| | P M A  C A P I T A L
| | --------------------

Selected Financial Data

|(dollar amounts in thousands, except per share data)         | 2002(1) |  | 2001(1) |            | 2000(1) |   | 1999       |  | 1998 |           
|------------------------------------------------------------ | ------- |  | ------- | ---------- | ------- | - | ---------- |  | ---- | ----------
|                                                            
|                                                             |         |  |         |            |         |   |            |  |      |           
|                                                            
|Net premiums written                                         |         |  | $       | 1,104,997  |         | $ | 769,058    |  | $    | 545,555   
|                                                             |        
|Consolidated Results of Operations:                          |         | 
|Net premiums earned                                          |         |  | $       | 991,011    |         | $ | 732,440    |  | $    | 531,424   
|Net investment income                                        |         |  |         | 84,881     |         |   | 86,945     |  |      | 102,591   
|Net realized investment gains (losses)                       |         |  |         | (16,085    | )       |   | 7,988      |  |      | 11,975    
|Other revenues                                               |         |  |         | 15,330     |         |   | 22,599     |  |      | 14,000    
|                                                             |        
|Total consolidated revenues                                  |         |  | $       | 1,075,137  |         | $ | 849,972    |  | $    | 659,990   
|                                                             |        
|Income (loss) before cumulative effect of accounting change  |         |  | $       | (48,024    | )       | $ | 7,103      |  | $    | 1,325     
|Cumulative effect of accounting change,                      |         | 
|net of related tax effect(2)                                 |         |  |         | --         |         |   | --         |  |      | --        
|                                                             |        
|Net income (loss)                                            |         |  | $       | (48,024    | )       | $ | 7,103      |  | $    | 1,325     
|                                                             |        
|Per Share Data:                                              |         | 
|Weighted average shares:                                     |         | 
|Basic                                                        |         |  |         | 31,284,848 |         |   | 21,831,725 |  |      | 21,898,967
|Diluted                                                      |         |  |         | 31,284,848 |         |   | 22,216,695 |  |      | 22,353,622
|Income (loss) before cumulative effect of accounting change: |         | 
|Basic                                                        |         |  | $       | (1.53      | )       | $ | 0.33       |  | $    | 0.06      
|Diluted                                                      |         |  |         | (1.53      | )       |   | 0.32       |  |      | 0.06      
|Net income (loss) per share:                                 |         | 
|Basic                                                        |         |  |         | (1.53      | )       |   | 0.33       |  |      | 0.06      
|Diluted                                                      |         |  |         | (1.53      | )       |   | 0.32       |  |      | 0.06      
|Dividends paid per Common share(3)                           |         |  |         | --         |         |   | --         |  |      | 0.16      
|Dividends paid per Class A Common share(3)                   |         |  |         | 0.42       |         |   | 0.42       |  |      | 0.375     
|Shareholders' equity per share                               |         |  |         | 18.56      |         |   | 19.64      |  |      | 20.40     
|                                                             |        
|Consolidated Financial Position:                             |         | 
|Total investments                                            |         |  | $       | 1,828,610  |         | $ | 1,775,335  |  | $    | 1,826,949 
|Total assets                                                 |         |  |         | 4,105,794  |         |   | 3,802,979  |  |      | 3,469,406 
|Reserves for unpaid losses and LAE                           |         |  |         | 2,449,890  |         |   | 2,324,439  |  |      | 2,053,138 
|Debt                                                         |         |  |         | 151,250    |         |   | 62,500     |  |      | 163,000   
|Shareholders' equity                                         |         |  |         | 581,390    |         |   | 612,006    |  |      | 440,046   

|(1) |  | Operating
results in 2002, 2001 and 2000 were impacted by approximately $90 million pre-tax ($59
million after-tax), $52 million pre-tax ($34 million after-tax) and $60 million pre-tax
($39 million after-tax), respectively, of reserve strengthening. Operating results for
2002 were also 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. In addition, operating results for 2001 were impacted by $30 million pre-tax
($20 million after-tax) for World Trade Center losses.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | In
1999, the Company adopted SOP 97-3, Accounting by Insurance and Other Enterprises
for Insurance-Related Assessments.As a result of adopting SOP 97-3, the Company
recorded a liability of $4.3 million pre-tax and a resulting charge to earnings of $2.8
million, net of tax effect.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) |  | 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.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

22

---

| | P M A  C A P I T A L
| | --------------------

|(dollar amounts in thousands, except per share data) | 2002(1) |  | 2001(1) |         | 2000(1) |   | 1999    |   | 1998 |        
|---------------------------------------------------- | ------- |  | ------- | ------- | ------- | - | ------- | - | ---- | -------
|                                                    
|                                                    
|Pre-tax operating income (loss)(4):                  |         |  |         |         |         |   |         |   |      |        
|PMA Re                                               |         |  | $       | 13,422  |         | $ | (3,062  | ) | $    | (7,297 
|The PMA Insurance Group                              |         |  |         | 25,346  |         |   | 23,148  |   |      | 21,601 
|Corporate and Other                                  |         |  |         | (14,339 | )       |   | (6,322  | ) |      | (19,142
|                                                     |        
|Ongoing Operations                                   |         |  |         | 24,429  |         |   | 13,764  |   |      | (4,838 
|Run-off Operations(5)                                |         |  |         | (87,501 | )       |   | (26,168 | ) |      | (7,014 
|                                                     |        
|Pre-tax operating income (loss)                      |         |  |         | (63,072 | )       |   | (12,404 | ) |      | (11,852
|Net realized investment gains (losses)               |         |  |         | (16,085 | )       |   | 7,988   |   |      | 11,975 
|                                                     |        
|Income (loss) before income taxes and                |         | 
|cumulative effect of accounting change               |         |  |         | (79,157 | )       |   | (4,416  | ) |      | 123    
|Income tax expense (benefit)                         |         |  |         | (31,133 | )       |   | (11,519 | ) |      | (1,202 
|                                                     |        
|Income (loss) before extraordinary loss and          |         | 
|cumulative effect of accounting change               |         |  |         | (48,024 | )       |   | 7,103   |   |      | 1,325  
|Cumulative effect of accounting change,              |         | 
|net of related tax effect(3)                         |         |  |         | -       |         |   | -       |   |      | -      
|                                                     |        
|Net income (loss)                                    |         |  | $       | (48,024 | )       | $ | 7,103   |   | $    | 1,325  
|                                                     |        
|GAAP Ratios for Ongoing Insurance Segments:          |         | 
|PMA Re:                                              |         | 
|Loss and LAE ratio                                   |         |  |         | 79.6    | %       |   | 87.4    | % |      | 91.6   
|Expense ratio                                        |         |  |         | 26.8    | %       |   | 26.8    | % |      | 31.7   
|                                                     |        
|Combined ratio(6)                                    |         |  |         | 106.4   | %       |   | 114.2   | % |      | 123.3  
|                                                     |        
|Operating ratio(7)                                   |         |  |         | 97.6    | %       |   | 100.9   | % |      | 102.9  
|                                                     |        
|The PMA Insurance Group:                             |         | 
|Loss and LAE ratio                                   |         |  |         | 75.0    | %       |   | 74.7    | % |      | 74.9   
|Expense ratio(8)                                     |         |  |         | 26.4    | %       |   | 26.7    | % |      | 29.3   
|Policyholders dividend ratio                        |         |  |         | 1.8     | %       |   | 4.1     | % |      | 7.5    
|                                                     |        
|Combined ratio(6)                                    |         |  |         | 103.2   | %       |   | 105.5   | % |      | 111.7  
|                                                     |        
|Operating ratio(7)                                   |         |  |         | 94.5    | %       |   | 94.1    | % |      | 92.7   
|                                                     |        

|(4) |  | Pre-tax
operating income (loss) excludes net realized investment gains (losses). Pre-tax
operating income by business segment for all periods is unaudited and has been presented
in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and
Related Information,which the Company adopted on January 1, 1998. See Managements
Discussion and Analysis of Financial Condition and Results of Operations and Note 15
to the Company's Consolidated Financial Statements. The Company excludes net realized
investment gains (losses) from the profit and loss measure it utilizes to assess the
performance of its operating segments because (i) net realized investment gains (losses)
are unpredictable and not necessarily indicative of current operating fundamentals or
future performance 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
(losses) that do not relate to the operations of the individual segments.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) |  | In
May 2002, we exited the excess and surplus lines business and placed this business,
formerly known as Caliber One, into run-off.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------

|(6) |  | The
combined ratio computed on a GAAP basis is equal to losses and loss adjustment expenses
plus acquisition expenses, operating 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 earned premiums.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) |  | The
GAAP operating expense ratios exclude $11.3 million, $8.8 million, $7.0 million, $7.9
million and $9.0 million for the years ended December 31, 2002, 2001, 2000, 1999 and
1998, respectively, of PMA Management Corp. direct expenses related to service revenues,
which are not included in premiums earned.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|23
|--

---

| | P M A  C A P I T A L
| | --------------------

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, 2002, compared with
December 31, 2001, and the results of operations of PMA Capital for 2002 and 2001,
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 on pages 49 to 72 in this Annual Report.
You should also read our discussion of Critical Accounting Estimates beginning on page 45
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 judgements.

This
Managements Discussion and Analysis of Financial Condition and Results of Operations
("MD&A") contains forward-looking statements, including those made in
the Business Outlook section, which involve inherent risks and uncertainties. Statements
that are not historical facts, including statements about our beliefs and expectations,
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 the Cautionary Statements on page 48 for a list of factors that could cause our
actual results to differ materially from those contained in any forward-looking statement.
Also, see the Business  Risk Factors in our Form 10-K for the year ended December 31, 2002
("2002 Form 10-K") for a further discussion of risks that could materially
affect our business.

Consolidated Results

In this MD&A, in addition to
providing net income (loss), we also provide 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) differs from net income (loss) under generally accepted accounting
principles ("GAAP") and does not replace net income (loss) as the GAAP
measure of our results of operations. In arriving at operating income (loss), we start
with GAAP net income (loss) and exclude net realized investment gains and losses because
(i) net realized investment gains and losses are unpredictable and not necessarily
indicative of current operating fundamentals or future performance of our insurance and
reinsurance 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.

The major components of revenues, pre-tax
operating income (loss) and net income (loss) are as follows:

|(dollar amounts in thousands)                                        | 2002 |  | 2001 |           | 2000 |  
|-------------------------------------------------------------------- | ---- |  | ---- | --------- | ---- | -
|                                                                    
|                                                                    
|                                                                     |      |  |      |           |      |  
|Revenues:                                                            |      | 
|Net premiums written                                                 |      |  | $    | 1,104,997 |      | $
|                                                                     |     
|Net premiums earned                                                  |      |  | $    | 991,011   |      | $
|Net investment income                                                |      |  |      | 84,881    |      |  
|Net realized investment gains (losses)                               |      |  |      | (16,085   | )    |  
|Other revenues                                                       |      |  |      | 15,330    |      |  
|                                                                     |     
|Total revenues                                                       |      |  | $    | 1,075,137 |      | $
|                                                                     |     
|Components of pre-tax operating income (loss) and net income (loss): |      | 
|PMA Re                                                               |      |  | $    | 13,422    |      | $
|The PMA Insurance Group                                              |      |  |      | 25,346    |      |  
|Corporate and Other                                                  |      |  |      | (14,339   | )    |  
|                                                                     |     
|Pre-tax operating income (loss)-- Ongoing Operations                 |      |  |      | 24,429    |      |  
|Run-off Operations(1)                                                |      |  |      | (87,501   | )    |  
|                                                                     |     
|Pre-tax operating loss                                               |      |  |      | (63,072   | )    |  
|Net realized investment gains (losses)                               |      |  |      | (16,085   | )    |  
|                                                                     |     
|Income (loss) before income taxes                                    |      |  |      | (79,157   | )    |  
|Income tax benefit                                                   |      |  |      | (31,133   | )    |  
|                                                                     |     
|Net income (loss)                                                    |      |  | $    | (48,024   | )    | $
|                                                                     |     

|(1) |  | In
May 2002, we announced our decision to withdraw from the excess and           surplus
lines marketplace. As a result of this decision, the results of           this segment,
formerly known as Caliber One, are reported as Run-off Operations.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

24

---

| | P M A  C A P I T A L
| | --------------------

We
recorded a net loss of $48.0 million in 2002, compared to net income of $7.1 million and
$1.3 million in 2001 and 2000. Included in net income (loss) are after-tax net realized
investment losses of $10.5 million in 2002, compared to after-tax net realized investment
gains of $5.2 million and $7.8 million for 2001 and 2000. After-tax net realized
investment losses for 2002 include impairment losses of $15.4 million ($23.8 million
pre-tax) on fixed income securities, primarily corporate bonds issued by
telecommunications and energy companies. Net realized investment gains for 2001 reflect
the sale of securities because of our decision to shift the mix of our invested asset
portfolio from U.S. Treasury and agency securities to corporate bonds and structured
securities as a means to enhance our portfolios yield. As a result of investment
sales pursuant to this strategy and the declining interest rates in 2001, we recorded net
realized investment gains in 2001. During 2000, realized investment gains resulted
primarily from the sale of equity securities, which had reached our targeted price level.

Also
included in net income for 2001 are a $6.3 million after-tax gain ($9.8 million pre-tax
included in Other revenues) on the sale of certain real estate properties and a tax
benefit of $10.1 million resulting from the completion of an IRS examination of our 1996
tax return.

Following
is a reconciliation of our operating results as discussed below to GAAP pre-tax income
(loss) and net income (loss):

|                                               |  | 2002    |   | 2001      |   | 2000    |        
|---------------------------------------------- |  | ------- | - | --------- | - | ------- | -------
|                                               | 
|(dollar amounts in thousands)                  |  | Pre-tax |   | After-tax |   | Pre-tax |        
|                                              
|Operating income (loss) for Ongoing Operations |  |         | $ | 24,429    |   | $       | 19,299 
|Operating loss for Run-off Operations          |  |         |   | (87,501   | ) |         | (56,868
|Gain on sale of real estate                    |  |         |   | --        |   |         | --     
|Tax benefit                                    |  |         |   | --        |   |         | --     
|                                               | 
|Operating income (loss)                        |  |         |   | (63,072   | ) |         | (37,569
|Net realized investment gains (losses)         |  |         |   | (16,085   | ) |         | (10,455
|                                               | 
|Income (loss)                                  |  |         | $ | (79,157   | ) | $       | (48,024
|                                               | 

Pre-tax operating income for the Ongoing
Operations was $24.4 million in 2002, compared to pre-tax operating income of $4.0 million
in 2001 and a pre-tax operating loss of $4.8 million in 2000. The improvement in pre-tax
operating results in 2002 reflects improved underwriting results at both PMA Re and The
PMA Insurance Group. Partially offsetting the improved underwriting results is a pre-tax
net charge of approximately $45 million ($26 million after-tax) recognized in the fourth
quarter, primarily reflecting higher than expected losses and LAE at PMA Re of $50 million pre-tax.
Results for 2001 include a charge of approximately $30 million pre-tax ($20 million
after-tax) relating to losses resulting from the attack on the World Trade Center.
Operating results for 2000 include a charge of approximately $60 million pre-tax
(approximately $40 million after-tax) for higher than expected losses and LAE at PMA Re.

After-tax
operating income for the Ongoing Operations was $19.3 million in 2002, compared to
after-tax operating income of $6.0 million in 2001 and an after-tax operating loss of $1.8
million in 2000.

Operating
results for the Run-off Operations for 2002 reflect unfavorable prior year loss
development of approximately $52 million pre-tax ($34 million after-tax) and a charge of $43
million pre-tax ($28 million after-tax) associated with our decision to exit from and run
off our excess and surplus lines business, partially offset by better than expected
underwriting results for the current accident year. Operating results for the Run-off
Operations for 2001 and 2000 reflect net unfavorable prior year development of $22 million
pre-tax ($14 million after-tax) and $3 million pre-tax ($2 million after-tax),
respectively.

Consolidated
revenues were $1,075.1 million, $850.0 million and $660.0 million in 2002, 2001 and 2000.
The increase in revenues in 2002, compared to 2001, primarily reflects higher net premiums
earned by PMA Re and The PMA Insurance Group mainly due to price increases across all
lines of business. The increase in revenues in 2001, compared to 2000, primarily reflects
higher net premiums earned, partially offset by lower net investment income.

|25
|--

---

| | P M A  C A P I T A L
| | --------------------

Management's Discussion and Analysis
(continued)

Impact on 2001 Results from the
September 11th Terrorist Attack on the World Trade Center

Results for our Ongoing Operations in
2001 were adversely impacted by approximately $30 million pre-tax ($20 million after-tax)
as a result of losses incurred at PMA Re from the September 11th terrorist attack on the
World Trade Center. The 2001 charge of approximately $30 million pre-tax consisted of
total assumed losses of approximately $135 million, which is before (1) reinsurance
recoveries ($110 million), (2) additional premiums due to PMA Res retrocessionaires
($30 million) and (3) additional premiums due to PMA Re on its assumed business ($25
million). Results for the Run-off Operations for 2001 include approximately $1 million of
net property losses related to the September 11th terrorist attack on the World Trade
Center, net of $9 million of ceded losses. Our estimate of the net loss from the terrorist
attack on the World Trade Center continues to be approximately $30 million pre-tax and is
based on our analysis to date of known exposures. However, it is difficult to fully
estimate our loss from the attack given the uncertain nature of damage theories and loss
amounts, and the development of additional facts related to the attack. As more
information becomes available, our estimate may need to be increased.

Business Outlook

Our current expectation is that
throughout 2003 premium rates will remain adequate, which will enable PMA Re and The PMA
Insurance Group to achieve premium growth of 10-15%. Premium growth may accelerate beyond
our current forecasts if rates move higher than we are expecting. However, if rates do not
maintain adequate levels during 2003, then we would constrain our premium writings.

Overall,
we expect underwriting results to improve in 2003 due to expected price strengthening that
we believe will continue to outpace loss cost and expense trends. Accordingly, embedded
underwriting margins should remain strong in 2003. We would expect to see the 2003
combined ratio for PMA Re to be around 95%, which is several points below their long-term
goal of 100% and we expect the combined ratio for The PMA Insurance Group to be in line
with their long-term goal of 104%.

Based
on our current expectations, the estimated range of consolidated after-tax operating
earnings for 2003 is between $1.70 and $1.85 per diluted share. Our range of estimated
operating earnings per share for 2003 assumes that rate adequacy will continue to improve
as prices continue to increase in 2003. In addition, it assumes that loss trends run at a
similar pace as 2002 levels, excluding catastrophes, and that loss reserves for prior
accident years continue to be adequate. In addition, our 2003 earnings per share estimate
does not reflect any dilution from our 4.25% convertible senior debentures. If we were to
assume conversion of this debt, then our earnings per share figures would be lower by
about 10%.

We
are unable to provide a reasonable estimate of the range of GAAP net income per share for
2003 because this would require us to forecast net realized investment gains and losses,
which are included in GAAP net income but excluded from operating income. We are unable to
reasonably estimate future net realized investment gains and losses because they are
unpredictable and not necessarily indicative of our current operating fundamentals or our
future performance. In addition, in many instances, decisions to buy and sell securities
are made for reasons unrelated to our insurance and reinsurance businesses and are made at
the holding company level in part due to credit concerns or overall changes in the fixed
income markets.

The
statements made in this Business Outlook section are forward-looking. Our actual results
may differ materially from our current expectations as a result of the factors described
in the cautionary statements accompanying the forward-looking statements and other factors
described in the Cautionary Statements on page 48. Also, see the Business  Risk Factors
described in our 2002 Form 10-K.

Please
see our earnings release dated February 5, 2003, which is available on our website at
www.pmacapital.com for information regarding the status of this business outlook.

Recent Developments

On February 25, 2003, A.M. Best announced
that it was lowering the insurance financial strength rating of PMA Capital Insurance
Company from A ("Excellent"  3rd of 16) to A-
("Excellent"  4th of 16), with their outlook moved from negative to
stable. The current financial strength rating of A- ("Excellent"  4th
of 16) of the domestic insurance companies within The PMA Insurance Group was affirmed
with a stable outlook.

On
March 5, 2003, Moodys Investors Service ("Moodys") announced
that it lowered the senior debt rating of PMA Capital Corporation to Ba1
("Moderate"  11th of 21) from Baa3 ("Medium"  10th
of 21) and also lowered the insurance financial strength rating of PMA Capital Insurance
Company to Baa1 ("Adequate"  8th of 21) from A3 ("Good"
 7th of 21). In addition, Moodys affirmed the insurance financial strength
ratings of the members of The PMA Insurance Group at Baa1 ("Adequate" 
8th of 21). Moodys has a negative outlook on these ratings.

On
February 7, 2003, Standard & Poors Ratings Services announced that it was not
taking any ratings action in response to our fourth quarter 2002 results.

See the Ratings discussion in our 2002 Form 10-K for additional information.

26

---

| | P M A  C A P I T A L
| | --------------------

PMA Re

Summarized financial results of PMA Re are
as follows:

|(dollar amounts in thousands)      |  |  |   | 2002    |  |   | 2001    |   |   | 2000    |  
|---------------------------------- |  |  | - | ------- |  | - | ------- | - | - | ------- | -
|                                  
|Net premiums written               |  |  | $ | 639,039 |  | $ | 360,604 |   | $ | 261,505 |  
|                                   | 
|Net premiums earned                |  |  | $ | 551,513 |  | $ | 340,401 |   | $ | 251,109 |  
|Net investment income              |  |  |   | 48,736  |  |   | 45,361  |   |   | 51,125  |  
|                                   | 
|Operating revenues                 |  |  |   | 600,249 |  |   | 385,762 |   |   | 302,234 |  
|                                   | 
|Losses and LAE                     |  |  |   | 439,228 |  |   | 297,623 |   |   | 229,925 |  
|Acquisition and operating expenses |  |  |   | 147,599 |  |   | 91,201  |   |   | 79,606  |  
|                                   | 
|Total losses and expenses          |  |  |   | 586,827 |  |   | 388,824 |   |   | 309,531 |  
|                                   | 
|Pre-tax operating income (loss)    |  |  | $ | 13,422  |  | $ | (3,062  | ) | $ | (7,297  | )
|                                   | 
|Combined ratio                     |  |  |   | 106.4%  |  |   | 114.2%  |   |   | 123.3%  |  
|Less: net investment income ratio  |  |  |   | 8.8%    |  |   | 13.3%   |   |   | 20.4%   |  
|                                   | 
|Operating ratio                    |  |  |   | 97.6%   |  |   | 100.9%  |   |   | 102.9%  |  
|                                   | 

PMA Res pre-tax operating income
was $13.4 million in 2002, compared to pre-tax operating losses of $3.1 million in 2001
and $7.3 million in 2000. PMA Res 2002 operating results reflect improved
underwriting results, partially offset by a net charge of approximately $45 million
pre-tax. This charge primarily relates to strengthening of PMA Res loss reserve
position for prior accident years at year-end 2002 ($64 million) to reflect our most
current projection of the ultimate results for these underwriting years. PMA Res
2002 results benefitted from better than expected current accident year business ($14
million), mainly property reinsurance, and a net benefit of approximately $5 million
recognized in the fourth quarter primarily due to reductions in acquisition and operating
expenses, partially offset by costs associated with ceding certain of its prior year loss
development. Operating results for 2001 include a pre-tax charge of approximately $30
million relating to the effects of the losses caused by the attack on the World Trade
Center. Operating results for 2000 include a pre-tax charge of approximately $60 million
relating to the effects of higher than expected losses and LAE. For additional
information, see the discussion under Losses and Expenses on page 29 and the
discussion under Impact on 2001 Results from the September 11th Terrorist Attack on the
World Trade Center on page 26.

