**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


**Washington,
D. C. 20549**





**FORM
10-K**


**(MARK
ONE)**


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





**FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2004**





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





**FOR
THE TRANSITION PERIOD FROM __________ TO __________**





**Commission
File Number 000-22761**





**PMA
Capital Corporation**


(Exact
name of registrant as specified in its charter)





**Pennsylvania**
    
    **23-2217932**(State
      or other jurisdiction of
    
    (IRS
      Employerincorporation
      or organization)
    
    Identification
      No.)**380
      Sentry Parkway****Blue
      Bell, Pennsylvania**
    
    **19422**(Address
      of principal executive offices)
    
    (Zip
      Code)


**Registrant's
telephone number, including area code:** **(215)
665-5046**





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





**Name
      of each exchange on****Title
      of each class:**
    
    **which
      registered:****8.50%
      Monthly Income Senior**
    
    **American
      Stock Exchange****Notes
      due 2018**








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





**Class
A Common Stock, par value $5.00 per share**


**(Title
of Class)**





**Rights
to Purchase Preferred Stock**


**(Title
of Class)**





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





Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). YES /X/
NO / /





The
aggregate market value of the Class A Common Stock held by non-affiliates of the
registrant on June 30, 2004, based on the last price at which the Class A Common
Stock was sold on such date, was $265,925,034.





There
were 31,683,961 shares outstanding of the registrant’s Class A Common stock, $5
par value per share, as of the close of business on February 28,
2005.





**DOCUMENTS
INCORPORATED BY REFERENCE:**





(1)
    Part III of this Form 10-K incorporates by reference
      portions of the registrant’s proxy statement for its 2005 Annual Meeting
      of Shareholders.





Table of Contents













**Explanatory
Note**





In
November 2004, we exchanged $84.1 million aggregate principal amount of 6.50%
Senior Secured Convertible Debentures due 2022 (the “6.50% Convertible Debt”)
for an equal amount of our 4.25% Senior Convertible Debentures due 2022. The
6.50% Convertible Debt is secured by a first lien on a portion of the capital
stock of our principal operating subsidiaries, PMA Capital Insurance Company,
Pennsylvania Manufacturers Indemnity Company, Pennsylvania Manufacturers’
Association Insurance Company and Manufacturers Alliance Insurance Company. As a
result of the security interest granted, we are required to file three years of
separate audited GAAP financial statements for these subsidiaries. These
financial statements are currently being prepared and when completed and audited
will be filed by amendment to this Report on Form 10-K. The
Annual Statements for these subsidiaries, which we file with the Pennsylvania
Insurance Department, contain financial statements prepared in accordance with
statutory accounting practices. Annual Statements covering the years ended
December 31, 2004, 2003 and 2002 for each of these subsidiaries are available on
the Investor Information portion of our website www.pmacapital.com .








Table of Contents





**INDEX**








**PART
      I**
    
    **Page**Item 1.
    Business
    1Company Overview
    1The PMA Insurance Group
    2Run-off Operations
    8Reinsurance and Retrocessional
      Protection
    9Loss Reserves
    9Investments
    12Ratings
    12Regulatory Matters
    13Employees
    17Available Information
    17Glossary of Selected Insurance
      Terms
    18Risk Factors
    21Item 2.
    Properties
    30Item 3.
    Legal Proceedings
    30Item 4.
    Submission of Matters to a Vote of
      Security Holders
    31Executive Officers of the
      Registrant
    31**PART II**Item 5.
    Market for the Registrant’s Common Equity, Related
      Shareholder Matters andIssuer Purchases of Equity Securities
    32Item 6.
    Selected Financial Data
    33Item 7.
    Management’s Discussion and Analysis of Financial Conditionand Results of Operations
    35Item 7A.
    Quantitative and Qualitative Disclosure About Market
      Risk
    60Item 8.
    Financial Statements and Supplementary
    Data
    61Item 9.
    Changes in and Disagreements with Accountants onAccounting and Financial Disclosure
    97Item 9A.
    Controls and Procedures
    97**PART III**Item 10.
    Directors and Executive Officers of the
      Registrant
    98Item 11.
    Executive Compensation
    98Item 12.
    Security Ownership of Certain Beneficial Owners and
      Management
    98Item 13.
    Certain Relationships and Related
      Transactions
    99Item 14.
    Principal Accountant Fees and Services
    99**PART IV**Item 15.
    Exhibits and Financial Statement Schedules
    100Signatures
    101Index to Financial Statement Schedules
    FS-1Index to Exhibits
    E-1











Table of Contents





**PART
I**





The “Business”
Section and other parts of this Form 10-K contain forward-looking statements
that involve inherent risks and uncertainties. Statements that are not
historical facts, including statements about our beliefs and expectations, and
containing words such as “believe,” “estimate,” “anticipate,” “expect” or
similar words are forward-looking statements. Our actual results may differ
materially from the projected results discussed in the forward-looking
statements. Factors that could cause such differences include, but are not
limited to, those discussed in “Risk Factors” beginning on page 21 and in the
“Cautionary Statements” in “Item 7 -Management’s Discussion and Analysis of
Financial Condition and Results of Operations” (“MD&A”).





**Item
1.****Business**





**COMPANY OVERVIEW**





We are a
property and casualty insurance holding company, which offers through our
subsidiaries workers’ compensation, integrated disability and, to a lesser
extent, other standard lines of commercial insurance, primarily in the eastern
part of the United States. These products are written through The PMA Insurance
Group, our property and casualty insurance segment, which has been in operation
since 1915. Our Run-off Operations include our prior reinsurance and excess and
surplus lines operations. Additionally, we have a Corporate and Other segment,
which primarily includes corporate expenses, including debt service. At December
31, 2004, we had total assets of $3.3 billion and shareholders’ equity of $445.5
million.





Our
business profile changed significantly in 2003 and 2004. On November 4, 2003, we
announced a third quarter pre-tax charge of $150 million to increase the loss
reserves for our reinsurance business for prior accident years. Following this
announcement, A.M. Best Company, Inc. (“A.M. Best”) reduced the financial
strength ratings of PMA Capital Insurance Company (“PMACIC”), our reinsurance
subsidiary, and The PMA Insurance Group companies, our primary insurance
business, to B++ (Very Good). The B++ financial strength rating constrained The
PMA Insurance Group’s ability to attract and retain business during 2004. As a
result of the reserve charge and ratings change, on November 6, 2003, we
announced our decision to cease writing reinsurance business and to run off our
existing reinsurance business, previously known as PMA Re. Our Run-off
Operations remain a significant component of our financial position,
representing 40% of our consolidated assets as of December 31, 2004. We also
decided to suspend payment of dividends on our Class A common stock.





We
achieved our most important goal for 2004, the restoration of The PMA Insurance
Group's A- (Excellent) financial strength rating, on November
15, 2004.





Financial
information in the tables that follow is presented in conformity with accounting
principles generally accepted in the United States of America (“GAAP”), unless
otherwise indicated. Certain reclassifications have been made to prior periods’
financial information to conform to the 2004 presentation. Revenues, pre-tax
operating income (loss) and assets attributable to each of our operating
segments and our Corporate and Other segment for the last three years are set
forth in Note 15 in Item 8 of this Form 10-K.





Our gross
and net premiums written by segment were as follows:





2004
    
    
    2003
    
    
    2002*(dollar
      amounts in thousands)*
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetThe
      PMA Insurance Group
    
    $
    423,054
    
    $
    377,795
    
    $
    678,434
    
    $
    603,593
    
    $
    515,332
    
    $
    452,276Run-off
      Operations
    
    
    (69,967
    )
    
    (75,360
    )
    
    751,998
    
    
    589,449
    
    
    882,095
    
    
    653,602Corporate
      and Other
    
    
    (825
    )
    
    (825
    )
    
    (788
    )
    
    (788
    )
    
    (10,881
    )
    
    (881
    )Total
    
    $
    352,262
    
    $
    301,610
    
    $
    1,429,644
    
    $
    1,192,254
    
    $
    1,386,546
    
    $
    1,104,997


Property
and casualty insurance and reinsurance companies provide loss protection to
insureds in exchange for premiums. If earned premiums exceed the sum of losses
and loss adjustment expenses (which we refer to as LAE), acquisition expenses,
operating expenses and policyholders’ dividends, then underwriting profits are
realized. When earned premiums do not exceed the sum of these items, the result
is an underwriting loss.





1
 Table of Contents








The
“combined ratio” is a frequently used measure of property and casualty
underwriting performance. The combined ratio computed on a GAAP basis is equal
to losses and LAE, plus acquisition expenses, operating expenses and
policyholders’ dividends, where applicable, all divided by net premiums earned.
Thus, a combined ratio of under 100% reflects an underwriting profit. Combined
ratios of The PMA Insurance Group were 105.4%, 102.8% and 103.2% for 2004, 2003
and 2002, respectively.





Because
time normally elapses between the receipt of premiums and the payment of claims
and certain related expenses, we invest the available premiums. Underwriting
results do not include investment income from these funds. Given the long-tail
nature of our liabilities, we believe that the operating ratios are also
important in evaluating our business. The operating ratio is the combined ratio
less the net investment income ratio, which is net investment income divided by
premiums earned. The operating ratios of The PMA Insurance Group were 98.4%,
97.0% and 94.5% in 2004, 2003 and 2002, respectively.





A glossary of selected insurance termsused in
this Form 10-K is included on pages 18 to 20.





**THE PMA INSURANCE GROUP**




***Background***




The PMA
Insurance Group emphasizes its traditional core business, workers’ compensation
insurance and integrated disability. We also provide a range of other commercial
insurance products but generally only if they complement our workers’
compensation products, including commercial automobile and multi-peril
coverages, general liability and related services. The PMA Insurance Group
focuses primarily on middle-market and large accounts operating in our principal
marketing territory concentrated in the eastern part of the United States.
Approximately 87% of this business was produced through independent agents and
brokers in 2004.





The PMA
Insurance Group competes on the basis of its ability to offer tailored workplace
disability management solutions to its clients, its long-term relationships with
its agents and brokers, its localized service and its reputation as a
high-quality claims and risk control service provider.





The PMA
Insurance Group has the ability to handle multi-state clients based in its
operating territory but which have operations in other parts of the U.S. by
being authorized to do business in 52 jurisdictions (including Puerto Rico and
the District of Columbia) for workers’ compensation, general liability and
commercial automobile. The PMA Insurance Group intends to continue writing other
lines of property and casualty insurance, but generally only if such writings
are supported by its core workers’ compensation business. The PMA Insurance
Group also provides integrated disability products, with 99 accounts as of
December 31, 2004 that generated approximately $32 million in combined workers’
compensation and integrated disability written premiums in 2004. The PMA
Insurance Group’s primary insurance subsidiaries (Pennsylvania Manufacturers’
Association Insurance Company, Manufacturers Alliance Insurance Company and
Pennsylvania Manufacturers Indemnity Company) will sometimes be referred to as
the Pooled Companies because they share results under an intercompany pooling
agreement.


***Products***





The PMA
Insurance Group's premiums written were as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    2003
    
    2002Gross
      premiums written:Workers'
      compensation and integrated
      disability
    
    $
    375,643
    
    
    88%
    
    $
    570,858
    
    
    84%
    
    $
    410,977
    
    
    80%Commercial
      automobile
    
    
    23,739
    
    
    6%
    
    
    55,899
    
    
    8%
    
    
    55,946
    
    
    11%Commercial
      multi-peril
    
    
    16,046
    
    
    4%
    
    
    34,166
    
    
    5%
    
    
    34,898
    
    
    7%Other
    
    
    7,626
    
    
    2%
    
    
    17,511
    
    
    3%
    
    
    13,511
    
    
    2%Total
    
    $
    423,054
    
    
    100%
    
    $
    678,434
    
    
    100%
    
    $
    515,332
    
    
    100%Net
      premiums written:Workers'
      compensation and integrated
      disability
    
    $
    341,315
    
    
    90%
    
    $
    512,151
    
    
    85%
    
    $
    373,353
    
    
    82%Commercial
      automobile
    
    
    21,796
    
    
    6%
    
    
    52,125
    
    
    8%
    
    
    44,743
    
    
    10%Commercial
      multi-peril
    
    
    12,190
    
    
    3%
    
    
    28,374
    
    
    5%
    
    
    26,627
    
    
    6%Other
    
    
    2,494
    
    
    1%
    
    
    10,943
    
    
    2%
    
    
    7,553
    
    
    2%Total
    
    $
    377,795
    
    
    100%
    
    $
    603,593
    
    
    100%
    
    $
    452,276
    
    
    100%


******


2
 Table of Contents




**Workers’
Compensation Insurance**
 
  Most
states require employers to provide workers’ compensation benefits to their
employees for injuries and occupational diseases arising out of employment,
regardless of whether such injuries result from the employer’s or the employee’s
negligence. Employers may insure their workers’ compensation obligations subject
to state regulation or, subject to regulatory approval, self-insure their
liabilities. Workers’ compensation statutes require that a policy cover three
types of benefits: medical expenses, disability (indemnity) benefits and death
benefits. The amounts of disability and death benefits payable for various types
of claims are set and limited by statute, but no maximum dollar limitation
exists for medical benefits. Workers’ compensation benefits vary among states,
and the insurance rates we charge to our customers are subject to differing
forms of state regulation.





Statutory
direct workers’ compensation business written by jurisdiction was as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Pennsylvania
    
    $
    136,275
    
    
    43%
    
    $
    193,129
    
    
    40%
    
    $
    176,705
    
    
    45%New
      York
    
    
    35,596
    
    
    11%
    
    
    43,978
    
    
    9%
    
    
    33,176
    
    
    8%New
      Jersey
    
    
    27,784
    
    
    9%
    
    
    44,314
    
    
    9%
    
    
    36,312
    
    
    9%Florida
    
    
    23,338
    
    
    7%
    
    
    21,723
    
    
    4%
    
    
    7,024
    
    
    2%Maryland
    
    
    11,861
    
    
    4%
    
    
    21,133
    
    
    4%
    
    
    15,834
    
    
    4%Virginia
    
    
    9,781
    
    
    3%
    
    
    22,400
    
    
    5%
    
    
    23,230
    
    
    6%North
      Carolina
    
    
    8,470
    
    
    3%
    
    
    21,407
    
    
    4%
    
    
    17,726
    
    
    5%Georgia
    
    
    7,753
    
    
    2%
    
    
    18,244
    
    
    4%
    
    
    10,325
    
    
    3%Other
    
    
    57,623
    
    
    18%
    
    
    101,437
    
    
    21%
    
    
    69,908
    
    
    18%Total
    
    $
    318,481
    
    
    100%
    
    $
    487,765
    
    
    100%
    
    $
    390,240
    
    
    100%


The PMA
Insurance Group has focused primarily on the jurisdictions in the table above
based upon its knowledge of their workers’ compensation systems and its
assessment of each state’s respective business, economic, legal and regulatory
climates. We closely monitor and take into consideration rate adequacy,
regulatory climate and economic conditions in each state in the underwriting
process. The PMA Insurance Group employs similar analyses in determining whether
and to what extent it will offer products in additional jurisdictions.





The PMA
Insurance Group is focused on expanding its premium base in territories that
meet its underwriting standards. We continue to benefit from writing business
for insureds mainly operating in The PMA Insurance Group’s principal marketing
territory but with some operations in other states.





During
2004, premium writings were lower then in prior years, primarily reflecting the
impact of the B++ A.M. Best financial strength rating between November 2003 and
November 2004. Prior to November 2003, The PMA Insurance
Group had increased its writings of workers’ compensation premiums through
focused marketing efforts in its principal marketing territories.

Workers’
compensation insurers doing business in certain states are required to provide
insurance for risks that are not otherwise written on a voluntary basis by the
private market. We refer to this business as residual market business.
Typically, an insurer’s share of this residual market business is assigned on a
lag based on its market share in terms of direct premiums in the voluntary
market. This system exists in all of The PMA Insurance Group’s marketing
jurisdictions, except Pennsylvania, New York and Maryland. In these three
states, separate governmental entities write all of the workers’ compensation
residual market business. In 2004, The PMA Insurance Group wrote $34.1 million
in premiums of residual market business, which constituted 10% of its gross
workers’ compensation premiums written. Based upon data for policy year 2004
reported by the National Council on Compensation Insurance, the percentage of
residual market business for the industry as a whole, in all states, was 15% of
direct workers’ compensation premiums written.

The PMA
Insurance Group offers a variety of workers’ compensation products to its
customers. Rate-sensitive products are essentially based on manual rates filed
and approved by state insurance departments, while loss-sensitive products are
priced to a certain extent on the basis of the insured’s loss experience during
the policy period. We have also developed and sold alternative market products,
such as large deductible products and other programs





3
 Table of Contents





and
services to customers who agree to assume even greater exposure to loss than
under more traditional loss-sensitive products. We decide which type of product
to offer a customer based upon the customer’s needs, an underwriting review and
credit history.





The PMA
Insurance Group’s voluntary
workers’ compensation direct premiums written by product type were as
follows:





2004
    
    
    2003
    
    
    2002Rate-sensitive
      products
    
    
    55%
    
    
    59%
    
    
    58%Loss-sensitive
      products
    
    
    35%
    
    
    31%
    
    
    33%Alternative
      market products
    
    
    10%
    
    
    10%
    
    
    9%Total
    
    
    100%
    
    
    100%
    
    
    100%


·
    Rate-sensitive
      products include fixed-cost policies and dividend paying policies. The
      premium charged on a fixed-cost policy is essentially based upon the
      manual rates filed with and approved by the state insurance department and
      does not increase or decrease based upon the losses incurred during the
      policy period. Under policies that are subject to dividend plans, the
      customer may receive a dividend based upon loss experience during the
      policy period.





·
    Loss-sensitive
      products enable us to adjust the amount of the insured’s premiums after
      the policy period expires based, to a certain extent, upon the insured’s
      actual losses incurred during the policy period. These loss-sensitive
      products are generally subject to less price regulation than
      rate-sensitive products and reduce, but do not eliminate, risk to the
      insurer. Under these types of policies, claims professionals periodically
      evaluate the reserves on losses after the policy period expires to
      determine whether additional premium adjustments are required under the
      policy. These policies are typically subject to adjustment for an average
      of five years after policy expiration. We generally restrict
      loss-sensitive products to accounts with minimum annual premiums in excess
      of $100,000.





·
    The
      PMA Insurance Group offers a variety of alternative market products for
      larger accounts, including large deductible policies and off-shore captive
      programs. Typically, we receive a lower up-front premium for these types
      of alternative market product plans. However, under this type of business,
      the insured retains a greater share of the underwriting risk than under
      rate-sensitive or loss-sensitive products, which reduces the potential for
      unfavorable claim activity on the accounts and encourages loss control on
      the part of the insured. For example, under a large deductible policy, the
      customer is contractually obligated to pay its own losses up to the amount
      of the deductible for each occurrence, subject to an aggregate limit. The
      deductibles under these policies generally range from $250,000 to $1.0
      million. In addition to these products, we offer our clients certain
      workers’ compensation services such as claims administration, risk
      management and other services.




The PMA
Insurance Group has a product for group integrated occupational and
non-occupational disability coverages, named PMA One ® . PMA One
leverages what we consider to be one of The PMA Insurance Group’s most important
core competencies: managing employee disabilities. PMA One offers employers the
benefits of coordinated workers’ compensation and disability administration,
reduced costs, programs designed to encourage faster return to work and
heightened employee productivity. As of
December 31, 2004, we had 99 PMA One clients, which generated approximately $32
million of combined workers’ compensation and integrated disability written
premiums in 2004.
PMA One clients include health care systems, educational institutions,
manufacturers and financial institutions.





Through
The PMA Insurance Group’s workers’ compensation product offerings, we provide a
comprehensive array of managed care services to control loss costs. These
include:





·
    Case
      review and intervention by disability management coordinators, all of whom
      are registered nurses. This service is also provided for our integrated
      disability product. These disability management coordinators employ an
      early intervention model to proactively manage medical treatment and
      length of disability in concert with The PMA Insurance Group’s claims
      professionals and the insured employer. There are also case management
      nurses who manage more serious claims via on-site visits with injured
      workers and medical providers. These professionals are supplemented by a
      full time Medical Director, who






4
 Table of Contents




assists
in implementing programs to monitor the quality and medical necessity of
recommended treatment and identifying peer experts for complex
claims.


·
    Access
      to the First Health®Network, a workers’ compensation preferred provider network, which
      includes doctors, hospitals, physical therapists, outpatient clinics and
      imaging centers. Utilization of the network generally results in reduced
      medical costs, in comparison to medical costs incurred when a claim is
      handled outside this network.





·
    Utilization
      of an automated medical bill review system to detect duplicate billings,
      unrelated charges and coding discrepancies. Complex bills are forwarded to
      our cost containment unit, which is staffed by registered nurses and other
      medical professionals, to resolve questions regarding causal relationship
      and appropriate utilization levels.





·
    Use
      of Paradigm Corporation for the medical management of certain catastrophic
      injuries. Paradigm adds a team of catastrophic case management experts to
      assist in achieving enhanced clinical and financial outcomes on these
      catastrophic injuries.





·
    TMESYS®pharmacy benefit management program. TMESYS®is
      the only “Cardless” pharmacy program designed specifically for the
      workers’ compensation industry. It includes access to a nationwide network
      of pharmacies, increased savings through volume pricing, on-line drug
      utilization review and the ability to capture the first prescription
      within the program.




***Other
Commercial Lines***





The PMA
Insurance Group writes other property and liability coverages for larger and
middle market accounts that satisfy its underwriting standards. See “Underwriting” on page 6. These coverages feature
commercial automobile, commercial multi-peril, general liability and umbrella
business. The PMA Insurance Group offers these products, but generally only if
they complement the core workers’ compensation business.




***Other
Products and Services***





The PMA
Insurance Group offers “rent-a-captive” products for certain insureds and
associations. The purpose of a rent-a-captive program is to offer a customer an
alternative method of managing its loss exposures by obtaining many of the
benefits of a captive insurer without establishing and capitalizing its own
captive; in effect, the insured is investing in a captive facility that we have
already established.





Under
this arrangement, the client purchases an insurance policy from us and chooses a
participation level. We then cede a portion of the premium and loss exposures to
either a Bermuda- or Cayman-based subsidiary. The client participates in the
loss and investment experience of the portion ceded to the Bermuda- or
Cayman-based subsidiary through a dividend mechanism. The client is responsible
for any loss that may arise within its participation level, and this
potential obligation is typically secured through a letter of credit or similar
arrangement. Our principal sources of income from this rent-a-captive program
are the premium revenue on the risk retained by us and captive management
fees earned.





Through
PMA Management Corp., The PMA Insurance Group provides claims administration,
risk management, loss prevention and related services primarily to self-insureds
under fee for service arrangements.





***Distribution***




The PMA
Insurance Group distributes its products through multiple channels, including
national, regional and local brokers and agents, employee benefits brokers, and
direct sales representatives.





The PMA
Insurance Group has contracts with 360 independent agents and brokers. The
current distribution network generally consists of large regional agents and
brokers, local agents, and national brokers that specialize in larger to middle
market accounts that require the variety of workers’ compensation, commercial
lines and alternative market products offered by The PMA Insurance Group. In
2004, independent brokers and agents accounted for approximately 87% of The PMA
Insurance Group’s direct written premiums. The top
ten independent brokers and








5
 Table of Contents





agents
accounted for 30% of The PMA Insurance Group’s direct written premiums, the
largest of which accounted for 10% of its direct written premiums.




We
typically pay commissions to the agents and brokers on individual policies
placed with us.  We have also entered into agreements with our agents
and brokers under which they have the potential to earn
additional commission based on specified contractual criteria, primarily
related to premium growth and retention.
 
 The New
York Attorney General and certain other state regulators have initiated
investigations and commenced legal actions against certain brokers and other
insurance companies concerning their compensation agreements and other
practices.  Various states’ Insurance Departments and Attorneys General
have also responded to recent publicity surrounding broker compensation
practices by issuing inquiries and subpoenas to insurance companies and
insurance producers domiciled or doing business in their states.  To date,
we have received inquiries from the Pennsylvania and North Carolina Insurance
Departments concerning our business relationships with brokers, as did most or
all other insurance companies doing business in these jurisdictions. We have
responded fully to these inquiries and believe that our contractual
relationships and business practices with agents and brokers are in compliance
with all applicable statutes and regulations.
 
 The
outcome of these investigations into broker compensation and placement practices
and the impact of any future regulatory changes governing agent and broker
commissions is uncertain.


As of
December 31, 2004, The PMA Insurance Group employed 12 direct sales
representatives who are generally responsible for certain business located in
Pennsylvania and Delaware. These employees produced $49 million in direct
premiums written in 2004.





The PMA
Insurance Group’s underwriters review all business submissions before they are
accepted. The PMA Insurance Group monitors several statistics with respect to
its independent brokers and agents, including a complete profile of the
broker/agent, the number of years the broker/agent has been associated with The
PMA Insurance Group, the percentage of the broker/agent’s business that is
underwritten by The PMA Insurance Group, the ranking of The PMA Insurance Group
within the broker/agent’s business and the profitability of the broker/agent’s
business.





As of
December 31, 2004, our field organization consisted of 17 branch or satellite
offices throughout The PMA Insurance Group’s principal marketing territory. Branch
offices deliver a full range of services directly to customers located in their
service territory, while satellite offices primarily offer risk control and
claim adjustment services.





***Underwriting***





The PMA
Insurance Group’s underwriters, in consultation with actuaries, determine the
general type of business to be written using a number of criteria, including
past performance, relative exposure to hazard, premium size, type of business
and other indicators of potential loss. Specific types of business are referred
to underwriting specialists and actuaries for individual pricing. The
underwriting team also establishes classes of business that The PMA Insurance
Group generally will not write, such as certain property exposures, certain
hazardous products and activities, and certain environmental coverages. Because
terrorism exclusions have never been permitted for workers' compensation
business, we refined our workers’ compensation underwriting guidelines after
September 11, 2001 to manage the underwriting exposure from terrorism
risks, including the review of aggregation of risks by geographic location,
evacuation and security of buildings in which insured employees work, and the
type of entities located in the vicinity of the prospective insured. These
refined procedures have not materially affected The PMA Insurance Group’s mix of
business.





Underwriters
and risk-control professionals in the field report functionally to the Chief
Underwriting Officer and locally to branch vice presidents who are accountable
for territorial operating results. Underwriters also work with the field
marketing force to identify business that meets prescribed underwriting
standards and to develop specific strategies to write the desired business. In
performing this assessment, the field office professionals also consult with
actuaries who have been assigned to the specific field office regarding loss
trends and pricing and utilize actuarial loss rating models to assess the
projected underwriting results of accounts.  A formal
underwriting quality assurance program is also employed to ensure consistent
adherence to underwriting standards and controls.





6
 Table of Contents





The PMA
Insurance Group also employs credit analysts. These employees review the
financial strength and stability of customers who utilize loss-sensitive and
alternative market products and specify the type and amount of collateral that
customers must provide under these arrangements. Premium
auditors perform audits to determine that premiums charged accurately reflect
the actual exposure bases.





***Claims
Administration***





Claims
services are delivered to customers primarily through employees located in
branch or satellite offices. Claims are assigned to claims professionals based on
coverage and jurisdictional expertise . Claims
meeting certain criteria are referred to line of business claim specialists.
Certain claims arising outside of our principal marketing territory are assigned
to an independent claims service provider. A formal quality assurance program is
carried out to ensure the consistency and effectiveness of claims adjustment
activities . Claims
professionals are also supported by a network of in-house legal counsel and an
anti-fraud investigative unit. A special claims unit in the home office manages
more complex specialized matters such as asbestos and environmental
claims.





The PMA
Insurance Group maintains a centralized claims processing center in order to
minimize the volume of clerical and repetitive administrative demands on our
claims professionals. The center’s ability to handle loss reports, perform claim
set-up, issue payments and conduct statutory reporting allows the claims
professionals to focus on immediate contact and timely, effective claim
resolution. PMA’s Customer Service Center also houses a centralized call center
providing 24 hour coverage for customer requests and inquiries. Currently,
approximately 40% of new losses are reported electronically through our internet
based technology, including Cinch ® , our
internet risk management information technology.





***Competition***





The
domestic property and casualty insurance industry is very competitive and
consists of many companies, with no one company dominating the market for all
products. In addition, the degree and nature of competition varies from state to
state for a variety of reasons, including the regulatory climate and other
market participants in each state. In addition to competition from other
insurance companies, The PMA Insurance Group competes with certain alternative
market arrangements, such as captive insurers, risk-sharing pools and
associations, risk retention groups, and self-insurance programs. Many of our
competitors are larger and have greater financial resources than
us.





The main
factors upon which entities in our markets compete are price, service, product
capabilities and financial security. The PMA Insurance Group attempts to price
its products in such a way that the prices charged to its clients are
commensurate with the overall marketplace while still adhering to our
underwriting standards. The PMA Insurance Group will reject or non-renew
accounts where we believe the market rates, terms and conditions for such risks
are not acceptable.





We
maintain service standards concerning turn-around time for underwriting
submissions, information flow, claims handling and the quality of other
services. These standards help ensure that clients are satisfied with our
products and services. We periodically participate in client surveys to gain an
understanding of the perceptions of our service as compared to our
competitors.





We
attempt to design products that meet the needs of clients in our markets. In
recent years, The PMA Insurance Group has developed products that reflect the
evolving nature of the workers' compensation market. Specifically, it has
developed PMA One, a product that provides for group integrated occupational and
non-occupational disability coverages. The PMA Insurance Group has also
increased its focus on rehabilitation and managed care to control workers'
compensation costs for the employers. In addition, it also continues to benefit
from writing business for insureds mainly operating in The PMA Insurance Group's
principal marketing territory but with some operations in other states. See "The PMA Insurance Group—Products" for
additional discussion. We continually evaluate new product opportunities for The
PMA Insurance Group.





***Industry
Trends***





During
the late 1990s and into 2000, the property and casualty insurance industry was
characterized by excess capacity, which resulted in highly competitive market
conditions evidenced by declining premium rates and, in many cases, policy terms
less favorable to the insurers. As a result of this prolonged soft market,
capacity in the property and casualty market began to contract late in 2000, as
companies withdrew from the business or ceased operations.





7
 Table of Contents





In
response to market conditions, many insurance and reinsurance companies,
including our companies, independently sought and achieved significant price
increases and improved policy terms commencing in the secondhalf of
2000. In 2002, we realized price increases at The PMA Insurance Group in excess
of 15%. These increases continued in 2003 and 2004, but at a lesser rate. The
PMA Insurance Group obtained price increases of 10% for its workers’
compensation business in 2003 and 6% in 2004. We have also increased the
relative amount by which we can adjust insureds’ premiums based on actual losses
incurred on loss-sensitive products.





Despite
current market conditions, there can be no assurance that prices and premiums
will increase at a level consistent with loss cost inflation. Even if the
industry in general experiences those types of increases, we cannot assure you
that we will see similar increases or that we will achieve price increases
consistent with 2004. Further, any benefit that we derive from such price
increases may be partially or completely offset by increases in ceded
reinsurance premiums, frequency of reported losses or by loss cost
inflation.





**RUN-OFF OPERATIONS**





In
November 2003, we announced our decision to withdraw from the reinsurance
business previously served by our PMA Re operating segment. We are no longer
writing new reinsurance business. As a result of this decision, the results of
PMA Re are reported as Run-off Operations. Run-off Operations also includes the
results of our former excess and surplus lines business, which we placed in
run-off in May 2002.





See Note 14 in Item 8 of this Form 10-K for additional
information regarding the Run-off Operations.





Reinsurance
is an arrangement in which an insurance company, the reinsurer, agrees to
indemnify another insurance company, the ceding company, against all or a
portion of the insurance risks underwritten by the ceding company under one or
more insurance contracts. Reinsurance provides ceding companies with several
benefits: reducing exposure on individual risks, protecting against catastrophic
losses, stabilizing underwriting results and maintaining acceptable capital
ratios.





Late in
2000, PMA Re invested in a Lloyd’s of London managing general agency, Cathedral
Capital PLC, and commencing in 2001, we began participating in the results of
Syndicate 2010, which primarily writes property and aviation reinsurance.
Cathedral Capital primarily provides underwriting and management services for
various Lloyd’s syndicates providing primarily property and casualty coverages.
Cathedral Capital agreed to indemnify us for losses exceeding £300,000 arising
from Syndicate 2010 related to the 2001 and 2002 underwriting years of account
in which we participated. In consideration for the indemnification, we agreed to
pay Cathedral Capital 30% of any underwriting profit related to the 2001 and
2002 years of account. During 2004, we sold our interest in Cathedral Capital
and recorded a gain of $2.5 million on the sale.





PMA Re
had five distinct underwriting units, organized by class of business. The
Traditional-Treaty, Finite Risk and Financial Products, Specialty-Treaty, and
Accident-Treaty units provided treaty reinsurance coverage. The fifth unit,
Facultative, provided reinsurance on a facultative basis. The Traditional-Treaty
underwriting unit wrote general property and casualty business. The Traditional
casualty portfolio included general liability, umbrella, commercial automobile
and workers’ compensation.





The
Finite Risk and Financial Products underwriting unit provided PMA Re’s insurance
company clients with risk management solutions that complemented their
traditional reinsurance program. Under its finite risk covers, PMA Re assumed a
measured amount of insurance risk in exchange for a specified margin. Our finite
risk reinsurance covers typically included a combination of sub-limits and caps
on the maximum gain or loss to PMA Re as the reinsurer. As part of our run-off
strategy, we sold the renewal rights to the business in November
2003.





The
Specialty-Treaty underwriting unit wrote business that fell outside the confines
of our traditional property and casualty risks. The Facultative underwriting
unit wrote property and casualty reinsurance on an individual risk basis and on
a program/semi-automatic basis, in which we agreed to accept risks that fell
within certain predetermined parameters. The Accident-Treaty unit offered a wide
variety of accident products to life insurance companies, writers of workers’
compensation insurance and writers of Special Risk insurance. In 2004, we
entered into a 100% quota share reinsurance agreement with a third-party
reinsurer covering all of the liabilities of the Accident-Treaty unit occurring
after December 31, 2003, in return for 100% of the Unit’s unearned
premiums.








8
 Table of Contents





Our
excess and surplus lines business focused on excess and surplus lines of
insurance for low frequency/high severity risks that were declined by the
standard market. The Run-off Operations wrote business throughout the United
States, generally through surplus lines brokers.


The
claims departments of the Run-off Operations analyze reported claims, establish
individual claim reserves, pay claims, provide claims-related services to
clients and audit the claims activities of selected clients. The claims
department’s evaluation of claims activity includes reviewing loss reports
received from ceding companies to confirm that claims are covered under the
terms of the relevant reinsurance contract, establishing reserves on an
individual case basis and monitoring the adequacy of those reserves. The claims
department also monitors the progress and ultimate outcome of the claims to
determine that subrogation, salvage and other cost recovery opportunities have
been adequately explored. The claims department performs these functions in
coordination with the actuarial department.





In
addition to evaluating and adjusting claims, the claims department conducts
claims audits at the offices of selected ceding companies. The claims department
also conducts annual claims audits of many client ceding
companies.





**REINSURANCE AND RETROCESSIONAL
PROTECTION**





We follow
the customary insurance practice of reinsuring with other insurance companies a
portion of the risks under the policies written by our insurance subsidiaries.
This reinsurance is maintained to protect the insurance subsidiaries against the
severity of losses on individual claims and unusually serious occurrences in
which a number of claims produce an aggregate extraordinary loss. Although
reinsurance does not discharge the insurance subsidiaries from their primary
liabilities to policyholders for losses insured under the insurance policies, it
does make the assuming reinsurer liable to the insurance subsidiaries for the
reinsured portion of the risk.





The ceded
reinsurance agreements of our insurance subsidiaries generally may be terminated
at their annual anniversary by either party upon 30 to 120 days’ notice. In
general, the reinsurance agreements are treaty agreements, which cover all
underwritten risks of the types specified in the treaties. Our reinsurance is on
a per risk and per occurrence basis. Per risk reinsurance offers reinsurance
protection for each risk involved in each occurrence. Per occurrence reinsurance
is a form of reinsurance under which the date of the loss event is deemed to be
the date of the occurrence regardless of when reported and permits all losses
arising out of one event to be aggregated.





See “Item 7 - MD&A - Reinsurance” and Note 5 in Item 8 of this 10-K for additional
information.





**LOSS RESERVES**





Insurers
establish reserves representing estimates of future amounts needed to pay claims
with respect to insured events that have occurred, including events that have
not been reported to the insurer. Reserves are also established for LAE
representing the estimated expenses of settling claims, including legal and
other fees, and general expenses of administering the claims adjustment
process.





After a
claim is reported, claims personnel establish a “case reserve” for the estimated
amount of the ultimate payment. The estimate reflects the informed judgment of
management based on reserving practices and management’s experience and
knowledge regarding the nature and value of the specific type of claim. Claims
personnel review and update their estimates as additional information becomes
available and claims proceed toward resolution. In addition, reserves are also
established on an aggregate basis:





·
    to
      provide for losses incurred but not yet reported to the insurer;





·
    to
      provide for the estimated expenses of settling claims, including legal and
      other fees and general expenses of administering the claims adjustment
      process; and





·
    to
      adjust for the fact that, in the aggregate, case reserves may not
      accurately estimate the ultimate liability for reported claims.





Reserves
are estimated using various generally accepted actuarial methodologies. As part
of the reserving process, historical and industry data is reviewed and
consideration is given to the anticipated impact of various factors such as
legal developments, changes in social attitudes and economic conditions,
including the effects of inflation. This


9
 Table of Contents





process
relies on the basic assumption that past experience, adjusted for the effect of
current developments and probable trends, provides a reasonable basis for
predicting future events. The reserving process provides implicit recognition of
the impact of inflation and other factors affecting claims payments by taking
into account changes inhistoric payment patterns and perceived
probable trends. There is generally no precise method, however, for subsequently
evaluating the adequacy of the consideration given to inflation or to any other
specific factor, since the eventual deficiency or redundancy of reserves is
affected by many factors, some of which are interdependent.





Due to
the “long-tail” nature of a significant portion of our business, in many cases,
significant periods of time, ranging up to several years or more, may elapse
between the occurrence of an insured loss, the reporting of the loss to us and
our payment of that loss. We define long-tail business as those lines of
business in which a majority of coverage involves average loss payment lags of
several years beyond the expiration of the policy. Our major long-tail lines
include our workers’ compensation and casualty reinsurance business. In
addition, because reinsurers rely on their ceding companies to provide them with
information regarding incurred losses, reported claims for reinsurers become
known more slowly than for primary insurers and are generally subject to more
unforeseen development and uncertainty. Estimating our ultimate claims liability
is necessarily a complex and judgmental process inasmuch as the amounts are
based on management’s informed estimates, assumptions and judgments using data
currently available. As additional experience and data become available
regarding claims payment and reporting patterns, legal and legislative
developments, judicial theories of liability, the impact of regulatory trends on
benefit levels for both medical and indemnity payments, changes in social
attitudes and economic conditions, the estimates are revised accordingly. If our
ultimate losses, net of reinsurance, prove to differ substantially from the
amounts recorded at December 31, 2004, the related adjustments could have a
material adverse effect on our financial condition, results of operations and
liquidity.





The table
on the next page presents the subsequent development of the estimated year-end
property and casualty reserves, net of reinsurance (“net reserves”), for the ten
years prior to 2004. The first section of the table shows the estimated net
reserves that were recorded at the end of each respective year for all current
and prior year unpaid losses and LAE. The second section shows the cumulative
amounts of such previously recorded net reserves paid in succeeding years. The
third section shows the re-estimates of the net reserves made in each succeeding
year.





The
cumulative deficiency (redundancy) as shown in the table represents the
aggregate change in the reserve estimates from the original balance sheet dates
through December 31, 2004; an increase in a loss estimate that related to a
prior year occurrence generates a deficiency in each intervening year. For
example, a deficiency first recognized in 2000 relating to losses incurred in
1994 would be included in the cumulative deficiency amount for each of the years
1994 through 1999. However, the deficiency would be reflected in operating
results in 2000 only.





Conditions
and trends that have affected the reserve development reflected in the table may
change, and care should be exercised in extrapolating future reserve
redundancies or deficiencies from such development.








10
 Table of Contents





**Consolidated
Loss and Loss Adjustment Expense Development**





**December
31,**


(dollar
amounts in millions)





1994
    
    
    1995
    
    
    1996
    
    
    1997
    
    
    1998
    
    
    1999
    
    
    2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004**I.
      **Initial
      estimated liability for****
    
    
    ******unpaid
      losses and LAE,****net
      of reinsurance**
    
    
    
    
    $
    1,855.9
    
    $
    1,808.5
    
    $
    1,834.5
    
    $
    1,670.9
    
    $
    1,347.2
    
    $
    1,284.4
    
    $
    1,128.7
    
    $
    1,143.1
    
    $
    1,184.3
    
    $
    1,346.3
    
    $
    998.8**II.
      **Amount
      of reserve paid,****
    
    
    ******net
      of reinsurance through:**-
      one year later
    
    
    
    
    $
    398.9
    
    $
    437.6
    
    $
    398.8
    
    $
    360.7
    
    $
    354.6
    
    $
    494.9
    
    $
    457.0
    
    $
    644.3
    
    $
    650.5
    
    $
    605.8
    
    $
    --
      two years later
    
    
    
    
    
    763.7
    
    
    780.0
    
    
    669.6
    
    
    646.0
    
    
    717.7
    
    
    764.1
    
    
    838.8
    
    
    1,064.2
    
    
    1,015.2-
      three years later
    
    
    
    
    
    1,072.9
    
    
    999.0
    
    
    894.8
    
    
    924.6
    
    
    880.3
    
    
    1,052.9
    
    
    1,107.6
    
    
    1,297.6-
      four years later
    
    
    
    
    
    1,252.2
    
    
    1,183.5
    
    
    1,118.2
    
    
    1,013.0
    
    
    1,125.8
    
    
    1,248.3
    
    
    1,226.1-
      five years later
    
    
    
    
    
    1,405.9
    
    
    1,369.7
    
    
    1,172.3
    
    
    1,196.9
    
    
    1,261.0
    
    
    1,330.7-
      six years later
    
    
    
    
    
    1,573.2
    
    
    1,407.9
    
    
    1,325.2
    
    
    1,289.7
    
    
    1,327.8-
      seven years later
    
    
    
    
    
    1,595.8
    
    
    1,542.2
    
    
    1,394.5
    
    
    1,336.0-
      eight years later
    
    
    
    
    
    1,722.5
    
    
    1,609.8
    
    
    1,428.2-
      nine years later
    
    
    
    
    
    1,783.3
    
    
    1,637.1-
      ten years later
    
    
    
    
    
    1,806.1**III.
      **Reestimated
      liability,****
    
    
    ******net
      of reinsurance, as of**-
      one year later
    
    
    
    
    $
    1,907.4
    
    $
    1,964.6
    
    $
    1,748.5
    
    $
    1,624.3
    
    $
    1,314.7
    
    $
    1,290.9
    
    $
    1,152.2
    
    $
    1,302.8
    
    $
    1,403.1
    
    $
    1,305.9
    
    $
    --
      two years later
    
    
    
    
    
    2,073.4
    
    
    1,866.8
    
    
    1,700.5
    
    
    1,557.6
    
    
    1,299.7
    
    
    1,304.1
    
    
    1,269.4
    
    
    1,499.0
    
    
    1,395.6-
      three years later
    
    
    
    
    
    1,986.7
    
    
    1,819.2
    
    
    1,611.1
    
    
    1,495.3
    
    
    1,288.9
    
    
    1,336.6
    
    
    1,399.8
    
    
    1,499.3-
      four years later
    
    
    
    
    
    1,942.0
    
    
    1,742.1
    
    
    1,542.3
    
    
    1,480.8
    
    
    1,326.3
    
    
    1,426.9
    
    
    1,397.3-
      five years later
    
    
    
    
    
    1,880.3
    
    
    1,672.6
    
    
    1,524.3
    
    
    1,482.9
    
    
    1,346.7
    
    
    1,436.1-
      six years later
    
    
    
    
    
    1,822.1
    
    
    1,658.0
    
    
    1,519.0
    
    
    1,487.5
    
    
    1,350.2-
      seven years later
    
    
    
    
    
    1,807.6
    
    
    1,655.3
    
    
    1,514.0
    
    
    1,492.4-
      eight years later
    
    
    
    
    
    1,807.3
    
    
    1,650.0
    
    
    1,517.8-
      nine years later
    
    
    
    
    
    1,804.9
    
    
    1,655.1-
      ten years later
    
    
    
    
    
    1,804.7**IV.
      **Cumulative
      deficiency****
    
    
    ******(redundancy):**
    
    
    
    
    $
    (51.2
    )
    $
    (153.4
    )
    $
    (316.7
    )
    $
    (178.5
    )
    $
    3.0
    
    $
    151.7
    
    $
    268.6
    
    $
    356.2
    
    $
    211.3
    
    $
    (40.4
    )
    $
    -**V.
      **Net
      liability****
    
    
    ****
    
    $
    1,855.9
    
    $
    1,808.5
    
    $
    1,834.5
    
    $
    1,670.9
    
    $
    1,347.2
    
    $
    1,284.4
    
    $
    1,128.7
    
    $
    1,143.1
    
    $
    1,184.3
    
    $
    1,346.3
    
    $
    998.8**Reinsurance
      recoverables**
    
    
    
    
    
    247.9
    
    
    261.5
    
    
    256.6
    
    
    332.3
    
    
    593.7
    
    
    648.2
    
    
    924.4
    
    
    1,181.3
    
    
    1,265.6
    
    
    1,195.0
    
    
    1,112.8**Gross
      liability**
    
    
    
    
    $
    2,103.8
    
    $
    2,070.0
    
    $
    2,091.1
    
    $
    2,003.2
    
    $
    1,940.9
    
    $
    1,932.6
    
    $
    2,053.1
    
    $
    2,324.4
    
    $
    2,449.9
    
    $
    2,541.3
    
    $
    2,111.6**VI. 
      **Re-estimated
      net liability****
    
    
    ****
    
    $
    1,804.7
    
    $
    1,655.1
    
    $
    1,517.8
    
    $
    1,492.4
    
    $
    1,350.2
    
    $
    1,436.1
    
    $
    1,397.3
    
    $
    1,499.3
    
    $
    1,395.6
    
    $
    1,305.9**Re-estimated
      reinsurance recoverables**
    
    
    
    
    
    263.4
    
    
    292.7
    
    
    271.0
    
    
    330.9
    
    
    624.2
    
    
    867.8
    
    
    1,184.3
    
    
    1,296.3
    
    
    1,246.0
    
    
    1,200.5**Re-estimated
      gross liability**
    
    
    
    
    $
    2,068.1
    
    $
    1,947.8
    
    $
    1,788.8
    
    $
    1,823.3
    
    $
    1,974.4
    
    $
    2,303.9
    
    $
    2,581.6
    
    $
    2,795.6
    
    $
    2,641.6
    
    $
    2,506.4


For
additional information regarding our loss reserves and prior year loss
development, see Note 4 in Item 8 of this Form 10-K and the
sections of our MD&A in Item 7 of this Form 10-K
entitled “The PMA Insurance Group - Losses
and Expenses,” “Run-off Operations” and “Loss Reserves and
Reinsurance.”





