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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003.



OR



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



Commission File Number 1-7461



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ACCEPTANCE INSURANCE COMPANIES INC.

(Exact name of registrant as specified in its charter)



|Delaware                                                       |  | 31-0742926                             
|-------------------------------------------------------------- |  | ---------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



Suite 1600, 300 West
Broadway

Council Bluffs, Iowa 51503

(Address of principal executive offices)

(Zip Code)



(712) 328-3918

Registrants Telephone Number, Including Area Code:



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



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



The number of shares of each
class of the Registrants common stock outstanding on August 12, 2003 was:



|Class of Common Stock        |  | No. of Shares Outstanding
|---------------------------- |  | -------------------------
|Common Stock, $.40 Par Value |  | 14,201,486               



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



FORM 10-Q



TABLE OF CONTENTS



|                              |  |               |  |                                                                                         |  | PAGE
|----------------------------- |  | ------------- |  | --------------------------------------------------------------------------------------- |  | ----
|PART I. FINANCIAL INFORMATION |  |              
|                              |  |               | 
|                              |  | Item 1.       |  | Financial Statements (unaudited):                                                       |  |     
|                              |  |               | 
|                              |  |               |  | Consolidated Balance Sheets June 30, 2003 and December 31, 2002                         |  | 3   
|                              |  |               | 
|                              |  |               |  | Consolidated Statements of Operations Three and Six Months Ended June 30, 2003 and 2002 |  | 4   
|                              |  |               | 
|                              |  |               |  | Consolidated Statements of Cash Flows Six Months Ended June 30, 2003 and 2002           |  | 5   
|                              |  |               | 
|                              |  |               |  | Notes to Interim Consolidated Financial Statements                                      |  | 6   
|                              |  |               | 
|                              |  | Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations   |  | 19  
|                              |  |               | 
|                              |  | Item 3.       |  | Quantitative and Qualitative Disclosure about Market Risk                               |  | 26  
|                              |  |               | 
|                              |  | Item 4.       |  | Controls and Procedures                                                                 |  | 26  
|                              | 
|PART II. OTHER INFORMATION    |  |              
|                              |  |               | 
|                              |  | Item 1.       |  | Legal Proceedings                                                                       |  | 28  
|                              |  |               | 
|                              |  | Item 4.       |  | Submission of Matters to a Vote of Security Holders                                     |  | 29  
|                              |  |               | 
|                              |  | Item 5.       |  | Other Information                                                                       |  | 29  
|                              |  |               | 
|                              |  | Item 6.       |  | Exhibits and Reports on Form 8-K                                                        |  | 30  
|                              |  |              
|                              |  | Signatures    |  | 31                                                                                     
|                              |  |              
|                              |  | Exhibit Index |  | 32                                                                                     



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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS (dollars in thousands except share data)



