UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D. C. 20549

FORM 10-Q

/X/   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

OR

/  /   TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number 022316

PENN-AMERICA GROUP, INC.
 (Exact name of registrant as specified in its charter)

|Pennsylvania                    |  | 23-2731409         
|------------------------------- |  | -------------------
|(State or other jurisdiction of |  | (IRS Employer      
|incorporation or organization)  |  | Identification No.)

420 S. York Road, Hatboro, PA 19040 (Address of principal executive
offices) (Zip code)

Registrant's telephone number, including area code: (215) 443-3600

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

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

As of July 30, 2004, the registrant had 14,775,679 shares of
common stock, $0.01 par value, outstanding.

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Penn-America Group, Inc. and Subsidiaries

Table of Contents

|         |                                                                                                             | Page
|-------- | ----------------------------------------------------------------------------------------------------------- | ----
|         |                                                                                                             |     
|Part I.  | Financial Information                                                                                       |     
|         |                                                                                                             |     
|Item 1.  | Financial Statements                                                                                        |     
|         |                                                                                                             |     
|         | Consolidated Balance Sheets as of June 30, 2004 (unaudited) andDecember 31, 2003                            | 3   
|         |                                                                                                             |     
|         | Consolidated Statements of Operations for the Three and Six Months
Ended June 30, 2004 and 2003 (unaudited) | 4   
|         |                                                                                                             |     
|         | Consolidated Statements of Stockholders Equity for the Six
      Months Ended June 30, 2004 (unaudited)    | 5   
|         |                                                                                                             |     
|         | Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2004 and 2003 (unaudited)           | 6   
|         |                                                                                                             |     
|         | Notes to the Consolidated Financial Statements (unaudited)                                                  | 7   
|         |                                                                                                             |     
|Item 2.  | Management's Discussion and Analysis of Financial Condition
      and Results of Operations                 | 10  
|         |                                                                                                             |     
|Item 3.  | Quantitative and Qualitative Disclosure About Market Risk                                                   | 23  
|         |                                                                                                             |     
|Item 4.  | Controls and Procedures                                                                                     | 24  
|         |                                                                                                             |     
|Part II. | Other Information                                                                                           |     
|         |                                                                                                             |     
|Item 1.  | Legal Proceedings                                                                                           | 25  
|         |                                                                                                             |     
|Item 2.  | Changes in Securities and Use of Proceeds                                                                   | 25  
|         |                                                                                                             |     
|Item 3.  | Defaults Upon Senior Securities                                                                             | 25  
|         |                                                                                                             |     
|Item 4.  | Submission of Matters to a Vote by Security Holders                                                         | 25  
|         |                                                                                                             |     
|Item 5.  | Other Information                                                                                           | 25  
|         |                                                                                                             |     
|Item 6.  | Exhibits and Reports on Form 8-K                                                                            | 27  

2

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|Penn-America Group, Inc. and Subsidiaries Consolidated Balance Sheets     
|--------------------------------------------------------------------------
|(In thousands, except share data)                                         
|                                                                          
|                                                                          
|Assets                                                                    
|Investments:                                                              
|Fixed maturities:                                                         
|Available for sale, at fair value (amortized cost 2004, $331,199;         
|2003, $315,509)                                                           
|Held to maturity, at amortized cost (fair value 2004, $286;               
|2003, $293)                                                               
|Equity securities, at fair value (cost 2004, $26,826; 2003, $10,048)      
|                                                                          
|Total investments                                                         
|Cash and cash equivalents                                                 
|Accrued investment income                                                 
|Premiums receivable (net of allowances of $825 for 2004 and $750 for 2003)
|Reinsurance recoverable                                                   
|Prepaid reinsurance premiums                                              
|Deferred policy acquisition costs                                         
|Capital lease, affiliate                                                  
|Deferred income taxes                                                     
|Other assets                                                              
|                                                                          
|Total assets                                                              
|                                                                          
|Liabilities & Stockholders' Equity                                        
|Liabilities:                                                              
|Unpaid losses and loss adjustment expenses                                
|Unearned premiums                                                         
|Accounts payable and accrued expenses                                     
|Capitalized lease obligation, affiliate                                   
|Junior subordinated debentures                                            
|Income tax payable                                                        
|Other liabilities                                                         
|                                                                          
|Total liabilities                                                         
|                                                                          
|Commitments and Contingencies (Note 7)                                    
|Stockholders' equity:                                                     
|Preferred stock, $.01 par value; authorized 2,000,000 shares;             
|None issued                                                               
|Common stock, $.01 par value; authorized 2004 and 2003, 30,000,000        
|and 20,000,000 shares, respectively; issued and outstanding 2004          
|and 2003, 14,775,679 and 14,743,698 shares, respectively                  
|Additional paid-in capital                                                
|Accumulated other comprehensive income (loss)                             
|Retained earnings                                                         
|Officers' stock loans                                                     
|Unearned compensation from restricted stock awards                        
|                                                                          
|Total stockholders' equity                                                
|                                                                          
|Total liabilities and stockholders' equity                                
|                                                                          

See accompanying Notes to Consolidated Financial Statements.

3

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|Penn-America Group, Inc. and Subsidiaries
                         Consolidated Statements of Operations
                            (Unaudited)
|------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                
|                                                                                                                                                
|                                                                                                                                                
|(In thousands, except share data)                                                                                                               
|                                                                                                                                                
|Revenues                                                                                                                                        
|Premiums earned                                                                                                                                 
|Net investment income                                                                                                                           
|Net realized investment gain                                                                                                                    
|                                                                                                                                                
|Total revenues                                                                                                                                  
|                                                                                                                                                
|Losses and expenses                                                                                                                             
|Losses and loss adjustment expenses                                                                                                             
|Amortization of deferred policy acquisition costs                                                                                               
|Other underwriting expenses                                                                                                                     
|Corporate expenses                                                                                                                              
|Interest expense                                                                                                                                
|                                                                                                                                                
|Total losses and expenses                                                                                                                       
|                                                                                                                                                
|Income before income tax                                                                                                                        
|Income tax expense                                                                                                                              
|                                                                                                                                                
|Net income                                                                                                                                      
|                                                                                                                                                
|Net income per share                                                                                                                            
|Basic                                                                                                                                           
|Diluted                                                                                                                                         
|                                                                                                                                                
|Weighted average shares outstanding                                                                                                             
|Basic                                                                                                                                           
|Diluted                                                                                                                                         
|                                                                                                                                                
|Cash dividend per share                                                                                                                         

See accompanying Notes to Consolidated Financial Statements.

4

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|Penn-America Group, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Equity
Six Months Ended June 30, 2004
(Unaudited)
|-----------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                   
|(In thousands, except share data)                                                                                                  
|                                                                                                                                   
|                                                                                                                                   
|Balance at December 31, 2003                                                                                                       
|Net income                                                                                                                         
|Other comprehensive loss:                                                                                                          
|Unrealized loss on investments,                                                                                                    
|net of tax and reclassification                                                                                                    
|adjustment                                                                                                                         
|Unrealized loss on cash flow                                                                                                       
|hedging instrument, net of tax                                                                                                     
|                                                                                                                                   
|Comprehensive income                                                                                                               
|                                                                                                                                   
|Issuance of common stock                                                                                                           
|Compensation expense on stock                                                                                                      
|options                                                                                                                            
|Amortization of unearned                                                                                                           
|compensation from restricted                                                                                                       
|stock awards issued                                                                                                                
|Forgiveness of officers' stock loans                                                                                               
|Cash dividend paid                                                                                                                 
|($0.12 per share)                                                                                                                  
|                                                                                                                                   
|Balance at June 30, 2004                                                                                                           
|                                                                                                                                   

See accompanying Notes to Consolidated Financial Statements.