Unpaid
losses and LAE on a GAAP basis were $2,111.6 million and $2,541.3 million at
December 31, 2004 and 2003, respectively. Unpaid losses and LAE on a statutory
basis were $823.3 million and $1,080.1 million at December 31, 2004 and 2003,
respectively. The difference between GAAP and statutory loss reserves reflects:
1) reinsurance receivables on unpaid losses and LAE, which are recorded as
assets for GAAP but netted against statutory loss reserves, and 2) non-U.S.
domiciled insurance companies, whose unpaid losses and LAE are included for GAAP
purposes, but not for statutory purposes.





At
December 31, 2004 and
2003, our gross unpaid losses and LAE were recorded net of discount of $244.2
million and $247.0 million, respectively. Our net liability for unpaid losses
and LAE was recorded net of discount of $70.5 million and $82.3 million at
December 31, 2004 and 2003, respectively. Unpaid losses for our workers’
compensation claims, net of reinsurance, at December 31, 2004 and 2003 were
$448.7 million and $433.8 million,











11
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net of
discount of $48.2 million and $54.6 million, respectively. Unpaid losses on
certain workers’ compensation claims are discounted to present value using our
payment experience and mortality and interest assumptions in accordance with
statutory accounting practices prescribed by the Pennsylvania Insurance
Department. We also discount unpaid losses and LAE for certain other claims at
rates permitted by domiciliary regulators or if the timing and amount of such
claims are fixed and determinable. Pre-tax income (loss) is negatively impacted
by accretion of discount on prior year reserves and favorably impacted by
recording of discount for current year reserves. The net of these amounts is
referred to as net discount accretion. Net discount accretion reduced pre-tax
results by $3.9 million in 2004 and benefited 2003 pre-tax results by $6.3
million.





At
December 31, 2004, our loss reserves were stated net of $30.8 million of salvage
and subrogation. Our policy with respect to estimating the amounts and
realizability of salvage and subrogation is to develop accident year schedules
of historic paid salvage and subrogation by line of business, which are then
projected to an ultimate basis using actuarial projection techniques. The
anticipated salvage and subrogation is the estimated ultimate salvage and
subrogation less any amounts received by us. The realizability of anticipated
salvage and subrogation is reflected in the historical data that is used to
complete the projection, as historical paid data implicitly considers
realization and collectibility.





**INVESTMENTS**





An
important component of our financial results is the return on invested assets.
Our investment objectives are to (i) seek competitive after-tax income and total
return as appropriate, (ii) maintain medium to high investment grade asset
quality and high marketability, (iii) maintain maturity distribution
commensurate with our business objectives, (iv) provide portfolio flexibility
for changing business and investment climates and (v) provide liquidity to meet
operating objectives. Our investment strategy includes guidelines for asset
quality standards, asset allocations among investment types and issuers, and
other relevant criteria for our portfolio. In addition, invested asset cash
flows, both current income and investment maturities, are structured after
considering projected liability cash flows of loss reserve payouts using
actuarial models. Property and casualty claim demands are somewhat unpredictable
in nature and require liquidity from the underlying invested assets, which are
structured to emphasize current investment income to the extent consistent with
maintaining appropriate portfolio quality and diversity. The liquidity
requirements are met primarily through publicly traded fixed maturities as well
as operating cash flows and short-term investments.





The
Strategy and Operations Committee of our Board of Directors is responsible for
reviewing our investment objectives. We retain outside investment advisers to
provide investment advice and guidance, supervise our portfolio and arrange
securities transactions through brokers and dealers. Investments by the Pooled
Companies and PMA Capital Insurance Company must comply with the insurance laws
and regulations of the Commonwealth of Pennsylvania.





We do not
currently have any derivative financial instruments in our investment portfolio.
We do not use derivatives for speculative purposes. Our investment portfolio
does not contain any significant concentrations in single issuers other than
U.S. Treasury and agency obligations. In addition, we do not have a significant
concentration of investments in any single industry segment other than finance
companies, which comprise 10% of invested assets at December 31, 2004. Included
in this industry segment are diverse financial institutions, including financing
subsidiaries of automotive manufacturers.





For
additional information on our investments, including carrying values by
category, quality ratings and net investment income, see “Item
7 - MD&A - Investments” as well as Notes 2-B and 3 in Item 8 of this Form 10-K.





**RATINGS**





Nationally
recognized ratings agencies rate the financial strength of our principal
insurance subsidiaries and of the debt of PMA Capital Corporation. Ratings are
not recommendations to buy our securities.





Rating
agencies rate insurance companies based on financial strength and the ability to
pay claims, factors more relevant to policyholders than investors. We believe
that the ratings assigned by nationally recognized, independent rating agencies,
particularly A.M. Best, are material to our operations. We currently participate
in the ratings process of A.M. Best and Moody’s Investor Services. Other rating
agencies also rate our securities, which we do not disclose in our
reports.





12
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The
rating scales of A.M. Best and Moody’s are characterized as
follows:





·
    A.M.
      Best—A++ to S (“Superior” to “Suspended”)


·
    Moody’s—Aaa
      to C (Exceptional financial security to lowest-rated
      class)




As of
February 28, 2005, the financial strength ratings of our principal insurance
subsidiaries and the debt ratings of PMA Capital Corporation, as published by
the principal rating agencies, are as follows:





Financial
      Strength Ratings:
    
    
    A.
      M. Best
    
    
    Moody's(1)Pooled
      Companies(2)
    
    
    A-
    
    
    (4th
      of 16
    )
    
    Ba1
    
    
    (11th
      of 21
    )PMA
      Capital Insurance Company
    
    
    B+
    
    
    (6th
      of 16
    )
    
    B1
    
    
    (14th
      of 21
    )Senior
      Debt Ratings:
    
    
    Moody's(1)PMA
      Capital Corporation
    
    
    B3
    
    
    (16th
      of 21
    )


*(1)*
    *Developing
      outlook.*


*(2)*
    *The
      Pooled Companies represent the domestic subsidiary insurance companies
      through which The PMA Insurance Group writes its insurance business, which
      share results through an intercompany pooling agreement. The Pooled
      Companies are rated as one entity.*





A
downgrade in the A.M. Best financial strength rating of the Pooled Companies
would result in a material loss of business as policyholders move to other
companies with higher financial strength ratings. Accordingly, such a downgrade
to our A.M. Best insurer financial strength rating would have a material adverse
effect on our results of operations, liquidity and capital resources.





A
downgrade in our debt ratings will affect our ability to raise additional debt
with terms and conditions similar to our current debt, and, accordingly, will
increase our cost of capital. In addition, a downgrade of our debt ratings will
make it more difficult to raise capital to refinance any maturing debt
obligations and to maintain or improve the current financial strength ratings of
our principal insurance subsidiaries.





These
ratings are subject to revision or withdrawal at any time by the rating
agencies, and therefore, no assurance can be given that we or our principal
insurance subsidiaries can maintain these ratings. Each rating should be
evaluated independently of any other rating.





See “Risk Factors” beginning on page 21 for additional
information regarding our ratings.





**REGULATORY MATTERS**




***General***





One or
more of The PMA Insurance Group’s Pooled Companies are licensed to transact
insurance business in, and are subject to regulation and supervision by, 52
jurisdictions (including Puerto Rico and the District of Columbia). PMACIC is
licensed or accredited to transact business in, and is subject to regulation and
supervision by, 49 states and the District of Columbia. Our insurance
subsidiaries are authorized and regulated in all jurisdictions where they
conduct insurance business.





In
supervising and regulating insurance and reinsurance companies, state insurance
departments, charged primarily with protecting policyholders and the public
rather than investors, enjoy broad authority and discretion in applying
applicable insurance laws and regulations for that purpose. The Pooled Companies
and PMACIC are domiciled in Pennsylvania, and the Pennsylvania Insurance
Department exercises principal regulatory jurisdiction over them. The extent of
regulation by the states varies, but in general, most jurisdictions have laws
and regulations governing standards of solvency, adequacy of reserves,
reinsurance, capital adequacy and standards of business conduct.





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In
addition, statutes and regulations usually require the licensing of insurers and
their agents, the approval of policy forms, certain terms and
conditions and related material and, for certain lines of insurance,
including rate-sensitive workers’ compensation, the approval of rates. Property
and casualty reinsurers are generally not subject to filing or other regulatory
requirements applicable to primary standard lines insurers with respect to
rates, underwriting rules and policy forms. The form and content of statutory
financial statements are regulated.





The U.S.
federal government does not directly regulate the insurance industry; however,
federal initiatives from time to time can
impact the insurance industry. In
November 2002, the Terrorism Risk Insurance Act of 2002 (“TRIA”) became effective.
TRIA provides federal reinsurance protection for property and casualty losses in
the United States or to United States aircraft or vessels arising from certified
terrorist acts through the end of 2005. TRIA
expires on December 31, 2005 and although legislation has been introduced in
Congress to extend TRIA, there is no assurance that it will be re-enacted or
extended. For
terrorist acts to be covered under TRIA, they must be certified as such by the
United States Government and must be committed by individuals acting on behalf
of a foreign person or interest. TRIA contains a “make available” provision,
which requires insurers subject to the Act, to offer coverage for acts of
terrorism that does not differ materially from the terms (other than price),
amounts and other coverage limitations offered to the policyholder for losses
from events other than acts of terrorism. The “make available” provision permits
exclusions for certain types of losses, if a state permits exclusions for such
losses. TRIA requires insurers to retain losses based on a percentage of their
commercial lines direct earned premiums for the prior year equal to a 15%
deductible for 2005. The federal government covers 90% of the losses above the
deductible, while a company retains 10% of the losses. TRIA contains an annual
limit of $100 billion of covered industry-wide losses. TRIA applies to
commercial lines of property and casualty insurance, including workers’
compensation insurance, offered by The PMA Insurance Group, but does not apply
to reinsurance. The PMA Insurance Group would have a deductible of approximately
$70 million in 2005 if a covered terrorist act were to occur.





Workers’
compensation insurers were not permitted to exclude terrorism from coverage
prior to the enactment of TRIA, and continue to be subject to this prohibition.
When underwriting new and renewal commercial insurance business, The PMA
Insurance Group considers the added potential risk of loss due to terrorist
activity, and this may lead it to decline to write or non-renew certain
business. Additional rates may be charged for terrorism coverage, and as of
January 1, 2004, The PMA Insurance Group had adopted premium charges for
workers’ compensation insurance in all states. The PMA Insurance Group has also
refined its underwriting procedures in consideration of terrorism risks.





However, because
of the unpredictable nature of terrorism, TRIA’s uncertain application, the
amount of terrorism losses that The PMA Insurance Group must retain under TRIA
and the fact that TRIA does not apply to, and we do not have terrorism
exclusions in all of, our reinsurance business, future terrorist attacks may
result in losses that could have a material adverse effect on our financial
condition, results of operations and liquidity. For additional information
regarding The PMA Insurance Group’s underwriting criteria, see Business - The
PMA Insurance Group, Underwriting on page 6 of
this Form 10-K.





Further,
although we do not write health insurance, federal and state rules and
regulations affecting health care services can affect the workers’ compensation
services we provide. We cannot predict what health care reform legislation will
be adopted by Congress or by state legislatures where we do business or the
effect, if any, that the adoption of health care legislation or regulations at
the federal or state level will have on our results of operations.





State
insurance departments in jurisdictions in which our insurance subsidiaries do
business also conduct periodic examinations of their respective operations and
accounts and require the filing of annual and other reports relating to their
financial condition. The Pennsylvania Insurance Department has completed
examinations of PMA Capital Insurance Company and the Pooled Companies as of
December 31, 2002. The examinations did not result in any material adjustments
to our statutory capital as previously filed in our statutory financial
statements. No material qualitative matters were raised as a result of the
examinations.




***Insurance Holding Company
Regulation***





The
Company and its insurance subsidiaries are subject to regulation pursuant to the
insurance holding company laws of the Commonwealth of Pennsylvania.
Pennsylvania’s state insurance holding company laws generally require an
insurance holding company and insurers and reinsurers that are members of such
insurance holding company's system to register with the insurance department
authorities, to file with it certain reports disclosing information including
their capital structure, ownership, management, financial condition, certain
intercompany transactions, including material transfers of assets and
intercompany business agreements, and to report material changes in that





14
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information.
These laws also require that intercompany transactions be fair and reasonable
and, under certain circumstances, prior approval of the Pennsylvania Insurance
Department must be received before entering into an intercompany transaction.
Further, these laws require that an insurer's policyholders’ surplus following
any dividends or distributions to shareholder affiliates be reasonable in
relation to the insurer's outstanding liabilities and adequate for its financial
needs.





As a
result of discussions with the Pennsylvania Insurance Department, PMACIC entered
into a voluntary agreement with the Department, dated December 22, 2003.
Pursuant to the agreement, PMACIC agreed to request the Department’s prior
approval of certain actions, including: entering into any new reinsurance
contracts, treaties or agreements, except as may be required by law; making any
payments, dividends or other distributions to, or engaging in any transactions
with, any of PMACIC’s affiliates; making any withdrawal of monies from PMACIC’s
bank accounts or making any disbursements, payments or transfers of assets in an
amount exceeding five percent (which equaled $32.9 million as of December 31,
2004) of the fair market value of PMACIC’s then aggregate cash and investments;
incurring any debt, obligation or liability for borrowed money, pledging its
assets or loaning monies to any person or entity (whether or not affiliated);
appointing any new director or executive officer; or altering its or its
Pennsylvania-domiciled insurance company subsidiaries’ ownership structure. The
letter agreement shall remain in effect until the Commissioner, or PMACIC and
the Commissioner, determine it is no longer necessary, or until and unless it is
superseded by a regulatory order.





In June
2004, the Pennsylvania Insurance Department approved our application for the
Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly
owned subsidiaries of PMA Capital Corporation. However, in its Order approving
the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the
Pennsylvania Insurance Department prohibited PMACIC from any declaration or
payment of dividends, return of capital or any other types of distributions in
2004 and 2005 to PMA Capital Corporation. In 2006, PMACIC may declare and pay
ordinary dividends or returns of capital without the prior approval of the
Pennsylvania Insurance Department if, immediately after giving effect to the
dividend or returns of capital, PMACIC’s risk-based capital equals or exceeds
225% of Authorized Control Level Capital as defined by the National Association
of Insurance Commissioners. In 2007 and beyond, PMACIC may make dividend
payments, as long as such dividends are not considered “extraordinary” under
Pennsylvania insurance law.





Under
Pennsylvania law, no person may acquire, directly or indirectly, a controlling
interest in our capital stock unless such person, corporation or other entity
has obtained prior approval from the Commissioner for such acquisition of
control. Pursuant to the Pennsylvania law, any person acquiring, controlling or
holding the power to vote, directly or indirectly, ten percent or more of the
voting securities of an insurance company, is presumed to have "control" of such
company. This presumption may be rebutted by a showing that control does not
exist in fact. The Commissioner, however, may find that "control" exists in
circumstances in which a person owns or controls a smaller amount of voting
securities. To obtain approval from the Commissioner of any acquisition of
control of an insurance company, the proposed acquirer must file with the
Commissioner an application containing information regarding: the identity and
background of the acquirer and its affiliates; the nature, source and amount of
funds to be used to carry out the acquisition; the financial statements of the
acquirer and its affiliates; any potential plans for disposition of the
securities or business of the insurer; the number and type of securities to be
acquired; any contracts with respect to the securities to be acquired; any
agreements with broker-dealers; and other matters.





Other
jurisdictions in which our insurance subsidiaries are licensed to transact
business may have requirements for prior approval of any acquisition of control
of an insurance or reinsurance company licensed or authorized to transact
business in those jurisdictions. Additional requirements in those jurisdictions
may include re-licensing or subsequent approval for renewal of existing licenses
upon an acquisition of control. As further described below, laws that govern the
holding company structure also govern payment of dividends to us by our
insurance subsidiaries.





***Restrictions
on Subsidiaries’ Dividends and Other Payments***





We are a
holding company that transacts substantially all of our business directly and
indirectly through subsidiaries. Our primary assets are the stock of our
operating subsidiaries. Our ability to meet our obligations on our outstanding
debt and to pay dividends and our general and administrative expenses depends on
the surplus and earnings of our subsidiaries and the ability of our subsidiaries
to pay dividends or to advance or repay funds to us.





Under
Pennsylvania laws and regulations, our insurance subsidiaries may pay dividends
only from unassigned surplus and future earnings arising from their businesses
and must receive prior approval of the Pennsylvania








15
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Insurance
Commissioner to pay a dividend if such dividend would exceed the statutory
limitation. The current statutory limitation is the greater of (i) 10% of the
insurer's policyholders' surplus, as shown on its last annual statement on file
with the Pennsylvania Insurance Commissioner or (ii) the insurer's statutory net
income for the previous calendar year, but in no event to exceed statutory
unassigned surplus. Pennsylvania law gives the Pennsylvania Insurance
Commissioner broad discretion to disapprove requests for dividends in excess of
these limits. Pennsylvania law also provides that following the payment of any
dividend, the insurer's policyholders'surplus
must be reasonable in relation to its outstanding liabilities and adequate for
its financial needs, and permits the Pennsylvania Insurance Commissioner to
bring an action to rescind a dividend which violates these standards. In the
event that the Pennsylvania Insurance Commissioner determines that the
policyholders’ surplus of one subsidiary is inadequate, the Commissioner could
use his or her broad discretionary authority to seek to require us to apply
payments received from another subsidiary for the benefit of that insurance
subsidiary.





The
Pooled Companies paid dividends of $12.1 million to PMA Capital Corporation in
2004. As of December 31, 2004, The PMA Insurance Group’s Pooled Companies can
pay up to $23.5 million in dividends to PMA Capital Corporation during 2005
without the prior approval of the Pennsylvania Insurance Department. In
considering its future dividend policy, the Pooled Companies will consider,
among other things, the impact of paying dividends on its financial strength
ratings. See “Insurance Holding Company
Regulation” on page 14 for information regarding restrictions on PMACIC’s
ability to pay dividends to PMA Capital Corporation.





In
addition to the regulatory restrictions, we may not declare or pay cash
dividends or distributions on our Class A Common stock if we elect to exercise
our right to defer interest payments on our $43.8 million of trust preferred
debt outstanding.




***Risk-Based
Capital***





The
National Association of Insurance Commissioners (“NAIC”) has adopted risk-based
capital requirements for property/casualty insurance companies to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks such as asset quality, asset and liability matching, loss
reserve adequacy and other business factors. Under risk-based capital (“RBC”)
requirements, regulatory compliance is determined by the ratio of a company’s
total adjusted capital, as defined by the NAIC, to its authorized control level
of RBC (known as the RBC ratio), also as defined by the NAIC.





Four
levels of regulatory attention may be triggered if the RBC ratio is
insufficient:





·
    “Company
      action level”—If the RBC ratio is between 150% and 200%, then the insurer
      must submit a plan to the regulator detailing corrective action it
      proposes to undertake.





·
    “Regulatory
      action level”—If the RBC ratio is between 100% and 150%, then the insurer
      must submit a plan, but a regulator may also issue a corrective order
      requiring the insurer to comply within a specified period.





·
    “Authorized
      control level”—If the RBC ratio is between 70% and 100%, then the
      regulatory response is the same as at the “Regulatory action level,” but
      in addition, the regulator may take action to rehabilitate or liquidate
      the insurer.





·
    “Mandatory
      control level”—If the RBC ratio is less than 70%, then the regulator must
      rehabilitate or liquidate the insurer.





At
December 31, 2004, the RBC ratios of the Pooled Companies ranged from 428% to
1036% and PMACIC’s RBC ratio was 379%.





We
believe that we will be able to maintain the RBC ratios of our insurance
subsidiaries in excess of “Company action level” through prudent underwriting,
claims handling, investing and capital management. However, no assurances can be
given that developments affecting the insurance subsidiaries, many of which
could be outside of our control, including but not limited to changes in the
regulatory environment, economic conditions and competitive conditions in the
jurisdictions in which we write business, will not cause the RBC ratios to fall
below required levels resulting in a corresponding regulatory response.








16
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The NAIC
has also developed a series of twelve ratios (known as the IRIS ratios) designed
to further assist regulators in assessing the financial condition of insurers.
These ratio results are computed annually and reported to the NAIC and the
insurer’s state of domicile. In 2004, each of the Pooled Companies reported
unusual values in two ratios, relating to: (1) change in net premiums written,
and (2) investment yield. The unusual value related to change in net premiums
written was a result of our decrease in writings primarily due to the B++
financial strength rating. The unusual value related to investment yield related
primarily to a decrease in yield on our bond portfolio.





In 2004,
PMACIC reported five unusual values, relating to: (1) liabilities to liquid
assets ratio, (2) investment yield, (3) change in policyholder’s surplus, (4)
the two-year overall operating ratio, and (5) change in net premiums. The
unusual value relating to the liabilities to liquid assets ratio is principally
due to assets, such as funds held by reinsureds and deposit accounting assets,
that are not included as assets for purposes of the calculation. The unusual
value related to investment yield relates primarily to a decrease in yield on
our bond portfolio. The unusual value related to the change in policyholder’s
surplus is due to the transfer of the Pooled Companies to PMA Capital
Corporation during 2004. The unusual value relating to the two-year overall
operating ratio related to the unfavorable prior year loss development in 2003.
The unusual value for change in net premiums written related primarily to the
cessation of writing new business at PMACIC.




**EMPLOYEES**





As of
February 28, 2005, we had approximately 1,025 full-time employees. None of our
employees are represented by a labor union and we are not a party to any
collective bargaining agreements. We consider the relationship with our
employees to be good.




**AVAILABLE INFORMATION**





The
address for our internet website is www.pmacapital.com. We make available, free
of charge, through our internet website, our annual report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and all
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after we electronically file such material with, or furnish it to, the
SEC.





The
Annual Statements for PMACIC and the Pooled Companies, which we file with the
Pennsylvania Insurance Department, contain financial statements prepared in
accordance with statutory accounting practices. Annual Statements for the years
ended December 31, 2004, 2003 and 2002 for each of these subsidiaries are
available on the Investor Information portion of our website www.pmacapital.com .








17
 Table of Contents





**GLOSSARY OF SELECTED INSURANCE
TERMS**





Accident
      year
    The
      year in which an occurrence occurs, regardless of when any policies
      covering it are written, when the occurrence is reported, or when the
      associated claims are closed and paid.Acquisition
      expense
    The
      cost of acquiring both new and renewal insurance business, including
      commissions to agents or brokers and premium taxes.Agent
    One
      who negotiates insurance contracts on behalf of an insurer. The agent
      receives a commission for placement and other services
      rendered.Broker
    One
      who negotiates insurance or reinsurance contracts between parties. An
      insurance broker negotiates on behalf of an insured and a primary insurer.
      A reinsurance broker negotiates on behalf of a primary insurer or other
      reinsured and a reinsurer. The broker receives a commission for placement
      and other services rendered.Case
      reserves
    Loss
      reserves established with respect to individual reported
      claims.Casualty
      insurance and/orreinsurance
    Insurance
      and/or reinsurance that is concerned primarily with the losses caused by
      injuries to third persons (in other words, persons other than the
      policyholder) and the legal liability imposed on the insured resulting
      therefrom.Catastrophe
      reinsurance
    A
      form of excess of loss property reinsurance that, subject to a specified
      limit, indemnifies the ceding company for the amount of loss in excess of
      a specified retention with respect to an accumulation of losses resulting
      from a catastrophic event.Cede;
      ceding company
    When
      a company reinsures its risk with another, it “cedes” business and is
      referred to as the “ceding company.”Claims-made
      policy
    A
      term describing an insurance policy that covers claims made (reported or
      filed) during the year the policy is in force for any incidents that occur
      that year or during any previous period during which the insured was
      covered under a “claims-made” contract.Combined
      ratio
    The
      sum of losses and LAE, acquisition expenses, operating expenses and
      policyholders’ dividends, where applicable, all divided by net premiums
      earned.Direct
      reinsurer, directunderwriter,
      direct writer
    A
      reinsurer that markets and sells reinsurance directly to its reinsureds
      without the assistance of brokers.Excess
      and surplus lines
    Surplus
      lines risks are those risks not fitting normal underwriting patterns,
      involving a degree of risk that is not commensurate with standard rates
      and/or policy forms, or that will not be written by standard carriers
      because of general market conditions. Excess insurance refers to coverage
      that attaches for an insured over the limits of a primary policy or a
      stipulated self-insured retention. Policies are bound or accepted by
      carriers not licensed in the jurisdiction where the risk is located, and
      generally are not subject to regulations governing premium rates or policy
      language.Excess
      of loss reinsurance
    The
      generic term describing reinsurance that indemnifies the reinsured against
      all or a specified portion of losses on underlying insurance policies in
      excess of a specified dollar amount, called a “layer” or “retention.” Also
      known as nonproportional reinsurance.
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   Facultative
      reinsurance
    The
      reinsurance of all or a portion of the insurance provided by a single
      policy. Each policy reinsured is separately negotiated.Finite
      risk reinsurance
    A
      form of reinsurance combining common features of traditional reinsurance
      with additional features that recognize the reinsured’s needs regarding
      cash flows,
      investment yields and capital management. This type of reinsurance usually
      includes caps on the maximum gain or loss to the
      reinsurer.


Funds
      held
    The
      holding by a ceding company of funds representing the unearned premium
      reserve or the outstanding loss reserve applied to the business it cedes
      to a reinsurer.Gross
      premiums written
    Total
      premiums for direct insurance and reinsurance assumed during a given
      period.Incurred
      but not reported(“IBNR”)
      reserves
    Loss
      reserves for estimated losses that have been incurred but not yet reported
      to the insurer or reinsurer.Incurred
      losses
    The
      total losses sustained by an insurance company under a policy or policies,
      whether paid or unpaid. Incurred losses include a provision for claims
      that have occurred but have not yet been reported to the insurer
      (“IBNR”).Loss
      adjustment expenses("LAE")
    The
      expenses of settling claims, including legal and other fees and the
      portion of general expenses allocated to claim settlement
      costs.Loss
      and LAE ratio
    Loss
      and LAE ratio is equal to losses and LAE divided by earned premiums.Loss
      reserves
    Liabilities
      established by insurers and reinsurers to reflect the estimated cost of
      claims payments that the insurer or reinsurer ultimately will be required
      to pay in respect of insurance or reinsurance it has written. Reserves are
      established for losses and for LAE and consist of case reserves and bulk
      reserves.Manual
      rates
    Insurance
      rates for lines and classes of business that are approved and published by
      state insurance departments.Net
      premiums earned
    The
      portion of net premiums written that is earned during a period and
      recognized for accounting purposes as revenue.Net
      premiums written
    Gross
      premiums written for a given period less premiums ceded to reinsurers
      during such period.Occurrence
      policy
    A
      term describing an insurance policy that covers an incident occurring
      while the policy is in force regardless of when the claim arising out of
      that incident is asserted.Per
      occurrence
    A
      form of insurance or reinsurance under which the date of the loss event is
      deemed to be the date of the occurrence, regardless of when reported and
      permits all losses arising out of one event to be aggregated instead of
      being handled on a risk-by-risk basis.Policyholders’
      dividend ratio
    The
      ratio of policyholders’ dividends to earned premiums.Primary
      insurer
    An
      insurance company that issues insurance policies to consumers or
      businesses on a first dollar basis, sometimes subject to a
      deductible.
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  Pro
      rata reinsurance
    A
      form of reinsurance in which the reinsurer shares a proportional part of
      the ceded insurance liability, premiums and losses of the ceding company.
      Pro rata reinsurance also is known as proportional reinsurance or
      participating reinsurance.




Property
      insuranceand/or
      reinsurance
    Insurance
      and/or reinsurance that indemnifies a person with an insurable interest in
      tangible property for his property loss, damage or loss of
      use.Reinsurance
    A
      transaction whereby the reinsurer, for consideration, agrees to indemnify
      the reinsured company against all or part of the loss the company may
      sustain under the policy or policies it has issued. The reinsured may be
      referred to as the original or primary insurer, the direct writing company
      or the ceding company.Retention,
      retention layer
    The
      amount or portion of risk that an insurer or reinsurer retains for its own
      account. Losses in excess of the retention layer are paid by the reinsurer
      or retrocessionaire. In proportional treaties, the retention may be a
      percentage of the original policy’s limit. In excess of loss business, the
      retention is a dollar amount of loss, a loss ratio or a
      percentage.Retrocession;retrocessionaire
    A
      transaction whereby a reinsurer cedes to another reinsurer (the
      “retrocessionaires”) all or part of the reinsurance it has assumed.
      Retrocession does not legally discharge the ceding reinsurer from its
      liability with respect to its obligations to the
  reinsured.Statutory
      accountingprinciples
      ("SAP")
    Recording
      transactions and preparing financial statements in accordance with the
      rules and procedures prescribed or permitted by state insurance regulatory
      authorities and the NAIC.Statutory
      or policyholders’surplus;
      statutory capital&
      surplus
    The
      excess of admitted assets over total liabilities (including loss
      reserves), determined in accordance with SAP.Treaty
      reinsurance
    The
      reinsurance of a specified type or category of risks defined in a
      reinsurance agreement (a “treaty”) between a primary insurer or other
      reinsured and a reinsurer. Typically, in treaty reinsurance, the primary
      insurer or reinsured is obligated to offer and the reinsurer is obligated
      to accept a specified portion of all agreed upon types or categories of
      risks originally written by the primary insurer or
    reinsured.Underwriting
    The
      insurer’s/reinsurer's process of reviewing applications submitted for
      insurance coverage, deciding whether to accept all or part of the coverage
      requested and determining the applicable premiums.Unearned
      premiums
    The
      portion of a premium representing the unexpired portion of the exposure
      period as of a certain date.Unearned
      premium reserve
    Liabilities
      established by insurers and reinsurers to reflect unearned premiums which
      are refundable to policyholders if an insurance or reinsurance contract is
      canceled prior to expiration of the contract term.







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****


**RISK FACTORS**







Our
business faces significant risks. The risks described below may not be the only
risks we face. Additional risks that we do not yet know of or that we currently
think are immaterial may also impair our business operations. If any of the
following risks actually occur, our business, financial condition, results of
operations or prospects could be affected materially.





**Reserves
are estimates and do not and cannot represent an exact measure of liability. If
our actual losses from insureds exceed our loss reserves, our financial results
would be adversely affected.**




We
establish reserves representing estimates of future amounts needed to pay claims
with respect to insured events that have occurred, including events that have
not been reported to us. We also establish reserves for loss adjustment
expenses, which represent the estimated expenses of settling claims, including
legal and other fees, and general expenses of administering the claims
adjustment process. Our reserves as of December 31, 2004 were in the aggregate
$2.1 billion, consisting of $1.2 billion related to The PMA Insurance Group and
$919 million related to Run-off Operations. During the years ended December 31,
2003 and 2002, we increased our reserves for prior years’ losses and loss
adjustment expenses by $218.8 million and $159.7 million, respectively. Reserves
are estimates and do not and cannot represent an exact measure of liability. The
reserving process involves actuarial models, which rely on the basic assumption
that past experience, adjusted for the effect of current developments and likely
trends in claims severity, frequency, judicial theories of liability and other
factors, is an appropriate basis for predicting future events. The inherent
uncertainties of estimating insurance reserves are generally greater for
casualty coverages than for property coverages. Due to the “long-tail” nature of
a significant portion of our business, in many cases, significant periods of
time, ranging up to several years or more, may elapse between the occurrence of
an insured loss, the reporting of the loss to us and our payment of that loss.
We define long-tail business as those lines of business in which a majority of
coverage involves average loss payment lags of several years beyond the
expiration of the policy. Our major long-tail lines include our workers’
compensation and casualty reinsurance business. In addition, because reinsurers
rely on their ceding companies to provide them with information regarding
incurred losses, liabilities for reinsurers become known more slowly than for
primary insurers and are subject to more unforeseen development and
uncertainty.




Reserve
estimates are continually refined through an ongoing process as further claims
are reported and settled and additional information concerning loss experience
becomes known. Because setting reserves is inherently uncertain, our current
reserves may prove inadequate in light of subsequent developments. If we
increase our reserves, our earnings for the period will generally decrease by a
corresponding amount. Therefore, future reserve increases could have a material
adverse effect on our results of operations, financial condition and financial
strength and credit ratings.




**We
have recorded significant reserve charges in the past and if we experience
additional significant reserve charges it could adversely affect our ability to
continue in the ordinary course of our business.**




We have
recorded significant reserve charges in the past. In the third quarter of 2003,
we recorded a charge of $150 million pre-tax, related to higher than expected
underwriting losses, primarily from casualty reinsurance business written in
accident years 1997 to 2000. As a result of this charge, the financial strength
ratings of our insurance subsidiaries and our debt ratings were reduced, and we
decided to exit the reinsurance business. We also suspended the payment of our
regular cash dividend. Our capital position was also diminished. If, in the
future, actual losses and loss adjustment expenses develop larger than our loss
reserve estimates, which may be due to a wide range of factors, including
inflation, changes in claims and litigation trends and legislative or regulatory
changes, we would have to increase reserves. A significant increase in reserves
could have a material adverse effect on our ability to continue in the ordinary
course of our business.




**We
experienced a significant reduction in premium volume in 2004 following our
ratings downgrade.**




We
reported consolidated net premiums written of $1,192 million in 2003. For 2004,
we had consolidated net premiums written of $302 million, a decrease of $890
million, or 75%, from 2003. The lower net premiums written in 2004 reflect the
impact of our decision to exit the reinsurance business and, to a lesser extent,
the impact to The PMA Insurance Group’s operations of its “B++” A.M. Best
financial strength rating between November 2003 and November 2004. A further
reduction in premium volume, or a continuation of the reduced volumes
experienced in 2004, would have a material adverse effect on our results of
operations, liquidity and capital resources.







21
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**Because
insurance ratings, particularly from A.M. Best, are important to our
policyholders downgrades in our ratings may adversely affect
us.**




Nationally
recognized ratings agencies rate the financial strength of our principal
insurance subsidiaries. Ratings are not recommendations to buy our
securities.




Between
November 2003 and November 2004, The PMA Insurance Group’s financial strength
rating was downgraded from “A-” to “B++” which constrained its ability to
attract and retain business. Certain clients, particularly large account clients
and clients in the construction industry will not purchase property and casualty
insurance from insurers with less than an “A-” (4th of 16) A.M. Best rating. The
PMA Insurance Group’s “A-” rating was restored on November 15, 2004, however,
any future downgrade in The PMA Insurance Group’s A.M. Best rating could result
in a material loss of business as policyholders could move to other companies
with higher financial strength ratings and we could lose key executives
necessary to operate our business. Accordingly, such a downgrade to our insurer
financial strength ratings will likely result in lower premiums written and
lower profitability and would have a material adverse effect on our results of
operations, liquidity and capital resources.




These
ratings are subject to revision or withdrawal at any time by the rating
agencies, and therefore, no assurance can be given that we or our principal
insurance subsidiaries can maintain or improve these ratings. Each rating should
be evaluated independently of any other rating.




**The
Pennsylvania Insurance Department’s restriction on the declaration and payment
of dividends from PMA Capital Insurance Company could adversely affect our
ability to meet our obligations.**




In June
2004, the Pennsylvania Insurance Department approved our application for our
primary insurance subsidiaries that comprise The PMA Insurance Group, or the
Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly
owned subsidiaries of PMA Capital Corporation. As a result, the Pooled Companies
became direct subsidiaries of PMA Capital Corporation and can pay dividends
directly to PMA Capital Corporation. In its Order approving the unstacking, the
Pennsylvania Insurance Department prohibited PMACIC from any declaration or
payment of dividends or return of capital or any other types of distributions in
2004 and 2005 to PMA Capital Corporation. In 2006, PMACIC may declare and pay
ordinary dividends or return of capital without the prior approval of the
Pennsylvania Insurance Department if, immediately after giving effect to the
dividend or return of capital, PMACIC’s risk-based capital equals or exceeds
225% of Authorized Control Level Capital, as defined by the National Association
of Insurance Commissioners. In 2007 and beyond, PMACIC may make dividend
payments, as long as such dividends are not considered “extraordinary” under
Pennsylvania law. As a result, we may not be able to receive dividends from
PMACIC at times and in amounts necessary to meet our debt obligations and
corporate expenses. As of December 31, 2004, the statutory surplus of PMACIC was
$224.5 million and its risk based capital ratio was 379% of Authorized Control
Level Capital.




**We
may not have sufficient funds to satisfy our obligations under our indebtedness
and our other financial obligations.**




As of
December 31, 2004, we had $214.5 million of outstanding indebtedness. Our
ability to service our indebtedness and to meet our other financial obligations
will depend upon our future operating performance, which in turn is subject to
market conditions and other factors, including factors beyond our control. In
order to obtain funds sufficient to satisfy our obligations under our
indebtedness as well as meet our other financial obligations, we may need to
raise additional capital through the sale of securities or certain of our
assets. However, we may not be able to enter into or complete any such
transactions by the maturity date or put date of our indebtedness or on terms
and conditions that are acceptable to us. In addition, we may be required to use
all or a portion of the proceeds of such transactions to repay obligations under
our 6.50% Convertible Debt or our 8.50% Monthly Income Senior Notes due 2018.
Accordingly, we cannot assure you that we will have sufficient funds to satisfy
our obligations under our indebtedness and to meet our other financial
obligations.




**The
indentures governing our indebtedness restrict our ability to engage in certain
activities.**




The
indentures governing our indebtedness restrict our ability to, among other
things:




·  incur
additional debt;







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·  pay
dividends on or redeem or repurchase capital stock;




·  make
certain investments;




·  enter
into transactions with affiliates;




·  transfer
or dispose of capital stock of subsidiaries; and




·  merge or
consolidate with another company.




The above
restrictions could limit our ability to obtain future financing and may prevent
us from taking advantage of attractive business opportunities.




**Because
credit ratings are important to our creditors, downgrades in our credit ratings
may adversely affect us.**




Nationally
recognized rating agencies rate the debt of PMA Capital Corporation. Ratings are
not recommendations to buy our securities. A downgrade in our debt ratings will
affect our ability to raise additional debt with terms and conditions similar to
our current debt, and, accordingly, will increase our cost of capital. In
addition, a downgrade of our debt ratings will make it more difficult to raise
capital to refinance any maturing debt obligations and to maintain or improve
the current financial strength ratings of our principal insurance
subsidiaries.




**Our
reserves for asbestos and environmental claims may be
insufficient.**




Estimating
reserves for asbestos and environmental exposures continues to be difficult
because of several factors, including: (i) evolving methodologies for the
estimation of the liabilities; (ii) lack of reliable historical claim data;
(iii) uncertainties with respect to insurance and reinsurance coverage related
to these obligations; (iv) changing judicial interpretations; and (v) changing
government standards and regulations. We believe that our reserves for asbestos
and environmental claims are appropriately established based upon known facts,
existing case law and generally accepted actuarial methodologies. However, due
to changing interpretations by courts involving coverage issues, the potential
for changes in federal and state standards for clean-up and liability, as well
as issues involving policy provisions, allocation of liability and damages among
participating insurers, and proof of coverage, our ultimate exposure for these
claims may vary significantly from the amounts currently recorded, resulting in
a potential future adjustment that could be material to our financial condition,
results of operations and liquidity. At December 31, 2004, 2003 and 2002, gross
reserves for asbestos-related losses were $27.9 million, $37.8 million, and
$42.1 million, respectively ($14.0 million, $17.8 million and $25.8 million, net
of reinsurance, respectively). Of the net asbestos reserves, approximately $10.3
million, $14.9 million and $22.9 million related to IBNR losses at December 31,
2004, 2003 and 2002, respectively. At December 31, 2004, 2003 and 2002, gross
reserves for environmental-related losses were $16.1 million, $14.2 million and
$18.2 million, respectively ($6.4 million, $8.8 million and $14.3 million, net
of reinsurance, respectively). Of the net environmental reserves, approximately
$3.0 million, $3.7 million and $7.9 million related to IBNR losses at December
31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental
losses were for accident years 1986 and prior.




**The
effects of emerging claims and coverage issues on our business are
uncertain.**




As
industry practices and legal, judicial, social and other environmental
conditions change, unexpected and unintended issues related to claims and
coverage may emerge. These issues may harm our business by either extending
coverage beyond our underwriting intent or by increasing the number or size of
claims. Recent examples of emerging claims and coverage issues that have
affected us include:




·
    increases
      in the number and size of claims relating to construction defects and
      mold, which often present complex coverage and damage valuation questions,
      making it difficult for us to predict our exposure to losses;
      and




·
    changes
      in interpretation of the named insured provision with respect to the
      uninsured/ underinsured motorist coverage in commercial automobile
      policies, effectively broadening coverage and increasing our exposure to
      claims.







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The
effects of these and other unforeseen emerging claim and coverage issues are
extremely hard to predict and could harm our business.





**We
rely on independent agents and brokers and therefore we are exposed to certain
risks.**





Approximately
87% of The PMA Insurance Group’s business in 2004 was produced through
independent agents and brokers. We do business with a large number of
independent brokers on a non-exclusive basis and we cannot rely on their ongoing
commitment to our insurance products.





In
accordance with industry practice, our customers often pay the premiums for
their policies to agents and brokers for payment over to us. These premiums are
considered paid when received by the broker and, thereafter, the customer is no
longer liable to us for those amounts, whether or not we have actually received
the premiums from the agent or broker. Consequently, we assume a degree of
credit risk associated with our reliance on agents and brokers in connection
with the settlement of insurance balances.





Additionally,
the New York Attorney General and certain state regulators have initiated
investigations and commenced legal actions against certain brokers and other
insurance companies concerning their commission agreements and other
practices.  The outcome of these investigations and actions and the impact
of any regulatory changes governing agent and broker commissions is
uncertain.  Any disruption in the ability of agents and brokers to sell our
insurance products could harm our business.





**Our
failure to realize our deferred income tax asset could lead to a writedown,
which could adversely affect our results of operations.**





Realization
of our deferred income tax asset is dependent upon the generation of taxable
income in those jurisdictions where the relevant tax losses and other timing
differences exist. As of December 31, 2004, our net deferred tax asset was $86.5
million. Failure to achieve projected levels of profitability could lead to a
writedown in the deferred tax asset if the recovery period becomes uncertain or
longer than expected.





**We
face a risk of non-collectibility of reinsurance, which could materially affect
our results of operations.**





We follow
the insurance practice of reinsuring with other insurance and reinsurance
companies a portion of the risks under the policies written by our insurance and
reinsurance subsidiaries (known as ceding). During 2004, we had $352.3 million
of gross premiums written of which we ceded $50.7 million, or 14% of gross
premiums written, to reinsurers for reinsurance protection. This reinsurance is
maintained to protect our insurance and reinsurance subsidiaries against the
severity of losses on individual claims and unusually serious occurrences in
which a number of claims produce an aggregate extraordinary loss. Although
reinsurance does not discharge our subsidiaries from their primary obligation to
pay policyholders for losses insured under the policies we issue, reinsurance
does make the assuming reinsurer liable to the insurance subsidiaries for the
reinsured portion of the risk. As of December 31, 2004, we had $1.1 billion of
reinsurance receivables from reinsurers for paid and unpaid losses, for which
they are obligated to reimburse us under our reinsurance contracts. Our ability
to collect reinsurance is dependent upon numerous factors including the solvency
of our reinsurers, the payment performance of our reinsurers and whether there
are any disputes or collection issues with our reinsurers. We perform credit
reviews on our reinsurers, focusing on, among other things, financial capacity,
stability, trends and commitment to the reinsurance business. We also require
assets in trust, letters of credit or other acceptable collateral to support
balances due from reinsurers not authorized to transact business in the
applicable jurisdictions. Despite these measures, a reinsurer’s insolvency,
inability or unwillingness to make payments under the terms of a reinsurance
contract could have a material adverse effect on our results of operations and
financial condition.





**Because
we are heavily regulated by the states in which we do business, we may be
limited in the way we operate.**





We are
subject to extensive supervision and regulation in the states in which we do
business. The supervision and regulation relate to numerous aspects of our
business and financial condition. The primary purpose of the supervision and
regulation is the protection of our insurance policyholders, and not our
investors. The extent of regulation varies, but generally is governed by state
statutes. These statutes delegate regulatory, supervisory and administrative
authority to state insurance departments.


24
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This
system of supervision and regulation covers, among other things:


·
    standards
      of solvency, including risk-based capital
measurements;




·
    restrictions
      of certain transactions between our insurance subsidiaries and their
      affiliates, including us;




·
    restrictions
      on the nature, quality and concentration of
investments;




·
    limitations
      on the rates that we may charge on our primary insurance
      business;




·
    restrictions
      on the types of terms and conditions that we can include in the insurance
      policies offered by our primary insurance
operations;




·
    limitations
      on the amount of dividends that insurance subsidiaries can
      pay;




·
    the
      existence and licensing status of the company under circumstances where it
      is not writing new or renewal business;




·
    certain
      required methods of accounting;




·
    reserves
      for unearned premiums, losses and other purposes;
and




·
    assignment
      of residual market business and potential assessments for the provision of
      funds necessary for the settlement of covered claims under certain
      policies provided by impaired, insolvent or failed insurance
      companies.




