EXHIBIT 13

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| | Professionals
    Direct, Inc.
| | ------------------------------

2005
Annual Report

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PRESIDENT'S MESSAGE

TO OUR SHAREHOLDERS:

We are pleased to present our 2004 results in this annual report. Professionals Direct is in the business of providing insurance programs to lawyers on a national basis. 2004 represented a return to somewhat more normal conditions in the professional liability insurance markets. In 2002 and 2003 Professionals Direct was favored with exceptional growth in part due to abrupt changes in the professional liability markets. As I wrote last year, the events that created the growth in those two years would not be immediately recurring and shareholders should not expect to see a repeat performance in the near term.

The lawyers professional liability markets consolidated quickly after the disruption of 2003. In the changed market, a dozen or so national providers emerged as the dominant providers of lawyers professional liability insurance. By 2004, it became clear that Professionals Direct had achieved the transition to become a recognized national provider in its specialized marketplace and had established a sustainable national market presence.

Operationally, Professionals Direct focused on renewing the accounts that were new business in 2003. The insurance renewal process is in many ways harder than writing new business. We were pleased to see a renewal rate of more than 80% on the 2003 new business. Also in 2004, Professionals Direct enhanced its claims administration to provide top quality service around the United States to the lawyers insured under our policies.

In 2004, Professionals Direct earned $531,000 or $1.59 per share. Book value per share increased to $30.85 per share. This book value per share represents a significant increase over the $10 acquisition price in the July, 2001 demutualization. The 2004 operating results were less dramatic than the 2003 results, chiefly due to the change in the professional liability pricing environment between 2003 and 2004.

Please read the enclosed report and participate in our system of corporate governance by voting in person at our annual meeting or by proxy.

Sincerely,



Stephen M. Tuuk
President and Chief Executive Officer

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Professionals Direct, Inc.

2005 Annual Report

|Contents                                          | Page
|------------------------------------------------- | ----
|                                                  |     
|Professionals Direct, Inc.                        | A-2 
|                                                  |     
|A Message to our Shareholders                     | A-2 
|                                                  |     
|Five-Year Summary of Selected Financial Reporting | A-3 
|                                                  |     
|Management's Discussion and Analysis              | A-5 
|                                                  |     
|Report of Independent Public Accountants          | A-13
|                                                  |     
|Consolidated Financial Statements                 | A-14
|                                                  |     
|Notes to Consolidated Financial Statements        | A-18

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Professionals Direct, Inc.

Professionals Direct Inc. is an insurance holding company with four wholly-owned subsidiaries, Professionals Direct Insurance Company, the property and casualty insurance company ("PDIC"); Professionals Direct Employer Organization, Inc., an inactive Michigan professional employer organization; Professionals Direct Finance, Inc., a premium finance company and Professionals Direct Insurance Services, Inc., a company providing underwriting claims, accounting, information technology services and selling professionals liability and other insurance ("Services"). PDIC, Professionals Direct's principal subsidiary, provides professional liability insurance to attorneys and law firms in Michigan and other states. Through its other subsidiaries, Professionals Direct provides underwriting, policy issuance, claims administration, accounting and information systems services to insurance companies and provides financing for premiums to customers of PDIC.

A Message to our Shareholders

This 2005 Annual Report contains audited financial statements and a detailed financial review. This is Professionals Direct, Inc.'s 2005 Annual Report to Shareholders. Although attached to our proxy statement, this report is not part of our proxy statement, is not deemed to be soliciting material, and is not deemed to be filed with the Securities and Exchange Commission (the "SEC") except to the extent that it is expressly incorporated by reference in a document filed with the SEC.

Our Annual Report on Form 10-KSB, as filed with the SEC, will be provided to any shareholder, without charge, upon written request to Professionals Direct, Inc., Attn. Corporate Secretary, 161 Ottawa Avenue, N.W., Suite 607, Grand Rapids, Michigan 49503.

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Five Year Summary of Selected Financial Data

The following table provides selected consolidated financial and operating data (unaudited) for Professionals Direct and its subsidiaries as of December 31, 2000, 2001, 2002, 2003 and 2004 and for the years then ended. The consolidated financial and operating data are derived from, and should be read in conjunction with, Professionals Direct's Consolidated Financial Statements and Notes thereto.

|                                                                             | Years Ended                                                
|---------------------------------------------------------------------------- | -----------------------------------------------------------
|                                                                             | 2004                                                       
|                                                                             |                                                            
|                                                                             | (in thousands of dollars, except for ratios and ratio data)
|                                                                             |                                                            
|Revenue Data:                                                                |                                                            
|                                                                             |                                                            
|Direct premiums written                                                      | $24,009                                                    
|                                                                             |                                                            
|Net premiums written                                                         | 14,085                                                     
|                                                                             |                                                            
|Net premiums earned                                                          | 16,203                                                     
|                                                                             |                                                            
|Fees and commissions earned                                                  | 731                                                        
|                                                                             |                                                            
|Net investment income                                                        | 893                                                        
|                                                                             |                                                            
|Finance and other income earned                                              | 152                                                        
|                                                                             |                                                            
|Total Revenues                                                               | 17,979                                                     
|                                                                             |                                                            
|Losses and Expenses:                                                         |                                                            
|                                                                             |                                                            
|Losses and loss adjustment expenses                                          | 11,937                                                     
|                                                                             |                                                            
|Operating expenses                                                           | 4,804                                                      
|                                                                             |                                                            
|Interest expense                                                             | 447                                                        
|                                                                             |                                                            
|Total Expenses                                                               | 17,188                                                     
|                                                                             |                                                            
|Income before federal income taxes and
policyholder dividend                 | 791                                                        
|                                                                             |                                                            
|Policyholder dividend                                                        | 0                                                          
|                                                                             |                                                            
|Income (loss) before federal income taxes                                    | 791                                                        
|                                                                             |                                                            
|Federal income taxes (benefit)                                               | 260                                                        
|                                                                             |                                                            
|Net income (loss)                                                            | $531                                                       
|                                                                             |                                                            
|Selected Balance Sheet Data:
               (at year end)                    |                                                            
|                                                                             |                                                            
|Total investments and cash                                                   | 37,863                                                     
|                                                                             |                                                            
|Total assets                                                                 | 54,441                                                     
|                                                                             |                                                            
|Total liabilities                                                            | 44,153                                                     
|                                                                             |                                                            
|Total shareholders' equity (2004-2001) or
     policyholders' surplus (2000) | 10,288                                                     
|                                                                             |                                                            
|Per Share Data: (1)                                                          |                                                            
|                                                                             |                                                            
|Net Income (loss)                                                            | $1.59                                                      
|                                                                             |                                                            
|Book value                                                                   | $30.85                                                     
|                                                                             |                                                            
|Selected GAAP Ratios:                                                        |                                                            
|                                                                             |                                                            
|Return on prior year equity                                                  | 5.4%                                                       
|                                                                             |                                                            
|Return on current year revenue                                               | 3.0%                                                       
|                                                                             |                                                            
|Return on current year assets                                                | 1.0%                                                       

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|                                                             | Years Ended                                                
|------------------------------------------------------------ | -----------------------------------------------------------
|                                                             | 2004                                                       
|                                                             |                                                            
|                                                             | (in thousands of dollars, except for ratios and ratio data)
|                                                             |                                                            
|Statutory (SAP) Ratio Data:                                  |                                                            
|                                                             |                                                            
|Loss Ratio (2)                                               | 76.2%                                                      
|                                                             |                                                            
|Expense Ratio (3)                                            | 33.9%                                                      
|                                                             |                                                            
|Combined ratio (4)                                           | 110.1%                                                     
|                                                             |                                                            
|Operating Ratio (5)                                          | 104.5%                                                     
|                                                             |                                                            
|A. M. Best Industry% operating ratio (6)                     | N/A                                                        
|                                                             |                                                            
|Statutory surplus (7)                                        | 16,074                                                     
|                                                             |                                                            
|Earned surplus (8)                                           | 13,543                                                     
|                                                             |                                                            
|Ratio of statutory net written premiums to
statutory surplus | 87.6%                                                      

| | (1) | The Company became a shareholder owned company on July 1, 2001, following the conversion and demutualization of its predecessor, Michigan Lawyers Mutual Insurance Company. Accordingly, per share data is presented only for 2002 to 2004, the only years of operations as a shareholder owned company.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | Calculated by dividing losses and loss adjustment expenses by net premiums earned.                                                                                                                                                                                                                      
| | (3) | Calculated by dividing other underwriting expenses by net premiums written.                                                                                                                                                                                                                             
| | (4) | The sum of the statutory loss and loss adjustment expense ratio and the total underwriting expense ratio.                                                                                                                                                                                               
| | (5) | Calculated by taking the combined ratio and subtracting the ratio of net investment income divided by net premiums earned. An operating ratio of more than 100% indicates that an insurance company is unable to recoup underwriting losses with investment earnings.                                   
| | (6) | As reported by A. M. Best, Best's Aggregate & Averages - Property - Casualty (Other Liability Quantitative Analysis Report).                                                                                                                                                                            
| | (7) | As of December 31, 2000, statutory surplus includes $4.345 million in surplus certificates. For 2004, 2003, 2002 and 2001, statutory surplus includes $2.531 million in surplus certificates. In all years, interest on the surplus certificates was not accrued until actually approved by the OFIS.   
| | (8) | Statutory surplus less surplus contributed under surplus certificates.                                                                                                                                                                                                                                  

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Management's Discussion and Analysis

The following discussion and analysis for the years ended December 31, 2004 and 2003 should be read in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this report. The following discussion of our financial condition and results of operations contains certain forward-looking statements. A discussion of the limitations of forward looking statements appears at the end of this section.