|                                                                                                                                                  |  | June 30,2003 |          |   | December 31,2002 |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | -
|ASSETS                                                                                                                                            |  |              |          |   |                  |  
|                                                                                                                                                  |  |             
|Cash and cash equivalents                                                                                                                         |  | $            | 1,481    |   |                  | $
|Restricted cash equivalents                                                                                                                       |  |              | 1,127    |   |                  |  
|Receivables, net                                                                                                                                  |  |              | 1,305    |   |                  |  
|Property and equipment, net                                                                                                                       |  |              |         |   |                  |  
|Other assets                                                                                                                                      |  |              | 3,349    |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|                                                                                                                                                  |  |              | 7,262    |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Discontinued operations:                                                                                                                          |  |              |          |   |                  |  
|Investments:                                                                                                                                      |  |              |          |   |                  |  
|Fixed maturities available-for-sale, at fair value                                                                                                |  |              | 71,583   |   |                  |  
|Marketable equity securities available-for-sale, at fair value                                                                                    |  |              | 1,615    |   |                  |  
|Real estate                                                                                                                                       |  |              | 3,026    |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|                                                                                                                                                  |  |              | 76,224   |   |                  |  
|Cash and cash equivalents                                                                                                                         |  |              | 25,068   |   |                  |  
|Receivables, net                                                                                                                                  |  |              | 47,622   |   |                  |  
|Reinsurance recoverable on unpaid losses and loss adjustment expenses                                                                             |  |              | 134,565  |   |                  |  
|Prepaid reinsurance premiums                                                                                                                      |  |              | 101      |   |                  |  
|Property and equipment, net of accumulated depreciation                                                                                           |  |              | 1,737    |   |                  |  
|Other assets                                                                                                                                      |  |              | 286      |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Discontinued operations                                                                                                                           |  |              | 285,603  |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|                                                                                                                                                  |  | $            | 292,865  |   |                  | $
|                                                                                                                                                  |  |              |          |   |                  |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)                                                                                                    |  |              |          |   |                  |  
|                                                                                                                                                  |  |             
|Accounts payable and accrued liabilities                                                                                                          |  | $            | 749      |   |                  | $
|Accrued interest on Junior Subordinated Debentures                                                                                                |  |              | 6,587    |   |                  |  
|Company-obligated mandatorily redeemable Preferred Securities of AICI Capital Trust, holding solely Junior Subordinated Debentures
of the Company |  |              | 94,875   |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|                                                                                                                                                  |  |              | 102,211  |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Discontinued operations:                                                                                                                          |  |              |          |   |                  |  
|Losses and loss adjustment expenses                                                                                                               |  |              | 242,534  |   |                  |  
|Unearned premiums                                                                                                                                 |  |              | 128      |   |                  |  
|Amounts payable to reinsurers                                                                                                                     |  |              | 257      |   |                  |  
|Accounts payable and accrued liabilities                                                                                                          |  |              | 16,123   |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Discontinued operations                                                                                                                           |  |              | 259,042  |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Total liabilities                                                                                                                                 |  |              | 361,253  |   |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Commitments and contingencies                                                                                                                     |  |              |          |   |                  |  
|                                                                                                                                                  |  |             
|Stockholders equity (deficit):                                                                                                                   |  |              |          |   |                  |  
|Preferred stock, no par value, 5,000,000 shares authorized, none issued                                                                           |  |              |         |   |                  |  
|Common stock, $.40 par value, 40,000,000 shares authorized; 15,685,473 shares issued                                                              |  |              | 6,274    |   |                  |  
|Capital in excess of par value                                                                                                                    |  |              | 199,660  |   |                  |  
|Accumulated other comprehensive income, net of tax                                                                                                |  |              | 829      |   |                  |  
|Accumulated deficit                                                                                                                               |  |              | (244,953 | ) |                  |  
|Treasury stock, at cost, 1,463,591 shares                                                                                                         |  |              | (29,969  | ) |                  |  
|Contingent stock, 20,396 shares                                                                                                                   |  |              | (229     | ) |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|Total stockholders equity (deficit)                                                                                                              |  |              | (68,388  | ) |                  |  
|                                                                                                                                                  |  |              |          |   |                  |  
|                                                                                                                                                  |  | $            | 292,865  |   |                  | $
|                                                                                                                                                  |  |              |          |   |                  |  



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



3



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002



|                                                     |  | Three Months |         |   | Six Months |  
|---------------------------------------------------- |  | ------------ | ------- | - | ---------- | -
|                                                     |  | 2003         |         |   | 2002       |  
|Revenues:                                            |  |              |         |   |            |  
|Net investment income                                |  | $            | 25      |   |            | $
|Net realized capital gains                           |  |              |        |   |            |  
|                                                     |  |              |         |   |            |  
|                                                     |  |              | 25      |   |            |  
|                                                     |  |              |         |   |            |  
|Costs and expenses:                                  |  |              |         |   |            |  
|General and administrative expenses                  |  |              | 484     |   |            |  
|                                                     |  |              |         |   |            |  
|Operating loss                                       |  |              | (459    | ) |            |  
|                                                     |  |              |         |   |            |  
|Interest expense                                     |  |              | (2,263  | ) |            |  
|                                                     |  |              |         |   |            |  
|Loss before income taxes and discontinued operations |  |              | (2,722  | ) |            |  
|                                                     |  |              |         |  
|Income tax expense (benefit):                        |  |              |         |   |            |  
|Current                                              |  |              |        |   |            |  
|Deferred                                             |  |              | (953    | ) |            |  
|Change in valuation allowance                        |  |              | 953     |   |            |  
|                                                     |  |              |         |   |            |  
|                                                     |  |              |        |   |            |  
|                                                     |  |              |         |   |            |  
|Loss from continuing operations                      |  |              | (2,722  | ) |            |  
|                                                     |  |              |         |  
|Loss from discontinued operations, net of tax        |  |              | (8,346  | ) |            |  
|                                                     |  |              |         |   |            |  
|Net loss                                             |  | $            | (11,068 | ) |            | $
|                                                     |  |              |         |   |            |  
|Loss per share:                                      |  |              |         |   |            |  
|Basic and diluted                                    |  |              |         |   |            |  
|Loss from continuing operations                      |  | $            | (0.19   | ) |            | $
|Loss from discontinued operations                    |  |              | (0.59   | ) |            |  
|Net loss                                             |  |              | (0.78   | ) |            |  