Premiums

PMA Res gross premiums written by
business unit and major lines of business are as follows:

|(dollar amounts in thousands)      |  |  |   | 2002    |  |   | 2001    |  |   | 2000    | 
|---------------------------------- |  |  | - | ------- |  | - | ------- |  | - | ------- | 
|                                  
|Business Unit:                     |  | 
|Traditional - Treaty               |  |  | $ | 382,955 |  | $ | 171,318 |  | $ | 224,226 | 
|Finite Risk and Financial Products |  |  |   | 252,413 |  |   | 244,527 |  |   | 109,062 | 
|Specialty - Treaty                 |  |  |   | 92,088  |  |   | 34,180  |  |   | 50,971  | 
|Facultative                        |  |  |   | 49,331  |  |   | 26,566  |  |   | 10,564  | 
|                                   | 
|Total                              |  |  | $ | 776,787 |  | $ | 476,591 |  | $ | 394,823 | 
|                                   | 
|Major Lines of Business:           |  | 
|Casualty                           |  |  | $ | 503,644 |  | $ | 266,672 |  | $ | 268,877 | 
|Property                           |  |  |   | 247,279 |  |   | 206,940 |  |   | 123,393 | 
|Other(1)                           |  |  |   | 25,864  |  |   | 2,979   |  |   | 2,553   | 
|                                   | 
|Total                              |  |  | $ | 776,787 |  | $ | 476,591 |  | $ | 394,823 | 
|                                   | 

|(1) |  | Primarily
aviation, ocean marine and accident in 2002.
|--- |  | ------------------------------------------------------

PMA Res net premiums written by
business unit and major lines of business are as follows:

|(dollar amounts in thousands)      |  |  |   | 2002    |  |   | 2001    |  |   | 2000    | 
|---------------------------------- |  |  | - | ------- |  | - | ------- |  | - | ------- | 
|                                  
|Business Unit:                     |  | 
|Traditional - Treaty               |  |  | $ | 314,172 |  | $ | 115,814 |  | $ | 134,724 | 
|Finite Risk and Financial Products |  |  |   | 230,720 |  |   | 209,939 |  |   | 89,254  | 
|Specialty - Treaty                 |  |  |   | 75,471  |  |   | 26,252  |  |   | 34,062  | 
|Facultative                        |  |  |   | 18,676  |  |   | 8,599   |  |   | 3,465   | 
|                                   | 
|Total                              |  |  | $ | 639,039 |  | $ | 360,604 |  | $ | 261,505 | 
|                                   | 
|Major Lines of Business:           |  | 
|Casualty                           |  |  | $ | 396,598 |  | $ | 186,603 |  | $ | 157,887 | 
|Property                           |  |  |   | 217,711 |  |   | 171,056 |  |   | 101,086 | 
|Other(1)                           |  |  |   | 24,730  |  |   | 2,945   |  |   | 2,532   | 
|                                   | 
|Total                              |  |  | $ | 639,039 |  | $ | 360,604 |  | $ | 261,505 | 
|                                   | 

|(1) |  | Primarily
aviation, ocean marine and accident in 2002.
|--- |  | ------------------------------------------------------

Gross
premiums written were $776.8 million, $476.6 million and $394.8 million, and net premiums
written were $639.0 million, $360.6 million and $261.5 million in 2002, 2001 and 2000,
respectively.

Gross
and net premiums written for 2002 include additional premiums as a result of a change in
estimate during 2002 of ultimate premiums written for prior years, including $58.1 million
and $44.2 million, respectively, of gross and net premiums written and $39.9 million of
net premiums earned resulting from a second quarter revision in our estimate. Because
premiums from ceding companies are typically reported on a delayed basis, we monitor and
update, as appropriate, the estimated ultimate premiums written. During the

|27
|--

---

| | P M A  C A P I T A L
| | --------------------

Management's Discussion and Analysis
(continued)

second quarter of 2002, 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 in the Traditional- and Specialty-Treaty units,
were higher than originally estimated. This increase in net premiums earned in 2002 was
completely offset by losses and LAE, and acquisition expenses.

In
2001, gross and net premiums written include approximately $25 million of premiums (mainly
property premiums in the Finite Risk and Financial Products unit) due under contractual
provisions of certain of PMA Res assumed business where additional premiums were due
to us because of the cession of World Trade Center losses to us by our reinsureds. These
additional premiums were more than offset by approximately $30 million of ceded premiums
payable by PMA Re to its retrocessionaires because PMA Re ceded a portion of its World
Trade Center gross losses to these retrocessionaires. In 2000, net premiums written were
reduced by ceded premiums of $52.1 million on existing retrocessional contracts covering
higher than expected losses and LAE in 2000.

Excluding
the effects, as discussed above, of the change in our estimate of ultimate
premiums written in 2002, the attack on the World Trade Center in 2001 and the additional ceded
premiums on existing retrocessional contracts covering higher than expected losses and LAE
in 2000:

| |  | Gross premiums written increased approximately $267 million, or 59%, in 2002, compared to
2001, reflecting higher premiums in all of our business units. We have been able to obtain
significant price increases and improved terms and conditions on business written across
all underwriting units in 2002. For example, the Traditional- and Specialty-Treaty units,
which comprise 61% of 2002 gross premiums written, experienced rate increases, as measured
by the level of premium increase on renewed in-force business, of approximately 35%.
Additionally, gross premiums written increased in 2002, compared to 2001, due to PMA Res
increased writings of aviation, ocean marine and accident reinsurance business (included in Other in the tables on page 27) due to
significantly improved market conditions in these lines.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Gross
premiums written increased approximately $57 million, or 14%, in 2001, compared to 2000.
In addition to rate increases on business written in 2001, the increase in gross and net
written premiums in 2001, compared to 2000, reflects higher premium volume for both
property and casualty coverages written by the Finite Risk and Financial Products unit due
primarily to increased demand for these coverages. Partially offsetting premium growth in
2001 was lower premium volume from PMA Res Specialty- and Traditional-Treaty units,
which primarily write casualty lines of business. During 2001, approximately 35% of the
beginning in-force business for the Traditional- and Specialty-Treaty units was
non-renewed, largely reflecting non-renewal of accounts that did not meet our pricing
guidelines. Despite the full year decline in writings for PMA Res Traditional and
Specialty treaty coverages, the environment for writing these coverages on acceptable
terms became increasingly more favorable as 2001 progressed due to significant price
increases and better contract terms and conditions. This resulted in an increase in
premiums written for the Traditional and Specialty treaty coverages for the second half of
2001, compared with the first half of the year. This increase continued into 2002 as
discussed above.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ceded premiums increased by approximately $38 million in 2002, compared to 2001, and
increased $5 million in 2001, compared to 2000. The increase in ceded premiums primarily
reflects the increase in gross premiums written and an increase in premiums charged by
retrocessionaires.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Net premiums written increased approximately 63% in 2002 and 17% in 2001, mainly
reflecting the trends discussed above for gross premiums written. Net premiums earned
increased by approximately 48% in 2002 and 14% in 2001, compared to the immediately
preceding year. Traditionally, trends in net premiums earned follow patterns similar to
net premiums written. Generally, in periods of premium growth, the increase in net
premiums written will be greater than the increase in net premiums earned, as was the case
in 2002 and 2001. 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 premium in the period in which the adjustment is made.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

28

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| | P M A  C A P I T A L
| | --------------------

Losses and Expenses

The components of the GAAP combined
ratios are as follows:

|                     |  |  |  | 2002  |   |  | 2001  |   |  | 2000  |  
|-------------------- |  |  |  | ----- | - |  | ----- | - |  | ----- | -
|                    
|Loss and LAE ratio   |  |  |  | 79.6  | % |  | 87.4  | % |  | 91.6  | %
|                     | 
|Expense ratio:       |  | 
|Acquisition expenses |  |  |  | 24.3  | % |  | 20.9  | % |  | 26.1  | %
|Operating expenses   |  |  |  | 2.5   | % |  | 5.9   | % |  | 5.6   | %
|                     | 
|Total expense ratio  |  |  |  | 26.8  | % |  | 26.8  | % |  | 31.7  | %
|                     | 
|Combined ratio       |  |  |  | 106.4 | % |  | 114.2 | % |  | 123.3 | %
|                     | 

PMA Res loss and LAE ratio for 2002
reflects a $50 million increase in net loss reserves in the fourth quarter of 2002 due to
higher than expected losses and LAE in certain lines of business. In the fourth quarter,
PMA Res actuarial department conducted its routine year-end reserve study to
determine the impact of any emerging data on anticipated loss development trends and
recorded unpaid losses and LAE reserves. During the fourth quarter, our actuaries noticed
a higher than expected increase in the level of reported losses by our ceding companies. Based on the actuarial work performed, which
included analyzing recent trends in the levels of the reported and paid claims using
various loss projection techniques, an updated selection of actuarially determined loss
reserve estimates was developed by accident year for each major line of business written
by PMA Re. Managements selection of the ultimate losses indicated that gross loss
and LAE reserves needed to be increased by approximately $72 million in the fourth
quarter, due to an $86 million increase in gross loss and LAE reserves, primarily for
excess of loss and pro rata general liability occurrence contracts ($54 million) and, to a
lesser extent, excess of loss general liability claims-made contracts ($13 million), from
accident years 1998, 1999 and 2000. Under existing retrocessional contracts, approximately
$22 million of the higher than expected losses were ceded to PMA Res
retrocessionaires, reducing the net impact of prior year development to approximately $64
million. Partially offsetting the prior year development was a $14 million decrease in
reserves for full year 2002 accident year business, mainly property reinsurance,
reflecting better than expected underwriting results.

The
$64 million of higher than expected losses and LAE for prior accident years recorded in
the fourth quarter contributed approximately 12 points to the loss and LAE ratio and to
the combined ratio for 2002. In 2001, PMA Res loss and LAE ratio and combined ratio
included approximately 9 points due to the unfavorable loss activity related to the attack
on the World Trade Center. Absent these items, the improvement in underwriting results in
2002, compared to 2001, reflects the continued strong current year pricing environment,
along with tighter terms and conditions, which resulted in us achieving more premium per
unit of exposure in all segments of our reinsurance business.

PMA
Res loss and LAE ratio for 2000 reflected the recognition in the third quarter of
2000 of the effects of higher than expected losses and LAE in certain lines of business,
primarily coverages for 1998 and 1999 written on a pro rata basis, partially offset by
lower than expected losses and LAE for treaties covering losses occurring in accident
years 1996 and prior. The increase in the estimate of gross loss and LAE reserves of $83
million primarily reflected higher than expected losses mainly in our pro rata business.
The concentration of estimated adverse loss development related primarily to general
liability treaties written on a claims made basis covering losses in 1998 and 1999,
property treaties covering 1999 losses and, to a lesser extent, commercial automobile
liability treaties covering losses in 1998 and 1999. In addition, the reserve increase
reflects unfavorable prior year loss reserve development in the excess of loss general
liability line for accident years 1998 and 1999. Under existing retrocessional contracts,
$60 million of gross losses were ceded to PMA Res retrocessionaires, reducing the
impact on net incurred losses and LAE to $23 million. The increase in net incurred losses
and LAE, combined with $35 million of ceded premiums and interest on funds held under
existing retrocessional contracts covering the ceded losses, resulted in a pre-tax charge
of approximately $60 million to PMA Res operating results in 2000.

For
additional information about PMA Res loss reserves, see page 34 and Note 4 to our
Consolidated Financial Statements. For additional information, see Impact on 2001 Results
from the September 11th Terrorist Attack on the World Trade Center on page 26.

Net
premiums earned, which are used in calculating the components of the expense ratio, were
positively impacted by the change in our estimate of ultimate premiums written in 2002 and
negatively impacted by the attack on the World Trade

|29
|--

---

| | P M A  C A P I T A L
| | --------------------

Management's Discussion and Analysis
(continued)

Center in 2001 and the higher than
expected losses in 2000 discussed above. Excluding the effect of these items from the
calculations of our acquisition and operating expense ratios:

| |  | The acquisition expense ratio increased 3.9 points and the operating expense ratio
decreased 3.2 points in 2002, compared to 2001. The increase in the acquisition expense
ratio is primarily due to lower ceding commissions received by PMA Re on our
retrocessional programs and a shift towards pro rata reinsurance business in the Finite
Risk and Financial Products business unit, which generally has higher acquisition expense
ratios and lower loss ratios than excess of loss business. The improvement in the
operating expense ratio is primarily due to growth in our net premiums earned, combined
with a lower level of operating expenses in 2002 compared to 2001. The lower operating
expenses are primarily due to improved results related to our participation in a
Lloyds of London syndicate and managing general agency.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The acquisition expense ratio decreased 1.0 point and the operating expense ratio
increased 1.1 points for 2001, compared to 2000. The lower acquisition expense ratio is
primarily due to the shift in business towards excess of loss Finite Risk and Financial
Products business, which generates a lower acquisition expense ratio than traditional
treaty business. The increase in the operating expense ratio is due to operating expenses
growing at a faster rate than earned premiums in 2001, which reflects net results related
to our participation in a Lloyds of London syndicate and managing general agency.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net Investment Income

Net investment income was $48.7 million,
$45.4 million and $51.1 million in 2002, 2001 and 2000, respectively. The increase in
2002, compared to 2001, reflects higher interest earned of $9.7 million on funds held
arrangements. In a funds held arrangement, the ceding company holds onto 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 rate of interest. The higher interest on funds held in 2002
was partially offset by lower investment earnings of $6.4 million on the invested asset
portfolio. The lower investment earnings resulted from a drop in yields of approximately
100 basis points on an average invested asset base that increased approximately 5% during
2002. The decrease in net investment income in 2001, compared to 2000, is primarily due to
lower investment yields.

The PMA Insurance Group

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

|(dollar amounts in thousands)      |  |  |   | 2002    |  |   | 2001    |  |   | 2000    | 
|---------------------------------- |  |  | - | ------- |  | - | ------- |  | - | ------- | 
|                                  
|Net premiums written               |  |  | $ | 452,276 |  | $ | 355,547 |  | $ | 268,839 | 
|                                   | 
|Net premiums earned                |  |  | $ | 410,266 |  | $ | 346,574 |  | $ | 252,348 | 
|Net investment income              |  |  |   | 35,613  |  |   | 39,444  |  |   | 47,969  | 
|Other revenues                     |  |  |   | 14,694  |  |   | 11,240  |  |   | 10,099  | 
|                                   | 
|Operating revenues                 |  |  |   | 460,573 |  |   | 397,258 |  |   | 310,416 | 
|                                   | 
|Losses and LAE                     |  |  |   | 307,734 |  |   | 258,933 |  |   | 189,001 | 
|Acquisition and operating expenses |  |  |   | 119,906 |  |   | 101,090 |  |   | 80,959  | 
|Dividends to policyholders         |  |  |   | 7,587   |  |   | 14,087  |  |   | 18,855  | 
|                                   | 
|Total losses and expenses          |  |  |   | 435,227 |  |   | 374,110 |  |   | 288,815 | 
|                                   | 
|Pre-tax operating income           |  |  | $ | 25,346  |  | $ | 23,148  |  | $ | 21,601  | 
|                                   | 
|Combined ratio                     |  |  |   | 103.2%  |  |   | 105.5%  |  |   | 111.7%  | 
|Less: net investment income ratio  |  |  |   | 8.7%    |  |   | 11.4%   |  |   | 19.0%   | 
|                                   | 
|Operating ratio                    |  |  |   | 94.5%   |  |   | 94.1%   |  |   | 92.7%   | 
|                                   | 

Pre-tax operating income for The PMA
Insurance Group improved to $25.3 million in 2002, compared to $23.1 million in 2001 and
$21.6 million in 2000. The 10% and 7% increases in operating income were primarily due to
improved underwriting results reflecting improved pricing and rate adequacy, partially
offset by lower net investment income.

Premiums

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

|(dollar amounts in thousands) |  |  |   | 2002    |   |   | 2001    |   |   | 2000    |  
|----------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------- | -
|                             
|Workers' compensation and     |  | 
|integrated disability:        |  | 
|Direct premiums written       |  |  | $ | 397,639 |   | $ | 315,611 |   | $ | 246,617 |  
|Premiums assumed              |  |  |   | 13,338  |   |   | 6,331   |   |   | 3,620   |  
|Premiums ceded                |  |  |   | (37,624 | ) |   | (29,771 | ) |   | (39,367 | )
|                              | 
|Net premiums written          |  |  | $ | 373,353 |   | $ | 292,171 |   | $ | 210,870 |  
|                              | 
|Commercial Lines:             |  | 
|Direct premiums written       |  |  | $ | 102,918 |   | $ | 92,107  |   | $ | 83,381  |  
|Premiums assumed              |  |  |   | 1,437   |   |   | 2,646   |   |   | 1,848   |  
|Premiums ceded                |  |  |   | (25,432 | ) |   | (31,377 | ) |   | (27,260 | )
|                              | 
|Net premiums written          |  |  | $ | 78,923  |   | $ | 63,376  |   | $ | 57,969  |  
|                              | 
|Total:                        |  | 
|Direct premiums written       |  |  | $ | 500,557 |   | $ | 407,718 |   | $ | 329,998 |  
|Premiums assumed              |  |  |   | 14,775  |   |   | 8,977   |   |   | 5,468   |  
|Premiums ceded                |  |  |   | (63,056 | ) |   | (61,148 | ) |   | (66,627 | )
|                              | 
|Net premiums written          |  |  | $ | 452,276 |   | $ | 355,547 |   | $ | 268,839 |  
|                              | 

30

---

| | P M A  C A P I T A L
| | --------------------

Direct workers compensation and
integrated disability premiums written increased 26% in 2002 and 28% in 2001, compared to
the immediately preceding year, primarily due to price increases of approximately 17% and
14% on workers compensation business and, to a lesser extent, an increase in the
volume of risks underwritten for the workers compensation and integrated disability
lines of business. In recent years, The PMA Insurance Group increased its writings of
workers compensation premiums through focused marketing efforts in its principal
marketing territories covering the eastern part of the United States. It has also
increased the level of business written for insureds operating primarily in one of The PMA
Insurance Groups principal marketing territories but with some operations in other
states.

For
workers compensation coverages, the premium charged on fixed-cost policies is
primarily based upon the manual rates filed with the state insurance department. Manual
rates in The PMA Insurance Groups principal marketing territories for workers
compensation increased on average approximately 13% in 2002, 10% in 2001 and 8% in 2000.
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 include fixed cost and dividend policies that comprise approximately 58%
of workers compensation premium for 2002.

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"), increased by $10.8 million and $8.7
million in 2002 and 2001, compared to the immediately preceding year, primarily due to
weighted average annual rate increases of approximately 28% in 2002 and 2001 for
commercial auto, general liability and commercial multi-peril lines.

Premiums
ceded increased $1.9 million in 2002, compared to 2001 and decreased $5.5 million in 2001,
compared to 2000. Premiums ceded for workers compensation and integrated disability
increased by $7.9 million in 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 $5.9 million in 2002, primarily as a result of higher retentions in the
Commercial Lines reinsurance programs. The change in premiums ceded in 2001,
compared to 2000, reflects a decrease of $9.6 million in premiums ceded for workers
compensation, partially offset by an increase of $4.1 million in premiums ceded for
Commercial Lines in 2001, compared to 2000. Premiums ceded for workers compensation
decreased despite the growth in gross premiums written for workers compensation
because The PMA Insurance Group increased its net retention by adding a deductible limit
of approximately $10 million on its workers compensation reinsurance program,
effective January 1, 2001. The increase in premiums ceded for Commercial Lines is
primarily due to the increase in direct premiums written for these products.

Net
premiums written increased 27% in 2002 and 32% in 2001, compared to the immediately
preceding year, mainly reflecting the trends discussed above for direct premiums written.
Net premiums earned increased 18% in 2002 and 37% in 2001. 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. 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.

Losses and Expenses

The components of the GAAP combined
ratios are as follows:

|                              |  |  |  | 2002  |   |  | 2001  |   |  | 2000  |  
|----------------------------- |  |  |  | ----- | - |  | ----- | - |  | ----- | -
|                             
|Loss and LAE ratio            |  |  |  | 75.0  | % |  | 74.7  | % |  | 74.9  | %
|                              | 
|Expense ratio:                |  | 
|Acquisition expenses          |  |  |  | 17.5  | % |  | 17.6  | % |  | 18.4  | %
|Operating expenses(1)         |  |  |  | 8.9   | % |  | 9.1   | % |  | 10.9  | %
|                              | 
|Total expense ratio           |  |  |  | 26.4  | % |  | 26.7  | % |  | 29.3  | %
|Policyholders' dividend ratio |  |  |  | 1.8   | % |  | 4.1   | % |  | 7.5   | %
|                              | 
|Combined ratio(1)             |  |  |  | 103.2 | % |  | 105.5 | % |  | 111.7 | %
|                              | 

|(1) |  | The
expense ratio and the combined ratio exclude $11.3 million, $8.8 million           and
$7.0 million in 2002, 2001 and 2000, respectively, for direct           expenses related
to loss adjusting services and risk control fees included in           other revenues,
which are not included in premiums earned.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The loss and LAE ratio increased slightly
in 2002, compared to 2001, and improved slightly in 2001, compared to 2000. The increase
in 2002, compared to 2001, is primarily due to a higher current accident year loss and LAE
ratio, partially offset by lower unfavorable prior year development and the favorable
impact of net discount accretion. The improvement in 2001, compared to 2000, is primarily
due to an improved current accident year loss ratio and the favorable impact of net
discount accretion, partially offset by the unfavorable impact of changes in prior year
development.

|31
|--

---

| | P M A  C A P I T A L
| | --------------------

Management's Discussion and Analysis
(continued)

The
current accident year loss and LAE ratio increased by 1.0 point in 2002, compared to 2001,
primarily due to increased reinsurance costs and higher workers compensation loss
trends, partially offset by price increases. Medical cost inflation continues in the 8%
range, which has primarily contributed to increased severity of workers compensation
losses. The PMA Insurance Group continues its efforts to try to mitigate medical cost
inflation primarily through its affiliation with a national preferred provider
organization, an extensive medical review process and utilization of nurses, where
appropriate. As discussed below, lower policyholder
dividends are also used as a means to improve a policys overall profitability.