On
December 22, 2003, PMACIC entered into a voluntary agreement with the
Pennsylvania Insurance Department. Pursuant to the agreement, PMACIC has agreed
to request the Pennsylvania Insurance Department’s prior approval of certain
actions, including: entering into any new reinsurance contracts, treaties or
agreements, except as may be required by law; making any payments, dividends or
other distributions to, or engaging in any transactions with, any of PMACIC’s
affiliates; making any withdrawal of monies from PMACIC’s bank accounts or
making any disbursements, payments or transfers of assets in an amount exceeding
five percent of the fair market value of PMACIC’s then aggregate cash and
investments; incurring any debt, obligation or liability for borrowed money,
pledging its assets or loaning monies to any person or entity (whether or not
affiliated); appointing any new director or executive officer; or altering its
or its Pennsylvania-domiciled insurance company subsidiaries’ ownership
structure. Finally, the Pennsylvania Insurance Department may impose additional
operational or administrative restrictions deemed necessary by the Pennsylvania
Insurance Commissioner for implementation of the agreement. These restrictions,
as well as any further restrictions on the conduct of PMACIC’s business, may
adversely affect its ability to efficiently conduct the run-off of its insurance
liabilities.





In June
2004, the Pennsylvania Insurance Department approved our application for the
Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly
owned subsidiaries of PMA Capital Corporation. However, in its Order approving
the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the
Pennsylvania Insurance Department prohibited PMACIC from any declaration or
payment of dividends, return of capital or any other types of distributions in
2004 and 2005 to PMA Capital Corporation. In 2006, PMACIC may declare and pay
ordinary dividends or returns of capital without the prior approval of the
Pennsylvania Insurance Department if, immediately after giving effect to the
dividend or returns of capital, PMACIC’s risk-based capital equals or exceeds
225% of Authorized Control Level Capital as defined by the National Association
of Insurance Commissioners. In 2007 and beyond, PMACIC may make dividend
payments, as long as such dividends are not considered “extraordinary” under
Pennsylvania insurance law.





The
regulations of the state insurance departments may affect the cost or demand for
our products and may impede us from obtaining rate increases on insurance
policies offered by our primary insurance operations or taking other actions we
might wish to take to increase our profitability. Further, we may be unable to
maintain all required licenses and approvals and our business may not fully
comply with the wide variety of applicable laws and regulations or the relevant
authority’s interpretation of the laws and regulations, which may change from
time to








25
 Table of Contents
 
 time.
Also, regulatory authorities have relatively broad discretion to grant, renew or
revoke licenses and approvals. If we do not have the requisite licenses and
approvals or do not comply with applicable regulatory requirements, theinsurance regulatory authorities could preclude or temporarily suspend us
from carrying on some or all of our activities or impose substantial fines.
Further, insurance regulatory authorities have relatively broad discretion to
issue orders of supervision, which permit such authorities to supervise the
business and operations of an insurance company. As of December 31, 2004, no
state insurance regulatory authority had imposed on us any substantial fines or
revoked or suspended any of our licenses to conduct insurance business in any
state or issued an order of supervision with respect to our insurance
subsidiaries, which would have a material adverse effect on our results of
operations or financial condition. In light of recent insolvencies of large
property and casualty insurers, it is possible that the regulations governing
the level of the guaranty fund or association assessments against us may change,
requiring us to increase our level of payments.




**Our
results may fluctuate as a result of many factors, including cyclical changes in
the insurance industry.**




The
results of companies in the property and casualty insurance industry
historically have been subject to significant fluctuations and uncertainties.
The industry’s profitability can be affected significantly by:




·
    rising
      levels of actual costs that are not known by companies at the time they
      price their products;




·
    volatile
      and unpredictable developments, including man-made, weather-related and
      other natural catastrophes;




·
    changes
      in reserves resulting from the general claims and legal environments as
      different types of claims arise and judicial interpretations relating to
      the scope of insurers’ liability develop;




·
    fluctuations
      in interest rates, inflationary pressures and other changes in the
      investment environment, which affect returns on invested capital and may
      impact the ultimate payout of losses; and




·
    volatility
      associated with the long-tail nature of the reinsurance business, which
      may impact our operating results.




The
property and casualty insurance industry historically is cyclical in nature. The
demand for property and casualty insurance can vary significantly, rising as the
overall level of economic activity increases and falling as such activity
decreases. The property and casualty insurance industry has been very
competitive and the fluctuations in demand and competition and the impact on us
of other factors identified above could have a negative impact on our results of
operations and financial condition.




**We
operate in a highly competitive industry which makes it more difficult to
attract and retain new business.**




Our
business is highly competitive and we believe that it will remain so for the
foreseeable future. The PMA Insurance Group has six major competitors: Liberty
Mutual Insurance Company, American International Group, Inc., Zurich/Farmers
Group, St. Paul Travelers, The Hartford Insurance Group and CNA. All of these
companies and some of our other competitors have greater financial, marketing
and management resources than we do.




A number
of new, proposed or potential legislative or industry developments could further
increase competition in our industry. These developments include:




·
    an
      influx of new capital in the marketplace as existing companies attempt to
      expand their business and new companies attempt to enter the insurance and
      reinsurance business;




·
    the
      enactment of the Gramm-Leach-Bliley Act of 1999 (which permits financial
      services companies, such as banks and brokerage firms, to engage in
      certain insurance activities), which could result in increased competition
      from financial services companies;




·
    programs
      in which state-sponsored entities provide property insurance in
      catastrophe-prone areas or other alternative markets types of coverage;
      and







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·
    changing
      practices caused by technology, which have led to greater competition in
      the insurance business.




Many
commercial property and casualty insurers and industry groups and associations
currently offer alternative forms of risk protection in addition to traditional
insurance products. These products, including large deductible programs and
various forms of self-insurance that utilize captive insurance companies and
risk retention groups, have been instituted to allow for better control of risk
management and costs. We cannot predict how continued growth in alternative
forms of risk protection will affect our future results of operations, but it
could reduce our premium volume.




Following
the terrorist attacks on September 11, 2001, a number of new insurers and
reinsurers have been formed to compete in our industry, and a number of existing
market participants have raised new capital which may enhance their ability to
compete with us. In addition, other financial institutions are now able to offer
services similar to our own as a result of the Gramm-Leach-Bliley Act, which was
adopted in November 1999.




**Because
our investment portfolio is primarily fixed-income securities, the fair value of
our investment portfolio and our investment income could suffer as a result of
fluctuations in interest rates.**




We
currently maintain and intend to continue to maintain an investment portfolio
primarily of fixed-income securities. The fair value of these securities can
fluctuate depending on changes in interest rates. Generally, the fair market
value of these investments increases or decreases in an inverse relationship to
changes in interest rates, while net investment income earned by us from future
investments in fixed-income securities will generally increase or decrease with
interest rates. Our overall investment strategy is to invest in high quality
securities while maintaining diversification to avoid significant concentrations
in individual issuers, industry segments and geographic regions. However, there
can be no assurance that our investment securities will not become impaired or
decline in quality or value. All of our fixed-income securities are classified
as available for sale; as a result, changes in the market value of our
fixed-income securities are reflected in our balance sheet. Accordingly, changes
in interest rates may result in fluctuations in the income from, and the
valuation of, our fixed-income investments, which could have an adverse effect
on our results of operations and financial condition.




**Our
business is dependent upon our key executives, certain of whom do not have
employment agreements with restrictive covenants and can leave our employment at
any time.**




Our
success depends significantly on the efforts and abilities of our key
executives. We currently have employment agreements that include restrictive
covenants with three of our key executives; however, we do not have employment
agreements with our other executives. Accordingly, such other executives may
leave our employ at any time. Our future results of operations could be
adversely affected if we are unable to retain our current executives, attract
new executives or if our current executives leave our employ and join companies
that compete with us.




**We
have exposure to catastrophic events, which can materially affect our financial
results.**




We are
subject to claims arising out of catastrophes that may have a significant effect
on our results of operations, liquidity and financial condition. Catastrophes
can be caused by various events, including hurricanes, windstorms, earthquakes,
hailstorms, explosions, severe winter weather and fires. The incidence and
severity of catastrophes are inherently unpredictable. The extent of losses from
a catastrophe is a function of both the total amount of insured exposure in the
area affected by the event and the severity of the event. Insurance companies
are not permitted to reserve for catastrophes until such event takes place.
Therefore, although we actively manage our exposure to catastrophes through our
underwriting process and the purchase of reinsurance protection, an especially
severe catastrophe or series of catastrophes, or terrorist event, could
exceed our reinsurance protection and may have a material adverse impact on our
financial condition, results of operations and liquidity.




Man-made
events, such as terrorism, can also cause catastrophes. For example, the attack
on the World Trade Center has, to date, resulted in approximately $30 million in
pre-tax losses to us, after deduction of all reinsurance and retrocessional
protection, for 2001. Because of the jury verdict on December 6, 2004 that
concluded that the attack on the World Trade Center was two occurrences instead
of one, this estimate may change. However, it is difficult to fully estimate our
losses from the attack given the uncertain nature of damage theories and loss
amounts, the possible development of additional facts related to the attack and
whether the recent court decision will







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be
successfully appealed. As more information becomes available, we may need to
change our estimate of these losses.




Although
the Terrorism Risk Insurance Act of 2002 (“TRIA”) may mitigate the impact of
future terrorism losses in connection with the commercial insurance business
offered by The PMA Insurance Group, because of its uncertain application, the
amount of losses a company must retain and the fact that it does not apply to
reinsurance business, future terrorist attacks may result in losses that have a
material adverse effect on our financial condition, results of operations and
liquidity. TRIA expires on December 31, 2005 and although legislation has been
introduced in Congress to extend TRIA, there is no assurance that it will be
re-enacted or extended.




**We
face a risk of non-availability of reinsurance, which could materially affect
our ability to write business and our results of
operations.**




Market
conditions beyond our control, such as the amount of surplus in the reinsurance
market and natural and man-made catastrophes, determine the availability and
cost of the reinsurance protection we purchase. We cannot assure you that
reinsurance will remain continuously available to us to the same extent and on
the same terms and rates as are currently available. If we are unable to
maintain our current level of reinsurance or purchase new reinsurance protection
in amounts that we consider sufficient, we would either have to be willing to
accept an increase in our net exposures or reduce our insurance
writings.




**Purported
class action lawsuits may result in financial losses and may divert management
resources. In addition, we are subject to litigation in the ordinary course of
our business.**




We and
certain of our directors and key executive officers are defendants in several
purported class actions that were filed in 2003 in the United States District
Court for the Eastern District of Pennsylvania by alleged purchasers of our
Class A common stock, the 4.25% Senior Convertible Debentures due 2022 and 8.50%
Monthly Income Senior Notes due 2018. On June 28, 2004, the District Court
issued an order consolidating the cases under the caption In Re
PMA Capital Corporation Securities Litigation (civil
action no. 03-6121) and appointing Sheet Metal Workers Local 9 Pension Trust,
Alaska Laborers Employers Retirement Fund and Communications Workers of America
for Employees’ Pension and Death Benefits as lead plaintiff. On September 20,
2004, the plaintiffs filed an amended and consolidated complaint on behalf of an
alleged class of purchasers of our securities between May 5, 1999 and February
11, 2004. The complaint alleges, among other things, that the defendants
violated Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder by making
materially false and misleading public statements and material omissions during
the class period regarding our underwriting performance, loss reserves and
related internal controls. The complaint alleges, among other things, that the
defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act by making
materially false and misleading statements in registration statements and
prospectuses about our financial results, underwriting performance, loss
reserves and related internal controls.




The
complaint seeks unspecified compensatory damages, the right to rescind the
purchases of securities in the public offerings, interest, and plaintiffs’
reasonable costs and expenses, including attorneys’ fees and expert fees. We
intend to vigorously defend against the claims asserted in this consolidated
action. The lawsuit is in its earliest stages; therefore, it is not possible at
this time to reasonably estimate the impact on us. However, the lawsuit may have
a material adverse effect on our financial condition, results of operations and
liquidity.




We are
continuously involved in numerous lawsuits arising, for the most part, in the
ordinary course of business, either as a liability insurer defending third-party
claims brought against our insureds, or as an insurer defending coverage claims
brought against it by our policyholders or other insurers.




**We
may require additional capital in the future, which may not be available or may
be available only on unfavorable terms.**




Our
capital requirements depend on many factors, including our ability to write new
and renewal business and rating agency capital requirements. To the extent that
our existing capital is insufficient to meet these requirements, we may need to
raise additional funds through financings.




Any
equity or debt financing, if available at all, may be on terms that are not
favorable to us. Equity financings could result in dilution to our shareholders
and the securities may have rights, preferences and privileges that are senior
to those of our shares of common stock. If our need for capital arises because
of significant losses,







28
 Table of Contents





the
occurrence of these losses may make it more difficult for us to raise the
necessary capital. If we cannot obtain adequate capital on favorable terms or at
all, our business, operating results and financial condition could be adversely
affected.




**We
are an insurance holding company with no direct operations. Statutory
requirements governing dividends from our principal operating subsidiaries could
adversely affect our ability to meet our obligations.**




We are a
holding company that transacts substantially all of our business directly and
indirectly through subsidiaries. Our primary assets are the stock of our
operating subsidiaries. Our ability to meet our obligations on our outstanding
debt and to pay dividends and our general and administrative expenses depends on
the surplus and earnings of our subsidiaries and the ability of our subsidiaries
to pay dividends or to advance or repay funds to us. Payments of dividends
within any twelve month period and advances and repayments by our insurance
operating subsidiaries are restricted by state insurance laws, including laws
establishing minimum solvency and liquidity thresholds. Generally this
limitation is the greater of statutory net income for the preceding calendar
year or 10% of the statutory surplus, but only to the extent of unassigned
surplus. In addition, insurance regulators have broad powers to prevent
reduction of statutory surplus to inadequate levels, and could refuse to permit
the payment of dividends of the maximum amounts calculated under any applicable
formula.




**Provisions
in our charter documents may impede attempts to replace or remove our board or
management with management favored by shareholders.**




Our
Restated Articles of Incorporation and Amended and Restated Bylaws contain
provisions that could delay or prevent changes in our board of directors or
management that shareholders may desire. These provisions include:




·
    requiring
      advance notice requirements for nominations for election to the board of
      directors or for proposing business that can be acted on by shareholders
      at meetings;




·
    establishing
      a classified board of directors and permitting our board to increase its
      size and appoint directors to fill newly created board
      vacancies;




·
    requiring
      shareholders to show cause to remove one or more directors;
      and




·
    prohibiting
      shareholders from acting by written
consent.










29
 Table of Contents





**Item
2.****Properties**





Our
headquarters are located in a four story, 110,000 square foot building that we
own in Blue Bell, Pennsylvania. We lease approximately 27,000 square feet in
Philadelphia, Pennsylvania. We also lease approximately 63,000 square feet of
office space in Yardley, Pennsylvania, which previously housed our excess and
surplus lines business and now is subleased to an unaffiliated third party.





Through
various wholly owned subsidiaries, we also own and occupy additional office
facilities in three other locations and rent additional office space for our
insurance operations in 16 other locations. We believe that such owned and
leased properties are suitable and adequate for our current business
operations.




**Item
3.****Legal
Proceedings**





We are
continuously involved in numerous lawsuits arising, for the most part, in the
ordinary course of business, either as a liability insurer defending third-party
claims brought against our insureds, or as an insurer defending coverage claims
brought against it by our policyholders or other insurers. While the outcome of
all litigation involving us, including insurance-related litigation, cannot be
determined, litigation is not expected to result in losses that differ from
recorded reserves by amounts that would be material to our financial condition,
results of operations or liquidity. In addition, reinsurance recoveries related
to claims in litigation, net of the allowance for uncollectible reinsurance, are
not expected to result in recoveries that differ from recorded receivables by
amounts that would be material to our financial condition, results of operations
or liquidity.





We and
certain of our directors and key executive officers are defendants in several
purported class actions that were filed in 2003 in the United States District
Court for the Eastern District of Pennsylvania by alleged purchasers of our
Class A common stock, the 4.25% Senior Convertible Debentures due 2022 and 8.50%
Monthly Income Senior Notes due 2018. On June 28, 2004, the District Court
issued an order consolidating the cases under the caption In Re
PMA Capital Corporation Securities Litigation (civil
action no. 03-6121) and appointing Sheet Metal Workers Local 9 Pension Trust,
Alaska Laborers Employers Retirement Fund and Communications Workers of America
for Employees’ Pension and Death Benefits as lead plaintiff. On September 20,
2004, the plaintiffs filed an amended and consolidated complaint on behalf of an
alleged class of purchasers of our securities between May 5, 1999 and February
11, 2004. The complaint alleges, among other things, that the defendants
violated Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder by making
materially false and misleading public statements and material omissions during
the class period regarding our underwriting performance, loss reserves and
related internal controls. The complaint alleges, among other things, that the
defendants violated Sections 11, 12(a)(2) and 15 of the Securities Act by making
materially false and misleading statements in registration statements and
prospectuses about our financial results, underwriting performance, loss
reserves and related internal controls.


The
complaint seeks unspecified compensatory damages, the right to rescind the
purchases of securities in the public offerings, interest, and plaintiffs’
reasonable costs and expenses, including attorneys’ fees and expert
fees. We intend to vigorously defend against the claims asserted in this
consolidated action. The lawsuit is in its earliest stages; therefore, it is not
possible at this time to reasonably estimate the impact on us. However, the
lawsuit may have a material adverse effect on our financial condition,
results of operations and liquidity.





On
December 15, 2004, we filed a motion to dismiss with the United States District
Court for the Eastern District of Pennsylvania. The Judge has scheduled oral
arguments with respect to our motion on April 11, 2005.





30
 Table of Contents





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





There
were no matters submitted to a vote of security holders during the fourth
quarter of 2004.




***Executive Officers of the
Registrant***





Our
executive officers are as follows:





Name
    Age
    PositionVincent
      T. Donnelly
    52
    President
      and Chief Executive OfficerWilliam
      E. Hitselberger
    47
    Executive
      Vice President and Chief Financial OfficerRobert
      L. Pratter
    60
    Senior
      Vice President, General Counsel and
Secretary




Vincent
T. Donnelly was elected as President and Chief Executive Officer in February
2004 and served as head of the interim-Office of the President from November
2003 to February 2004. Prior to that, he served as President and Chief Operating
Officer of The PMA Insurance Group since February 1997, and has served as
Executive Vice President of PMA Capital Insurance Company since November 2000.
Mr. Donnelly served as Senior Vice President Finance and Chief Actuary of The
PMA Insurance Group from 1995 to 1997.





William
E. Hitselberger was elected as Executive Vice President in April 2004 and serves
as our Chief Financial Officer. Prior to that date, he had served as our Senior
Vice President, Chief Financial Officer and Treasurer since June 2002. He has
also served as Vice President and Chief Financial Officer of The PMA Insurance
Group from 1998 to June 2002 and Vice President of The PMA Insurance Group from
1996 to 1998.





Robert L.
Pratter has served as our Senior Vice President, General Counsel and Secretary
since June 1999, and has served as Vice President and General Counsel of PMA
Capital Insurance Company since November 2000. From 1969 to 1999, Mr. Pratter
was an attorney and partner in the law firm of Duane Morris LLP.








31
 Table of Contents





**PART II**





**Item
5.****Market
for the Registrant’s Common Equity, Related Shareholder Matters and Issuer
Purchases of Equity Securities**





Our Class
A Common stock is listed on The Nasdaq Stock Market  ̈ . It trades
under the stock symbol: PMACA.





Following
is information regarding trading prices for our Class A Common
Stock:





First
    
    
    Second
    
    
    Third
    
    
    FourthQuarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter**2004****Class
      A Common Stock Prices:**High
    
    **$**
    7.08
    
    $
    9.13
    
    $
    9.16
    
    $
    10.85Low
    
    
    4.70
    
    
    6.01
    
    
    5.70
    
    
    6.74Close
    
    
    6.07
    
    
    9.00
    
    
    7.55
    
    
    10.35**2003****Class
      A Common Stock Prices:**High
    
    $
    15.00
    
    $
    12.76
    
    $
    13.10
    
    $
    14.25
    ****Low
    ****
    ****
    6.40
    
    
    6.28
    
    
    11.53
    
    
    3.88Close
    ****
    ****
    6.77
    
    
    12.12
    
    
    12.53
    
    
    5.12
    ********
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****
    ****





There
were 192 holders of record of our Class A Common stock at February 28,
2005. We declared quarterly dividends of $0.105 per share for our Class A Common
stock in the first three quarters of 2003. On November 4, 2003, our Board of
Directors resolved to suspend the dividends on our Class A Common stock. Our
domestic insurance subsidiaries’ ability to pay dividends to us is limited by
the insurance laws and regulations of Pennsylvania. Furthermore, in its Order
approving the transfer of the Pooled Companies from PMA Capital Insurance
Company ("PMACIC") to PMA Capital Corporation, the Pennsylvania Insurance
Department prohibited PMACIC from any declaration or payment of dividends,
return of capital or any other types of distributions in 2004 and 2005. In 2006,
PMACIC may declare and pay ordinary dividends or returns of capital without the
prior approval of the Pennsylvania Insurance Department if, immediately after
giving effect to the dividend or returns of capital, PMACIC’s risk-based capital
equals or exceeds 225% of Authorized Control Level Capital as defined by the
National Association of Insurance Commissioners. For additional information on
these restrictions, see “Item 7 -
MD&A - Liquidity and Capital Resources.”





*Issuer
Purchase of* *Equity
Securities*





The
following table provides information regarding repurchases we made of our
convertible debt during 2004:





Period
    
    
    Total
      Number of Shares Purchased
    
    
    Average
      Price Paid per Share
    
    
    Total
      Number of Shares Purchased as Part of Publicly Announced Plans or
      Programs
    
    
    Maximum
      Number of Shares that May yet be Purchased Under Publicly Announced Plans
      or Programs10/1/04-10/31/04
    
    
    -
    
    
    -
    
    
    -
    
    
    -11/1/04-11/30/04
    
    
    -
    
    
    -
    
    
    -
    
    
    -12/1/04-12/31/04(1)
    
    
    72,397
    
    $
    16.368
    
    
    -
    
    
    -
   *(1)*
    *Transactions
      represent the repurchase of a portion of our outstanding 4.25% Convertible
      Debt prior to its scheduled maturity. The average price paid per share is
      calculated by dividing the total cash paid for the debt by the number of
      shares of Class A common stock into which the debt is currently
      convertible.*











32
 Table of Contents





**Item
6.****Selected
Financial Data**





*(dollar
      amounts in thousands, except per share data)*
    
    
    2004
    
    
    2003(1
    )
    
    2002(1
    )
    
    2001(1
    )
    
    2000**Net
      Premiums Written**
    
    $
    301,610
    
    $
    1,192,254
    
    $
    1,104,997
    
    $
    769,058
    
    $
    545,555**Consolidated
      Results of Operations:**Net
      premiums earned
    
    $
    518,585
    
    $
    1,198,165
    
    $
    991,011
    
    $
    732,440
    
    $
    531,424Net
      investment income
    
    
    56,945
    
    
    68,923
    
    
    84,881
    
    
    86,945
    
    
    102,591Net
      realized investment gains (losses)
    
    
    6,493
    
    
    13,780
    
    
    (16,085
    )
    
    7,988
    
    
    11,975Other
      revenues
    
    
    25,941
    
    
    20,379
    
    
    15,330
    
    
    22,599
    
    
    14,000Total
      consolidated revenues
    
    $
    607,964
    
    $
    1,301,247
    
    $
    1,075,137
    
    $
    849,972
    
    $
    659,990**Net
      income (loss)**
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )
    $
    7,103
    
    $
    1,325**Per
      Share Data:**Weighted
      average shares:Basic
    
    
    31,344,858
    
    
    31,330,183
    
    
    31,284,848
    
    
    21,831,725
    
    
    21,898,967Diluted
    
    
    31,729,061
    
    
    31,330,183
    
    
    31,284,848
    
    
    22,216,695
    
    
    22,353,622Net
      income (loss) per shareBasic
    
    $
    0.06
    
    $
    (2.99
    )
    $
    (1.53
    )
    $
    0.33
    
    $
    0.06Diluted
    
    $
    0.06
    
    $
    (2.99
    )
    $
    (1.53
    )
    $
    0.32
    
    $
    0.06Dividends
      declared per Common share(2)
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    0.08Dividends
      declared per Class A Common share(2)
    
    $
    -
    
    $
    0.315
    
    $
    0.42
    
    $
    0.42
    
    $
    0.39Shareholders'
      equity per share
    
    $
    14.06
    
    $
    14.80
    
    $
    18.56
    
    $
    19.64
    
    $
    20.40**Consolidated
      Financial Position:**Total
      investments
    
    $
    1,427,832
    
    $
    2,012,187
    
    $
    1,828,610
    
    $
    1,775,335
    
    $
    1,826,949Total
      assets
    
    
    3,253,985
    
    
    4,187,958
    
    
    4,105,794
    
    
    3,802,979
    
    
    3,469,406Reserves
      for unpaid losses and LAE
    
    
    2,111,598
    
    
    2,541,318
    
    
    2,449,890
    
    
    2,324,439
    
    
    2,053,138Debt
    
    
    214,467
    
    
    187,566
    
    
    151,250
    
    
    62,500
    
    
    163,000Shareholders'
      equity
    
    
    445,451
    
    
    463,667
    
    
    581,390
    
    
    612,006
    
    
    440,046





*(1)*
    *Results
      for 2003 were impacted by $49 million from the recording of a valuation
      allowance on the Company’s deferred tax asset.**Results
      for 2002 were impacted by $43 million pre-tax ($28 million after-tax) for
      costs associated with the exit from and run off of Caliber One, our former
      excess and surplus lines business. Results for 2001 were impacted by $30
      million pre-tax ($20 million after-tax) for World Trade Center
      losses.*


*(2)*
    *Effective
      at the close of business April 24, 2000, all shares of Common Stock were
      reclassified as Class A Common stock. Accordingly, all dividends
      subsequent to April 24, 2000 are for the Class A Common
      stock.*





33
 Table of Contents





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    (1)
    
    
    
    
    2002
    (1)
    
    
    
    
    2001
    (1)
    
    
    
    
    2000**Components
      of net income (loss)****(3)****:**Pre-tax
      operating income (loss):The
      PMA Insurance Group
    
    $
    13,166
    
    $
    21,541
    
    
    
    
    $
    25,346
    
    
    
    
    $
    23,148
    
    
    
    
    $
    21,601Run-off
      Operations(4)
    
    
    5,509
    
    
    (80,376
    )
    
    
    
    
    (74,204
    )
    
    
    
    
    (29,355
    )
    
    
    
    
    (14,436
    )Corporate
      and Other
    
    
    (21,223
    )
    
    (22,691
    )
    
    
    
    
    (14,214
    )
    
    
    
    
    (6,197
    )
    
    
    
    
    (19,017
    )Net
      realized investment gains (losses)
    
    
    6,493
    
    
    13,780
    
    
    
    
    
    (16,085
    )
    
    
    
    
    7,988
    
    
    
    
    
    11,975Income
      (loss) before income taxes
    
    
    3,945
    
    
    (67,746
    )
    
    
    
    
    (79,157
    )
    
    
    
    
    (4,416
    )
    
    
    
    
    123Income
      tax expense (benefit)
    
    
    2,115
    
    
    25,823
    
    
    
    
    
    (31,133
    )
    
    
    
    
    (11,519
    )
    
    
    
    
    (1,202
    )**Net
      income (loss)**
    
    $
    1,830
    
    $
    (93,569
    )
    
    
    
    $
    (48,024
    )
    
    
    
    $
    7,103
    
    
    
    
    $
    1,325**GAAP
      Insurance Ratios:**The
      PMA Insurance Group:Loss
      and LAE ratio
    
    
    74.9%
    
    
    77.6%
    
    
    
    
    
    75.0%
    
    
    
    
    
    74.7%
    
    
    
    
    
    74.9%Expense
      Ratio(5)
    
    
    29.4%
    
    
    25.1%
    
    
    
    
    
    26.4%
    
    
    
    
    
    26.7%
    
    
    
    
    
    29.3%Policyholders'
      dividend ratio
    
    
    1.1%
    
    
    0.1%
    
    
    
    
    
    1.8%
    
    
    
    
    
    4.1%
    
    
    
    
    
    7.5%Combined
      ratio(6)
    
    
    105.4%
    
    
    102.8%
    
    
    
    
    
    103.2%
    
    
    
    
    
    105.5%
    
    
    
    
    
    111.7%Operating
      ratio(7)
    
    
    98.4%
    
    
    97.0%
    
    
    
    
    
    94.5%
    
    
    
    
    
    94.1%
    
    
    
    
    
    92.7%




*(3)*
    *In
      addition to providing consolidated net income (loss), we also provide
      segment operating income (loss) because we believe that it is a meaningful
      measure of the profit or loss generated by our operating segments.
      Operating income (loss), which is GAAP net income (loss) excluding net
      realized investment gains and losses, is the financial performance measure
      used by our management and Board of Directors to evaluate and assess the
      results of our insurance businesses. Accordingly, we report operating
      income by segment in Note 16 to our Consolidated Financial Statements as
      required by SFAS No. 131, "Disclosures About Segments of an Enterprise and
      Related Information." Our management and Board of Directors use operating
      income as the measure of financial performance because (i) net realized
      investment gains and losses are unpredictable and not necessarily
      indicative of current operating fundamentals or future performance of the
      business segments and (ii) in many instances, decisions to buy and sell
      securities are made at the holding company level, and such decisions
      result in net realized gains and losses that do not relate to the
      operations of the individual segments. Operating income (loss) does not
      replace net income (loss) as the GAAP measure of our consolidated results
      of operations.*


*(4)*
    *On
      November 6, 2003, we announced our decision to withdraw from the
      reinsurance business previously served by PMA Re. As a result of this
      decision, the results of PMA Re are reported as Run-off Operations. In May
      2002, we exited the excess and surplus lines business and placed this
      business, formerly known as Caliber One, into
run-off.*


*(5)*
    *The
      expense ratio equals the sum of acquisition and insurance-related
      operating expenses divided by net premiums earned. Acquisition and
      insurance-related expenses for The PMA Insurance Group were $129.7
      million, $142.7 million, $108.6 million, $92.3 million and $72.5 million
      for 2004, 2003, 2002, 2001 and
2000.*


*(6)*
    *The
      combined ratio computed on a GAAP basis is equal to losses and loss
      adjustment expenses plus acquisition expenses and policyholders' dividends
      (where applicable), all divided by net premiums
earned.*


*(7)*
    *The
      operating ratio is equal to the combined ratio less the net investment
      income ratio, which is computed by dividing net investment income by net
      premiums earned.*








34
 Table of Contents





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





The
following is a discussion of the financial condition of PMA Capital Corporation
and its consolidated subsidiaries (“PMA Capital” or the “Company” which also may
be referred to as “we” or “us”) as of December 31, 200 4,
compared with December 31, 2003, and the results of operations of PMA Capital
for 2004 and 2003, compared with the immediately preceding year. The balance
sheet information presented below is as of December 31 for each respective year.
The statement of operations information is for the year ended December 31 for
each respective year.





This
discussion and analysis should be read in conjunction with our audited
Consolidated Financial Statements and Notes thereto presented in Item 8 of this
Form 10-K (“Consolidated Financial Statements”). You should also read our
discussion of Critical Accounting Estimates beginning on page 55 for an
explanation of those accounting estimates that we believe are most important to
the portrayal of our financial condition and results of operations and that
require our most difficult, subjective and complex judgments.





This
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (“MD&A”) contains forward-looking statements, which involve
inherent risks and uncertainties. Statements that are not historical facts,
including statements about our beliefs and expectations, and containing words
such as “believe,” “estimate,” “anticipate,” “expect” or similar words, are
forward-looking statements. These statements are based upon current estimates,
assumptions and projections. Actual results may differ materially from those
projected in such forward-looking statements, and therefore, you should not
place undue reliance on them. See “Cautionary Statements” beginning on page
59 for a list of factors that could cause our actual results to differ
materially from those contained in any forward-looking statement. Also, see “Item 1 - Business - Risk Factors” for a further
discussion of risks that could materially affect our business.





**OVERVIEW**





We are a
property and casualty insurance holding company, which offers through our
subsidiaries workers’ compensation, integrated disability and, to a lesser
extent, other standard lines of commercial insurance, primarily in the eastern
part of the United States. These products are written through The PMA Insurance
Group business segment. Our Run-off Operations include our prior reinsurance and
excess and surplus lines operations.





Our
business profile changed significantly
in 2003 and 2004. On November 4, 2003, we announced a third quarter pre-tax
charge of $150 million to increase the loss reserves for our reinsurance
business for prior accident years. Following this announcement, A.M. Best
Company, Inc. (“A.M. Best”) reduced the financial strength ratings of PMA
Capital Insurance Company (“PMACIC”), our reinsurance subsidiary, and The PMA
Insurance Group companies, our primary insurance business, to B++ (Very Good).
On November 6, 2003, we announced our decision to cease writing reinsurance
business and to run off our existing reinsurance business. We also decided to
suspend payment of dividends on our Class A common stock. The B++ financial
strength rating constrained The PMA Insurance Group’s ability to attract and
retain business during 2004.





We
achieved o ur most
important goal for 2004, the restoration of The PMA Insurance Group's A-
(Excellent) financial strength rating, on November
15, 2004. We
believe the restoration of The PMA Insurance Group’s A-financial strength rating
will enable us to achieve measured written premium growth in 2005, compared to
2004.





I n June
2004, the Pennsylvania Insurance Department approved our application for our
primary insurance subsidiaries that comprise The PMA Insurance Group, or the
Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly
owned subsidiaries of PMA Capital Corporation. As a result, the Pooled Companies
can pay dividends directly to PMA Capital Corporation. In 2004, the Pooled
Companies paid dividends of  $12.1 million to PMA Capital and can pay up to
$23.5 million in dividends in 2005 without the prior approval of the
Pennsylvania Insurance Department.





In its
Order approving the transfer of the Pooled Companies from PMACIC to PMA Capital
Corporation, the Pennsylvania Insurance Department prohibited PMACIC from any
declaration or payment of dividends, return of capital or any other types of
distributions in 2004 and 2005 to PMA Capital Corporation. In 2006, PMACIC may
declare and pay ordinary dividends or returns of capital without the prior
approval of the Pennsylvania Insurance Department if, immediately after giving
effect to the dividend or return of capital, PMACIC’s risk-based capital equals
or exceeds 225% of Authorized Control Level Capital as defined by the National
Association of Insurance Commissioners. In 2007 and beyond, PMACIC may make
dividend payments, as long as such dividends are not





35
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considered
“extraordinary” under Pennsylvania insurance law. At December 31, 2004, PMACIC’s
risk-based capital is 379% of Authorized Control Level Capital.





On
November 15, 2004, we exchanged $84.1 million aggregate principal amount of
6.50% Senior Secured Convertible Debt due 2022 (“6.50% Convertible Debt”) for
$84.1 million aggregate principal amount of 4.25% Senior Convertible Debt due
2022 (“4.25% Convertible Debt”). We did not receive any proceeds as a result of
the exchange offer. The exchange allowed us to extend the first put date
associated with our convertible debt from September 2006 to June 2009. We also
raised an additional $15 million of capital from the sale of 6.50% Convertible
Debt on November 15, 2004. We expect
to be able to receive capital distributions from our principal operating
subsidiaries sufficient to repurchase the new debt on the put date of June 30,
2009.





The PMA
Insurance Group earns revenue and generates cash primarily by writing insurance
policies and collecting insurance premiums. The PMA Insurance Group also earns
other revenues by providing risk control and claims adjusting services to
customers. Because time normally elapses between the receipt of premiums and the
payment of claims and certain related expenses, we invest the available premiums
and earn investment income. From our revenues are deducted:





·
    losses
      we pay under insurance policies that we
write;


·
    loss
      adjustment expenses (“LAE”),
      which are the expenses of settling claims;


·
    acquisition
      and operating expenses, which are direct and indirect costs of acquiring
      both new and renewal business, including commissions paid to agents and
      brokers, and the internal expenses to operate the business segment;
      and


·
    dividends
      that are paid to policyholders of certain of our insurance
      products.





These
items are further described elsewhere in the MD&A and in “Item 1 - Business.”





Losses
and LAE are the most significant expense items affecting our insurance business
and represent the most significant accounting estimates in our financial
statements. We
establish reserves representing estimates of future amounts needed to pay claims
with respect to insured events that have occurred, including events that have
not been reported to us. We also establish reserves for LAE, which represent the
estimated expenses of settling claims, including legal and other fees, and
general expenses of administering the claims adjustment process. Reserves are
estimates of amounts to be paid in the future for losses and LAE and do not and
cannot represent an exact measure of liability. If actual losses and LAE are
larger than our loss reserve estimates, or if actual claims reported to us
exceed our estimate of the number of claims to be reported to us, we have to
increase reserve estimates with respect to prior periods. Changes in reserve
estimates may be due to a wide range of factors, including inflation, changes in
claims and litigation trends and legislative or regulatory changes. We incur a
charge to earnings in the period the reserves are increased.





**RESULTS
OF OPERATIONS**





**Consolidated
Results**





We
recorded net income of $1.8 million in 2004, compared to net losses of $93.6
million in 2003 and $48.0 million in 2002. The
exchange and sale of the 6.50% Convertible Debt reduced 2004 results by $6.4
million after-tax ($9.8 million pre-tax), which included a loss on the debt
exchange of $3.9 million after-tax ($6.0 million pre-tax) and a loss of $2.5
million after-tax ($3.8 million pre-tax) for the subsequent increase in the fair
value of the derivative component of the 6.50% Convertible Debt. The loss
associated with the derivative component is included in net realized investment
gains and losses.





Including
the increase in the fair value of the derivative component of the 6.50%
Convertible Debt, after-tax net realized investment gains were $4.2 million for
2004, primarily reflecting sales reducing our per issuer exposure and general duration
management trades. After-tax net realized gains were $9.0 million in 2003,
compared to after-tax losses of $10.5 million in 2002. Net realized investment
gains in 2003 were primarily attributable to sales intended to change the
duration of our investment portfolio in order to better match our cash flows
with our liability payouts. Net realized investment losses for 2002 primarily
reflect impairment losses of $15.4 million after-tax ($23.8 million pre-tax) on
fixed income securities, primarily corporate bonds issued by telecommunications
and energy companies.





Results
for 2004 were also reduced by $3.9 million after-tax ($6.0 million pre-tax)
which was attributable to our purchasing reinsurance that protects our statutory
capital in the event of further adverse loss development at the
Run-





36
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off
Operations. Also included in 2004 results was an after-tax gain of $4.3 million
($6.6 million pre-tax) on the sale of a partnership interest.





The net
loss for 2003 reflects
a third quarter after-tax charge of $97.5 million ($150 million pre-tax), to
increase loss reserves for our reinsurance business. On November 6, 2003, we
announced our decision to exit the reinsurance business and we are no longer
writing new reinsurance business. Additionally, we established a valuation
allowance of $49 million on our deferred tax asset in 2003.





Results
for 2002 were reduced
by approximately $76 million after-tax ($116 million pre-tax: $64 million for
our reinsurance business and $52
million for our excess and surplus lines
business) due to unfavorable prior year loss development at the Run-off
Operations. Additionally, results for 2002 included a charge of $28 million
after-tax for non-reserve charges ($43 million pre-tax) associated with our
decision to exit and run off our excess and surplus lines business.





Consolidated
revenues were $608.0 million, $1,301.2  million
and $1,075.1 million in 2004, 2003 and 2002. The lower revenues in 2004 reflect
lower net premiums earned due to our fourth quarter 2003 withdrawal from the
reinsurance business and, to a lesser extent, the impact of the B++ financial
strength rating on The PMA Insurance Group. The increase in revenues in 2003,
compared to 2002, primarily reflected higher net premiums earned.





In this
MD&A, in addition to providing consolidated net income (loss), we also
provide segment operating income (loss) because we believe that it is a
meaningful measure of the profit or loss generated by our operating segments.
Operating income (loss), which is GAAP net income (loss) excluding net realized
investment gains and losses, is the financial performance measure used by our
management and Board of Directors to evaluate and assess the results of our
insurance businesses. Accordingly, we report operating income by segment in Note
15 to the Consolidated Financial Statements as required by SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information." Our
management and Board of Directors use operating income as the measure of
financial performance because (i) net realized investment gains and losses are
unpredictable and not necessarily indicative of current operating fundamentals
or future performance of the business segments and (ii) in many instances,
decisions to buy and sell securities are made at the holding company level, and
such decisions result in net realized gains and losses that do not relate to the
operations of the individual segments. Operating income (loss) does not replace
net income (loss) as the GAAP measure of our consolidated results of operations.





Following
is a reconciliation of our segment operating results to GAAP net income (loss).
See Note 15 to our Consolidated Financial Statements for
additional information.





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**Components
      of net income (loss):**Pre-tax
      operating income (loss):The
      PMA Insurance Group
    
    $
    13,166
    
    $
    21,541
    
    $
    25,346Run-off
      Operations(1)
    
    
    5,509
    
    
    (80,376
    )
    
    (74,204
    )Corporate
      and Other
    
    
    (21,223
    )
    
    (22,691
    )
    
    (14,214
    )Net
      realized investment gains (losses)
    
    
    6,493
    
    
    13,780
    
    
    (16,085
    )Income
      (loss) before income taxes
    
    
    3,945
    
    
    (67,746
    )
    
    (79,157
    )Income
      tax expense (benefit)
    
    
    2,115
    
    
    25,823
    
    
    (31,133
    )Net
      income (loss)
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )


*(1)*
    *In
      November 2003 we announced our decision to withdraw from the reinsurance
      business previously served by our PMA Re operating segment. As a result of
      this decision, the results of PMA Re are reported as Run-off Operations.
      Run-off Operations also includes the results of our former excess and
      surplus lines business.*





We also
provide combined ratios and operating ratios for The PMA
Insurance Group on page 38. The “combined ratio” is a measure of property and
casualty underwriting performance. The combined ratio computed using GAAP-basis
numbers is equal to losses and LAE, plus acquisition expenses, insurance-related
operating expenses and policyholders’ dividends, where applicable, all divided
by net premiums earned. A combined ratio of less than 100% reflects an
underwriting profit. Because time normally elapses between the receipt of
premiums and the payment of claims and certain related expenses, we invest the
available premiums. Underwriting results do not include investment income from
these funds. Given the long-tail





37
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nature of
our liabilities, we believe that the operating ratios are also important in
evaluating our business. The operating ratio is the combined ratio less the net
investment income ratio, which is net investment income divided by net premiums
earned.





**Segment
Results**





***The
PMA Insurance Group***





Summarized
financial results of The PMA Insurance Group are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Net
      premiums written
    
    $
    377,795
    
    $
    603,593
    
    $
    452,276Net
      premiums earned
    
    
    442,343
    
    
    570,032
    
    
    410,266Net
      investment income
    
    
    30,984
    
    
    32,907
    
    
    35,613Other
      revenues
    
    
    19,008
    
    
    17,493
    
    
    14,694Total revenues
    
    
    492,335
    
    
    620,432
    
    
    460,573Losses
      and LAE
    
    
    331,181
    
    
    442,502
    
    
    307,734Acquisition
      and operating expenses
    
    
    142,989
    
    
    155,748
    
    
    119,906Dividends
      to policyholders
    
    
    4,999
    
    
    641
    
    
    7,587Total
      losses and expenses
    
    
    479,169
    
    
    598,891
    
    
    435,227Pre-tax
      operating income
    
    $
    13,166
    
    $
    21,541
    
    $
    25,346Combined
      ratio
    
    
    105.4
    %
    
    102.8
    %
    
    103.2
    %Less:
      net investment income ratio
    
    
    7.0
    %
    
    5.8
    %
    
    8.7
    %Operating
      ratio
    
    
    98.4
    %
    
    97.0
    %
    
    94.5
    %


Pre-tax
operating income for The PMA Insurance Group was $13.2
million in 2004, compared to $21.5  million
in 2003 and $25.3 million in 2002. The lower pre-tax operating income in 2004,
compared to 2003, primarily reflects lower underwriting results and lower net
investment income. The lower pre-tax operating income in 2003, compared to 2002,
primarily reflects lower underwriting results from
accident years 2001 and 2002 in the workers’ compensation lines of
business and
lower net investment income, partially offset by improved current accident year
underwriting results.








38
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*Premiums*





The PMA
Insurance Group’s premiums written are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Workers'
      compensation and integrated disability:Direct
      premiums written
    
    $
    341,242
    
    $
    546,059
    
    $
    397,639Premiums
      assumed
    
    
    34,401
    
    
    24,799
    
    
    13,338Premiums
      ceded
    
    
    (34,328
    )
    
    (58,707
    )
    
    (37,624
    )Net
      premiums written
    
    $
    341,315
    
    $
    512,151
    
    $
    373,353Commercial
      Lines:Direct
      premiums written
    
    $
    45,801
    
    $
    106,399
    
    $
    102,918Premiums
      assumed
    
    
    1,610
    
    
    1,177
    
    
    1,437Premiums
      ceded
    
    
    (10,931
    )
    
    (16,134
    )
    
    (25,432
    )Net
      premiums written
    
    $
    36,480
    
    $
    91,442
    
    $
    78,923Total:Direct
      premiums written
    
    $
    387,043
    
    $
    652,458
    
    $
    500,557Premiums
      assumed
    
    
    36,011
    
    
    25,976
    
    
    14,775Premiums
      ceded
    
    
    (45,259
    )
    
    (74,841
    )
    
    (63,056
    )Net
      premiums written
    
    $
    377,795
    
    $
    603,593
    
    $
    452,276****


Direct
workers’ compensation and integrated disability premiums written were $341.2
million in 2004, compared to $546.1 million in 2003, primarily reflecting the
impact of the B++ A.M. Best financial strength rating between November 2003 and
November 2004. This rating constrained our ability to write new business and to
retain existing business in 2004. In 2003, direct workers' compensation and
integrated disability premiums written increased by 37%, compared to 2002,
primarily due to an increase in the volume of risks underwritten, and to a
lesser extent, pricing increases. In addition, direct workers' compensation
premiums written for 2003 included $35 million of retrospectively rated premiums
recorded in the fourth quarter under loss-sensitive policies that are
attributable to the higher than expected losses from accident years 2001 and
2002. See “Losses and Expenses”
beginning on page 40 for additional information. Our renewal retention rate on
existing workers’ compensation accounts was 62% for 2004, compared to 84% for
2003 and 82% for 2002. New workers’ compensation and integrated disability
business was $42.1 million for 2004, compared to $133.3 million and $123.3
million for 2003 and 2002, respectively. We obtained price increases of
approximately 6% in 2004, 10% in 2003 and 17% in 2002 on workers’ compensation
business.