5

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|Penn-America Group, Inc. and Subsidiaries
                          Consolidated Statements of Cash Flows
                                 (Unaudited)
|------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                      
|                                                                                                                                                      
|(In thousands)                                                                                                                                        
|                                                                                                                                                      
|                                                                                                                                                      
|Cash flows from operating activities:                                                                                                                 
|Net income                                                                                                                                            
|Adjustments to reconcile net income to                                                                                                                
|net cash provided by operating activities:                                                                                                            
|Amortization/accretion and depreciation                                                                                                               
|expense, net                                                                                                                                          
|Net realized investment gain                                                                                                                          
|Deferred income tax benefit                                                                                                                           
|Net decrease in premiums receivable,                                                                                                                  
|prepaid reinsurance premiums and                                                                                                                      
|unearned premiums                                                                                                                                     
|Net increase in unpaid losses and loss adjustment                                                                                                     
|expenses and reinsurance recoverable                                                                                                                  
|Change in:                                                                                                                                            
|Accrued investment income                                                                                                                             
|Deferred policy acquisition costs                                                                                                                     
|Income tax recoverable/payable                                                                                                                        
|Other assets                                                                                                                                          
|Accounts payable and accrued expenses                                                                                                                 
|Other liabilities                                                                                                                                     
|                                                                                                                                                      
|Net cash provided by operating activities                                                                                                             
|                                                                                                                                                      
|Cash flows from investing activities:                                                                                                                 
|Purchases of equity securities                                                                                                                        
|Purchases of fixed maturities available for sale                                                                                                      
|Proceeds from sales of equity securities                                                                                                              
|Proceeds from sales of fixed maturities available for sale                                                                                            
|Proceeds from maturities or calls of fixed maturities                                                                                                 
|available for sale                                                                                                                                    
|Proceeds from maturities and calls of fixed maturities                                                                                                
|held to maturity                                                                                                                                      
|Increase in payable for investment purchases                                                                                                          
|                                                                                                                                                      
|Net cash used by investing activities                                                                                                                 
|                                                                                                                                                      
|Cash flows from financing activities:                                                                                                                 
|Issuance of common stock                                                                                                                              
|Net proceeds from issuance of junior subordinated debentures                                                                                          
|Principal payments on capital lease obligations, affiliate                                                                                            
|Repayment of officers' loans                                                                                                                          
|Dividends paid                                                                                                                                        
|                                                                                                                                                      
|Net cash provided (used) by financing activities                                                                                                      
|                                                                                                                                                      
|Increase in cash and cash equivalents                                                                                                                 
|Cash and cash equivalents, beginning of period                                                                                                        
|                                                                                                                                                      
|Cash and cash equivalents, end of period                                                                                                              
|                                                                                                                                                      

See accompanying Notes to Consolidated Financial Statements.

6

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Penn-America Group, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)

Note 1 Organization and Basis of Presentation

Penn-America Group, Inc. (PAGI) is an insurance
holding company. Penn Independent Corporations wholly-owned subsidiary,
PIC Holdings, Inc. (PIC Holdings) owned approximately 31% of the
outstanding common stock of PAGI at June 30, 2004. On May 19, 2004,
Penn-Independent Corporation transferred all of its shares of PAGIs common
stock to PIC Holdings. The accompanying condensed unaudited consolidated
financial statements are prepared in conformity with accounting principles
generally accepted in the United States (GAAP) and include the
accounts of PAGI and its wholly owned subsidiary, Penn-America Insurance Company
(Penn-America), and its wholly owned subsidiary, Penn-Star Insurance
Company (Penn-Star) (collectively the Company). In the
opinion of management, all adjustments (consisting of normal and recurring
adjustments) considered necessary for a fair presentation of results for the
interim periods have been included. The Companys results of operations for
interim periods are not necessarily indicative of the results to be expected for
the entire year. It is suggested that these condensed unaudited consolidated
financial statements and notes be read in conjunction with the financial
statements and notes in the Companys Annual Report on Form 10-K for the
year ended December 31, 2003.

PAGIs wholly-owned business trust subsidiaries,
Penn-America Statutory Trust I and Penn-America Statutory Trust II, are not
consolidated pursuant to Financial Accounting Standards Board Interpretation No.
46, Consolidation of Variable Interest Entities. The Companys business
trust subsidiaries have issued $30.0 million in floating rate capital securities
(Trust Preferred Securities). PAGI guarantees all obligations of
these business trust subsidiaries with respect to distributions and payments of
the Trust Preferred Securities. The sole assets of the Companys business
trust subsidiaries are junior subordinated debentures issued by the Company,
which have the same terms with respect to maturity, payments and distributions
as the Trust Preferred Securities.

Note 2 Reinsurance

Premiums earned are presented net of amounts ceded to reinsurers
of $8,491,000 and $6,706,000 for the three months ended June 30, 2004 and 2003,
respectively. Losses and loss adjustment expenses are presented net of amounts
ceded to reinsurers of $5,110,000 and $4,445,000 for the three months ended June
30, 2004 and 2003, respectively.

Premiums earned are presented net of amounts ceded to reinsurers
of $17,120,000 and $12,906,000 for the six months ended June 30, 2004 and 2003,
respectively. Losses and loss adjustment expenses are presented net of amounts
ceded to reinsurers of $13,227,000 and $8,314,000 for the six months ended June
30, 2004 and 2003, respectively.

As of June 30, 2004, the Company had a remaining reinsurance
recoverable of $1,100,000 relating to a claim for an insured involving multiple
policies written over multiple years beginning in 1998. The Company settled this
claim in February 2004, but has not yet finalized the reinsurance recoverable
with its reinsurer. The Company believes that resolution of this reinsurance
recoverable will not have a material adverse impact on its results of operations.

7

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Note 3 Comprehensive Income (Loss)

For the three months ended June 30, 2004, comprehensive loss was
$1,434,000, which consisted of net income of $4,900,000 and other comprehensive
loss of $6,334,000 related to net unrealized loss on investments and a cash flow
hedging instrument. For the three months ended June 30, 2003, comprehensive
income was $6,051,000, which consisted of net income of $3,999,000 and other
comprehensive gain of $2,052,000 related to net unrealized gain on investments
and an unrealized loss on a cash flow hedging instrument.

For the six months ended June 30, 2004, comprehensive income was
$4,410,000, which consisted of net income of $9,558,000 and other comprehensive
loss of $5,148,000 related to net unrealized loss on investments and a cash flow
hedging instrument. For the six months ended June 30, 2003, comprehensive income
was $9,423,000, which consisted of net income of $7,573,000 and other
comprehensive gain of $1,850,000 related to net unrealized gain on investments
and an unrealized loss on a cash flow hedging instrument.

Note 4 Net Income Per Share

Basic net income per share is computed by dividing net income
available to common stockholders by the weighted average number of common shares
outstanding for each period. Diluted net income per share includes the potential
dilution that could occur if outstanding contracts to issue common stock were
exercised and converted to common stock. The following is a reconciliation of
the basic and diluted net income per share computations:

|                                  | Three months ended June 30, |  | Six months ended June 30, |           
|--------------------------------- | --------------------------- |  | ------------------------- | ----------
|                                  |                             |  |                           |           
|(In thousands, except share data) |                             |  |                           | 2004      
|                                  |                            
|Basic per share computation:      |                             | 
|Net income                        |                             |  | $                         | 4,900     
|Weighted average common shares    |                             | 
|outstanding                       |                             |  |                           | 14,770,836
|                                  |                            
|Basic net income per share        |                             |  | $                         | 0.33      
|                                  |                             | 
|Diluted per share computation:    |                             | 
|Net income                        |                             |  | $                         | 4,900     
|Weighted average common shares    |                             | 
|outstanding                       |                             |  |                           | 14,770,836
|Additional shares outstanding     |                             | 
|after the assumed exercise of     |                             | 
|options by applying the treasury  |                             | 
|stock method                      |                             |  |                           | 233,992   
|                                  |                             | 
|Total shares                      |                             |  |                           | 15,004,828
|                                  |                             | 
|Diluted net income per share      |                             |  | $                         | 0.33      
|                                  |                             | 

Note 5 Segment Information

The Company has one reportable segment that consists of its
commercial property and casualty lines of business. In 1999, the Company exited
the non-standard personal automobile line of business and announced that it
would run-off its remaining portfolio of such business. For the three and six
months ended June 30, 2004 and 2003, amounts relating to the non-standard
personal automobile business were not material to the financial statements
presented, and therefore, are not presented separately.

8

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Note 6 Unpaid Losses and Loss Adjustment Expenses

The liability for losses and loss adjustment expenses represents
the Companys best estimate of the ultimate amounts needed to pay both
reported and unreported claims. These estimates are based on certain actuarial
and other assumptions. The Company continually reviews these estimates and,
based on new developments and information, the Company includes adjustments of
the probable ultimate liability in the operating results for the periods in
which the adjustments are made.

During the first six months of 2004, the Company increased
incurred losses and loss adjustment expenses attributable to insured events of
prior years by $1,500,000. This increase consisted of an increase in the
Companys estimate for the commercial casualty lines of business by
$4,000,000 relating primarily to accident years 1997 through 2000, partially
offset by a decrease in the Companys estimate for the commercial property
lines of business by $2,500,000 relating primarily to the 2003 accident year.