Introduction

The increase in earned premiums in 2004 was the result of an increase in policies written by PDIC in 2003. The increase was moderated by a lower reinsurance retention on policies written with 2004 effective dates. Loss and loss adjustment expenses increased in 2004 as claims were reported to PDIC on policies written in 2003. Operating and administrative expenses have decreased compared to the same period last year partly due to ceding commissions under PDIC's 2004 reinsurance treaties:

|                                                          | Years Ended                                         
|--------------------------------------------------------- | ----------------------------------------------------
|                                                          | 2004                                                
|                                                          | (in thousands of dollars, except for per share data)
|                                                          |                                                     
|Revenue Data:                                             |                                                     
|                                                          |                                                     
|Net premiums earned                                       | $16,203                                             
|                                                          |                                                     
|Fees and commissions earned                               | 731                                                 
|                                                          |                                                     
|Net investment income                                     | 893                                                 
|                                                          |                                                     
|Finance and other income earned                           | 152                                                 
|                                                          |                                                     
|Total Revenues                                            | 17,979                                              
|                                                          |                                                     
|Losses and Expenses:                                      |                                                     
|                                                          |                                                     
|Losses and loss adjustment expenses                       | 11,937                                              
|                                                          |                                                     
|Operating expenses                                        | 4,804                                               
|                                                          |                                                     
|Interest expense                                          | 447                                                 
|                                                          |                                                     
|Total Expenses                                            | 17,188                                              
|                                                          |                                                     
|Income before federal income taxes                        | 791                                                 
|                                                          |                                                     
|Federal income taxes                                      | 260                                                 
|                                                          |                                                     
|Net income                                                | $531                                                
|                                                          |                                                     
|Selected Balance Sheet Data:
               (at year end) |                                                     
|                                                          |                                                     
|Total investments and cash                                | $37,863                                             
|                                                          |                                                     
|Total assets                                              | 54,441                                              
|                                                          |                                                     
|Total liabilities                                         | 44,153                                              
|                                                          |                                                     
|Total shareholders' equity                                | 10,288                                              
|                                                          |                                                     
|Per Share Data:                                           |                                                     
|                                                          |                                                     
|Net Income                                                | $1.59                                               
|                                                          |                                                     
|Book value                                                | $30.85                                              

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Results of Operations (000 omitted):

The following is a summary and analysis of the material revenue and expense components of our operational results for 2004 with comparisons to 2003.

        Net Premiums Earned.Net premiums earned are equal to direct premiums earned (premiums earned for policies written) less ceded premiums earned (amounts ceded to reinsurers). The increase in net premiums earned was primarily from the large increase in polices written in 2003 offset by a lower reinsurance retention on policies written in 2004. As a revenue line, insurance underwriting was our largest revenue source in 2004 and 2003. In 2004, with additional reinsurance, the amount of premium ceded to reinsurers increased substantially with the result that net premiums written declined. The following is a summary of premium writings by PDIC:

|                        | Years Ended              
|----------------------- | -------------------------
|                        | 2004                     
|                        | (in thousands of dollars)
|                        |                          
|Direct premiums written | $24,009                  
|                        |                          
|Net premiums written    | 14,085                   

Direct premiums written decreased 1.2% when compared to the prior year. PDIC's new business premium writings for 2004 were significantly less than for the same period in 2003 due, in part, to the absence of significant disruptions in the markets in which PDIC operates. For the year, new business totaled $3,583 compared to $13,722 for 2003. For its policies with 2004 effective dates, PDIC decreased the per claim retention by purchasing more reinsurance from third party reinsurers. This reduces PDIC's net premiums written and will reduce net premiums earned as the policies are earned out. In 2005 we do not expect to see significant changes in the levels of direct premiums written.

Fee and Commissions Earned. We earn fee and commission income from two sources. The first source is the membership fees earned by Lawyers Direct Risk Purchasing Group, an affiliate organized, formed and managed by Services as part of the Lawyers Direct® program for one to five person law firms. The second source is the operations of Services in placing insurance business with unrelated third parties and performing management services. Fee and commission income earned was $731 in 2004, an increase of $112 or 18.1%, compared to 2003. Almost all of the increase was attributable to an increase in the membership fees from the Purchasing Group. Fee and commission income for Services did not change materially from 2003 to 2004. In 2005, our fee and commission income is expected to increase only slightly as membership in the Purchasing Group has stabilized and as we expect to see only slight increases in commission income from the sale of more products of other insurance carriers by Services.

Net Investment Income.Net investment income is comprised of interest on fixed income investments and realized investment gains and losses. The investment income decrease of $33 or 3.6% in 2004 as compared to 2003 is partly attributable to realized capital gains in 2003 that did not recur in 2004. Gains from the sale of securities for 2004 totaled $5 and in 2003 were $172. Exclusive of the gains, investment income increased $134. The increase is largely attributable to the overall increase in the size of the investment portfolio combined with some improvement in the percentage yield on fixed income investments.

Finance and Other Income Earned.We earn finance income primarily by providing premium financing incidental to the sale of PDIC's insurance policies. Premium financing is offered to PDIC policyholders in Michigan and selected other states. Premium finance income increased modestly from 2003 to 2004 and is expected to increase modestly again in 2005 with rising interest rates.

Losses and Loss Adjustment Expenses.The loss ratio for the year was 73.7% compared to 48.6% for 2003. The loss ratio is the sum of the losses and loss adjustment expenses incurred expressed as a percentage of net premiums earned. This loss ratio increase resulted from fluctuations in claims severity and increases in the estimates of losses for claims reported in prior years. Claim frequency occurred within an expected range based on our past experience. Severity is impacted in part by the differing reinsurance retentions and is also within expected levels based on past experience. PDIC recorded losses and loss adjustment expenses of $11,937 of which $11,180 was for claims which were made and reported in the current year and $757 was for claims which were made and

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reported in years prior to 2004. For 2003, PDIC recorded losses and loss adjustment expenses of $7,737 of which the entire amount was for claims which were made and reported in that year. Overall profitability is in great part determined by the loss estimate for current year claims plus the favorable or adverse development of prior report year reserves.

Operating Expenses.Operating and administrative expenses for 2004 compared to 2003 decreased 11.4% or a total of $616. This decrease is the result of the effects of ceding commissions earned offset by increased costs associated with the increase in net premiums earned. During 2004 ceding commissions earned increased $934 compared to 2003. This was partially offset by increased acquisition costs during 2004 resulting in the net decrease of $616.

Interest Expense. Interest expense in 2004 increased $147 from 2003, primarily the result of the increased outstanding line of credit balance. Total interest expense for 2004 consisted of $133 on surplus certificates, $132 on the trust preferred securities, $29 on the line of credit used to fund premium finance receivables, and $153 on the general line of credit. For 2005, interest expense is expected to decrease as the line of credit debt is paid down.

Income Taxes. The effective federal income tax rate was 32.9% for 2004 compared to 34.8% for 2003, both of which approximate the expected rate.

Financial Condition, Liquidity, and Capital Resources (000 omitted):

The primary sources of liquidity, on both a short-term and long-term basis, are funds provided by insurance premiums collected, net investment income, recoveries from reinsurance, and proceeds from the maturity or sale of invested assets. The primary uses of cash, on both a short-term and long-term basis, are losses, loss adjustment expenses, operating expenses, reinsurance premiums, taxes, debt repayment and acquisition of investments.

Trends or uncertainties that may impact short-term or long-term liquidity include changes in the cost and availability of reinsurance, changes in interest rates and changes in investment income. As the costs of obtaining reinsurance may change in the future, we intend to adjust the rates we charge our customers. However, such rate changes may be limited by statutory regulation and competition. We believe that we will be able to manage these reinsurance costs so the impact on overall liquidity is minimized.

When interest rates decline, the cost of borrowing decreases and the market value of our investment portfolio, which primarily consists of debt securities, generally increases. At the same time, the overall yield on new investments tends to decrease. When interest rates increase, the opposite effects are realized. While interest rates continue to be at historically low levels, they are starting to increase. We believe that it is unlikely material gains will be realized on portfolio assets or be a source of liquidity during 2005.

Our net cash flow from operations for 2004 was $4,164 compared to $10,814 for 2003. This decrease is the result of written premiums leveling-off and an increase in premiums ceded to reinsurers. This cash flow plus existing cash was invested in fixed maturities which resulted in negative cash flow from investing activities of $5,009 for the year. Cash used for financing activities was $1,767, the result of net repayments under the lines of credit. In the same period last year, the net borrowings increased $3,689.

At December 31, 2004, we had cash and cash equivalents of $4,394. This represents that portion of total assets necessary to be kept liquid to meet demand for operations and loss and reinsurance payments. It is expected that this will be maintained in cash and other short-term instruments to meet cash flow needs for 2005.

To provide additional liquidity, we have three lines of credit available from a bank. The first line is a $1,800 revolving line used by Finance to finance insurance premiums and bears interest at .5% over the bank's prime rate. The second line is for $1,000, which can be used for potential acquisitions, and bears interest at 1% over the bank's prime rate. The third line is a $3,000 declining balance facility that requires quarterly principal payments of $150 which began on April 1, 2004 and matures October 1, 2006. As a result of the declining balance feature the maximum credit available under this facility at December 31, 2004 was $2,550. This line has a current balance outstanding of $2,400 as of December 31, 2004. These lines of credit require, among other things, that we maintain a minimum tangible net worth of $7,500, that PDIC maintain a minimum surplus of not less than 240% of the Authorized Control Level Risk Based Capital (as defined by the National Association of Insurance Commissioners), and that we deliver periodic financial reports to the bank. The bank has a security interest in substantially all assets

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of the Company, Services and Finance. In addition, the shares of PDIC are pledged, subject to the rights of policyholders under insurance laws and the rights of insurance regulators.