For
workers’ compensation coverages, the premium charged on fixed-cost policies is
primarily based upon the manual rates filed with state insurance departments.
Manual rates in The PMA Insurance Group’s principal marketing territories for
workers’ compensation increased on average 4% in
2004, 8% in 2003 and 13% in 2002. These increases in manual rates generally
reflect the effects of higher average medical and indemnity costs in recent
years. Manual rate changes directly affect the prices that The PMA Insurance
Group can charge for its rate sensitive workers’ compensation products, which
comprise 55% of workers’ compensation premiums for 2004.





Direct
writings of commercial lines of business other than workers’ compensation, such
as commercial auto, general liability, umbrella, multi-peril and commercial
property lines (collectively, “Commercial Lines”), decreased
by $60.6 million in 2004, compared to 2003, reflecting
the impact of The PMA Insurance Group’s B++ A.M. Best financial strength rating,
partially offset by price increases that averaged 19% in 2004 . Direct
writings increased by $3.5 million in 2003, compared to the immediately
preceding year, primarily due to weighted average price increases of
approximately 17% in 2003.





Premiums
assumed increased $10.0 million and $11.2 million in 2004 and 2003,
respectively, compared to the immediately preceding year, primarily due to an
increase in the amount of residual market business in The PMA Insurance Group’s
principal marketing territories. Companies that write premiums in certain states
generally must share in the risk of insuring entities that cannot obtain
insurance in the voluntary market. Typically, an insurer’s share of this
residual market business is





39
 Table of Contents





assigned
on a lag based on its market share in terms of direct premiums in the voluntary
market. These assignments are accomplished either by direct assignment or by
assumption from pools of residual market business.





Premiums
ceded decreased $29.6 million in 2004 and increased $11.8 million in 2003,
compared to the immediately preceding years. Premiums ceded for workers’
compensation and integrated disability decreased by $24.4 million in 2004,
compared to 2003, as a
result of lower direct premiums written for those lines and because The PMA
Insurance Group increased its aggregate annual deductible for losses in excess
of $250,000 to $18.8 million from $5.0 million on its workers’ compensation
reinsurance program. Premiums ceded for workers’ compensation and integrated
disability increased
by $21.1 million in 2003, compared to 2002, as a result of the increase in
direct premiums written as well as higher rates being charged by reinsurers.
Premiums ceded for Commercial Lines were lower by $5.2 million and $9.3 million
in 2004 and 2003, respectively, compared to the immediately preceding
years, primarily reflecting the
decrease in direct premiums written for commercial lines in 2004 and the
increase in our net
retentions in Commercial Lines from $500,000 in 2002 to $1.5 million in
2003.





Net
premiums written and earned decreased 37% and 22%, respectively, in 2004,
compared to 2003 and increased 33% and 39%, respectively, in 2003, compared to
2002. Generally, trends in net premiums earned follow patterns similar to net
premiums written adjusted for the customary lag related to the timing of premium
writings within the year. In periods of decreasing premium writings, the
decrease in net premiums written will typically be greater than the decrease in
net premiums earned, as was the case in 2004. Direct premiums are earned
principally on a pro rata basis over the terms of the policies. However, with
respect to policies that provide for premium adjustments, such as
experience-rated or exposure-based adjustments, such premium adjustment may be
made subsequent to the end of the policy’s coverage period and will be recorded
as earned premium in the period in which the adjustment is made. We made such an
adjustment in 2003 as described above.





*Losses and Expenses*




The
components of the GAAP combined ratios are as follows:





**
    
    
    2004
    
    
    2003
    
    
    2002Loss
      and LAE ratio
    
    
    74.9%
    
    
    77.6%
    
    
    75.0%Expense
      ratio:Acquisition
      expenses
    
    
    19.5%
    
    
    15.9%
    
    
    17.5%Operating
      expenses(1)
    
    
    9.9%
    
    
    9.2%
    
    
    8.9%Total
      expense ratio
    
    
    29.4%
    
    
    25.1%
    
    
    26.4%Policyholders'
      dividend ratio
    
    
    1.1%
    
    
    0.1%
    
    
    1.8%Combined
      ratio
    
    
    105.4%
    
    
    102.8%
    
    
    103.2%


*(1)*
    *The
      operating expense ratio equals insurance-related operating expenses
      divided by net premiums earned. Insurance-related operating expenses were
      $43.7 million, $52.2 million and $36.7 million for 2004, 2003 and 2002,
      respectively.*





The loss
and LAE ratio improved
2.7 points in 2004, compared to 2003. The lower
loss and LAE ratio in 2004, compared to 2003, primarily reflects the effects on
the 2003 loss and LAE ratio of the higher than expected losses and LAE for
workers’ compensation business written for accident years 2001 and 2002 as
discussed below, partially offset by a higher current accident year loss and LAE
ratio in 2004. Overall
loss trends in workers’ compensation are rising modestly ahead of price
increases. Medical cost inflation, which has contributed to increased severity
of workers’ compensation losses, was the primary reason for the increasing
accident year loss costs in 2004. We estimate our medical cost inflation for
2004 to be 11%, which is the same as our estimate for 2003. We expect medical
cost inflation to remain a significant component of loss costs in 2005.





As part
of the year end closing process, in the fourth quarter of 2003, our internal
actuaries completed a comprehensive year-end actuarial analysis of loss
reserves. Based on the actuarial work performed, we noticed higher than expected
claims severity in our workers' compensation business written for accident years
2001 and 2002, primarily from loss-sensitive and participating workers'
compensation business. As a result, The PMA Insurance Group increased loss
reserves for prior years by $50 million. An independent actuarial firm also
conducted a comprehensive review of The PMA Insurance Group’s loss reserves as
of December 31, 2003 and concluded that such carried loss reserves were
reasonable as of December 31, 2003. Under The PMA Insurance Group's
loss-sensitive rating plans we adjust the





40
 Table of Contents





amount of
the insured's premiums after the policyperiod expires based, to a large
extent, upon the insured's actual losses incurred during the policy period.
Under policies that are subject to dividend plans, the ultimate amount of the
dividend that the insured may receive is also based, to a large extent, upon
loss experience during the policy period. Accordingly, offsetting the effects of
this unfavorable prior year loss development were premium adjustments of $35
million under loss-sensitive plans and reduced policyholder dividends of $8
million, resulting in a net fourth quarter pre-tax charge of $7 million. This
unfavorable prior year loss development and resulting premium and policyholders'
dividend adjustments in 2003 increased the loss and LAE ratio by approximately 4
points and decreased the total expense ratio and policyholder's dividend ratio
each by approximately 1.5 points. The total impact to the combined ratio was
approximately 1 point.





Overall,
the loss and LAE ratio increased by 2.6 points in 2003,
compared to 2002, reflecting the effects of prior year loss development
described above, partially offset by an improved current accident year loss and
LAE ratio. Our current accident year loss and LAE ratio improved 5.3 points in
2003, compared to 2002, including 4.5 points due to the premium adjustment of
$35 million recorded in the fourth quarter for policies of loss-sensitive plans.
The remainder of the improvement is primarily due to price increases that
outpaced increasing loss costs. Medical cost inflation was the primary reason
for the increasing loss costs in 2003.





In
addition to the 1.5 point impact in the total expense ratio for 2003 discussed
above, the total expense ratio increased 2.8 points in 2004, compared to 2003.
In 2004, we did not reduce our level of operating expenses as quickly as
revenues decreased in order to be in a position to respond to anticipated market
demand after the restoration of the A- financial strength rating.





*Net
Investment Income*





Net
investment income was $1.9
million lower in 2004 and $2.7 million lower in 2003, compared to the
immediately preceding years. The lower net investment income in 2004, compared
to 2003, primarily reflects a reduction in invested asset yields of
approximately 50 basis points, partially offset by a higher invested asset base
that increased approximately 5%. The decline in 2003, compared to 2002,
primarily reflects a reduction in invested asset yields of approximately 90
basis points, partially offset by a higher invested asset base that increased
approximately 12%.





***Run-off Operations***





In
November 2003, we announced our decision to withdraw from the reinsurance
business previously served by our PMA Re operating segment. We are no longer
writing new reinsurance business. As a result of this decision, the results of
PMA Re are reported as Run-off Operations. Run-off Operations also includes the
results of our former excess and surplus lines business,
which we placed in run-off in May 2002.





Summarized
financial results of the
Run-off Operations are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Net
      premiums written
    
    $
    (75,360
    )
    $
    589,449
    
    $
    653,602Net
      premiums earned
    
    
    77,067
    
    
    628,921
    
    
    581,626Net
      investment income
    
    
    24,655
    
    
    34,362
    
    
    49,751Other
      revenues
    
    
    -
    
    
    2,500
    
    
    -Total
      revenues
    
    
    101,722
    
    
    665,783
    
    
    631,377Losses
      and LAE
    
    
    49,375
    
    
    555,845
    
    
    515,924Acquisition
      and operating expenses
    
    
    46,838
    
    
    190,314
    
    
    189,657Total
      losses and expenses
    
    
    96,213
    
    
    746,159
    
    
    705,581Pre-tax
      operating income (loss)
    
    $
    5,509
    
    $
    (80,376
    )
    $
    (74,204
    )


The
Run-off Operations recorded pre-tax operating income of $5.5 million in 2004,
compared to pre-tax operating losses of $80.4 million and $74.2 million for 2003
and 2002, respectively. Net premiums earned, losses and LAE, and acquisition and
operating expenses have decreased significantly in 2004, compared to 2003 and
2002, due to our





41
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exitfrom the reinsurance business. Results for the Run-off Operations for
2004 will not be indicative of futureresults due to our expectation that
earned premiums and related losses and expenses will decrease significantly and
due to the unpredictability of the impact of future commutations, if any.
Results for 2003 reflected the third quarter $150 million charge to
increase loss reserves for our reinsurance business associated mainly with
accident years 1997 to 2000. Results
for 2002 were reduced by approximately $116 million ($64 million for our
reinsurance business and$52
million for our excess and surpluslines
business) due to unfavorable prior year loss development. Additionally, the
Run-off Operations recorded a charge of $43 million pre-tax as a result of our
decision to exit the excess and surplus line business in 2002.





Premiums
written and earned declined significantly in 2004, compared to 2003 and 2002 due
to our exit from the reinsurance business. Additionally, as we have continued
our runoff of the business, ceding companies have cancelled reinsurance
contracts, which results in negative gross and net premiums written. Net
premiums written and earned for 2004 also reflect a charge of $6.0 million for a
reinsurance agreement covering potential adverse loss development. Net
premiums written declined in 2003, compared to 2002, due primarily to lower
reinsurance premiums written. Additionally, premiums written for 2002 included
an additional $58.1 million of gross premiums written ($44.2 million of net
premiums written) recorded in the second quarter of 2002 as a result of a change
in our estimate of ultimate premiums written. Because premiums from ceding
companies are typically reported on a delayed basis, we monitor and update, as
appropriate, the estimated ultimate premiums written. Our periodic review of
estimated ultimate premiums written, comparing actual reported premiums to
originally estimated premiums based on ceding company estimates, indicated that
premiums written in recent years, primarily for 2001 and 2000 were higher than
originally estimated. The increase in net premiums earned of $39.9 million in
2002 caused by this adjustment was offset by corresponding losses and LAE and
acquisition expenses.





Generally,
trends in net premiums earned
follow patterns similar to net premiums written. In periods of decreasing
premium writings, the decrease in net premiums written will typically be greater
than the decrease in net premiums earned, as was the case in 2004 and 2003.
Premiums are earned principally on a pro rata basis over the coverage periods of
the underlying policies. However, with respect to policies that provide for
premium adjustments, such as experience-rated or exposure-based adjustments,
such premium adjustments may be made subsequent to the end of the policy’s
coverage period and will be recorded as earned premiums in the period in which
the adjustment is made.


Losses
and LAE incurred decreased significantly for 2004, compared to 2003 and 2002,
primarily due to the effects of lower net premiums earned in 2004, compared to
2003 and 2002, and the adverse prior year loss development recorded in 2003 and
2002.





During
2003, the Run-off Operations increased its net loss reserves for prior accident
years for reinsurance business by $169.1 million, including $150 million during
the third quarter. The third quarter 2003 reserve charge related to higher than
expected underwriting losses, primarily from casualty business written in
accident years 1997 through 2000. Approximately 75% of the charge was related to
general liability business written from 1997 to 2000 with substantially all of
the remainder of the charge from the commercial automobile line written during
those same years. During the third quarter, our actuaries conducted their
periodic comprehensive reserve review. Based on the actuarial work performed,
which included analyzing recent trends in the levels of the reported and paid
claims, an updated selection of actuarially determined loss reserve estimates
was developed by accident year for each major line of reinsurance business
written. The information derived during this review indicated that a large
portion of the change in expected loss development was due to increasing loss
trends emerging in calendar year 2003 for prior accident years. This increase in
2003 loss trends caused us to determine that the reserve levels, primarily for
accident years 1997 to 2000, needed to be increased by $150 million. An
independent actuarial firm also conducted a comprehensive review of our
Traditional-Treaty, Specialty-Treaty and Facultative reinsurance loss
reserves, and concluded that those carried loss reserves were reasonable at
September 30, 2003.





This
analysis was enhanced by an extensive review of specific accounts, comprising
about 40% of the carried reserves of the reinsurance business for accident years
1997 to 2000. Our actuaries visited a number of former ceding company clients,
which collectively comprised about 25% of the reinsurance business’s total gross
loss and LAE reserves from accident years 1997 to 2000, to discuss reserving and
reporting experience with these ceding companies. Our actuaries separately
evaluated an additional number of other ceding companies, representing
approximately 15% of the reinsurance business’s total gross loss and LAE
reserves from accident years 1997 to 2000, to understand and examine data
trends.





Net
unfavorable prior year loss development impacted results by approximately $116
million ($64 million for our reinsurance business and $52 million for excess and
surplus lines) in 2002. During 2002, company actuaries conducted reserve reviews
to determine the impact of any emerging data on anticipated loss development
trends and recorded unpaid losses and LAE reserves. Based on the actuarial work
performed, which included analyzing recent trends in the





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levels of
the reported and paid claims, an updated selection of actuarially determined
loss reserve estimates was developed by accident year for each major line of
business. Management’s selection of the ultimate losses resulting from their
reviews indicated that net loss reserves for the excess and surplus lines
business for prior accident years, mainly 1999 and 2000, needed to be increased
by $52 million. This unfavorable prior year development reflects the impact of
higher than expected claim severity and, to a lesser extent, frequency, that
emerged in 2002 on casualty lines of business, primarily professional liability
policies for the nursing homes class of business; general liability, including
policies covering contractors’ liability for construction defects; and
commercial automobile, mainly for accident years 1999 and 2000. For the
reinsurance business, during the fourth quarter, our actuaries observed a higher
than expected increase in the frequency and, to a lesser extent, severity of
reported claims by our ceding companies. Management’s selection of the ultimate
losses indicated that net loss and LAE reserves for prior accident years needed
to be increased by $64 million in the fourth quarter of 2002, primarily for
excess of loss and pro rata general liability occurrence contracts and, to a
lesser extent, excess of loss general liability claims-made contracts, from
accident years 1998, 1999 and 2000.





Operating
expenses for 2004 were reduced by $2.5 million from a gain on the sale of our
interest in Cathedral Capital PLC, a Lloyd’s of London managing general agency.
Operating expenses for 2003 include exit costs of $2.6 million , mainly
employee termination benefits, as a result of the decision to exit from and run off the reinsurance
business. The majority of these costs were paid during 2004. Approximately 80
employees were terminated in accordance with our exit plan. Approximately 60
positions, primarily claims and financial personnel, remain after the
terminations. We have established an employee retention arrangement for these
remaining employees. Under this arrangement, expenses of $1.7 million were
recorded in 2004, which includes retention bonuses and severance. We expect to
incur an additional $1.3 million of these expenses in 2005.





As a
result of our decision to exit from and run off our excess and surplus lines
business, results for the Run-off Operations included a pre-tax charge of $43
million in 2002. Components of the pre-tax charge included approximately $16
million to write-down assets to their estimated net realizable value, including
non-cash charges of approximately $6 million for leasehold improvements and
other fixed assets and $1.3 million for goodwill. In addition, the $43 million
pre-tax charge included expenses associated with the recognition of liabilities
of approximately $27 million, including reinsurance costs of approximately $19
million, long-term lease costs of approximately $4 million and involuntary
employee termination benefits of approximately $3 million. During 2003, the
Run-off Operations recognized an additional $2.5 million write-down of assets,
made up of approximately $2 million for reinsurance receivables and $500,000 for
premiums receivable, reflecting an updated assessment of their estimated net
realizable value. The write-down is included in operating expenses in the
Statement of Operations for 2003.





Other
revenues for 2003 reflected the gain on the sale of the capital stock of Caliber
One Indemnity Company. Pursuant to the agreement of sale, we retained all assets
and liabilities related to the in-force policies and outstanding claim
obligations relating to Caliber One’s business written prior to closing on the
sale.





Net
investment income was $24.7 million, $34.4 million and $49.8 million in 2004,
2003 and 2002, respectively. The lower net investment income in 2004, compared
to 2003, reflects lower yields of approximately 30 basis points on an average
invested asset base that decreased approximately 18%, partially offset by lower
net interest credited of $1.7
million on funds held. The decline in 2003, compared to 2002, reflected lower
yields on the invested asset portfolio of approximately 110 basis points on an
average invested asset base that increased approximately 9%, and lower interest
earned of $7.5 million on funds held. For 2003, the reduction in interest earned
on funds held arrangements was substantially offset by lower losses on the
associated assumed Finite Risk and Financial Products contracts. In a funds held
arrangement, the ceding company retains the premiums, and losses are offset
against these funds in an experience account. Because the reinsurer is not in
receipt of the funds, the reinsurer earns interest on the experience fund
balance at a predetermined credited interest rate.





***Corporate
and Other***





The
Corporate and Other segment primarily includes corporate expenses, including
debt service. This segment recorded pre-tax operating losses of $21.2 million,
$22.7 million and $14.2 million in 2004, 2003 and 2002, respectively. During
2004, we sold a real estate partnership interest resulting in a pre-tax gain of
$6.6 million, which is included in other revenues. Partially offsetting this
gain was a pre-tax loss of $6.0 million related to the convertible debt
exchange, including $4.7 million to record the 6.50% Convertible Debt at fair
value and $1.3 million to write off the unamortized issuance costs on the 4.25%
Convertible Debt. Results for 2004 also reflect lower operating expenses,
partially offset by higher interest expense. Operating expenses for 2003
included approximately $3 million of accrued costs associated primarily with the
remaining salary obligations under





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employment
contracts with certain of our former executive officers. Interest expense
increased by $2.5 million in 2004 and $6.6 million in 2003, compared to the
immediately preceding years, primarily due to a higher average amount of debt
outstanding.





***Loss Reserves and
Reinsurance***





*Loss
Reserves*





Our
consolidated unpaid losses and LAE, net of reinsurance, at December 31, 2004 and
2003 were $998.8 million and $1,346.3 million, respectively, net of discount of
$70.5 million and $82.3 million, respectively. Included in the consolidated
unpaid losses and LAE are amounts related to our workers’ compensation claims of
$448.7 million and $433.8 million, net of discount of $48.2 million and $54.6
million at December 31, 2004 and 2003, respectively. The discount rate used was
approximately 5% at December 31, 2004 and 2003.





During
2004, our actuaries conducted their periodic reserve review s of The
PMA Insurance Group and the Run-off Operations. Based on the actuarial work
performed, which included analyzing recent trends in the levels of the reported
and paid claims, an updated selection of actuarially determined loss reserve
estimates was developed by accident year for each major line of business. The
information derived during these reviews indicated that general liability and
professional liability lines written by the Run-off Operations continued to
exhibit volatility. While the conclusion of the reviews indicated that no
adjustments to reserves were necessary and that our carried reserves were
reasonable, continued volatility could require adjustments in future
periods.





Unpaid
losses and LAE reflect management’s best estimate of future amounts needed to
pay claims and related settlement costs with respect to insured events which
have occurred, including events that have not been reported to us.  Due to
the Òlong-tailÓ nature of a significant portion of our business, in many cases,
significant periods of time, ranging up to several years or more, may elapse
between the occurrence of an insured loss, the reporting of the loss to us and
our payment of that loss. We define long-tail business as those lines of
business in which a majority of coverage involves average loss payment lags of
several years beyond the expiration of the policy. Our major long-tail lines
include our workers’ compensation and casualty reinsurance business. In
addition, because reinsurers rely on their ceding companies to provide them with
information regarding incurred losses, reported claims for reinsurers become
known more slowly than for primary insurers and are subject to more unforeseen
development and uncertainty. As part of the process for determining our unpaid
losses and LAE, various actuarial models are used that analyze historical data
and consider the impact of current developments and trends, such as trends in
claims severity and frequency and claims settlement trends. Also considered are
legal developments, regulatory trends, legislative developments, changes in
social attitudes and economic conditions.





Management
believes that its unpaid losses and LAE are fairly stated at December 31,
200 4.
However, estimating the ultimate claims liability is necessarily a complex and
judgmental process inasmuch as the amounts are based on management’s informed
estimates, assumptions and judgments using data currently available. As
additional experience and data become available regarding claims payment and
reporting patterns, legal and legislative developments, judicial theories of
liability, the impact of regulatory trends on benefit levels for both medical
and indemnity payments, changes in social attitudes and economic conditions, the
estimates are revised accordingly. If our ultimate losses, net of reinsurance,
prove to differ substantially from the amounts recorded at December 31, 2004,
the related adjustments could have a material adverse effect on our financial
condition, results of operations and liquidity. See the discussion under Losses and Expenses beginning on page 40,
and Run-off Operations beginning on page 41 for
additional information regarding increases in loss reserves for prior
years.





At
December 31, 2004, 2003 and 2002, our gross reserves for asbestos-related losses
were $27.9 million, $37.8 million and $42.1 million, respectively ($14.0
million, $17.8 million and $25.8 million, net of reinsurance, respectively). At
December 31, 2004, 2003 and 2002, our gross reserves for environmental-related
losses were $16.1 million, $14.2 million and $18.2 million, respectively ($6.4
million, $8.8 million and $14.3 million, net of reinsurance,
respectively).





Estimating
reserves for asbestos and environmental exposures continues to be difficult
because of several factors, including: (i) evolving methodologies for the
estimation of the liabilities; (ii) lack of reliable historical claim data;
(iii) uncertainties with respect to insurance and reinsurance coverage related
to these obligations; (iv) changing judicial interpretations; and (v) changing
government standards. Management believes that its reserves for asbestos and
environmental claims are appropriately established based upon known facts,
existing case law and generally accepted





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actuarial
methodologies. However, due to changing interpretations by courts involving
coverage issues, the potential for changes in Federal and state standards for
clean-up and liability, as well as issues involving policy provisions,
allocation of liability and damages among participating insurers, and proof of
coverage, our ultimate exposure for these claims may vary significantly from the
amounts currently recorded, resulting in a potential future adjustment that
could be material to our financial condition and results of operations.





See “Critical Accounting Estimates — Unpaid
Losses and Loss Adjustment Expenses” beginning on page 55 for additional
information. In addition, see “Cautionary
Statements” beginning on page 59 and “Item 1 -
Business - Risk Factors” for a discussion of factors that may adversely
impact our losses and LAE in the future.





*Reinsurance*





Under our
reinsurance and retrocessional coverages in place during 2004, 2003 and 2002, we
ceded premiums totaling $78.9 million, $228.6 million and $300.6 million, and we
ceded losses and LAE of $99.8 million, $243.1 million and $223.2 million to
reinsurers and retrocessionaires.





At
December 31, 2004 and 2003, we had amounts receivable from our reinsurers and
retrocessionaires totaling $1,142.6 million and $1,220.3 million, respectively.
As of December 31, 2004 and 2003, $58.7 million and $39.1 million, or 5% and 3%,
respectively, of these amounts were due to us on losses we have already paid.
The remainder of the reinsurance receivables related to unpaid
claims.





At
December 31, 2004, we had reinsurance receivables due from the following
unaffiliated reinsurers in excess of 5% of our shareholders’
equity:


Reinsurance*(dollar
      amounts in thousands)*
    
    
    Receivables
    
    
    CollateralThe
      London Reinsurance Group and Affiliates(1)
    
    $
    288,777
    
    $
    274,717Swiss
      Reinsurance America Corporation
    
    
    140,824
    
    
    27,087PXRE
      Reinsurance Company
    
    
    128,542
    
    
    72,509St.
      Paul and Affiliates(2)
    
    
    102,910
    
    
    79,709Houston
      Casualty Company
    
    
    75,701
    
    
    -Imagine
      Insurance Company Limited
    
    
    34,212
    
    
    34,212Partner
      Reinsurance Co
    
    
    30,474
    
    
    -Hannover
      Ruckversicherungs AG
    
    
    30,065
    
    
    -


*(1)*
    *Includes
      Trabaja Reinsurance Company ($**264.1
      million) and London Life & General Reinsurance Company ($24.7
      million).*


*(2)*
    *Includes
      United States Fidelity & Guaranty Insurance Company ($68.6 million),
      Mountain Ridge Insurance Company ($24.6 million) and other affiliated
      entities ($9.7 million).*





We
perform credit reviews of our reinsurers focusing on, among other things,
financial capacity, stability, trends and commitment to the reinsurance
business. Reinsurers failing to meet our standards are excluded from our
reinsurance programs. In addition, we require collateral, typically assets in
trust, letters of credit or funds withheld, to support balances due from certain
reinsurers, generally those not authorized to transact business in the
applicable jurisdictions. At December 31, 2004 and 2003, our reinsurance
receivables were supported by $507.2 million and $644.1 million of collateral.
Of the uncollateralized reinsurance receivables at December 31, 2004, 94% were
due from reinsurers rated “A-” or better by A.M. Best and is broken down as
follows: “A++” - 5%; “A+” - 43%; “A” - 39% and “A-” - 7%. We believe that
our reinsurance receivables, net of the valuation allowance, are fully
collectible. In 2003 and 2002, we wrote off reinsurance receivables of $3.0
million and $3.5 million, respectively, all from the Run-off Operations. The
timing and collectibility of reinsurance receivables have not had a material
adverse effect on our liquidity.





The PMA
Insurance Group has recorded reinsurance receivables of $13.9 million at
December 31, 2004, related to certain umbrella policies covering years prior to
1977. The reinsurer has disputed the extent of coverage under these policies.
The ultimate resolution of this dispute cannot be determined at this time. An
unfavorable resolution of the dispute could have a material adverse effect on
our financial condition and results of operations. See “Critical Accounting Estimates -
Reinsurance Receivables” beginning on page 57 and Note
5 to our Consolidated Financial Statements for additional
information.





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At
December 31, 2004, our reinsurance and retrocessional protection for major lines
of business that we write was as follows:


Retention
    
    
    
    
    
    Limits(1)**The
      PMA Insurance Group**Per
      Occurrence:Workers'
      compensation
    
    $
    250,000
    (2)
    
    
    
    $
    104.8
      million
    (3)Other
      casualty lines(4)
    
    $
    1.5
      million
    
    
    
    
    $
    48.5
      millionPer
      Risk:Property
      lines
    
    $
    500,000
    
    
    
    
    $
    19.5
      millionAuto
      physical damage
    
    $
    500,000
    
    
    
    
    $
    2.5
      million


*(1)*
    *Represents
      the amount of loss protection above our level of loss
      retention.*


*(2)*
    *The
      PMA Insurance Group retains**an aggregate $18.8 million deductible on the first layer of its workers'
      compensation reinsurance, which is $1.25 million excess
      $250,000.*


*(3)*
    *Our
      maximum limit for any one claimant is $4.8 million (increased to $5.8
      million effective January 1, 2005).*


*(4)*
    *Effective
      January 1, 2005, the retention was reduced to $1.0 million and the limit
      was increased to $49.0 million.*





The PMA
Insurance Group does not write a significant amount of natural catastrophe
exposed business. We actively manage our exposure to catastrophes through our
underwriting process, where we generally monitor the accumulation of insurable
values in catastrophe-prone regions. The PMA Insurance Group maintains property
catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0
million per occurrence.





In 2004,
2003 and 2002, our loss and LAE ratios were not significantly impacted by
catastrophes.





With
respect to the reinsurance and retrocessional protection shown in the table above, our treaties do not cover us for losses
sustained from terrorist activities. Therefore, if future terrorist attacks
occur, they may result in losses that have a material adverse effect on our
financial condition, results of operations and liquidity.





In 2004,
the Run-off Operations purchased reinsurance to protect its statutory capital
from adverse loss development of its loss and LAE reserves. Under the
agreement, we ceded
$100 million in carried loss and LAE reserves and paid $146.5 million in cash.
During
2004, the Run-off Operations incurred $6.0 million in cededpremiums
for this agreement. In addition, the contract requiresadditional
premiums of $2.5 million if it is not commuted by December2007. At
December 31, 2004, the Run-off Operations had $105 million of available coverage
under this agreement for future adverse loss development. Any
future cession of losses may require the Company to cede additional premiums of up to $35
million on a pro
rata basis , at the
following contractually determined levels :





Losses
      ceded
    
    Additional
      premiums$0
      - $20 million
    
    No
      additional premiums$20
      - $50 million
    
    Up
      to $20 million$50
      - $80 million
    
    Up
      to $15 million$80
      - $105 million
    
    No
      additional premiums





The
additional premiums have been prepaid and are included in other assets on the
Balance Sheet. Because the coverage is retroactive, we will not record the
benefit of this reinsurance in our consolidated Statements of Operations until
we receive the related recoveries. See Run-off Operations beginning on page 41 for additional information regarding this
reinsurance coverage.





See Note 5 to our Consolidated Financial Statements for additional discussion.





*Terrorism*





In
November 2002, the Terrorism Risk Insurance Act of 2002 (“TRIA”) became
effective. TRIA provides federal reinsurance protection for property and
casualty losses in the United States or to United States aircraft or vessels
arising from certified terrorist acts through the end of 2005. TRIA
expires on December 31, 2005 and although legislation has been introduced in
Congress to extend TRIA, there is no assurance that it will be re-enacted or
extended. For terrorist acts to be








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covered
under TRIA, they must be certified as such by the United States Government and
must be committed by individuals acting on behalf of a foreign person or
interest. TRIA contains a “make available” provision, which requires insurers
subjectto the Act, to offer coverage for acts of terrorism that
does not differ materially from the terms (other than price), amounts and other
coverage limitations offered to the policyholder for losses from events other
than acts of terrorism. The “make available” provision permits exclusions for
certain types of losses, if a state permits exclusions for such losses. TRIA
requires insurers to retain losses based on a percentage of their commercial
lines direct earned premiums for the prior year equal to a 15% deductible for
2005. The federal government covers 90% of the losses above the deductible,
while a company retains 10% of the losses. TRIA contains an annual limit of $100
billion of covered industry-wide losses. TRIA applies to commercial lines of
property and casualty insurance, including workers’ compensation insurance,
offered by The PMA Insurance Group, but does not apply to reinsurance. The PMA
Insurance Group would have a deductible of approximately $70 million in 2005 if
a covered terrorist act were to occur.





Workers’
compensation insurers were not permitted to exclude terrorism from coverage
prior to the enactment of TRIA, and continue to be subject to this prohibition.
When underwriting existing and new commercial insurance business, The PMA
Insurance Group considers the added potential risk of loss due to terrorist
activity, and this may lead it to decline to write or non-renew certain
business. Additional rates may be charged for terrorism coverage, and as of
January 1, 2004, The PMA Insurance Group had adopted premium charges for
workers’ compensation insurance in all states. The PMA Insurance Group has also
refined its underwriting procedures in consideration of terrorism risks.





However , because
of the unpredictable nature of terrorism, TRIA’s uncertain application and the
amount of terrorism losses that The PMA Insurance Group must retain under TRIA,
if future terrorist attacks occur, they may result in losses that could have a
material adverse effect on our financial condition, results of operations and
liquidity. For additional information regarding the underwriting criteria of our
operating segments, see “Item 1 - Business - The PMA
Insurance Group, Underwriting.”








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**LIQUIDITY AND CAPITAL
RESOURCES**





Liquidity
is a measure of an entity’s ability to secure sufficient cash to meet its
contractual obligations and operating needs. Our insurance operations generate
cash by writing insurance policies and collecting premiums. The cash generated
is used to pay losses and LAE and operating expenses. Any excess cash is
invested and earns investment income.





Operating
cash flows declined significantly in 2004, compared to 2003, primarily due to
the run-off of our reinsurance business, including the commutation and novation
of certain reinsurance and retrocessional contracts of the Run-off Operations
occurring in 2004 and the purchase of a reinsurance agreement covering potential
adverse development at the Run-off Operations. See Notes 4
and 5 to the Consolidated Financial Statements for
additional information regarding commutations and novations by the Run-off
Operations and the reinsurance agreement covering potential adverse loss
development, respectively. To a lesser extent, the impact of The PMA Insurance
Group’s B++ financial strength rating between November 2003 and November 2004
also negatively impacted operating cash flows. Operating cash flows increased significantly in 2003, compared to 2002,
reflecting higher revenues.





At the
holding company level, our primary sources of liquidity are dividends and net
tax payments received from subsidiaries, and capital raising activities. We
utilize cash to pay debt obligations, including interest costs; taxes to the
Federal government; corporate expenses ; and
dividends to shareholders.





I n 2004,
the Pennsylvania Insurance Department approved our application for the Pooled
Companies, previously subsidiaries of PMACIC, to become direct, wholly owned
subsidiaries of PMA Capital Corporation. However, in its Order approving the
transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the
Pennsylvania Insurance Department prohibited PMACIC, our reinsurance subsidiary
which is currently in run-off, from any declaration or payment of dividends,
return of capital or any other types of distributions in 2004 and 2005 to PMA
Capital Corporation. In 2006, PMACIC may declare and pay ordinary dividends or
returns of capital without the prior approval of the Pennsylvania Insurance
Department if, immediately after giving effect to the dividend or returns of
capital, PMACIC’s risk-based capital equals or exceeds 225% of Authorized
Control Level Capital as defined by the National Association of Insurance
Commissioners. In 2007 and beyond, PMACIC may make dividend payments, as long as
such dividends are not considered “extraordinary” under Pennsylvania insurance
law. At December 31, 2004, PMACIC’s risk-based capital is 379% of Authorized
Control Level Capital.





The
Pooled Companies, which are not subject to the Pennsylvania Insurance
Department’s Order, paid dividends of $12.1 million to PMA Capital Corporation
in 2004. The Pooled Companies can pay up to $23.5 million in dividends in 2005
without the prior approval of the Pennsylvania Insurance Department. In
considering its future dividend policy, the Pooled Companies consider, among
other things, the impact of paying dividends on its financial strength ratings. PMA
Capital received dividends from subsidiaries of $24.0 million and $28.0 million
in 2003 and 2002, respectively.





O n
November 15, 2004, we exchanged $84.1 million aggregate principal amount of
6.50% Convertible Debt for $84.1 million aggregate principal amount of 4.25%
Convertible Debt. We did not receive any proceeds as a result of the exchange
offer. The exchange allowed us to extend the first put date associated with our
convertible debt from September 2006 to June 2009. Additionally, in November
2004, we received net proceeds of $15.2 million from the issuance of $15 million
aggregate principal amount of 6.50% Convertible Debt in a private placement to a
limited number of qualified institutional buyers. We expect
to be able to receive capital distributions from our principal operating
subsidiaries sufficient to repurchase the new debt on the put date of June 30,
2009.





On June
30, 2009, holders of the 6.50% Convertible Debt will have the right to require
us to repurchase for cash any amounts outstanding for 114% of the principal
amount of the debt plus accrued and unpaid interest, if any, to the settlement
date. In 2006, in the event we receive any extraordinary dividends from our
subsidiaries, we will be required to use 50% of those dividends to redeem up to
$35 million principal amount of the debt at 110% of the original principal
amount. Holders may elect to receive any premium over the principal amount in
either cash or Class A common stock (with the number of shares determined based
on a value of $8.00 per share).





The 6.50%
Convertible Debt is secured equally and ratably with our $57.5 million 8.50%
Monthly Income Senior Notes due 2018 (“Senior Notes”) by a first lien on 20% of
the capital stock of our principal operating subsidiaries. We have
agreed to make an additional pledge of the remainder of the capital stock of
these subsidiaries if the A.M. Best financial strength rating of the Pooled
Companies is not A- or higher on December 31, 2005 or is reduced below B++ prior
to December 31, 2005. However, execution of any lien by the holders of the 6.50%
Convertible Debt is
subject
to the approval by the Pennsylvania Insurance Department. The 6.50% Convertible
Debt is





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convertible
at the rate of 61.0948 shares, equivalent to a conversion price of $16.368 per
share of Class A common stock. The indenture governing the 6.50% Convertible
Debt contains restrictive covenants with respect to limitations on our
ability to incur indebtedness, enter into transactions with affiliates or engage
in a merger or sale of all or substantially all of the Company's
assets.





Net tax
payments received from subsidiaries were $4.9
million, $5.6 million and $12.0 million in 2004, 2003 and 2002, respectively.





At
December 31, 2004, we had $31.3 million of cash and short-term investments at
the holding company and its non-regulated subsidiaries, which, we
believe combined with our other capital sources, will continue to provide us
with sufficient funds to meet our foreseeable ongoing expenses and interest
payments.





Our
contractual obligations by payment due period are as follows:


*(dollar
      amounts in thousands)*
    
    
    2005
    
    
    2006-2007
    
    
    2008-2010
    
    
    Thereafter
    
    
    TotalLong-Term
      Debt (Principal and Interest):6.50%
      Convertible Debt(1)
    
    $
    6,444
    
    $
    12,888
    
    $
    122,686
    
    $
    -
    
    $
    142,0184.25%
      Convertible Debt(2)
    
    
    39
    
    
    79
    
    
    118
    
    
    1,387
    
    
    1,623Trust
      Preferred Debt(3)
    
    
    2,853
    
    
    5,705
    
    
    8,557
    
    
    108,168
    
    
    125,2848.50%
      Senior Notes
    
    
    4,888
    
    
    9,775
    
    
    14,662
    
    
    94,156
    
    
    123,48114,224
    
    
    28,447
    
    
    146,023
    
    
    203,711
    
    
    392,405Operating
      Leases(4)
    
    
    6,741
    
    
    10,121
    
    
    7,458
    
    
    3,080
    
    
    27,400Unpaid
      losses and loss adjustment expenses(5)
    
    
    543,311
    
    
    633,293
    
    
    417,654
    
    
    761,544
    
    
    2,355,802Total
    
    $
    564,276
    
    $
    671,861
    
    $
    571,135
    
    $
    968,335
    
    $
    2,775,607


*(1)*
    *Assumes
      holders require us to repurchase all of this debt on June 30, 2009 at 114%
      of the principal amount. This debt may be converted at any time, at the
      holder's option, at a current price of $16.368 per
    share.*


*(2)*
    *Holders
      of the Convertible Debt, at their option, may require the Company to
      repurchase all or a portion of their debt on September 30, 2006, 2008,
      2010, 2012 and 2017. This debt may be converted at any time, at the
      holder’s option, at a current price of $16.368 per share.*


*(3)*
    *See
      discussion below for the variable interest rates on the Trust Preferred
      Debt. The obligations related to the Trust Preferred Debt have been
      calculated using the interest rates in effect at December 31,
      2004.*


*(4)*
    *The
      operating lease obligations referred to in the table above are primarily
      obligations of our insurance subsidiaries and are net of sublease payments
      of $1.5 million in 2005, $3.1 million in 2006-2007, $4.9 million in
      2008-2010 and $6.2 million thereafter.*


*(5)*
    *Our
      unpaid losses and LAE do not have contractual maturity dates and the exact
      timing of payments cannot be predicted with certainty. However, based on
      historical payment patterns, we have included an estimate, gross of
      discount of $244.2 million, of when we expect our unpaid losses and LAE
      (without the benefit of reinsurance recoveries) to be paid. We maintain an
      investment portfolio with varying maturities that we believe will provide
      adequate cash for the payment of
claims.*





In 2004,
the Run-off Operations paid a $1.0 million fee to shorten the term of our
Philadelphia office lease from fifteen years to seven years and reduce the
leased space by approximately 75% effective October 1, 2004, which reduced our
contractual obligations under the lease by $661,000 annually from 2005 through
2008, $870,000 in 2009 and $14.6 million thereafter. In addition to the reduced
contractual obligations, we estimate that this change will also result in
reduced related expenses of approximately $830,000 annually.





In 2003,
we issued $57.5 million of 8.50% Senior Notes due June 15, 2018, from which we
realized net proceeds of $55.1 million. We used the proceeds from the offering
to repay the remaining balance outstanding under our prior bank credit facility,
to increase the statutory capital and surplus of our insurance subsidiaries, and
for general corporate purposes. We have the right to call these securities
beginning in June 2008.





In 2003, we
issued $43.8 million of 30-year floating rate subordinated debentures to three
wholly owned statutory trust subsidiaries. We used all of the $41.2 million of
net proceeds to pay down a portion of our then outstanding bank credit facility
and for general corporate purposes. The trust preferred debt matures in 2033 and
is redeemable, in whole or in part, in 2008 at its stated liquidation amount
plus accrued and unpaid interest. The interest rates on the trust preferred debt
equals the three-month London InterBank Offered Rate ("LIBOR") plus 4.10%, 4.20%
and 4.05% and is payable on a quarterly basis. At December 31, 2004, the
weighted average interest rate on the trust preferred securities was
6.51%.




We have
the right to defer interest payments on the trust
preferred securities for up to twenty consecutive quarters but, if so deferred,
we may not declare or pay cash dividends or distributions on our Class A common
stock. The obligations of the


49
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statutory
trust subsidiaries are guaranteed by PMA Capital with respect to distributions
and payments of the trust preferred securities.


In
October 2002, we issued $86.25 million of 4.25% Convertible Debt from which we
received net proceeds of $83.7 million. We used the proceeds from this offering
primarily to increase the capital and surplus of our reinsurance and insurance
subsidiaries. As discussed above, we exchanged $84.1 million of this debt in
November 2004. During
December 2004, we retired $1.2 million of this debt at par through open market
purchases. As of December 31, 2004, $925,000 remained outstanding. See Note 6 to our Consolidated Financial Statements for additional
information.





At
December 31, 2004, we had $214.5 million of long-term debt, compared to $187.6
million at December 31, 2003. During
2004, 2003 and 2002, we incurred $12.4 million, $9.9 million and $3.3 million of
interest expense, and paid interest of $11.6 million, $8.4 million and $2.1
million in each respective year.





During
2003 and 2002 we paid dividends to shareholders of $9.9 million and $12.1
million, respectively. We did not declare a dividend in the fourth quarter of
2003 and we have suspended common stock dividends at the current time.





We did
not repurchase any shares during 2004 or
2003. We repurchased 90,000 shares of our Class A Common stock at a cost of $1.7
million in 2002. Decisions regarding share repurchases are subject to prevailing
market conditions and an evaluation of the costs and benefits associated with
alternative uses of capital.





In 2002,
we contributed $16.5 million to our qualified pension plan in order to ensure
that the plan assets were at least equal to our accumulated benefit obligation
at the end of 2002. We did not make a contribution to our qualified pension plan
in 2004 or 2003. We made the contribution in 2002 due to a significant decline
in the market value of our plan assets, stemming from the broad market declines
in the bond and equity markets over the previous three years. Our accumulated
benefit obligation was greater than the fair value of plan assets by
approximately $8 million and $3 million at December 31, 2004 and December 31,
2003, respectively, largely due to reductions in the discount rate used to
measure the benefit obligation. As a result, we recorded a minimum pension
liability of $25.3 million and reduced accumulated other comprehensive income by
$15.6 million, after-tax in 2003. In 2004, we increased the additional minimum
pension liability by $1.2 million and reduced accumulated other comprehensive
income by $806,000 after-tax. In 2004 and 2003, the Company was not required to
make any contribution to the pension plan under the minimum funding requirements
of the Employee Retirement Income Security Act (“ERISA”) of 1974. Our plan
assets are composed of 31% fixed maturities and 69% equities at December 31,
2004. We currently estimate that the pension plan’s assets will generate a
long-term rate of return of 8.50%, which we believe is a reasonable long-term
rate of return, in part, because of the historical performance of the broad
financial markets. Pension expense in 2004, 2003 and 2002 was $4.9 million, $4.4
million and $3.0 million, respectively.





**Off-Balance
Sheet Arrangements**





W e had an
interest in a real estate partnership for which we had provided a guaranty of
$7.0 million related to loans on properties of the partnership. We sold our
interest in the partnership in 2004, and as such, this guaranty terminated at
the time of the sale.





At
December 31, 2004, The PMA Insurance Group is guarantor of $2.2 million
principal amount on certain premium finance loans made by unaffiliated premium
finance companies to insureds.





Under the
terms of the sale of one of our insurance subsidiaries , PMA
Insurance Cayman, Ltd. (renamed Trabaja Reinsurance Company), to London Life and
Casualty Reinsurance Corporation in 1998, we have agreed to indemnify the buyer,
up to a maximum of $15.0 million if the actual claim payments in the aggregate
exceed the estimated payments upon which the loss reserves of the former
subsidiary were established. If the actual claim payments in the aggregate are
less than the estimated payments upon which the loss reserves have been
established, we will participate in such favorable loss reserve development.
Trabaja Reinsurance Company is our largest reinsurer. See Note
5 to the Consolidated Financial Statements for additional
information.