In 2003, the Company received an unexpected increase in the
number of new claims reported relating to four policies issued to a single
insured between January 1, 1980 and April 1, 1983. The insured was a
manufacturer of safety equipment including industrial masks and the new claims
reported allege existing and potential bodily injury due to a medical condition
called silicosis. The original policies covered products and completed
operations only and were issued with a $500,000 indemnity policy aggregate limit
of liability. At June 30, 2004, the Companys loss and loss adjustment
expense reserves included its best estimate for its ultimate obligations for
these claims based on current information.

Note 7 Commitments and Contingencies

The Companys insurance subsidiaries are subject to routine
legal proceedings in connection with their property and casualty business. The
Company is involved in no other pending or threatened legal or administrative
proceedings which management believes might have a material adverse effect on
the Companys financial condition or results of operations.

Note 8 Officers Stock Loans

In May 2004, the Companys board of directors forgave
officers stock loans in consideration of the Companys strong
financial results and in recognition that no long-term equity compensation plan
was in place over the last two fiscal years. The Company recorded compensation
expense of $1,200,000, which is included in other underwriting expenses in the
consolidated statements of operation for the three and six months ended June 30,
2004. This compensation expense consisted of $569,000 for the principal amounts
of the loans, $140,000 for the accrued interest on the loans and $491,000 for
cash bonuses granted to these officers to compensate them for their
federal, state and local tax obligations.

9

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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion and analysis of Penn-America Group,
Inc. (PAGI) and subsidiaries (collectively Penn-America
or the Company) should be read in conjunction with the
Companys Consolidated Financial Statements and related Notes included in
Item 1, Financial Information, of this report on Form 10-Q and the
Companys Annual Report on Form 10-K for the year ended December 31, 2003.
This discussion and analysis may contain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Forward looking
statements are not statements of historical fact, and involve risks and
uncertainties which could cause actual results to differ materially from those
expected. The risks and uncertainties include, but are not limited to, those in
the section entitled Risk Factors of the Companys Annual
Report on Form 10-K for the year ended December 31, 2003.

Overview

Business. PAGI is a specialty property and casualty insurance
holding company that markets and underwrites general liability, commercial
property and multi-peril insurance for small businesses with average annual
premiums of about $2,000. These small businesses are located primarily in small
towns and rural areas in all fifty states and the District of Columbia. The
small businesses Penn-America insures, such as restaurants, service contractors,
retail stores and apartments, often cannot obtain insurance because of their
rural locations, small premium size or non-standard risk characteristics. As a
result, these small businesses must turn to companies like Penn-America, which
operate in a small business niche of the secondary or residual market called the
excess and surplus lines or E&S market. By operating
in the E&S market, Penn-America is rewarded with higher prices than the
standard lines market, more flexibility in excluding coverage for specific loss
exposures and lower premium taxes and state guarantee fund assessments.

Penn-America distributes its insurance products through a small
network of sixty-five (65) high-quality wholesale general agents who serve the
needs of the more than 30,000 retail insurance brokers who work directly with
Penn-America insureds. Penn-America has about one-half the number of general
agents as its nearest competitor. By maintaining strong relationships with a
small, select group of agents, a relationship with Penn-America offers true
franchise value to each general agent by providing relative market
exclusivity and a high level of service and support. The Companys
distribution strategy has resulted in strong and consistent growth. From 1992 to
2003, the Companys commercial gross written premiums grew from $22.6
million to $209.4 million (a 22% annual compounded growth rate). Most of the
growth was due to an increase in gross written premiums per agent from $590,000
in 1992 to $3.9 million in 2003.

Key Financial Measures. The Company utilizes a number of
financial measures to evaluate its operating performance and financial
condition. The Companys overall financial goal is to produce a 12 to 15
percent return on equity (ROE) over the long-term. For the twelve
months ended June 30, 2004, ROE was 14.3 percent. The Company calculates ROE by
dividing net income by average stockholders equity. The following table
summarizes ROE for each year in the ten-year period ended December 31, 2003:

|                 | Year ended December 31,
|---------------- | -----------------------
|                 |                        
|                 |                        
|                 | 2003                   
|                
|Return on Equity | 13.5%                  

The  Companys philosophy has been to distribute a portion  of the
ROE it generates  through cash dividends to stockholders. Cash dividend  per share
increased to $0.12 for  the six months ended June 30,

10

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2004, compared  with $0.0875 for the six months ended June 30, 2003.
Through June 30, 2004, the  Company has paid cash dividends to stockholders in 37
consecutive quarters  totaling over $15.6 million.   The remainder of the ROE generated by the Company is invested in
growing the book value per share of the Company. Book value per share increased
2.6 % in the first six months of 2004 to $9.10 from $8.87 at December 31, 2003.
Book value per share is calculated by dividing stockholders equity by
outstanding common shares.

The Company utilizes other financial measures to evaluate its
operating performance, such as gross written premiums, operating income, GAAP
underwriting income, GAAP combined ratio, net income and cash flows provided by
operations. These additional financial measures are more fully described in
Results of Operations and Liquidity and Capital Resources in this discussion and
analysis.

This discussion and analysis consists of the following
components:

| |  | Results
of Operations
|- |  | ---------------------

| |  | Critical
Accounting Estimates and Policies
|- |  | ------------------------------------------

| |  | Reinsurance
|- |  | -----------

| |  | Investments
|- |  | -----------

| |  | Liquidity
and Capital Resources
|- |  | -------------------------------

Results of Operations

Three Months Ended June 30, 2004 Compared With Three Months Ended June
30, 2003

Premiums earned increased 39.5% to $50.6 million for the three
months ended June 30, 2004 compared with $36.3 million for the three months
ended June 30, 2003 due to the growth in net written premiums over the last 12
months.

Gross written premiums, which represent the amount received or
to be received for insurance policies written without reduction for acquisition
costs, reinsurance costs or other deductions, increased 19.2% to $64.9 million
for the three months ended June 30, 2004 compared with $54.5 million for the
three months ended June 30, 2003. The increase was attributable to growth in new
business and premium rate increases.

Ceded written premiums, the portion of gross written premiums
reinsured by unaffiliated insurers, decreased 7.3% to $7.9 million for the three
months ended June 30, 2004 compared with $8.5 million for the three months ended
June 30, 2003. The decline in ceded written premiums was due primarily to lower
reinsurance rates on the Companys multiple-line excess of loss reinsurance
treaty, partially offset by growth in gross written premiums. These lower
reinsurance rates were due primarily to an increase in the Companys
reinsurance retention on its property lines of business from $300,000 per risk
in 2003 to $500,000 per risk in 2004.

Net written premiums, which are gross written premiums less
ceded written premiums, increased 24.2% to $57.0 million for the three months
ended June 30, 2004 compared with $45.9 million for the three months ended June
30, 2003. The increase in net written premiums was higher than the increase in
gross written premiums due to lower reinsurance costs.

Net investment income increased to $3.5 million for the three
months ended June 30, 2004 compared with $3.2 million for the three months ended
June 30, 2003, due primarily to the growth in average invested assets, partially
offset by a decrease in average yield on fixed-maturity investments.

11

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Net realized investment gain was $0.2 million for the three
months ended June 30, 2004 compared with $0.4 million for the three months ended
June 30, 2003. The net realized investment gain for the 2004 period was
primarily attributable to the sale of certain of the Companys investments
in equity securities. The net realized investment gain for the 2003 period was
primarily attributable to the sale of certain of the Companys
fixed-maturity investments.

Losses and loss adjustment expenses increased 32.0% to $29.3
million for the three months ended June 30, 2004 compared with $22.2 million for
the three months ended June 30, 2003. The increase was due primarily to growth
in premiums earned, as the loss ratio improved to 57.8 for the 2004 period from
61.1 for the 2003 period. The loss ratio is calculated by dividing losses and
loss adjustment expenses by premiums earned. The improvement in the loss ratio
was primarily attributable to rate increases implemented in 2003 and 2004 and a
reduction in catastrophe-related losses to $0.6 million for the 2004 period from
$1.1 million for the 2003 period, partially offset by an increase in losses and
loss adjustment expenses attributable to insured events of prior years to $1.5
million for the 2004 period from $0.6 million for the 2003 period. For more
information regarding the $1.5 million in losses and loss adjustment expenses
attributable to insured events of prior years, see the section entitled
Critical Accounting Estimates and Policies of this discussion and
analysis beginning on page 14.

Amortization of deferred policy acquisition costs
(ADAC) increased 42.3% to $12.9 million for the three months ended
June 30, 2004 from $9.1 million for the three months ended June 30, 2003, due
primarily to the growth in premiums earned.