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



4



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)

SIX MONTHS ENDED JUNE 30, 2003 AND 2002



|                                                                        |  | 2003 |         |   | 2002 |  
|----------------------------------------------------------------------- |  | ---- | ------- | - | ---- | -
|Cash flows from operating activities:                                   |  |      |         |   |      |  
|Net loss                                                                |  | $    | (14,648 | ) |      | $
|Adjustments to reconcile net loss to net cash from operating activities |  |      | 13,949  |   |      |  
|                                                                        |  |      |         |   |      |  
|Net cash from operating activities                                      |  |      | (699    | ) |      |  
|                                                                        |  |      |         |   |      |  
|Cash flows from investing activities:                                   |  |      |         |   |      |  
|                                                                        |  |     
|Increase in restricted cash and cash equivalents                        |  |      | (1,127  | ) |      |  
|Sale of property and equipment                                          |  |      | 204     |   |      |  
|                                                                        |  |      |         |   |      |  
|Net cash from investing activities                                      |  |      | (923    | ) |      |  
|                                                                        |  |      |         |   |      |  
|Cash flows from financing activities:                                   |  |      |         |   |      |  
|Proceeds from issuance of common stock                                  |  |      |        |   |      |  
|                                                                        |  |      |         |   |      |  
|Net cash from financing activities                                      |  |      |        |   |      |  
|                                                                        |  |      |         |   |      |  
|Net decrease in cash and cash equivalents                               |  |      | (1,622  | ) |      |  
|                                                                        |  |     
|Cash and cash equivalents at beginning of period                        |  |      | 3,103   |   |      |  
|                                                                        |  |      |         |   |      |  
|Cash and cash equivalents at end of period                              |  | $    | 1,481   |   |      | $
|                                                                        |  |      |         |   |      |  



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



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

SIX MONTHS ENDED JUNE 30, 2003 AND 2002

(Columnar Amounts in Thousands Except Per Share Data)



|1. |  | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
|-- |  | ------------------------------------------



Description of OperationsAcceptance Insurance Companies Inc. and subsidiaries (the Company) historically has been an
agricultural risk management company providing comprehensive insurance products (Agricultural Segment) and a provider of property and casualty insurance (Property and Casualty Segment). Due to the financial condition of the
Company and regulatory restrictions placed on the Company in the fourth quarter of 2002, the Company neither intends nor has the ability to continue its operations in the Agricultural Segment or the Property and Casualty Segment. As such, all
operations in these segments have been presented as discontinued operations. Assets and liabilities have been reflected separately as discontinued operations on the consolidated balance sheets.



The Companys results may be influenced by factors which are largely
beyond the Companys control. Important among such factors are changes in state and federal regulations, decisions by regulators including any increased regulatory control over Acceptance Insurance Company, changes in the reinsurance market,
including the ability and willingness of reinsurers to pay claims, changes in tax laws, financial market performance, changes in federal policies or court decisions affecting coverages, changes in the rate of inflation, interest rates and general
economic conditions.