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 and long-term liquidity needs over the next year and beyond. Because economic, market and regulatory conditions may change, however, there can be no assurance that our funds will be sufficient to meet these liquidity needs. In addition, competition, pricing, the frequency and severity of losses and interest rates could significantly affect our short-term and long-term liquidity needs.

Critical Accounting Estimates and Judgments

The consolidated financial statements include certain amounts, based upon informed estimates and judgments made by management, for transactions not yet complete or for which the ultimate resolution is not certain. Such estimates and judgments effect the reported amounts in the financial statements. Although management believes that they are making the best decisions based upon information then available, it is possible that as conditions and experience develop, these estimates may change and may be materially different from originally reported in the financial statements. Our reserves for unpaid loss and loss adjustment expenses represent the most critical estimate present within the financial statements.

Loss and Loss Adjustment Expense Reserves

PDIC is required 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. PDIC provides for the estimated ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what PDIC expects 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 claim severity, and other variable factors such as inflation and changing judicial theories of liability. As part of the process of establishing those estimates, the following should be noted:

(a)          Estimates of the loss reserve liability are reviewed by independent actuaries twice a year. Various methodologies are used to calculate the appropriate amount of the loss reserve liability that should be recorded each year.

(b)          In the years after a claim is reported, there is a significant amount of uncertainty over what the ultimate loss will be. Therefore, estimating the loss reserve liability for claims recently reported tends to be more difficult. As claims get older, the loss reserve liabilities may be estimated with less inaccuracy, but are still subject to material fluctuations until the claims are paid or otherwise closed. Eventually, all claims in a particular year are closed and no additional development, favorable or adverse, will be experienced because the amount of the claims is certain.

(c)          A factor that impacts incurred losses is reserve development from prior years. Favorable or adverse development occurs when subsequent estimates of the loss reserve liability change. A subsequent decrease in estimate results in favorable development; a subsequent increase in estimate results in adverse development. Favorable or adverse development is reflected as a decrease or increase in the current year's loss and loss adjustment expenses.

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. PDIC's current reserve policy recognizes this uncertainty by maintaining bulk reserves or case supplement reserves to provide for the possibility that actual results may be less favorable compared to the estimated costs relative to the normal case reserve estimation process. The bulk reserve is determined by estimating the ultimate liability for the claims which have been made and reported and then subtracting the case reserves. PDIC does not discount its reserves to recognize the time value of money.

When a claim is reported to PDIC, claims personnel establish a case reserve for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices 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. The claims staff periodically adjusts case reserves as more information becomes available.

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Each quarter, PDIC computes its estimated liability using appropriate principles and procedures. Because the establishment of loss reserves is an inherently uncertain process, however, there can be no assurance that losses will not exceed reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. As required by insurance regulatory authorities, PDIC annually receives a statement of opinion from its appointed actuary concerning the reasonableness of its reserves.

A reconciliation of the beginning and ending net liability for unpaid losses and loss adjustment expenses for the years ended December 31, 2004 and 2003 is provided in Note 7 to the consolidated financial statements included in this report.

The following table shows the development of the reserve for unpaid losses and loss adjustment expenses (excluding unallocated loss adjustment expenses) for report years 1994 through 2004 for PDIC. The top line of the table shows the reserve for unpaid losses and loss adjustment expense at the respective balance sheet dates. The upper portion of the table shows the cumulative amounts paid in successive years. The lower portion of the table shows the reestimated amount of losses 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. A redundancy (deficiency) exists when the reestimated liability at each December 31 is less (greater) than the prior year's liability estimate. The "cumulative redundancy" (deficiency) for a calendar year represents the difference between the initial and current year estimate for each calendar year.

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.

|                                                            | Report Year Ended December 31,
|----------------------------------------------------------- | ------------------------------
|                                                            | 1994                          
|                                                            | (in thousands)                
|Reserve for unpaid losses and
     loss adjustment expenses | $3,619                        
|                                                            |                               
|Cumulative amount of liability
     paid through:           |                               
|One year later                                              | 1,451                         
|Two years later                                             | 2,658                         
|Three years later                                           | 4,296                         
|Four years later                                            | 4,532                         
|Five years later                                            | 4,791                         
|Six years later                                             | 4,865                         
|Seven years later                                           | 4,904                         
|Eight years later                                           | 4,902                         
|Nine years later                                            | 4,911                         
|Ten years later                                             | 4,911                         
|                                                            |                               
|Reestimated net liability as of:                            |                               
|One year later                                              | 4,076                         
|Two years later                                             | 4,427                         
|Three years later                                           | 5,067                         
|Four years later                                            | 5,057                         
|Five years later                                            | 4,959                         
|Six years later                                             | 4,957                         
|Seven years later                                           | 4,904                         
|Eight years later                                           | 4,902                         
|Nine years later                                            | 4,911                         
|Ten years later                                             | 4,911                         
|                                                            |                               
|Net cumulative (deficiency)
     redundancy                 | (1,292)                       

As previously discussed, the process of estimating loss and loss adjustment expense reserves is inherently uncertain, which results in favorable and adverse development on initial estimates. The table above illustrates such uncertainty. Another variable in the process of estimating reserves is the quality of the claims administration. The

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underlying claims must be promptly analyzed to accurately estimate the potential loss. Prior to 1997, PDIC's claims were administered by an outside claims administrator. Beginning in 1997, PDIC hired its own employees to administer the claims. At the same time, PDIC also engaged a new actuarial firm.

An independent actuary that specializes in the lawyers' professional liability industry performs a semi-annual study for PDIC that results in a recommended reserve level for losses and loss adjustment expenses. The actuary reviews PDIC's historical claim payment data and premiums data. In addition, the actuary performs statistical analyses based upon many factors, including the size of the firms insured, the ages of the attorneys, the practice areas of the attorneys, and the nature of the underlying errors that drive the claims. The actuary also considers the terms of PDIC's reinsurance contracts. Ultimately, based on this examination, the actuary provides PDIC with an estimate of the reserves that should be recorded. These estimates vary from study to study based on new information available about previous claims and uncertainties inherent in new claims. Occasionally, as can be seen in the table, the estimates initially recorded for losses and loss adjustment expenses based upon the actuarial studies prove to be significantly different from actual results.

Beginning in 1996, PDIC has focused its efforts on refining the process of estimating the ultimate cost of claims and in decreasing the length of time it takes to settle a claim. Decreasing the length of time to settle claims brings certainty to the estimates more quickly. In the first few years after bringing claims administration in-house and in reaction to the prior underestimated reserves recorded by the outside claims administrator, reserve levels were too conservative, resulting in high reserves. With more experience, refined assessment procedures and working closely with its actuary, PDIC expects to improve its accuracy for setting initial reserves with the hopes that subsequent development as a percentage of the initial estimate will be minimal. Unfortunately, any improvement in the accuracy of such estimates, if any, will not be known for some time.

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 net (i.e. after reinsurance). Generally accepted accounting principles require reserves to be reported gross (i.e. before reinsurance) with a corresponding asset established for the reinsurance recoverable. When compared on a net basis, Statutory and GAAP reserves are identical.

Market for Common Stock and Dividends

There is no active public trading market for the Company's securities. Bid and asked quotations for the Company's securities may be reported on the over-the-counter bulletin board (the "OTC") under the symbol PFLD. Transactions in the Company's securities are occasionally effected by individuals through the OTC or on an informal basis. The prices at which such transactions are effected are only occasionally reported to the Company.

Holders. As of December 31, 2004, there were approximately 730 record holders of the Company's common stock.

Dividends. The Company has never declared a cash dividend on its common stock. Payment of dividends by the Company may be contingent on the receipt of dividends from PDIC. The payment of dividends by PDIC is subject to limitations imposed by the Michigan Insurance Code and the plan that governed the Company's Conversion. PDIC is not presently permitted to pay any dividends until such time as the Surplus Certificates are paid in full.

Recent Sales of Unregistered Securities. On December 4, 2002, Professionals Direct Statutory Trust I, a wholly owned unconsolidated trust subsidiary of the Company, issued $2 million in 30-year floating rate trust preferred securities (less issuance expenses of $93,848). The proceeds from the sale of the trust preferred securities were used by Professionals Direct Statutory Trust I to purchase an equivalent amount of subordinated debentures from the Company. The Company subsequently contributed some of the proceeds to PDIC as additional surplus and used the remainder to pay off bank indebtedness. The trust preferred securities were issued in reliance on an exemption from registration under Section 4(2) of the federal Securities Act of 1933.

Equity Compensation Plans. As of December 31, 2004, no equity securities of the Company were authorized for issuance under compensation plans.

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Forward-Looking Statements

This report contains forward-looking statements, including, but not limited to, statements relating to the Company's business objectives and strategy. Such forward-looking statements are based on current expectations, management beliefs, certain assumptions made by the Company's management, and estimates and projections about the Company's industry. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "hopeful," "judgment," "objective," "plans," "predicts," "projects," "seeks," variations of such words and similar expressions are intended to identify such forward-looking statements. Determination of loss and loss adjustment expense reserves and amounts due from insurers are based substantially on estimates and the amounts so determined are inherently forward-looking.

Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict with respect to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may differ materially from those expressed, forecasted, or contemplated by any such forward-looking statements. Other factors, some of which are listed below, also influence the results of operations, financial condition and business of the Company and its subsidiaries:

| |  | future economic conditions and the legal and regulatory environment in the markets served by the Company's subsidiaries;                                   
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                            
| |  | re-insurance market conditions, including changes in pricing and availability of re-insurance;                                                             
| |   |                                                                                                                                                            
| |  | financial market conditions, including, but not limited to, changes in interest rates and the values of investments;                                       
| |   |                                                                                                                                                            
| |  | inflation;                                                                                                                                                 
| |   |                                                                                                                                                            
| |  | credit worthiness of the issuers of investment securities, reinsurers and others with whom the Company and its subsidiaries do business;                   
| |   |                                                                                                                                                            
| |  | estimates of loss reserves and trends in losses and loss adjustment expenses;                                                                              
| |   |                                                                                                                                                            
| |  | changing competition;                                                                                                                                      
| |   |                                                                                                                                                            
| |  | the company's ability to execute its business plan;                                                                                                        
| |   |                                                                                                                                                            
| |  | the effects of war and terrorism on investment and reinsurance markets;                                                                                    
| |   |                                                                                                                                                            
| |  | changes in financial ratings issued by independent organizations, including A.M. Best, Standard & Poors and Moody's;                                       
| |   |                                                                                                                                                            
| |  | the company's ability to enter new markets successfully and capitalize on growth opportunities; and                                                        
| |   |                                                                                                                                                            
| |  | changes in the laws, rules and regulations governing insurance holding companies and insurance companies, as well as applicable tax and accounting matters.

Changes in any of these factors, or others, could have an adverse affect on the business, results of operations, or business of the Company or its subsidiaries. Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

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Independent Auditor's Report

The Board of Directors
Professionals Direct Inc. and Subsidiaries
Grand Rapids, Michigan

We have audited the accompanying consolidated balance sheet of Professionals Direct Inc. and Subsidiaries as of December 31, 2004, and the related consolidated statements of income and comprehensive income, shareholders' equity and cash flows for the two years in the period then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Professionals Direct Inc. and Subsidiaries as of December 31, 2004, and the consolidated results of their operations and their cash flows for the two years in the period then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO Seidman, LLP

Grand Rapids, Michigan
March 4, 2005

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PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET

|December 31,                                                                                        |  |  |   | 2004   |  
|--------------------------------------------------------------------------------------------------- |  |  | - | ------ | -
|                                                                                                    |  |  |   |        |  
|Assets (Note 9)                                                                                     |  |  |   | (000)  |  
|                                                                                                    |  |  |   |        |  
|Fixed maturities held to maturity, at amortized cost (Note 3)                                       |  |  | $ | 252    |  
|Fixed maturities available for sale, at fair value (Note 3)                                         |  |  |   | 32,949 |  
|Other invested asset, at cost which approximates fair value                                         |  |  |   | 268    |  
|                                                                                                    |  |  |   |        |  
|Total investments                                                                                   |  |  |   | 33,469 |  
|                                                                                                    |  |  |   |        |  
|Cash and cash equivalents                                                                           |  |  |   | 4,394  |  
|Receivables:                                                                                        |  |  |   |        |  
|Premiums (Note 4)                                                                                   |  |  |   | 1,102  |  
|Amounts due from reinsurers (Note 8)                                                                |  |  |   | 6,279  |  
|Investment income                                                                                   |  |  |   | 404    |  
|Ceding commissions                                                                                  |  |  |   | 347    |  
|Prepaid reinsurance premiums                                                                        |  |  |   | 4,163  |  
|Federal income taxes recoverable                                                                    |  |  |   | 561    |  
|Property and equipment, net (Note 6)                                                                |  |  |   | 299    |  
|Deferred acquisition costs (Note 14)                                                                |  |  |   | 1,415  |  
|Net deferred federal income taxes (Note 13)                                                         |  |  |   | 1,438  |  
|Intangible assets, net (Note 5)                                                                     |  |  |   | 567    |  
|Other assets                                                                                        |  |  |   | 3      |  
|                                                                                                    |  |  |   |        |  
|                                                                                                    |  |  |   | 20,972 |  
|                                                                                                    |  |  |   |        |  
|Total Assets                                                                                        |  |  | $ | 54,441 |  
|                                                                                                    |  |  |   |        |  
|Liabilities and Shareholders' Equity                                                                |  |  |   |        |  
|                                                                                                    |  |  |   |        |  
|Liabilities                                                                                         |  |  |   |        |  
|Loss and loss adjustment expense reserves (Note 7)                                                  |  |  | $ | 21,048 |  
|Unearned premiums                                                                                   |  |  |   | 10,738 |  
|Amounts due to reinsurers                                                                           |  |  |   | 2,036  |  
|Lines of credit (Note 9)                                                                            |  |  |   | 2,507  |  
|Unearned ceding commission (Note 14)                                                                |  |  |   | 786    |  
|Accrued expenses and other liabilities                                                              |  |  |   | 987    |  
|Accrued interest                                                                                    |  |  |   | 1,520  |  
|Surplus certificates (Note 11)                                                                      |  |  |   | 2,531  |  
|Trust preferred securities (Note 10)                                                                |  |  |   | 2,000  |  
|                                                                                                    |  |  |   |        |  
|Total Liabilities                                                                                   |  |  |   | 44,153 |  
|                                                                                                    |  |  |   |        |  
|Commitments and Contingencies(Notes 8, 9 and 15)                                                    |  |  |   |        |  
|                                                                                                    |  |  |   |        |  
|Shareholders' Equity(Note 11)                                                                       |  |  |   |        |  
|Preferred stock, no par (500,000 shares authorized, no shares issued)                               |  |  |   | -      |  
|Common stock, no par (5,000,000 shares authorized, 333,500 shares
          issued and outstanding) |  |  |   | 3,206  |  
|Retained Earnings                                                                                   |  |  |   | 7,299  |  
|Accumulated other comprehensive loss (Note 18)                                                      |  |  |   | (217   | )
|                                                                                                    |  |  |   |        |  
|Total Shareholders' Equity                                                                          |  |  |   | 10,288 |  
|                                                                                                    |  |  |   |        |  
|Total Liabilities and Shareholders' Equity                                                          |  |  | $ | 54,441 |  

See accompanying notes to consolidated financial statements.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME

|Year ended December 31,                                             |   | 2004   |   |   | 2003   |  
|------------------------------------------------------------------- | - | ------ | - | - | ------ | -
|                                                                    |   | (000)  |   |   | (000)  |  
|Revenues                                                            |   |        |   |   |        |  
|Net premiums earned (Note 8)                                        | $ | 16,203 |   | $ | 15,927 |  
|Fees and commissions earned                                         |   | 731    |   |   | 619    |  
|Net investment income (Note 3)                                      |   | 893    |   |   | 926    |  
|Finance and other income earned                                     |   | 152    |   |   | 127    |  
|                                                                    |   |        |   |   |        |  
|Total revenues                                                      |   | 17,979 |   |   | 17,599 |  
|                                                                    |   |        |   |   |        |  
|Expenses                                                            |   |        |   |   |        |  
|Losses and loss adjustment expenses
       incurred (Notes 7 and 8) |   | 11,937 |   |   | 7,737  |  
|Operating and administrative (Note 14)                              |   | 4,804  |   |   | 5,420  |  
|Interest                                                            |   | 447    |   |   | 300    |  
|                                                                    |   |        |   |   |        |  
|Total expenses                                                      |   | 17,188 |   |   | 13,457 |  
|                                                                    |   |        |   |   |        |  
|Income before federal income tax expense                            |   | 791    |   |   | 4,142  |  
|                                                                    |   |        |   |   |        |  
|Federal Income Tax Expense(Note 13)                                 |   | 260    |   |   | 1,442  |  
|                                                                    |   |        |   |   |        |  
|Net Income                                                          |   | 531    |   |   | 2,700  |  
|                                                                    |   |        |   |   |        |  
|Other Comprehensive Loss(Note 18)                                   |   | (106   | ) |   | (152   | )
|                                                                    |   |        |   |   |        |  
|Comprehensive Income                                                | $ | 425    |   | $ | 2,548  |  
|                                                                    |   |        |   |   |        |  
|Per share of common stock (not in thousands):                       |   |        |   |   |        |  
|Basic and diluted net income per share                              | $ | 1.59   |   |   | 8.10   |  
|Basic and diluted comprehensive income per share                    |   | 1.27   |   |   | 7.64   |  

See accompanying notes to consolidated financial statements.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

|                                                                                    | Common
shares |         | Common
stock
par value |       | Retained
earnings | Accumulated
other
comprehensive
income (loss) |   |       | Total |  
|----------------------------------------------------------------------------------- | ------------- | ------- | ---------------------- | ----- | ----------------- | --------------------------------------------- | - | ----- | ----- | -
|                                                                                    |               |         |                        | (000) |                   | (000)                                         |   | (000) |       |  
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Balance, January 1, 2003                                                            |               | 333,500 | $                      | 3,206 | $                 | 4,068                                         | $ | 41    |       | $
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Net income for the year                                                             |               | -       |                        | -     |                   | 2,700                                         |   | -     |       |  
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Net depreciation on available
     for sale securities, net of
     taxes (Note 18) |               | -       |                        | -     |                   | -                                             |   | (152  | )     |  
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Balance, December 31, 2003                                                          |               | 333,500 | $                      | 3,206 | $                 | 6,768                                         | $ | (111  | )     | $
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Net income for the year                                                             |               | -       |                        | -     |                   | 531                                           |   | -     |       |  
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Net depreciation on available
     for sale securities, net of
     taxes (Note 18) |               | -       |                        | -     |                   | -                                             |   | (106  | )     |  
|                                                                                    |               |         |                        |       |                   |                                               |   |       |       |  
|Balance, December 31, 2004                                                          |               | 333,500 | $                      | 3,206 | $                 | 7,299                                         | $ | (217  | )     | $