50
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**INVESTMENTS**

Our
investment objectives are to (i) seek competitive after-tax income and total
return, as appropriate, (ii) maintain medium to high investment grade asset
quality and high marketability, (iii) maintain maturity distribution
commensurate with our business objectives, (iv) provide portfolio flexibility
for changing business and investment climates and (v) provide liquidity to meet
operating objectives. Our investment strategy includes guidelines for asset
quality standards, asset allocations among investment types and issuers, and
other relevant criteria for our portfolio. In addition, invested asset cash
flows, both currentincome and investment maturities, are structured
after considering projected liability cash flows of loss reserve payouts using
actuarial models. Property and casualty claim demands are somewhat unpredictable
in nature and require liquidity from the underlying invested assets, which are
structured to emphasize current investment income to the extent consistent with
maintaining appropriate portfolio quality and diversity. The liquidity
requirements are met primarily through publicly traded fixed maturities as well
as operating cash flows and short-term investments.





Our
investments at December 31 were as follows:


2004
    
    
    2003*(dollar
      amounts in millions)*
    
    
    Fair
      Value
    
    
    Percent
    
    
    Fair
      Value
    
    
    PercentU.S.
      Treasury securities and obligations of U.S. Government
      agencies
    
    $
    314.2
    
    
    22%
    
    $
    351.3
    
    
    17%States,
      political subdivisions and foreign government securities
    
    
    19.8
    
    
    1%
    
    
    20.8
    
    
    1%Corporate
      debt securities
    
    
    468.2
    
    
    33%
    
    
    795.2
    
    
    40%Mortgage-backed
      and other asset-backed securities
    
    
    501.9
    
    
    35%
    
    
    687.3
    
    
    34%Total
      fixed maturities available for sale
    
    $
    1,304.1
    
    
    91%
    
    $
    1,854.6
    
    
    92%Short-term
      investments
    
    
    123.7
    
    
    9%
    
    
    157.6
    
    
    8%Total
    
    $
    1,427.8
    
    
    100%
    
    $
    2,012.2
    
    
    100%


Our
investment portfolio includes only fixed maturities, short-term investments and
cash. The portfolio is diversified and does not contain any significant
concentrations in single issuers other than U.S. Treasury and agency
obligations. Our largest exposure to a single corporate issuer is $ 17.2
million, or 1%  of total
invested assets. In addition, we do not have a significant concentration of our
investments in any single industry segment other than finance companies, which
comprise 10% of invested assets at December 31, 2004. Included in this industry
segment are diverse financial institutions, including the financing subsidiaries
of automotive manufacturers. Substantially all of our investments are dollar
denominated as of December 31, 2004.





Mortgage-backed
and other asset-backed securities in the table above include collateralized
mortgage obligations (“CMOs”) of $170.1 million and $209.2 million carried at
fair value as of December 31, 2004 and 2003. CMO holdings are concentrated in
securities with limited prepayment, extension and default risk, such as planned
amortization class bonds.





As of
December 31, 2004, the duration of our investments that support the insurance
reserves was 3.6 years and the duration of our insurance reserves was 2.9 years.
The difference in the duration of our investments and our insurance reserves
reflects our decision to maintain a longer asset duration in order to enhance
overall yield.





The net
unrealized gain on our investments at December 31, 2004 was $20.8 million, or
1.5% of the amortized cost basis. The net unrealized gain included gross
unrealized gains of $33.1 million and gross unrealized losses of $12.3
million.





For all
but two securities, which were carried at a fair value of $16.9 million at
December 31, 2004, we determine the market value of each fixed income security
using prices obtained in the public markets. For these two securities, whose
fair values are not reliably determined from these public market sources, we
utilize the services of our outside professional investment asset managers to
determine the fair value. The asset managers determine the fair value of the
securities by using a discounted present value of the estimated future cash
flows (interest and principal repayment).








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At
December 31, our fixed maturities had an overall average credit quality of AA,
broken down as follows:





2004
    
    
    
    
    
    2003*(dollar
      amounts in millions)*
    
    
    Fair
      Value
    
    
    Percent
    
    
    Fair
      Value
    
    
    PercentU.S.
      Treasury securities and AAA
    
    $
    813.1
    
    
    62%
    
    $
    1,040.7
    
    
    56%AA
    
    
    24.8
    
    
    2%
    
    
    63.1
    
    
    3%A
    
    
    275.3
    
    
    21%
    
    
    435.9
    
    
    24%BBB
    
    
    178.5
    
    
    14%
    
    
    299.3
    
    
    16%Below
      investment grade
    
    
    12.4
    
    
    1%
    
    
    15.6
    
    
    1%Total
    
    $
    1,304.1
    
    
    100%
    
    $
    1,854.6
    
    
    100%


*Ratings
as assigned by Standard and Poor’s. Such ratings are generally assigned at the
time of the issuance of the securities, subject to revision on the basis of
ongoing evaluations.*





Our
investment income and net effective yield were as follows:





*(dollar
      amounts in millions)*
    
    
    2004
    
    
    2003
    
    
    2002Average
      invested assets(1)
    
    $
    1,677.4
    
    $
    1,886.2
    
    $
    1,716.1Investment
      income(2)
    
    $
    65.6
    
    $
    79.1
    
    $
    87.4Net
      effective yield(3)
    
    
    3.91
    %
    
    4.19
    %
    
    5.09
    %


*(1)*
    *Average
      invested assets throughout the year, at amortized cost, excluding amounts
      related to securities lending activities.*


*(2)*
    *Gross
      investment income less investment expenses and before interest credited on
      funds held treaties. Excludes net realized investment gains and losses and
      amounts related to securities lending
activities.*


*(3)*
    *Investment
      income for the period divided by average invested assets for the same
      period.*





We review
the securities in our fixed income portfolio on a periodic basis to specifically
review individual securities for any meaningful decline in market value below
amortized cost. Our analysis addresses all securities whose fair value is
significantly below amortized cost at the time of the analysis, with additional
emphasis placed on securities whose fair value has been below amortized cost for
an extended period of time. As part of our periodic review process, we utilize
the expertise of our outside professional asset managers who provide us with an
updated assessment of each issuer’s current credit situation based on recent
issuer activities, such as quarterly earnings announcements or other pertinent
financial news for the company, recent developments in a particular industry,
economic outlook for a particular industry and rating agency
actions.





In
addition to company-specific financial information and general economic data, we
also consider our ability and intent to hold a particular security to maturity
or until the market value of the bond recovers to a level in excess of the
carrying value. Our ability and intent to hold securities to such time is
evidenced by our strategy and process to match the cash flow characteristics of
the invested asset portfolio, both interest income and principal repayment, to
the actuarially determined estimated liability pay-out patterns of each
insurance company’s claims liabilities. As a result of this periodic review
process, we have determined that there currently is no need to sell any of the
fixed maturity investments prior to their scheduled/expected maturity to fund
anticipated claim payments.








52
 Table of Contents





As of
December 31, 2004, our investment asset portfolio had gross unrealized losses of
$12.3 million. For securities that were in an unrealized loss position at
December 31, 2004, the length of time that such securities have been in an
unrealized loss position, as measured by their month-end fair values, is as
follows:





PercentageNumber
      of
    
    
    Fair
    
    
    Amortized
    
    
    Unrealized
    
    
    Fair
      Value to*(dollar
      amounts in millions)*
    
    
    Securities
    
    
    Value
    
    
    Cost
    
    
    Loss
    
    
    Amortized
      CostLess
      than 6 months
    
    
    152
    
    $
    138.2
    
    $
    139.1
    
    $
    (0.9
    )
    
    99%6
      to 9 months
    
    
    71
    
    
    108.5
    
    
    110.0
    
    
    (1.5
    )
    
    99%9
      to 12 months
    
    
    7
    
    
    8.2
    
    
    8.4
    
    
    (0.2
    )
    
    98%More
      than 12 months
    
    
    34
    
    
    44.0
    
    
    49.4
    
    
    (5.4
    )
    
    89%Subtotal
    
    
    264
    
    
    298.9
    
    
    306.9
    
    
    (8.0
    )
    
    97%U.S.
      Treasury and Agency securities
    
    
    107
    
    
    277.3
    
    
    281.6
    
    
    (4.3
    )
    
    98%Total
    
    
    371
    
    $
    576.2
    
    $
    588.5
    
    $
    (12.3
    )
    
    98%


Of the 34
securities that have been in an unrealized loss position for more than 12
months, 33 securities have an unrealized loss of less than $1 million each and
less than 20% of each security's amortized cost. These 33 securities have a
total fair value of 96% of the amortized cost basis at December 31, 2004, and
the average unrealized loss per security is approximately $33,000. There is only
one security out of the 34 with an unrealized loss in excess of $1 million at
December 31, 2004, and it has a market value of $15.7 million and a par value
and cost of $20.0 million. The security, which matures in 2011, is a structured
security backed by a U.S. Treasury Strip, and is rated AAA. We have both the
ability and intent to hold this security until it matures.





The
contractual maturity of securities in an unrealized loss position at December
31, 2004 was as follows:


PercentageFair
    
    Amortized
    
    Unrealized
    
    Fair
      Value to*(dollar
      amounts in millions)*
    
    Value
    
    Cost
    
    Loss
    
    Amortized
      Cost2005
    
    $
    21.9
    
    $
    22.0
    
    $
    (0.1
    )
    
    100%2006-2009
    
    
    102.0
    
    
    103.2
    
    
    (1.2
    )
    
    99%2010-2014
    
    
    37.5
    
    
    38.3
    
    
    (0.8
    )
    
    98%2015
      and later
    
    
    9.5
    
    
    9.7
    
    
    (0.2
    )
    
    98%Mortgage-backed
      and other asset-backed securities
    
    
    128.0
    
    
    133.7
    
    
    (5.7
    )
    
    96%Subtotal
    
    
    298.9
    
    
    306.9
    
    
    (8.0
    )
    
    97%U.S.
      Treasury and Agency securities
    
    
    277.3
    
    
    281.6
    
    
    (4.3
    )
    
    98%Total
    
    $
    576.2
    
    $
    588.5
    
    $
    (12.3
    )
    
    98%





For all
securities that are in an unrealized loss position for an extended period of
time, we perform an evaluation of the specific events attributable to the market
decline of the security. We consider the length of time and extent to which the
security’s market value has been below cost as well as the general market
conditions, industry characteristics and the fundamental operating results of
the issuer to determine if the decline is due to changes in interest rates,
changes relating to a decline in credit quality of the issuer, or general market
conditions. We also consider as part of the evaluation our intent and ability to
hold the security until its market value has recovered to a level at least equal
to the amortized cost. Where we determine that a security’s unrealized loss is
other than temporary, a realized loss is recognized in the period in which the
decline in value is determined to be other than temporary.





At
December 31, 2004, 99% of our fixed income investments were publicly traded and
all were rated by at least one nationally recognized credit rating agency. In
addition, at December 31, 2004, $12.4 million, or 0.9%, of our total investments
were below investment grade. Of these below investment grade investments, $2.9
million were in an unrealized loss position, which totaled
$195,000.





During
200 4, we
determined there were other than temporary declines in the market value of
securities issued by two companies, resulting in impairment losses of $334,000
in 2004. The impairment losses for 2004 were related to an asset-backed security
and a security issued by an airline company.  The
write-downs were measured based on public market prices and our expectation of
the future realizable value for the securities at the time we determined the
decline in value was other than temporary.





53
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During
2003, we recorded other than temporary impairment charges for securities issued
by four companies, resulting in impairment losses of $2.6 million in 2003,
primarily related to securities issued by airline companies and one asset-backed
security.  During
2002, we impaired securities issued by 11 companies, resulting in impairment
charges of $23.8 million during 2002, including $14.2 million for WorldCom. See
Critical Accounting Estimates -
Investments on page 56 for additional information.





**Net
Realized Investment Gains and Losses**





We had
pre-tax net realized investment gains of $6.5 million in 2004, compared to $13.8
million in 2003 and net realized investment losses of $16.1 million in 2002.
During 2004, there were gross realized investment gains and losses of $20.1
million and $4.9 million, respectively. Also included in 2004 net realized
investment gains were realized losses of $3.8
million related to the increase in the fair value of the derivative component of
our 6.50% Convertible Debt and $4.9
million of foreign exchange losses. Gross realized losses in 2004 reflected
sales reducing our per issuer exposure and general duration management trades,
impairment losses of $334,000 on fixed income securities and realized losses of
$380,000 on sales of securities where we reduced and/or eliminated our positions
in certain issuers due to credit concerns.





Results
for 2003 include gross realized gains and losses of $18.7 million and $4.9
million, respectively. Included in the gross realized losses were impairment
losses of $2.6 million on fixed income securities, primarily securities issued
by airline companies and one asset-backed security and realized losses of
$800,000 on sales of securities where we reduced and/or eliminated our positions
in certain issuers due to credit concerns. Realized losses also include sales
reducing our per issuer exposure and general duration management trades. The net
realized investment losses for 2002 primarily reflect impairment losses of $23.8
million on fixed income securities, primarily corporate bonds issued by
telecommunications and energy companies.





See “Item 1 - Business - Investments” and Notes 2B and 3 to our Consolidated
Financial Statements for additional discussion about our investment
portfolio.





**OTHER
MATTERS**





**Other
Factors Affecting Our Business**





In
general, our businesses are subject to a changing social, economic, legal,
legislative and regulatory environment that could affect them. Some of the
changes include initiatives to restrict insurance pricing and the application of
underwriting standards and reinterpretations of insurance contracts long after
the policies were written in an effort to provide coverage unanticipated by us.
The eventual effect on us of the changing environment in which we operate
remains uncertain.





The
Pennsylv ania
Insurance Department has completed examinations of PMA Capital Insurance Company
and the Pooled Companies as of December 31, 2002. The examinations did not
result in any material adjustments to our statutory capital in our previously
filed statutory financial statements. No material qualitative matters were
raised as a result of the examinations.





**Comparison
of SAP and GAAP Results**





Results
presented in accordance with GAAP vary in certain respects from results
presented in accordance with statutory accounting practices prescribed or
permitted by the Pennsylvania Insurance Department, (collectively “SAP”).
Prescribed SAP includes state laws, regulations and general administrative
rules, as well as a variety of National Association of Insurance Commissioners
publications. Permitted SAP encompasses all accounting practices that are not
prescribed. Our domestic insurance subsidiaries use SAP to prepare various
financial reports for use by insurance regulators.





**Recent
Accounting Pronouncements**





In
December 2003, the Financial Accounting Standards Board (“FASB”) revised
Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’
Disclosures About Pensions and Other Postretirement Benefits,” to require
additional disclosures regarding defined benefit pension plans and other defined
benefit postretirement plans. We have applied the disclosure provisions of SFAS
No. 132, as revised, to our Consolidated Financial Statements.





54
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In
December 2004, we adopted Emerging
Issues Task Force (“EITF”) Consensus 04-8,
“ The
Effect of Contingently Convertible Debt on Diluted Earnings Per Share,” which
requires the inclusion of the dilutive effect of contingently convertible debt
instruments in the computation of diluted income (loss) per share
regardless of whether the contingency triggering convertibility has been met.
Our earnings per share calculation for the first and second quarters of 2003 did
not include the effects of potential conversion because the conditions for
convertibility had not yet occurred. Adoption of EITF 04-8 resulted in a
reduction in our first and second quarter 2003 diluted income per share by three
and four cents, respectively, but has no effect for full year 2003, because the
effect would have been anti-dilutive. Beginning in the third quarter of 2003,
the conversion requirements were met on our convertible debt. See unaudited “Quarterly Financial Information” in Item 8 of this
Form 10-K for additional information.





In March
2004, the EITF
reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments.”  The consensus
provides guidance for evaluating whether an investment is other-than-temporarily
impaired.  The disclosure provisions of EITF 03-1 were effective for
year-end 2003, with the recognition and measurement provisions scheduled to be
effective for the third quarter of 2004. However, in September 2004, the FASB
issued Staff Position EITF 03-1-1, which delays the effective date of the
application of the recognition and measurement provisions of EITF 03-1. The
delay of the recognition and measurement provisions is expected to be superseded
concurrently with the issuance of a FASB Staff Position which will provide
additional implementation guidance. We will assess whether this guidance will
have a material impact on our financial condition or results of operations once
the new guidance is released.





In
December 2004, the FASB revised SFAS No. 123, “Share-Based Payment” to require
the recognition of expenses relating to share-based payment transactions,
including employee stock option grants, based on the fair value of the equity
instruments issued. We are required to adopt the revised SFAS No. 123 in the
third quarter of 2005. Effective with the third quarter of 2005, we will
recognize an expense over the required service period for any stock options
granted, modified, cancelled, or repurchased after that date and for the portion
of grants for which the requisite service has not yet been rendered, based on
the grant-date fair value of those awards. In December 2002, we adopted the
disclosure provisions of SFAS No. 148, “Accounting
for Stock-Based Compensation - Transition and Disclosure,” which required
prominent disclosures in financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. See Note 2-J to the Consolidated Financial
Statements for the effect on net income (loss) if the fair value based
method had been applied.





**Critical Accounting
Estimates**





Our
Consolidated Financial Statements have been prepared in accordance with GAAP.
Some of the accounting policies permitted by GAAP require us to make estimates
of the amounts of assets and liabilities to be reported in our Consolidated
Financial Statements. We have provided a summary of all of our significant
accounting policies in Note 2 to our Consolidated Financial
Statements. We recommend that you read all of these policies.





The
following discussion is intended to provide you with an understanding of our
critical accounting estimates, which are those accounting estimates that we
believe are most important to the portrayal of our financial condition and
results of operations, and that require our most difficult, subjective and
complex judgments.





***Unpaid
losses and loss adjustment expenses***





At
December 31, 2004, we estimated that under all insurance policies and
reinsurance contracts issued by our insurance businesses, our liability for all
events that occurred as of December 31, 2004 is $2,111.6 million. This amount
includes estimated losses from claims plus estimated expenses to settle claims.
Our estimate also includes amounts for losses occurring prior to December 31,
2004 whether or not these claims have been reported to us.





In
arriving at the estimate of unpaid claims, our actuaries performed detailed
studies of historical data for customer mix, incurred claims, reported claims
and paid claims for each major line of business and by accident year. The review
of this data results in patterns and trends that are analyzed using various
actuarial models that assume that historical development patterns will be
predictive of future patterns. Along with this historical data, our actuaries
consider the impact of legal and legislative developments, regulatory trends,
changes in social attitudes and economic conditions. From this assessment, we
develop various sets of assumptions that we believe are reasonable, valid and
can be used to help us predict future claim trends. These
assumptions are then applied to various actuarially accepted methods and
techniques, which provide us with a range of possible outcomes of the ultimate
claims to be paid by us in the future. Management uses its judgment to select
the





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best
estimate of the amounts needed to pay all future claims and related expenses
from this range of possible outcomes. Under GAAP, we record a liability on our
balance sheet equal to our best estimate of the ultimate claims
liability.





It is
important to realize and understand that the process of estimating our ultimate
claims liability is necessarily a complex and judgmental process inasmuch as the
amounts are based on management’s informed estimates, assumptions and judgments
using data currently available. As additional experience and data become
available regarding claims payment and reporting patterns, legal and legislative
developments, judicial theories of liability, the impact of regulatory trends on
benefit levels for both medical and indemnity payments, and changes in social
attitudes and economic conditions, we revise our estimates accordingly. Due to
the long-tail nature of a significant portion of our business, in many cases,
significant periods of time, ranging up to several years or more, may elapse
between the occurrence of an insured loss, the reporting of the loss to us and
our payment of that loss. Furthermore, because reinsurers rely on their ceding
companies to provide them with information regarding incurred losses, reported
claims for reinsurers become known more slowly than for primary insurers and are
subject to more unforeseen development and uncertainty. We believe that our
liability for unpaid losses and loss adjustment expenses is fairly stated at
December 31, 2004. However, if our future estimate of ultimate unpaid losses is
larger than the recorded amounts, we would have to increase our reserves. Any
increase in reserves would result in a charge to earnings in the period
recorded. For example, in 2003 we increased net reserves for our reinsurance
business by $169 million and took earnings charges as a result. Accordingly, any
reserve adjustment could have a material adverse effect on our financial
condition, results of operations and liquidity.





As
outlined above, our loss and LAE reserves at December 31, 2004 have been
established relying on generally accepted actuarial techniques and are based on
numerous critical assumptions and informed judgments about reported and paid
claim trends and their implication on our estimate of the ultimate loss for
reported and incurred but unreported claims at the balance sheet date. We have
established a loss and LAE reserve for unpaid claims at December 31, 2004 that
we believe is a reasonable and adequate provision based on the information
available to us. If we revised our assessment of loss reporting and claims
payment patterns because of changes in those patterns, such that it resulted in
a 1% change in our net loss and LAE reserves, then our pre-tax income would
change by approximately $10 million.





For
additional information about our liability for unpaid losses and loss adjustment
expenses, see Notes 2-D and 4 to the
Consolidated Financial Statements as well as “Item 1 -
Business - Loss Reserves.”





***Investments***





All
investments in our portfolio are carried at market value. For 99% of our
investments, we determine the market value using prices obtained in the public
markets, both primary and secondary markets. These market prices reflect
publicly reported values of recent purchase and sale transactions for each
specific, individual security. Therefore, we believe that the reported fair
values for our investments at December 31, 2004 reflect the value that we could
realize if we sold these investments in the open market at that
time.





As part
of determining the market value for each specific investment that we hold, we
evaluate each issuer’s ability to fully meet their obligation to pay all
amounts, both interest and principal, due in the future. Because we have
invested in fixed income obligations with an overall average credit quality of
AA, and all of our investments are currently meeting their obligations with
respect to scheduled interest income and principal payments, we believe that we
will fully realize the value of our investments. However, future general
economic conditions and/or specific company performance issues may cause a
particular issuer, or group of issuers in the same industry segment, to become
unable to meet their obligation to pay principal and interest as it comes due.
If such events were to occur, then we would evaluate our ability to fully
recover the recorded value of our investment. Ultimately, we may have to write
down an investment to its then determined net realizable value and reflect that
write-down in earnings in the period such determination is made.





Based on
our evaluation of securities with an unrealized loss at December 31, 2004, we do
not believe that any additional other-than-temporary impairment losses, other
than those already reflected in the financial statements, are necessary at the
balance sheet date. However, if we were to have determined that all securities
that were in an unrealized loss position at December 31, 2004 should have been
written down to their fair value, we would have recorded an additional
other-than-temporary impairment loss of $12.3 million pre-tax.




For
additional information about our investments, see Notes 2-B , 3 and 11 of the
Consolidated Financial Statements as well as “Investments” beginning
on page 51.





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***Reinsurance
Receivables***





We follow
the customary insurance industry practice of reinsuring with other insurance and
reinsurance companies a portion of the risks under the policies written by our
insurance and reinsurance subsidiaries. Our reinsurance receivables total
$ 1,142.6
million at December 31, 2004. We have estimated that $9.0 million of our total
reinsurance receivables will be uncollectible, and we have provided a valuation
allowance for that amount.





Although
the contractual obligation of individual reinsurers to pay their reinsurance
obligations is determinable from specific contract provisions, the
collectibility of such amounts requires significant estimation by management.
Many years may pass between the occurrence of a claim, when it is reported to us
and when we ultimately settle and pay the claim. As a result, it can be several
years before a reinsurer has to actually remit amounts to us. Over this period
of time, economic conditions and operational performance of a particular
reinsurer may impact their ability to meet these obligations and while they may
still acknowledge their contractual obligation to do so, they may not have the
financial resources to fully meet their obligation to us. If this occurs, we may
have to write down a reinsurance receivable to its then determined net
realizable value and reflect that write-down in earnings in the period such
determination is made. We attempt to limit any such exposure to uncollectible
reinsurance receivables by performing credit reviews of our reinsurers. In
addition, we require collateral, such as assets held in trust or letters of
credit, for certain reinsurance receivables. However, if our future estimate of
uncollectible receivables exceeds our current expectations, we may need to
increase our allowance for uncollectible reinsurance receivables. The increase
in this allowance would result in a charge to earnings in the period recorded.
Accordingly, any related charge could have a material adverse effect on our
financial condition, results of operations and liquidity.





Based on
our evaluation of reinsurance receivables at December 31, 2004, we have
established an allowance for amounts that we have concluded are uncollectible at
the balance sheet date. In evaluating collectibility, we considered historical
payment performance of our reinsurers, the fact that our reinsurers are current
on their obligations to our insurance subsidiaries, and any known disputes or
collection issues as of the balance sheet date. To these factors, we applied our
informed judgment in ascertaining the appropriate level of allowance for
uncollectible amounts. At December 31, 2004, approximately $17.6 million of
uncollateralized reinsurance receivables, including $6.5 million due for ceded
IBNR, are due from reinsurers who have ratings that declined to below
“Adequate,” defined as B++ or below by A.M. Best, in 2004 or who were under
regulatory supervision or in liquidation in 2004.





For
additional information about reinsurance receivables, see Note
5 to the Consolidated Financial Statements as well as “Reinsurance” beginning on page 45.





***Deferred
Tax Assets***





We record
deferred tax assets and liabilities to the extent of the tax effect of
differences between the financial statement carrying values and tax bases of
assets and liabilities. The recoverability of deferred tax assets is evaluated
based upon management’s estimates of the future profitability of our taxable
entities based on current forecasts. We establish a valuation allowance for
deferred tax assets where it appears more likely than not that we will not be
able to recover the deferred tax asset. At December 31, 2004, PMA Capital has a
net deferred tax asset of $86.5 million, resulting from $170.9 million of gross
deferred tax assets reduced by a deferred tax asset valuation allowance of $57.0
million and by $27.4 million of deferred tax liabilities. In establishing the
appropriate value of this asset, management must make judgments about our
ability to utilize the net tax benefit from the reversal of temporary
differences and the utilization of operating loss carryforwards that expire
mainly from 2018 through 2024.





In 2003,
a valuation allowance in the amount of $49 million was established. In the
fourth quarter of 2004, we reassessed the valuation allowance previously
established against our net deferred tax assets and determined that it needed to
be increased by $8 million. Included in management’s reassessment were such
factors as the recent losses and revised projections of future earnings at the
Run-off Operations. Accordingly, we have estimated at December 31, 2004 that our
insurance operations will generate sufficient future taxable income to utilize
the net deferred tax asset, net of the $57.0 million valuation allowance, over a
period of time not exceeding the expiration of our operating loss carryforwards.
As a result, we determined that it is more likely than not that we will be able
to realize the future tax benefit of our net deferred tax asset. In making this
determination, we have made reasonable estimates of our future taxable income.
If our estimates of future
income were to be revised downward and we determined that it was then more
likely than not that we would not be able to realize the value of our net
deferred tax asset, then this could have a material adverse effect on our
results of operations. For additional information seeNote 12to our
Consolidated Financial Statements.





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***Premiums***





Premiums,
including estimates of additional premiums resulting from audits of insureds’
records, and premiums from ceding companies which are typically reported on a
delayed basis, are earned principally on a pro rata basis over the terms of the
policies.  As
discussed in “PMA Insurance Group - Premiums” beginning on page 39 , in the
fourth quarter of 2003, T he PMA
Insurance Group recorded $35 million of retrospectively rated premiums under
loss sensitive policies that were attributable to higher than expected losses
from accident years 2001 and 2002. Under The PMA Insurance Group’s
loss-sensitive rating plans, we adjust the amount of the insured’s premiums
after the policy period expires based, to a large extent, upon the insured’s
actual loss experience during the policy period. Retrospectively rated premium
adjustments and audit premium adjustments are recorded as earned in the
period in which the adjustment
is made .





The
premiums on reinsurance business ceded are recorded as incurred on a pro rata
basis over the contract period. Certain ceded reinsurance contracts contain
provisions requiring us to pay additional premiums ranging from 20% to 50% of
ceded losses or reinstatement premiums in the event that losses of a significant
magnitude are ceded under such contracts. Under accounting rules, we are not
permitted to establish reserves for potential additional premiums or record such
amounts until a loss occurs that would obligate us to pay such additional or
reinstatement premiums. As a result, the net benefit to our results from ceding
losses to our retrocessionaires in the event of a loss may be reduced by the
payment of additional premiums and reinstatement premiums to our
retrocessionaires.








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**CAUTIONARY
STATEMENTS**





Except
for historical information provided in Management’s Discussion and Analysis and
otherwise in this report, statements made throughout, are forward-looking and
contain information about financial results, economic conditions, trends and
known uncertainties. Words such as “believe,” “estimate,” “anticipate,” “expect”
or similar words are intended to identify forward-looking statements. These
forward-looking statements are based on currently available financial,
competitive and economic data and our current operating plans based on
assumptions regarding future events. Our actual results could differ materially
from those expected by our management.





The
factors that could cause actual results to vary materially, some of which are
described with the forward-looking statements, include, but are not limited
to:





·
    our
      ability to effect an efficient withdrawal from the reinsurance business,
      including the commutation of reinsurance business with certain large
      ceding companies, without incurring any significant additional
      liabilities;


·
    adverse
      property and casualty loss development for events that we insured in prior
      years, including unforeseen increases in medical
costs;


·
    our
      ability to have sufficient cash at the holding company to meet our debt
      service and other obligations, including any restrictions such as those
      imposed by the Pennsylvania Insurance Department on receiving dividends
      from our insurance subsidiaries in an amount sufficient to meet such
      obligations;


·
    our
      ability to increase the amount of new and renewal business written by The
      PMA Insurance Group at adequate prices;


·
    any
      future lowering or loss of one or more of our financial strength and debt
      ratings, and the adverse impact that any such downgrade may have on our
      ability to compete and to raise capital, and our liquidity and financial
      condition;


·
    adequacy
      and collectibility of reinsurance that we
purchased;


·
    adequacy
      of reserves for claim liabilities;


·
    the
      uncertain nature of damage theories and loss amounts and the development
      of additional facts related to the attack on the World Trade
      Center;


·
    regulatory
      changes in risk-based capital or other regulatory standards that affect
      the cost of, or demand for, our products or otherwise affect our ability
      to conduct business, including any future action with respect to our
      business taken by the Pennsylvania Insurance Department or any other state
      insurance department;


·
    the
      impact of future results on the recoverability of our deferred tax
      asset;


·
    the
      outcome of any litigation against us, including the outcome of the
      purported class action lawsuits;


·
    competitive
      conditions that may affect the level of rate adequacy related to the
      amount of risk undertaken and that may influence the sustainability of
      adequate rate changes;


·
    ability
      to implement and maintain rate increases;


·
    the
      effect of changes in workers’ compensation statutes and their
      administration, which may affect the rates that we can charge and the
      manner in which we administer claims;


·
    our
      ability to predict and effectively manage claims related to insurance and
      reinsurance policies;


·
    uncertainty
      as to the price and availability of reinsurance on business we intend to
      write in the future, including reinsurance for terrorist
    acts;


·
    severity
      of natural disasters and other catastrophes, including the impact of
      future acts of terrorism, in connection with insurance and reinsurance
      policies;


·
    changes
      in general economic conditions, including the performance of financial
      markets, interest rates and the level of
unemployment;


·
    uncertainties
      related to possible terrorist activities or international hostilities and
      whether TRIA is extended beyond its December 31, 2005 termination date;
      and


·
    other
      factors or uncertainties disclosed from time to time in our filings with
      the Securities and Exchange Commission.





You
should not place undue reliance on any such forward-looking statements. Unless
otherwise stated, we disclaim any current intention to update forward-looking
information and to release publicly the results of any future revisions we may
make to forward-looking statements to reflect events or circumstances after the
date hereof or to reflect the occurrence of unanticipated events.





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**Item 7A. Quantitative and Qualitative Disclosure About Market
Risk**





Caution
should be used in evaluating our overall market risk from the information below,
since actual results could differ materially because the information was
developed using estimates and assumptions as described below, and because
insurance liabilities and reinsurance receivables are excluded in the
hypothetical effects (insurance liabilities represent 75% of
our total liabilities and reinsurance receivables represent 35% of our total
assets).





A
significant portion of our assets and liabilities are financial instruments that
are subject to the market risk of potential losses from adverse changes in
market rates and prices. Our primary market risk exposures relate to interest
rate risk on fixed rate domestic medium-term instruments and, to a lesser
extent, domestic short- and long-term instruments. To manage our exposure to
market risk, we have established strategies, asset quality standards, asset
allocations and other relevant criteria for our investment portfolio. In
addition, invested asset cash flows are structured after considering projected
liability cash flows with actuarial models. All of our financial instruments are
held for purposes other than trading. Our portfolio does not contain a
significant concentration in single issuers other than U.S. Treasury and agency
obligations. In addition, we do not have a significant concentration of our
investments in any single industry segment other than finance companies, which
comprise approximately 10% of invested assets at December 31, 2004. Included in
this industry segment are diverse financial institutions, including the
financing subsidiaries of automotive manufacturers. See Notes
2-B, 2-G, 2-L, 3, 6 and 11 to our
Consolidated Financial Statements for additional information about financial
instruments.





The
hypothetical effects of changes in market rates or prices on the fair values of
financial instruments as of December 31, 2004, excluding insurance liabilities
and reinsurance receivables on unpaid losses because such insurance related
assets and liabilities are not carried at fair value, would have been as
follows:





·
    If
      interest rates had increased by 100 basis points, there would have been a
      decrease of approximately $8 million in the fair value of our debt. The
      change in fair values was determined by estimating the present value of
      future cash flows using models that measure the change in net present
      values arising from selected hypothetical changes in market interest
      rates.





·
    If
      interest rates had increased by 100 basis points, there would have been a
      net decrease of approximately $58 million in the fair value of our
      investment portfolio. The change in fair values was determined by
      estimating the present value of future cash flows using various models,
      primarily duration modeling.











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**Item
8.****Financial
Statements and Supplementary Data**





Index to
Consolidated Financial Statements





Consolidated Balance Sheets at December 31,
      2004 and 2003
    62Consolidated Statements of Operations for
      the years ended December 31, 2004, 2003 and 2002
    63Consolidated Statements of Cash Flows for the years
      ended December 31, 2004, 2003 and 2002
    64Consolidated Statements of Shareholders’
      Equity for the years ended December 31, 2004, 2003 and
      2002
    65Consolidated Statements of
      Comprehensive Income (Loss) for the years ended December 31, 2004, 2003
      and 2002
    66Notes to Consolidated Financial
      Statements
    67Reports of Independent Registered Public
      Accounting Firms
    93Quarterly Financial Information
    96





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PMA
CAPITAL CORPORATION


CONSOLIDATED BALANCE SHEETS





*(in
      thousands, except share data)*
    
    
    2004
    
    
    2003**Assets:**Investments:Fixed
      maturities available for sale, at fair value (amortized
      cost:2004
      - $1,283,256; 2003 - $1,806,090)
    
    $
    1,304,086
    
    $
    1,854,555Short-term
      investments
    
    
    123,746
    
    
    151,332Short-term
      investments, loaned securities collateral
    
    
    -
    
    
    6,300Cash
    
    
    35,537
    
    
    28,963Total
      investments and cash
    
    
    1,463,369
    
    
    2,041,150Accrued
      investment income
    
    
    15,517
    
    
    20,870Premiums
      receivable (net of valuation allowance: 2004 - $7,049; 2003 -
      $7,972)
    
    
    197,831
    
    
    364,125Reinsurance
      receivables (net of valuation allowance: 2004 - $9,002; 2003 -
      $6,769)
    
    
    1,142,552
    
    
    1,220,320Deferred
      income taxes, net
    
    
    86,501
    
    
    76,962Deferred
      acquisition costs
    
    
    31,426
    
    
    83,975Funds
      held by reinsureds
    
    
    142,064
    
    
    124,695Other
      assets
    
    
    174,725
    
    
    255,861Total
      assets
    
    $
    3,253,985
    
    $
    4,187,958**Liabilities:**Unpaid
      losses and loss adjustment expenses
    
    $
    2,111,598
    
    $
    2,541,318Unearned
      premiums
    
    
    158,489
    
    
    403,708Long-term
      debt
    
    
    214,467
    
    
    187,566Accounts
      payable, accrued expenses and other liabilities
    
    
    196,744
    
    
    314,830Funds
      held under reinsurance treaties
    
    
    121,234
    
    
    262,105Dividends
      to policyholders
    
    
    5,977
    
    
    8,479Payable
      under securities loan agreements
    
    
    25
    
    
    6,285Total
      liabilities
    
    
    2,808,534
    
    
    3,724,291Commitments
      and contingencies (Note 7)**Shareholders'
      Equity:**Class
      A Common stock, $5 par value(2004
      - 60,000,000 shares authorized; 34,217,945 shares issued and 31,676,851
      outstanding;2003
      - 60,000,000 shares authorized; 34,217,945 shares issued and 31,334,403
      outstanding)
    
    
    171,090
    
    
    171,090Additional
      paid-in capital
    
    
    109,331
    
    
    109,331Retained
      earnings
    
    
    213,313
    
    
    216,115Accumulated
      other comprehensive income (loss)
    
    
    (1,959
    )
    
    19,622Notes
      receivable from officers
    
    
    -
    
    
    (65
    )Treasury
      stock, at cost (2004 - 2,541,094 shares; 2003 - 2,883,542
      shares)
    
    
    (45,573
    )
    
    (52,426
    )Unearned
      restricted stock compensation
    
    
    (751
    )
    
    -Total
      shareholders' equity
    
    
    445,451
    
    
    463,667Total
      liabilities and shareholders' equity
    
    $
    3,253,985
    
    $
    4,187,958**


**


**


**


*See accompanying notes to the consolidated
financial statements.*


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PMA
CAPITAL CORPORATION


CONSOLIDATED STATEMENTS OF
OPERATIONS





*(in
      thousands, except per share data)*
    
    
    2004
    
    
    2003
    
    
    2002**Revenues:**Net
      premiums written
    
    $
    301,610
    
    $
    1,192,254
    
    $
    1,104,997Change
      in net unearned premiums
    
    
    216,975
    
    
    5,911
    
    
    (113,986
    )Net
      premiums earned
    
    
    518,585
    
    
    1,198,165
    
    
    991,011Net
      investment income
    
    
    56,945
    
    
    68,923
    
    
    84,881Net
      realized investment gains (losses)
    
    
    6,493
    
    
    13,780
    
    
    (16,085
    )Other
      revenues
    
    
    25,941
    
    
    20,379
    
    
    15,330Total
      revenues
    
    
    607,964
    
    
    1,301,247
    
    
    1,075,137**Losses
      and Expenses:**Losses
      and loss adjustment expenses
    
    
    380,556
    
    
    998,347
    
    
    823,658Acquisition
      expenses
    
    
    115,225
    
    
    256,446
    
    
    216,984Operating
      expenses
    
    
    84,912
    
    
    103,672
    
    
    102,808Dividends
      to policyholders
    
    
    4,999
    
    
    641
    
    
    7,587Interest
      expense
    
    
    12,354
    
    
    9,887
    
    
    3,257Loss
      on debt exchange
    
    
    5,973
    
    
    -
    
    
    -Total
      losses and expenses
    
    
    604,019
    
    
    1,368,993
    
    
    1,154,294Income
      (loss) before income taxes
    
    
    3,945
    
    
    (67,746
    )
    
    (79,157
    )Income
      tax expense (benefit)
    
    
    2,115
    
    
    25,823
    
    
    (31,133
    )Net
      income (loss)
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )**Income
      (loss) per share:**Basic
    
    $
    0.06
    
    $
    (2.99
    )
    $
    (1.53
    )Diluted
    
    $
    0.06
    
    $
    (2.99
    )
    $
    (1.53
    )









































*See accompanying notes to the consolidated
financial statements.*





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PMA
CAPITAL CORPORATION


CONSOLIDATED STATEMENTS OF CASH FLOWS





*(in
      thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**Cash
      flows from operating activities:**Net
      income (loss)
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )Adjustments
      to reconcile net income (loss) to net cash flowsprovided
      by (used in) operating activities:Deferred
      income tax expense (benefit)
    
    
    2,115
    
    
    25,823
    
    
    (27,527
    )Net
      realized investment (gains) losses
    
    
    (6,493
    )
    
    (13,780
    )
    
    16,085Depreciation
      and amortization
    
    
    19,667
    
    
    21,229
    
    
    9,199Loss
      on debt exchange
    
    
    5,973
    
    
    -
    
    
    -Change
      in:Premiums
      receivable and unearned premiums, net
    
    
    (78,925
    )
    
    (2,121
    )
    
    34,516Reinsurance
      receivables
    
    
    77,768
    
    
    74,763
    
    
    (34,319
    )Unpaid
      losses and loss adjustment expenses
    
    
    (429,720
    )
    
    91,428
    
    
    125,451Funds
      held by reinsureds
    
    
    (17,369
    )
    
    32,784
    
    
    (12,240
    )Funds
      held under reinsurance treaties
    
    
    (140,871
    )
    
    12,435
    
    
    21,778Deferred
      acquisition costs
    
    
    52,549
    
    
    5,247
    
    
    (24,872
    )Accounts
      payable, accrued expenses and other liabilities
    
    
    (118,116
    )
    
    38,329
    
    
    25,836Dividends
      to policyholders
    
    
    (2,502
    )
    
    (6,519
    )
    
    (2,134
    )Accrued
      investment income
    
    
    5,353
    
    
    (2,270
    )
    
    521Other,
      net
    
    
    25,474
    
    
    (34,149
    )
    
    (12,103
    )Net
      cash flows provided by (used in) operating activities
    
    
    (603,267
    )
    
    149,630
    
    
    72,167**Cash
      flows from investing activities:**Fixed
      maturities available for sale:Purchases
    
    
    (484,142
    )
    
    (1,062,420
    )
    
    (964,047
    )Maturities
      and calls
    
    
    231,622
    
    
    319,241
    
    
    256,625Sales
    
    
    779,494
    
    
    395,287
    
    
    634,480Net
      (purchases) sales of short-term investments
    
    
    28,664
    
    
    147,584
    
    
    (29,942
    )Proceeds
      from sale of subsidiary, net of cash sold
    
    
    -
    
    
    17,676
    
    
    -Proceeds
      from other assets sold
    
    
    41,147
    
    
    -
    
    
    -Other,
      net
    
    
    (1,043
    )
    
    (3,358
    )
    
    (20,961
    )Net
      cash flows provided by (used in) investing activities
    
    
    595,742
    
    
    (185,990
    )
    
    (123,845
    )**Cash
      flows from financing activities:**Dividends
      paid to shareholders
    
    
    -
    
    
    (9,870
    )
    
    (12,102
    )Issuance
      of long-term debt
    
    
    15,825
    
    
    100,000
    
    
    151,250Debt
      issue costs
    
    
    (600
    )
    
    (3,662
    )
    
    (3,009
    )Repayment
      of debt
    
    
    (1,185
    )
    
    (65,000
    )
    
    (62,500
    )Proceeds
      from exercise of stock options
    
    
    -
    
    
    2
    
    
    2,866Purchase
      of treasury stock
    
    
    -
    
    
    -
    
    
    (1,726
    )Net
      repayments of notes receivable from officers
    
    
    59
    
    
    -
    
    
    96Net
      cash flows provided by financing activities
    
    
    14,099
    
    
    21,470
    
    
    74,875Net
      increase (decrease) in cash
    
    
    6,574
    
    
    (14,890
    )
    
    23,197Cash
      - beginning of year
    
    
    28,963
    
    
    43,853
    
    
    20,656Cash
      - end of year
    
    $
    35,537
    
    $
    28,963
    
    $
    43,853**Supplementary
      cash flow information:**Income
      tax paid (refunded)
    
    $
    (2,592
    )
    $
    2,600
    
    $
    (10,649
    )Interest
      paid
    
    $
    11,607
    
    $
    8,366
    
    $
    2,091














*See accompanying notes to the consolidated
financial statements.*





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PMA
CAPITAL CORPORATION


CONSOLIDATED STATEMENTS OF SHAREHOLDERS’
EQUITY





*(in
      thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**Class
      A Common Stock**
    
    $
    171,090
    
    $
    171,090
    
    $
    171,090**Additional
      paid-in capital - Class A Common stock**
    
    
    109,331
    
    
    109,331
    
    
    109,331**Retained
      earnings:**Balance
      at beginning of year
    
    
    216,115
    
    
    319,014
    
    
    382,165Net
      income (loss)
    
    
    1,830
    
    
    (93,569
    )
    
    (48,024
    )Class
      A Common stock dividends declared
    
    
    -
    
    
    (9,870
    )
    
    (13,142
    )Reissuance
      of treasury shares under employee benefit plans
    
    
    (4,632
    )
    
    540
    
    
    (1,985
    )Balance
      at end of year
    
    
    213,313
    
    
    216,115
    
    
    319,014**Accumulated
      other comprehensive income (loss):**Balance
      at beginning of year
    
    
    19,622
    
    
    34,552
    
    
    5,375Other
      comprehensive income (loss), net of tax expense
      (benefit):2004
      - ($11,620); 2003 - ($8,039); 2002 - $15,710
    
    
    (21,581
    )
    
    (14,930
    )
    
    29,177Balance
      at end of year
    
    
    (1,959
    )
    
    19,622
    
    
    34,552**Notes
      receivable from officers:**Balance
      at beginning of year
    
    
    (65
    )
    
    (62
    )
    
    (158
    )Repayment
      (interest accrued) of notes receivable from officers
    
    
    65
    
    
    (3
    )
    
    96Balance
      at end of year
    
    
    -
    
    
    (65
    )
    
    (62
    )**Treasury
      stock - Class A Common:**Balance
      at beginning of year
    
    
    (52,426
    )
    
    (52,535
    )
    
    (55,797
    )Purchase
      of treasury shares
    
    
    -
    
    
    -
    
    
    (1,726
    )Reissuance
      of treasury shares under employee benefit plans
    
    
    6,853
    
    
    109
    
    
    4,988Balance
      at end of year
    
    
    (45,573
    )
    
    (52,426
    )
    
    (52,535
    )**Unearned
      restricted stock compensation:**Balance
      at beginning of year
    
    
    -
    
    
    -
    
    
    -Issuance
      of restricted stock, net of cancellations
    
    
    (2,185
    )
    
    -
    
    
    -Amortization
      of unearned restricted stock compensation
    
    
    1,434
    
    
    -
    
    
    -Balance
      at end of year
    
    
    (751
    )
    
    -
    
    
    -**Total
      shareholders' equity:**Balance
      at beginning of year
    
    
    463,667
    
    
    581,390
    
    
    612,006Net
      income (loss)
    
    
    1,830
    
    
    (93,569
    )
    
    (48,024
    )Class
      A Common stock dividends declared
    
    
    -
    
    
    (9,870
    )
    
    (13,142
    )Purchase
      of treasury shares
    
    
    -
    
    
    -
    
    
    (1,726
    )Reissuance
      of treasury shares under employee benefit plans
    
    
    2,221
    
    
    649
    
    
    3,003Other
      comprehensive income (loss)
    
    
    (21,581
    )
    
    (14,930
    )
    
    29,177Repayment
      (interest accrued) of notes receivable from officers
    
    
    65
    
    
    (3
    )
    
    96Issuance
      of restricted stock, net of cancellations
    
    
    (2,185
    )
    
    -
    
    
    -Amortization
      of unearned restricted stock compensation
    
    
    1,434
    
    
    -
    
    
    -Balance
      at end of year
    
    $
    445,451
    
    $
    463,667
    
    $
    581,390




















*See accompanying notes to the consolidated
financial statements.*





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PMA
CAPITAL CORPORATION


CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME (LOSS)





*(in
      thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**Net
      income (loss)**
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )**Other
      comprehensive income (loss), net of tax:**Unrealized
      gains (losses) on securitiesHolding
      gains (losses) arising during the period
    
    
    (13,540
    )
    
    7,077
    
    
    17,355Less:
      reclassification adjustment for (gains) losses included in
      netincome
      (loss), net of tax expense (benefit): 2004 - $2,273;2003
      - $4,823; 2002 - ($5,630)
    
    
    (4,220
    )
    
    (8,957
    )
    
    10,455Total
      unrealized gains (losses) on securites
    
    
    (17,760
    )
    
    (1,880
    )
    
    27,810Pension
      plan liability adjustment, net of tax benefit2004
      - $434; 2003 - $8,406
    
    
    (806
    )
    
    (15,609
    )
    
    -Foreign
      currency translation gains (losses), net of tax expense
      (benefit):2004
      - ($1,623); 2003 - $1,378; 2002 - $736
    
    
    (3,015
    )
    
    2,559
    
    
    1,367Other
      comprehensive income (loss), net of tax
    
    
    (21,581
    )
    
    (14,930
    )
    
    29,177**Comprehensive
      loss**
    
    $
    (19,751
    )
    $
    (108,499
    )
    $
    (18,847
    )



















*See accompanying notes to the consolidated
financial statements.* ****





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**Notes to
Consolidated Financial Statements**




**Note 1. Business Description**





The
accompanying consolidated financial statements include the accounts of PMA
Capital Corporation and its subsidiaries (collectively referred to as “PMA
Capital” or the “Company”). PMA Capital Corporation
is an insurance holding company that owns and operates specialty risk management
businesses:





*The
PMA Insurance Group* — The
PMA Insurance Group writes workers’ compensation, integrated disability and, to
a lesser extent, other standard lines of commercial insurance, primarily in the
eastern part of the United States. Approximately 87% of The PMA Insurance
Group’s business for 2004 was produced through independent agents and
brokers.