Principles of
ConsolidationThe Companys consolidated financial statements include the accounts of its majority-owned subsidiaries. All significant intercompany transactions have been eliminated. American Growers Insurance Company
(AGIC), the Companys subsidiary previously conducting insurance operations within the Agricultural Segment, was placed into rehabilitation by the District Court of Lancaster County, Nebraska on December 20, 2002. Effective as of
December 20, 2002, AGIC and its subsidiaries ceased to be under the control of the Company and are not included as consolidated subsidiaries of the Company after that date. As the Companys equity interest in AGIC and its subsidiaries is
negative, the Company has reflected its investment in AGIC and its subsidiaries at fair market value of zero as the Company is no longer responsible for AGICs net liabilities.



Going ConcernThe Companys only remaining consolidated insurance subsidiary at June 30, 2003,
Acceptance Insurance Company (AIC), is regulated by the Nebraska Department of Insurance (NEDOI). AIC is currently under supervision by the NEDOI. The NEDOI Director (Director) currently has the authority to
increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial condition of AIC. The Company believes that an Order of Rehabilitation
would have a significant negative impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company.



In August 2003, the NEDOI orally informed the Company of the results of a draft report regarding AICs loss and loss adjustment expense reserves at
December 31, 2002 prepared by an outside actuary engaged by the NEDOI in connection with the NEDOIs triennial examination of AIC. The NEDOI informed the Company of the range of estimated adequate loss reserves for AIC at December 31, 2002
determined by the NEDOIs outside actuary in the draft report. This range of estimated reserves, including the lower amount of the estimate, is significantly higher than the estimate of adequate loss reserves at December 31, 2002 determined by
the Company and the independent actuary engaged by the Company to review the Companys loss reserving process and reserve estimates. The Company has not yet received the final written report of the NEDOIs outside actuary. Although the
Company believes it



6



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will receive this final written report during the third quarter of 2003, there can be no assurance as to when it will receive the report.



Upon receipt of the report by the NEDOIs outside actuary, the Company
will review fully this report. Upon completion of this review, the Company will decide to take the course of action that is in the best interests of the Company based all relevant factors, including any reasonable basis for protesting the report and
what action, if any, is taken by the NEDOI. At this time, there can be no assurance as to what actions, if any, the NEDOI will take in connection with this report. If the NEDOI does take action there can be no assurance as to when it may do so or
how long it may take to complete any such action; however, the Company believes that if the NEDOI takes any action, it would initiate such action during the third or fourth quarter of 2003. The Director currently has the authority to increase
regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial condition of AIC and regardless of the reserve estimate by the NEDOIs
outside actuary. The Company believes that an Order of Rehabilitation would have a significant negative impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company. If the NEDOI seeks and obtains an
Order of Rehabilitation or Order of Liquidation, the Company will decide to take the course of action that is in the best interests of the Company based on all relevant factors. The Company believes that its possible options will range from no
action to filing bankruptcy depending on what type of order, if any, is sought and obtained by the NEDOI, what actions the NEDOI takes pursuant to any such order and all other factors relevant to taking the actions that are in the best interests of
the Company. The filing of a bankruptcy proceeding would constitute an event of default under the trust agreement for the Trust Preferred Securities.



Additionally, there is significant uncertainty as to whether AIC will be able to meet its future cash flow needs. A major portion of AICs
investments are pledged and AICs ability to meet its cash flow needs will be highly dependent upon AICs ability to get significant amounts of pledged funds released. Additionally, AICs cash flows are significantly impacted by any
changes in the expected payout of insurance losses and loss adjustment expenses. AICs ability to meet its cash flow needs is also dependent upon the timely recovery of reinsurance balances, including the favorable resolution of balances
currently in dispute. While based upon current estimates AIC would likely have the ability to meet its cash flow needs through June 30, 2004 if the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC, there
can be no assurances considering the significant uncertainties that exist.