See accompanying notes to consolidated financial statements.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

|Year ended December 31,                                                    |   | 2004    |   |   | 2003    |  
|-------------------------------------------------------------------------- | - | ------- | - | - | ------- | -
|                                                                           |   | (000)   |   |   | (000)   |  
|Operating Activities                                                       |   |         |   |   |         |  
|Net income                                                                 | $ | 531     |   | $ | 2,700   |  
|Adjustments to reconcile net income to net cash from operating activities: |   |         |   |   |         |  
|Deferred federal income tax expense                                        |   | (267    | ) |   | (269    | )
|Realized gains                                                             |   | (5      | ) |   | (173    | )
|Depreciation                                                               |   | 152     |   |   | 181     |  
|Amortization                                                               |   | 868     |   |   | 620     |  
|Changes in operating assets and liabilities:                               |   |         |   |   |         |  
|Premiums receivable                                                        |   | 150     |   |   | (540    | )
|Amounts due from reinsurers                                                |   | (3,913  | ) |   | 587     |  
|Deductibles receivable                                                     |   | 33      |   |   | 19      |  
|Investment income receivable                                               |   | (47     | ) |   | (92     | )
|Ceding commissions receivable                                              |   | (49     | ) |   | (57     | )
|Federal income taxes recoverable                                           |   | (561    | ) |   | 57      |  
|Prepaid reinsurance premiums                                               |   | (2,388  | ) |   | (760    | )
|Deferred acquisition costs                                                 |   | 214     |   |   | (816    | )
|Other assets                                                               |   | 23      |   |   | 5       |  
|Loss and loss adjustment expense reserves                                  |   | 7,587   |   |   | 3,323   |  
|Unearned premiums                                                          |   | 270     |   |   | 4,952   |  
|Unearned ceding commissions                                                |   | 675     |   |   | 111     |  
|Amounts due to reinsurers                                                  |   | 1,543   |   |   | 123     |  
|Federal income taxes payable                                               |   | (306    | ) |   | 306     |  
|Accrued expenses and other liabilities                                     |   | (482    | ) |   | 396     |  
|Accrued interest                                                           |   | 136     |   |   | 141     |  
|                                                                           |   |         |   |   |         |  
|Net cash from operating activities                                         |   | 4,164   |   |   | 10,814  |  
|                                                                           |   |         |   |   |         |  
|Investing Activities                                                       |   |         |   |   |         |  
|Cost of fixed maturities acquired                                          |   | (12,169 | ) |   | (21,678 | )
|Proceeds from sales or maturities of fixed maturities                      |   | 7,207   |   |   | 9,902   |  
|Cost of property and equipment acquired                                    |   | (47     | ) |   | (118    | )
|                                                                           |   |         |   |   |         |  
|Net cash for investing activities                                          |   | (5,009  | ) |   | (11,894 | )
|                                                                           |   |         |   |   |         |  
|Financing Activities                                                       |   |         |   |   |         |  
|Net borrowings (repayments) under lines of credit                          |   | (1,767  | ) |   | 3,689   |  
|Payment of debt issue costs                                                |   | -       |   |   | (45     | )
|                                                                           |   |         |   |   |         |  
|Net cash from (for) financing activities                                   |   | (1,767  | ) |   | 3,644   |  
|                                                                           |   |         |   |   |         |  
|Net Increase (Decrease) in Cash and Cash Equivalents                       |   | (2,612  | ) |   | 2,564   |  
|                                                                           |   |         |   |   |         |  
|Cash and Cash Equivalents, beginning of year                               |   | 7,006   |   |   | 4,442   |  
|                                                                           |   |         |   |   |         |  
|Cash and Cash Equivalents, end of year                                     | $ | 4,394   |   | $ | 7,006   |  
|                                                                           |   |         |   |   |         |  
|Supplemental Disclosures of Cash Flow Information                          |   |         |   |   |         |  
|Federal income tax payments - net                                          | $ | 1,387   |   | $ | 1,110   |  
|Interest payments                                                          |   | 311     |   |   | 159     |  

See accompanying notes to consolidated financial statements.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.          Organization of the Company and Nature of Business

Professionals Direct Inc. (Company) is an insurance holding company with four subsidiaries (see Note 2). One of the subsidiaries, Professionals Direct Insurance Company (PDIC) is the former Michigan Lawyers Mutual Insurance Company (the Mutual). The Mutual was originally formed in the State of Michigan on June 4, 1987, for the principal purpose of providing professional liability insurance on a claims-made basis to attorneys practicing in Michigan. PDIC continues to provide professional liability insurance to attorneys and law firms in Michigan and other states. In 2004, 38% of premiums were written in Michigan, 10% in Florida, 9% each in Arizona and Pennsylvania with the balance in twenty-four additional states with no other state exceeding 7%.

The Lawyers Direct Risk Purchasing Group (Group) was formed during 2002 to facilitate the purchase of liability insurance by certain of the Company's insureds. The Group is a non-profit corporation with current management of the Company comprising its Board.

2.          Basis of Presentation and Significant Accounting Policies

Basis of Presentation

These consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP).

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries (Professionals Direct Insurance Company, a property and casualty insurance company; Professionals Direct Employer Organization, Inc., an inactive Michigan professional employer organization; Professionals Direct Finance, Inc. (Finance), a premium finance company; Professionals Direct Insurance Services, Inc. (Services), a company providing underwriting claims, accounting, information technology services and selling professionals liability and other insurance), plus Lawyers Direct Risk Purchasing Group which the company controls.

All significant intercompany transactions and balances have been eliminated.

Investments

The Company classifies marketable investment securities in one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held to maturity securities are those securities which the Company has the ability and intent to hold until maturity. All other securities are classified as available for sale.

Held to maturity securities are recorded at amortized cost. Unrealized gains and losses are excluded from comprehensive income.

Available for sale securities are recorded at fair value based upon quoted market prices of the underlying securities. Unrealized gains and losses, net of the related tax effect, on available for sale securities are excluded from net income and reported as accumulated other comprehensive income, until realized. A decline in the fair value of any available for sale security below cost that is deemed other than temporary is charged to earnings and results in the establishment of a new cost basis for the security.

Premiums and discounts are amortized or accreted over the life of the related fixed maturity security as an adjustment to yield using the effective interest method. Dividend and interest income is recognized when earned. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of the securities sold.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Other Invested Asset

Other invested asset is an investment in a non-public reinsurance company accounted for using cost basis accounting. The fair value of this investment represents management's best estimate of fair value based upon information received from the investee. A decline in the estimated fair value of any other invested asset below cost that is deemed other than temporary is charged to earnings and results in the establishment of a new cost basis for the security.

Cash and Cash Equivalents

Cash and cash equivalents includes money market mutual funds and investments with maturities of one year or less and are stated at cost, which approximates fair value.

Property and Equipment

Property and equipment, consisting principally of computer equipment and software, is stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using accelerated and straight-line methods over estimated useful lives, which range from three to seven years.

Intangible Assets

Intangible assets consist of customer lists and non-compete agreements that are amortized on a straight-line basis over the estimated benefit periods from two to fifteen years and debt issue costs that are amortized by the effective interest method over the term of the securities.

Revenue Recognition

Insurance premiums are earned on a daily pro-rata basis over the term of the policy. Most policies have a term of twelve months.

Commission Income

Commissions are recognized when the respective policies become effective.

Deferred Acquisition Costs and Unearned Ceding Commissions

Acquisition costs, consisting of commissions, premium taxes and other underwriting costs are deferred and amortized ratably over the terms of the policies. Unearned ceding commissions are deferred and amortized ratably over the terms of the treaties.

Unearned Premiums

Unearned premiums represent the portion of premiums written which is applicable to the unexpired terms of policies in force, calculated using the daily pro-rata basis.

Loss and Loss Adjustment Expenses

A liability for losses is provided based upon formula and case basis estimates for losses reported on direct premiums written and estimates of additional development of these losses over case basis estimates based upon past experience.

A liability for loss adjustment expenses is provided by estimating future expenses to be incurred in settlement of the claims provided for in the liability for losses.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Federal Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates in effect at the balance sheet date. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as a charge or credit to income tax expense in the period that includes the enactment date.

Use of Estimates

In preparing the financial statements, management is required 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 reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.

The most significant estimates that are susceptible to significant change in the near term relate to the determination of the loss and loss adjustment expense reserves and amounts due from reinsurers. Although considerable variability is inherent in these estimates, management believes that they are fairly stated, based on presently available information. Estimates are reviewed regularly and adjusted as deemed appropriate. Such adjustments are reflected in current operations.

Earnings Per Share of Common Stock

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share is equal to basic earnings per share as there are no stock options or other dilutive instruments outstanding.

Certain Significant Risks

Following is a description of the more significant risks facing property/casualty insurers and how the Company mitigates those risks:

Legal/Regulatory Risk - is the risk that changes in the legal or regulatory environment in which an insurer operates will change and create additional loss costs or expenses not anticipated by the insurer in pricing its products. That is, regulatory initiatives designed to reduce insurer profits or new legal theories may create costs for the insurer beyond those recorded in the financial statements. The Company mitigates this risk through underwriting and loss adjusting practices intended to identify and minimize the adverse impact of this risk.