The
current accident year loss and LAE ratio improved by 1.7 points in 2001, compared to 2000,
primarily reflecting price increases in workers compensation and integrated
disability lines of business. The reduction in the loss and LAE ratios for workers
compensation and integrated disability in 2001 also reflected a decline in claims
frequency for workers compensation business.

The
PMA Insurance Group experienced $1.1 million and $2.9 million of unfavorable prior year
development in 2002 and 2001, respectively, compared to favorable prior year development
of $6.1 million in 2000. The lower unfavorable prior year development reduced the loss and
LAE ratio by 0.5 points in 2002, compared to 2001. The change in prior year development
unfavorably impacted the loss and LAE ratio by 3.2 points in 2001, compared to 2000. The
unfavorable prior year development in 2002 and 2001 primarily reflects higher than
expected claims handling costs. The favorable prior year development in 2000 primarily
reflects better than expected loss experience from loss-sensitive and rent-a-captive
workers compensation business. Premium adjustments for loss-sensitive business and
policyholders dividends for rent-a-captive business 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.

The
loss and LAE ratio is negatively impacted by accretion of discount on prior year reserves
and favorably impacted by the recording of discount for current year reserves. The net of
these amounts is referred to as net discount accretion. The recording of discount
essentially offset the accretion of discount on prior year reserves for 2002 and 2001, and
resulted in a favorable impact to the loss and LAE ratio of 0.2 points year over year. The
accretion of discount on prior year reserves exceeded the recording of discount for 2000.
The change in net discount accretion in 2001, compared to 2000, favorably impacted the
loss and LAE ratio by 1.7 points. The lower accretion of discount in 2001, compared to
2000, primarily reflects the transfer of substantially all of the assets and liabilities,
including discounted loss reserves, of The PMA Insurance Groups run-off operations
to a third party under an assumption reinsurance agreement effective December 31, 2000.
See Note 5 to the Consolidated Financial Statements for additional information.

For
additional information regarding The PMA Insurance Groups loss reserves, see page
34.

The
expense ratio improved by 0.3 points in 2002 and by 2.6 points in 2001, compared to the
immediately preceding year, as premium growth outpaced the increase in expenses.

The
policyholders dividend ratio was 1.8%, 4.1% and 7.5% in 2002, 2001 and 2000,
respectively. Under policies that are subject to dividend plans, the customer may receive
a dividend based upon loss experience during the policy period. The improvements in the
policyholders dividend ratio occurred primarily because The PMA Insurance Group sold
less business under dividend plans and wrote business under lower paying dividend plans.
Lower dividend payments are effectively another form of price increase that contribute to
the overall profitability of our workers compensation business.

Net Investment Income

Net investment income was $3.8 million
lower in 2002 and $8.5 million lower in 2001, compared to the immediately preceding year.
The decline in 2002, compared to 2001, primarily reflects a reduction in invested asset
yields of approximately 50 basis points. The decline in 2001, compared to 2000, reflects a
lower invested asset base due to the transfer of substantially all of the assets and
liabilities of The PMA Insurance Groups run-off operations to a third party
effective December 31, 2000 under an assumption reinsurance agreement.

Run-off Operations

Summarized financial results of the
Run-off Operations, formerly known as Caliber One, are as follows:

|(dollar amounts in thousands)      |  |  |   | 2002    |   |   | 2001    |   |   | 2000   |  
|---------------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------ | -
|                                  
|Net premiums written               |  |  | $ | 14,563  |   | $ | 53,674  |   | $ | 16,043 |  
|                                   | 
|Net premiums earned                |  |  | $ | 30,113  |   | $ | 46,232  |   | $ | 28,799 |  
|Net investment income              |  |  |   | 1,140   |   |   | 3,124   |   |   | 4,424  |  
|                                   | 
|Operating revenues                 |  |  |   | 31,253  |   |   | 49,356  |   |   | 33,223 |  
|                                   | 
|Losses and LAE                     |  |  |   | 76,696  |   |   | 60,207  |   |   | 30,462 |  
|Acquisition and operating expenses |  |  |   | 42,058  |   |   | 15,317  |   |   | 9,775  |  
|                                   | 
|Total losses and expenses          |  |  |   | 118,754 |   |   | 75,524  |   |   | 40,237 |  
|                                   | 
|Pre-tax operating loss             |  |  | $ | (87,501 | ) | $ | (26,168 | ) | $ | (7,014 | )
|                                   | 

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In May 2002, we announced our decision to
withdraw from the excess and surplus lines marketplace previously served by the Caliber
One operating segment. On January 2, 2003, we completed the sale of the capital stock of
Caliber One Indemnity Company and received gross proceeds of approximately $31 million,
representing $3.5 million plus surplus of approximately $27 million. Pursuant to the
agreement of sale, we have 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. The transaction is not expected to have a material effect on our
financial condition and results of operations. As a result of our decision to exit this
business, the results of this segment are reported as Run-off Operations.

In
2002, the Run-off Operations recorded pre-tax operating losses of $87.5 million. As a
result of our decision to exit from and run off this business, the Run-off Operations
recorded a charge of $43 million pre-tax. Components of the charge include 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. In
addition, the $43 million charge includes approximately $16 million to write-down assets
to their estimated net realizable value, including approximately $9 million for
reinsurance, premiums and other receivables and non-cash charges of approximately $6
million for leasehold improvements and other fixed assets and $1.3 million for goodwill.
The charge was included in Operating expenses (approximately $24 million) and Net premiums
earned (approximately $19 million) in the Statement of Operations in 2002.

During
2002, approximately 80 employees were terminated in accordance with our exit plan. All of
the terminated employees worked for Caliber One, primarily in the underwriting area.
Approximately 17 positions, primarily claims, remain after the terminations. Involuntary
employee termination benefits of $1.9 million were paid during 2002. The remainder will be
paid in 2003.

Pre-tax
operating results for 2002 also include net unfavorable prior year loss development of
approximately $52 million. 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
range of actuarially determined loss reserve estimates was developed by accident year for
each major line of business written by this segment. Managements selection of the
ultimate losses resulting from their reviews indicated that net loss reserves for prior
accident years, mainly 1999 and 2000, needed to be increased by approximately $52 million,
net of $12 million of ceded losses. 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.

The
Run-off Operations recorded a pre-tax operating loss of $26.2 million and $7.0 million for
2001 and 2000, respectively. The results for 2001 include net unfavorable prior year
development of $22.2 million, which is net of losses of approximately $26 million ceded to
third party reinsurers under existing reinsurance contracts. These losses primarily
reflect higher than expected claim frequency and severity that emerged in 2001 on certain
casualty lines of business, primarily professional liability policies for the nursing
homes class of business and, to a lesser extent, property lines of business. As a result
of its reserve reviews conducted in 2001, the Run-off Operations revised its estimate of
ultimate expected claim activity and, accordingly, increased its estimate of ultimate
losses, substantially all for accident years 1999 and 2000.

Operating
results for the Run-off Operations for 2000 reflect higher than expected losses and LAE in
certain segments of the professional liability (nursing homes), commercial automobile, general liability
and property lines of business for coverage of 1999 and 2000 exposures. The loss and LAE
ratio for 2000 also reflects the ceding of a substantial amount of losses and LAE from the
professional liability and commercial automobile lines of business to reinsurers. For
additional information regarding loss reserves, see Loss Reserves on page 34.

|33
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Management's Discussion and Analysis
(continued)

Loss Reserves and
Reinsurance

Loss Reserves

Our consolidated unpaid losses and LAE,
net of reinsurance, at December 31, 2002 and 2001 were $1,184.3 million and $1,143.1
million, net of discount of $103.8 million and $113.7 million, respectively. Included in
the consolidated unpaid losses and LAE are amounts related to our workers
compensation claims of $368.7 million and $363.5 million, net of discount of $82.7 million
and $91.0 million at December 31, 2002 and 2001, respectively. The discount rate used was
approximately 5% at December 31, 2002 and 2001.

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. 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. In general,
liabilities 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, 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. See the discussion under Losses and Expenses beginning on page 29 and
Run-off Operations beginning on page 32 for additional information regarding higher than expected
losses and LAE during the past three years at PMA Re and the Run-off Operations.

Management
believes that its unpaid losses and LAE are fairly stated at December 31, 2002. However,
estimating the ultimate claims liability is necessarily a complex and judgmental process
inasmuch as the amounts are based on managements informed estimates 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, 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, 2002, the related adjustments could have a
material adverse effect on our financial condition, results of operations and liquidity.

At
December 31, 2002, 2001 and 2000, our gross reserves for asbestos-related losses were
$42.1 million, $59.9 million and $49.2 million, respectively ($25.8 million, $28.6 million
and $32.0 million, net of reinsurance, respectively). At December 31, 2002, 2001 and 2000,
our gross reserves for environmental-related losses were $18.2 million, $29.6 million and
$29.5 million, respectively ($14.3 million, $16.0 million and $18.0 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 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 on page 45
for additional information. In addition, see the Cautionary Statements on page 48 and
Business  Risk Factors in our 2002 Form 10-K for a discussion of factors that may adversely
impact our losses and LAE in the future.

34

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Reinsurance

Under our reinsurance and retrocessional
coverages in place during 2002, 2001 and 2000, we ceded earned premiums totaling $300.6 million,
$243.4 million and $278.6 million, and we ceded earned losses and LAE of $223.2 million, $359.6
million and $308.8 million to reinsurers and retrocessionaires. The increase in ceded
losses in 2001, compared to 2000, is primarily related to losses from the attack on the
World Trade Center. See Impact on 2001 Results from the September 11th Terrorist Attack on
the World Trade Center on page 26 for additional information.

At
December 31, 2002 and 2001, we had amounts receivable from our reinsurers and
retrocessionaires totaling $1,295.1 million and $1,210.8 million, respectively.
Approximately $37 million and $36 million, or 3% of these amounts are due to us on losses
we have already paid at December 31, 2002 and 2001. The remainder of the reinsurance
receivables relate to unpaid claims.

At
December 31, 2002, we had reinsurance receivables due from the following unaffiliated
reinsurers in excess of 5% of our shareholders equity:

|(dollar amounts in thousands)                  |  | ReinsuranceReceivables |   | Collateral | 
|---------------------------------------------- |  | ---------------------- | - | ---------- | 
|                                              
|                                               |  |                        |   |            | 
|The London Reinsurance Group and Affiliates(1) |  |                        | $ | 421,415    | 
|St. Paul and Affiliates(2)                     |  |                        |   | 157,196    | 
|Underwriters Re                                |  |                        |   | 101,500    | 
|Houston Casualty                               |  |                        |   | 97,050     | 
|PXRE                                           |  |                        |   | 53,520     | 
|PartnerRe                                      |  |                        |   | 39,781     | 
|Folksamerica Re                                |  |                        |   | 36,157     | 
|Berkley Insurance Company                      |  |                        |   | 35,985     | 

|(1) |  | Includes Trabaja
Reinsurance Company ($369.7 million), London Life & General Reinsurance Company
($50.7 million) and LondonLife & Casualty Reinsurance Corporation ($1.0 million).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes  United
States Fidelity & Guaranty Insurance Company ($106.4           million) and Mountain
Ridge Insurance Company ($50.8 million).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

We perform credit reviews of our
reinsurers focusing on, among other things, financial capacity, stability, trends and
commitment to the reinsurance business. Prospective and existing 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, consisting generally of those not authorized to
transact business in the applicable jurisdictions. At December 31, 2002 and 2001, our
reinsurance receivables were supported by $666.9 million and $626.9 million of collateral.
Of the uncollateralized reinsurance receivables at December 31, 2002, approximately 91%,
were due from reinsurers rated "A-" or better by A.M. Best and is broken
down as follows: "A++"  5%; "A+"  37%;
"A"  35% and "A-"  14%. We believe that the
amounts receivable from reinsurers are fully collectible and that the valuation allowance
is adequate to cover any disputes about amounts owed by reinsurers to
us. In the last three years combined, we have written off approximately $4 million of
reinsurance receivables, substantially all from the Run-off Operations in 2002. The timing
and collectibility of reinsurance receivables have not had, and are not expected to have,
a material adverse effect on our liquidity. See Critical Accounting Estimates 
Reinsurance Receivables on page 46 and Note 5 to our Consolidated Financial
Statements for additional information.

At
December 31, 2002, our reinsurance and retrocessional protection for major lines of
business that we write was as follows:

|                           |  | Retention |   | Limits (1)   |    
|-------------------------- |  | --------- | - | ------------ | ---
|                          
|                          
|PMA Re                     |  |           |   |              |    
|Per Occurrence:            |  |          
|Casualty lines             |  |           | $ | 5.0 million  |    
|Property lines             |  |           | $ | 10.0 million |    
|Per Risk:                  |  |          
|Property lines             |  |           | $ | 1.0 million  |    
|Casualty lines             |  |           | $ | 1.5 million  |    
|                          
|The PMA Insurance Group    |  |          
|Per Occurrence:            |  |          
|Workers' compensation      |  |           | $ | 250,000      | (2)
|Per Risk:                  |  |          
|Property lines(3)          |  |           | $ | 500,000      |    
|Auto physical damage       |  |           | $ | 500,000      |    
|Other casualty lines(4)(5) |  |           | $ | 500,000      |    

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

|(2) | The
PMA Insurance Group retains the first $3 million of losses.
|--- | ---------------------------------------------------------------

|(3) | This
coverage also provides protection of $41.5 million per occurrence over the combined net
retention of $500,000.
|--- | -------------------------------------------------------------------------------------------------------------------

|(4) | This
coverage also provides protection of $59.5 million per occurrence over the combined net
retention of $500,000.
|--- | -------------------------------------------------------------------------------------------------------------------

|(5) | Effective
January 1, 2003, the retention and limits were changed to $1.5 million and $3.5 million,
respectively. The coverage also provides protection of $48.5 million over the combined
net retention of $1.5 million.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Management's Discussion and Analysis
(continued)

In
addition to the reinsurance and retrocessional protections shown in the table above, for
2002 we had excess of loss retrocessional protection that allows us to cede losses up to a
limit of $150 million once our loss and LAE ratio exceeds a predetermined level. This
policy includes protection for losses caused by terrorist activities. In January 2002, the
Company supplemented its reinsurance and retrocessional programs with coverage for adverse loss
development on certain lines of business written prior to 2002. The program provides
coverage of up to $125 million in losses in return for $55 million, which the Company
funded in 2002. Cessions 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. For additional information regarding our reinsurance arrangements with Trabaja,
see Business  Reinsurance and Retrocessional Protection in our 2002 Form 10-K.

PMA
Re and The PMA Insurance Group do not write a significant amount of natural catastrophe
exposed business in their traditional underwriting units. Excluding PMA Res Finite
Risk and Financial Products writings, less than 1% of gross written premiums is for property
catastrophe coverage. The Finite Risk and Financial Products unit wrote $35 million in
premiums for property catastrophe coverage in 2002. However, these contracts generally
provide for additional premiums payable to PMARe to mitigate the severity of the
catastrophe loss to PMA Re. We actively manage our exposure to catastrophes through our
underwriting process, where we generally monitor the accumulation of insurable values in
catastrophe-prone regions. Also, in writing property reinsurance coverages, PMA Re
typically requires per occurrence loss limitations for contracts that could have
catastrophe exposure. Through per risk reinsurance, we manage our net retention in each
exposure. PMA Res property per occurrence reinsurance provides catastrophe
protection of $40.0 million in excess of $10.0 million on its traditional property book
and $12.5 million in excess of $5.0 million for property exposures underwritten by its
Finite Risk and Financial Products unit. PMA Re can also recover an additional $20.0
million of Traditional and/or Finite Risk and Financial Products occurrence losses under
certain industry loss scenarios. Certain of these contracts require that we cede
additional premiums of up to 20% of ceded losses depending on the level of such losses.
The PMA Insurance Group maintains catastrophe reinsurance protection of 95% of $18.0
million excess of $2.0 million.

In
2002 and 2000, our loss and LAE ratios were not significantly impacted by catastrophes. In
2001, our loss and LAE ratios were impacted by the attack on the World Trade Center as
discussed on page 26. Although we believe that we have adequate reinsurance to protect
against the estimated probable maximum gross loss from a catastrophe, an especially severe
catastrophe or series of catastrophes could exceed our reinsurance and/or retrocessional
protection and may have a material adverse impact on our financial condition, results of
operations and liquidity.

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

Terrorism

On November 26, 2002, President Bush
signed into law the Terrorism Risk Insurance Act of 2002 ("TRIA"). 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. For terrorist acts to be covered under TRIA, they must be
certified as such by the Secretary of the Treasury, Secretary of State and Attorney
General 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 7% deductible for 2003, 10% for 2004 and 15% 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 $35 million
in 2003.

Because
TRIA does not apply to assumed reinsurance business, PMA Re is currently attempting to
exclude coverage of losses due to terrorist activity in our assumed reinsurance contracts
where underwriters determine that there is a significant risk of loss from terrorist
activities. However, because PMA Res clients may not accept a full terrorism
exclusion in connection with business that it may still desire to

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write without an
exclusion, some or many of our reinsurance contracts may not include a terrorism exclusion
or only include a limited exclusion. PMA Re has refined its underwriting procedures to
take into account terrorism risk.

For
the commercial insurance business other than workers compensation offered by The PMA
Insurance Group, in general, TRIA voided all existing terrorism exclusions. 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. Appropriate rates may be charged for terrorism
coverage, and as of February 28, 2003, The PMA Insurance Group had adopted premium charges
for workers compensation insurance in all states except California, Massachusetts
and Texas, where filings were still pending. The PMA Insurance Group has refined its
underwriting procedures to take into account terrorism risks.

Although,
as discussed above, we have refined our underwriting processes to account for terrorism
risks and TRIA may mitigate the potential impact of terrorism losses on our results,
because of 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
underwriting criteria of our operating segments, see Business  PMARe, Underwriting
and The PMA Insurance Group, Underwriting in our 2002 Form 10-K.

Corporate and Other

The Corporate and Other segment includes
unallocated investment income and expenses, including debt service, as well as the results
of certain of our real estate properties. This segment had pre-tax operating losses of
$14.3 million, $6.3 million and $19.1 million in 2002, 2001 and 2000, respectively. During
2001, we sold certain real estate properties for net proceeds totaling $14.4 million,
resulting in a pre-tax gain of $9.8 million, which is recorded in other revenues. Absent
the gain on sale of real estate in 2001, pre-tax operating results for Corporate and Other
improved in 2002 and 2001, compared to the immediately preceding year, primarily due to
declines in interest expense of $3.3 million and $5.3 million during 2002 and 2001,
respectively. The lower interest expense reflects a lower average amount of debt
outstanding and lower interest rates throughout the years.

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. At the holding company level, our primary sources of liquidity are
dividends from subsidiaries, net tax payments received from subsidiaries and capital
raising activities (both debt and equity). We utilize cash to pay debt obligations,
including interest costs; dividends to shareholders; taxes to the federal government; and
corporate obligations. In addition, we utilize cash resources to capitalize subsidiaries
and to repurchase shares of our common stock from time to time.

Our
domestic insurance subsidiaries ability to pay dividends to us is limited by the
insurance laws and regulations of Pennsylvania. All of our domestic insurance entities are
owned by PMA Capital Insurance Company ("PMACIC"). As a result, dividends
from The PMA Insurance Groups Pooled Companies may not be paid directly to PMA
Capital Corporation. Instead, only PMACIC, a Pennsylvania domiciled company, may pay
dividends directly to PMA Capital Corporation. Approximately $58 million of dividends are
available to be paid by PMACIC to PMA Capital Corporation in 2003 without the prior approval of
the Pennsylvania Insurance Commissioner. As of December 31, 2002, The PMA
Insurance Groups Pooled Companies can pay up to $24.6 million in dividends to PMACIC
during 2003. Dividends received in the past three years from subsidiaries were $28.0
million, $29.6 million and $36.0 million in 2002, 2001 and 2000, respectively, and
represent approximately 50% of the maximum dividend capacity in each year.

Net
tax payments received from subsidiaries were $12.0 million, $2.4 million and $6.4 million
in 2002, 2001 and 2000, respectively.

In
2002 and 2001, we raised $244 million of capital through two public capital markets
transactions. In October 2002, we issued $86.25 million of 4.25% convertible senior
debentures ("Convertible Debt") due September 30, 2022 from which we
received net proceeds of approximately $83.7 million. We used the proceeds from this
offering primarily to increase the capital and surplus of our reinsurance and insurance
subsidiaries. See Note 6 to our Consolidated Financial Statements for additional
information. In December 2001, we issued 9,775,000 shares of Class A Common stock, for net
proceeds of approximately $158 million. We used the net proceeds from this issuance to
contribute additional capital to our reinsurance subsidiary and to repay $62.5 million of
our outstanding debt maturing at year-end 2001 under our bank credit facility.

|37
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Management's Discussion and Analysis
(continued)

At
December 31, 2002, we had $65 million of outstanding debt representing borrowings under
our new credit facility ("Credit Facility"), which was executed in September
2002 and replaced our existing bank facility that was scheduled to mature at December 31,
2002. The proceeds from the Credit Facility were used to repay the existing bank facility,
which had $62.5 million outstanding. The Credit Facility will mature in September 2003, or
we may convert the outstanding principal amount into a term loan maturing June 30, 2004,
if we meet certain financial performance targets. At December 31, 2002, the interest rate
on the utilized portion of the Credit Facility was 3.6%, which equals the London InterBank
Offered Rate ("LIBOR") plus 1.8%. The Credit Facility carries a facility fee
on any unutilized portion of 0.375% per annum. Effective March 2003, we amended the Credit
Facility to reduce it to $45 million in borrowing capacity and repaid $20 million. In
addition, the March 2003 amendment increased the interest rate to LIBOR plus 2.125%. See
Note 6 to our Consolidated Financial Statements for additional information.

During
2002, 2001 and 2000, we incurred $3.3 million, $6.5 million and $11.9 million of interest
expense, and $2.1 million, $7.1 million and $11.8 million was paid in each respective year.

We
maintain a committed facility of $50.0 million for letters of credit (the "Letter
of Credit Facility"), which we utilize primarily for collateralizing reinsurance
obligations of our insurance subsidiaries. As of December 31, 2002, we had $15.7 million
outstanding in letters of credit under the Letter of Credit Facility.

During
2002, 2001 and 2000, we paid dividends to shareholders of $12.1 million, $9.0 million and
$8.0 million, respectively. The increase in dividends paid in 2002 is due to the
additional shares outstanding resulting from our December 2001 issuance of 9,775,000
shares of Class A Common stock. Our dividends to shareholders are restricted by certain of
our debt agreements. Under the most restrictive debt covenant, PMA Capital would be able
to pay dividends of approximately $25 million in 2003.