There is also significant uncertainty as to whether Acceptance Insurance Companies Inc. (AICI) will be able to meet its cash flow needs. AICI has deferred interest payments on its Junior Subordinated
Debentures, which in turn deferred the interest on the Trust Preferred Securities issued by AICI Capital Trust, as permitted by the trust agreement and indenture, and has disputed or denied payments of certain other liabilities and commitments.
While based upon current estimates AICI would likely have the ability to meet its cash flow needs through June 30, 2004 if the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC, there can be no assurances
considering the significant uncertainties that exist. If the NEDOI obtains an Order of Rehabilitation or Order of Liquidation with respect to AIC, the Company believes that AICI may not be able to meet its cash flow needs.



Basis of PresentationThe accompanying consolidated
financial statements reflect all adjustments, consisting only of normal recurring adjustments except as otherwise disclosed, which in the opinion of management are considered necessary to fairly present the Companys consolidated financial
position as of June 30, 2003 and December 31, 2002, and the results of operations for the three and six months ended June 30, 2003 and 2002 and cash flows for the six months ended June 30, 2003 and 2002.



Recent Statements of Financial Accounting StandardsIn
December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 148 (SFAS No. 148), Accounting for Stock-Based CompensationTransition and Disclosure, an amendment
of SFAS No. 123, which provides alternative methods of transition for a voluntary change to the fair value based



7



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method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more
prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. The transition guidance and annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after December 15, 2002.
The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company adopted the disclosure requirements of SFAS No. 148.



In November 2002, the FASB issued Interpretation (FIN) No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. Initial recognition and initial measurement provisions of this interpretation are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of annual periods ending after December 15, 2002. The adoption of FIN No. 45 had no impact on our consolidated
financial statements.



In January 2003, the FASB issued FIN
No. 46, Consolidation of Variable Interest Entities, which addresses the consolidation of certain entities (variable interest entity) when control exists through other than voting interests. FIN No. 46 requires that a variable
interest entity be consolidated by the holder of the majority of the risks and rewards associated with the activities of the variable interest entity. FIN No. 46 is effective immediately for variable interest entities created after January 31, 2003.
For variable interest entities created prior to February 1, 2003, FIN No. 46 is effective for the first interim period beginning after June 15, 2003, and may be applied retroactively or prospectively. The adoption of FIN No. 46 had no impact on our
consolidated financial statements.



In April 2003, the FASB
issued SFAS No. 149, Amendments of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments
embedded in other contracts, and hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The Company believes the adoption of SFAS No. 149 will not have any impact on its consolidated financial statements.



In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. SFAS No. 150 establishes standards on how to classify and measure certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise effective as of the beginning of the first interim period beginning after June 15, 2003. The Company is still in the process of evaluating the impact of this statement on its consolidated financial position
and results of operations.



ReclassificationsCertain prior period amounts have been reclassified to conform with the current period presentation.



|2. |  | RECEIVABLES
|-- |  | -----------



At June 30, 2003 and December 31, 2002, the Company had a $27.5 million receivable from AGIC related to the draw down of an Acceptance Insurance Companies
Inc. letter of credit by an AGIC reinsurer during the fourth quarter of 2002. Considering the uncertainty regarding the collection of this balance from AGIC, the Company has recorded an allowance for the entire $27.5 million.



At June 30, 2003 the Company had a note receivable of approximately $1.3
million. During the first quarter of 2003, the Company sold its office building and certain contents in Council Bluffs, Iowa. The proceeds included approximately $204,000 of cash and a note receivable with a fair value of approximately $1.3 million
and the sale resulted in a gain of approximately $334,000. The terms of the



8



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note include interest of 5.25% from August 1, 2003 to February 28, 2008 and 6% from March 1, 2008 to March 31, 2010. Principal and interest payments of
approximately $9,100 are due monthly beginning in September 2003 with a balloon payment for the remaining amounts on March 31, 2010.



|3. |  | COMPANY-OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF AICI CAPITAL TRUST, HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES OF THE COMPANY
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------



In August 1997, AICI Capital Trust, a Delaware business trust organized by
the Company (the Issuer Trust) issued 3.795 million shares or $94.875 million aggregate liquidation amount of its 9% Preferred Securities (liquidation amount $25 per Preferred Security). The Company owns all of the common securities (the
Common Securities) of the Issuer Trust. The Preferred Securities represent preferred undivided beneficial interests in the Issuer Trusts assets. The assets of the Issuer Trust consist solely of the Companys 9% Junior
Subordinated Debentures due in 2027, which were issued in August 1997 in an amount equal to the total of the Preferred Securities and the Common Securities.