*Run-off
Operations* —
Run-off Operations consists of the results of the Company’s former reinsurance
and excess and
surplus lines businesses. The Company’s former reinsurance operations offered
excess of loss and pro rata property and casualty reinsurance protection mainly
through reinsurance brokers. In November 2003, the Company decided to withdraw
from the reinsurance business. In May 2002, the Company withdrew from its former
excess and surplus lines business.





**Note 2. Summary of Significant Accounting
Policies**





**A.
Basis of Presentation —** The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
(“GAAP”). All significant intercompany accounts and transactions have been
eliminated in consolidation. The preparation of consolidated financial
statements in conformity with GAAP requires management to make certain estimates
and assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the period.
Actual results could differ from those estimates. In addition, certain prior
year amounts have been restated to conform to the current year classification.
The balance sheet information presented in these financial statements and notes
thereto is as of December 31 for each respective year. The statement of
operations information is for the year ended December 31 for each respective
year.





**B.
Investments —** All
fixed maturities are classified as available-for-sale and, accordingly, are
carried at fair value. Changes in fair value of fixed maturities, net of income
tax effects, are reflected in accumulated other comprehensive income (loss). All
short-term, highly liquid investments, which have original maturities of one
year or less from acquisition date, are treated as short-term investments and
are carried at amortized cost, which approximates fair value.





Realized
gains and losses, determined by the first-in, first-out method, are reflected in income in
the period in which the sale transaction occurs. For all securities that are in
an unrealized loss position for an extended period of time and for all
securities whose fair value is significantly below amortized cost, the Company
performs an evaluation of the specific events attributable to the market decline
of the security. The Company considers the length of time and extent to which
the security’s market value has been below cost as well as the general market
conditions, industry characteristics and the fundamental operating results of
the issuer to determine if the decline is other than temporary. The Company also
considers as part of the evaluation its intent and ability to hold the security
until its market value has recovered to a level at least equal to the amortized
cost. When the Company determines that a security’s unrealized loss is other
than temporary, a realized loss is recognized in the period in which the decline
in value is determined to be other than temporary. The write-downs are measured
based on public market prices and the Company’s expectation of the future
realizable value for the security at the time the Company determines the decline
in value was other than temporary.





The
Company participates in a securities lending program through which securities
are lent from the Company’s portfolio for short periods of time to qualifying
third parties via a lending agent. Borrowers of these securities must provide
collateral equal to a minimum of 102% of the market value including accrued
interest of the lent securities. Acceptable collateral may be in the form of
either cash or securities. Cash received as collateral is invested in short-term
investments, and is recorded as such on the Balance Sheet, along with a
corresponding liability included in payable under securities loan agreements.
All securities received as collateral are of similar quality to those securities
lent by the Company. The Company is not permitted by contract to sell or
repledge the securities received as collateral. Additionally, the Company limits
securities lending to 40% of statutory admitted assets of its insurance
subsidiaries, with a 2% limit on statutory admitted assets to any individual
borrower. The Company either receives a fee from the borrower or retains a
portion of the income earned on the collateral. Under the terms of the
securities lending program, the Company is indemnified against borrower default,
with the lending





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agent
responsible to the Company for any deficiency between the cost of replacing a
security that was not returned and the amount of collateral held by the Company.





**C.
Premiums —** Premiums, including estimates of additional premiums resulting from audits of
insureds’ records, and premiums from ceding companies which are typically
reported on a delayed basis, are earned principally on a pro rata basis over the
terms of the policies. For reinsurance premiums assumed, management must
estimate the subject premiums associated with the treaties in order to determine
the level of written and earned premiums for a reporting period. Such estimates
are based on information from brokers and ceding companies, which can be subject
to change as new information becomes available. Any changes occurring or
reported to the Company after the policy term are recorded as earned premiums in
the period in which the adjustment is made. See Note 4 for
additional information. With respect to policies that provide for premium
adjustments, such as experience-rated or exposure-based adjustments, such
premium adjustments may be made subsequent to the end of the policy’s coverage
period and will be recorded as earned premiums in the period in which the
adjustment is made. Premiums applicable to the unexpired terms of policies in
force are reported as unearned premiums. The estimated premiums receivable on
retrospectively rated policies are reported as a component of premiums
receivable.





**D.
Unpaid Losses and Loss Adjustment Expenses —** Unpaid
losses and loss adjustment expenses (“LAE”), which are stated net of estimated
salvage and subrogation, are estimates of losses and LAE on known claims and
estimates of losses and LAE incurred but not reported (“IBNR”). IBNR reserves
are calculated utilizing various actuarial methods. Unpaid losses on certain
workers’ compensation claims are discounted to present value using the Company’s
payment experience and mortality and interest assumptions in accordance with
statutory accounting practices prescribed by the Pennsylvania Insurance
Department. The Company also discounts unpaid losses and LAE for certain other
claims at rates permitted by domiciliary regulators or if the timing and amount
of such claims are fixed and determinable. The methods of making such estimates
and establishing the resulting reserves are continually reviewed and updated and
any adjustments resulting there from are reflected in earnings in the period
identified. See Note 4 for additional
information.





**E.
Reinsurance —** In the
ordinary course of business, PMA Capital’s reinsurance and insurance
subsidiaries assume and cede premiums with other insurance companies and are
members of various insurance pools and associations. The Company’s insurance and
reinsurance subsidiaries cede business in order to limit the maximum net loss
and limit the accumulation of many smaller losses from a catastrophic event. The
insurance and reinsurance subsidiaries remain primarily liable to their clients
in the event their reinsurers are unable to meet their financial obligations.
Reinsurance receivables include claims paid by the Company and estimates of
unpaid losses and LAE that are subject to reimbursement under reinsurance and
retrocessional contracts. The method for determining the reinsurance receivable
for unpaid losses and LAE involves reviewing actuarial estimates of unpaid
losses and LAE to determine the Company’s ability to cede unpaid losses and LAE
under its existing reinsurance contracts. This method is continually reviewed
and updated and any adjustments resulting there from are reflected in earnings
in the period identified. Under certain of the Company’s reinsurance and
retrocessional contracts, additional premium and interest may be required if
predetermined loss and LAE thresholds are exceeded.





Certain
of the Company’s reinsurance contracts are retroactive in nature. Any benefit
derived from retroactive reinsurance contracts is deferred and amortized into
income over the payout pattern of the underlying claim liabilities unless the
contracts call for immediate recovery by the Company from reinsurers as ceded
losses are incurred.





Certain
of the Company’s assumed and ceded reinsurance contracts are funds held
arrangements. In a funds held arrangement, the ceding company retains the
premiums instead of paying them to the reinsurer and losses are offset against
these funds in an experience account. Because the reinsurer is not in receipt of
the funds, the reinsurer will generally earn interest on the experience fund
balance at a predetermined credited rate of interest. The Company generally
earns an interest rate of between 6% and 8% on its assumed funds held
arrangements and generally pays interest at a rate of between 6% and 7% on its
ceded funds held arrangements. The interest earned or credited on funds held
arrangements is included in net investment income in the Statement of
Operations. In addition, interest on funds held arrangements will continue to be
earned or credited until the experience account is fully depleted, which can
extend many years beyond the expiration of the coverage period.





**F.
Deferred Acquisition Costs —** Costs
that directly relate to and vary with the acquisition of new and renewal
business are deferred and amortized over the period during which the related
premiums are earned. Such direct costs include commissions or brokerage and
premium taxes, as well as other policy issuance costs and underwriting expenses.
The Company determines whether acquisition costs are recoverable considering
future losses and LAE, maintenance costs and





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anticipated investment income. To the extent that acquisition costs
are not recoverable, the deficiency is charged to income in the period
identified.





**G.
Derivatives —** The
derivative component of the Company’s 6.50% Senior Secured Convertible Debt due
2022 (“6.50% Convertible Debt”) is bifurcated and recorded at fair value in
long-term debt on the Balance Sheet. Changes in fair value are recorded in net
realized investment gains (losses). See Note 6 for
additional information.





**H.
Dividends to Policyholders —** The PMA
Insurance Group sells certain workers’ compensation insurance policies with
dividend payment features. These policyholders share in the underwriting results
of their respective policies in the form of dividends declared at the discretion
of the Board of Directors of The PMA Insurance Group’s operating companies.
Dividends to policyholders are accrued during the period in which the related
premiums are earned and are determined based on the terms of the individual
policies.





**I.
Income Taxes —** The
Company records deferred tax assets and liabilities to the extent of the tax
effect of differences between the financial statement carrying values and tax
bases of assets and liabilities. A valuation allowance is recorded for deferred
tax assets where it appears more likely than not that the Company will not be
able to recover the deferred tax asset. See Note 12 for
additional information.





**J** **.
Stock-Based Compensation —** The
Company accounts for stock-based compensation using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. Accordingly, compensation
cost for stock options is measured as the excess, if any, of the quoted market
price of the Company’s Class A Common stock at grant date or other measurement
date over the amount an employee must pay to acquire the Class A Common stock.
The following table illustrates the effect on net income (loss) if the fair
value based method had been applied:





*(in
      thousands, except per share)*
    
    
    2004
    
    
    2003
    
    
    2002Net
      income (loss)
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )Stock-based
      compensation expense alreadyincluded
      in reported net income (loss), net of tax
    
    
    820
    
    
    156
    
    
    140Total
      stock-based compensation expensedetermined
      under fair value based method,net
      of tax
    
    
    (2,112
    )
    
    (1,302
    )
    
    (1,480
    )Pro
      forma net income (loss)
    
    $
    538
    
    $
    (94,715
    )
    $
    (49,364
    )Net
      income (loss) per share:Basic
      - as reported
    
    $
    0.06
    
    $
    (2.99
    )
    $
    (1.53
    )Basic
      - pro forma
    
    $
    0.02
    
    $
    (3.02
    )
    $
    (1.58
    )Diluted
      - as reported
    
    $
    0.06
    
    $
    (2.99
    )
    $
    (1.53
    )Diluted
      - pro forma
    
    $
    0.02
    
    $
    (3.02
    )
    $
    (1.58
    )





**K** **.
Other Revenues —** Other
revenues include service revenues related to unbundled claims, risk management
and related services provided by The PMA Insurance Group, which are earned over
the term of the related contracts in proportion to the actual
services rendered, and other miscellaneous revenues. During 2004, other revenues
included a $6.6 million gain on the sale of a partnership interest.





**L.
Recent Accounting Pronouncements —** In
December 2003, the Financial Accounting Standards Board (“FASB”) revised
Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’
Disclosures About Pensions and Other Postretirement Benefits,” to require
additional disclosures regarding defined benefit pension plans and other defined
benefit postretirement plans. The Company has applied the disclosure provisions
of SFAS No. 132, as revised, to its Consolidated Financial
Statements.





69
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In
December 2004, the Company adopted Emerging Issues Task Force (“EITF”) Consensus
04-8, “ The
Effect of Contingently Convertible Debt on Diluted Earnings Per Share,” which
requires the inclusion of the dilutive effect of contingently convertible debt
instruments in the computation of diluted income (loss) per share
regardless of whether the contingency triggering convertibility has been met.
The Company’s earnings per share calculation for the first and second quarters
of 2003 did not include the effects of potential conversion because the
conditions for convertibility had not yet occurred. Adoption of EITF 04-8
resulted in a reduction in the Company’s first and second quarter 2003 diluted
income per share by three and four cents, respectively, but has no effect for
full year 2003, because the effect of conversion would have been anti-dilutive.
Beginning in the third quarter of 2003, the conversion requirements were met on
the Company’s convertible debt. See unaudited “Quarterly Financial Information” for additional
information.





In March
2004, the EITF reached a consensus regarding EITF 03-1, “The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments.”  The consensus provides guidance for evaluating whether an
investment is other-than-temporarily impaired.  The disclosure provisions
of EITF 03-1 were effective for year-end 2003, with the recognition and
measurement provisions scheduled to be effective for the third quarter of 2004.
However, in September 2004, the FASB issued Staff Position EITF 03-1-1, which
delays the effective date of the application of the recognition and measurement
provisions of EITF 03-1. The delay of the recognition and measurement provisions
is expected to be superseded concurrently with the issuance of a FASB Staff
Position which will provide additional implementation guidance. The Company will
assess whether this guidance will have a material impact on its financial
condition or results of operations once the new guidance is
released.





In
December 2004, the FASB revised SFAS No. 123, “Share-Based Payment” to require
the recognition of expenses relating to share-based payment transactions,
including employee stock option grants, based on the fair value of the equity
instruments issued. The Company is required to adopt the revised SFAS No. 123 in
the third quarter of 2005. Effective with the third quarter of 2005, the Company
will recognize an expense over the required service period for any stock options
granted, modified, cancelled, or repurchased after that date and for the portion
of grants for which the requisite service has not yet been rendered, based on
the grant-date fair value of those awards. In December 2002, the Company adopted
the disclosure provisions of SFAS No. 148, "Accounting for Stock-Based Compensation
- Transition and Disclosure,” which required prominent disclosures in financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results. See Note
2-J for the effect on net income (loss) if the fair value based method had
been applied.





**Note 3. Investments**





The
Company’s investment portfolio is diversified and does not contain any
significant concentrations in single issuers other than U.S. Treasury and agency
obligations. In addition, the Company does not have a significant concentration
of investments in any single industry segment other than finance companies,
which comprise 10% of
invested assets at December 31, 2004. Included in this industry segment are
diverse financial institutions, including the financing subsidiaries of
automotive manufacturers.








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The
amortized cost and fair value of the Company’s investment portfolio are as
follows:


Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair*(dollar
      amounts in thousands)*
    
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    Value**December
      31, 2004**Fixed
      maturities available for sale:U.S.
      Treasury securities and obligations of U.S. Government
      agencies
    
    $
    312,954
    
    $
    4,671
    
    $
    3,431
    
    $
    314,194States,
      political subdivisions and foreign government securities
    
    
    19,026
    
    
    832
    
    
    90
    
    
    19,768Corporate
      debt securities
    
    
    450,396
    
    
    20,031
    
    
    2,163
    
    
    468,264Mortgage-backed
      and other asset-backed securities
    
    
    500,880
    
    
    7,562
    
    
    6,582
    
    
    501,860Total
      fixed maturities available for sale
    
    
    1,283,256
    
    
    33,096
    
    
    12,266
    
    
    1,304,086Short-term
      investments
    
    
    123,746
    
    
    -
    
    
    -
    
    
    123,746Total
      investments
    
    $
    1,407,002
    
    $
    33,096
    
    $
    12,266
    
    $
    1,427,832**December
      31, 2003**Fixed
      maturities available for sale:U.S.
      Treasury securities and obligations of U.S. Government
      agencies
    
    $
    340,483
    
    $
    11,975
    
    $
    1,253
    
    $
    351,205States,
      political subdivisions and foreign government securities
    
    
    20,200
    
    
    718
    
    
    95
    
    
    20,823Corporate
      debt securities
    
    
    764,710
    
    
    32,833
    
    
    2,360
    
    
    795,183Mortgage-backed
      and other asset-backed securities
    
    
    680,697
    
    
    15,008
    
    
    8,361
    
    
    687,344Total
      fixed maturities available for sale
    
    
    1,806,090
    
    
    60,534
    
    
    12,069
    
    
    1,854,555Short-term
      investments
    
    
    157,632
    
    
    -
    
    
    -
    
    
    157,632Total
      investments
    
    $
    1,963,722
    
    $
    60,534
    
    $
    12,069
    
    $
    2,012,187





As of
December 31, 200 4, gross
unrealized losses on the Company’s investment asset portfolio were $12.3
million. For securities that were in an unrealized loss position at December 31,
2004, the length of time that such securities have been in an unrealized loss
position, as measured by their month-end fair values, is as
follows:


PercentageFair
      ValueNumber
      of
    
    
    Fair
    
    
    Amortized
    
    
    Unrealized
    
    
    Amortized
      to*(dollar
      amounts in millions)*
    
    
    Securities
    
    
    Value
    
    
    Cost
    
    
    Loss
    
    
    CostLess
      than 6 months
    
    
    152
    
    $
    138.2
    
    $
    139.1
    
    $
    (0.9
    )
    
    99%6
      to 9 months
    
    
    71
    
    
    108.5
    
    
    110.0
    
    
    (1.5
    )
    
    99%9
      to 12 months
    
    
    7
    
    
    8.2
    
    
    8.4
    
    
    (0.2
    )
    
    98%More
      than 12 months
    
    
    34
    
    
    44.0
    
    
    49.4
    
    
    (5.4
    )
    
    89%Subtotal
    
    
    264
    
    
    298.9
    
    
    306.9
    
    
    (8.0
    )
    
    97%U.S.
      Treasury and Agency securities
    
    
    107
    
    
    277.3
    
    
    281.6
    
    
    (4.3
    )
    
    98%Total
    
    
    371
    
    $
    576.2
    
    $
    588.5
    
    $
    (12.3
    )
    
    98%


The
amortized cost and fair value of fixed maturities at December 31,
200 4, by
contractual maturity, are as follows:





Amortized
    
    
    Fair*(dollar
      amounts in thousands)*
    
    
    Cost
    
    
    Value2005
    
    $
    93,874
    
    $
    93,7272006-2009
    
    
    308,918
    
    
    307,7782010-2014
    
    
    215,822
    
    
    221,0562015
      and thereafter
    
    
    163,762
    
    
    179,665Mortgage-backed
      and other asset-backed securities
    
    
    500,880
    
    
    501,860$
    1,283,256
    
    $
    1,304,086





Actual
maturities may differ from contractual maturities because certain securities may
be called or prepaid with or without call or prepayment penalties.





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Net
investment income consists of the following:





*(dollars
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Fixed
      maturities
    
    $
    69,540
    
    $
    81,090
    
    $
    84,957Short-term
      investments
    
    
    1,707
    
    
    2,684
    
    
    5,073Other
    
    
    749
    
    
    627
    
    
    913Total
      investment income
    
    
    71,996
    
    
    84,401
    
    
    90,943Investment
      expenses
    
    
    (6,348
    )
    
    (5,070
    )
    
    (3,173
    )Interest
      on funds held, net
    
    
    (8,703
    )
    
    (10,408
    )
    
    (2,889
    )Net
      investment income
    
    $
    56,945
    
    $
    68,923
    
    $
    84,881





Net
realized investment gains (losses) consist of the following:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Realized
      gains
    
    $
    20,083
    
    $
    18,726
    
    $
    18,659Realized
      losses
    
    
    (4,847
    )
    
    (4,946
    )
    
    (34,744
    )Foreign
      exchange loss
    
    
    (4,897
    )
    
    -
    
    
    -Change
      in fair value of derivative
    
    
    (3,846
    )
    
    -
    
    
    -Total
      net realized investments gains (losses)
    
    $
    6,493
    
    $
    13,780
    
    $
    (16,085
    )





Included
in realized losses for 2004, 2003 and 2002 were impairment losses of $334,000,
$2.6 million and $23.8 million, respectively. The impairment losses for 2004
were related to an asset-backed security and a security issued by an airline
company. The impairment losses for 2003 primarily related to securities issued
by airline companies and an asset-backed security. The impairment losses for
2002 primarily related to corporate bonds issued by telecommunications and
energy companies, including $14.2 million for WorldCom. The write-downs were
measured based on public market prices and the Company’s expectation of the
future realizable value for the security at the time when the Company determined
the decline in value was other than temporary.





The
realized loss on the change in fair value of derivative related to the increase
in the fair value of the derivative component of the 6.50% Convertible Debt from
the date of issuance/exchange to December 31, 2004. See Note
6 for additional information.





A t
December 31, 2003, the Company had $6.3 million of collateral related to
securities on loan, substantially all of which was cash received and
subsequently reinvested in short-term investments.





On
December 31, 2004, the Company had securities with a total amortized cost of
$47.9 million and fair value of $48.5 million on deposit with various
governmental authorities, as required by law. In addition, the Company had
securities with a total amortized cost of $27.8 million and fair value of $28.2
million held in trust for the benefit of certain ceding companies on reinsurance
balances assumed by the Run-off
Operations .
Securities with a total amortized cost and fair value of $7.0 million were held
in trust to support the Company’s participation in the underwriting capacity of
a Lloyd’s of London syndicate. There were also securities with a total amortized
cost and fair value of $4.0 million pledged as collateral for letters of credit
issued on behalf of the Company. The securities held in trust, on deposit or
pledged as collateral are included in fixed maturities and short-term
investments on the
Balance Sheet.








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**Note 4. Unpaid Losses and Loss Adjustment
Expenses**





Activity
in the liability for unpaid losses and LAE is summarized as
follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Balance
      at January 1
    
    $
    2,541,318
    
    $
    2,449,890
    
    $
    2,324,439Less:
      reinsurance recoverable on unpaid losses and LAE
    
    
    1,195,048
    
    
    1,265,584
    
    
    1,181,322Net
      balance at January 1
    
    
    1,346,270
    
    
    1,184,306
    
    
    1,143,117Losses
      and LAE incurred, net:Current
      year, net of discount
    
    
    406,828
    
    
    768,114
    
    
    655,395Prior
      years
    
    
    (40,363
    )
    
    218,774
    
    
    159,748Accretion
      of prior years' discount
    
    
    14,091
    
    
    11,459
    
    
    8,515Total
      losses and LAE incurred, net
    
    
    380,556
    
    
    998,347
    
    
    823,658Losses
      and LAE paid, net:Current
      year
    
    
    (122,256
    )
    
    (185,850
    )
    
    (138,127
    )Prior
      years
    
    
    (605,755
    )
    
    (650,533
    )
    
    (594,342
    )Total
      losses and LAE paid, net
    
    
    (728,011
    )
    
    (836,383
    )
    
    (732,469
    )Reserves
      transferred
    
    
    -
    
    
    -
    
    
    (50,000
    )Net
      balance at December 31
    
    
    998,815
    
    
    1,346,270
    
    
    1,184,306Reinsurance
      recoverable on unpaid losses and LAE
    
    
    1,112,783
    
    
    1,195,048
    
    
    1,265,584Balance
      at December 31
    
    $
    2,111,598
    
    $
    2,541,318
    
    $
    2,449,890


Unpaid
losses and LAE reflect management’s best estimate of future amounts needed to
pay claims and related settlement costs with respect to insured events which
have occurred, including events that have not been reported to the Company. Due
to the “long-tail” nature of a significant portion of the Company’s business, in
many cases, significant periods of time, ranging up to several years or more,
may elapse 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 defines
long-tail business as those lines of business in which a majority of coverage
involves average loss payment lags of several years beyond the expiration of the
policy. The Company’s major long-tail lines include its workers’ compensation
and casualty reinsurance business. In addition, because reinsurers rely on their
ceding companies to provide them with information regarding incurred losses,
reported claims for reinsurers become known more slowly than for primary
insurers and are subject to more unforeseen development and uncertainty. As part
of the process for determining the Company’s unpaid losses and LAE, various
actuarial models are used that analyze historical data and consider the impact
of current developments and trends, such as trends in claims severity and
frequency and claims settlement trends. Also considered are legal developments,
regulatory trends, legislative developments, changes in social attitudes and
economic conditions.








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The
following table summarizes the effect on the Company’s underwriting assets and
liabilities of the commutation and novation of certain reinsurance and
retrocessional contracts by the Run-off Operations segment occurring in 2004.
The commutations and novations did not have a material effect on the Company’s
results of operations for 2004.





*(dollar
      amounts in thousands)*
    
    
    2004Assets:Reinsurance
      receivables
    
    $
    (63,662
    )Funds
      held by reinsureds
    
    
    (31,330
    )Other
      assets
    
    
    (70,537
    )Liabilities:Unpaid
      losses and loss adjustment expenses
    
    $
    (202,667
    )Unearned
      premiums
    
    
    (26,596
    )Other
      liabilities
    
    
    (70,228
    )Funds
      held under reinsurance treaties
    
    
    (82,095
    )





The
components of the Company’s ( favorable)
unfavorable development of reserves for losses and LAE for prior accident years,
excluding accretion of discount, are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002The
      PMA Insurance Group
    
    $
    (2,070
    )
    $
    49,685
    
    $
    1,082Run-off
      Operations
    
    
    (38,293
    )
    
    169,089
    
    
    158,666Total
      net (favorable) unfavorable development
    
    $
    (40,363
    )
    $
    218,774
    
    $
    159,748





During
2004, the favorable prior year loss development at the Run-off Operations
related primarily to reinsurance contracts that were novated or commuted. This
favorable prior
year loss
development was substantially offset by net premiums earned and acquisition
expenses.





The PMA
Insurance Group recorded favorable prior year loss development of $2.1 million
in 2004, primarily reflecting better than expected loss experience from
rent-a-captive workers’ compensation business. Dividends to policyholders offset
this favorable development. Rent-a-captives are used by customers as an
alternative method to manage their loss exposure without establishing and
capitalizing their own captive insurance company.





During
2003, The PMA Insurance Group recorded unfavorable prior year loss
development of $49.7 million. As part of the year end closing process, in the
fourth quarter of 2003, the Company’s actuaries completed a comprehensive
year-end actuarial analysis of loss reserves. Based on the actuarial work
performed, the Company’s actuaries noticed higher than expected claims severity
in workers' compensation business written for accident years 2001 and 2002,
primarily from loss-sensitive and participating workers' compensation business.
As a result, The PMA Insurance Group increased loss reserves for prior years by
$50 million. An independent actuarial firm also conducted a comprehensive review
of The PMA Insurance Group’s loss reserves as of December 31, 2003 and concluded
that such carried loss reserves were reasonable as of December 31, 2003. Under
The PMA Insurance Group's loss-sensitive rating plans, the amount of the
insured's premiums is adjusted after the policy period expires based, to a large
extent, upon the insured's actual losses incurred during the policy period.
Under policies that are subject to dividend plans, the ultimate amount of the
dividend that the insured may receive is also based, to a large extent, upon
loss experience during the policy period. Accordingly, offsetting the effects of
this unfavorable prior year loss development were premium adjustments of $35
million under loss-sensitive plans and reduced policyholder dividends of $8
million, resulting in a net fourth quarter pre-tax charge of $7
million.





During
2003, the Run-off Operations increased its net loss reserves for prior accident
years for reinsurance business by $169.1 million, including $150 million during
the third quarter. The third quarter 2003 reserve charge related to higher than
expected underwriting losses, primarily from casualty business written in
accident years 1997 through 2000. Approximately





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75% of
the charge was related to general liability business written from 1997 to 2000
with substantially all of the remainderof the charge from the commercial
automobile line written during those same years. During the third quarter, the
Company’s actuaries conducted their periodic comprehensive reserve review. Based
on the actuarial work performed, which included analyzing recent trends in the
levels of the reported and paid claims, an updated selection of actuarially
determined loss reserve estimates was developed by accident year for each major
line of reinsurance business written. The information derived during this review
indicated that a large portion of the change in expected loss development was
due to increasing loss trends emerging in calendar year 2003 for prior accident
years. This increase in 2003 loss trends caused management to determine that the
reserve levels, primarily for accident years 1997 to 2000, needed to be
increased by $150 million. An independent actuarial firm also conducted a
comprehensive review of the Company’s Traditional-Treaty, Specialty-Treaty and
Facultative reinsurance loss reserves, and concluded that those carried loss
reserves were reasonable at September 30, 2003.





The
Company’s analysis was enhanced by an extensive review of specific accounts,
comprising about 40% of the carried reserves of the reinsurance business for
accident years 1997 to 2000. The Company’s actuaries visited a number of former
ceding company clients, which collectively comprised about 25% of the
reinsurance business total gross loss and LAE reserves from accident years 1997
to 2000, to discuss reserving and reporting experience with these ceding
companies. The Company’s actuaries separately evaluated an additional number of
other ceding companies, representing approximately 15% of the reinsurance
business total gross loss and LAE reserves from accident years 1997 to 2000, to
understand and examine data trends.





During
2002, the Run-off Operations recorded net unfavorable prior year loss
development of $159 million ($107 million for reinsurance and $52 million for
excess and surplus lines). During 2002, company actuaries conducted reserve
reviews to determine the impact of any emerging data on anticipated loss
development trends and recorded unpaid losses and LAE reserves. Based on the
actuarial work performed, which included analyzing recent trends in the levels
of the reported and paid claims, an updated selection of actuarially determined
loss reserve estimates was developed by accident year for each major line of
business. Management’s selection of the ultimate losses resulting from their
reviews indicated that net loss reserves for the excess and surplus lines
business for prior accident years, mainly 1999 and 2000, needed to be increased
by $52 million. This unfavorable prior year development reflects the impact of
higher than expected claim severity and, to a lesser extent, frequency, that
emerged in 2002 on casualty lines of business, primarily professional liability
policies for the nursing homes class of business; general liability, including
policies covering contractors’ liability for construction defects; and
commercial automobile, mainly for accident years 1999 and 2000.





During
2002, the Run-off Operations also recorded unfavorable prior year development of
$107 million for the reinsurance business. During the fourth quarter, the
Company’s actuaries observed a higher than expected increase in the frequency
and, to a lesser extent, severity of reported claims by ceding companies.
Management’s selection of the ultimate losses indicated that net loss and LAE
reserves for prior accident years needed to be increased by $64 million in the
fourth quarter of 2002, primarily for excess of loss and pro rata general
liability occurrence contracts and, to a lesser extent, excess of loss general
liability claims-made contracts, from accident years 1998, 1999 and 2000.





The
remaining $43 million of unfavorable prior year development on
reinsurance business in 2002 primarily reflects the recording of losses and LAE
on additional earned premiums recorded during 2002 as a result of a change in
the Company’s estimate of ultimate premiums written from prior years. Because
premiums from ceding companies are typically reported on a delayed basis, the
Company monitors and updates as appropriate the estimated ultimate premiums
written. The Company’s periodic reviews of estimated ultimate premiums written,
which compared actual reported premiums and originally estimated premiums based
on ceding company estimates, indicated that premiums written in recent years,
primarily in the Traditional- and Specialty-Treaty units for 2001 and 2000, were
higher than originally estimated. As a result, the Company recorded additional
net premiums earned during 2002, including $39.9 million in the second quarter,
which were completely offset by losses and LAE and acquisition
expenses.





Reserves
transferred in 2002 reflect the assumption of losses by an unaffiliated third
party. Cash and short-term investments of $50 million were transferred to
support the payment of the transferred reserves.





Unpaid
losses for the Company’s workers’ compensation claims, net of reinsurance, at
December 31, 2004 and 2003 were $448.7 million and $433.8 million, net of
discount of $48.2 million and $54.6 million, respectively. The discount rate
used was approximately 5% at December 31, 2004 and 2003.








75
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The
Company’s loss reserves were stated net of salvage and subrogation of $30.8
million and $33.2 million at December 31, 2004 and 2003,
respectively.


During
2004, the
Company’s actuaries conducted their periodic reserve reviews of The PMA
Insurance Group and the Run-off Operations. Based on the actuarial work
performed, which included analyzing recent trends in the levels of the reported
and paid claims, an updated selection of actuarially determined loss reserve
estimates was developed by accident year for each major line of business. The
information derived during these reviews indicated that general liability and
professional liability lines written by the Run-off Operations continued to
exhibit volatility. While the conclusion of the reviews indicated that no
adjustments to reserves were necessary and that the Company's carried reserves
were resonable, continued volatility could require adjustments in future
periods.


On
December 6, 2004, the New York jury in the trial regarding the insurance
coverage for the World Trade Center rendered a verdict that the September 11,
2001 attack on the World Trade Center constituted two occurrences under the
policies issued by certain insurers. The Company considers the jury's verdict to
be contrary to the terms of the insurance coverage in force and to the intent of
the parties involved. Because the litigation is ongoing and the appraisal and
valuation process is pending, the ultimate resolution of this issue cannot be
determined at this time. The Company estimates that it could be required to
incur a charge of up to $5 million pre-tax at the Run-off Operations if it is
ultimately determined that the September 11, 2001 attack on the World Trade
Center constituted two occurrences under the policies issued by certain of its
ceding companies and if as a result of this determination, additional losses are
incurred by its ceding companies.





Management
believes that its unpaid losses and LAE are fairly stated at December 31, 2004.
However, estimating the ultimate claims liability is necessarily a complex and
judgmental process inasmuch as the amounts are based on management’s informed
estimates, assumptions and judgments using data currently available. As
additional experience and data become available regarding claims payment and
reporting patterns, legal and legislative developments, judicial theories of
liability, the impact of regulatory trends on benefit levels for both medical
and indemnity payments, changes in social attitudes and economic conditions, the
estimates are revised accordingly. If the Company’s ultimate losses, net of
reinsurance, prove to differ substantially from the amounts recorded at December
31, 2004, the related adjustments could have a material adverse effect on the
Company’s financial condition, results of operations and liquidity.





At
December 31, 2004, 2003 and 2002, gross reserves for asbestos-related losses
were $27.9 million, $37.8 million and $42.1 million, respectively ($14.0
million, $17.8 million and $25.8 million, net of reinsurance, respectively). Of
the net asbestos reserves, approximately $10.3 million, $14.9 million and $22.9
million related to IBNR losses at December 31, 2004, 2003 and 2002,
respectively.





At
December 31, 2004, 2003 and 2002, gross reserves for environmental-related
losses were $16.1 million, $14.2 million and $18.2 million, respectively ($6.4
million, $8.8 million and $14.3 million, net of reinsurance, respectively). Of
the net environmental reserves, approximately $3.0 million, $3.7 million, and
$7.9 million related to IBNR losses at December 31, 2004, 2003 and 2002,
respectively. All incurred asbestos and environmental losses were for accident
years 1986 and prior.





Estimating
reserves for asbestos and environmental exposures continues to be difficult
because of several factors, including: (i) evolving methodologies for the
estimation of the liabilities; (ii) lack of reliable historical claim data;
(iii) uncertainties with respect to insurance and reinsurance coverage related
to these obligations; (iv) changing judicial interpretations; and (v) changing
government standards. Management believes that its reserves for asbestos and
environmental claims are appropriately established based upon known facts,
existing case law and generally accepted actuarial methodologies. However, due
to changing interpretations by courts involving coverage issues, the potential
for changes in Federal and state standards for clean-up and liability, as well
as issues involving policy provisions, allocation of liability and damages among
participating insurers, and proof of coverage, the Company’s ultimate exposure
for these claims may vary significantly from the amounts currently recorded,
resulting in a potential future adjustment that could be material to the
Company’s financial condition, results of operations and liquidity.








76
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**Note 5. Reinsurance**





The
components of net premiums written and earned, and losses and LAE incurred are
as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Written
      premiums:Direct
    
    $
    386,260
    
    $
    652,795
    
    $
    604,984Assumed
    
    
    (33,998
    )
    
    776,848
    
    
    781,562Ceded
    
    
    (50,652
    )
    
    (237,389
    )
    
    (281,549
    )Net
    
    $
    301,610
    
    $
    1,192,254
    
    $
    1,104,997Earned
      premiums:Direct
    
    $
    461,365
    
    $
    638,716
    
    $
    599,827Assumed
    
    
    136,131
    
    
    788,025
    
    
    691,740Ceded
    
    
    (78,911
    )
    
    (228,576
    )
    
    (300,556
    )Net
    
    $
    518,585
    
    $
    1,198,165
    
    $
    991,011Losses
      and LAE:Direct
    
    $
    372,059
    
    $
    484,889
    
    $
    503,867Assumed
    
    
    108,308
    
    
    756,570
    
    
    543,025Ceded
    
    
    (99,811
    )
    
    (243,112
    )
    
    (223,234
    )Net
    
    $
    380,556
    
    $
    998,347
    
    $
    823,658





In 2004,
the Company purchased reinsurance covering potential adverse loss development of
the loss and LAE reserves of the Run-off Operations. Under the agreement, the
Company ceded $100 million in carried loss and LAE reserves and paid $146.5
million in cash. During 2004, the Company incurred $ 6 . 0 million
in ceded premiums for this agreement. In addition, the contract requires
additional premiums of $2.5 million if it is not commuted by December
2007.  At Dec ember
3 1 , 2004,
the Run-off Operations have $105 million of available coverage
under this agreement for future adverse loss development.





Any
future cession of losses may require the Company to cede additional premiums of up to $35
million on a pro
rata basis , at the
following contractually determined levels :





Losses
      ceded
    
    Additional
      premiums$0
      - $20 million
    
    No
      additional premiums$20
      - $50 million
    
    Up
      to $20 million$50
      - $80 million
    
    Up
      to $15 million$80
      - $105 million
    
    No
      additional premiums





The
additional premiums have been prepaid and are included in other assets on the
Balance Sheet. Because the coverage is retroactive, the Company will not record
the benefit of this reinsurance in its Statement of Operations until it receives
the related recoveries.








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At
December 31, 2004, the Company had reinsurance receivables due from the
following unaffiliated reinsurers in excess of 5% of shareholders’ equity:


Reinsurance*(dollar
      amounts in thousands)*
    
    
    Receivables
    
    
    CollateralThe
      London Reinsurance Group and Affiliates(1)
    
    $
    288,777
    
    $
    274,717Swiss
      Reinsurance America Corporation
    
    
    140,824
    
    
    27,087PXRE
      Reinsurance Company
    
    
    128,542
    
    
    72,509St.
      Paul and Affiliates(2)
    
    
    102,910
    
    
    79,709Houston
      Casualty Company
    
    
    75,701
    
    
    -Imagine
      Insurance Company Limited
    
    
    34,212
    
    
    34,212Partner
      Reinsurance Co
    
    
    30,474
    
    
    -Hannover
      Ruckversicherungs AG
    
    
    30,065
    
    
    -


*(1)*
    *Includes
      Trabaja Reinsurance Company ($**264.1
      million) and London Life & General Reinsurance Company ($24.7
      million).*


*(2)*
    *Includes
      United States Fidelity & Guaranty Insurance Company ($68.6 million),
      Mountain Ridge Insurance Company ($24.6 million) and other affiliated
      entities ($9.7 million).*





The
Company performs credit reviews of its reinsurers focusing on, among other
things, financial capacity, stability, trends and commitment to the reinsurance
business. Reinsurers
failing to meet the Company’s standards are excluded from the Company’s
reinsurance programs. In addition, the Company requires collateral, typically
assets in trust, letters of credit or funds withheld, to support balances due
from certain reinsurers, generally those not authorized to transact business in
the applicable jurisdictions. At December 31, 2004 and 2003, the Company’s
reinsurance receivables of $1,142.6 million and $1,220.3 million were supported
by $507.2 million and $644.1 million of collateral. Of the uncollateralized
reinsurance receivables as of December 31, 2004, approximately 94% were from
reinsurers rated “A-” or better by A.M. Best.





The PMA
Insurance Group has recorded reinsurance receivables of $13.9 million at
December 31, 2004, related to certain umbrella policies covering years prior to
1977. The reinsurer has disputed the extent of coverage under these policies.
The ultimate resolution of this dispute cannot be determined at this time. An
unfavorable resolution of the dispute could have a material adverse effect on
the Company’s financial condition and results of operations.





The
Company's largest reinsurer is Trabaja Reinsurance Company (“Trabaja”).
Reinsurance receivables from Trabaja were $ 264.1
million at December 31, 2004, of which 95% were collateralized.





Trabaja,
formerly PMA Insurance Cayman, Ltd. (“PMA Cayman”), is a wholly owned subsidiary of London Life and Casualty Reinsurance
Corporation (“London Reinsurance Group”). The Company sold PMA Cayman to London
Reinsurance Group for $1.8 million, and transferred approximately $230 million
of cash and invested assets as well as loss reserves to the buyer in 1998. Under
the terms of the sale of PMA Cayman to London Reinsurance Group in 1998, the
Company has agreed to indemnify London Reinsurance Group, up to a maximum of $15
million if the actual claim payments in the aggregate exceed the estimated
payments upon which the loss reserves of PMA Cayman were established. If the
actual claim payments in the aggregate are less than the estimated payments upon
which the loss reserves have been established, then the Company will participate
in such favorable loss reserve development.





In
January 2002, the Company supplemented its in-force reinsurance programs for The
PMA Insurance Group and its former reinsurance business with retroactive
reinsurance contracts with Trabaja that provide coverage for adverse loss
development on certain lines of business for accident years prior to 2002. These
contracts provide coverage of up to $125 million in losses in return for $55
million of funding, which included $50 million of assets and $5 million in ceded
premiums. Under the terms of the contracts, losses and LAE of the Run-off
Operations ceded to Trabaja for accident years 1996 through 2001 are recoverable
as they are incurred by the Company. In 2002, the Run-off Operations recognized
a benefit of $25 million for losses ceded to these reinsurance contracts. Any
future cession of losses under these contracts may require the Company to cede
additional premiums ranging from 40% to 50% of ceded losses depending on the
level of such losses.








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**Note 6. Debt**





The
Company’s outstanding debt is as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003Long-term
      debt:6.50%
      Convertible Debt
    
    $
    99,140
    
    $
    -Derivative
      component of 6.50% Convertible Debt
    
    
    13,086
    
    
    -4.25%
      Convertible Debt
    
    
    925
    
    
    86,250Trust
      preferred debt
    
    
    43,816
    
    
    43,8168.50%
      Senior Notes
    
    
    57,500
    
    
    57,500Total
      long-term debt
    
    $
    214,467
    
    $
    187,566





In
November 2004, the Company exchanged $84.1 million aggregate principal amount of
6.50% Convertible Debt for $84.1 million aggregate principal amount of its
outstanding 4.25% Senior Convertible Debt due 2022 (“4.25% Convertible Debt” and
together with the 6.50% Convertible Debt, the “Convertible Debt” ). The
Company did not receive any proceeds as a result of the exchange offer. The
Company recorded a loss on the debt exchange of $6.0 million, which resulted
from the initial recording of the 6.50% Convertible Debt at fair value and the
write-off of unamortized issuance costs associated with the 4.25% Convertible
Debt. In November 2004, the Company received net proceeds of $15.2 million from
the issuance of $15 million aggregate principal amount of 6.50% Convertible Debt
in a private placement to a limited number of qualified institutional buyers.
The Convertible Debt may be converted at any time, at the holder's option, at a
current price of $16.368 per share.





On June
30, 2009, holders of the 6.50% Convertible Debt will have the right to require
the Company to repurchase for cash any amounts outstanding for 114% of the
principal amount of the debt plus accrued and unpaid interest, if any, to the
settlement date. In 2006, in the event PMA Capital Corporation receives any
extraordinary dividends from its subsidiaries, the Company will be required to
use 50% of those dividends to redeem up to $35 million principal amount of the
6.50% Convertible Debt at 110% of the original principal amount. Holders may
elect to receive any premium over the principal amount (“Put Premium”) in either
cash or Class A common stock, with the number of shares determined based on a
value of $8.00 per share.





The 6.50%
Convertible Debt is secured equally and ratably with the Company's $57.5 million
8.50% Monthly Income Senior Notes due 2018 (the “8.50% Senior Notes”) by a first
lien on 20% of the capital stock of the Company's principal operating
subsidiaries. The Company has agreed to make an additional pledge of the
remainder of the capital stock of these subsidiaries if the
A.M. Best financial strength rating of the Pooled Companies is not A- or higher
on December 31, 2005 or is reduced below B++ prior to December 31,
2005 . The
6.50% Convertible Debt is convertible at the rate of 61.0948 shares per $1000
principal amount, equivalent to a conversion price of $16.368 per share of Class
A common stock.