Other underwriting expenses increased 83.8% to $4.3 million for
the three months ended June 30, 2004 from $2.3 million for the three months
ended June 30, 2003, due primarily to expenses related to the forgiveness of
officers stock loans totaling $1.2 million. For more information regarding
the forgiveness of officers stock loans, see the section entitled
Executive Loans in Item 5, Other Information, of Part II
of this quarterly report on Form 10-Q.

The overall GAAP combined ratio, which is the sum of the loss
and expense ratios, improved to 91.7 for the three months ended June 30, 2004
from 92.5 for the three months ended June 30, 2003. The loss ratio improved to
57.8 for 2004 period from 61.1 for the 2003 period. The expense ratio, which is
calculated by dividing the sum of ADAC and other underwriting expenses by
premiums earned, increased to 33.9 for the 2004 period from 31.4 for the 2003
period, due primarily to expenses related to the forgiveness of officers
stock loans totaling $1.2 million. The GAAP combined ratio is a standard measure
of underwriting profitability used throughout the property and casualty
insurance industry. A ratio below 100.0 generally indicates underwriting
profitability.

Underwriting income increased to $4.2 million for the three
months ended June 30, 2004 from $2.7 million for the three months ended June 30,
2003. Underwriting income is a non-GAAP financial measure used by the Company,
among other measures, to evaluate the performance of its underwriting
operations. Underwriting income is equal to premiums earned less losses and loss
adjustment expenses, ADAC and other underwriting expenses. The improvement in
underwriting income for the 2004 period was due to growth in earned premiums and
improvement in the GAAP combined ratio.

Interest expense increased to $0.5 million for the three months
ended June 30, 2004 from $0.4 million for the three months ended June 30, 2003,
due primarily to interest expense on the Companys junior subordinated
debentures issued in May 2003.

Income tax expense increased to $2.2 million for the three
months ended June 30, 2004 from $1.7 million for the three months ended June 30,
2003. This increase was due primarily to improved underwriting profitability.

12

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Operating income increased to $4.8 million or $0.32 per share
(basic and diluted) for the three months ended June 30, 2004 from $3.7 million
or $0.25 per share (basic and diluted) for the three months ended June 30, 2003.
Operating income is calculated by subtracting net realized investment gain,
after taxes, from net income. Operating income is a non-GAAP financial measure
used by the Company, among other measures, to evaluate its performance because
the realization of net realized investment gains or losses in a given period is
largely discretionary as to timing and could distort the comparability of
results. The increase in operating income for the 2004 period was due to the
improvement in underwriting income, after taxes, and growth of investment
income, after taxes.

The factors described above resulted in net income of $4.9
million or $0.33 per share (basic and diluted) for the three months ended June
30, 2004 compared with $4.0 million or $0.27 per share (basic and diluted) for
the three months ended June 30, 2003.

Six Months Ended June 30, 2004 Compared With Six Months Ended June 20,
2003

Premiums earned increased 38.8% to $98.1 million for the six
months ended June 30, 2004 compared with $70.7 million for the six months ended
June 30, 2003 due to the growth in net written premiums over the last 12 months.

Gross written premiums increased 36.0% to $129.0 million for the
six months ended June 30, 2004 compared with $94.9 million for the six months
ended June 30, 2003. The increase was attributable to growth in new business and
premium rate increases.

Ceded written premiums increased 10.5% to $16.5 million for the
six months ended June 30, 2004 compared with $14.9 million for the six months
ended June 30, 2003. The increase in ceded written premiums was due primarily to
growth in gross written premiums, partially offset by lower reinsurance rates on
the Companys multiple-line excess of loss reinsurance treaty. These lower
reinsurance rates were primarily due to an increase in Companys
reinsurance retention on its property lines of business from $300,000 per risk
in 2003 to $500,000 per risk in 2004.

Net written premiums increased 40.8% to $112.5 million for the
six months ended June 30, 2004 compared with $79.9 million for the six months
ended June 30, 2003. The increase in net written premiums was higher than the
increase in gross written premiums due to lower reinsurance costs.

Net investment income increased to $7.0 million for the six
months ended June 30, 2004 compared with $6.5 million for the six months ended
June 30, 2003, due primarily to the growth in average invested assets, partially
offset by a decrease in average yield on fixed-maturity investments.

Net realized investment gain was $0.7 million for the six months
ended June 30, 2004 compared with $1.1 million for the six months ended June 30,
2003. The net realized investment gain for the 2004 period was primarily
attributable to the sale of certain of the Companys fixed-maturity
investments and investments in equity securities. The net realized investment
gain for the 2003 period was primarily attributable to the sale of certain of
the Companys fixed-maturity investments and all of the Companys then
existing common stock investments.

Losses and loss adjustment expenses increased 34.7% to $59.5
million for the six months ended June 30, 2004 compared with $44.2 million for  the six
months ended June 30, 2003. The increase was due primarily to growth in  premiums earned,
as the loss ratio improved to 60.7 for the 2004 period from  62.5 for the 2003 period.
The improvement in the loss ratio was primarily  attributable to rate increases
implemented in 2003 and 2004 and a reduction in  catastrophe-related losses to $1.1
million for the 2004 period from $1.7 million  for the 2003 period, partially offset by
an increase in losses and loss  adjustment expenses attributable to insured events of
prior years to $1.5  million for the 2004 period from $0.9 million for the 2003 period.
For more  information regarding the $1.5 million in losses and loss adjustment

13

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expenses  attributable to insured events of prior years, see the section
entitled  Critical Accounting Estimates and Policies of this discussion and
analysis.

Amortization of deferred policy acquisition costs increased
39.0% to $24.6 million for the six months ended June 30, 2004 from $17.7 million
for the six months ended June 30, 2003, due primarily to the growth in premiums
earned.

Other underwriting expenses increased 45.2% to $6.4 million for
the six months ended June 30, 2004 from $4.4 million for the six months ended
June 30, 2003, due primarily to expenses related to the forgiveness of
officers stock loans totaling $1.2 million. For more information regarding
the forgiveness of officers stock loans, see the section entitled
Executive Loans in Item 5, Other Information, of Part II
of this quarterly report on Form 10-Q.

The overall GAAP combined ratio improved to 92.2 for the six
months ended June 30, 2004 from 93.7 for the six months ended June 30, 2003. The
loss ratio improved to 60.7 for the 2004 period from 62.5 for the 2003 period.
The GAAP expense ratio increased slightly to 31.5 for the 2004 period from 31.2
for the 2003 period.

Underwriting income increased to $7.6 million for the six months
ended June 30, 2004 from $4.4 million for the six months ended June 30, 2003.
The improvement in underwriting income for the 2004 period was due to growth in
earned premiums and improvement in the GAAP combined ratio.

Interest expense increased to $1.0 million for the six months
ended June 30, 2004 from $0.7 million for the six months ended June 30, 2003,
due primarily to interest expense on the Companys junior subordinated
debentures issued in May, 2003.

Income tax expense increased to $4.3 million for the six months
ended June 30, 2004 from $3.3 million for the six months ended June 30, 2003.
This increase was due primarily to improved underwriting profitability.

Operating income increased to $9.1 million or $0.62 per basic
share and $0.61 per diluted share for the six months ended June 30, 2004 from
$6.8 million or $0.47 per basic share and $0.46 per diluted share for the six
months ended June 30, 2003. The increase in operating income for the 2004 period
was due to the improvement in underwriting income, after taxes, and growth of
investment income, after taxes.

The factors described above resulted in net income of $9.6
million or $0.65 per basic share and $0.64 per diluted share for the six months
ended June 30, 2004 compared with $7.6 million or $0.52 per basic share and
$0.51 per diluted share for the six months ended June 30, 2003.

Critical Accounting Estimates and Policies

The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires the
Company to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting periods. Actual results
could differ from those estimates.

The Company has identified that the establishment of reserves
for unpaid losses and loss adjustment expenses and the valuation of certain
investments are critical accounting estimates because they involve a high degree
of judgment. Although variability is inherent in these estimates, the Company
believes the amounts provided in its financial statements are appropriate based
upon the facts available at the time. For information related to the valuation
of investments, see the section entitled Investments in this
discussion and analysis beginning on page 18.

14

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The Company is directly liable for losses and loss adjustment
expenses under the terms of the insurance policies that it writes. In many
cases, several years may lapse between the occurrence of an insured loss, the
reporting of the loss to the Company and the Companys payment of that
loss. The Company reflects its liability for the ultimate payment of all
incurred losses and loss adjustment expenses by establishing loss and loss
adjustment expense reserves as balance sheet liabilities for both reported and
unreported claims.