Distributions on the Preferred Securities and Junior Subordinated Debentures are cumulative, accrue from the date of issuance and are payable quarterly in
arrears. The Junior Subordinated Debentures are subordinate and junior in right of payment to all senior indebtedness of the Company and are subject to certain events of default and can be called at par value after September 30, 2002. At June 30,
2003 and December 31, 2002, the Company had Preferred Securities of $94.875 million outstanding at a weighted average interest cost of 9.2%.



During April 2002 the Company paid $2.1 million of interest on the Junior Subordinated Debentures. The distribution of interest for the second quarter of
2002 was due and paid in July 2002. Effective November 18, 2002, the Company elected to defer payment of interest on its Junior Subordinated Debentures, as permitted by the trust agreement and indenture, beginning with the interest payment date on
December 31, 2002 until not later than September 30, 2007. The interest payments on the Preferred Securities will be deferred for a corresponding period. As of June 30, 2003 approximately $6.6 million of accrued interest had been deferred.



9



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|4. |  | NET LOSS PER SHARE
|-- |  | ------------------



The net loss per basic and diluted share for the three and six months ended June 30, 2003 and 2002 were as follows:



|                                           |  | Three Months |         |   | Six Months |  
|------------------------------------------ |  | ------------ | ------- | - | ---------- | -
|                                           |  | 2003         |         |   | 2002       |  
|Loss from continuing operations            |  | $            | (2,722  | ) |            | $
|Loss from discontinued operations          |  |              | (8,346  | ) |            |  
|                                           |  |              |         |   |            |  
|Net loss                                   |  | $            | (11,068 | ) |            | $
|                                           |  |              |         |   |            |  
|Weighted average common shares outstanding |  |              | 14,201  |   |            |  
|                                           |  |              |         |   |            |  
|Loss per share:                            |  |              |         |   |            |  
|Basic and diluted:                         |  |              |         |   |            |  
|Loss from continuing operations            |  | $            | (0.19   | ) |            | $
|Loss from discontinued operations          |  |              | (0.59   | ) |            |  
|Net loss                                   |  |              | (0.78   | ) |            |  



Stock options were not
included in the above calculations for the three and six months ended June 30, 2003 and 2002 due to their antidilutive nature.



|5. |  | OTHER COMPREHENSIVE INCOME
|-- |  | --------------------------



Other comprehensive income determined in accordance with SFAS No. 130 for the three and six months ended June 30, 2003 and 2002 are as follows:



|                                                                                     |  | Three Months |         |   | Six Months |  
|------------------------------------------------------------------------------------ |  | ------------ | ------- | - | ---------- | -
|                                                                                     |  | 2003         |         |   | 2002       |  
|Net loss                                                                             |  | $            | (11,068 | ) |            | $
|                                                                                     |  |              |         |  
|Unrealized holding gains (losses) of investments, net of reclassification adjustment |  |              | 101     |   |            |  
|Income tax expense (benefit)                                                         |  |              |        |   |            |  
|                                                                                     |  |              |         |   |            |  
|                                                                                     |  |              | 101     |   |            |  
|                                                                                     |  |              |         |   |            |  
|Other comprehensive loss                                                             |  | $            | (10,967 | ) |            | $
|                                                                                     |  |              |         |   |            |  



|6. |  | STOCK-BASED COMPENSATION
|-- |  | ------------------------



The Company accounts for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. No stock-based employee compensation cost has been recognized in the financial statements as all options granted under those plans had an exercise price equal to the market value
of the underlying common stock at the date of the grant.