Credit Risk - is the risk that issuers of securities owned by the Company will default, or other parties, including reinsurers and customers which owe the Company money, will not pay. The Company has a concentration of amounts due from customers in the State of Michigan as approximately 38% of current year revenues were derived from customers in Michigan. The Company manages this risk by adhering to a conservative investment strategy, by maintaining sound reinsurance and credit and collection policies, and by providing for any amounts deemed uncollectible.

Interest Rate Risk - is the risk that interest rates will change and cause a decrease in the value of an insurer's investments. The Company mitigates this risk by attempting to match the maturity schedule of its assets with the expected payout of its liabilities. To the extent that liabilities come due more quickly than assets mature or the Company liquidates investments to meet operating needs, the Company would have to sell assets prior to maturity and recognize a gain or loss. At December 31, 2004, the estimated fair value of the Company's bond portfolio was less than its cost.

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PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.          Investments

A summary of amortized cost, gross unrealized gains and losses, and fair value of fixed maturities available for sale is as follows:

|                                                                               |   |                |  | Gross unrealized |       |   |       
|------------------------------------------------------------------------------ | - | -------------- |  | ---------------- | ----- | - | ------
|December 31, 2004                                                              |   | Amortized
cost |  |                  | Gains |   | Losses
|                                                                               |   | (000)          |  |                  | (000) |   | (000) 
|Fixed maturities held to maturity:                                             |   |                |  |                  |       |   |       
|Obligations of states and political
          subdivisions                     | $ | 252            |  | $                | 1     | $ | -     
|                                                                               |   |                |  |                  |       |   |       
|Fixed maturities available for sale:                                           |   |                |  |                  |       |   |       
|U.S. treasury securities and obligations
          of U.S. government agencies | $ | 5,131          |  | $                | -     | $ | 59    
|Obligations of states and political
          subdivisions                     |   | 13,169         |  |                  | 20    |   | 225   
|Corporate securities                                                           |   | 14,082         |  |                  | 27    |   | 111   
|Mortgage and other asset-backed
          securities                           |   | 913            |  |                  | 8     |   | 6     
|                                                                               |   |                |  |                  |       |   |       
|Total fixed maturities                                                         | $ | 33,547         |  | $                | 56    | $ | 401   

The amortized cost and fair value of fixed maturities, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

|December 31, 2004                                                             |   | Amortized
cost |   | Fair value |  | 
|----------------------------------------------------------------------------- | - | -------------- | - | ---------- |  | 
|                                                                              |   | (000)          |   | (000)      |  | 
|Fixed maturities, other than mortgage and other asset-backed
     securities: |   |                |   |            |  | 
|Due in one year or less                                                       | $ | 6,809          | $ | 6,783      |  | 
|Due after one year through five years                                         |   | 18,730         |   | 18,451     |  | 
|Due after five years through ten years                                        |   | 5,617          |   | 5,606      |  | 
|Due after ten years                                                           |   | 1,478          |   | 1,447      |  | 
|                                                                              |   |                |   |            |  | 
|                                                                              |   | 32,634         |   | 32,287     |  | 
|                                                                              |   |                |   |            |  | 
|Mortgage and other asset-backed securities                                    |   | 913            |   | 915        |  | 
|                                                                              |   |                |   |            |  | 
|                                                                              | $ | 33,547         | $ | 33,202     |  | 

Proceeds from sales of fixed maturities were $6,325,011 and $8,691,828 in 2004 and 2003, respectively, on which gross gains of $4,932 and $218,534 and gross losses of $0 and $35,772 were realized in 2004 and 2003, respectively.

Other than Temporary Impairments of Securities and Unrealized Losses on Investments

At December 31, 2004, the Company had 58 securities deemed to be temporarily impaired. These investments had unrealized losses of less than 10% each and no single security loss exceeded $30,000. Twelve investments, which

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PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

are obligations of state or political subdivisions, have had unrealized losses for more than one year, which losses aggregated $208,000 at December 31, 2004.

In concluding that investments with unrealized losses are not other-than-temporarily impaired, positive evidence consisted of: 1) no specific events caused concern; 2) interest payments are current; 3) market prices have risen; 4) changes in market value are normal relative to fluctuations in overall interest rates; and 5) the Company has the ability to hold the security until the anticipated recovery in value occurs.

The fair value and amount of unrealized losses segregated by the time period the investment has been in an unrealized loss position is as follows:

|December 31, 2004                                                                       |   | Less than 12 months                              |   |                         | Greater than 12 months |  
|--------------------------------------------------------------------------------------- | - | ------------------------------------------------ | - | ----------------------- | ---------------------- | -
|                                                                                        |   |                                                  |   |                         |                        |  
|                                                                                        |   | Fair Value of
Investments with
Unrealized
Losses |   | Gross
Unrealized
Losses |                        |  
|                                                                                        |   | (000)                                            |   | (000)                   |                        |  
|Debt Securities:                                                                        |   |                                                  |   |                         |                        |  
|U.S. treasury securities and
         obligations of U.S.
          government agencies | $ | 4,344                                            | $ | (31                     | )                      | $
|Obligations of states and
          political subdivisions                              |   | 3,533                                            |   | (45                     | )                      |  
|Corporate securities                                                                    |   | 11,436                                           |   | (112                    | )                      |  
|Mortgage and other asset-
          backed securities                                   |   | 250                                              |   | (5                      | )                      |  
|                                                                                        |   |                                                  |   |                         |                        |  
|Totals                                                                                  | $ | 19,563                                           | $ | (193                    | )                      | $

At December 31, 2004, investments with a fair value of $2,933,744 and amortized cost of $2,932,794 were on deposit with regulatory authorities, as required by law.

Net investment income was comprised of the following components:

|Year ended December 31,     |   | 2004  |   | 2003  |  | 
|--------------------------- | - | ----- | - | ----- |  | 
|                            |   | (000) |   | (000) |  | 
|Investment income:          |   |       |   |       |  | 
|Fixed maturities            | $ | 927   | $ | 769   |  | 
|Short-term investments      |   | 59    |   | 63    |  | 
|Net realized gains (losses) |   | 5     |   | 172   |  | 
|                            |   |       |   |       |  | 
|                            |   | 991   |   | 1,004 |  | 
|Less investment expenses    |   | 98    |   | 78    |  | 
|                            |   |       |   |       |  | 
|Net investment income       | $ | 893   | $ | 926   |  | 

No individual investment exceeds ten percent of stockholders' equity.

4.          Premiums and Deductibles Receivable and Allowance for Doubtful Accounts

Premium receivables are primarily customer obligations due under terms of premium finance contracts. We sell our policies exclusively to lawyers and law firms. Professionals Direct Finance, Inc. provides premium

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

financing to policyholders of Professionals Direct Insurance Company for up to eighty percent of the premium. Typically, Finance will accept installment payments over nine months, including a finance charge. Finance holds the policy as collateral and if an account is delinquent will have the insurance company cancel the policy. The return of unearned premium will exceed the amount owed on the contract and the difference is paid to the policyholder. As a result, no allowance for doubtful accounts is provided.

Deductible receivables are amounts due from policyholders under the terms of the policy when the Company pays indemnity on behalf of a policyholder. There are typically a limited number of policyholders with balances outstanding for deductible. We record an allowance for doubtful accounts based on specifically identified amounts that we believe to be uncollectible. After all attempts to collect a receivable have failed, the receivable is written off against the allowance. The allowance for doubtful accounts at December 31, 2004 and 2003 was $25,000 and $30,000, respectively.

5.          Intangible Assets

Intangible assets consist of the following:

|December 31,                      |  |  |   | 2004  |  | 
|--------------------------------- |  |  | - | ----- |  | 
|                                  |  |  |   | (000) |  | 
|Cost:                             |  |  |   |       |  | 
|Debt issue costs                  |  |  | $ | 139   |  | 
|Covenants not to compete          |  |  |   | 310   |  | 
|Renewal rights and customer lists |  |  |   | 526   |  | 
|                                  |  |  |   |       |  | 
|                                  |  |  |   | 975   |  | 
|Less accumulated amortization     |  |  |   | 408   |  | 
|                                  |  |  |   |       |  | 
|Net intangible assets             |  |  | $ | 567   |  | 

Intangible assets include debt issue costs of $93,848 incurred in 2002 in connection with the issuance of the trust preferred securities (see Note 10) and $45,000 incurred in 2003 in connection with additional bank financing. In 2002 the Company purchased the renewal rights to the direct written lawyers professional liability policies of Interlex Insurance Company for $309,000. In conjunction with this purchase, the Company obtained certain non-competition covenants from Interlex and its employees for $132,428 and acquired the renewal rights and a covenant not to compete from a former Interlex agent for $49,371.

The renewal rights are being amortized on a straight line basis over fifteen years. The covenants are being amortized over the associated duration of the covenant ranging from 15 to 51 months. Debt issue costs are being amortized by the effective interest method over the term of the repayment period ranging from 3 to 30 years and has been included in interest expense.