We
repurchased 90,000 shares, 299,000 shares and 989,000 shares of our Class A Common stock
at a cost of $1.7 million, $5.3 million and $18.4 million in 2002, 2001 and 2000,
respectively. Since the inception of our share repurchase program, we have repurchased a
total of approximately 3.9 million shares at a cost of $74.6 million. Our remaining share
repurchase authorization at December 31, 2002 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.

In
2002 and 2001, we increased the capital and surplus of our insurance subsidiaries through
providing funds totaling $73.5 million and $58.0 million, respectively.

In
2002 and 2001, we contributed $16.5 million and $9.0 million, respectively, 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 each year. If plan assets were not at least
equal to our accumulated benefit obligation at the end of any particular year, then the
company would recognize a reduction in Shareholders equity. In 2002, 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. We made the contributions in 2002 and 2001 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 past three years. Our plan assets are composed of 65% fixed
maturities and 35% equities at December 31, 2002, and 45% fixed maturities and 55%
equities at December 31, 2001. We currently estimate that the pension plans assets
will generate a 9% long-term rate of return, which we believe is a reasonable long-term
rate of return, in part, because of the historical performance of the broad financial
markets. For example, for the 20-year period from 1982 to 2002, the S&P 500 Index and
the Lehman Bond Aggregate Index have returned 14.0% and 9.8% on average. We believe that
this is a reasonable period of time over which to evaluate market returns as it
approximates the current duration of the pension plans liabilities. Pension plan
funding is currently expected to be insignificant in 2003 assuming plan assets achieve the
expected long-term rate of return of 9% in 2003. If plan assets were to decline by 10% in
2003, then we would need to contribute approximately $6.4 million to our pension plan
assets by year-end 2003 to ensure that the plan assets remain at least equal to the
accumulated

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benefit obligation. However, no contribution is expected to be required under
ERISA in 2003. Pension expense in 2002, 2001 and 2000 was $3.0 million, $1.9 million and
$686,000, respectively. We currently expect that 2003 pension costs will increase by $1.0
million, or 33%, over 2002 costs due to the continued amortization of unrecognized
actuarial losses primarily from lower than expected returns on plan assets over the
previous three years.

In
addition to the $45 million of debt scheduled to mature in September 2003, we have
contractual obligations to pay $7.7 million in operating lease payments, net of sublease
rentals of $242,000 in 2003. Our future commitments for operating lease payments are $5.2
million in 2004, $4.2 million in 2005 and $21.8 million thereafter, net of sublease
rentals of $1.5 million in 2004, $1.5 million in 2005 and $14.1 million thereafter. Other
than these future commitments, we have $86.25 million of convertible debt due to mature in
2022.

We
have provided guarantees of $7.0 million related to loans on properties in which we have
an interest. We have also provided guarantees of $2.2 million related to an executive loan
program for officers of the Company with a financial institution. The program expires on
December 31, 2003.

Under
the terms of the sale of one of our insurance subsidiaries in 1998, we have agreed to
indemnify the buyer, 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 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.

We
believe that our available sources of funds will provide sufficient liquidity to meet our
short-term and long-term obligations. However, because we depend primarily upon dividends
from our operating subsidiaries to meet our short-term and long-term obligations, any
event that has a material adverse effect on the results of operations of our insurance
subsidiaries could affect our liquidity and ability to meet our contractual obligations
and operating needs. In addition, our ability to

refinance our existing debt obligations or
raise additional capital is dependent upon several factors, including conditions with
respect to both the equity and debt markets and the ratings of any securities that we may
issue as established by the principal rating agencies. Our ability to refinance our
outstanding debt obligations, as well as the cost of such borrowings, could be adversely
affected by any future ratings downgrade. See BusinessRisk Factors in our 2002 Form 10-K
for additional discussion.

We
currently believe that the existing capital structure is adequate for our current and near
term needs, but we believe that additional capital and longer-term capital would provide
better support for our growth objectives. Given our debt-to-total capital ratio of 20%, we
believe that we have the financial flexibility to provide the necessary capital and
support to our insurance businesses so that they are in position to participate in what we
believe will be a favorable property and casualty insurance market in 2003. We continually
monitor the capital structure in light of developments in our businesses, and our present
assessment could change as we become aware of new opportunities and challenges in our
businesses.

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 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.

|39
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Management's Discussion and Analysis
(continued)

Our investments at December 31 were as
follows:

|                                                                     |  | 2002       | 2001
|-------------------------------------------------------------------- |  | ---------- | ----
|                                                                     | 
|(dollar amounts in millions)                                         |  | Fair Value |     
|                                                                    
|                                                                    
|                                                                     |  |            |     
|U.S. Treasury securities and obligations of U.S. Government agencies |  |            | $   
|States, political subdivisions and foreign government securities     |  |            |     
|Corporate debt securities                                            |  |            |     
|Mortgage-backed and other asset-backed securities                    |  |            |     
|                                                                     | 
|Total fixed maturities available for sale                            |  |            |     
|Short-term investments                                               |  |            |     
|                                                                     | 
|Total                                                                |  |            | $   
|                                                                     | 

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 $25 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 15% of invested assets at December 31, 2002. Included in this industry segment
are financial institutions, including the financing subsidiaries of automotive
manufacturers. Substantially all of our investments are dollar denominated as of December
31, 2002.

Mortgage-backed
and other asset-backed securities in the table above include collateralized mortgage
obligations ("CMOs") of $181.2 million and $125.6 million carried at fair
value as of December 31, 2002 and 2001. CMO holdings are concentrated in securities with
limited prepayment, extension and default risk, such as planned amortization class bonds.

As
of December 31, 2002, the duration of our investments that support the insurance reserves
was 2.6 years and the duration of our insurance reserves was 3.4 years. The difference in
the duration of our investments and our insurance reserves reflects our decision to
maintain a shorter asset duration due to our current expectation that interest rates will
rise throughout 2003.

We
determine the market value of each fixed income security using prices obtained in the
public markets. There is only one security, which was carried at its fair value of $14.6
million at December 31, 2002, whose fair value is not reliably determined from these
public market sources. For this security, we utilized the services of our outside
professional investment asset manager to determine the fair value. The asset manager
determines the fair value of the security by using a discounted present value of the
estimated future cash flows (interest and principal repayment).

The
net unrealized gain on our investment assets at December 31, 2002 was $52.0 million, or
2.9% of the amortized cost basis. The net unrealized gain included gross unrealized gains
of $64.5 million and gross unrealized losses of $12.5 million.

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

|                                 |  | 2002       | 2001
|-------------------------------- |  | ---------- | ----
|                                 | 
|(dollar amounts in millions)     |  | Fair Value |     
|                                
|                                
|                                 |  |            |     
|U.S. Treasury securities and AAA |  |            | $   
|AA                               |  |            |     
|A                                |  |            |     
|BBB                              |  |            |     
|Below investment grade           |  |            |     
|                                 | 
|Total                            |  |            | $   
|                                 | 

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.

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Our investment income and net effective
yield were as follows:

|(dollar amounts in thousands) |  |  |   | 2002    |  |   | 2001    |  |   | 2000    | 
|----------------------------- |  |  | - | ------- |  | - | ------- |  | - | ------- | 
|                             
|Average invested assets(1)    |  |  | $ | 1,716.1 |  | $ | 1,648.2 |  | $ | 1,742.8 | 
|Investment income(2)          |  |  | $ | 87.4    |  | $ | 98.6    |  | $ | 112.7   | 
|Net effective yield(3)        |  |  |   | 5.09%   |  |   | 5.98%   |  |   | 6.47%   | 
|                              | 

|(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 of $2.9 million, $12.0 million and $10.6 million in 2002, 2001 and 2000,
respectively. 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 the ability and intent of our insurance operations 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 currently there is no
need to sell any of the fixed maturity investments prior to their scheduled or expected
maturity to fund anticipated claim payments.

As
of December 31, 2002, our investment asset portfolio had gross unrealized losses of $12.5
million. For securities that were in an unrealized loss position at December 31, 2002, the
length of time that such securities have been in an unrealized loss position, as measured
by their month-end market values, is as follows:

|(dollar amounts in millions) |  | Number ofSecurities |  | FairValue |  | AmortizedCost |       | UnrealizedLoss |   | PercentageFair Value toAmortized Cost | 
|---------------------------- |  | ------------------- |  | --------- |  | ------------- | ----- | -------------- | - | ------------------------------------- | 
|                            
|Less than 6 months           |  |                     |  | 39        |  | $             | 85.8  |                | $ | 89.6                                  | 
|6 to 9 months                |  |                     |  | 9         |  |               | 22.1  |                |   | 22.6                                  | 
|9 to 12 months               |  |                     |  | 3         |  |               | 4.0   |                |   | 4.2                                   | 
|More than 12 months          |  |                     |  | 19        |  |               | 46.9  |                |   | 54.9                                  | 
|                             | 
|Subtotal                     |  |                     |  | 70        |  |               | 158.8 |                |   | 171.3                                 | 
|U.S. Treasury and            |  |                    
|Agency securities            |  |                     |  | 5         |  |               | 0.6   |                |   | 0.6                                   | 
|                             | 
|Total                        |  |                     |  | 75        |  | $             | 159.4 |                | $ | 171.9                                 | 
|                             | 

Of the 19 securities that have been in an
unrealized loss position for more than 12 months, 18 securities have an unrealized loss of
less than $1 million and/or less than 20% of their amortized cost. These 18 securities
have an average unrealized loss per security of approximately $140,000. In addition, 12 of
these securities have fair values at December 31, 2002 that are 90% or more of the
amortized cost basis. There is only one security out of the 19 with an unrealized loss in
excess of $1 million at December 31, 2002, and it has a market value of $14.6 million and
a cost of $20.0 million. The security is a structured security backed by a U.S. Treasury
Strip, and is rated AAA. This security matures in 2011 at a value of $20 million, and we
have both the ability and intent to hold this security until it matures.

41

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Management's Discussion and Analysis
(continued)

The
contractual maturity of securities in an unrealized loss position at December 31, 2002 was
as follows:

|(dollar amounts in millions)                      |  | FairValue |   | AmortizedCost |  | UnrealizedLoss |       | PercentageFair Value toAmortized Cost |  
|------------------------------------------------- |  | --------- | - | ------------- |  | -------------- | ----- | ------------------------------------- | -
|                                                 
|2003                                              |  |           | $ | 3.9           |  | $              | 3.9   |                                       | $
|2004 - 2007                                       |  |           |   | 42.5          |  |                | 42.9  |                                       |  
|2008 - 2012                                       |  |           |   | 31.0          |  |                | 32.3  |                                       |  
|2013 and later                                    |  |           |   | 32.0          |  |                | 33.9  |                                       |  
|Mortgage-backed and other asset-backed securities |  |           |   | 49.4          |  |                | 58.3  |                                       |  
|                                                  | 
|Subtotal                                          |  |           |   | 158.8         |  |                | 171.3 |                                       |  
|U.S. Treasury and Agency securities               |  |           |   | 0.6           |  |                | 0.6   |                                       |  
|                                                  | 
|Total                                             |  |           | $ | 159.4         |  | $              | 171.9 |                                       | $
|                                                  | 

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, 2002, all 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, 2002, $14.3 million, or 0.8%, of our total investments were below investment grade, of
which $5.1 million of these below investment grade investments were in an unrealized loss
position, which totaled $500,000.

During
2002, we determined there were other than temporary declines in market value of securities
issued by 11 companies, resulting in impairment charges of $23.8 million pre-tax, including $14.2 million for WorldCom. The write-downs were measured based on public
market prices and our expectation of the future realizable value for the security at the
time we determined the decline in value was other than temporary. In 2001, we recognized
an impairment loss of $1.6 million pre-tax resulting from one issuer filing for
bankruptcy. We did not recognize any impairment losses during 2000. See Critical
Accounting Estimates  Investments on page 46 for additional information.

Net Realized Investment
Gains and Losses

We recorded pre-tax net realized
investment losses of $16.1 million in 2002, compared to pre-tax net realized investment
gains of $8.0 million and $12.0 million in 2001 and 2000, respectively. During 2002, there
were gross realized gains and losses of $18.7 million and $34.8 million, respectively.
Included in the gross losses of $34.8 million were $23.8 million of impairment losses on
fixed income securities, primarily corporate bonds issued by telecommunications and energy
companies. Realized losses also include $7.3 million of realized losses on sales of
securities where we reduced and/or eliminated our positions in certain issuers due to
credit concerns. To a lesser extent, realized losses also include sales reducing our per
issuer exposure and general duration management trades.

Net
realized investment gains for 2001 reflect the sale of securities because of our decision to shift
the mix of our invested asset portfolio from U.S. Treasury and agency securities to
corporate bonds and structured securities as a means to enhance our portfolios
yield. As a result of investment sales pursuant to this strategy and the declining
interest rates in 2001, we recorded net realized investment gains in 2001. During 2000,
realized investment gains primarily reflect the sale of equity securities, which had
reached our targeted price level.

See Business  Investments,  in our 2002 Form 10-K, and Notes 2B
and 3 to our Consolidated Financial Statements for additional discussion about our
investment portfolio.

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Market Risk of Financial
Instruments

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. As stated above, 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 15% of invested assets at December 31, 2002. Included in this
industry segment are financial institutions, including the financing subsidiaries of
automotive manufacturers. See Notes 2B, 3, 6
and 11 to our Consolidated Financial
Statements for additional information about financial instruments.

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 70% of our total liabilities and reinsurance receivables represent 32% of our total assets).

The
hypothetical effects of changes in market rates or prices on the fair values of financial
instruments as of December 31, 2002, 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 no significant
change 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 $64 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.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Other Matters

Environmental Factors

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.

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. See Note 17 to our Consolidated Financial
Statements for additional information.

Recent Accounting
Pronouncements

In January, 2003, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation
 Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require 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. We account for stock-based employee compensation using
the intrinsic value method prescribed in Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees." Accordingly, we
have applied the disclosure provisions of SFAS No. 148 to our Consolidated Financial Statements as of
and for the year ended December 31, 2002. See Note 2K to our Condolidated Financial Statements for additional information.

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Management's Discussion and Analysis
(continued)

In
May 2002, we announced our decision to withdraw from the excess and surplus lines
marketplace previously served by our Caliber One operating segment. We accounted for the
discontinuation of this business under the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," which are effective January
1, 2002. SFAS No. 144 supersedes SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions,"
and establishes a single accounting model for the disposal of long-lived assets and asset
groups.

In
January 2003, we sold the capital stock of Caliber One Indemnity Company. Pursuant to the
agreement of sale, we have retained all assets and liabilities related to in-force
policies and outstanding claim obligations and will runoff such in-force policies and
claim obligations. Accordingly, under SFAS No. 144, the results of operations of this
segment are reported in results from continuing operations, and will continue to be
reported as such until all in-force policies and outstanding claim obligations are
satisfied, at which point we will report the results of the Run-off segment as
discontinued operations. The long-lived assets of this segment were tested for impairment
in the second quarter of 2002 in accordance with the provisions of SFAS No. 144. See Note
14 to our Consolidated Financial Statements for additional information.

In
July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities." SFAS No. 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002. Accordingly, this
standard does not apply to our exit from the excess and surplus lines business, which we
announced in May 2002.

In
January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable
Interest Entities" ("FIN 46"), which requires a company to assess if
consolidation of an entity is appropriate based upon its variable economic interests in a
variable interest entity ("VIE"). The initial determination of whether an
entity is a VIE is required to be made on the date at which a company becomes involved
with the entity. A VIE is an entity in which the equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional subordinated financial
support from other parties. A company shall consolidate a VIE if the company has a
variable interest that will absorb a majority of the VIEs expected losses if they occur,
receive a majority of the entitys expected residual returns if they occur or both.

FIN
46 is effective for new VIEs established subsequent to January 31, 2003, and for existing
VIEs as of July 1, 2003. FIN 46 also requires the disclosure of certain information
related to VIEs in which an entity holds a significant variable interest. We are currently
assessing the impact that implementing FIN 46 may have on our consolidated financial
statements. In this regard, we will be evaluating whether Trabaja Reinsurance Company
("Trabaja") is a variable interest entity as defined in FIN 46 and, if so,
whether our business activities with Trabaja would warrant consolidation and/or additional disclosure
in our future financial statements. We expect that any impact from implementing FIN 46
would be a non-cash adjustment recorded in our consolidated financial statements as a
cumulative effect adjustment no later than the third quarter of 2003. Any such cumulative
effect adjustment may be material to our consolidated financial condition and results of
operations. However, there will be no effect on the statutory capital of our insurance
subsidiaries. See Note 5 to our Consolidated Financial Statements for additional
information relating to our business activities with Trabaja.

In
November 2002, the FASB issued Interpretation No. 45, "Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others" ("FIN 45"). FIN 45 requires certain guarantees to be
recorded at fair value and also requires a guarantor to make certain disclosures, even
when the likelihood of making payments under the guarantee is remote. Generally, FIN 45
 applies to contracts or indemnification agreements that contingently
require the guarantor to make payments to the guaranteed party. The recognition provisions
of FIN 45 are effective on a prospective basis for guarantees issued or modified after
December 31, 2002. The disclosure requirements are effective for financial statements of
interim and annual periods ending after December 15, 2002. We are currently assessing the
impact of adopting FIN 45, and we currently do not expect that it will have a material
adverse effect on our consolidated financial condition, results of operations or liquidity.

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Effective
January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." In accordance with SFAS No. 142, we no longer amortize goodwill, but
instead test it periodically for impairment. As of December 31, 2002, we had approximately
$3.0 million of goodwill, which is included in Other assets on the balance sheet.
Amortization of goodwill was $960,000, or $0.04 per basic and diluted share, for 2001, and $220,000,
or $0.01 per basic and diluted share, for 2000. In 2002, we
recognized an impairment charge of $1.3 million associated with goodwill at the Run-off
Operations, which is included in Operating expenses.

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, 2002, we estimated that
under all insurance policies and reinsurance contracts issued by our insurance businesses
the ultimate amount that we would have to pay for all events that occurred as of December
31, 2002 is $2,449.9 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, 2002 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 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 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 relied upon 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
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 and judgments using data currently available
to us. As additional experience and data become available regarding claim payment and
reporting patterns, legal and legislative developments, judicial theories of liability, regulatory trends on benefit
levels for both medical and indemnity payments, changes in social attitudes and economic conditions, we revise our
estimates accordingly. We believe that our liability for unpaid losses and loss adjustment
expenses is fairly stated at December 31, 2002. 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. 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, 2002 have been established using
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, 2002 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 operating income would change by
approximately $12 million.

For
additional information about our liability for unpaid losses and LAE,
see Notes 2D and 4 to our Consolidated Financial Statements as well as the discussion
on page 34 of this Managements Discussion and Analysis.

|45
|--

---

| | P M A  C A P I T A L
| | --------------------

Management's Discussion and Analysis
(continued)

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, 2002 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 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, 2002, 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, 2002 should have been written down to their fair value, we would
have recorded an additional other-than-temporary impairment loss of $12.5 million pre-tax.

For
additional information about our investments, see Notes 2B, 3
and 11 as well as the
discussion on pages 39 to 43 of this Managements Discussion and Analysis.

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 $1,295.1 million at December 31, 2002. We have also
estimated that $5.5 million of 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 recoverables at December 31, 2002, we have established an
allowance for amounts that we have concluded are uncollectible at the balance sheet date.
In reaching our conclusion, we relied on historical performance as well as any known
disputes or collection issues as of the balance sheet date and applied our informed
judgment in ascertaining the appropriate level of allowance for uncollectible amounts.
Because our current relationships with reinsurers are considered sound and because such
reinsurers are current on their obligations to our insurance subsidiaries, we currently
consider all amounts to be collectible. At December 31, 2002, approximately $38 million
of uncollateralized reinsurance receivables, including $25 million due for ceded IBNR, are
due from reinsurers whose A.M. Best financial strength rating had declined to below A- in 2002 or who were under regulatory supervision or
in liquidation in 2002.

46

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| | P M A  C A P I T A L
| | --------------------

For
additional information about reinsurance receivables, see Note 5 to the Consolidated
Financial Statements as well as the discussion on pages 35 and 36 of this Managements
Discussion and Analysis.

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 deferral of tax losses is
evaluated based upon managements estimates of the future profitability of the
Companys taxable entities based on current forecasts. A valuation allowance is
established for any portion of a deferred tax asset that management believes is more
likely than not going to be realized. At December 31, 2002, PMA Capital has a net deferred
tax asset of $94.1 million, resulting from $165.9 million of deferred tax assets reduced
by $71.8 million of deferred tax liabilities. In establishing the appropriate value of
this asset, management must make judgments about the Companys 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 2022.

In
evaluating the recoverability of our net deferred tax asset, management has considered the
recent performance of its business, which generated pre-tax losses of $79.2 million and
$4.4 million in 2002 and 2001 due primarily to losses from Run-off Operations and World
Trade Center losses. While such performance may call into question our ability to be
profitable, we believe that future results will be substantially improved due to our exit
from the business segment that generated a substantial portion of our net loss in 2002 and
2001, as well as the unprecedented loss event in 2001 stemming from the attack on the
World Trade Center. Accordingly, despite our recent earnings history, we have estimated at
year-end 2002 that our ongoing insurance operations will generate sufficient future
taxable income to utilize the net deferred tax asset 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 see Note 12 to our Consolidated
Financial Statements.

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 on page 27, in the second
quarter of 2002, PMA Re recognized $44 million of net written premiums for prior
underwriting years due to a difference between the originally estimated and actual
premiums. Due to the customary lag in reporting premium data by some of PMA Res
clients, PMA Re must estimate the ultimate written premiums to be received from a ceding
company based upon data received when we initially receive the submission, including broker
and ceding company data and projections. Actual premiums written for PMA Re reported in
the Statement of Operations are based upon reports received from ceding companies,
supplemented by our own estimates of premiums written for which ceding company reports
have not been received. Differences between such estimates and actual amounts are recorded
in the period in which the actual amounts are determined.