10



---

Had compensation cost for the Companys stock-based compensation plans been determined based on the
fair value for awards under those plans consistent with the method of SFAS No. 123, the Companys net loss and net loss per share for the three and six months ended June 30, 2003 and 2002 would have been as indicated below:



|                                             |  | Three Months |         |   | Six Months |  
|-------------------------------------------- |  | ------------ | ------- | - | ---------- | -
|                                             |  | 2003         |         |   | 2002       |  
|Net loss:                                    |  |              |         |   |            |  
|As reported                                  |  | $            | (11,068 | ) |            | $
|Fair value based method compensation expense |  |              | (82     | ) |            |  
|                                             |  |              |         |   |            |  
|Pro forma                                    |  | $            | (11,150 | ) |            | $
|                                             |  |              |         |   |            |  
|Net loss per share:                          |  |              |         |   |            |  
|Basic and diluted:                           |  |              |         |   |            |  
|As reported                                  |  | $            | (0.78   | ) |            | $
|Pro forma                                    |  |              | (0.79   | ) |            |  



|7. |  | EMPLOYEE BENEFITS AND INCENTIVES
|-- |  | --------------------------------



As discussed in Note 1, the Company exited its Agricultural Segment and Property and Casualty Segment operations during 2002. In the Property and Casualty
Segment, the Company expects to incur approximately $1.1 million of employee termination benefits, comprised primarily of retention and severance amounts. Approximately $128,000 and $308,000 of employee termination benefits have been expensed in
discontinued operationsunderwriting expenses during the three and six months ended June 30, 2003, respectively, and $131,000 had been expensed in previous periods. During the six months ended June 30, 2003 approximately $87,000 of termination
benefits were paid and as of June 30, 2003 the Company has an accrued liability of approximately $352,000.



In order to induce employees of AIC to remain in the employment of AIC, AICI has agreed to pay each employee a retention bonus in the event AIC would be
unable to meet this obligation. Additionally, AICI has agreed to guarantee certain amounts due under employment agreements with the President and Treasurer. During the second quarter of 2003, AICI agreed to guarantee these obligations by
establishing an appropriate trust with a bank whereby the amount of such guarantees, totaling approximately $1.1 million, have been deposited in such trust account. The amounts held in the trust account are presented as restricted cash equivalents
on the Companys consolidated balance sheet.



During the
second quarter of 2003, the Company established an incentive bonus plan. The purpose of the incentive bonus plan is to protect and enhance the interest of creditors and stockholders by providing all employees with meaningful incentives. The
incentive bonus plan establishes that up to 20% of an incentive bonus pool, determined based upon value added criteria detailed in the agreement, would be allocated and paid to employees based upon established allocation percentages. As of June 30,
2003, the criteria established within the agreement have not been met and the Company is unable to estimate any amounts that may become due and, as such, no amounts have been accrued.



11



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|8. |  | COMMITMENTS AND CONTINGENCIES
|-- |  | -----------------------------



In December 1999 the Company was sued in the United States District Court for the District of Nebraska. Plaintiffs alleged the Company knowingly and
intentionally understated the Companys liabilities in order to maintain the market price of the Companys common stock at artificially high levels and made untrue statements of material fact, and sought compensatory damages, interest,
costs and attorney fees. In February 2000 other plaintiffs sued the Company in the same Court, alleging the Company intentionally understated liabilities in a registration statement filed in conjunction with the Companys Trust Preferred
Securities.



The Court consolidated these suits in April 2000
and Plaintiffs subsequently filed a consolidated class action complaint. Plaintiffs sought to represent a class consisting of all persons who purchased either Company common stock between March 10, 1998 and November 16, 1999, or AICI Capital Trust
Preferred Securities between the July 29, 1997 public offering and November 25, 1999. In the consolidated complaint Plaintiffs alleged violation of Section 11 of the Securities Act of 1933 through misrepresentation or omission of a material fact in
the registration statement for the Trust Preferred Securities, and violation of Section 10b of the Securities Exchange Act of 1934 and Rule 10b5 of the U.S. Securities and Exchange Commission through failure to disclose material information
between March 10, 1998 and November 16, 1999. The Company, three of its former officers, the Companys Directors and independent accountants and other individuals, as well as the financial underwriters for the Companys Trust Preferred
Securities, were defendants in the consolidated action.