When a claim involving a probable loss is reported, the Company
establishes a case reserve for the estimated amount of the Companys
ultimate loss. The estimate of the amount of the ultimate loss is based upon
such factors as:

| |  | the
type of loss;
|- |  | -----------------

| |  | jurisdiction
of the occurrence;
|- |  | -------------------------------

| |  | knowledge
of the circumstances surrounding the claim;
|- |  | -----------------------------------------------------

| |  | severity
of injury or damage;
|- |  | -----------------------------

| |  | potential
for ultimate exposure; and
|- |  | ------------------------------------

| |  | policy
provisions relating to the claim.
|- |  | ----------------------------------------

The Company determines loss adjustment expenses as a percentage
of expected indemnity losses based on historical patterns adjusted to reflect
current experience.

In addition to case reserves, management establishes reserves on
an aggregate basis to provide for incurred but not reported losses and loss
adjustment expenses, commonly referred to as IBNR. To establish
reserves for IBNR the Company must estimate the ultimate liability based
primarily on past experience. The Company applies a variety of traditional
actuarial techniques to determine its estimate of ultimate liability. The
techniques recognize, among other factors:

| |  | the
Companys and the industrys experience;
|- |  | --------------------------------------------

| |  | historical
trends in  reserving patterns and loss payments;
|- |  | -----------------------------------------------------------

| |  | the
impact of claim inflation;
|- |  | ------------------------------

| |  | the
pending level of unpaid claims;
|- |  | -----------------------------------

| |  | the
cost of claim settlements;
|- |  | ------------------------------

| |  | the
line of  business mix; and
|- |  | ------------------------------

| |  | the
economic environment in which property and casualty  insurance companies operate.
|- |  | -------------------------------------------------------------------------------------

The Company continually reviews these estimates and, based on
new developments and information, the Company includes adjustments of the
probable ultimate liability in the operating results for the periods in which
the adjustments are made. In general, initial reserves are based upon the
actuarial and underwriting data utilized to set pricing levels and are reviewed
as additional information, including claims experience, becomes available.

The establishment of loss and loss adjustment expense reserves
makes no provision for the broadening of coverage by legislative action or
judicial interpretation, or the emergence of new types of losses not
sufficiently represented in the Companys historical experience or that
cannot yet be quantified. The Company regularly analyzes its reserves and
reviews pricing and reserving methodologies so that future adjustments to prior
year reserves can be minimized. However, given the complexity of this process,
reserves will require continual updates and the ultimate liability may be higher
or lower than previously indicated. Changes in estimates for loss and loss
adjustment expense reserves, as required by Statement of Financial Accounting
Standards (SFAS) No. 60, Accounting and Reporting by Insurance
Enterprises, are recorded in the period that the change in these estimates is
made. The Company does not discount its loss reserves.

15

---

Unpaid losses and loss adjustment expenses increased 14.4% to
$200.1 million at June 30, 2004 from $174.9 million at December 31, 2003. During
the first six months of 2004, the Company increased incurred losses and loss
adjustment expenses attributable to insured events of prior years by $1.5
million. This increase consisted of an increase in the Companys estimate
for the commercial casualty lines of business by $4.0 million relating primarily
to accident years 1997 through 2000, partially offset by an decrease in
the Companys estimate for the commercial property lines of business of
$2.5 million relating primarily to the 2003 accident year.

In 2003, the Company received an unexpected increase in the
number of new claims reported relating to four policies issued to a single
insured between January 1, 1980 and April 1, 1983. The insured was a
manufacturer of safety equipment including industrial masks and the new claims
reported allege existing and potential bodily injury due to a medical condition
called silicosis. The original policies covered products and completed
operations only and were issued with a $500,000 indemnity policy aggregate limit
of liability. At June 30, 2004, the Companys loss and loss adjustment
expense reserves included its best estimate for its ultimate obligations for
these claims based on current information.

Reinsurance

Overview. To reduce its exposure to liability on individual
risks and to protect against catastrophic losses, the Company purchases
reinsurance through contracts called treaties or on a facultative
basis. Reinsurance involves an insurance company transferring or
ceding a portion of its exposure on a risk to another insurer (the
reinsurer). The reinsurer assumes the exposure in return for a
portion of the premium. The ceding of liability to a reinsurer does not legally
discharge the primary insurer from its liability for the full amount of the
policies on which it obtains reinsurance. The primary insurer will be required
to pay the entire loss if the reinsurer fails to meet its obligations under the
reinsurance agreement.

In formulating its reinsurance programs, the Company is
selective in its choice of reinsurers and considers numerous factors, the most
important of which are the financial stability of the reinsurer, its history of
responding to claims and its overall reputation. In an effort to minimize its
exposure to the insolvency of its reinsurers, the Company evaluates the
acceptability and reviews the financial condition of each reinsurer annually.
The Companys policy is to use only reinsurers that have an A.M. Best
rating of A (Excellent) or better and that have at least $500
million in statutory surplus.

The Companys principal reinsurance treaties include
multiple-line excess of loss, umbrella quota share and property catastrophic
loss.

Multiple-Line Excess of Loss. The Companys multiple-line
excess of loss reinsurance treaty is placed with American Reinsurance Company
(American Re), part of the Munich Re Group. American Re has an A.M.
Best rating of A+ (Superior). The following is a summary of the
Companys multiple-line excess of loss reinsurance treaty for 2004:

|Line of Business             | Company Policy Limit      | Reinsurance Coverage / Company Retention                                      
|---------------------------- | ------------------------- | ------------------------------------------------------------------------------
|                            
|Commercial property          | $2,000,000 per risk       | $1,500,000 per risk / $4,500,000 per occurrence in excess of $500,000 per risk
|                            
|Commercial general liability | $3,000,000 per occurrence | $2,500,000 per occurrence in excess of $500,000 per occurrence                
|                            

The Companys combined retention for any one loss resulting  from a
common occurrence involving both the commercial property and commercial  general
liability coverage on a single risk is $500,000. The Companys  multiple-line excess
of loss treaty reinsurer also provides reinsurance coverage  of $10,000,000 per
occurrence/aggregate for extra-contractual obligations,  losses in excess of policy
limits,

16

---

loss adjustment expenses and liability  resulting from two or more of the
Companys insureds from the same  occurrence.

Umbrella Quota Share. The Company offers umbrella liability
policies up to $5.0 million per occurrence. For policies where the Company
writes the primary general liability, 90% of policy limits up to $1.0 million
per occurrence and 100% of policy limits up to $4.0 million in excess of $1.0
million per occurrence are reinsured with American Re. For policies where
another insurer writes the primary general liability, 85% of policy limits up to
$1.0 million per occurrence, 90% of policy limits up to $1 million in excess of
$1.0 million per occurrence and 100% of policy limits up to $3.0 million in
excess of $2.0 million per occurrence are reinsured with American Re.

Property Catastrophic Loss. The Company maintains a catastrophic
loss reinsurance program. As of January 1, 2004, the terms of this program
provide for 100% retention of the first $1.0 million per occurrence and
reinsurance of 100% of $29.0 million per occurrence in excess of $1.0 million
per occurrence.

For 2004, the Companys catastrophic loss reinsurance
program includes: American Agricultural Insurance Company, Converium Reinsurance
(North America) Inc., Converium (UK), Everest Reinsurance Company, Hannover Re
(Bermuda) Ltd., PXRE Reinsurance Company, Shelter Reinsurance Company, Sirius
International Insurance Corporation and XL Re Ltd. All of these reinsurers have
statutory surplus greater than $500 million and an A.M. Best rating of
A (Excellent) or higher, with the exception of Converium Reinsurance
(North America) Inc. and Converium (UK) which were rated A-
(Excellent) by A.M.Best.