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. For example, in 2000, PMA Re increased its gross losses by $83 million
and ceded $60 million of these losses to our retrocessionaires. Under the terms of the
retrocessional coverage to which we ceded these losses, we were required to pay $35
million of additional ceded premiums to our retrocessionaires, which reduced the net
benefit of the loss cessions from $60 million to $25 million. For additional information,
see Notes 4 and 5 to our Consolidated Financial Statements.

|47
|--

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| | P M A  C A P I T A L
| | --------------------

Management's Discussion and Analysis
(continued)

Cautionary Statements

Except for historical information
provided in Managements Discussion and Analysis and otherwise in this report,
statements made throughout, including in the Business Outlook section on page 26, are forward-looking
and contain information about financial results, economic conditions, trends and known
uncertainties. Words such as "believes," "estimates,"
"anticipates," "expects" 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 may differ
materially from our current expectations. 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:

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

| |  | regulatory or tax changes, including 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;
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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;
|- |  | ---------------------------------------------------------------------------------------------------

| |  | the
lowering or loss of one or more of the financial strength or claims paying ratings of our
insurance subsidiaries;
|- |  | ---------------------------------------------------------------------------------------------------------------------

| |  | adequacy of reserves for claim liabilities;
|- |  | -------------------------------------------

| |  | adverse
property and casualty loss development for events we insured in prior years;
|- |  | ------------------------------------------------------------------------------------

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

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

| |  | adequacy and collectibility of reinsurance that we
purchased;
|- |  | -------------------------------------------------------------

| |  | severity of natural disasters and other catastrophes, including future
acts of terrorism in connection with insurance and reinsurance policies;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | reliance on key management;
|- |  | ---------------------------

| |  | uncertainties related to possible
terrorist activities or international hostilities; and
|- |  | ----------------------------------------------------------------------------------------

| |  | other factors disclosed from time to time in our most recent Forms 10-K, 10-Q and 8-K
filed 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.

48

---

| | P M A  C A P I T A L
| | --------------------

Consolidated Balance Sheets

|(in thousands, except share data)                                                  |  |  |   | 2002      |   |   | 2001      |  
|---------------------------------------------------------------------------------- |  |  | - | --------- | - | - | --------- | -
|                                                                                  
|Assets:                                                                            |  | 
|Investments:                                                                       |  | 
|Fixed maturities available for sale, at fair value (amortized cost:                |  | 
|2002 - $1,477,921; 2001 - $1,416,901)                                              |  |  | $ | 1,529,924 |   | $ | 1,425,281 |  
|Short-term investments                                                             |  |  |   | 298,686   |   |   | 325,054   |  
|Short-term investments, loaned securities collateral                               |  |  |   | --        |   |   | 25,000    |  
|Cash                                                                               |  |  |   | 43,853    |   |   | 20,656    |  
|                                                                                   | 
|Total investments and cash                                                         |  |  |   | 1,872,463 |   |   | 1,795,991 |  
|Accrued investment income                                                          |  |  |   | 18,600    |   |   | 19,121    |  
|Premiums receivable (net of valuation allowance: 2002 - $9,528; 2001 - $12,583)    |  |  |   | 363,675   |   |   | 301,104   |  
|Reinsurance receivables (net of valuation allowance: 2002 - $5,483; 2001 - $4,562) |  |  |   | 1,295,083 |   |   | 1,210,764 |  
|Deferred income taxes, net                                                         |  |  |   | 94,074    |   |   | 82,120    |  
|Deferred acquisition costs                                                         |  |  |   | 89,222    |   |   | 64,350    |  
|Funds held by reinsureds                                                           |  |  |   | 157,479   |   |   | 145,239   |  
|Other assets                                                                       |  |  |   | 215,198   |   |   | 184,290   |  
|                                                                                   | 
|Total assets                                                                       |  |  | $ | 4,105,794 |   | $ | 3,802,979 |  
|                                                                                   | 
|                                                                                  
|Liabilities:                                                                       |  | 
|Unpaid losses and loss adjustment expenses                                         |  |  | $ | 2,449,890 |   | $ | 2,324,439 |  
|Unearned premiums                                                                  |  |  |   | 405,379   |   |   | 308,292   |  
|Short-term debt                                                                    |  |  |   | 65,000    |   |   | 62,500    |  
|Long-term debt                                                                     |  |  |   | 86,250    |   |   | --        |  
|Accounts payable, accrued expenses and other liabilities                           |  |  |   | 253,175   |   |   | 217,490   |  
|Funds held under reinsurance treaties                                              |  |  |   | 249,670   |   |   | 227,892   |  
|Dividends to policyholders                                                         |  |  |   | 14,998    |   |   | 17,132    |  
|Payable under securities loan agreements                                           |  |  |   | 42        |   |   | 33,228    |  
|                                                                                   | 
|Total liabilities                                                                  |  |  |   | 3,524,404 |   |   | 3,190,973 |  
|                                                                                   | 
|Commitments and contingencies (Note 7)                                             |  | 
|                                                                                   | 
|Shareholders' Equity:                                                              |  | 
|Class A Common stock, $5 par value (40,000,000 shares authorized;                  |  | 
|2002 - 34,217,945 shares issued and 31,328,922 outstanding;                        |  | 
|2001 - 34,217,945 shares issued and 31,167,006 outstanding)                        |  |  |   | 171,090   |   |   | 171,090   |  
|Additional paid-in capital                                                         |  |  |   | 109,331   |   |   | 109,331   |  
|Retained earnings                                                                  |  |  |   | 319,014   |   |   | 382,165   |  
|Accumulated other comprehensive income                                             |  |  |   | 34,552    |   |   | 5,375     |  
|Notes receivable from officers                                                     |  |  |   | (62       | ) |   | (158      | )
|Treasury stock, at cost (2002 - 2,889,023 shares; 2001 - 3,050,939 shares)         |  |  |   | (52,535   | ) |   | (55,797   | )
|                                                                                   | 
|Total shareholders' equity                                                         |  |  |   | 581,390   |   |   | 612,006   |  
|                                                                                   | 
|Total liabilities and shareholders' equity                                         |  |  | $ | 4,105,794 |   | $ | 3,802,979 |  
|                                                                                   | 

See accompanying notes to the consolidated
financial statements.

|49
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| | P M A  C A P I T A L
| | --------------------

Consolidated Statements of Operations

|(in thousands, except per share data)  |  |  |   | 2002      |   |   | 2001    |   |   | 2000    |  
|-------------------------------------- |  |  | - | --------- | - | - | ------- | - | - | ------- | -
|                                      
|Revenues:                              |  | 
|Net premiums written                   |  |  | $ | 1,104,997 |   | $ | 769,058 |   | $ | 545,555 |  
|Change in net unearned premiums        |  |  |   | (113,986  | ) |   | (36,618 | ) |   | (14,131 | )
|                                       | 
|Net premiums earned                    |  |  |   | 991,011   |   |   | 732,440 |   |   | 531,424 |  
|Net investment income                  |  |  |   | 84,881    |   |   | 86,945  |   |   | 102,591 |  
|Net realized investment gains (losses) |  |  |   | (16,085   | ) |   | 7,988   |   |   | 11,975  |  
|Other revenues                         |  |  |   | 15,330    |   |   | 22,599  |   |   | 14,000  |  
|                                       | 
|Total revenues                         |  |  |   | 1,075,137 |   |   | 849,972 |   |   | 659,990 |  
|                                       | 
|                                       | 
|Losses and Expenses:                   |  | 
|Losses and loss adjustment expenses    |  |  |   | 823,658   |   |   | 616,763 |   |   | 449,388 |  
|Acquisition expenses                   |  |  |   | 216,984   |   |   | 138,982 |   |   | 112,654 |  
|Operating expenses                     |  |  |   | 102,808   |   |   | 78,015  |   |   | 67,081  |  
|Dividends to policyholders             |  |  |   | 7,587     |   |   | 14,087  |   |   | 18,855  |  
|Interest expense                       |  |  |   | 3,257     |   |   | 6,541   |   |   | 11,889  |  
|                                       | 
|Total losses and expenses              |  |  |   | 1,154,294 |   |   | 854,388 |   |   | 659,867 |  
|                                       | 
|Income (loss) before income taxes      |  |  |   | (79,157   | ) |   | (4,416  | ) |   | 123     |  
|Income tax benefit                     |  |  |   | (31,133   | ) |   | (11,519 | ) |   | (1,202  | )
|                                       | 
|Net income (loss)                      |  |  | $ | (48,024   | ) | $ | 7,103   |   | $ | 1,325   |  
|                                       | 
|                                       | 
|Income (loss) per share:               |  | 
|Basic                                  |  |  | $ | (1.53     | ) | $ | 0.33    |   | $ | 0.06    |  
|                                       | 
|Diluted                                |  |  | $ | (1.53     | ) | $ | 0.32    |   | $ | 0.06    |  
|                                       | 

See accompanying notes to the consolidated
financial statements.

50

---

| | P M A  C A P I T A L
| | --------------------

Consolidated Statements of Cash Flows

|(in thousands)                                               |  |  |   | 2002     |   |   | 2001       |   |   | 2000     |  
|------------------------------------------------------------ |  |  | - | -------- | - | - | ---------- | - | - | -------- | -
|                                                            
|Cash flows from operating activities:                        |  | 
|Net income (loss)                                            |  |  | $ | (48,024  | ) | $ | 7,103      |   | $ | 1,325    |  
|Adjustments to reconcile net income (loss) to net cash flows |  | 
|provided by (used in) operating activities:                  |  | 
|Deferred income tax benefit                                  |  |  |   | (27,527  | ) |   | (3,147     | ) |   | (82      | )
|Net realized investment (gains) losses                       |  |  |   | 16,085   |   |   | (7,988     | ) |   | (11,975  | )
|Gain on sale of real estate                                  |  |  |   | --       |   |   | (9,763     | ) |   | --       |  
|Change in:                                                   |  | 
|Premiums receivable and unearned premiums, net               |  |  |   | 34,516   |   |   | 20,236     |   |   | (18,127  | )
|Dividends to policyholders                                   |  |  |   | (2,134   | ) |   | (114       | ) |   | 3,464    |  
|Reinsurance receivables                                      |  |  |   | (34,319  | ) |   | (276,875   | ) |   | (275,725 | )
|Unpaid losses and loss adjustment expenses                   |  |  |   | 125,451  |   |   | 257,520    |   |   | 120,537  |  
|Funds held by reinsureds                                     |  |  |   | (12,240  | ) |   | (72,588    | ) |   | (54,721  | )
|Funds held under reinsurance treaties                        |  |  |   | 21,778   |   |   | 54,130     |   |   | 79,317   |  
|Accrued investment income                                    |  |  |   | 521      |   |   | 1,746      |   |   | 1,866    |  
|Deferred acquisition costs                                   |  |  |   | (24,872  | ) |   | (15,828    | ) |   | 427      |  
|Accounts payable, accrued expenses and other liabilities     |  |  |   | 25,836   |   |   | 45,122     |   |   | 96,667   |  
|Other, net                                                   |  |  |   | (2,904   | ) |   | (9,129     | ) |   | 1,988    |  
|                                                             | 
|Net cash flows provided by (used in) operating activities    |  |  |   | 72,167   |   |   | (9,575     | ) |   | (55,039  | )
|                                                             | 
|Cash flows from investing activities:                        |  | 
|Fixed maturities available for sale:                         |  | 
|Purchases                                                    |  |  |   | (964,047 | ) |   | (1,054,794 | ) |   | (422,350 | )
|Maturities and calls                                         |  |  |   | 256,625  |   |   | 297,549    |   |   | 121,814  |  
|Sales                                                        |  |  |   | 634,480  |   |   | 833,884    |   |   | 408,233  |  
|Equity securities:                                           |  | 
|Purchases                                                    |  |  |   | --       |   |   | --         |   |   | (24,706  | )
|Sales                                                        |  |  |   | --       |   |   | --         |   |   | 78,182   |  
|Net purchases of short-term investments                      |  |  |   | (29,942  | ) |   | (102,637   | ) |   | (131,688 | )
|Proceeds from sale of real estate                            |  |  |   | --       |   |   | 14,401     |   |   | --       |  
|Other, net                                                   |  |  |   | (20,961  | ) |   | (8,071     | ) |   | (29,522  | )
|                                                             | 
|Net cash flows used in investing activities                  |  |  |   | (123,845 | ) |   | (19,668    | ) |   | (37      | )
|                                                             | 
|Cash flows from financing activities:                        |  | 
|Proceeds from issuance of stock                              |  |  |   | --       |   |   | 157,868    |   |   | --       |  
|Dividends paid to shareholders                               |  |  |   | (12,102  | ) |   | (9,035     | ) |   | (8,020   | )
|Proceeds from exercise of stock options                      |  |  |   | 2,866    |   |   | 1,387      |   |   | 2,866    |  
|Purchase of treasury stock                                   |  |  |   | (1,726   | ) |   | (5,323     | ) |   | (18,427  | )
|Proceeds from issuance of debt                               |  |  |   | 151,250  |   |   | --         |   |   | --       |  
|Debt issue costs                                             |  |  |   | (3,009   | ) |   | --         |   |   | --       |  
|Repayments of debt                                           |  |  |   | (62,500  | ) |   | (100,500   | ) |   | --       |  
|Net repayments (issuance) of notes receivable from officers  |  |  |   | 96       |   |   | (102       | ) |   | --       |  
|                                                             | 
|Net cash flows provided by (used in) financing activities    |  |  |   | 74,875   |   |   | 44,295     |   |   | (23,581  | )
|                                                             | 
|Net increase (decrease) in cash                              |  |  |   | 23,197   |   |   | 15,052     |   |   | (78,657  | )
|Cash - beginning of year                                     |  |  |   | 20,656   |   |   | 5,604      |   |   | 84,261   |  
|                                                             | 
|Cash - end of year                                           |  |  | $ | 43,853   |   | $ | 20,656     |   | $ | 5,604    |  
|                                                             | 
|Supplementary cash flow information:                         |  | 
|Income tax paid (refunded)                                   |  |  | $ | (10,649  | ) | $ | (8,991     | ) | $ | 7,300    |  
|Interest paid                                                |  |  | $ | 2,091    |   | $ | 7,074      |   | $ | 11,795   |  

See accompanying notes to the consolidated
financial statements.

|51
|--

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| | P M A  C A P I T A L
| | --------------------

Consolidated Statements of
Shareholders' Equity

|                                                           |  |  |  
|---------------------------------------------------------- |  |  | -
|(in thousands)                                             |  |  |  
|                                                          
|Class A Common stock:                                      |  | 
|Balance at beginning of year                               |  |  | $
|Issuance of Class A Common stock                           |  |  |  
|Conversion of Common stock into Class A Common stock       |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  |  
|                                                           | 
|Additional paid-in capital - Class A Common stock:         |  | 
|Balance at beginning of year                               |  |  |  
|Issuance of Class A Common stock                           |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  |  
|                                                           | 
|Retained earnings:                                         |  | 
|Balance at beginning of year                               |  |  |  
|Net income (loss)                                          |  |  |  
|Class A Common stock dividends declared                    |  |  |  
|Common stock dividends declared                            |  |  |  
|Reissuance of treasury shares under employee benefit plans |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  |  
|                                                           | 
|Accumulated other comprehensive income (loss):             |  | 
|Balance at beginning of year                               |  |  |  
|Other comprehensive income, net of tax expense:            |  | 
|2002 - $15,710; 2001 - $10,634; 2000 - $17,484;            |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  |  
|                                                           | 
|Notes receivable from officers:                            |  | 
|Balance at beginning of year                               |  |  |  
|Repayment (issuance) of notes receivable from officers     |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  |  
|                                                           | 
|Treasury stock - Class A Common:                           |  | 
|Balance at beginning of year                               |  |  |  
|Purchase of treasury shares                                |  |  |  
|Conversion of Common stock into Class A Common stock       |  |  |  
|Reissuance of treasury shares under employee benefit plans |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  |  
|                                                           | 
|Total shareholders' equity:                                |  | 
|Balance at beginning of year                               |  |  |  
|Net income (loss)                                          |  |  |  
|Issuance of Class A Common stock                           |  |  |  
|Class A Common stock dividends declared                    |  |  |  
|Common stock dividends declared                            |  |  |  
|Purchase of treasury shares                                |  |  |  
|Reissuance of treasury shares under employee benefit plans |  |  |  
|Other comprehensive income                                 |  |  |  
|Repayment (issuance) of notes receivable from officers     |  |  |  
|                                                           | 
|Balance at end of year                                     |  |  | $
|                                                           | 

In 2000, all shares and related dollar
amounts of Common stock ($65,423) and Treasury stock - Common ($5,582) were converted
into Class A Common stock.

See accompanying notes to the consolidated
financial statements.

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Consolidated Statements of
Comprehensive Income (Loss)

|(in thousands)                                                          |  |  |   | 2002    |   |   | 2001   |   |   | 2000   |  
|----------------------------------------------------------------------- |  |  | - | ------- | - | - | ------ | - | - | ------ | -
|                                                                       
|Net income (loss)                                                       |  |  | $ | (48,024 | ) | $ | 7,103  |   | $ | 1,325  |  
|                                                                        | 
|Other comprehensive income (loss), net of tax:                          |  | 
|Unrealized gain on securities:                                          |  | 
|Holding gain arising during the period                                  |  |  |   | 17,355  |   |   | 25,175 |   |   | 40,095 |  
|Less: reclassification adjustment for (gains) losses included           |  | 
|in net income, net of tax expense (benefit): 2002 - ($5,630);           |  | 
|2001 - $2,796; 2000 - $4,191                                            |  |  |   | 10,455  |   |   | (5,192 | ) |   | (7,784 | )
|                                                                        | 
|Total unrealized gain on securities                                     |  |  |   | 27,810  |   |   | 19,983 |   |   | 32,311 |  
|Foreign currency translation gain (loss), net of tax expense (benefit): |  | 
|2002 - $736; 2001 - ($127); 2000 - $87                                  |  |  |   | 1,367   |   |   | (235   | ) |   | 160    |  
|                                                                        | 
|Other comprehensive income, net of tax                                  |  |  |   | 29,177  |   |   | 19,748 |   |   | 32,471 |  
|                                                                        | 
|Comprehensive income (loss)                                             |  |  | $ | (18,847 | ) | $ | 26,851 |   | $ | 33,796 |  
|                                                                        | 

See accompanying notes to the consolidated
financial statements.

|53
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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 is an insurance holding company that owns and operates the following specialty
risk management businesses:

PMA Re PMA Capitals
reinsurance operations offer excess of loss and pro rata property and casualty reinsurance
protection mainly through reinsurance brokers. PMA Re focuses on risk-exposed business,
which it believes allows it to best utilize its underwriting and actuarial expertise.

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. Currently, approximately 90% of The PMA Insurance Groups
business is produced through independent agents and brokers.

Prior to
May 1, 2002, the Company operated a third specialty risk management business, Caliber One,
which wrote excess and surplus lines of business throughout the United States, generally
through surplus lines brokers. Effective May 1, 2002, the Company announced its decision
to withdraw from the excess and surplus lines marketplace. As a result of this decision,
the results of this segment are reported as Run-off Operations. See Note 14 for additional
information.

Note 2. Summary of
Significant Accounting Policies

A.
Basis of Presentation The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
("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, 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 due to
changes in interest rates, changes relating to a decline in credit quality of the issuer,
or general market conditions. 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. Where 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

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| | P M A  C A P I T A L
| | --------------------

against borrower default, with the lending
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.
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 premium 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 loss adjustment expenses on
known claims, and estimates of losses and loss adjustment expenses 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
(collectively "SAP"). 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 therefrom 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 reinsurance and insurance subsidiaries cede business in order
to limit the maximum net loss from large risks and limit the accumulation of
many smaller losses from a catastrophic event. The reinsurance and insurance
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 gross 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 therefrom 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 ceded loss and LAE thresholds are exceeded.

Certain
of the Companys assumed and ceded reinsurance contracts are funds held arrangements.
In a funds held arrangement, the ceding company holds onto 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 earns 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 8% 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.

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.

|55
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Notes to Consolidated Financial Statements
(continued)

F.
Deferred Acquisition Costs Costs that directly relate to and vary with
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, brokerage and premium taxes, as well as other policy issuance costs
and underwriting expenses. The Company determines whether deferred acquisition
costs are recoverable considering future losses and loss adjustment expenses,
maintenance costs and anticipated investment income. To the extent that deferred
acquisition costs are not recoverable, the deficiency is charged to income in
the period identified.

G.
Dividends to Policyholders The PMA Insurance Group issues certain
workers compensation insurance policies with dividend payment features.
These policyholders share in the operating 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.

H.
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.

I.
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.
See Note 2K for additional information.

J.
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 2001, other revenues included a $9.8 million gain on the sale of certain
real estate properties.

K.
Recent Accounting Pronouncements In January 2003, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation  Transition and Disclosure." SFAS No. 148
amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to
require 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. The Company accounts for stock-based employee
compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." Accordingly, the
Company has applied the disclosure provisions of SFAS No. 148 to our Financial
Statements as of and for the year ended December 31, 2002.

The
following table illustrates the effect on net income (loss) if the fair value based method
had been applied:

|(in thousands, except per share)) |  |  |   | 2002    |   |   | 2001   |   |   | 2000   |  
|--------------------------------- |  |  | - | ------- | - | - | ------ | - | - | ------ | -
|                                 
|Net income (loss)                 |  |  | $ | (48,024 | ) | $ | 7,103  |   | $ | 1,325  |  
|Stock-based compensation expense  |  | 
|already included in reported      |  | 
|net income (loss), net of tax     |  |  |   | 140     |   |   | --     |   |   | (650   | )
|Total stock-based compensation    |  | 
|expense determined under fair     |  | 
|value based method, net of tax    |  |  |   | (1,480  | ) |   | (1,043 | ) |   | (1,308 | )
|                                  | 
|Pro forma net income (loss)       |  |  | $ | (49,364 | ) | $ | 6,060  |   | $ | (633   | )
|                                  | 
|Income (loss) per share:          |  | 
|Basic - as reported               |  |  | $ | (1.53   | ) | $ | 0.33   |   | $ | 0.06   |  
|                                  | 
|Basic - pro forma                 |  |  | $ | (1.58   | ) | $ | 0.28   |   | $ | (0.03  | )
|                                  | 
|Diluted - as reported             |  |  | $ | (1.53   | ) | $ | 0.32   |   | $ | 0.06   |  
|                                  | 
|Diluted - pro forma               |  |  | $ | (1.58   | ) | $ | 0.27   |   | $ | (0.03  | )
|                                  | 

In May 2002, the Company announced its
decision to withdraw from the excess and surplus lines marketplace previously served by
its Caliber One operating segment. The Company accounted for the discontinuation of this
business under the provisions of SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which are effective January 1, 2002. SFAS No. 144
supersedes SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," and the accounting and reporting provisions
of APB Opinion No. 30,

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"Reporting the Results of
Operations  Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," and
establishes a single accounting model for the disposal of long-lived assets and asset
groups.

In
January 2003, the Company sold the capital stock of Caliber One Indemnity Company.
Pursuant to the agreement of sale, the Company has retained all assets and liabilities
related to in-force policies and outstanding claim obligations and will run-off such
in-force policies and claim obligations. Accordingly, under SFAS No. 144, the results of
operations of this segment are reported in results from continuing operations, and will
continue to be reported as such until all in-force policies and outstanding claim
obligations are satisfied, at which point the Company will report the results of the
Run-off segment as discontinued operations. The long-lived assets of this segment were
tested for impairment in the second quarter of 2002 in accordance with the provisions of
SFAS No. 144. See Note 14 for additional information.

In
July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit
or Disposal Activities." SFAS No. 146 requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied prospectively
to exit or disposal activities initiated after December 31, 2002. Accordingly, this
standard does not apply to the Companys exit from the excess and surplus lines
business, which was announced in May 2002.

