                                          
|        | *10.25 |  |             | Executive Employment Agreement, dated as of
    May 13, 2002, between R. Kevin Clinton and APAssurance(1)                                                                       
|        | 21.1   |  |             | Subsidiaries of APCapital(6)                                                                                                                                                    
|        | 10.26  |  |             | Agency Agreement between MICOA Management
    Company, Inc. and Stratton, Cheeseman, Walsh-Nevada, Inc., dated
    May 25, 1999(1)                                              
|        | 23.1   |  |             | Consent of PricewaterhouseCoopers LLP(1)                                                                                                                                        
|        | 99.1   |  |             | Certification of CEO pursuant to Section 906
    of the Sarbanes-Oxley Act of 2002(1)                                                                                           
|        | 99.2   |  |             | Certification of CFO pursuant to Section 906
    of the Sarbanes-Oxley Act of 2002(1)                                                                                           



---



| |   |                                                                        
| | - | -----------------------------------------------------------------------
| | * | Current management contracts or compensatory
    plans or arrangements.



|    |                
|--- | ---------------
|(1) | Filed herewith.



---



##### Table of Contents





|    |                                                                                                                                                 
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------
|(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.