Reinsurance Recoverable. The Companys reinsurance
recoverable increased to $39.5 million as of June 30, 2004 compared with $38.0
million as of December 31, 2003. This increase was due primarily to the growth
in unpaid losses and loss adjustment expenses, which increased 14.4% to $200.1
million as of June 30, 2004 from $174.9 million at December 31, 2003. The
following table summarizes the Companys outstanding reinsurance
recoverable, net of a $700,000 allowance for doubtful accounts, as of June 30,
2004, by reinsurer:

|                       |                  |                                 |                                    
|---------------------- | ---------------- | ------------------------------- | -----------------------------------
|(Dollars in thousands) | A.M. Best Rating | AmountReflected onBalance Sheet | Percentage ofReinsuranceRecoverable
|                      
|American Re            | "A+" (Superior)  | $26,047                         | 65.9%                              
|General Re             | "A++" (Superior) | 12,979                          | 32.8                               
|Other reinsurers       | ---              | 492                             | 1.3                                
|                       |                 
|                       |                  | $39,518                         | 100.0%                             
|                       |                 

As of June 30, 2004, the Company had a remaining reinsurance
recoverable of $1.1 million relating to a claim for an insured involving
multiple policies written over multiple years beginning in 1998. The Company
settled this claim in February 2004, but has not yet finalized the reinsurance
recoverable with its reinsurer. The Company believes that resolution of this
reinsurance recoverable will not have a material adverse impact on its results of
operations.

17

---

Investments

The Companys investment strategy emphasizes quality,
liquidity and diversification, as well as total return. With respect to
liquidity, the Company considers liability durations, specifically related to
loss reserves, when determining desired investment maturities. In addition,
maturities have been staggered to produce cash flows for loss payments and
reinvestment opportunities. The Company outsources the management of its
investment portfolio to Gen Re New England Asset Management Inc.
(NEAMS). In accordance with the asset management agreement between
the Company and NEAMS, all investment transactions are approved by the
Investment Committee of the Company within 60 days of their initiation by NEAMS.

Total cash and investments increased 7.3% to $370.9 million at
June 30, 2004 from $345.7 million at December 31, 2003. This increase resulted
primarily from net cash provided by operating activities of $33.3 million,
partially offset by net unrealized loss on investments, before taxes, of $7.9
million for the first six months of 2004. Total cash and investments of $370.9
million at June 30, 2004 consisted of $331.8 million in fixed-maturity
securities, $26.5 million in equity securities, consisting of preferred stocks,
common stocks and a mutual fund invested in adjustable rate mortgages, and $12.6
million in cash.

The following summarizes the classifications of the
Companys cash and investments at June 30, 2004:

|(Dollars in thousands)                   | Fair Value |  | AmountReflected onBalance Sheet |         | Percentage ofCash andInvestments |  
|---------------------------------------- | ---------- |  | ------------------------------- | ------- | -------------------------------- | -
|                                         |            |  |                                 |         |                                  |  
|                                        
|Fixed maturities:                        |            | 
|Available for sale:                      |            | 
|U.S. Treasury securities and obligations |            | 
|of U.S. government agencies              |            |  | $                               | 19,214  |                                  | $
|Corporate securities                     |            |  |                                 | 104,134 |                                  |  
|Mortgage-backed securities               |            |  |                                 | 89,115  |                                  |  
|Other-structured securities              |            |  |                                 | 20,658  |                                  |  
|Municipal securities                     |            |  |                                 | 98,388  |                                  |  
|                                         |           
|Total available for sale                 |            |  |                                 | 331,509 |                                  |  
|                                         |           
|Held to maturity:                        |            | 
|U.S. Treasury securities and obligations |            | 
|of U.S. government agencies              |            |  |                                 | 26      |                                  |  
|Corporate securities                     |            |  |                                 | 260     |                                  |  
|                                         |           
|Total held to maturity                   |            |  |                                 | 286     |                                  |  
|                                         |           
|Total fixed-maturity securities          |            |  |                                 | 331,795 |                                  |  
|Equity securities                        |            |  |                                 | 26,493  |                                  |  
|Cash                                     |            |  |                                 | 12,592  |                                  |  
|                                         |           
|Total cash and investments               |            |  | $                               | 370,880 |                                  | $
|                                         |           

The Companys fixed-maturity portfolio of $331.8 million
was 89.5% of the total cash and investments as of June 30, 2004. Of the
fixed-maturity portfolio, 95.0% of the securities were rated A or
better by Standard & Poors. Standard & Poors rates publicly
traded securities in 20 categories ranging from AAA to CC. Securities with
ratings from AAA to BBB- (the top ten categories) are commonly referred to as
having an investment grade rating.

18

---

The quality of the fixed-maturity portfolio at June 30, 2004 was
as follows:

|                           |                                      |  
|-------------------------- | ------------------------------------ | -
|Standard and Poor's Rating | Percentage ofFixed-MaturityPortfolio |  
|                          
|"AAA"                      | 57.5                                 | %
|"AA"                       | 15.8                                 |  
|"A"                        | 21.7                                 |  
|"BBB"                      | 4.7                                  |  
|Below "BBB"                | 0.3                                  |  
|                           |                                     
|                           | 100.0                                | %
|                           |                                     

As of June 30, 2004, the investment portfolio contained $109.8
million of mortgage-backed, asset-backed and collateralized mortgage
obligations. These securities are publicly traded, and have market values
obtained from an independent pricing service. Changes in estimated cash flows
due to changes in prepayment assumptions from the original purchase assumptions
are revised based on current interest rates and the economic environment. The
Company had no investments in real estate or mortgage loans in its investment
portfolio as of June 30, 2004.

As of June 30, 2004, the Companys investment portfolio
contained corporate fixed-maturities, common stocks and preferred stocks with a
market value of $126.8 million. A summary of these securities by industry
segment was as follows:

|                       |                                                                               |  
|---------------------- | ----------------------------------------------------------------------------- | -
|Industry Segment       | Percentage ofCorporateFixed-Maturity,Common Stockand PreferredStock Portfolio
|                      
|Consumer, non-cyclical | 26.8                                                                          | %
|Financial institutions | 23.1                                                                         
|Utilities              | 18.9                                                                         
|Communications         | 9.4                                                                          
|Consumer, cyclical     | 7.4                                                                          
|Industrial             | 7.2                                                                          
|Energy                 | 3.7                                                                          
|Basic materials        | 2.9                                                                          
|Technology             | 0.6                                                                          
|                       |                                                                              
|                       | 100.0                                                                         | %
|                       |                                                                              

19

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The Company regularly evaluates its investment portfolio to
identify other-than-temporary impairments of individual securities. The Company
considers many factors in determining if an other-than-temporary impairment
exists, including the length of time and extent to which the market value of the
security has been less than cost, the financial condition and near-term
prospects of the issuer of the security and the Companys ability and
willingness to hold the security until the market value is expected to recover.
The following table contains an analysis of the Companys securities with
gross unrealized losses, categorized by the period that the securities were in a
continuous unrealized loss position as of June 30, 2004:

|                         | Gross Unrealized Losses
|------------------------ | -----------------------
|                         |                        
|(Dollars in thousands)   | NumberofSecurities     
|                         |                        
|                        
|Fixed-maturitysecurities |                        
|Equity securities        |                        
|                         |                        
|                         |                        
|                         |                        

As of June 30, 2004, the Companys fixed-maturity
investment portfolio had eleven (11) securities with $0.4 million of gross
unrealized losses that were in a continuous gross unrealized loss position for
over one year. The Company believes that the gross unrealized loss positions of
these securities are due to changes in market interest rates. All of these
securities were rated A or better by Standard & Poors.
Currently, the Company has the intent and ability to hold these securities until
maturity and expects that the contractual obligations of these securities will
be satisfied.

As of June 30, 2004, the Company held twenty-four (24) equity
securities in a gross unrealized loss position, consisting primarily of common
stocks purchased by the Company in the first six months of 2004.

Liquidity and Capital Resources

Capital Resources. PAGI is a holding company, the principal
asset of which is the common stock of Penn-America Insurance Company. At June
30, 2004, PAGIs capital structure consisted of common stockholders
equity of $134.5 million and junior subordinated debentures of $30.0 million.
The following table summarizes the capital resources:

|(In thousands)                 | June 30,2004 |  | December 31,2003 |        
|------------------------------ | ------------ |  | ---------------- | -------
|                              
|                               |              |  |                  |        
|Stockholders' equity           |              |  | $                | 134,492
|Junior subordinated debentures |              |  |                  | 30,000 
|                               |              | 
|Total capital                  |              |  | $                | 164,492
|                               |              | 

Stockholders equity increased 2.8% to $134.5 million at
June 30, 2004, compared with $130.8 million at December 31, 2003 due primarily
to net income of $9.6 million for the first six months of 2004, partially offset
by a net unrealized loss on investments, after taxes, of $5.1 million in the
first six months of 2004.

The Company continually evaluates the adequacy and mix of its
capital resources. The Companys strategy is to maintain capital at an
adequate level to support its insurance operations, while achieving its 12% to
15% ROE financial goal over the long-term.