The Put
Premium and conversion features of the 6.50% Convertible Debt constitute a
derivative which requires bifurcation. Any change in the fair value of the
derivative component of the 6.50% Convertible Debt is recognized in net realized
investment gains (losses). The Company had a net realized loss of $3.8 million
in 2004 for the increase in the fair value of the derivative component of the
6.50% Convertible Debt from the date of issuance to December 31, 2004.





In 2003,
the Company issued $43.8 million of 30-year floating rate subordinated
debentures to three wholly owned statutory trust subsidiaries. The Company used
all of the $41.2 million of net proceeds to pay down a portion of its then
outstanding bank credit facility and for general corporate purposes. The trust
preferred debt matures in 2033 and is redeemable, in whole or in part, in 2008
at the stated liquidation amount plus accrued and unpaid interest. The interest
rates on the trust preferred debt equal the three-month London InterBank Offered
Rate ("LIBOR") plus 4.10%, 4.20% and 4.05% and is payable on a quarterly basis.
At December 31, 2004, the weighted average interest rate on the trust preferred
securities was 6.51%.











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The
Company has the right to defer interest payments on the Trust Preferred
securities for up to twenty consecutive quarters but, if so deferred, it may not
declare or pay cash dividends or distributions on its Class A common stock. The
Company hasguaranteed the obligations of these statutory trust
subsidiaries with respect to distributions and payments on the trust preferred
securities issued by these subsidiaries.





In 2003,
the Company issued $57.5 million of 8.50% Senior Notes due June 15, 2018, from
which it realized net proceeds of $55.1 million. The Company used the proceeds
from the offering to repay the remaining balance outstanding under its prior
bank credit facility, to increase the statutory capital and surplus of its
insurance subsidiaries, and for general corporate purposes. The Company has the
right to call these securities beginning in June 2008.





In
October 2002, the Company issued
$86.25 million of 4.25% Convertible Debt from which the Company received net
proceeds of $83.7 million. The Company used the proceeds from this offering
primarily to increase the capital of its insurance and reinsurance subsidiaries.
As discussed above, the Company exchanged $84.1 million of this debt in November
2004. The Company also retired $1.2 million of this debt in December 2004
through open market purchases. As of December 31, 2004, $925,000 remained
outstanding. This debt is convertible at a conversion price of $16.368 per
share, subject to adjustment upon certain events. Further, holders of this debt,
at their option, may require the Company to repurchase all or a portion of the
debt on September 30, 2006, 2008, 2010, 2012 and 2017, or subject to specified
exceptions, upon a change in control. The Company may choose to pay the
repurchase price in cash or shares of Class A common stock. The Convertible Debt
is redeemable in cash, in whole or in part, at the Company’s option at any time
on or after September 30, 2006.





The
indenture governing the 6.50% Convertible Debt contains restrictive covenants
with respect to limitations on the Company’s ability to incur indebtedness,
enter into transactions with affiliates or engage in a merger or sale of all or
substantially all of the Company’s assets.





**Note****7.
Commitments and Contingencies**





The
Company leases certain office space and office equipment such as computers under
noncancelable operating leases. Future minimum net operating lease obligations
as of December 31, 2004 are as follows:





*(dollar
      amounts in thousands)*
    
    
    Office
      space (1)
    
    
    Office
      equipment
    
    
    Total
      operating leases2005
    
    $
    3,724
    
    $
    3,017
    
    $
    6,7412006
    
    
    3,469
    
    
    2,171
    
    
    5,6402007
    
    
    3,518
    
    
    963
    
    
    4,4812008
    
    
    2,992
    
    
    169
    
    
    3,1612009
    
    
    2,443
    
    
    13
    
    
    2,4562010
      and thereafter
    
    
    4,921
    
    
    -
    
    
    4,921$
    21,067
    
    $
    6,333
    
    $
    27,400





*(1)*
    *Net
      of sublease rentals of $1.5 million in 2005 and 2006, $1.6 million in
      2007, 2008 and 2009 and $7.8 million
thereafter.*





Total
rent expense incurred under operating leases was $3.9 million, $4.0 million and
$4.1 million for 2004, 2003 and 2002, respectively.





In the
event a property and casualty insurer operating in a jurisdiction where the
Company’s insurance subsidiaries also operate becomes or is declared insolvent,
state insurance regulations provide for the assessment of other insurers to fund
any capital deficiency of the insolvent insurer. Generally, this assessment is
based upon the ratio of an insurer’s voluntary premiums written to the total
premiums written for all insurers in that particular jurisdiction. As of
December 31, 200 4 and
2003, the Company had recorded liabilities of $6.6 million and $7.5 million for
these assessments, which are included in accounts payable, accrued expenses and
other liabilities on the Balance Sheet.










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Prior to
December 2004, the Company had an interest in a real estate partnership for
which it had provided a guaranty of $7.0 million related to loans on properties
of the partnership. In December 2004, the Company sold the partnership and as
such, this guaranty terminated at the time of the sale.





Until
December 31, 2003, the Company had an executive loan program, through which a
financial institution provided personal demand loans to the Company’s officers.
The Company had provided collateral and agreed to purchase any loan in default.
In November 2003, the financial institution sold the Company’s collateral
partially securing the loans of two former officers of the Company in
satisfaction of their loans in the aggregate amount of $2.0 million. The Company
received $1.7 million in repayment for the loans of one former officer in 2004,
and in consideration of the Company forgiving $166,000 of indebtedness, the
former officer executed an agreement, which, among other things, includes a
release of the Company and its officers, employees and affiliates from any and
all claims as of the date of that agreement. The loan of the other former
officer in the outstanding principal amount of $185,000 is fully secured and is
due on April 30, 2005. The Company is accruing interest on this loan, which is
included in other
assets on the Balance Sheet, at a
rate of 4.5% as of December 31, 2004.





Under the
terms of the sale of PMA Cayman in 1998, the Company has agreed to indemnify the
buyer, up to a maximum of $15.0 million if the actual claim payments in the
aggregate exceed the estimated payments upon which the loss reserves of the
former subsidiary were established. If the actual claim payments in the
aggregate are less than the estimated payments upon which the loss reserves have
been established, the Company will participate in such
favorable loss reserve development.





At
December 31, 2004, The PMA Insurance Group is guarantor of $2.2 million
principal amount on certain premium finance loans made by unaffiliated premium
finance companies to insureds.





See Note 4 for information regarding losses related to the
September 11, 2001 attack on the World Trade Center and Note 5 for information
regarding disputed reinsurance receivables.





The
Company is continuously involved in numerous lawsuits arising, for the most
part, in the ordinary course of business, either as a liability insurer
defending third-party claims brought against its insureds, or as an insurer
defending coverage claims brought against it by its policyholders or other
insurers. While the outcome of all litigation involving the Company, including
insurance-related litigation, cannot be determined, litigation is not expected
to result in losses that differ from recorded reserves by amounts that would be
material to the Company’s financial condition, results of operations or
liquidity. In addition, reinsurance recoveries related to claims in litigation,
net of the allowance for uncollectible reinsurance, are not expected to result
in recoveries that differ from recorded receivables by amounts that would be
material to the Company’s financial condition, results of operations or
liquidity.





The
Company and certain of its directors and key executive officers are defendants
in several purported class actions that were filed in 2003 in the United States
District Court for the Eastern District of Pennsylvania by alleged purchasers of
the Company’s Class A Common Stock, 4.25% Convertible Debt and 8.50% Senior
Notes. On June 28, 2004, the District Court issued an order consolidating the
cases under the caption In Re PMA Capital Corporation Securities Litigation
(civil action no. 03-6121) and appointing Sheet Metal Workers Local 9 Pension
Trust, Alaska Laborers Employers Retirement Fund and Communications Workers of
America for Employees’ Pension and Death Benefits as lead plaintiff. On
September 20, 2004, the plaintiffs filed an amended and consolidated complaint
on behalf of an alleged class of purchasers of the Company's securities between
May 5, 1999 and February 11, 2004. The complaint alleges, among other things,
that the defendants violated Section 10(b) of the Exchange Act, and Rule 10b-5
thereunder by making materially false and misleading public statements and
material omissions during the class period regarding the Company's underwriting
performance, loss reserves and related internal controls. The complaint alleges,
among other things, that the defendants violated Sections 11, 12(a) (2) and 15
of the Securities Act by making materially false and misleading statements in
registration statements and prospectuses about the Company's financial results,
underwriting performance, loss reserves and related internal controls. The
complaint seeks unspecified compensatory damages, the right to rescind the
purchases of securities in the public offerings, interest, and plaintiffs’
reasonable costs and expenses, including attorneys’ fees and expert fees. The
Company intends to vigorously defend against the claims asserted in this
consolidated action. The lawsuit is in its earliest stages; therefore, it is not
possible at this time to reasonably estimate the impact on the Company. However,
the lawsuit may have a material adverse effect on the Company’s financial
condition, results of operations and liquidity.








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**Note 8. Shareholders’ Equity**





Changes
in Class A Common stock shares were as follows:





**
    
    
    2004
    
    
    2003
    
    
    2002Treasury
      stock - Class A Common stock:Balance
      at beginning of year
    
    
    2,883,542
    
    
    2,889,023
    
    
    3,050,939Purchase
      of treasury shares
    
    
    **-**
    
    
    -
    
    
    90,185Reissuance
      of treasury shares under employee benefit plans
    
    
    (342,448
    )
    
    (5,481
    )
    
    (252,101
    )Balance
      at end of year
    
    
    2,541,094
    
    
    2,883,542
    
    
    2,889,023


In 2004,
the Company issued 262,600 shares of restricted Class A common stock to
employees under the Company’s 2002 Equity Incentive Plan and 79,326 shares of
restricted Class A common stock to its Directors under the 2004 Directors Plan.
The restricted stock vests (restrictions lapse) between one and three years. The
Company also issued 16,422 shares of Class A Common stock to Directors in 2004
in lieu of a portion of their retainer under the 2004 Directors Plan.





During
the vesting period, restricted shares issued are nontransferable and subject to
forfeiture, but the shares are entitled to all of the other rights of the
outstanding shares. Restricted shares are forfeited if employees terminate
employment, or Directors resign from the Board, prior to the lapse of
restrictions except upon death or permanent disability. The Company determines
the cost of restricted stock awarded, which is recognized as compensation
expense over the vesting period, based on the market value of the stock at the
time of the award. The Company recorded expenses of $1.3 million during 2004 for
restricted stock awards and $112,000 for Class A Common stock issued to
Directors in lieu of their retainer. During 2004, 15,900 restricted shares were
forfeited.





In 2003,
shareholders approved an increase in the authorized shares of the Company’s
Class A Common stock, which has a $5 par value, from 40 million shares to 60
million shares.





The
Company repurchased 90, 185
shares of its Class A Common stock at a cost of $1.7 million in 2002. No shares
were repurchased in 2004 or 2003. The Company’s remaining share repurchase
authorization at December 31, 2004 is $15.4 million. Decisions regarding share
repurchases are subject to prevailing market conditions and an evaluation of the
costs and benefits associated with alternative uses of capital.





The
Company declared dividends on its Class A
Common stock of $0.315 and $0.42 per share in 2003 and 2002, respectively. In
November 2003, the Company’s Board of Directors suspended dividends on the
Company’s Class A Common stock.





The
Company has 2,000,000 shares of undesignated Preferred stock, $0.01 par value
per share authorized. There are no shares of Preferred stock issued or
outstanding.





In 2000,
the Company’s Board of Directors adopted a shareholder rights plan that will
expire on May 22, 2010. The rights automatically attached to each share of Class
A Common stock. Generally, the rights become exercisable after the acquisition
of 15% or more of the Company’s Class A Common stock and permit rights-holders
to purchase the Company’s Class A Common stock or that of an acquirer at a
substantial discount. The Company may redeem the rights for $0.001 per right at
any time prior to an acquisition.





The
Company ’s
domestic insurance subsidiaries’ ability to pay dividends to PMA Capital
Corporation is limited by the insurance laws and regulations of the Commonwealth
of Pennsylvania. Prior to June 2004, all of PMA Capital’s domestic insurance
entities were owned by PMA Capital Insurance Company (“PMACIC”). Only PMACIC, a
Pennsylvania domiciled company, could pay dividends directly to PMA Capital
Corporation.


In June
2004, the Pennsylvania Insurance Department approved the application for the
Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly
owned subsidiaries of PMA Capital Corporation. However, in its Order approving
the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the
Pennsylvania Insurance Department prohibited PMACIC, the Company’s reinsurance
subsidiary which is currently in run-off, from any declaration or payment of
dividends, return of capital or any other types of distributions in 2004 and
2005 to PMA Capital Corporation.





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 Table of Contents





In 2006, PMACIC may declare and pay ordinary dividends or
returns of capital without the prior approval of the Pennsylvania Insurance
Department if, immediately after giving effect to the dividend or returns of
capital, PMACIC’s risk-based capital equals or exceeds 225% of Authorized
Control Level Capital as defined by the National Association of Insurance
Commissioners (“NAIC”). In 2007 and beyond, PMACIC may make dividend payments,
as long as such dividends are not considered “extraordinary” under Pennsylvania
insurance law.





The
Pooled Companies, which are not subject to the Pennsylvania Insurance
Department’s Order, paid dividends of $12.1 million to PMA Capital Corporation
in 2004. As of December 31, 2004, The Pooled Companies can pay up to $23.5
million in dividends in 2005 without the prior approval of the Pennsylvania
Insurance Department.





Dividends received
from subsidiaries were $24.0 million and $28.0 million in 2003 and 2002,
respectively.





**Note****9.
Stock Options**





The
Company currently has stock option plans in place for stock options granted to
officers and other key employees for the purchase of the Company’s Class A
Common stock, under which 4,800,314
Class A Common shares were reserved for issuance at December 31, 2004. The stock
options were granted under terms and conditions determined by the Compensation
Committee of the Board of Directors. Stock options granted have a maximum term
of ten years, generally vest over periods ranging between one and four years,
and are typically granted with an exercise price at least equal to the fair
market value of the Class A Common stock on the date the options are granted.
Information regarding these option plans is as follows:





2004
    
    
    2003
    
    
    2002Weighted
    
    
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    
    
    Average
    
    
    
    
    
    AverageShares
    
    
    Price
    
    
    Shares
    
    
    Price
    
    
    Shares
    
    
    PriceOptions
      outstanding, beginning of year
    
    
    2,871,619
    
    $
    16.07
    
    
    3,096,494
    
    $
    16.93
    
    
    3,387,154
    
    $
    16.45Options
      granted
    
    
    1,350,200
    
    
    6.34
    
    
    511,960
    
    
    9.21
    
    
    440,500
    
    
    19.50Options exercised
    
    
    -
    
    
    -
    
    
    (50,141
    )
    
    11.50
    
    
    (302,465
    )
    
    12.66Options
      forfeited or expired
    
    
    (1,464,614
    )
    
    14.61
    
    
    (686,694
    )
    
    15.17
    
    
    (428,695
    )
    
    18.78Options
      outstanding, end of year(1)
    
    
    2,757,205
    
    $
    12.09
    
    
    2,871,619
    
    $
    16.07
    
    
    3,096,494
    
    $
    16.93Options
      exercisable, end of year
    
    
    1,523,047
    
    $
    15.74
    
    
    1,861,489
    
    $
    16.85
    
    
    2,059,729
    
    $
    15.74Option price range at end of year
    
    
    $5.78
      to $21.50
    
    $
      9.14 to $21.50
    
    $11.50
      to $21.50Option
      price range for exercised shares
    
    
    -
    
    $11.50
    
    $10.00
      to $17.00Options
      available for grant at end of year
    
    
    2,043,109
    
    2,057,054
    
    305,158


*(1)*
    *Included
      in the options outstanding at December 31, 2002 are 260,000 options
      (“Target Price Options”), with an exercise price of $17.00. Because the
      stock did not reach the necessary price, the Target Price Options expired
      as unvested options in 2003.*





All
options granted in 200 4 and
2003 were granted with an exercise price that equaled or exceeded the market
value of the Class A Common stock on the grant date (“out-of-the-money”). The
weighted average fair value of options granted in 2004 and 2003 was $3.43 per
share and $4.91 per share, respectively. Of the total options granted in 2002,
225,000 were granted with an exercise price that was lower than the market value
of the Class A Common stock on the grant date, and such options had a weighted
average exercise price of $19.50 per share and a weighted average fair value of
$14.61 per share. The remaining 215,500 options were granted out-of-the-money,
and such options had an exercise price of $19.50 per share and a weighted
average fair value of $7.66 per share.





The
Company accounts for stock option
compensation using the intrinsic value method. Included in the Company’s net
income (loss) were pre-tax stock option compensation costs of $(172,000),
$239,000 and $215,000 for 2004, 2003 and 2002, respectively. Stock
option compensation increased pre-tax income in 2004 due to the impact of the
cancellation of unvested stock options.








83
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The fair
value of options at date of grant was estimated using an option-pricing model
with the following weighted average assumptions:





**
    
    
    2004
    
    
    2003
    
    
    2002Expected
      life (years)
    
    
    5
    
    
    10
    
    
    10Risk-free
      interest rate
    
    
    3.1
    %
    
    3.4
    %
    
    5.1
    %Expected
      volatility
    
    
    60.5
    %
    
    44.3
    %
    
    16.8
    %Expected
      dividend yield
    
    
    0.0
    %
    
    4.6
    %
    
    2.0
    %





Stock
options outstanding and options exercisable at December 31, 2004 were as
follows:





Options
      Outstanding
    
    Options
      ExercisableWeightedAverage
    
    
    Weighted
    
    
    
    
    
    WeightedNumber
      of
    
    
    Remaining
    
    
    Average
    
    
    Number
    
    
    AverageShares
    
    
    Life
    
    
    Exercise
      Price
    
    
    of
      Shares
    
    
    Exercise
      Price$5.78
      to $8.00
    
    
    1,291,100
    
    
    9.28
    
    $
    6.37
    
    
    304,800
    
    $
    7.02$8.01
      to $12.00
    
    
    149,850
    
    
    8.41
    
    $
    9.14
    
    
    -
    
    $
    -$12.01
      to $16.00
    
    
    315,800
    
    
    0.43
    
    $
    15.33
    
    
    315,800
    
    $
    15.33$16.01
      to $20.00
    
    
    803,891
    
    
    4.01
    
    $
    18.27
    
    
    705,883
    
    $
    18.10$20.01
      to $21.50
    
    
    196,564
    
    
    5.05
    
    $
    21.43
    
    
    196,564
    
    $
    21.43





See Note 2-J and 2-L for additional
information.





**Note 10. Earnings Per Share**





Shares
used as the denominator of the basic and diluted earnings per share were
computed as follows:





2004
    
    
    2003
    
    
    2002**Denominator:**Basic
      shares
    
    
    31,344,858
    
    
    31,330,183
    
    
    31,284,848Dilutive
      effect of:Restricted
      stock
    
    
    243,977
    
    
    -
    
    
    -Stock
      options
    
    
    136,994
    
    
    -
    
    
    -Convertible
      Debt
    
    
    3,232
    
    
    -
    
    
    -Total
      diluted shares
    
    
    31,729,061
    
    
    31,330,183
    
    
    31,284,848





The
effect of 1.5 million, 2.9 million and 3.1 million stock options were excluded
from the computation of diluted earnings per share for 2004, 2003 and 2002,
respectively, because they would have been anti-dilutive.





Diluted
shares for 2004, 2003 and 2002 do not assume the conversion of the Company’s
Convertible Debt into 6.1 million, 5.3 million and 5.3 million shares of Class A
Common stock, respectively, because it would have been anti-dilutive. The
dilutive effect of the Convertible Debt for 2004 represents the impact of the
Put Premium feature on the 6.50% Convertible Debt. See Note
6 for additional information.





**Note 11. Fair Value of Financial
Instruments**





As of
December 31, 2004 , the
carrying amounts for the Company’s financial instruments approximated their
estimated fair value. As of December 31, 2003, the carrying amounts for the
Company’s financial instruments approximated their estimated fair value, other
than the 4.25% Convertible Debt, which had a fair value of approximately $65
million, compared to a carrying value of $86.3 million, and the 8.50% Senior
Notes, which had a fair value of approximately $50 million,





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compared
to a carrying value of $57.5 million. The Company measures the fair value of
fixed maturities, the Convertible Debt and the Senior Notes based upon quoted
market prices or by obtaining quotes from dealers. For other financial
instruments, the carrying values approximate their fair values. Certain
financial instruments, specifically amounts relating to insurance and
reinsurance contracts, are excluded from this disclosure.





**Note 12. Income Taxes**





The
components of the Federal income tax expense (benefit) are:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Current
    
    $
    -
    
    $
    -
    
    $
    (3,606
    )Deferred
    
    
    2,115
    
    
    25,823
    
    
    (27,527
    )Income
      tax expense (benefit)
    
    $
    2,115
    
    $
    25,823
    
    $
    (31,133
    )





A
reconciliation between the total income tax expense
(benefit) and the
amounts computed at the statutory federal income tax rate of 35% is as
follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002Federal
      income tax at the statutory rate
    
    $
    1,381
    
    $
    (23,711
    )
    $
    (27,705
    )Change
      in valuation allowance
    
    
    8,000
    
    
    49,000
    
    
    -Reversal
      of income tax accruals
    
    
    (8,120
    )
    
    -
    
    
    (3,000
    )Other
    
    
    854
    
    
    534
    
    
    (428
    )Income
      tax expense (benefit)
    
    $
    2,115
    
    $
    25,823
    
    $
    (31,133
    )





The tax
effects of significant temporary differences between the financial statement
carrying amounts and tax bases of assets and liabilities that represent the net
deferred tax asset are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003Net
      operating loss and tax credit carryforwards
    
    $
    86,891
    
    $
    76,854Discounting
      of unpaid losses and LAE
    
    
    41,337
    
    
    61,619Unearned
      premiums
    
    
    10,949
    
    
    26,136Postretirement
      benefit obligation
    
    
    9,856
    
    
    7,712Allowance
      for uncollectible accounts
    
    
    6,666
    
    
    6,277Depreciation
    
    
    3,540
    
    
    3,264Other
    
    
    11,626
    
    
    9,549Gross
      deferred tax assets
    
    
    170,865
    
    
    191,411Valuation
      allowance
    
    
    (57,000
    )
    
    (49,000
    )Deferred
      tax assets, net of valuation allowance
    
    
    113,865
    
    
    142,411Deferred
      acquisition costs
    
    
    (10,999
    )
    
    (29,391
    )Unrealized
      appreciation of investments
    
    
    (7,335
    )
    
    (16,994
    )Losses
      of foreign reinsurance affiliates
    
    
    -
    
    
    (8,120
    )Capitalized
      software
    
    
    (4,204
    )
    
    (4,161
    )Foreign
      exchange translation adjustment
    
    
    (449
    )
    
    (1,973
    )Other
    
    
    (4,377
    )
    
    (4,810
    )Gross
      deferred tax liabilities
    
    
    (27,364
    )
    
    (65,449
    )Net
      deferred tax assets
    
    $
    86,501
    
    $
    76,962





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At
December 31, 2004, the Company had a net operating loss ("NOL") carryforward of
$221.9 million, which will expire in years 2018 through 2024, and an $8.5
million alternative minimum tax ("AMT") credit carryforward, which does not
expire. The NOL carryforward, which produces a gross deferred tax asset of $77.6
million, will be applied to reduce taxable income of the Company.





In 2003,
the Company recorded a valuation allowance in the amount of $49 million. In the
fourth quarter of 2004, the Company reassessed the valuation allowance
previously established against its net deferred tax assets and determined that
it needed to be increased by $8 million, considering a number of factors,
including the recent losses and revised projections of future earnings at the
Run-off Operations. Accordingly, management has estimated at December 31, 2004
that the insurance operations will generate sufficient future taxable income to
utilize the net deferred tax asset, net of the $57.0 million valuation
allowance, over a period of time not exceeding the expiration of the operating
loss carryforwards. The valuation allowance of $57.0 million reserves against
$46.3 million of gross deferred tax assets related to the NOL carryforward and
all of the projected deferred tax asset related to the AMT credit carryforward
because it is more likely than not that this portion of the benefit will not be
realized. The Company will continue to periodically assess the realizability of
its net deferred tax asset.





The
Company's Federal income tax returns are subject to audit by the Internal
Revenue Service ("IRS"). No tax years are currently under audit by the IRS. In
the fourth quarter of 2004, the Company reversed $8.1 million of certain tax
contingency reserves recorded in prior years, due primarily to closed
examination years.





In 2002,
the Company received refunds from the IRS of $10.6 million, resulting primarily
from an AMT net operating loss which was generated in 2001 and carried back to
1998 and 1999.





**Note 13. Employee Retirement, Postretirement and Postemployment
Benefits**





**A.
Pension and Other Postretirement Benefits:**




*Pension
Benefits —*  The
Company sponsors a qualified non-contributory defined benefit pension plan (the
"Qualified Pension Plan") covering substantially all employees. After meeting
certain requirements under the Qualified Pension Plan, an employee acquires a
vested right to future benefits. The benefits payable under the plan are
generally determined on the basis of an employee’s length of employment and
salary during employment. The Company’s policy is to fund pension costs in
accordance with the Employee Retirement Income Security Act of 1974.





The
Company also maintains non-qualified unfunded supplemental defined benefit
pension plans (the "Non- qualified
Pension Plans") for the benefit of certain key employees. The projected benefit
obligation and accumulated benefit obligation for the Non-qualified Pension
Plans were $7.6 million and $7.3 million, respectively, as of December 31,
2004.





*Other
Postretirement Benefits —*  In
addition to providing pension benefits, the Company provides certain health care
benefits for retired employees and their spouses. Substantially all of the
Company’s employees may become eligible for those benefits if they meet the
requirements for early retirement under the Qualified Pension Plan and have a
minimum of 10 years employment with the Company. For employees who retired on or
subsequent to January 1, 1993, the Company will pay a fixed portion of medical
insurance premiums, including Medicare Part B. Retirees will absorb future
increases in medical premiums.








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The
following tables set forth the amounts recognized in the Company’s financial
statements with respect to Pension Benefits and Other Postretirement
Benefits:





Pension
      Benefits
    
    
    Other
      Postretirement Benefits*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003Change
      in benefit obligation:Benefit
      obligation at beginning of year
    
    $
    77,470
    
    $
    66,924
    
    $
    9,777
    
    $
    8,808Service
      cost
    
    
    3,520
    
    
    3,202
    
    
    420
    
    
    364Interest
      cost
    
    
    4,937
    
    
    4,629
    
    
    597
    
    
    596Actuarial
      (gain) loss
    
    
    2,252
    
    
    4,927
    
    
    (41
    )
    
    652Benefits
      paid
    
    
    (2,427
    )
    
    (2,212
    )
    
    (756
    )
    
    (643
    )Benefit
      obligation at end of year
    
    $
    85,752
    
    $
    77,470
    
    $
    9,997
    
    $
    9,777Change
      in plan assets:Fair
      value of plan assets at beginning of year
    
    $
    62,401
    
    $
    57,118
    
    $
    -
    
    $
    -Actual
      return on plan assets
    
    
    5,066
    
    
    7,495
    
    
    -
    
    
    -Benefits
      paid
    
    
    (2,427
    )
    
    (2,212
    )
    
    -
    
    
    -Fair
      value of plan assets at end of year
    
    $
    65,040
    
    $
    62,401
    
    $
    -
    
    $
    -Benefit
      obligation greater than the fair value of plan assets
    
    $
    (20,712
    )
    $
    (15,069
    )
    $
    (9,997
    )
    $
    (9,777
    )Unrecognized
      actuarial (gain) loss
    
    
    31,016
    
    
    29,982
    
    
    (3,063
    )
    
    (3,162
    )Unrecognized
      prior service (cost) benefit
    
    
    482
    
    
    487
    
    
    (484
    )
    
    (603
    )Unrecognized
      net transition obligation
    
    
    342
    
    
    338
    
    
    -
    
    
    -Net
      amount recognized at end of year
    
    $
    11,128
    
    $
    15,738
    
    $
    (13,544
    )
    $
    (13,542
    )Amounts
      recognized in the balance sheet consist of:Prepaid
      benefit cost
    
    $
    17,139
    
    $
    21,075
    
    $
    -
    
    $
    -Accrued
      benefit cost
    
    
    (6,011
    )
    
    (5,337
    )
    
    (13,544
    )
    
    (13,542
    )Additional
      minimum liability
    
    
    (26,499
    )
    
    (25,288
    )
    
    -
    
    
    -Intangible
      asset
    
    
    1,244
    
    
    1,273
    
    
    -
    
    
    -Accumulated
      other comprehensive income, pre-tax
    
    
    25,255
    
    
    24,015
    
    
    -
    
    
    -Net
      amount recognized at end of year
    
    $
    11,128
    
    $
    15,738
    
    $
    (13,544
    )
    $
    (13,542
    )





Pension
      Benefits
    
    
    Other
      Postretirement Benefits*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2004
    
    
    2003
    
    
    2002Components
      of net periodic benefit cost:Service
      cost
    
    $
    3,520
    
    $
    3,202
    
    $
    2,396
    
    $
    419
    
    $
    364
    
    $
    316Interest
      cost
    
    
    4,937
    
    
    4,629
    
    
    4,278
    
    
    597
    
    
    596
    
    
    589Expected
      return on plan assets
    
    
    (5,198
    )
    
    (5,032
    )
    
    (4,333
    )
    
    -
    
    
    -
    
    
    -Amortization
      of transition obligation
    
    
    (4
    )
    
    (5
    )
    
    (4
    )
    
    -
    
    
    -
    
    
    -Amortization
      of prior service cost
    
    
    5
    
    
    5
    
    
    5
    
    
    (119
    )
    
    (119
    )
    
    (119
    )Recognized
      actuarial (gain) loss
    
    
    1,642
    
    
    1,643
    
    
    662
    
    
    (140
    )
    
    (91
    )
    
    (218
    )Net
      periodic pension cost
    
    $
    4,902
    
    $
    4,442
    
    $
    3,004
    
    $
    757
    
    $
    750
    
    $
    568Weighted
      average assumptions:Discount
      rate
    
    
    6.00
    %
    
    6.25
    %
    
    6.75
    %
    
    6.00
    %
    
    6.25
    %
    
    6.75
    %Expected
      return on plan assets
    
    
    8.50
    %
    
    9.00
    %
    
    9.00
    %
    
    -
    
    
    -
    
    
    -Rate
      of compensation increase
    
    
    3.75
    %
    
    4.00
    %
    
    4.50
    %
    
    -
    
    
    -
    
    
    -





The
Company uses a January 1 measurement date for its Plans. For the
measurement of Other Postretirement Benefits, a 10% annual rate of increase in
the per capita cost of covered health care benefits was assumed for 2004. The
rate was assumed to decrease gradually to 5% by 2009 and remain at that level
thereafter. A one percentage point change in assumed





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health
care cost trend rates would have an immaterial impact on the total service and
interest cost components of the net periodic benefit cost and the postretirement
benefit obligation.





Benefits
paid in the table above include only those amounts paid directly from plan
assets.





The
decline in Qualified
Pension Plan asset performance in 2000 to 2002, combined with historically low
interest rates (which are the key assumption in estimating plan liabilities)
caused the Company to record a $24.0 million increase in its accrued Qualified
Pension Plan liability and to take a $15.6 million non-cash charge to equity in
the fourth quarter of 2003. In 2004, the Company increased its Qualified Pension
Plan liability by an additional $1.2 million and recorded a non-cash charge to
equity of $806,000. These charges did not impact earnings or cash flow, and
could reverse in future periods if either interest rates increase or market
performance and plan asset returns improve.





The
projected benefit obligation, accumulated benefit obligation and fair value of
plan assets for the Qualified Pension Plan were $78.2 million, $73.2 million and
$65.0 million, respectively, at December 31, 2004 and $70.5 million, $65.3
million and $62.4 million, respectively, at December 31, 2003.





The asset
allocation for the Company’s Qualified
Pension Plan at the
end of 2004 and 2003, and the target allocation for 2005, by asset category, are
as follows:





Percentage
      of plan assetsTarget
      allocation
    
    
    As
      of December 31,Asset
      Category
    
    
    2005
    
    
    2004
    
    
    2003Equity
      Securities
    
    
    50-70%
    
    
    69%
    
    
    66%Debt
      Securities
    
    
    30-50%
    
    
    31%
    
    
    34%Total
    
    
    100%
    
    
    100%
    
    
    100%





The
Company’s Qualified
Pension Plan assets are managed by outside investment managers and are
rebalanced periodically. The Company’s investment strategy with respect to
Qualified Pension Plan assets includes guidelines for asset quality standards,
asset allocations among investment types and issuers, and other relevant
criteria for the portfolio *.*





Following
are expected cash flows for the Company's pension plans:





Qualified
      Pension
    
    Non-Qualified*(dollar
      amounts in thousands)*
    
    
    Benefits
    
    
    Pension
      BenefitsExpected
      Employer Contributions:2005
    
    $
    -
    
    $
    -Expected
      Benefit Payments:2005
    
    $
    2,583
    
    $
    3102006
    
    
    2,687
    
    
    3222007
    
    
    2,794
    
    
    3482008
    
    
    2,893
    
    
    4162009
    
    
    3,084
    
    
    4382010-2014
    
    
    20,882
    
    
    2,820





Qualified
Pension Plan  benefits
will be paid from the pension trust assets which have a fair value of $65.0
million at December 31, 2004. Non-qualified Pension Plan benefits will be paid
from the general assets of the Company.





**B.
Defined Contribution Savings Plan —** The
Company also maintains a voluntary defined contribution savings plan covering
substantially all employees. The Company matches employee contributions up to 5%
of compensation. Contributions under such plans expensed in 2004, 2003 and 2002
were $2.6 million, $3.3 million and $3.4 million, respectively.





**C.
Postemployment Benefits —** The
Company may provide certain benefits to employees subsequent to their
employment, but prior to retirement including severance, long-term and
short-term disability payments, and other related benefits. Postemployment
benefits attributable to prior service and/or that relate to benefits that vest
or accumulate are accrued





88
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presently
if the payments are probable and reasonably estimable. Postemployment benefits
that do not meet such criteria are accrued when payments are probable and
reasonably estimable. See Note 14 for additional
information regarding severance.





**Note 14. Run-Off Operations**





In
November 2003, the Company announced its decision to withdraw from the
reinsurance business previously served by the PMA Re operating segment. As a
result of this decision, the results of PMA Re are now reported as Run-off
Operations. Run-off Operations also includes the results of the
Company’s former excess and surplus lines business.





As a
result of the decision to exit from and run off the reinsurance business,
results for the Run-off Operations for 2003 included a charge of $2.6 million
pre-tax, mainly for employee termination benefits. Approximately 80 employees at
PMA Re have been terminated in accordance with the Company’s exit plan.
Approximately 60 positions, primarily claims and financial, remain. The Company
has established an employee retention arrangement for the remaining employees.
Under this arrangement, the Run-off Operations recorded expenses of $1.7
million, which include retention bonuses and severance, for 2004, and expects to
record expenses of approximately $1.3 million for 2005. Employee termination
benefits and retention bonuses of $3.3 million have been paid in accordance with
this plan, including $450,000 in 2003. Additionally, in 2004 the Run-off
Operations paid a $1 million fee to shorten
the term of its Philadelphia
office lease from fifteen years to seven and reduce the leased space by
approximately 75% effective October 1, 2004.





In May
2002, the Company announced its decision to withdraw from the excess and surplus
lines marketplace previously served by the Caliber One operating segment. In
January 2003, the Company closed on the sale of the capital stock of Caliber One
Indemnity Company. Pursuant to the agreement of sale, the Company has retained
all assets and liabilities related to the in-force policies and outstanding
claim obligations relating to Caliber One’s business written prior to closing on
the sale. As a result of the Company’s decision to exit from and run off this
business, its results are reported in Run-off Operations. The sale generated
gross proceeds of approximately $31 million and resulted in a pre-tax gain of
$2.5 million, which is included in other revenues in the Statement of Operations
for 2003.





As a
result of the decision to exit from and run off this business, 2002 results for
the Run-off Operations include a charge
of $43 million pre-tax. Components of the charge include approximately $16
million to write-down assets to their estimated net realizable value, including
non-cash charges of approximately $6 million for leasehold improvements and
other fixed assets and $1.3 million for goodwill. During
2003, the Company recognized an additional $2.5 million write-down of assets,
including approximately $2 million for reinsurance receivables and $500,000 for
premiums receivable, reflecting an updated assessment of their estimated net
realizable value. The write-down is included in operating expenses in the
Statement of Operations for 2003.





In
addition, the $43 million pre-tax charge includes expenses associated with the
recognition of liabilities of approximately $27 million, including reinsurance
costs of approximately $19 million, long-term lease costs of approximately $4
million and involuntary employee termination benefits of approximately $3
million. The charge was included in operating expenses (approximately $24
million) and net premiums earned (approximately $19 million) in the Statement of
Operations in 2002. At December 31, 2004, the Company had a remaining balance of
approximately $410,000 for net lease costs and approximately $114,000 for
severance.





During
2002, approximately 80 Caliber One employees, primarily in the underwriting
area, were terminated in accordance with the Company’s exit plan. Approximately
6 positions, primarily claims staff, remain as of December 31, 2004. Involuntary
employee termination benefits of $38,000, $730,000 and $1.9 million were paid
during 2004, 2003 and 2002, respectively.





**Note 15. Business Segments**





In
November 2003, the Company announced its decision to withdraw from the
reinsurance business previously served by the PMA Re operating segment. As a
result of this decision, the results of PMA Re are now reported as Run-off
Operations. Run-off Operations also includes the results of the Company’s former
excess and surplus lines business.





The
Company's total revenues, substantially all of which are generated within the
U.S., and pre-tax operating income (loss) by principal business segment are
presented in the table below.





89
 Table of Contents





Operating
income (loss), which is GAAP net income (loss) excluding net realized investment
gains and losses, is the financial performance measure used by the Company’s
management and Board of Directors to evaluate and assess the results of the
Company’s insurance businesses. Accordingly, the Company reports operating
income by segment in this footnote as required by SFAS No. 131, “Disclosures
About Segments of an Enterprise and Related Information.” The Company’s
management and Board of Directors use operating income as the measure of
financial performance for the Company’s business segments because (i) net
realized investment gains and losses are unpredictable and not necessarily
indicative of current operating fundamentals or future performance of the
business segments and (ii) in many instances, decisions to buy and sell
securities are made at the holding company level, and such decisions result in
net realized gains and losses that do not relate to the operations of the
individual segments. Operating income (loss) does not replace net income (loss)
as the GAAP measure of our consolidated results of operations.





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**Revenues:**The
      PMA Insurance Group
    
    $
    492,335
    
    $
    620,432
    
    $
    460,573Run-off
      Operations
    
    
    101,722
    
    
    665,783
    
    
    631,377Corporate
      and Other
    
    
    7,414
    
    
    1,252
    
    
    (728
    )Net
      realized investment gains (losses)
    
    
    6,493
    
    
    13,780
    
    
    (16,085
    )Total
      revenues
    
    $
    607,964
    
    $
    1,301,247
    
    $
    1,075,137**Components
      of net income (loss):**Pre-tax
      operating income (loss):The
      PMA Insurance Group
    
    $
    13,166
    
    $
    21,541
    
    $
    25,346Run-off
      Operations
    
    
    5,509
    
    
    (80,376
    )
    
    (74,204
    )Corporate
      and Other
    
    
    (21,223
    )
    
    (22,691
    )
    
    (14,214
    )Net
      realized investment gains (losses)
    
    
    6,493
    
    
    13,780
    
    
    (16,085
    )Income
      (loss) before income taxes
    
    
    3,945
    
    
    (67,746
    )
    
    (79,157
    )Income
      tax expense (benefit)
    
    
    2,115
    
    
    25,823
    
    
    (31,133
    )Net
      income (loss)
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )





Net
premiums earned by principal business segment are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**The
      PMA Insurance Group:**Workers'
      compensation and integrated disability
    
    $
    389,844
    
    $
    477,402
    
    $
    333,956Commercial
      automobile
    
    
    30,602
    
    
    53,541
    
    
    43,384Commercial
      multi-peril
    
    
    16,973
    
    
    28,700
    
    
    25,390Other
    
    
    4,924
    
    
    10,389
    
    
    7,536Total
      premiums earned
    
    
    442,343
    
    
    570,032
    
    
    410,266**Run-off
      Operations:**Reinsurance:Traditional
      - Treaty
    
    
    23,661
    
    
    278,971
    
    
    263,757Finite
      Risk and Financial Products
    
    
    15,501
    
    
    221,093
    
    
    207,531Specialty
      - Treaty
    
    
    36,348
    
    
    83,008
    
    
    58,348Facultative
    
    
    2,450
    
    
    27,237
    
    
    18,619Accident
      Reinsurance
    
    
    (873
    )
    
    13,940
    
    
    3,258Total
      reinsurance premiums earned
    
    
    77,087
    
    
    624,249
    
    
    551,513Excess
      and surplus lines
    
    
    (20
    )
    
    4,672
    
    
    30,113Total
      premiums earned - Run-off Operations
    
    
    77,067
    
    
    628,921
    
    
    581,626**Corporate
      and Other**
    
    
    (825
    )
    
    (788
    )
    
    (881
    )**Consolidated
      net premiums earned**
    
    $
    518,585
    
    $
    1,198,165
    
    $
    991,011








90
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The
Company’s amortization and depreciation expense by principal business segment
were as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002The
      PMA Insurance Group
    
    $
    7,648
    
    $
    7,117
    
    $
    3,598Run-off
      Operations
    
    
    12,015
    
    
    14,035
    
    
    5,472Corporate
      and Other
    
    
    4
    
    
    77
    
    
    129Total
      depreciation and amortization expense
    
    $
    19,667
    
    $
    21,229
    
    $
    9,199





The
Company's total assets (1) by
principal business segment were as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003The
      PMA Insurance Group
    
    $
    1,889,449
    
    $
    2,008,509Run-off
      Operations
    
    
    1,300,655
    
    
    2,128,461Corporate
      and Other(2)
    
    
    63,881
    
    
    50,988Total
      assets
    
    $
    3,253,985
    
    $
    4,187,958





*(1)*
    *Equity
      investments in subsidiaries, which eliminate in consolidation, are
      excluded from total assets for each
segment.*


*(2)*
    *Corporate
      and Other includes the effects of eliminating transactions between the
      various insurance segments.*





The PMA
Insurance Group’s operations are concentrated in ten
contiguous states in the eastern part of the U.S. As such, economic trends in
individual states may not be independent of one another. Also, The PMA Insurance
Group’s products are highly regulated by each of these states. For many of The
PMA Insurance Group’s products, the insurance departments of the states in which
it conducts business must approve rates and policy forms. In addition, workers’
compensation benefits are determined by statutes and regulations in each of
these states. While The PMA Insurance Group considers factors such as rate
adequacy, regulatory climate and economic factors in its underwriting process,
unfavorable developments in these factors could have an adverse impact on the
Company’s financial condition and results of operations. The PMA Insurance Group
is the Company’s sole remaining ongoing insurance segment. In 2004, workers’
compensation net premiums written represented 85% of The PMA Insurance Group’s
net premiums written. In 2003 and 2002, workers’ compensation net premiums
written by The PMA Insurance Group represented 41% and 32%, respectively, of the
Company’s net premiums written.





The
Company actively manages its exposure to catastrophes through its underwriting
process, where the Company generally monitors the accumulation of insurable
values in catastrophe-prone regions. The PMA
Insurance Group maintains catastrophe reinsurance protection of 95% of $18.0
million excess of $2.0 million.





Although
the Company believes that it has adequate reinsurance to protect against the
estimated probable maximum gross loss from a catastrophe, an especially severe
catastrophe or series of catastrophes, or terrorist event, could exceed the
Company’s reinsurance and/or retrocessional protection and may have a material
adverse impact on the Company’s financial condition, results of operations and
liquidity. In 2004,
2003 and 2002, the Company’s loss and LAE ratios were not significantly impacted
by catastrophes.





**Note 16. Transactions with Related Parties**





In 2003
and 2002, t he
Company and certain of its subsidiaries provided certain administrative services
to the PMA Foundation (the “Foundation”), for which the Company and its
subsidiaries received reimbursement. The Foundation, a not-for-profit
corporation qualified under Section 501(c)(6) of the Internal Revenue Code,
whose purposes include the promotion of the common business interests of its
members and the economic prosperity of the Commonwealth of Pennsylvania, owned
5,242,150 shares, or 16.7%, of the Company’s Class A Common stock as of December
31, 2003. As of December 31, 2004, the Foundation owns less than 5% of the
Company’s Class A Common Stock. Total reimbursements amounted to $13,000 for
both 2003 and 2002. The Foundation also leased its Harrisburg, Pennsylvania
headquarters facility from a subsidiary of the Company under an operating lease
which required rent payments of $25,000 per month, and reimbursed a subsidiary
of the Company for its use of office space. Rent and related reimbursements paid
to the Company’s affiliates by the Foundation was $304,000 in both 2003 and
2002. In 2004, the Company sold this building to the Foundation for gross
proceeds of $1.6 million, resulting in a gain of $458,000, which is included in
other revenues in the Statement of Operations.





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The
Company incurred legal and consulting expenses aggregating approximately $4.4
million, $3.7 million and $3.9 million in 2004, 2003 and 2002, respectively,
from firms in which directors of the Company are partners or
principals.





At
December 31, 200 3 and
2002, the Company had notes receivable from officers totaling $65,000 and
$62,000, respectively, that are accounted for as a reduction of shareholders’
equity. These loans were repaid in 2004.





**Note
1****7.
Statutory Financial Information**





These
consolidated financial statements vary in certain respects from financial
statements prepared using statutory accounting practices that are prescribed or
permitted by the Pennsylvania Insurance Department and the Delaware Insurance
Department (collectively, "SAP"). Prescribed SAP includes state laws,
regulations and general administrative rules, as well as a variety of NAIC
publications. Permitted SAP encompasses all accounting practices that are not
prescribed. The Codification of Statutory Accounting Principles ("Codification")
guidance is the NAIC’s primary guidance on statutory accounting. The
principal differences between GAAP and SAP are in the treatment of acquisition
expenses, reinsurance, deferred income taxes, fixed assets and investments.