In
January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable
Interest Entities" ("FIN 46") which requires a company to assess if
consolidation of an entity is appropriate based upon its variable economic interests in a
variable interest entity ("VIE"). The initial determination of whether an
entity is a VIE is required to be made on the date at which a company becomes involved
with the entity. A VIE is an entity in which the equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional subordinated financial
support from other parties. A company shall consolidate a VIE if the company has a
variable interest that will absorb a majority of the VIEs expected losses if they occur,
receive a majority of the entitys expected residual returns if they occur or both.

FIN
46 is effective for new VIEs established subsequent to January 31, 2003, and for existing
VIEs as of July 1, 2003. FIN 46 also requires the disclosure of certain information
related to VIEs in which the company holds a significant variable interest. The Company is
currently assessing the impact that implementing FIN 46 may have on its consolidated
financial statements. In this regard, the Company will be evaluating whether Trabaja
Reinsurance Company ("Trabaja") is a variable interest entity as defined in
FIN 46 and, if so, whether the Companys business activities with Trabaja would
warrant consolidation and/or additional disclosure in the Companys future financial statements.
The Company expects that any impact from implementing FIN 46 would be a non-cash
adjustment recorded in its consolidated financial statements as a cumulative effect
adjustment no later than the third quarter of 2003. Any such cumulative effect adjustment
may be material to the Companys consolidated financial condition and results of
operations. However, there will be no effect on the statutory capital of the
Companys insurance subsidiaries. See Note 5 for additional information regarding the
Companys business activities with Trabaja.

In
November 2002, the FASB issued Interpretation No. 45, "Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others" ("FIN 45"). FIN 45 requires certain guarantees to be
recorded at fair value and also requires a guarantor to make certain disclosures, even
when the likelihood of making payments under the guarantee is remote. Generally, FIN 45
applies to contracts or indemnification agreements that contingently require the guarantor
to make payments to the guaranteed party. The recognition provisions of FIN 45 are
effective on a prospective basis for guarantees issued or modified after December 31,
2002. The disclosure requirements are effective for financial statements of interim and
annual periods ending after December 15, 2002. The Company is currently assessing the
impact of adopting FIN 45, and currently does not expect that it will have a material
adverse effect on the Companys consolidated financial condition, results of
operations or liquidity.

Effective
January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible
Assets." In accordance with SFAS No. 142, the Company no longer amortizes goodwill,
but instead tests it periodically for impairment. As of December 31, 2002, the Company had
approximately $3.0 million of goodwill, which is included in other assets on the balance
sheet. Amortization of goodwill was $960,000, or $0.04 per basic and diluted share, for 2001, and
$220,000, or $0.01 per basic and diluted share, for 2000. For the
year ended December 31, 2002, the Company recognized an impairment charge of $1.3 million
associated with the goodwill of the Run-off Operations, which is included in Operating
expenses.

|57
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Notes to Consolidated Financial Statements
(continued)

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 15% of invested assets at December 31, 2002. Included in this
industry segment are financial institutions, including the financing subsidiaries of
automotive manufacturers.

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

|(dollar amounts in thousands)                                        |  | AmortizedCost |   | GrossUnrealizedGains |  | GrossUnrealizedLosses |        | FairValue |  
|-------------------------------------------------------------------- |  | ------------- | - | -------------------- |  | --------------------- | ------ | --------- | -
|                                                                    
|                                                                    
|December 31, 2002                                                    |  |               |   |                      |  |                       |        |           |  
|Fixed maturities available for sale:                                 |  |              
|U.S. Treasury securities and obligations of U.S. Government agencies |  |               | $ | 315,911              |  | $                     | 13,490 |           | $
|States, political subdivisions and foreign government securities     |  |               |   | 10,217               |  |                       | 936    |           |  
|Corporate debt securities                                            |  |               |   | 608,407              |  |                       | 28,026 |           |  
|Mortgage-backed and other asset-backed securities                    |  |               |   | 543,386              |  |                       | 22,018 |           |  
|                                                                     | 
|Total fixed maturities available for sale                            |  |               |   | 1,477,921            |  |                       | 64,470 |           |  
|Short-term investments                                               |  |               |   | 298,686              |  |                       | --     |           |  
|                                                                     | 
|Total investments                                                    |  |               | $ | 1,776,607            |  | $                     | 64,470 |           | $
|                                                                     | 
|December 31, 2001                                                    |  |              
|Fixed maturities available for sale:                                 |  |              
|U.S. Treasury securities and obligations of U.S. Government agencies |  |               | $ | 263,633              |  | $                     | 4,563  |           | $
|States, political subdivisions and foreign government securities     |  |               |   | 16,857               |  |                       | 272    |           |  
|Corporate debt securities                                            |  |               |   | 594,477              |  |                       | 13,354 |           |  
|Mortgage-backed and other asset-backed securities                    |  |               |   | 541,934              |  |                       | 10,215 |           |  
|                                                                     | 
|Total fixed maturities available for sale                            |  |               |   | 1,416,901            |  |                       | 28,404 |           |  
|Short-term investments                                               |  |               |   | 350,054              |  |                       | --     |           |  
|                                                                     | 
|Total investments                                                    |  |               | $ | 1,766,955            |  | $                     | 28,404 |           | $
|                                                                     | 

The amortized cost and fair value of
fixed maturities at December 31, 2002, by contractual maturity, are included in the table
below:

|(dollar amounts in thousands)                     |  | AmortizedCost |   | FairValue | 
|------------------------------------------------- |  | ------------- | - | --------- | 
|                                                 
|                                                 
|2003                                              |  |               | $ | 90,227    | 
|2004-2007                                         |  |               |   | 380,839   | 
|2008-2012                                         |  |               |   | 232,103   | 
|2013 and thereafter                               |  |               |   | 231,366   | 
|Mortgage-backed and other asset-backed securities |  |               |   | 543,386   | 
|                                                  | 
|                                                  |  |               | $ | 1,477,921 | 
|                                                  | 

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

Net
investment income consists of the following:

|(dollar amounts in thousands) |  |  |   | 2002   |   |   | 2001    |   |   | 2000    |  
|----------------------------- |  |  | - | ------ | - | - | ------- | - | - | ------- | -
|                             
|Fixed maturities              |  |  | $ | 84,957 |   | $ | 91,530  |   | $ | 103,490 |  
|Equity securities             |  |  |   | --     |   |   | --      |   |   | 716     |  
|Short-term investments        |  |  |   | 5,073  |   |   | 7,048   |   |   | 8,513   |  
|Other                         |  |  |   | 913    |   |   | 2,911   |   |   | 3,002   |  
|                              | 
|Total investment income       |  |  |   | 90,943 |   |   | 101,489 |   |   | 115,721 |  
|Investment expenses           |  |  |   | (3,173 | ) |   | (2,559  | ) |   | (2,490  | )
|Interest on funds held, net   |  |  |   | (2,889 | ) |   | (11,985 | ) |   | (10,640 | )
|                              | 
|Net investment income         |  |  | $ | 84,881 |   | $ | 86,945  |   | $ | 102,591 |  
|                              | 

The Company recognized income, net of
lending fees, from securities lending transactions of $360,000, $383,000 and $600,000 in
2002, 2001 and 2000, respectively, which was included in net investment income. At
December 31, 2002, the Company had no securities on loan.

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

|(dollar amounts in thousands)      |  |  |   | 2002    |   |   | 2001   |   |   | 2000   |  
|---------------------------------- |  |  | - | ------- | - | - | ------ | - | - | ------ | -
|                                  
|Realized gains:                    |  | 
|Fixed maturities                   |  |  | $ | 18,659  |   | $ | 15,768 |   | $ | 3,423  |  
|Equity securities                  |  |  |   | --      |   |   | --     |   |   | 15,698 |  
|                                   | 
|                                   |  |  |   | 18,659  |   |   | 15,768 |   |   | 19,121 |  
|Realized losses - fixed maturities |  |  |   | (34,744 | ) |   | (7,780 | ) |   | (7,146 | )
|                                   | 
|Total net realized                 |  | 
|investment gains (losses)          |  |  | $ | (16,085 | ) | $ | 7,988  |   | $ | 11,975 |  
|                                   | 

Net realized investment losses for 2002
include impairment losses of $23.8 million on fixed income securities, primarily corporate
bonds issued by telecommunications and energy companies, including $14.2 million for
WorldCom. Net realized losses for 2001 include impairment losses of $1.6 million. 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. No impairment losses were recorded in 2000.

The
change in unrealized gains (losses) on investments for 2002, 2001 and 2000 was $43.6
million, $30.7 million and $49.7 million, respectively, attributable to fixed maturities.

On
December 31, 2002, the Company had securities with a total amortized cost of $38.5 million
and fair value of $39.8 million on deposit with various governmental authorities, as
required by law. In addition, at December 31, 2002, securities with a total amortized cost
of $24.1 million and fair value of $25.0 million were pledged as collateral for letters of
credit issued on behalf of the Company. A security with an amortized cost of $1.9 million
and fair value of $2.0 million was pledged as collateral for an executive loan program with a
financial institution. Securities with a total amortized cost of $5.4
million and fair value of $5.5 million were held in trust to support the Companys
participation in the underwriting capacity of a Lloyds of London syndicate. The
securities on deposit, pledged as collateral or held in trust are included in Fixed
Maturities on the balance sheets.

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) |  |  |   | 2002      |   |   | 2001      |   |   | 2000      |  
|----------------------------- |  |  | - | --------- | - | - | --------- | - | - | --------- | -
|                             
|Balance at January 1          |  |  | $ | 2,324,439 |   | $ | 2,053,138 |   | $ | 1,932,601 |  
|Less: reinsurance             |  | 
|recoverable on unpaid         |  | 
|losses and LAE                |  |  |   | 1,181,322 |   |   | 924,429   |   |   | 648,227   |  
|                              | 
|Net balance at January 1      |  |  |   | 1,143,117 |   |   | 1,128,709 |   |   | 1,284,374 |  
|                              | 
|Losses and LAE incurred, net: |  | 
|Current year,                 |  | 
|net of discount               |  |  |   | 655,395   |   |   | 586,392   |   |   | 432,767   |  
|Prior years                   |  |  |   | 159,748   |   |   | 23,512    |   |   | 6,491     |  
|Accretion of                  |  | 
|prior years' discount         |  |  |   | 8,515     |   |   | 6,859     |   |   | 10,130    |  
|                              | 
|Total losses and LAE          |  | 
|incurred, net                 |  |  |   | 823,658   |   |   | 616,763   |   |   | 449,388   |  
|                              | 
|Losses and LAE paid, net:     |  | 
|Current year                  |  |  |   | (138,127  | ) |   | (145,352  | ) |   | (110,188  | )
|Prior years                   |  |  |   | (594,342  | ) |   | (457,003  | ) |   | (445,865  | )
|                              | 
|Total losses and LAE          |  | 
|paid, net                     |  |  |   | (732,469  | ) |   | (602,355  | ) |   | (556,053  | )
|                              | 
|Reserves transferred          |  |  |   | (50,000   | ) |   | --        |   |   | (49,000   | )
|                              | 
|Net balance at December 31    |  |  |   | 1,184,306 |   |   | 1,143,117 |   |   | 1,128,709 |  
|Reinsurance recoverable       |  | 
|on unpaid losses and LAE      |  |  |   | 1,265,584 |   |   | 1,181,322 |   |   | 924,429   |  
|                              | 
|Balance at December 31        |  |  | $ | 2,449,890 |   | $ | 2,324,439 |   | $ | 2,053,138 |  
|                              | 

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. 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. In
general, liabilities 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, 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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Notes to Consolidated Financial Statements
(continued)

Losses
and LAE incurred in 2001 were impacted by the September 11th terrorist attack on the World
Trade Center. The Company incurred $30 million of pre-tax net losses from this
catastrophe. Gross losses of approximately $145 million resulted from this catastrophe,
which is before (1) reinsurance recoveries ($120 million), (2) additional premiums due to
PMA Res retrocessionaires ($30 million) and (3) additional premiums due to PMA Re on
its assumed business ($25 million). The Companys estimate of net loss from the
September 11th terrorist attack on the World Trade Center continues to be approximately
$30 million pre-tax and is based on its analysis to date of known exposures. However, it
is difficult to fully estimate the Companys loss from the attack given the uncertain
nature of damage theories and loss amounts, and the development of additional facts
related to the attack. As more information becomes available, the Companys estimate
of these losses may need to be increased.

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)     |  |  |   | 2002    |  |   | 2001   |   |   | 2000   |  
|--------------------------------- |  |  | - | ------- |  | - | ------ | - | - | ------ | -
|                                 
|PMA Re                            |  |  | $ | 106,866 |  | $ | (1,568 | ) | $ | 9,691  |  
|The PMA Insurance Group           |  |  |   | 1,082   |  |   | 2,889  |   |   | (6,074 | )
|Run-off Operations                |  |  |   | 51,800  |  |   | 22,191 |   |   | 2,874  |  
|                                  | 
|Total net unfavorable development |  |  | $ | 159,748 |  | $ | 23,512 |   | $ | 6,491  |  
|                                  | 

During 2002, PMA Re recorded unfavorable
prior year development of $106.9 million. In the fourth quarter, PMA Res actuarial
department conducted its routine year-end reserve study to determine the impact of any
emerging data on anticipated loss development trends and recorded unpaid losses and LAE
reserves. During the fourth quarter, the Companys actuaries noticed a higher than
expected increase in level of reported losses by
our ceding companies. Based on the actuarial work performed, which included analyzing
recent trends in the levels of the reported and paid claims using
various loss projection techniques, an updated selection of
actuarially determined loss reserve estimates was developed by accident year for each
major line of business written by PMA Re. Managements selection of the ultimate
losses indicated that gross loss and LAE reserves for prior accident years needed to be increased by approximately
$86 million in the fourth quarter, primarily for excess of loss and pro rata general
liability occurrence contracts ($54 million) and, to a lesser extent, excess of loss
general liability claims-made contracts ($13 million), from accident years 1998, 1999 and
2000. Under existing retrocessional contracts, approximately $22 million of the higher
than expected losses were ceded to PMA Res retrocessionaires, reducing the impact on
net losses and LAE to approximately $64 million.

The
remaining $43 million of unfavorable prior year development at PMA Re in 2002 primarily
reflects the recording of losses and LAE on additional earned premium recorded during 2002
as a result of a change in our estimate of ultimate premiums written from prior years.
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
reviews of estimated ultimate premiums written, which compared actual reported premiums to
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, PMA Re 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.

In
2001, PMA Re recorded favorable prior year development of $1.6 million, reflecting
re-estimated loss trends for prior accident years that were lower than previous
expectations and concentrated in casualty lines of business.

In
2000, PMA Re recorded unfavorable prior year development of $9.7 million, mainly
reflecting the recognition of higher than expected losses and LAE primarily from more
recent accident years, partially offset by lower than expected losses and LAE for accident
years 1996 and prior. The unfavorable development primarily related to coverages for 1998
and 1999 written on a pro rata basis, partially offset by lower than expected losses and
LAE for treaties covering losses occurring in accident years 1996 and prior. In the third
quarter, the Company increased its estimate of gross loss and LAE reserves by $83
million primarily reflecting higher than expected losses mainly in the Companys pro
rata business. The concentration of estimated adverse loss development related primarily
to general liability treaties written on a claims made basis covering losses in 1998 and
1999, property treaties covering 1999 losses and, to a lesser extent, commercial
automobile liability treaties covering losses in 1998 and 1999. In addition, the third
quarter reserve increase reflects unfavorable prior year loss reserve development in the
excess of loss general liability line for accident years 1998 and 1999. Under existing
retrocessional contracts, $60 million of gross losses were ceded to PMA Res
retrocessionaires, reducing the impact on net incurred losses and LAE to $23 million
during the third quarter. This net unfavorable prior year development was partially offset
by favorable loss development for accident years prior to 1997.

60

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The
PMA Insurance Group experienced unfavorable prior year development of $1.1 million and
$2.9 million in 2002 and 2001, respectively, and favorable prior year development of $6.1
million in 2000. The unfavorable prior year development in 2002 and 2001 reflects higher
than expected claims handling costs. The favorable prior year development in 2000
primarily reflects better than expected loss experience from loss-sensitive and
rent-a-captive workers compensation business. Premium adjustments for loss-sensitive
business and policyholders dividends for rent-a-captive business 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
2002, the Run-off Operations recorded unfavorable prior year development of approximately
$52 million. 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 range of
actuarially determined loss reserve estimates was developed by accident year for each
major line of business written by Caliber One. Managements selection of the ultimate
losses resulting from their reviews indicated that net loss reserves for prior accident
years, mainly 1999 and 2000, needed to be increased by approximately $52 million, net of
$12 million of ceded losses. 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.

As
a result of its reserve reviews conducted during 2001, the Run-off Operations revised its
estimate of ultimate expected claims activity and, accordingly, increased its estimate of
ultimate losses, substantially all for accident years 1999 and 2000. During 2001, the
Run-off Operations recorded unfavorable prior year development of $22.2 million, which is
net of losses of approximately $26 million ceded to third party reinsurers under existing
reinsurance contracts. These losses primarily reflect higher than expected claim frequency
and severity that emerged in 2001 on certain casualty lines of business, primarily
professional liability policies for the nursing homes class of business and, to a lesser
extent, property lines of business.

During
2000, the Run-off Operations recorded unfavorable prior year development of $2.9 million,
primarily related to the emergence of higher than expected losses and LAE in certain
segments of the professional liability (nursing homes), commercial automobile, general
liability and property lines of business for coverage of 1999 exposures. During 2000, the
Run-off Operations discontinued writing or cancelled policies in the professional
liability (nursing homes) and commercial automobile classes of business that produced the
emergence of higher than expected losses.

Reserves
transferred in 2002 and 2000 reflect the assumption of PMA Res and The PMA Insurance
Groups losses by an unaffiliated third party. Cash and short-term investments of $50
million and $49 million were transferred in 2002 and 2000, respectively, to support the
payment of the transferred reserves.

Unpaid
losses for the Companys workers compensation claims, net of reinsurance, at
December 31, 2002 and 2001 were $368.7 million and $363.5 million, net of discount of
$82.7 million and $91.0 million, respectively. The discount rate used was approximately 5%
at December 31, 2002 and 2001.

The
Companys loss reserves were stated net of salvage and subrogation of $41.1 million
and $40.8 million at December 31, 2002 and 2001, respectively.

Management
believes that its unpaid losses and LAE are fairly stated at December 31, 2002. However,
estimating the ultimate claims liability is necessarily a complex and judgmental process
inasmuch as the amounts are based on managements informed estimates 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, regulatory trends on benefit levels for both medical and indemnity
payments, 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, 2002, the related adjustments could have a
material adverse effect on the Companys financial condition, results of operations
and liquidity.

At
December 31, 2002, 2001 and 2000, gross reserves for asbestos-related losses were $42.1
million, $59.9 million and $49.2 million, respectively ($25.8 million, $28.6 million and
$32.0 million, net of reinsurance, respectively). Of the net asbestos reserves,
approximately $22.9 million, $26.6 million and $27.2 million related to IBNR losses at
December 31, 2002, 2001 and 2000, respectively.

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Notes to Consolidated Financial Statements
(continued)

At
December 31, 2002, 2001 and 2000, gross reserves for environmental-related losses were
$18.2 million, $29.6 million and $29.5 million, respectively ($14.3 million, $16.0 million
and $18.0 million, net of reinsurance, respectively). Of the net environmental reserves,
approximately $7.9 million, $9.2 million and $9.2 million related to IBNR losses at
December 31, 2002, 2001 and 2000, 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 and results of
operations.

Note 5. Reinsurance

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

|(dollar amounts in thousands) |  |  |   | 2002      |   |   | 2001     |   |   | 2000     |  
|----------------------------- |  |  | - | --------- | - | - | -------- | - | - | -------- | -
|                             
|Written premiums:             |  | 
|Direct                        |  |  | $ | 604,984   |   | $ | 531,286  |   | $ | 422,537  |  
|Assumed                       |  |  |   | 781,562   |   |   | 485,568  |   |   | 398,726  |  
|Ceded                         |  |  |   | (281,549  | ) |   | (247,796 | ) |   | (275,708 | )
|                              | 
|Net                           |  |  | $ | 1,104,997 |   | $ | 769,058  |   | $ | 545,555  |  
|                              | 
|Earned premiums:              |  | 
|Direct                        |  |  | $ | 599,827   |   | $ | 508,821  |   | $ | 416,152  |  
|Assumed                       |  |  |   | 691,740   |   |   | 466,975  |   |   | 393,828  |  
|Ceded                         |  |  |   | (300,556  | ) |   | (243,356 | ) |   | (278,556 | )
|                              | 
|Net                           |  |  | $ | 991,011   |   | $ | 732,440  |   | $ | 531,424  |  
|                              | 
|Losses and LAE:               |  | 
|Direct                        |  |  | $ | 503,867   |   | $ | 478,013  |   | $ | 368,424  |  
|Assumed                       |  |  |   | 543,025   |   |   | 498,366  |   |   | 389,724  |  
|Ceded                         |  |  |   | (223,234  | ) |   | (359,616 | ) |   | (308,760 | )
|                              | 
|Net                           |  |  | $ | 823,658   |   | $ | 616,763  |   | $ | 449,388  |  
|                              | 

Losses and LAE ceded for 2001 included approximately
$120 million related to the September 11th attack on the World Trade Center.

At
December 31, 2002, the Company had reinsurance receivables due from the following
unaffiliated reinsurers in excess of 5% of shareholders equity:

|(dollar amounts in thousands) |  | ReinsuranceReceivables |   | Collateral | 
|----------------------------- |  | ---------------------- | - | ---------- | 
|                             
|The London Reinsurance Group  |  |                        |   |            | 
|and Affiliates(1)             |  |                        | $ | 421,415    | 
|St. Paul and Affiliates(2)    |  |                        |   | 157,196    | 
|Underwriters Re               |  |                        |   | 101,500    | 
|Houston Casualty              |  |                        |   | 97,050     | 
|PXRE                          |  |                        |   | 53,520     | 
|PartnerRe                     |  |                        |   | 39,781     | 
|Folksamerica Re               |  |                        |   | 36,157     | 
|Berkley Insurance Company     |  |                        |   | 35,985     | 

|(1) |  | Includes
Trabaja Reinsurance Company ($369.7 million), London Life &          General
Reinsurance Company ($50.7 million) and London Life &          Casualty Reinsurance
Corporation ($1.0 million).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes
United States Fidelity & Guaranty Insurance Company ($106.4 million) and Mountain
Ridge InsuranceCompany ($50.8 million).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------

The Company performs credit reviews of
its reinsurers focusing on, among other things, financial capacity, stability, trends and
commitment to the reinsurance business. Prospective and existing 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, consisting
generally of those not authorized to transact business in the applicable jurisdictions.