Future amortization expense is as follows:

|Year ending December 31, |  |  |   |       |  | 
|------------------------ |  |  | - | ----- |  | 
|                         |  |  |   | (000) |  | 
|                         |  |  |   |       |  | 
|2005                     |  |  | $ | 84    |  | 
|2006                     |  |  |   | 57    |  | 
|2007                     |  |  |   | 38    |  | 
|2008                     |  |  |   | 38    |  | 
|2009                     |  |  |   | 38    |  | 
|Thereafter               |  |  |   | 309   |  | 
|                         |  |  |   |       |  | 
|                         |  |  | $ | 564   |  | 

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PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.          Property and Equipment

        Property and equipment consist of the following:

|December 31,                                   |  |  |   | 2004  | 
|---------------------------------------------- |  |  | - | ----- | 
|                                               |  |  |   | (000) | 
|Cost:                                          |  |  |   |       | 
|Computer equipment                             |  |  | $ | 296   | 
|Furniture and other equipment                  |  |  |   | 258   | 
|Computer software                              |  |  |   | 1,076 | 
|Leasehold improvements                         |  |  |   | 47    | 
|                                               |  |  |   |       | 
|                                               |  |  |   | 1,677 | 
|Less accumulated depreciation and amortization |  |  |   | 1,378 | 
|                                               |  |  |   |       | 
|Net property and equipment                     |  |  | $ | 299   | 

7.          Loss and Loss Adjustment Expense Reserves

Activity in the loss and loss adjustment expense reserves is summarized as follows:

|December 31,                          |   | 2004   |   | 2003   |  
|------------------------------------- | - | ------ | - | ------ | -
|                                      |   | (000)  |   | (000)  |  
|                                      |   |        |   |        |  
|Balance, beginning of year            | $ | 13,461 | $ | 10,138 |  
|Less reinsurance balances recoverable |   | (2,163 | ) | (2,469 | )
|                                      |   |        |   |        |  
|Net balance, beginning of year        |   | 11,298 |   | 7,669  |  
|                                      |   |        |   |        |  
|Incurred related to:                  |   |        |   |        |  
|Current year                          |   | 11,180 |   | 7,738  |  
|Prior years                           |   | 757    |   | (1     | )
|                                      |   |        |   |        |  
|Total incurred                        |   | 11,937 |   | 7,737  |  
|                                      |   |        |   |        |  
|Paid related to:                      |   |        |   |        |  
|Current year                          |   | 2,000  |   | 1,094  |  
|Prior years                           |   | 5,886  |   | 3,014  |  
|                                      |   |        |   |        |  
|Total paid                            |   | 7,886  |   | 4,108  |  
|                                      |   |        |   |        |  
|Net balance, end of year              |   | 15,349 |   | 11,298 |  
|Plus reinsurance balances recoverable |   | 5,699  |   | 2,163  |  
|                                      |   |        |   |        |  
|Balance, end of year                  | $ | 21,048 | $ | 13,461 |  

The 2004 increase in incurred losses related to prior accident years resulted from adverse loss development on primarily the 2002 and 2003 accident years.

8.          Reinsurance

In the normal course of business, the Company seeks to reduce the loss that may arise from events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Although reinsurance agreements contractually obligate the Company's reinsurers to reimburse the Company for their proportionate share of losses, they do not discharge the primary liability of the Company. The Company is contingently liable for unpaid losses and loss adjustment expenses and unearned premiums associated with ceded insured risks in the event the assuming insurance organizations fail to meet their contractual obligations.

In 2004 and 2003, the Company's net retention on the majority of the policies issued was $250,000 and $500,000, respectively, per claim.

Amounts due from reinsurers consisted of amounts related to the following:

|December 31,                             |  |  |   | 2004  |   | 
|---------------------------------------- |  |  | - | ----- | - | 
|                                         |  |  |   | (000  | ) | 
|                                         |  |  |   |       |   | 
|Paid loss and loss adjustment expenses   |  |  | $ | 580   |   | 
|Unpaid loss and loss adjustment expenses |  |  |   | 5,699 |   | 
|                                         |  |  |   |       |   | 
|                                         |  |  | $ | 6,279 |   | 

The effect of reinsurance on premiums written and earned is as follows:

|             |   | 2004    |   | 2003   |   |        
|------------ | - | ------- | - | ------ | - | -------
|             |   |         |   |        |   |        
|             |   | Written |   | Earned |   | Written
|             |   | (000)   |   | (000)  |   | (000)  
|             |   |         |   |        |   |        
|Direct       | $ | 24,009  | $ | 23,739 | $ | 24,294 
|Ceded        |   | (9,924  | ) | (7,536 | ) | (4,176 
|             |   |         |   |        |   |        
|Net Premiums | $ | 14,085  | $ | 16,203 | $ | 20,118 

As a result of reinsurance ceded, loss and loss adjustment expenses incurred were reduced by $2,209,163 and $177,663 in 2004 and 2003, respectively.

The Company holds collateral under related reinsurance agreements in the form of irrevocable letters of credit with various banks. At December 31, 2004, the balance of these letters of credit was $2,670,602.

9.          Lines of Credit

At December 31, 2004, the Company owed $107,401 under a $1.8 million line of credit that bears interest at .5% over the bank's prime rate (effectively 5.75% at December 31, 2004). In addition, the Company owed $2,400,000 under a second line of credit that bears interest at 1.25% over the bank's prime rate (effectively 6.5% at December 31, 2004). This line of credit requires quarterly principal payments of $150,000 beginning April 1, 2004 and matures October 1, 2006. At December 31, 2004, the Company had available a third line of credit of $1,000,000 that bears interest at 1.0% over the bank's prime rate (effectively 6.25% at December 31, 2004). All of the lines of credit grant a security interest in substantially all assets of the Company, Services and Finance. In addition the Company provided a pledge of its shares of PDIC. All of the lines of credit impose financial covenants. The Company was in compliance with all covenants as of December 31, 2004.

10.          Trust Preferred Securities

On December 4, 2002, the Company issued a floating rate junior subordinated debenture (the "Debenture") having a principal amount of $2,062,000 to Professionals Direct Statutory Trust I (the "Trust"). Cumulative interest

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

on the principal sum of the Debenture accrues from December 4, 2002, and it is payable quarterly in arrears at a variable rate per annum equal to LIBOR (London Interbank Offering Rate) plus 4.00% (not to exceed 12.50%). At December 31, 2004, interest accrued at an annual rate per annum equal to 6.44%. Interest is computed on the actual number of days elapsed in a year of twelve 30 day months. The Debenture ranks subordinate and junior in right of payment to all Indebtedness (as defined) of the Company. The Debenture matures on December 4, 2032, but may be redeemed in whole or in part beginning on December 4, 2007, or earlier upon the occurrence of certain special events defined in the Indenture governing the Debenture.

On December 4, 2002, the Trust sold floating rate capital securities ("Capital Securities") having an aggregate liquidation amount of $2 million to investors and issued floating rate common securities ("Common Securities") having an aggregate liquidating amount of $2,062,000 to the Company. All of the proceeds from the sale of Capital Securities and Common Securities were invested in the Debenture. Capital Securities and Common Securities represent undivided beneficial interests in the Debenture, which is the sole asset of the Trust. Holders of Capital Securities and Common Securities are entitled to receive distributions from the Trust on terms which correspond to the interest and principal payments due on the Debenture. Payment of distributions by the Trust and payments on liquidation of the Trust or redemption of Capital Securities are guaranteed by the Company to the extent the Trust has funds available (the "Guarantee"). The Company's obligations under the Guarantee, taken together with its obligations under the Debenture and the Indenture, constitute a full and unconditional guarantee of all of the Trust's obligations under the Capital Securities issued by the Trust.

11.          Surplus Certificates

Surplus certificates were offered for sale only in the State of Michigan to lawyers resident in and authorized to practice in Michigan, and to law partnerships and professional corporations which have their principal place of business in Michigan. Certificate ownership was required for a lawyer to be insured by the Company prior to March 31, 1995, when the requirement was suspended and, effective December 9, 2000, this requirement was permanently removed.

Certificates have a principal value of $1,000 each and bear simple interest at the rate of 5.25% per annum from the issuance date until paid. Principal and accrued interest thereon may be paid only from surplus earnings, and then only upon the written consent of the Michigan Department of Financial and Insurance Services and in such amounts as are determined by the board of directors. Subject to these conditions for repayment, certificates are redeemable by the holder after they have been outstanding for ten years. To date, the Company has received approval to pay certain interest on certificates issued prior to December 31, 1993. No interest was paid during either 2004 or 2003 to these certificate holders.

During the Conversion in 2001, 1,814 surplus certificates were converted to common stock and interest totaling $540,798 was paid on these converted certificates. At December 31, 2004, 2,531 certificates remain outstanding.

In the event of liquidation, receivership, insolvency, reorganization, dissolution, or termination of existence of the Company, or the sale by the Company of substantially all its assets, the outstanding certificates will be of equal rank with each other regardless of the issuance date of a certificate, and redemption thereof will be subordinate to claims of creditors and policyholders and any other priority claims as provided by the insurance code. If there are insufficient assets in such event to pay, in full, interest and principal on all outstanding certificates, payment will be made pro rata.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12.          Statutory Information

Dividend Restrictions

As required by the Plan of Conversion, PDIC is prohibited from making any dividend payments to the Company until such time as the surplus certificates are repaid in full. In addition, under Michigan law, the maximum dividend that may be paid by PDIC to the Company during any twelve-month period without the prior approval of the OFIS is the greater of 10% of PDIC's statutory surplus as reported on the most recent annual statement filed with the OFIS or the net income of PDIC for the period covered by such annual statement.

Statutory Information

At December 31, 2004, statutory surplus of PDIC was $16.1 million. The State of Michigan requires insurance companies domiciled in Michigan to have minimum statutory surplus of $7 million. Statutory net income for the years ended December 31, 2004 and 2003 was $38,988 and $1,674,932, respectively.