20

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Liquidity. PAGIs principal source of cash to meet
short-term and long-term liquidity needs, including the payment of dividends to
stockholders, corporate expenses and interest on its junior subordinated
debentures, is dividends from Penn-America Insurance Company. PAGI has no
planned capital expenditures that could have an impact on its long-term
liquidity needs.

Penn-America Insurance Companys principal sources of funds
are underwriting operations, investment income and proceeds from sales and
redemptions of investments. Funds are used by Penn-America Insurance Company and
Penn-Star Insurance Company principally to pay claims and operating expenses, to
purchase investments and to make dividend payments to PAGI. PAGIs future
liquidity is dependent on the ability of Penn-America Insurance Company to pay
dividends to PAGI.

The Companys insurance subsidiaries are restricted by
statute as to the amount of dividends that they may pay without the prior
approval of regulatory authorities. Penn-America Insurance Company may pay
dividends to PAGI without advance regulatory approval only from unassigned
surplus and only to the extent that all dividends in the past twelve months do
not exceed the greater of 10% of total statutory surplus, or statutory net
income for the prior year. Using these criteria, the available ordinary dividend
for 2004 is $12,196,000. For the six months ended June 30, 2004, there were no
dividends paid by Penn-America Insurance Company to PAGI. Penn-America Insurance
Companys ability to pay future dividends to PAGI without advance
regulatory approval is dependent upon maintaining a positive level of unassigned
and statutory surplus, which in turn, is dependent upon Penn-America Insurance
Company and Penn-Star Insurance Company generating net income in excess of
dividends to PAGI. As of June 30, 2004, Penn-America Insurance Companys
statutory surplus was $129,575,000 and included unassigned surplus of
$44,035,000.

Penn-America Insurance Company and Penn-Star Insurance Company
are required by law to maintain a certain minimum level of statutory surplus.
Statutory surplus is calculated by subtracting total liabilities from total
assets. The National Association of Insurance Commissioners adopted risk-based
capital standards designed to identify property and casualty insurers that may
be inadequately capitalized based on inherent risks of each insurers
assets and liabilities and its mix of net written premiums. Insurers falling
below a calculated threshold may be subject to varying degrees of regulatory
action. As of December 31, 2003, the statutory surplus of Penn-America Insurance
Company and Penn-Star Insurance Company was in excess of the prescribed
risk-based capital requirements. Penn-America Insurance Companys statutory
surplus at December 31, 2003 was $121,960,000 and its regulatory action level
was $30,034,000. Penn-Star Insurance Companys statutory surplus at
December 31, 2003 was $42,232,000 and its regulatory action level was
$11,256,000.

Net cash provided by operating activities increased to $33.3
million for the six months ended June 30, 2004 compared with $15.1 million for
the six months ended June 30, 2003. This growth was due primarily to the
increase of cash received from collections of premiums for the first six months
of 2004 compared with the same period in 2003.

Net cash used by financing activities was $1.5 million for the
six months ended June 30, 2004 as compared to $14.3 million provided by
financing activities for the six months ended June 30, 2003. The cash provided
by financing activities for the six months ended June 30, 2003 was due primarily
to the junior subordinated debentures issued by the Company, which resulted in
net proceeds of $14.5 million.

As a result of cash provided by operating activities, cash used
by investing activities was $31.2 million for the six months ended June 30, 2004
compared with $24.3 million for the six months ended June 30, 2003.

21

---

The Company continually evaluates its short and long-term
liquidity. The Company has generated positive cash flows from operations and
acquired capital resources to support its liquidity. The Company believes that
cash flows from operations and strategy of matching its investment maturities
with liability durations will continue to support its short-term and long-term
liquidity.

Contractual Obligations. The Company's contractual obligations have not
materially changed from that identified at December 31, 2003.

22

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market Risk

Market risk is the potential economic loss principally arising
from adverse changes in the market value of financial instruments. The major
component of market risk affecting the Company is interest rate risk related to
its investment portfolio.

Interest Rate Risk. Interest rate risk is the Companys
underlying exposure to an economic loss from changes in market interest rates.
The Companys investment portfolio included fixed-maturity securities,
preferred stocks and a mutual fund invested in adjustable rate mortgages with a
market value of $339.3 million at June 30, 2004 that is subject to interest rate
risk. The Company manages its exposure to interest rate risk on investments
through a disciplined asset/liability matching and capital management process.
In the management of this risk, the characteristics of duration, credit and
variability of cash flows are critical elements. These risks constantly are
assessed and balanced within the context of the Companys liability and
capital position.

The Companys market risk associated with exposure to
interest rate risk has not materially changed from that identified at December
31, 2003.

Equity Price Risk. As of June 30, 2004, the Companys
investments in equity securities consist of common stocks of $19.0 million,
preferred stocks of $3.4 million and a mutual fund invested in adjustable rate
mortgages of $4.1 million. The market value of the Companys investments in
preferred stocks and a mutual fund invested in adjustable rate mortgages
totaling $7.5 million are primarily affected by changes in interest rates. The
Companys exposure to equity price risk is primarily attributable to its
investments in common stocks of $19.0 million, which were acquired in the first
six months of 2004.

The table below illustrates the sensitivity of the market value
of the Companys investments in common stocks to selected hypothetical
changes in market prices as of June 30, 2004. The selected scenarios are not
predictions of future events, but rather illustrative of the effect that such
events may have on the market value of the Companys investments in common
stocks and stockholders equity.

|(Dollars in thousands)              | EstimatedMarket Value of |  | EstimatedChange in |        | HypotheticalPercentageIncrease(Decrease) inStockholders |  
|----------------------------------- | ------------------------ |  | ------------------ | ------ | -------------------------------------------------------- | -
|Hypothetical Change in Market Price | Common Stocks            |  | Market Value       |        | Equity                                                   |  
|                                    |                          |  |                    |        |                                                          |  
|                                   
|20% price increase                  |                          |  | $                  | 22,777 |                                                          | $
|10% price increase                  |                          |  |                    | 20,879 |                                                          |  
|No change                           |                          |  |                    | 18,981 |                                                          |  
|10% price decrease                  |                          |  |                    | 17,083 |                                                          |  
|20% price decrease                  |                          |  |                    | 15,185 |                                                          |  

23

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Item 4. Controls and Procedures

As of the end of the period covered by this report, an
evaluation was performed under the supervision and with the participation of the
Companys management, including the President and CEO and Senior Vice
President, CFO and Treasurer, of the effectiveness of the design and operation
of the Companys disclosure controls and procedures. Based on that
evaluation, the Companys management, including the President and CEO and
Senior Vice President, CFO and Treasurer, concluded that the Companys
disclosure controls and procedures were effective as of the end of the period
covered by this report.

During the last fiscal quarter, there have been no changes in
the Companys internal control over financial reporting that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting.

24

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PART II

Item 1. Legal Proceedings  None

Item 2. Changes in Securities and Use of Proceeds  None

Item 3. Defaults Upon Senior Securities  None

Item 4. Submission of Matters to a Vote by Security Holders

On May 13, 2004, Penn-America Group, Inc. held its annual
meeting of stockholders. Seven board nominees for director were elected for
terms expiring at the 2005 annual meeting of stockholders, as follows:

|                   |  |           
|------------------ |  | ----------
|Nominee            |  | Votes for 
|                  
|Irvin Saltzman     |  | 13,725,532
|Jon S. Saltzman    |  | 13,722,046
|Richard L. Duszak  |  | 13,882,532
|Charles Ellman     |  | 13,602,532
|Robert A. Lear     |  | 13,602,432
|Dr. M. Moshe Porat |  | 13,882,532
|Martin Sheffield   |  | 13,924,032

In addition, an amendment to the Companys Certificate of
Incorporation to increase the aggregate number of authorized shares of Common
Stock from 20,000,000 to 30,000,000 was approved, as follows:

|           |  |              
|---------- |  | -------------
|Votes for  |  | Votes against
|          
|13,428,333 |  | 502,478      

Item 5. Other Information  None

Officers Stock Loans

In 2000 and 2001, the Companys board of directors and the
board of directors of Penn-America Insurance Company authorized the grant of
several loans to the Companys then officers to purchase common stock of
Penn-America Group. Under the terms of the loans, those employees were required
to repay principal, brokerage commissions, transaction costs and interest,
calculated semi-annually, within five years from the date of the loan. On
default, Penn-America Insurance Company had recourse against the defaulting
officer. This program was formally terminated by resolution of the
Companys board of directors on August 21, 2002. No loans were granted to
officers after May 2001.