62

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At December 31, 2002 and 2001, the Companys
reinsurance receivables of $1,295.1 million and $1,210.8 million were supported by $666.9
million and $626.9 million of collateral. Of the uncollateralized reinsurance receivables
as of December 31, 2002, approximately 91% were recoverable from reinsurers rated "A-" or
better by A.M. Best. The Company believes that the amounts receivable from reinsurers are
fully collectible and that the valuation allowance is adequate to cover any disputes
about amounts owed by reinsurers to the Company.

Our
largest reinsurance receivable is due from Trabaja Reinsurance Company ("Trabaja"). Reinsurance
receivables from Trabaja were $369.7 million at December 31, 2002, of which 81% 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.

The
total equity of Trabaja as of December 31, 2002 and 2001 is $1.3 million and $679,000,
respectively. Management believes that the assets of Trabaja of $272.5 million at December
31, 2002, are sufficient to satisfy Trabajas reinsurance obligations to the Company.
All of Trabajas reinsurance transactions are conducted with the Company.

In
January 2002, the Company supplemented its in-force reinsurance programs for PMA Re and
The PMA Insurance Group with retroactive reinsurance contracts with Trabaja that provide
coverage for adverse loss development on certain lines of business written
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. Such funding was provided by the Company in 2002. Under the terms of the
contracts, PMA Res losses and LAE ceded to Trabaja for accident years 1996 through
2001 are recoverable as they are incurred by the Company. In 2002, PMA Re 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. In addition
to the transfer of assets and loss reserves of $50 million in 2002 to Trabaja, PMA also
transferred $49 million of assets and loss reserves to Trabaja in 2000.

Note 6. Debt

At December 31, 2002, the Company had
$65.0 million outstanding under its new credit facility ("Credit Facility"),
which was executed in September 2002 and replaced the Companys existing bank
facility that was scheduled to mature at December 31, 2002. The proceeds from the Credit
Facility were used to repay the existing bank facility, which had $62.5 million
outstanding. The Credit Facility will mature in September 2003, or the Company may convert
the outstanding principal amount into a term loan that matures June 30, 2004, if the
Company meets certain financial performance targets. At December 31, 2002, the interest
rate on the utilized portion of the Credit Facility was 3.6%, which equals the London
InterBank Offered Rate ("LIBOR") plus 1.8%. The Credit Facility carries a
facility fee on any unutilized portion of 0.375% per annum. Effective March 2003, the
Company amended the Credit Facility to reduce it to $45 million in borrowing capacity and
repaid $20 million. In addition, the March 2003 amendment increased the interest rate to
LIBOR plus 2.125%.

In
October 2002, the Company issued $86.25 million of 4.25%
convertible senior debentures ("Convertible Debt") due September 30, 2022
from which the Company received net proceeds of approximately $83.7 million. The
Convertible Debt bears interest at a rate of 4.25% per annum, payable semi-annually,
beginning on March 30, 2003. In addition, contingent interest may be payable by the
Company to the holders of the Convertible Debt commencing September 30, 2006, under
certain circumstances. Each $1,000 principal amount of the Convertible Debt is convertible
into 61.0948 shares of the Companys Class A common stock under certain events
specified in the indenture, including once the stock price reaches $19.64 for a specified period
of time or if the Companys senior debt rating is below Ba3 or BB-. Further, holders
of the Convertible Debt, at their option, may require the Company to repurchase all or a
portion of their debentures 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. See Note 8 for additional information.

The
Company has a letter of credit facility (the "Letter of Credit Facility")
which provides for up to $50.0 million in letter of credit capacity. At December 31, 2002
and 2001, the aggregate outstanding face amount of letters of credit issued was $15.7
million and $27.9 million, respectively. The Letter

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Notes to Consolidated Financial Statements
(continued)

of Credit Facility is utilized primarily for
collateralizing reinsurance obligations of the insurance subsidiaries of the Company. At
December 31, 2002, fees for the Letter of Credit Facility were 0.45% per annum on the
utilized portion and 0.15% on the unutilized portion.

The
debt covenants supporting the Credit Facility and the Letter of Credit Facility contain
provisions that, among other matters, limit the Companys ability to incur additional
indebtedness, merge, consolidate and acquire or sell assets. The debt covenants of the
Companys currently outstanding debt also require the Company to satisfy certain
ratios related to statutory surplus, debt-to-capitalization, cash coverage, risk-based
capital and reinsurance recoverables to equity. Additionally, the debt covenants place
restrictions on dividends to shareholders.

Note 7. Commitments and
Contingencies

For the years ended December 31, 2002, 2001
and 2000 total rent expense was $4.1 million, $3.9 million and $3.4 million, respectively.
At December 31, 2002, the Company was obligated under noncancelable operating leases for
office space with aggregate minimum annual net rentals of $5.0 million in 2003, $3.4
million in 2004, $3.3 million in 2005, $3.0 million in 2006 and $18.3 million thereafter,
net of sublease rentals of $242,000 in 2003, $1.5 million in 2004, 2005 and 2006, and
$12.6 million thereafter. In addition, the Company was obligated under noncancelable
operating leases for office computers, equipment and other items of $2.7 million in 2003,
$1.8 million in 2004, $881,000 in 2005, $426,000 in 2006 and $65,000 thereafter.

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, 2002 and 2001, the Company
had recorded liabilities of $5.4 million and $3.8 million for these assessments, which is
included in accounts payable, accrued expenses and other liabilities on the balance sheet.

The
Company has provided guarantees of $7.0 million related to loans on properties in which
the Company has an interest. The Company has also provided guarantees of $2.2 million
related to an executive loan program for officers of the Company with a financial
institution. The program expires on December 31, 2003. See Note 16 for additional
information.

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 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, the Company will participate in such
favorable loss reserve development.

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.

Note 8.
Shareholders Equity

Changes in Class A Common stock shares
were as follows:

|                              |  |  |  | 2002       |   |  | 2001       |   |  | 2000       |  
|----------------------------- |  |  |  | ---------- | - |  | ---------- | - |  | ---------- | -
|                             
|Class A Common stock:         |  | 
|Balance at beginning of year  |  |  |  | 34,217,945 |   |  | 24,442,945 |   |  | 11,358,280 |  
|Issuance of Class A           |  | 
|Common stock                  |  |  |  | --         |   |  | 9,775,000  |   |  | --         |  
|Conversion of Common stock    |  | 
|into Class A Common stock     |  |  |  | --         |   |  | --         |   |  | 13,084,665 |  
|                              | 
|Balance at end of year        |  |  |  | 34,217,945 |   |  | 34,217,945 |   |  | 24,442,945 |  
|                              | 
|Treasury stock - Class A      |  | 
|Common stock:                 |  | 
|Balance at beginning of year  |  |  |  | 3,050,939  |   |  | 2,869,629  |   |  | 1,665,426  |  
|Purchase of treasury shares   |  |  |  | 90,185     |   |  | 299,300    |   |  | 988,800    |  
|Reissuance of treasury shares |  | 
|under employee benefit plans  |  |  |  | (252,101   | ) |  | (117,990   | ) |  | (220,604   | )
|Conversion of Common stock    |  | 
|into Class A Common stock     |  |  |  | --         |   |  | --         |   |  | 436,007    |  
|                              | 
|Balance at end of year        |  |  |  | 2,889,023  |   |  | 3,050,939  |   |  | 2,869,629  |  
|                              | 

In December 2001, the Company issued
9,775,000 shares of its Class A Common stock, realizing net proceeds of $157.9 million.
The Company used the net proceeds from this issuance to contribute additional capital to
its reinsurance

64

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| | P M A  C A P I T A L
| | --------------------

subsidiary and to repay $62.5 million of
its outstanding debt under its Credit Facility.

The
Company repurchased 90,000 shares of its Class A Common stock at a cost of $1.7 million in
2002, 299,000 shares at a cost of $5.3 million in 2001 and 989,000 shares at a cost of
$18.4 million in 2000. The Companys remaining share repurchase authorization at
December 31, 2002 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 $0.42, $0.42 and $0.39 per share
in 2002, 2001 and 2000, respectively. The Company declared dividends on its Common stock
of $0.08 per share in 2000.

Effective
on the close of business April 24, 2000, the Company eliminated its class of Common stock
from the Companys authorized capital and reclassified each issued share of Common
stock (13,084,665 shares of Common stock and 436,007 shares of Common Treasury stock) into
one share of Class A Common stock. In addition, in early 2000 the Company authorized
2,000,000 shares of undesignated Preferred stock, $0.01 par value per share. 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 the
holding company is limited by the insurance laws and regulations of Pennsylvania. All of
PMA Capitals domestic insurance entities are owned by PMA Capital Insurance Company
("PMACIC"). As a result, dividends from The PMA Insurance Groups
Pooled Companies may not be paid directly to PMA Capital. Instead, only PMACIC, a
Pennsylvania domiciled company, may pay dividends directly to PMA Capital. Approximately
$58 million of dividends are available to be paid by PMACIC to PMA Capital in 2003 without
the prior approval of the Pennsylvania Insurance Commissioner. As of December 31, 2002,
The PMA Insurance Groups Pooled Companies can pay up to $24.6 million in dividends
to PMACIC during 2003. Dividends received from subsidiaries were $28.0 million, $29.6
million and $36.0 million in 2002, 2001 and 2000, respectively.

PMA
Capitals dividends to shareholders are restricted by certain of its debt agreements.
Under the most restrictive debt covenant of the Credit Facility and the Letter of
Credit Facility, the Company would be able to pay dividends of approximately $25 million
in 2003.

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 3,401,652 Class A Common
shares were reserved for issuance at December 31, 2002. The stock options are granted
under terms and conditions determined by the Stock Option Committee of the Board of
Directors. Stock options granted have a maximum term of ten years, generally vest over
periods ranging between two 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:

|                                           |  | 2002   |                  | 2001                 |                  | 2000   |      
|------------------------------------------ |  | ------ | ---------------- | -------------------- | ---------------- | ------ | -----
|                                           |  |        |                  |                      |                  |       
|                                           |  | Shares |                  | WeightedAveragePrice |                  | Shares |      
|                                          
|Options outstanding, beginning of year     |  |        |                  | 3,387,154            |                  | $      | 16.45
|Options granted                            |  |        |                  | 440,500              |                  |        | 19.50
|Options exercised                          |  |        |                  | (302,465             | )                |        | 12.66
|Options forfeited or expired               |  |        |                  | (428,695             | )                |        | 18.78
|                                           | 
|Options outstanding, end of year(1)        |  |        |                  | 3,096,494            |                  | $      | 16.93
|                                           | 
|Options exercisable, end of year           |  |        |                  | 2,059,729            |                  | $      | 15.74
|                                           | 
|Option price range at end of year          |  |        | $11.50 to $21.50 |                      | $10.00 to $21.50 |        |      
|Option price range for exercised shares    |  |        | $10.00 to $17.00 |                      | $8.00 to $17.00  |        |      
|Options available for grant at end of year |  |        | 305,158          |                      | 48,466           |        |      

|(1) |  | Included
in the options outstanding at the end of 2002, 2001 and 2000           are 260,000,
420,000 and 420,000 options ("Target Price           Options"), respectively, with an
exercise price of $17.00, which would           have become exercisable had the Companys
Class A Common stock           achieved certain target prices by February 2003. Because
the stock did not reach the necessary price, the Target Price Options expired as unvested
          options in February 2003. In 2000, the Company reduced the accrual for
          these Target Price Options by approximately $1 million. There was no accrued
          liability for the Target Price Options as of December 31, 2002 and 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|65
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| | --------------------

Notes to Consolidated Financial Statements
(continued)

Of the total options granted in 2002,
225,000 were granted with an exercise price that was lower than the market value on the
grant date ("in-the-money"), 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 were granted with an exercise price that exceeded the market value
on the grant date ("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. In 2001
and 2000, all options were granted out-of-the-money at an exercise price of $20.00 and
$21.50 per share and a fair value of $6.39 and $7.16 per share, respectively.

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. Included in the Companys net loss
for 2002 were pre-tax compensation costs of $215,000. No compensation cost was recognized
in 2001. In 2000, net income included a benefit of $1 million pre-tax related to the
Target Price Options as discussed above.

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

|                        |  |  |  | 2002 |   |  | 2001 |   |  | 2000 |  
|----------------------- |  |  |  | ---- | - |  | ---- | - |  | ---- | -
|                       
|Expected life (years)   |  |  |  | 10   |   |  | 10   |   |  | 10   |  
|Risk-free interest rate |  |  |  | 5.1  | % |  | 5.2  | % |  | 6.5  | %
|Expected volatility     |  |  |  | 16.8 | % |  | 15.9 | % |  | 17.1 | %
|Expected dividend yield |  |  |  | 2.0  | % |  | 2.4  | % |  | 2.4  | %

Stock options outstanding and options
exercisable at December 31, 2002 were as follows:

|                 |  | Options Outstanding |  | Options Exercisable          | 
|---------------- |  | ------------------- |  | ---------------------------- | 
|                 |  |                     |  |                             
|Exercise Prices  |  | Numberof Shares     |  | WeightedAverageRemainingLife | 
|                
|                
|$11.50 to $14.00 |  | 572,139             |  | 0.83                         | 
|$14.01 to $16.50 |  | 445,300             |  | 2.43                         | 
|$16.51 to $19.00 |  | 989,750             |  | 3.36                         | 
|$19.01 to $21.50 |  | 1,089,305           |  | 7.63                         | 

See Note 2K 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:

|                                 |  |  |  | 2002       |  |  | 2001       |  |  | 2000       | 
|-------------------------------- |  |  |  | ---------- |  |  | ---------- |  |  | ---------- | 
|                                
|Basic shares - weighted          |  | 
|average shares outstanding       |  |  |  | 31,284,848 |  |  | 21,831,725 |  |  | 21,898,967 | 
|Effect of dilutive stock options |  |  |  | --         |  |  | 384,970    |  |  | 454,655    | 
|                                 | 
|Total diluted shares             |  |  |  | 31,284,848 |  |  | 22,216,695 |  |  | 22,353,622 | 
|                                 | 

For all years presented, there were no
differences in the numerator (net income (loss)) for the basic and diluted earnings per
share calculation.

The
effect of 3.1 million, 873,000 and 840,500 stock options were excluded from the
computation of diluted earnings per share because they would have been anti-dilutive for
2002, 2001 and 2000, respectively.

The
2002 diluted shares do not assume the conversion of the Companys 4.25% convertible
debentures into 5.3 million shares of Class A Common stock because under the terms of the
Convertible Debt agreement they did not meet the required conditions for holders to be
able to convert the debentures. See Note 6 for additional information.

Note 11. Fair Value of
Financial Instruments

As of December 31, 2002, 2001 and 2000,
the carrying amounts for the Companys financial instruments approximated their
estimated fair value, other than the Convertible Debt, which had a fair value of
approximately $95 million, compared to a carrying value of $86.25 million. The Company
measures the fair value of fixed maturities and the Convertible Debt based upon quoted
market prices or by obtaining quotes from dealers. The fair value of bank debt is
estimated using discounted cash flow calculations based upon the Companys current
incremental borrowing rate for similar types of borrowing facilities or the rate utilized
to prepay obligations, where applicable. 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
benefit are:

|(dollar amounts in thousands) |  |  |   | 2002    |   |   | 2001    |   |   | 2000   |  
|----------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------ | -
|                             
|Current                       |  |  | $ | (3,606  | ) | $ | (8,372  | ) | $ | (1,120 | )
|Deferred                      |  |  |   | (27,527 | ) |   | (3,147  | ) |   | (82    | )
|                              | 
|Income tax benefit            |  |  | $ | (31,133 | ) | $ | (11,519 | ) | $ | (1,202 | )
|                              | 

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

|(dollar amounts in thousands)   |  |  |   | 2002    |   |   | 2001    |   |   | 2000   |  
|------------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------ | -
|                               
|Federal income tax at the       |  | 
|statutory rate                  |  |  | $ | (27,705 | ) | $ | (1,546  | ) | $ | 43     |  
|Reversal of income tax accruals |  |  |   | (3,000  | ) |   | (10,076 | ) |   | (1,362 | )
|Other                           |  |  |   | (428    | ) |   | 103     |   |   | 117    |  
|                                | 
|Income tax benefit              |  |  | $ | (31,133 | ) | $ | (11,519 | ) | $ | (1,202 | )
|                                | 

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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)                   | 2002 |  | 2001 |        
|----------------------------------------------- | ---- |  | ---- | -------
|                                                |      |  |      |        
|                                               
|Discounting of unpaid losses and LAE            |      |  | $    | 61,824 
|Net operating loss and tax credit carryforwards |      |  |      | 50,914 
|Unearned premiums                               |      |  |      | 26,870 
|Allowance for uncollectible accounts            |      |  |      | 6,235  
|Postretirement benefit obligation               |      |  |      | 4,715  
|Deferred compensation                           |      |  |      | 1,944  
|Depreciation                                    |      |  |      | 2,043  
|Guaranty funds and other assessments            |      |  |      | 1,604  
|Other                                           |      |  |      | 9,706  
|                                                |     
|Gross deferred tax assets                       |      |  |      | 165,855
|Valuation allowance                             |      |  |      | --     
|                                                |     
|Deferred tax assets, net of valuation allowance |      |  |      | 165,855
|                                                |     
|Deferred acquisition costs                      |      |  |      | (31,227
|Losses of foreign reinsurance affiliate         |      |  |      | (8,120 
|Unrealized appreciation of investments          |      |  |      | (18,594
|Prepaid pension                                 |      |  |      | (8,106 
|Capitalized software                            |      |  |      | (4,066 
|Other                                           |      |  |      | (1,668 
|                                                |     
|Gross deferred tax liabilities                  |      |  |      | (71,781
|                                                |     
|Net deferred tax assets                         |      |  | $    | 94,074 
|                                                |     

At December 31, 2002, the Company had
$107.7 million of net operating loss carryforwards, which will expire in 2018 through
2022; $11.4 million of capital loss carryforwards, which will expire in 2007; and $8.5
million of alternative minimum tax ("AMT") credit carryforwards, which do
not expire.

Management
believes that it is more likely than not that the benefit of its deferred tax asset of
$94.1 million, as of December 31, 2002, will be fully realized. The Company has determined
that no valuation allowance is required on its future income tax asset as of December 31,
2002. Realization of the deferred tax asset is dependent on generating sufficient future
taxable income. Although realization is not assured, management believes it is more likely
than not that all of the deferred tax asset will be realized. The amount of the deferred
tax asset considered realizable, however, could be reduced if actual, or estimates, of
future taxable income are reduced. In 2002, the Company decreased its valuation allowance
on deferred tax assets relating to certain foreign insurance operations by $572,000
because the Company utilized $572,000 of foreign net operating loss carryovers in 2002.

The
Companys federal income tax returns are subject to audit by the Internal Revenue
Service ("IRS"), and provisions are made in the financial statements in
anticipation of the results of these audits. In 2001, the IRS completed their examination
of the Companys 1996 U.S. federal tax return with no material changes to the
Companys filed tax return. No other tax years are currently under audit by the IRS.
In managements opinion, adequate liabilities have been established for all years.

In
October 2002, the Company received a refund from the IRS of $9.6 million resulting 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 qualifications, 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 $6.2 million and $5.8 million, respectively, as of
December 31, 2002.

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.

|67
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Notes to Consolidated Financial Statements
(continued)

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)                                 |                  |  |                               | 2002  
|                                                             
|Change in benefit obligation:                                 |                  | 
|Benefit obligation at beginning of year                       |                  |  | $                             | 57,143
|Service cost                                                  |                  |  |                               | 2,396 
|Interest cost                                                 |                  |  |                               | 4,278 
|Actuarial loss                                                |                  |  |                               | 5,379 
|Benefits paid                                                 |                  |  |                               | (2,272
|                                                              |                 
|Benefit obligation at end of year                             |                  |  | $                             | 66,924
|                                                              |                 
|Change in plan assets:                                        |                  | 
|Fair value of plan assets at beginning of year                |                  |  | $                             | 49,327
|Actual return on plan assets                                  |                  |  |                               | (6,437
|Employer contributions                                        |                  |  |                               | 16,500
|Benefits paid                                                 |                  |  |                               | (2,272
|                                                              |                 
|Fair value of plan assets at end of year                      |                  |  | $                             | 57,118
|                                                              |                 
|Benefit obligation greater than the fair value of plan assets |                  |  | $                             | (9,806
|Unrecognized actuarial (gain) loss                            |                  |  |                               | 29,126
|Unrecognized prior service (cost) benefit                     |                  |  |                               | 492   
|Unrecognized net transition obligation                        |                  |  |                               | 333   
|                                                              |                 
|Prepaid (accrued) benefit at end of year                      |                  |  | $                             | 20,145
|                                                              |                 

|                                         | Pension Benefits |  | Other Postretirement Benefits |       
|---------------------------------------- | ---------------- |  | ----------------------------- | ------
|                                         |                 
|(dollar amounts in thousands)            |                  |  |                               | 2002  
|                                        
|Components of net periodic benefit cost: |                  | 
|Service cost                             |                  |  | $                             | 2,396 
|Interest cost                            |                  |  |                               | 4,278 
|Expected return on plan assets           |                  |  |                               | (4,333
|Amortization of transition obligation    |                  |  |                               | (4    
|Amortization of prior service cost       |                  |  |                               | 5     
|Recognized actuarial (gain) loss         |                  |  |                               | 662   
|                                         |                 
|Net periodic benefit cost                |                  |  | $                             | 3,004 
|                                         |                 
|Weighted average assumptions:            |                  | 
|Discount rate                            |                  |  |                               | 6.75% 
|Expected return on plan assets           |                  |  |                               | 9.00% 
|Rate of compensation increase            |                  |  |                               | 4.50% 

For the measurement of Other
Postretirement Benefits, a 9% annual rate of increase in the per capita cost of covered
health care benefits was assumed for 2003. The rate was assumed to decrease gradually to
5.5% by 2007 and remain at that level thereafter. A one percentage point change in assumed
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.

Qualified
Pension Plan assets consist of approximately 35% equity securities and approximately 65%
fixed maturity securities at December 31, 2002.

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. Contri-butions under such plans expensed
in 2002, 2001 and 2000 were $3.4 million, $2.9 million and $2.6 million,
respectively.

68

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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 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 May 2002, the Company announced its
decision to withdraw from the excess and surplus lines marketplace previously served by
the Caliber One operating segment. On January 2, 2003, the Company completed the sale of
the capital stock of Caliber One Indemnity Company, and received gross proceeds of
approximately $31 million, representing $3.5 million plus surplus of approximately $27
million. 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. The transaction is not expected to
have a material effect on the Companys financial condition and results of operations. As a result of the
Companys decision to exit this business, the results of this segment are reported as
Run-off Operations.