SAP net
income (loss) and capital and surplus for PMA Capital’s domestic insurance
subsidiaries are as follows:





*(dollar
      amounts in thousands)*
    
    
    2004
    
    
    2003
    
    
    2002**SAP
      net income (loss):**The
      PMA Insurance Group
    
    $
    19,000
    
    $
    7,169
    
    $
    4,984PMA
      Capital Insurance Company
    
    
    40,803
    
    
    (84,413
    )
    
    (8,039
    )Caliber
      One Indemnity Company(1)
    
    
    -
    
    
    409
    
    
    (27,874
    )Total
    
    $
    59,803
    
    $
    (76,835
    )
    $
    (30,929
    )**SAP
      capital and surplus:**The
      PMA Insurance Group
    
    $
    300,034
    
    $
    296,777
    
    $
    305,533PMA
      Capital Insurance Company
    
    
    224,510
    
    
    500,617
    
    
    580,151Caliber
      One Indemnity Company(1)
    
    
    -
    
    
    -
    
    
    26,844Eliminations(2)
    
    
    -
    
    
    (296,777
    )
    
    (332,377
    )Total
    
    $
    524,544
    
    $
    500,617
    
    $
    580,151


*(1)*
    *In
      January 2003, the Company sold the capital stock of Caliber One Indemnity
      Company.*


*(2)*
    *The
      surplus of The PMA Insurance Group’s domestic insurance subsidiaries (for
      2003 and 2002) and Caliber One Indemnity Company (2002 only) are
      eliminated as they are included in the statutory surplus of PMA Capital
      Insurance Company, then the parent company of these insurance companies.
      In June 2004, The PMA Insurance Group was transferred from PMA Capital
      Insurance Company to PMA Capital
Corporation.*





The
Company’s statutory financial statements are presented on the basis of
accounting practices prescribed or permitted by the Pennsylvania Insurance
Department (for PMA Capital Insurance Company and The PMA Insurance Group) and
the Delaware Insurance Department (for Caliber One Indemnity Company).
Pennsylvania and Delaware have adopted Codification as the basis of their
statutory accounting practices. However, Pennsylvania has retained the
prescribed practice of non-tabular discounting of unpaid losses and LAE for
workers’ compensation, which was not permitted under Codification. This
prescribed accounting practice increased statutory capital and surplus by $101,000,
$435,000 and $13.0 million at December 31, 2004, 2003 and 2002, respectively,
over what it would have been had the prescribed practice not been allowed.





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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM**





Board of
Directors and Shareholders


PMA
Capital Corporation





We have
audited the accompanying balance
sheets of PMA Capital Corporation and subsidiaries (the “Company”) as of
December 31, 2004 and 2003, and the related consolidated statements of
operations, cash flows, shareholders’ equity, and comprehensive income for the
years then ended. These consolidated financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits. The consolidated
financial statements of the Company for the year ended December 31, 2002 were
audited by other auditors whose report, dated February 5, 2003, expressed an
unqualified opinion on those statements.
 
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
 
 
 In our
opinion, such 2004 and 2003 consolidated financial statements present fairly, in
all material respects, the financial position of the Company as of December 31,
2004 and 2003, and the results of its operations and its cash flows for the
years then ended in conformity with accounting principles generally accepted in
the United States of America.
 
 
 We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Company’s internal
control over financial reporting as of December 31, 2004, based on the criteria
established in *Internal
Control—Integrated Framework* issued
by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 16, 2005 expressed an unqualified opinion on management’s
assessment of the effectiveness of the Company’s internal control over financial
reporting and an unqualified opinion on the effectiveness of the Company’s
internal control over financial reporting.





/s/
DELOITTE & TOUCHE LLP


Philadelphia,
PA


March 16,
2005







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**REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 Board of
Directors and Shareholders
 PMA
Capital Corporation
 
 We have
audited management’s assessment, included in the accompanying Management’s
Report on Internal Control over Financial Reporting, that PMA
Capital Corporation and subsidiaries (the “Company”) maintained effective
internal control over financial reporting as of December 31, 2004, based on
criteria established in *Internal
Control—Integrated Framework* issued
by the Committee of Sponsoring Organizations of the Treadway Commission. The
Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management’s assessment and an opinion on the effectiveness of the Company’s
internal control over financial reporting based on our audit.
 
 We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinions.
 
 
 A
company’s internal control over financial reporting is a process designed by, or
under the supervision of, the company’s principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company’s board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
 
 
 Because
of the inherent limitations of internal control over financial reporting,
including the possibility of collusion or improper management override of
controls, material misstatements due to error or fraud may not be prevented or
detected on a timely basis. Also, projections of any evaluation of the
effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
 
 
 In our
opinion, management’s assessment that the Company maintained effective internal
control over financial reporting as of December 31, 2004, is fairly stated, in
all
 material
respects, based on the criteria established in *Internal
Control—Integrated Framework* issued
by the Committee of Sponsoring Organizations of the Treadway Commission. Also in
our opinion, the Company maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2004, based on the
criteria established in *Internal
Control—Integrated Framework* issued
by the Committee of Sponsoring Organizations of the Treadway
Commission.
 
 
 We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements and
financial statement schedules as of and for the year ended December 31, 2004 of
the Company and our report dated March 16, 2005, expressed an unqualified
opinion on those financial statements and financial statement
schedules.
 
 
 
 /s/
DELOITTE & TOUCHE LLP
 Philadelphia,
PA
 March 16,
2005





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**Report
of Independent Registered Public Accounting Firm**


To the
Board of Directors and Shareholders


of PMA
Capital Corporation:
 
 In our
opinion, the accompanying consolidated statements of operations, of cash flows,
of shareholders’ equity and of comprehensive income (loss) for the year ended
December 31, 2002 (appearing on pages 63 through 66 of the 2004 PMA Capital
Corporation Annual Report to Shareholders included in this Form 10-K) present
fairly, in all material respects, the results of operations and cash flows of
PMA Capital Corporation and its subsidiaries for the year ended December 31,
2002 in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our
audits of these statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
 
 /s/
Pricewaterhouse Coopers LLP
 Philadelphia,
PA
 February
5, 2003


95
 Table of Contents





*QUARTERLY
      FINANCIAL INFORMATION*(unaudited)*First
    
    
    
    
    
    Second
    
    
    
    
    
    Third
    
    
    
    
    
    Fourth*(dollar
      amounts in thousands, except share data)*
    
    
    Quarter
    
    
    
    
    
    Quarter
    
    
    
    
    
    Quarter
    
    
    
    
    
    Quarter**2004****Income
      Statement Data:**Total
      revenues
    
    $
    237,365
    
    
    
    
    $
    140,083
    
    
    
    
    $
    125,468
    
    
    
    
    $
    105,048Income
      (loss) before income taxes
    
    
    18,793
    
    
    
    
    
    175
    
    
    
    
    
    (45
    )
    
    
    
    
    (14,978
    )Net
      income (loss)
    
    
    12,153
    
    
    
    
    
    64
    
    
    
    
    
    (74
    )
    
    
    
    
    (10,313
    )**Per
      Share Data:**Net
      income (loss) (Basic)
    
    $
    0.39
    
    
    
    
    $
    -
    
    
    
    
    $
    -
    
    
    
    
    $
    (0.33
    )Net
      income (loss) (Diluted)
    
    
    0.35
    
    
    
    
    
    -
    
    
    
    
    
    -
    
    
    
    
    
    (0.33
    )**2003****Income
      Statement Data:**Total
      revenues
    
    **$**
    303,070
    
    ****
    ****
    ****
    **$**
    312,619
    
    ****
    ****
    ****
    **$**
    316,188
    ****
    ****
    ****
    ****
    **$**
    369,370Income
      (loss) before income taxes
    
    
    16,599
    
    
    
    
    
    18,829
    
    
    
    
    
    (111,192
    )
    
    
    
    
    8,018Net
      income (loss)
    
    
    10,702
    
    
    
    
    
    12,167
    
    
    
    
    
    (96,406
    )
    (1)
    ****
    ****
    
    (20,032
    )
    **(1)**
    ****
    ******Per
      Share Data:**Net
      income (loss) (Basic)
    
    **$**
    0.34
    
    
    
    
    **$**
    0.39
    
    
    
    
    **$**
    (3.08
    )
    **(1)**
    ****
    ****
    **$**
    (0.64
    )
    **(1)**
    ****
    ****Net
      income (loss) (Diluted)
    
    
    0.31
    **(2)**
    
    ****
    ****
    
    0.35
    **(2)**
    
    ****
    ****
    
    (3.08
    )
    **(1)**
    ****
    ****
    
    (0.64
    )
    (**1)**
    ****
    *****





*(1)*
    *Includes
      $24 million, or $0.76 per basic and diluted share, for the third quarter,
      and $25 million, or $0.80 per basic and diluted share, for the fourth
      quarter, to record a valuation allowance on our deferred tax asset.*


*(2)*
    *Includes
      a reduction of $.03 and $.04 for the first and second quarters of 2003,
      respectively, from previously filed Forms 10-Q due to the December 2004
      adoption of EITF 04-8, “The Effect of Contingently Convertible Debt on
      Diluted Earnings Per Share,” which requires retroactive restatement of all
      periods presented. See Note 2-L to the Consolidated
      Financial Statements for additional
information.*























96
 Table of Contents





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





On April
2, 2003, our Audit Committee appointed Deloitte & Touche LLP as our
independent auditors for the year ended December 31, 2003 and dismissed our
independent auditors for the year ended December 31, 2002, Pricewaterhouse
Coopers LLP. The information required by Item 304 (a) of Regulation S-K
regarding our change in and disagreement with our prior independent auditors has
been previously reported in a Form 8-K dated April 2, 2003.





**Item
9A.****Controls
and Procedures**





Disclosure
Controls and Procedures





As of the
end of the period covered by this report on Form 10-K, we, under the supervision
and with the participation of our management, including Vincent T. Donnelly,
President and Chief Executive Officer, and William E. Hitselberger, Executive
Vice President and Chief Financial Officer, carried out an evaluation of the
effectiveness of our disclosure controls and procedures as defined in Rule
13a-15(e) of the Securities Exchange Act of 1934, as amended. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures are effective in timely alerting
them to material information relating to us (including our consolidated
subsidiaries) required to be disclosed in our periodic filings with the
Securities and Exchange Commission. During the period covered by this report,
there were no changes in our internal controls over financial reporting that
have materially affected, or are reasonably likely to materially affect, our
internal controls over financial reporting.





Management’s
Report on Internal Control over Financial Reporting





Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). Under the supervision and with the participation of management,
including the Company’s Chief Executive Officer and Chief Financial Officer, an
evaluation of the effectiveness of the Company’s internal control over financial
reporting was conducted based upon the framework in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (“COSO”). Based upon that evaluation, the Company’s
management concluded that the Company’s internal control over financial
reporting was effective as of December 31, 2004.





Management’s
assessment of the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2004 has been audited by Deloitte & Touche LLP,
an independent registered public accounting firm, as stated in their report
which is included herein.











97
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**PART III**





**Item
10.****Directors
and Executive Officers of the Registrant**





See “Executive Officers of the Registrant”
under Item 4 above. The information under the captions “The Board of Directors
and Corporate Governance,” “Nominees For Election,” “Directors Continuing in
Office” and “Committees of the Board - Audit Committee” and “Committees of the
Board - Nominating and Corporate Governance Committee” in our Proxy Statement
for the 2005 Annual Meeting of Shareholders (“Proxy Statement”) is incorporated
herein by reference, as is the information under the caption “Section 16(a)
Beneficial Ownership Reporting Compliance” in the Proxy Statement.





We have
had a Business Ethics and Practices Policy in place, which covers all officers
and employees, for some time. This policy expresses our commitment to
maintaining the highest legal and ethical standards in the conduct of our
business. In 2003, we enhanced our Business Ethics and Practices Policy by
adopting a Code of Ethics for the Chief Financial Officer and Senior Financial
Officers. In addition, in early 2004, our Board of Directors adopted a separate
Code of Ethics for Directors. Copies of our ethics policies can be found on our
website www.pmacapital.com.
Any amendment to or waiver from the provisions of the Code of Ethics for the
Chief Financial Officer and Senior Financial Officers will be disclosed on our
website www.pmacapital.com.





**Item
11.****Executive
Compensation**





The
information under the caption “Compensation of Executive Officers” and under the
caption “Director Compensation” in the Proxy Statement is incorporated herein by
reference.





**Item
12.****Security
Ownership of Certain Beneficial Owners and Management**





The
information under the caption “Beneficial Ownership of Class A Common Stock” in
the Proxy Statement is incorporated herein by reference.





*Securities
Authorized for Issuance Under Equity Compensation Plans*





The
following table provides information with respect to compensation plans under
which our equity securities are authorized for issuance as of December 31,
2004:





Plan
      Category
    Number
      of Securities to be issued upon exercise of outstanding options, warrants
      and rights
    Weighted-average
      exercise price of outstanding options, warrants and rights
    Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column
      (a))*(a)*
    *(b)*
    *(c)*Equity
      compensation plans approved by security holders
    2,757,205
    $12.09
    2,043,109(1)Equity
      compensation plans not approved by security holders
    0
    0
    0Total
    2,757,205
    $12.09
    2,043,109


*(1)*
    *These
      securities are issuable under our 2002 Equity Incentive Plan, which was
      approved by shareholders at the 2002 Annual Meeting of Shareholders. The
      Plan authorizes the grant of stock options, stock appreciation rights,
      restricted stock, bonus stock or stock in lieu of other obligations,
      dividend equivalent rights or other stock-based awards and performance
      awards.*





98
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**Item
13.****Certain
Relationships and Related Transactions**





The
information under the caption “Certain Transactions” in the Proxy Statement is
incorporated herein by reference.





**Item 14. Principal Accounting Fees and Services**





The
information under the caption “Ratification of the Appointment of the
Independent Auditors” in the Proxy Statement is incorporated herein by
reference.








99
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**PART IV**





**Item
15.****Exhibits
and Financial Statement Schedules**





***FINANCIAL
STATEMENTS AND SCHEDULES***





Page(a)
      (1)
    Index to Consolidated Financial
    StatementsConsolidated Balance Sheets at December 31,
      2004 and 2003
    62Consolidated Statements of Operations for
      the years ended December 31, 2004, 2003 and 2002
    63Consolidated Statements of Cash Flows for the years
      ended December 31, 2004, 2003 and 2002
    64Consolidated Statements of Shareholders’
      Equity for the years ended December 31, 2004, 2003 and
      2002
    65Consolidated Statements of
      Comprehensive Income (Loss) for the years ended December 31, 2004, 2003
      and 2002
    66Notes to Consolidated Financial
      Statements
    67Reports of Independent Registered Public
      Accountants
    93(a)
      (2)
    The Financial Statement Schedules are listed
      in the Index to Financial Statement Schedules on page
      FS-1.





All other
schedules specified by Article 7 of Regulation S-X are not required pursuant to
the related instructions or are inapplicable and, therefore, have been
omitted.





(a) (3)
    The Exhibits are listed in the Index
      to Exhibits beginning on page E-1.











100
 Table of Contents









**Signatures**




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








**PMA
      CAPITAL CORPORATION**Date:March
      16, 2005
    By:/s/ William E. HitselbergerWilliam
      E. HitselbergerExecutive
      Vice President andChief
      Financial Officer








Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities indicated on March 16 ,
2005.





Signature
    Title/s/
      William E. HitselbergerWilliam
      E. Hitselberger
    Executive
      Vice President and Chief Financial Officer(Principal
      Financial and Accounting Officer)/s/
      Vincent T. DonnellyVincent
      T. Donnelly
    President
      and Chief Executive Officer and a Director(Principal
      Executive Officer)Neal
      C. Schneider*
    Non-Executive
      Chairman of the Board and a DirectorPeter
      S. Burgess*
    DirectorJoseph
      H. Foster*
    DirectorThomas
      J. Gallen*
    DirectorAnne
      S. Genter*
    DirectorJames
      C. Hellauer*
    DirectorRichard
      Lutenski*
    DirectorJames
      F. Malone III*
    DirectorEdward
      H. Owlett*
    DirectorRoderic
      H. Ross*
    DirectorL.
      J. Rowell, Jr. *
    Director*
      By:/s/ William
      E. HitselbergerWilliam
      E. HitselbergerAttorney-in-Fact








101
 Table of Contents








**PMA
Capital Corporation**


**Index to Financial Statement
Schedules**





Schedule
      No.
    Description
    PageII
    Condensed Financial Information of
    FS-2Registrant as of December 31, 2004 and2003 and for the years ended December
      31,2004, 2003 and 2002III
    Supplementary Insurance Information for
      the
    FS-5years ended December 31, 2004, 2003 and
      2002IV
    Reinsurance for the years ended December
      31,
    FS-62004, 2003 and 2002V
    Valuation and Qualifying Accounts for
      the
    FS-7years ended December 31, 2004, 2003 and
      2002VI
    Supplemental Information
      Concerning
    FS-8Property and Casualty Insurance
      Operationsfor the years ended December 31, 2004,
      2003 and 2002Independent Auditors’ Reports on Financial
      Statement
    FS-9Schedules





Certain
financial statement schedules have been omitted because they are either not
applicable or the required financial information is contained in the Company’s
2004 Consolidated Financial Statements and notes thereto.





FS-1
 Table of Contents








**PMA Capital
  Corporation****Schedule
      II - Registrant Only Financial Statements****Balance
      Sheets*****(Parent
      Company Only)*****
    *December
31,**(dollar
      amounts in thousands)*
    
    
    **2004**
    
    
    **2003****Assets**Cash
    
    $
    434
    
    $
    500Short-term
      investments
    
    
    286
    
    
    14,481Investment
      in subsidiaries
    
    
    642,466
    
    
    659,149Related
      party receivables
    
    
    37,638
    
    
    6,312Deferred
      income taxes, net
    
    
    29,602
    
    
    21,989Other
      assets
    
    
    13,379
    
    
    9,380**Total
      assets**
    
    $
    723,805
    
    $
    711,811**Liabilities**Long-term
      debt
    
    $
    214,467
    
    $
    187,566Other
      liabilities
    
    
    63,887
    
    
    60,578Total
      liabilities
    
    
    278,354
    
    
    248,144**Shareholders'
      Equity**Class
      A Common stock, $5 par value(2004
      - 60,000,000 shares authorized; 34,217,945 shares issued and 31,676,851
      outstanding;2003
      - 60,000,000 shares authorized; 34,217,945 shares issued and 31,334,403
      outstanding)
    
    
    171,090
    
    
    171,090Additional
      paid-in capital
    
    
    109,331
    
    
    109,331Retained
      earnings
    
    
    213,313
    
    
    216,115Accumulated
      other comprehensive income (loss)
    
    
    (1,959
    )
    
    19,622Notes
      receivable from officers
    
    
    -
    
    
    (65
    )Treasury
      stock, at cost (2004 - 2,541,094 shares; 2003 - 2,883,542
      shares)
    
    
    (45,573
    )
    
    (52,426
    )Unearned
      restricted stock compensation
    
    
    (751
    )
    
    -Total
      shareholders' equity
    
    
    445,451
    
    
    463,667**Total
      liabilities and shareholders' equity**
    
    $
    723,805
    
    $
    711,811





























*These
financial statements should be read in conjunction with the Consolidated
Financial*


*Statements
and the notes thereto.*











FS-2
 Table of Contents











**PMA Capital Corporation**


**Schedule
II - Registrant Only Financial Statements**


**Statements of Operations**


**(Parent
Company Only)**





*******************Year
      Ended December 31,**(dollar
      amounts in thousands)*
    
    
    **2004**
    
    
    **2003**
    
    
    **2002****Revenues:**Net
      investment income (expense)
    
    $
    118
    
    $
    (31
    )
    $
    (18
    )Net
      realized investment loss
    
    
    (3,846
    )
    
    -
    
    
    -Other
      revenues
    
    
    6,680
    
    
    30
    
    
    8Total
      revenues
    
    
    2,952
    
    
    (1
    )
    
    (10
    )**Expenses:**General
      expenses
    
    
    9,893
    
    
    14,200
    
    
    8,819Interest
      expense
    
    
    12,579
    
    
    10,244
    
    
    4,090Loss
      on debt exchange
    
    
    5,973
    
    
    -
    
    
    -Total
      expenses
    
    
    28,445
    
    
    24,444
    
    
    12,909Loss
      before income taxes and equity in earnings(loss)
      of subsidiaries
    
    
    (25,493
    )
    
    (24,445
    )
    
    (12,919
    )Income
      tax expense (benefit)
    
    
    (11,094
    )
    
    23,676
    
    
    (32,548
    )Income
      (loss) before equity in earnings (loss)of
      subsidiaries
    
    
    (14,399
    )
    
    (48,121
    )
    
    19,629Equity
      in earnings (loss) of subsidiaries
    
    
    16,229
    
    
    (45,448
    )
    
    (67,653
    )**Net
      income (loss)**
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )




















*These
financial statements should be read in conjunction with the Consolidated
Financial*


*Statements
and the notes thereto.*





FS-3
 Table of Contents





**PMA Capital Corporation**


**Schedule
II - Registrant Only Financial Statements**


**Statements of Cash Flows**


**(Parent
Company Only)**


********************
    
    
    *Year
      ended December 31,**(dollar
      amounts in thousands)*
    
    
    **2004**
    
    
    **2003**
    
    
    **2002****Cash
      Flows From Operating Activities:**Net
      income (loss)
    
    $
    1,830
    
    $
    (93,569
    )
    $
    (48,024
    )Adjustments
      to reconcile net income (loss) to net cash flows providedby
      (used in) operating activities:Equity
      in (earnings) loss of subsidiaries
    
    
    (16,229
    )
    
    45,448
    
    
    67,653Dividends
      received from subsidiaries
    
    
    10,998
    
    
    24,000
    
    
    28,000Net
      tax sharing payments received from subsidiaries
    
    
    4,851
    
    
    5,637
    
    
    11,989Net
      realized investment losses
    
    
    3,846
    
    
    -
    
    
    -Loss
      on debt exchange
    
    
    5,973
    
    
    -
    
    
    -Deferred
      income tax expense (benefit)
    
    
    (7,143
    )
    
    25,138
    
    
    (16,954
    )Other,
      net
    
    
    (8,889
    )
    
    3,003
    
    
    (6,994
    )Net
      cash flows provided by (used in) operating activities
    
    
    (4,763
    )
    
    9,657
    
    
    35,670**Cash
      Flows From Investing Activities:**Net
      sales (purchases )of short-term investments
    
    
    14,195
    
    
    (14,481
    )
    
    -Cash
      contributions to subsidiaries
    
    
    -
    
    
    (500
    )
    
    (25,175
    )Proceeds
      from other assets sold
    
    
    7,729
    
    
    -
    
    
    -Net
      cash flows provided by (used in) investing activities
    
    
    21,924
    
    
    (14,981
    )
    
    (25,175
    )**Cash
      Flows From Financing Activities:**Dividends
      paid to shareholders
    
    
    -
    
    
    (9,870
    )
    
    (12,102
    )Issuance
      of long-term debt
    
    
    15,825
    
    
    100,000
    
    
    151,250Debt
      issue costs
    
    
    (600
    )
    
    (3,662
    )
    
    (3,009
    )Repayment
      of debt
    
    
    (1,185
    )
    
    (65,000
    )
    
    (62,500
    )Proceeds
      from exercise of stock options
    
    
    -
    
    
    2
    
    
    2,866Purchase
      of treasury stock
    
    
    -
    
    
    -
    
    
    (1,726
    )Net
      repayments of notes receivable from officers
    
    
    59
    
    
    -
    
    
    96Change
      in related party receivables and payables
    
    
    (31,326
    )
    
    (15,646
    )
    
    (85,371
    )Net
      cash flows provided by (used in) financing activities
    
    
    (17,227
    )
    
    5,824
    
    
    (10,496
    )Net
      increase (decrease) in cash
    
    
    (66
    )
    
    500
    
    
    (1
    )Cash
      - beginning of year
    
    
    500
    
    
    -
    
    
    1Cash
      - end of year
    
    $
    434
    
    $
    500
    
    $
    -**Supplementary
      cash flow information:**Income
      taxes paid (refunded)
    
    $
    (2,592
    )
    $
    2,600
    
    $
    (10,649
    )Interest
      paid
    
    $
    11,832
    
    $
    8,723
    
    $
    2,924
















*These
financial statements should be read in conjunction with the Consolidated
Financial*


*Statements
and the notes thereto.*





FS-4
 Table of Contents











**PMA Capital Corporation**


**Schedule
III**


**Supplementary
Insurance Information**





*************(dollar
      amounts in thousands)*
    
    
    Deferred
      acquisition costs
    
    
    Unpaid
      losses and loss adjustment expenses
    
    
    Unearned
      premiums
    
    
    Net
      premiums earned
    
    
    Net
      investment income(1)
    
    
    Losses
      and loss adjustment expenses
    
    
    Acquisition
      expenses
    
    
    Operating
      expenses
    
    
    Net
      premiums written**December
      31, 2004:**The
      PMA Insurance Group
    
    $
    30,984
    
    $
    1,226,781
    
    $
    156,484
    
    $
    442,343
    
    $
    30,984
    
    $
    331,181
    
    $
    86,078
    
    $
    56,911
    
    $
    377,795Run-off
      Operations
    
    
    442
    
    
    919,222
    
    
    2,005
    
    
    77,067
    
    
    24,655
    
    
    49,375
    
    
    29,147
    
    
    17,691
    
    
    (75,360
    )Corporate
      and Other (2)
    
    
    -
    
    
    (34,405
    )
    
    -
    
    
    (825
    )
    
    1,306
    
    
    -
    
    
    -
    
    
    10,310
    
    
    (825
    )Total
    
    $
    31,426
    
    $
    2,111,598
    
    $
    158,489
    
    $
    518,585
    
    $
    56,945
    
    $
    380,556
    
    $
    115,225
    
    $
    84,912
    
    $
    301,610**December
      31, 2003:**The
      PMA Insurance Group
    
    $
    38,635
    
    $
    1,259,737
    
    $
    227,262
    
    $
    570,032
    
    $
    32,907
    
    $
    442,502
    
    $
    90,575
    
    $
    65,173
    
    $
    603,593Run-off
      Operations
    
    
    45,340
    
    
    1,315,071
    
    
    176,446
    
    
    628,921
    
    
    34,362
    
    
    555,845
    
    
    165,871
    
    
    24,443
    
    
    589,449Corporate
      and Other (2)
    
    
    -
    
    
    (33,490
    )
    
    -
    
    
    (788
    )
    
    1,654
    
    
    -
    
    
    -
    
    
    14,056
    
    
    (788
    )Total
    
    $
    83,975
    
    $
    2,541,318
    
    $
    403,708
    
    $
    1,198,165
    
    $
    68,923
    
    $
    998,347
    
    $
    256,446
    
    $
    103,672
    
    $
    1,192,254**December
      31, 2002:**The
      PMA Insurance Group
    
    $
    32,266
    
    $
    1,192,069
    
    $
    189,799
    
    $
    410,266
    
    $
    35,613
    
    $
    307,734
    
    $
    71,874
    
    $
    48,032
    
    $
    452,276Run-off
      Operations
    
    
    56,956
    
    
    1,304,746
    
    
    215,580
    
    
    581,626
    
    
    49,751
    
    
    515,924
    
    
    145,110
    
    
    44,547
    
    
    653,602Corporate
      and Other (2)
    
    
    -
    
    
    (46,925
    )
    
    -
    
    
    (881
    )
    
    (483
    )
    
    -
    
    
    -
    
    
    10,229
    
    
    (881
    )Total
    
    $
    89,222
    
    $
    2,449,890
    
    $
    405,379
    
    $
    991,011
    
    $
    84,881
    
    $
    823,658
    
    $
    216,984
    
    $
    102,808
    
    $
    1,104,997




*(1)
Net investment income is based on each segment's invested
assets.*


*(2)
Corporate and Other includes unallocated investment income and expenses,
including debt service. Corporate and Other also inludes the effect of
elimiationg intercompany transactions.*






FS-5
 Table of Contents







**PMA Capital Corporation**


**Schedule
IV**


**Reinsurance**





*(dollar
      amounts in thousands)*
    
    
    **Direct
      amount**
    
    
    **Ceded
      to other companies**
    
    
    **Assumed
      from other companies**
    
    
    **Net
      amount**
    
    
    **Percentage
      of amount assumed to net****Year
      Ended December 31, 2004:**Property
      and liability insurance premiums
    
    $
    461,365
    
    $
    78,911
    
    $
    136,131
    
    $
    518,585
    
    
    26%**Year
      Ended December 31, 2003:**Property
      and liability insurance premiums
    
    $
    638,716
    
    $
    228,576
    
    $
    788,025
    
    $
    1,198,165
    
    
    66%**Year
      Ended December 31, 2002:**Property
      and liability insurance premiums
    
    $
    599,827
    
    $
    300,556
    
    $
    691,740
    
    $
    991,011
    
    
    70%














FS-6
 Table of Contents







**PMA Capital Corporation**


**Schedule
V**


**Valuation and Qualifying
Accounts**





*(dollar
      amounts in thousands)*Description
    
    
    Balance
      at beginning of period
    
    
    Charged
      (credited) to costs and expenses
    
    
    Deductions
      - write-offs of uncollectible accounts
    
    
    Balance
      at end of period**Year
      ended December 31, 2004:**Valuation
      allowance:Premiums
      receivable
    
    $
    7,972
    
    $
    (923
    )
    $
    -
    
    $
    7,049Reinsurance
      receivable
    
    
    6,769
    
    
    2,233
    
    
    -
    
    
    9,002Deferred
      income taxes, net
    
    
    49,000
    
    
    8,000
    
    
    -
    
    
    57,000**Year
      ended December 31, 2003:**Valuation
      allowance:Premiums
      receivable
    
    $
    9,528
    
    $
    (544
    )
    $
    (1,012
    )
    $
    7,972Reinsurance
      receivable
    
    
    5,483
    
    
    4,286
    
    
    (3,000
    )
    
    6,769Deferred
      income taxes, net
    
    
    -
    
    
    49,000
    
    
    -
    
    
    49,000**Year
      ended December 31, 2002:**Valuation
      allowance:Premiums
      receivable
    
    $
    12,583
    
    $
    245
    
    $
    (3,300
    )
    $
    9,528Reinsurance
      receivable
    
    
    4,562
    
    
    4,371
    
    
    (3,450
    )
    
    5,483Deferred
      income taxes, net
    
    
    -
    
    
    -
    
    
    -
    
    
    -





FS-7
 Table of Contents




**PMA Capital Corporation**


**Schedule
VI**


**Supplemental Information Concerning Property and
Casualty Insurance Operations**


Losses
      and loss adjustment expenses incurred related to(dollars
      in thousands)
    
    
    Deferred
      acquisition
    
    
    Unpaid
      losses and loss adjustment
    
    
    Discount
      on unpaid losses and loss adjustment
    
    
    Unearned
    
    
    Net
      premiums
    
    
    Net
      investment
    
    
    Current
    
    
    Prior
    
    
    Acquisition
    
    
    Paid
      losses and loss adjustment
    
    
    Net
      premiumsAffiliation
      with registrant
    
    
    costs
    
    
    expenses
    
    
    expenses(1)
    
    
    premiums
    
    
    earned
    
    
    income
    
    
    year
    
    
    years
      (2)
    
    
    expenses
    
    
    expenses
    
    
    writtenConsolidated
      property-casualtysubsidiaries:December
      31, 2004
    
    $
    31,426
    
    $
    2,111,598
    
    $
    60,787
    
    $
    158,489
    
    $
    518,585
    
    $
    56,945
    
    $
    406,828
    
    $
    (40,363
    )
    $
    115,225
    
    $
    728,011
    
    $
    301,610December
      31, 2003
    
    $
    83,975
    
    $
    2,541,318
    
    $
    67,012
    
    $
    403,708
    
    $
    1,198,165
    
    $
    68,923
    
    $
    768,114
    
    $
    218,774
    
    $
    256,446
    
    $
    836,383
    
    $
    1,192,254December
      31, 2002
    
    $
    89,222
    
    $
    2,449,890
    
    $
    97,849
    
    $
    405,379
    
    $
    991,011
    
    $
    84,881
    
    $
    655,395
    
    $
    159,748
    
    $
    216,984
    
    $
    732,469
    
    $
    1,104,997





*(1) -
Reserves discounted at approximately 5%.*


*(2) -
Exlcudes accretion of loss reserve discount of $14,091, $11,459 and $8,515 in
2004, 2003 and 2002, respectively.*








FS-8
 Table of Contents




**Report****of
Independent Registered Public Accounting Firm**
 ****
  Board of
Directors and Shareholders
 PMA
Capital Corporation
 
 We have
audited the consolidated financial statements of PMA Capital Corporation and
subsidiaries (the “Company”) as of December 31, 2004 and 2003, and for the years
then ended, management’s assessment of the effectiveness of the Company’s
internal control over financial reporting as of December 31, 2004, and the
effectiveness of the Company’s internal control over financial reporting as of
December 31, 2004, and have issued our reports thereon dated March 16,
2005; such reports are included elsewhere in this From 10-K. Our audits
also included the consolidated financial statement schedules of the Company
listed in Item 15. These consolidated financial statement schedules are the
responsibility of the Company’s management. Our responsibility is to express an
opinion based on our audits. In our opinion, such consolidated financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein. The financial statement schedules for the
years ended December 31, 2002 were audited by other auditors. Those auditors
expressed an opinion, in their report dated February 5, 2003, that such 2002
consolidated financial statement schedules, when considered in relation to the
2002 basic consolidated financial statements taken as a whole, presented fairly,
in all material respects, the information set forth therein.
 /s/
DELOITTE & TOUCHE LLP
 Philadelphia,
PA
 March 16,
2005











FS-9
 Table of Contents




**Report**  **of
Independent Registered Public Accounting Firm**
 **on**
 **Financial
Statement Schedules**
   To the
Board of Directors and Shareholders
 of PMA
Capital Corporation:
 
 Our audit
of the 2002 consolidated financial statements referred to in our report dated
February 5, 2003 appearing in the 2004 Annual Report to Shareholders of PMA
Capital Corporation (which report and consolidated financial statements are
included in this Annual Report on Form 10-K) also included an audit of the
2002 financial statement schedules listed in Item 15(a)(2) of this Form
10-K. In our opinion, these 2002 financial statement schedules present fairly,
in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.

**/s/
PricewaterhouseCoopers LLP**

Philadelphia,
PA
February
5, 2003


FS-10
 Table of Contents


**INDEX
TO EXHIBITS**
  Exhibit
      No.
    Description
      of Exhibit
    Method
      of Filing(3)
    
    Articles
      of Incorporation and Bylaws:3.1
    Restated
      Articles of Incorporation of the Company.
    Filed
      as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2003 and incorporated herein by
      reference.3.2
    Amended
      and Restated Bylaws of the Company.
    Filed
      as Exhibit 3.2 to the Company’s Annual Report on Form 10-K/A for the year
      ended December 31, 2003 and incorporated herein by
    reference.(4)
    
    Instruments
      defining the rights of security holders, including
      indentures*:4.1
    Rights
      Agreement, dated as of May 3, 2000, between the Company and The Bank of
      New York, as Rights Agent.
    Filed
      as Exhibit 1 to the Company's Registration Statement on Form 8-A dated May
      5, 2000 and incorporated herein by reference.4.2
    Senior
      Indenture, dated as of October 21, 2002, between the Company and State
      Street Bank and Trust Company, as Trustee.
    Filed
      as Exhibit 4.1 to the Company's Current Report on Form 8-K dated October
      16, 2002 and incorporated herein by reference.4.3
    First
      Supplemental Indenture, dated as of October 21, 2002, between the Company
      and State Street Bank and Trust Company (predecessor of U.S. Bank National
      Association), as Trustee.
    Filed
      as Exhibit 4.2 to the Company's Current Report on Form 8-K dated October
      16, 2002 and incorporated herein by reference.4.4
    Form
      of 4.25% Convertible Senior Debenture due September 30,
    2022.
    Filed
      as Exhibit 4.3 to the Company's Current Report on Form 8-K dated October
      16, 2002 and incorporated herein by reference.4.5
    Second
      Supplemental Indenture, dated as of June 5, 2003, between the Company and
      U.S. Bank National Association (successor to State Street Bank and Trust
      Company), as Trustee.
    Filed
      as Exhibit 4.3 to the Company's Current Report on Form 8-K dated May 29,
      2003 and incorporated herein by reference.4.6
    Form
      of 8.50% Monthly Income Senior Note due June 15, 2018.
    Filed
      as Exhibit 4.4 to the Company's Current Report on Form 8-K dated May 29,
      2003 and incorporated herein by reference.4.7
    Indenture,
      dated as of November 15, 2004, between the Company and U.S. Bank National
      Association, as Trustee.
    Filed
      herewith.4.8
    First
      Supplemental Indenture, dated as of November 15, 2004 between
      the Company and U.S. Bank National Association, as
      Trustee.
    Filed
      herewith.4.9
    Second
      Supplemental Indenture, dated as of November 15, 2004, between the Company
      and U.S. Bank National Association, as Trustee.
    Filed
      herewith.
   E-1
 Table of Contents
   4.10
    Forms
      of 6.50% Convertible Secured Senior Debentures due September 30,
      2022.
    Filed
      herewith (included in Exhibit 4.8 and 4.9).4.11
    Registration
      Rights Agreement, dated as of November 15, 2004, between the Company and
      Banc of America Securities, LLC.
    Filed
      herewith.
 (10)
    
    Material
      Contracts:Exhibits
      10.1 through 10.26 are management contracts or compensatory
      plans:10.1
    Description
      of 2001 stock appreciation rights.
    Filed
      as Exhibit 10 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2001 and incorporated herein by
      reference.10.2
    PMA
      Capital Corporation 401(k) Excess Plan (as Amended and Restated effective
      January 1, 2000).
    Filed
      as Exhibit 10.2 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.3
    PMA
      Capital Corporation Executive Deferred Compensation Plan (as Amended and
      Restated effective January 1, 2000).
    Filed
      as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.4
    PMA
      Capital Corporation Supplemental Executive Retirement Plan (as Amended and
      Restated effective January 1, 2000).
    Filed
      as Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.5
    PMA
      Capital Corporation Executive Management Pension Plan (as Amended and
      Restated effective January 1, 2000).
    Filed
      as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.6
    Amended
      and Restated Employment Agreement, dated May 1, 1999, between PMA Capital
      Corporation and Frederick W. Anton III.
    Filed
      herewith.10.7
    Employment
      Agreement by and between the Company and William E.
      Hitselberger.
    Filed
      as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2004 and incorporated herein by
      reference.
   E-2
 Table of Contents
   10.8
    Employment
      Agreement by and between the Company and Robert L.
Pratter.
    Filed
      as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2004 and incorporated herein by
      reference.
 10.9
    Employment
      Agreement by and between the Company and Vincent T.
    Donnelly.
    Filed
      as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended March 31, 2004 and incorporated herein by
      reference.10.10
    Employment
      Agreement dated May 1, 1995 between the Company and John. W.
      Smithson.
    Filed
      as Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.11
    Amended
      and Restated Deferred Compensation Plan for Non-Employee Directors of the
      Company.
    Filed
      as Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2000 and incorporated herein by
    reference.10.12
    Company's
      Annual Incentive Plan.
    Filed
      as Annex C to the Company's Definitive Proxy Statement on Schedule 14A
      dated March 23, 2000 and incorporated herein by
  reference.10.13
    Company's
      Amended and Restated 1991 Equity Incentive Plan.
    Filed
      as Exhibit 10.13 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.14
    Amendment
      No. 1 to the Amended and Restated 1991 Equity Incentive Plan dated May 5,
      1999.
    Filed
      herewith.10.15
    Company's
      Amended and Restated 1993 Equity Incentive Plan.
    Filed
      as Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.16
    Amendment
      No. 1 to the Amended and Restated 1993 Equity Incentive Plan dated May 5,
      1999.
    Filed
      herewith.10.17
    Company's
      Amended and Restated 1994 Equity Incentive Plan.
    Filed
      as Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.
 10.18
    Amendment
      No. 1 to the Amended and Restated 1994 Equity Incentive Plan dated May 5,
      1999.
    Filed
      herewith.10.19
    Company's
      1995 Equity Incentive Plan.
    Filed
      as Exhibit 10.19 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.
   E-3
 Table of Contents
  10.20
    Amendment
      No. 1 to the 1995 Equity Incentive Plan dated May 5, 1999.
    Filed
      herewith.10.21
    Company's
      1996 Equity Incentive Plan.
    Filed
      as Exhibit 10.21 to the Company's Annual Report on Form 10-K for the year
      ended December 31, 2002 and incorporated herein by
    reference.10.22
    Amendment
      No. 1 to the 1996 Equity Incentive Plan dated May 5, 1999.
    Filed
      herewith.10.23
    Company's
      1999 Equity Incentive Plan.
    Filed
      herewith.10.24
    Company's
      2002 Equity Incentive Plan.
    Filed
      as Appendix A to the Company's Proxy Statement on Schedule 14A dated March
      22, 2002 and incorporated herein by reference.10.25
    Amendment
      No. 1 to Company's 2002 Equity Incentive Plan.
    Filed
      as Exhibit 10.25 to the Company’s Annual Report on Form 10-K/A for the
      year ended December 31, 2003 and incorporated herein by
      reference.10.26
    PMA
      Capital Corporation Directors Stock Compensation Plan, effective May 12,
      2004.
    Filed
      as Appendix A of the Company's Proxy Statement on Schedule 14A dated April
      9, 2004 and incorporated herein by
reference.
 10.27
    Transfer
      and Purchase Agreement dated December 2, 2003, between PMACIC and Imagine
      Insurance Company Limited, a wholly-owned subsidiary of Imagine Group
      Holdings Limited.
    Filed
      as Exhibit 10.33 to the Company's Annual Report on Form 10-K/A for the
      year ended December 31, 2003 and incorporated herein by
      reference.10.28
    Office
      Lease by and between Nine Penn Center Associates, L.P., as Landlord, and
      Lorjo Corp, as Tenant, covering the premises located at Mellon Bank, 1735
      Market St, Philadelphia, dated May 26, 1994.
    Filed
      as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2003 and incorporated herein by
      reference.10.29
    First
      Amendment of Office Lease by and between Nine Penn Center Associates,
      L.P., as Landlord and Lorjo Corp., as Tenant, covering premises located at
      Mellon Bank Center, 1735 Market Street, Philadelphia, Pennsylvania, made
      as of October 30, 1996.
    Filed
      as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2003 and incorporated herein by
      reference.10.30
    Second
      Amendment of Office Lease by and between Nine Penn Center Associates,
      L.P., as Landlord and Lorjo Corp., as Tenant, covering premises located at
      Mellon Bank Center, 1735 Market Street, Philadelphia, Pennsylvania, made
      as of December 11, 1998.
    Filed
      as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2003 and incorporated herein by
      reference.
  
   E-4
 Table of Contents
   
  10.31
    Third
      Amendment of Office Lease by and between Nine Penn Center Associates,
      L.P., as Landlord and PMA Capital Insurance Company, as Tenant, covering
      premises located at Mellon Bank Center, 1735 Market Street, Philadelphia,
      Pennsylvania, retroactively as of May 16, 2001.
    Filed
      as Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2003 and incorporated herein by
      reference.10.32
    Fourth
      Amendment of Office Lease by and between Nine Penn Center Associates,
      L.P., as Landlord and PMA Capital Insurance Company, as Tenant, covering
      premises located at Mellon Bank Center, 1735 Market Street, Philadelphia,
      Pennsylvania, made and entered into effective as of July 2,
      2003.
    Filed
      as Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended September 30, 2003 and incorporated herein by
      reference.10.33
    Fifth
      Amendment of Office Lease by and between Nine Penn Center Associates,
      L.P., as Landlord, and PMA Capital Insurance Company, as Tenant, covering
      the premises located at Mellon Bank, 1735 Market Street, Philadelphia,
      made and entered into effective as of April 30, 2004.
    Filed
      as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2004 and incorporated herein by
      reference.10.34
    Sixth
      Amendment of Office Lease by and between Nine Penn Center Associates,
      L.P., as Landlord, and PMA Capital Insurance Company, as Tenant, covering
      the premises located at Mellon Bank, 1735 Market Street, Philadelphia,
      made and entered into effective as of June 14, 2004.
    Filed
      as Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2004 and incorporated herein by
      reference.10.35
    Purchase
      Agreement, dated as of November 10, 2004 between the Company and Banc of
      America Securities, LLC.
    Filed
      herewith.(12)
    
    Computation
      of Ratio of Earnings to Fixed Charges.
    Filed
      herewith.(21)
    
    Subsidiaries
      of the Company.
    Filed
      herewith.(24)
    
    Power
      of Attorney:24.1
    Powers
      of Attorney.
    Filed
      herewith.24.2
    Certified
      Resolutions.
    Filed
      herewith.(31)
    
    Rule
      13a-14(a) Certifications:31.1
    Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities
      Exchange Act of 1934
    Filed
      herewith.31.2
    Certification
      of CFO pursuant to Rule 13a-14(a) of the Securities Exchange Act of
      1934
    Filed
      herewith.
 (32)
    
    Section
      1350 Certifications:32.1
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.
    Filed
      herewith.32.2
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002.
    Filed
      herewith.
   E-5
 Table of Contents
   (99)
    
    Additional
      Exhibits:99.1
    Letter
      Agreement, dated 12/22/03, between PMA Capital Insurance Company and the
      Pennsylvania Department of Insurance.
    Filed
      as Exhibit 99 to the Company's Current Report on Form 8-K dated December
      22, 2003 and incorporated herein by
reference.
  * The
registrant will furnish to the Commission, upon request, a copy of any of the
registrant’s agreements with respect to its long-term debt not otherwise filed
with the Commission.
  Shareholders
may obtain copies of exhibits by writing to the Company at PMA Capital
Corporation, 380 Sentry Parkway, Blue Bell, PA. 19422, Attn: Secretary
  E-6