In consideration of the Company's strong financial results and in
recognition that no long-term equity  compensation plan was in place over the last two
fiscal years, on May 21, 2004, the Company's board of directors  forgave the loans to Jon
S. Saltzman, Joseph F. Morris, J. Ransley Lennon, Garland P. Pezzuolo and Thomas J.
Cannon.

25

---

As of May 21, 2004, the outstanding principal amount of loans to
these employees, accrued interest on the loans and the aggregate number of
shares of the Companys common stock acquired with the proceeds of the
loans were as follows:

|Name                |  | TotalPrincipalAmount |   | TotalAccruedInterest |  | TotalLoanAmount |         | WeightedAverageInterestRate |   | Numberof SharesAcquire | 
|------------------- |  | -------------------- | - | -------------------- |  | --------------- | ------- | --------------------------- | - | ---------------------- | 
|                   
|                    |  |                      |   |                      |  |                 |         |                             |   |                        | 
|Jon S. Saltzman     |  |                      | $ | 359,072              |  | $               | 92,356  |                             | $ | 451,428                | 
|Joseph F. Morris    |  |                      |   | 55,845               |  |                 | 9,019   |                             |   | 64,864                 | 
|J. Ransley Lennon   |  |                      |   | 97,943               |  |                 | 25,887  |                             |   | 123,830                | 
|Garland P. Pezzuolo |  |                      |   | 35,511               |  |                 | 7,496   |                             |   | 43,007                 | 
|Thomas J. Cannon    |  |                      |   | 20,416               |  |                 | 5,335   |                             |   | 25,751                 | 
|                    | 
|                    |  |                      | $ | 568,787              |  | $               | 140,093 |                             | $ | 708,880                | 
|                    | 

The Companys board of directors also granted cash bonuses
to these employees, with a total value of $491,000, to compensate them for their
individual federal, state and local tax obligations resulting from forgiveness
of the loans.

Compensation of Directors

In February 2004, the Companys board of directors
authorized for payment annually to the independent directors commencing in May
2004: (1) an annual retainer of $30,000 for serving on the Companys board
of directors and at least one committee and (2) an award of 2,000 shares of
restricted common stock, which vest over two years.

In May 2004, the Companys management informed its board of
directors that the Companys 2002 Stock Incentive Plan would not permit the
Company to make restricted stock awards to the independent directors as
authorized by the Companys board of directors unless and until the 2002
Stock Incentive Plan is amended to permit such awards and that amendment is
presented to, and approved by the requisite vote of, the Companys
stockholders. Therefore, these shares of restricted common stock were not
granted to the independent directors.

Additionally, in May 2004, the Companys management
informed its board of directors that under the 2002 Stock Incentive Plan the
independent directors were automatically granted non-qualified options to
purchase 5,000 shares of the Companys common stock on May 13, 2004. These
non-qualified stock options were issued at an exercise price equal to fair
market value on the date of grant, become exercisable on the first anniversary
of the date of grant, and are exercisable for five years from the first
anniversary of the date of grant.

26

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Item 6. Exhibits and Reports on Form 8-K

| | (a)
 Exhibits
| | -------------

| | An Exhibit Index
has been filed as part of this report beginning on page E-1.
| | -----------------------------------------------------------------------------

| | (b)
Reports on Form 8-K
| | -----------------------

| | On April 28, 2004, the Company filed a current report on Form
8-K announcing that the Company released its earnings for the first quarter of
2004.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | On May 14, 2004, the Company filed a current report on Form 8-K
announcing that Martin Sheffield was elected to the Companys Board of
Directors, giving the Company a majority of independent directors, as well as
declaring its 37th consecutive dividend.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On May 17, 2004, the Company filed a current report on Form 8-K
announcing the availability of the Quarterly Statements for its insurance
subsidiaries, Penn-America Insurance Company and Penn-Star Insurance Company, on
the Companys web-site, in hard copy from the Company, or from the
Pennsylvania Department of Insurance.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

27

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.

|                     |  |                         
|-------------------- |  | ------------------------
|                     |  | Penn-America Group, Inc.
|                     |  |                         
|                     |  |                         
|Date: August 5, 2004 |  | By: /s/ Jon S. Saltzman 
|                     |  | Jon S. Saltzman         
|                     |  | President and           
|                     |  | Chief Executive Officer 
|                     |  |                         
|                     |  |                         
|                     |  |                         
|                     |  | By: /s/ Joseph F. Morris
|                     |  | Joseph F. Morris        
|                     |  | Senior Vice President,  
|                     |  | Chief Financial Officer 
|                     |  | and Treasurer           

28

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Exhibit Index

|ExhibitNumber |  | Description
of Exhibit
|------------- |  | ----------------------

|3.1 |  | Articles
of Incorporation of the Registrant, as amended  through May 27, 2004.
|--- |  | ------------------------------------------------------------------------------

|10.1 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Amended and Restated Promissory Note and Security Agreement,  the original of which
agreement was September 19, 2000 and which, as ultimately  amended and restated, was
given effect on January 2, 2001, by and between Jon S.  Saltzman and Penn-America
Insurance Company.
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Amended and Restated Promissory Note and Security Agreement,  the original of which
agreement was January 17, 2000 and which, as ultimately  amended and restated, was given
effect on January 2, 2001, by and between Jon S.  Saltzman and Penn-America Insurance
Company.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.3 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Amended and Restated Promissory Note and Security Agreement,  the original of which
agreement was March 10, 2000 and which, as ultimately  amended and restated, was given
effect on January 2, 2001, by and between Jon S.  Saltzman and Penn-America Insurance
Company.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.4 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Promissory Note and Security Agreement, dated as of March 9,  2001, by and between Joseph
F. Morris and Penn-America Insurance Company.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.5 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Promissory Note and Security Agreement, dated as of March  28, 2001, by and between
Joseph F. Morris and Penn-America Insurance Company.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.6 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Amended and Restated Promissory Note and Security Agreement,  the original of which
agreement was February 11, 2000 and which, as ultimately  amended and restated, was given
effect on January 2, 2001, by and between  Garland P. Pezzuolo and Penn-America Insurance
Company.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.7 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Promissory Note and Security Agreement, dated as of March 9,  2001, by and between
Garland P. Pezzuolo and Penn-America Insurance Company.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.8 |  | Termination
of Promissory Note and Security Agreement dated as of May 21, 2004  with respect to the
Amended and Restated Promissory Note and Security Agreement,  the original of which
agreement was February 16, 2000 and which, as ultimately  amended and restated, was given
effect on January 2, 2001, by and between J.  Ransley Lennon and Penn-America Insurance
Company.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

E-1

---

|ExhibitNumber |  | Description
of Exhibit
|------------- |  | ----------------------

|10.9 |  | Cancellation
endorsement (No.2) effective January 1, 2004, of Property and  Casualty Excess of Loss
Reinsurance Agreement between Penn-America Insurance  Company, Penn-Star Insurance
Company and American Re-Insurance Company effective  January 1, 2003.
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10 |  | Property
and Casualty Excess of Loss Reinsurance Agreement between Penn-America  Insurance
Company, Penn-Star Insurance Company, Penn-Patriot Insurance Company  and American
Re-Insurance Company effective January 1, 2004.
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11 |  | Property
and Casualty Clash Excess of Loss Reinsurance Agreement between  Penn-America Insurance
Company, Penn-Star Insurance Company, Penn-Patriot  Insurance Company and American
Re-Insurance Company effective January 1, 2004.
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.12 |  | Certified
Terrorism Loss Aggregate Quota Share Reinsurance Agreement between  Penn-America
Insurance Company, Penn-Star Insurance Company, Penn-Patriot  Insurance Company and
American Re-Insurance Company effective January 1, 2004.
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.13 |  | Property
Catastrophe Excess of Loss Reinsurance Contract between subscribing  reinsurers and
Penn-America Insurance Company, Penn-Star Insurance Company, and  Penn-Patriot Insurance
Company effective January 1, 2004 to December 31, 2004.
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|31.1 |  | Certification
of Chief Executive Officer as adopted pursuant to Section 302(a)  of Sarbanes-Oxley Act
of 2002.
|---- |  | --------------------------------------------------------------------------------------------------------------

|31.2 |  | Certification
of Chief Financial Officer as adopted pursuant to Section 302(a)  of Sarbanes-Oxley Act
of 2002.
|---- |  | --------------------------------------------------------------------------------------------------------------

|32.1 |  | Certification
of Chief Executive Officer and Chief Financial Officer of  Penn-America Group, Inc. dated
August 5, 2004 in accordance with 18 U.S.C.  Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of  2002.
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

E-2

---