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 ($28 million after-tax).
Components of the pre-tax charge include 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. In addition, the $43 million pre-tax
charge includes approximately $16 million to write-down assets to their estimated net
realizable value, including approximately $9 million for reinsurance, premiums and other
receivables and a non-cash charge of approximately $6 million for leasehold improvements
and other fixed assets and $1.3 million for goodwill. See Note 15 for additional
information regarding the reinsurance component of the charge. The charge was included in
Operating expenses (approximately $24 million) and Net premiums earned (approximately $19
million) in the statement of operations in 2002.

During
2002, approximately 80 Caliber One employees, primarily in the underwriting area, were
terminated in accordance with the Companys exit plan. Approximately 17 positions,
primarily claims, remain after the terminations. Involuntary employee
termination benefits of $1.9 million were paid during 2002.

Note 15. Business Segments

The Companys pre-tax operating
income (loss) by principal business segment and net income (loss) are presented in the
table below. In addition to providing net income (loss), the Company also provides
operating income (loss) because management believes that it is a meaningful measure of the
profit or loss generated by the Companys operating segments. Operating income (loss)
differs from GAAP net income (loss) in that it excludes net realized investment gains and
losses because (i) net realized investment gains and losses are unpredictable and not
necessarily indicative of current operating fundamentals or future performance 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 results of operations.

|(dollar amounts in thousands)     |  |  |   | 2002    |   |   | 2001    |   |   | 2000    |  
|--------------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------- | -
|                                 
|Pre-tax operating income (loss):  |  | 
|PMA Re                            |  |  | $ | 13,422  |   | $ | (3,062  | ) | $ | (7,297  | )
|The PMA Insurance Group           |  |  |   | 25,346  |   |   | 23,148  |   |   | 21,601  |  
|Run-off Operations                |  |  |   | (87,501 | ) |   | (26,168 | ) |   | (7,014  | )
|Corporate and Other               |  |  |   | (14,339 | ) |   | (6,322  | ) |   | (19,142 | )
|                                  | 
|Pre-tax operating loss            |  |  |   | (63,072 | ) |   | (12,404 | ) |   | (11,852 | )
|Net realized investment           |  | 
|gains (losses)                    |  |  |   | (16,085 | ) |   | 7,988   |   |   | 11,975  |  
|                                  | 
|Income (loss) before income taxes |  |  |   | (79,157 | ) |   | (4,416  | ) |   | 123     |  
|Income tax benefit                |  |  |   | (31,133 | ) |   | (11,519 | ) |   | (1,202  | )
|                                  | 
|Net income (loss)                 |  |  | $ | (48,024 | ) | $ | 7,103   |   | $ | 1,325   |  
|                                  | 

The Companys revenues,
substantially all of which are generated within the U.S., by principal business segment
were as follows:

|(dollar amounts in thousands) |  |  |   | 2002      |   |   | 2001    |  |   | 2000    | 
|----------------------------- |  |  | - | --------- | - | - | ------- |  | - | ------- | 
|                             
|PMA Re                        |  |  | $ | 600,249   |   | $ | 385,762 |  | $ | 302,234 | 
|The PMA Insurance Group       |  |  |   | 460,573   |   |   | 397,258 |  |   | 310,416 | 
|Run-off Operations            |  |  |   | 31,253    |   |   | 49,356  |  |   | 33,223  | 
|Corporate and Other           |  |  |   | (853      | ) |   | 9,608   |  |   | 2,142   | 
|Net realized investment       |  | 
|gains (losses)                |  |  |   | (16,085   | ) |   | 7,988   |  |   | 11,975  | 
|                              | 
|Total revenues                |  |  | $ | 1,075,137 |   | $ | 849,972 |  | $ | 659,990 | 
|                              | 

|69
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| | P M A  C A P I T A L
| | --------------------

Notes to Consolidated Financial Statements
(continued)

Net premiums earned by principal business
segment are as follows:

|(dollar amounts in thousands)      |  |  |   | 2002    |   |   | 2001    |   |   | 2000    |  
|---------------------------------- |  |  | - | ------- | - | - | ------- | - | - | ------- | -
|                                  
|PMA Re:                            |  | 
|Traditional - Treaty               |  | 
|Casualty                           |  |  | $ | 167,411 |   | $ | 66,242  |   | $ | 79,942  |  
|Property                           |  |  |   | 94,655  |   |   | 50,347  |   |   | 44,779  |  
|Other                              |  |  |   | 4,949   |   |   | 1,285   |   |   | 683     |  
|                                   | 
|Total                              |  |  |   | 267,015 |   |   | 117,874 |   |   | 125,404 |  
|                                   | 
|Finite Risk and Financial Products |  | 
|Casualty                           |  |  |   | 101,885 |   |   | 74,499  |   |   | 30,236  |  
|Property                           |  |  |   | 86,639  |   |   | 108,395 |   |   | 45,085  |  
|Other                              |  |  |   | 19,007  |   |   | 1,163   |   |   | 2,876   |  
|                                   | 
|Total                              |  |  |   | 207,531 |   |   | 184,057 |   |   | 78,197  |  
|                                   | 
|Specialty - Treaty                 |  | 
|Casualty                           |  |  |   | 54,911  |   |   | 28,416  |   |   | 42,448  |  
|Property                           |  |  |   | 2,998   |   |   | 1,378   |   |   | 1,031   |  
|Other                              |  |  |   | 439     |   |   | 734     |   |   | 617     |  
|                                   | 
|Total                              |  |  |   | 58,348  |   |   | 30,528  |   |   | 44,096  |  
|                                   | 
|Facultative                        |  | 
|Casualty                           |  |  |   | 12,263  |   |   | 4,727   |   |   | 65      |  
|Property                           |  |  |   | 6,356   |   |   | 3,215   |   |   | 3,347   |  
|                                   | 
|Total                              |  |  |   | 18,619  |   |   | 7,942   |   |   | 3,412   |  
|                                   | 
|Total casualty                     |  |  |   | 336,470 |   |   | 173,884 |   |   | 152,691 |  
|Total property                     |  |  |   | 190,648 |   |   | 163,335 |   |   | 94,242  |  
|Total other(1)                     |  |  |   | 24,395  |   |   | 3,182   |   |   | 4,176   |  
|                                   | 
|Total premiums earned              |  |  |   | 551,513 |   |   | 340,401 |   |   | 251,109 |  
|                                   | 
|The PMA Insurance Group:           |  | 
|Workers' compensation and          |  | 
|integrated disability              |  |  |   | 333,956 |   |   | 284,128 |   |   | 195,856 |  
|Commercial automobile              |  |  |   | 43,384  |   |   | 32,664  |   |   | 26,963  |  
|Commercial multi-peril             |  |  |   | 25,390  |   |   | 25,863  |   |   | 27,669  |  
|Other                              |  |  |   | 7,536   |   |   | 3,919   |   |   | 1,860   |  
|                                   | 
|Total premiums earned              |  |  |   | 410,266 |   |   | 346,574 |   |   | 252,348 |  
|                                   | 
|Run-off Operations                 |  |  |   | 30,113  |   |   | 46,232  |   |   | 28,799  |  
|Corporate and Other                |  |  |   | (881    | ) |   | (767    | ) |   | (832    | )
|                                   | 
|Net premiums earned                |  |  | $ | 991,011 |   | $ | 732,440 |   | $ | 531,424 |  
|                                   | 

|(1) |  | Primarily
aviation, ocean marine and accident in 2002.
|--- |  | ------------------------------------------------------

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

|(dollar amounts in thousands) |  |  |   | 2002  |  |   | 2001  |  |   | 2000  | 
|----------------------------- |  |  | - | ----- |  | - | ----- |  | - | ----- | 
|                             
|PMA Re                        |  |  | $ | 4,159 |  | $ | 3,520 |  | $ | 1,803 | 
|The PMA Insurance Group       |  |  |   | 3,598 |  |   | 1,933 |  |   | 3,609 | 
|Run-off Operations            |  |  |   | 1,313 |  |   | 1,295 |  |   | 1,123 | 
|Corporate and Other           |  |  |   | 129   |  |   | 328   |  |   | 863   | 
|                              | 
|Total depreciation and        |  | 
|amortization expense          |  |  | $ | 9,199 |  | $ | 7,076 |  | $ | 7,398 | 
|                              | 

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

|(dollar amounts in thousands) |  |  |   | 2002      |  |   | 2001      |  
|----------------------------- |  |  | - | --------- |  | - | --------- | -
|                             
|PMA Re                        |  |  | $ | 2,000,960 |  | $ | 1,868,818 |  
|The PMA Insurance Group       |  |  |   | 1,874,610 |  |   | 1,678,206 |  
|Run-off Operations            |  |  |   | 206,849   |  |   | 299,756   |  
|Corporate and Other(2)        |  |  |   | 23,375    |  |   | (43,801   | )
|                              | 
|Total assets                  |  |  | $ | 4,105,794 |  | $ | 3,802,979 |  
|                              | 

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

PMA Re distributes its products through
reinsurance brokers, and PMA Res top four such brokers accounted for approximately
80% of PMA Res gross premiums written in 2002. During 2002, 2001 and 2000, total
revenues of approximately $287 million, $110 million and $76 million, respectively, were
placed through brokers which individually exceeded 10% of the Companys total
revenue.

The
PMA Insurance Groups operations are concentrated in nine 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. In 2002, 2001 and 2000,
workers compensation net premiums written by The PMA Insurance Group represented
32%, 36% and 37%, respectively, of the Companys net premiums written.

70

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| | P M A  C A P I T A L
| | --------------------

PMA
Re has agreed to assume the claims obligations of the Run-off Operations if the actual
claim payments in the aggregate exceed the estimated payments upon which the loss reserves
of the Run-off Operations were established. As a result of this transaction, PMA Re
recorded assumed premium of $10 million in 2002. No losses were recorded by PMA Re in
connection with this transaction. Also during 2002, PMA Re recorded assumed premium of
$8.5 million in connection with the assumption of losses from the Run-off Operations,
which PMA Re retroceded under its existing retrocessional contracts. As a result of these
two transactions, the Run-off Operations recorded a ceded premium charge of $18.5 million
in 2002 as part of the charge to exit from and run off the excess and surplus lines
business. These amounts are reflected in the individual business segments pre-tax
operating income (loss) and revenues.

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. Also, in writing property reinsurance coverages, PMA Re
typically requires per occurrence loss limitations for contracts that could have
catastrophe exposure. Through per risk reinsurance, the Company manages its net retention
in each exposure. PMA Res property per occurrence reinsurance provides catastrophe
protection of $40.0 million in excess of $10.0 million on its traditional property book
and $12.5 million in excess of $5.0 million for property exposures underwritten by its
Finite Risk and Financial Products unit. PMA Re can also recover an additional $20.0
million of Traditional and/or Finite Risk and Financial Products occurrence losses under
certain industry loss scenarios. Certain of these contracts require the cession of
additional premiums of up to 20% of ceded losses depending on the level of such losses. 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 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 2001, the Companys results
reflect approximately $30 million pre-tax ($20 million after-tax) of losses due to the
attack on the World Trade Center. See Note 4 for additional information. In 2002 and 2000,
the Companys loss and LAE ratios were not significantly impacted by catastrophes.

Note 16. Transactions
with Related Parties

The Companys largest shareholder is
PMA Foundation (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. As of December 31, 2002, the Foundation owned 5,558,050
shares, or 17.7%, of the Companys Class A Common stock, and all but two members of
the Companys Board of Directors currently serve as members of the Foundations
Board of Trustees. Also, Frederick W. Anton III, Chairman of the Company, serves as
President and Chief Executive Officer of the Foundation. The Company and certain of its
subsidiaries provide certain administrative services to the Foundation for which the
Company and its subsidiaries receive reimbursement. Total reimbursements amounted to
$13,000 for each of the years ended December 31, 2002, 2001 and 2000, respectively. The
Foundation also leases its Harrisburg, Pennsylvania headquarters facility from a
subsidiary of the Company under an operating lease presently requiring rent payments of
$25,000 per month, and reimburses 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 for each of the years ended December 31, 2002, 2001 and 2000.

The
Company incurred legal and consulting expenses aggregating approximately $3.9 million,
$4.8 million and $5.3 million in 2002, 2001 and 2000, respectively, from firms in which
directors of the Company are partners or principals.

At
December 31, 2002, 2001 and 2000, the Company had notes receivable from officers totaling
$62,000, $158,000 and $56,000, respectively, that are accounted for as a reduction of
shareholders equity. At December 31, 2002, the interest rate on these notes was
4.75%.

The
Company has arranged an executive loan program with a financial institution. The
institution provides personal demand loans to officers of the Company at a floating
interest rate equal to the financial institutions prime rate minus 1/2%. Such loans
are collateralized by Class A Common stock beneficially owned by the officer and a Company
treasury security. The Company has agreed to purchase any loan made to an officer
(including accrued interest and related expenses) from the financial institution in the
event that the borrower defaults on the loan. The amount of loans outstanding as of
December 31, 2002 under this program was $2.2 million. The program expires on December 31,
2003.

|71
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| | --------------------

Notes to Consolidated Financial Statements
(continued)

Note 17. 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
National Association of Insurance Commissioners ("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.

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

|(dollar amounts in thousands) |  |  |   | 2002     |   |   | 2001     |   |   | 2000     |  
|----------------------------- |  |  | - | -------- | - | - | -------- | - | - | -------- | -
|                             
|SAP net income (loss):        |  | 
|PMA Capital Insurance Co.     |  |  | $ | (8,039   | ) | $ | (18,708  | ) | $ | 8,920    |  
|The PMA Insurance Group       |  |  |   | 4,984    |   |   | 25,341   |   |   | 4,847    |  
|Caliber One Indemnity Co.     |  |  |   | (27,874  | ) |   | (3,658   | ) |   | 5,233    |  
|                              | 
|Total                         |  |  | $ | (30,929  | ) | $ | 2,975    |   | $ | 19,000   |  
|                              | 
|SAP capital and surplus:      |  | 
|PMA Capital Insurance Co.     |  |  | $ | 580,151  |   | $ | 559,578  |   | $ | 529,631  |  
|The PMA Insurance Group       |  |  |   | 305,533  |   |   | 264,476  |   |   | 254,633  |  
|Caliber One Indemnity Co.     |  |  |   | 26,844   |   |   | 37,060   |   |   | 42,859   |  
|Eliminations(1)               |  |  |   | (332,377 | ) |   | (301,536 | ) |   | (297,492 | )
|                              | 
|Total                         |  |  | $ | 580,151  |   | $ | 559,578  |   | $ | 529,631  |  
|                              | 

|(1) |  | The surplus
of The PMA Insurance Groups domestic insurance subsidiaries and Caliber Indemnity
Company are eliminated as they are included in the statutory surplus of PMA Capital
Insurance Company, the parent company of these insurance companies.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A reconciliation of PMA Capitals
domestic insurance subsidiaries SAP net income (loss) to the Companys GAAP
net income (loss) is as follows:

|(dollar amounts in thousands)        |  |  |   | 2002    |   |   | 2001    |   |   | 2000    |  
|------------------------------------ |  |  | - | ------- | - | - | ------- | - | - | ------- | -
|                                    
|SAP net income (loss) -              |  | 
|domestic insurance subsidiaries      |  |  | $ | (30,929 | ) | $ | 2,975   |   | $ | 19,000  |  
|GAAP adjustments:                    |  | 
|Dividends received from              |  | 
|subsidiaries                         |  |  |   | (15,200 | ) |   | (16,797 | ) |   | (1,706  | )
|Change in deferred acquisition costs |  |  |   | 24,872  |   |   | 15,828  |   |   | (109    | )
|Benefit (provision) for deferred     |  | 
|income taxes                         |  |  |   | 3,790   |   |   | (7,100  | ) |   | (5,205  | )
|Allowance for doubtful accounts      |  |  |   | 906     |   |   | 4,874   |   |   | (454    | )
|Guaranty fund and loss based         |  | 
|assessments                          |  |  |   | (910    | ) |   | 328     |   |   | 1,362   |  
|Other                                |  |  |   | (7,694  | ) |   | (10,610 | ) |   | 1,984   |  
|                                     | 
|GAAP net income (loss) -             |  | 
|domestic insurance subsidiaries      |  |  |   | (25,165 | ) |   | (10,502 | ) |   | 14,872  |  
|Other entities and eliminations      |  |  |   | (22,859 | ) |   | 17,605  |   |   | (13,547 | )
|                                     | 
|GAAP net income (loss)               |  |  | $ | (48,024 | ) | $ | 7,103   |   | $ | 1,325   |  
|                                     | 

A reconciliation of PMA Capitals
domestic insurance subsidiaries SAP capital and surplus to the Companys GAAP
shareholders equity is as follows:

|(dollar amounts in thousands)   |  |  |   | 2002     |   |   | 2001     |   |   | 2000     |  
|------------------------------- |  |  | - | -------- | - | - | -------- | - | - | -------- | -
|                               
|SAP capital and surplus -       |  | 
|domestic insurance subsidiaries |  |  | $ | 580,151  |   | $ | 559,578  |   | $ | 529,631  |  
|GAAP adjustments:               |  | 
|Deferred acquisition costs      |  |  |   | 89,222   |   |   | 64,350   |   |   | 48,522   |  
|Deferred income taxes           |  |  |   | 33,227   |   |   | 36,226   |   |   | 41,843   |  
|Allowance for doubtful accounts |  |  |   | (13,641  | ) |   | (13,954  | ) |   | (18,828  | )
|Retirement accruals             |  |  |   | (9,106   | ) |   | (8,943   | ) |   | (9,370   | )
|Non-admitted assets             |  |  |   | 22,101   |   |   | 88,150   |   |   | 50,770   |  
|Unrealized gain (loss) on fixed |  | 
|maturities available for sale   |  |  |   | 25,382   |   |   | 5,584    |   |   | (12,789  | )
|Other                           |  |  |   | (6,527   | ) |   | 12,030   |   |   | 16,969   |  
|                                | 
|GAAP shareholders' equity -     |  | 
|domestic insurance subsidiaries |  |  |   | 720,809  |   |   | 743,021  |   |   | 646,748  |  
|Other entities and eliminations |  |  |   | (139,419 | ) |   | (131,015 | ) |   | (206,702 | )
|                                | 
|GAAP shareholders' equity       |  |  | $ | 581,390  |   | $ | 612,006  |   | $ | 440,046  |  
|                                | 

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 $13.0 million, $22.2 million and $20.4 million at
December 31, 2002, 2001 and 2000, respectively, over what it would have been had the
prescribed practice not been allowed. In addition, under this prescribed accounting practice, the
Company discounted certain of its ceded unpaid loss and LAE reserves for
workers compensation and increased its statutory credit for ceded
reinsurance, which indirectly benefited statutory capital and surplus by
approximately $72 million at December 31, 2002. Only if these reserves were not
discounted and the Company was unsuccessful in obtaining collateral would the
statutory surplus be directly impacted.

|72
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Report of Independent Accountants

PRICEWATERHOUSECOOPERS [LOGO]

To the Board of Directors
and Shareholders ofPMA Capital Corporation

In our opinion, the accompanying
consolidated balance sheets and the related consolidated statements of operations, cash
flows, shareholders equity and comprehensive income (loss) present fairly, in all
material respects, the financial position of PMA Capital Corporation and its subsidiaries
at December 31, 2002 and 2001, and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 2002 in conformity with
accounting principles generally accepted in the United States of America. 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 auditing standards generally accepted in the
United States of America, which require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our
opinion.

/s/ PricewaterhouseCoopers LLP

Philadelphia, Pennsylvania
February 5, 2003, except for Note 6, 
as to which the date is March 17, 2003

|73
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| | --------------------

Quarterly Financial Information (Unaudited)

The following unaudited quarterly
financial data are presented on a consolidated basis for each of the years ended December
31, 2002 and 2001. Quarterly financial results necessarily rely on estimates and caution
is required in drawing specific conclusions from quarterly consolidated results.

|(dollar amounts in thousands, except share data) |  | FirstQuarter |   | SecondQuarter |   | ThirdQuarter |         | FourthQuarter |  
|------------------------------------------------ |  | ------------ | - | ------------- | - | ------------ | ------- | ------------- | -
|                                                
|2002                                             |  |              |   |               |   |              |         |               |  
|Income Statement Data:                           |  |             
|Total revenues                                   |  |              | $ | 227,375       |   | $            | 284,139 |               | $
|Income (loss) before income taxes                |  |              |   | (26,585       | ) |              | (45,550 | )(1)          |  
|Net income (loss)                                |  |              |   | (17,247       | ) |              | (29,749 | )(1)          |  
|                                                
|Per Share Data:                                  |  |             
|Net income (loss) (Basic)                        |  |              | $ | (0.55         | ) | $            | (0.95   | )(1)          | $
|Net income (loss) (Diluted)                      |  |              | $ | (0.55         | ) | $            | (0.95   | )(1)          | $
|                                                
|Class A Common Stock Prices:                     |  |             
|High                                             |  |              | $ | 23.10         |   | $            | 25.99   |               | $
|Low                                              |  |              |   | 18.71         |   |              | 17.65   |               |  
|Close                                            |  |              |   | 22.94         |   |              | 21.15   |               |  
|                                                
|2001                                             |  |              |   |               |  
|Income Statement Data:                           |  |             
|Total revenues                                   |  |              | $ | 193,599       |   | $            | 217,075 |               | $
|Income (loss) before income taxes                |  |              |   | (2,549        | ) |              | 9,726   |               |  
|Net income (loss)                                |  |              |   | 8,091         |   |              | 6,040   |               |  
|                                                
|Per Share Data:                                  |  |             
|Net income (loss) (Basic)                        |  |              | $ | 0.38          |   | $            | 0.28    |               | $
|Net income (loss) (Diluted)                      |  |              | $ | 0.37          |   | $            | 0.28    |               | $
|                                                
|Class A Common Stock Prices:                     |  |             
|High                                             |  |              | $ | 18.94         |   | $            | 18.05   |               | $
|Low                                              |  |              |   | 16.50         |   |              | 16.59   |               |  
|Close                                            |  |              |   | 17.38         |   |              | 18.05   |               |  

The Company had approximately
5,700 holders of its Class A Common stock at
January 31, 2003 based on recordholders and other beneficial owners. In each quarter of 2001 and 2002, the Company declared
quarterly dividends of $0.105 per share for its Class A Common stock.

|(1) |  | Includes approximately $43 million pre-tax ($28 million after-tax or
$0.90 per basic and diluted share) for costs associated with the exit from and run off of
Caliber One, our former excess and surplus lines business.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes losses of approximately $30 million pre-tax ($20 million
after-tax or $0.93 per basic and diluted share) for the attack on the World Trade Center.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

74

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Investor Information

Securities Listing

The Corporations Class A Common stock
is listed on The Nasdaq Stock Market®. It trades under the stock symbol: PMACA

Dividends

PMA Capital Corporations quarterly
dividends on Class A Common stock are paid on or about the first day of January, April,
July and October.

|77
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---