Risk-Based Capital

The NAIC has established RBC requirements to assist regulators in monitoring the financial strength and stability of property and casualty insurers. Under the NAIC requirements, each insurer must maintain its total capital and surplus above a calculated minimum threshold or take corrective measures to achieve that threshold. PDIC has calculated its RBC levels based on these requirements and determined that it has surplus in excess of the minimum threshold.

13.          Federal Income Taxes

Federal income tax expense consists of:

|Year ended December 31, |   | 2004  |   |   | 2003  |   | 
|----------------------- | - | ----- | - | - | ----- | - | 
|                        |   | (000) |   |   | (000) |   | 
|                        |   |       |   |   |       |   | 
|Current                 | $ | 527   |   | $ | 1,542 |   | 
|Deferred                |   | (267  | ) |   | (100  | ) | 
|                        |   |       |   |   |       |   | 
|                        | $ | 260   |   | $ | 1,442 |   | 

The significant components of federal income tax expense were as follows:

|Year ended December 31,                       |   | 2004  |   |   | 2003  |   | 
|--------------------------------------------- | - | ----- | - | - | ----- | - | 
|                                              |   | (000) |   |   | (000) |   | 
|                                              |   |       |   |   |       |   | 
|Operations                                    | $ | 260   |   | $ | 1,442 |   | 
|Equity - accumulated other comprehensive loss |   | (55   | ) |   | (82   | ) | 

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A reconciliation of the federal statutory tax rate to the Company's effective tax rate is as follows:

|Year ended December 31,              |  | 2004 |   | 2003 |   | 
|------------------------------------ |  | ---- | - | ---- | - | 
|                                     |  |      |   |      |   | 
|Federal statutory tax rate           |  | 34.0 | % | 34.0 | % | 
|Increase (reduction) in income taxes |  |      |   |      |   | 
|relating to:                         |  |      |   |      |   | 
|Tax-exempt municipal bond interest   |  | (1.1 | ) | (0.3 | ) | 
|Provision to return adjustment       |  | -    |   | 1.1  |   | 
|                                     |  |      |   |      |   | 
|Effective tax rate                   |  | 32.9 | % | 34.8 | % | 

Several provisions of the Internal Revenue Code specifically affect property and casualty insurers. Such provisions that materially affect the Company are the discounting of loss and loss adjustment expense reserves, a reduction in the allowable deduction for unearned premium reserves, and a reduced exclusion for interest from certain tax-exempt bonds. The tax effects of these and other temporary differences that give rise to deferred tax assets and liabilities are presented below:

|December 31,                          |   | 2004  |   | 
|------------------------------------- | - | ----- | - | 
|                                      |   | (000) |   | 
|Deferred tax assets:                  |   |       |   | 
|Loss reserve discounting              | $ | 475   |   | 
|Unearned premium reserves             |   | 447   |   | 
|Interest on surplus certificates      |   | 499   |   | 
|Other                                 |   | 231   |   | 
|                                      |   |       |   | 
|Total gross deferred tax assets       |   | 1,652 |   | 
|                                      |   |       |   | 
|Deferred tax liabilities:             |   |       |   | 
|Deferred acquisition costs            |   | (214  | ) | 
|                                      |   |       |   | 
|Net deferred federal income tax asset | $ | 1,438 |   | 

In assessing the realizability of deferred federal income tax assets, management considers whether it is more likely than not that some portion of the deferred federal income tax assets will not be realized. Because of the carryforward provisions of the Internal Revenue Code, and the Company's expectation that temporary differences will reverse during periods in which taxable income is generated, management believes it is more likely than not that the Company will fully realize the net deferred federal income tax assets. Accordingly, no valuation allowance has been established.

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14.          Deferred Acquisition Costs and Unearned Ceding Commissions

Changes in deferred acquisition costs are summarized as follows:

|Year ended December 31,             |   | 2004   |   | 2003   |   | 
|----------------------------------- | - | ------ | - | ------ | - | 
|                                    |   | (000)  |   | (000)  |   | 
|                                    |   |        |   |        |   | 
|Balance, beginning of year          | $ | 1,629  | $ | 813    |   | 
|                                    |   |        |   |        |   | 
|Amounts deferred:                   |   |        |   |        |   | 
|Commissions                         |   | 1,417  |   | 1,733  |   | 
|Premium taxes                       |   | 391    |   | 396    |   | 
|General and administrative expenses |   | 1,356  |   | 1,652  |   | 
|                                    |   |        |   |        |   | 
|Total amounts deferred              |   | 4,793  |   | 4,594  |   | 
|                                    |   |        |   |        |   | 
|Less amortization                   |   | (3,378 | ) | (2,965 | ) | 
|                                    |   |        |   |        |   | 
|Balance, end of year                | $ | 1,415  | $ | 1,629  |   | 

Changes in unearned ceding commissions are summarized as follows:

|Year ended December 31,     |   | 2004   |   | 2003  |   | 
|--------------------------- | - | ------ | - | ----- | - | 
|                            |   | (000)  |   | (000) |   | 
|                            |   |        |   |       |   | 
|Balance, beginning of year  | $ | 111    | $ | -     |   | 
|                            |   |        |   |       |   | 
|Ceding commissions deferred |   | 1,755  |   | 257   |   | 
|                            |   |        |   |       |   | 
|Less amortization           |   | (1,080 | ) | (146  | ) | 
|                            |   |        |   |       |   | 
|Balance, end of year        | $ | 786    | $ | 111   |   | 

15.          Commitments and Contingencies

The Company has entered into operating leases for office space and equipment. Rental expense for these items totaled $200,242 and $196,371 in 2004 and 2003, respectively. Future net minimum lease payments under noncancelable leases are as follows:

|Year ending December 31, |   |       |  | 
|------------------------ | - | ----- |  | 
|                         |   | (000) |  | 
|                         |   |       |  | 
|2004                     | $ | 118   |  | 
|2005                     |   | 20    |  | 
|2006                     |   | 6     |  | 
|2007                     |   | 1     |  | 
|                         |   |       |  | 
|                         | $ | 145   |  | 

---



PROFESSIONALS DIRECT INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company has purchased an annuity policy from a life insurance company for purposes of funding a structured claim settlement. At December 31, 2004, the Company remains contingently liable for this settlement in the amount of $396,000.

16.          Employee Benefit Plans

The Company maintains a 401(k) defined contribution employee benefit plan covering substantially all employees meeting eligibility requirements. The Company matches 50% of employee contributions up to an annual maximum of 5% of an employee's salary. The Company's expense under this plan was $53,027 and $46,781 in 2004 and 2003, respectively.

Effective January 1, 2001, the Company established a Savings & Retirement Plan. This plan was established to facilitate employee purchases of Company stock upon demutualization. There has been no activity in this plan.

17.          Related Party Transaction

The Company's president serves on the Board of Directors and is treasurer of Lawyers Reinsurance Company ("Lawyers Re"), in which the Company has an investment. Lawyers Re is a participant in the reinsurance treaties of PDIC. During 2004 and 2003, premiums of $253,000 and $424,000 were ceded to Lawyers Re. During 2004 $116,000 in losses were paid by Lawyers Re. As of December 31, 2004, unearned premiums ceded to Lawyers Re were $109,000.

18.          Other Comprehensive Income (Loss)

The significant components of other comprehensive income (loss) were as follows:

|Year ended December 31,                                              |   | 2004  |   |   | 2003  |   | 
|-------------------------------------------------------------------- | - | ----- | - | - | ----- | - | 
|                                                                     |   | (000) |   |   | (000) |   | 
|                                                                     |   |       |   |   |       |   | 
|Unrealized holding gain (loss) on securities arising during the year | $ | (156  | ) | $ | (58   | ) | 
|Income tax benefit                                                   |   | 53    |   |   | 20    |   | 
|                                                                     |   |       |   |   |       |   | 
|                                                                     |   | (103  | ) |   | (38   | ) | 
|                                                                     |   |       |   |   |       |   | 
|Reclassification adjustment for gains included in net income         |   | (5    | ) |   | (172  | ) | 
|Income taxes                                                         |   | 2     |   |   | 58    |   | 
|                                                                     |   |       |   |   |       |   | 
|                                                                     |   | (3    | ) |   | (114  | ) | 
|                                                                     |   |       |   |   |       |   | 
|Other comprehensive income (loss)                                    | $ | (106  | ) | $ | (152  | ) | 

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|                                                           
|-----------------------------------------------------------
|PROFESSIONALS DIRECT, INC. DIRECTORS AND EXECUTIVE OFFICERS

At December 31, 2004

Board of Directors

David W. Crooks - Value Added Consultants, Ltd.
          (general business consulting)

Tracy T. Larsen - Barnes & Thornburg
          (a full-service law firm)

Thomas J. Ryan - Thomas J. Ryan, P.C.
          (attorney at law)

Joseph A. Fink - Member, Dickinson Wright, PLLC
          (a full-service law firm)

Julius A. Otten - Independent consultant
          (consulting on matters in the insurance industry)

Thomas F. Dickinson - President and Chief Executive Officer of MHA Insurance
          Company
          (medical liability insurance provider)

Blake W. Krueger - Executive Vice President and Secretary of Wolverine World Wide,
          Inc.
          (international marketer of footwear and accessories)

Stephen M. Tuuk - President and Chief Executive Officer of Professionals Direct, Inc.

Mary L. Ursul - Vice President and Secretary of Professionals Direct, Inc.

Stephen M. Westfield - Vice President and Treasurer of Professionals Direct, Inc.

Executive Officers

Stephen M. Tuuk - Chairman, President and Chief Executive

Mary L. Ursul - Vice President and Secretary

Stephen M. Westfield - Vice President and Treasurer

---