On
March 2, 2001, the Court entered an order dismissing all claims alleging violations of Section 11 of the Securities Act, and dismissing the Companys Directors, financial underwriters, independent accountants and others as defendants in this
action. The Court also ruled that certain of Plaintiffs allegations regarding the remaining defendants alleged failure to properly report contingent losses attributable to the Montrose decision did not state a claim under Section
10b and Rule 10b-5. In two subsequent rulings, the Court and Magistrate Judge clarified the March 2 ruling to specify which of Plaintiffs Montrose-related allegations failed to state a Section 10b and Rule 10b-5 claim. These three
rulings reduced the litigation to a claim that the Company and three of its former officers, during the period from August 14, 1997 to November 16, 1999, failed to disclose adequately information about various aspects of the Companys
operations, including information relating to the Companys exposure after January 1, 1997 to losses resulting from the Montrose decision. Nevertheless, Plaintiffs continue to seek compensatory damages, reasonable costs and expenses
incurred in this action and such other and such further relief as the Court may deem proper.



On August 6, 2001, the Magistrate Judge granted Plaintiffs Motion for Class Certification. Plaintiffs fact discovery was concluded July 31, 2002 in accordance with a schedule established by the Court. On
September 16, 2002 Plaintiffs sought the Courts permission to reinstate certain previously dismissed claims under Section 11 and 15 of the Securities Act. The Court denied Plaintiffs request in its entirety on February 27, 2003;
Plaintiffs asked the Court to reconsider this decision and the Court has not ruled on that request. On March 31, 2003, however, the Court established a schedule for the submission during May 2003 of briefs regarding the Companys proposed
motion to decertify the class. The Court also established a schedule concluding in August 2003 for submission of briefs regarding both parties anticipated motions for summary judgment. The Company has filed a motion to decertify the class and
a motion for summary judgment. No hearings have been scheduled with respect to either motion.



The Company intends to continue vigorously contesting this action and believes Plaintiffs allegations are without merit. Nevertheless, the ultimate outcome of this action cannot be predicted at this time and the
Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows.



12



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|9. |  | DISCONTINUED OPERATIONSGENERAL
|-- |  | -------------------------------



In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (SFAS No. 144), Accounting for the Impairment or
Disposal of Long-Lived Assets. Under SFAS No. 144 a component of business is considered abandoned when it ceases to be used, and such business operations are to be reported as discontinued operations. Due to the financial condition of the
Company and regulatory restrictions placed on the Company in the fourth quarter of 2002, the Company does not intend nor have the ability to continue its operations in the Agricultural Segment or the Property and Casualty Segment. Accordingly, all
operations in both segments have ceased and these segments have been presented as discontinued operations.



Assets and liabilities have been separately classified on the face of the consolidated balance sheets. Operating results for these segments for the three
and six months ended June 30, 2003 and 2002 were as follows:



|                                              |  | Three Months |        |   | Six Months |  
|--------------------------------------------- |  | ------------ | ------ | - | ---------- | -
|                                              |  | 2003         |        |   | 2002       |  
|Revenues:                                     |  |              |        |   |            |  
|Insurance premiums earned                     |  | $            | 102    |   |            | $
|Net investment income                         |  |              | 835    |   |            |  
|Net realized capital gains (losses)           |  |              | 264    |   |            |  
|                                              |  |              |        |   |            |  
|                                              |  |              | 1,201  |   |            |  
|                                              |  |              |        |   |            |  
|Costs and expenses:                           |  |              |        |   |            |  
|Insurance losses and loss adjustment expenses |  |              | 7,664  |   |            |  
|Insurance underwriting expenses               |  |              | 1,883  |   |            |  
|Impairment of property and equipment          |  |              |       |   |            |  
|                                              |  |              |        |   |            |  
|                                              |  |              | 9,547  |   |            |  
|                                              |  |              |        |   |            |  
|Operating loss                                |  |              | (8,346 | ) |            |  
|                                              |  |              |        |   |            |  
|Income tax expense (benefit):                 |  |              |        |   |            |  
|Current                                       |  |              |       |   |            |  
|Deferred                                      |  |              | (2,922 | ) |            |  
|Change in valuation allowance                 |  |              | 2,922  |   |            |  
|                                              |  |              |        |   |            |  
|                                              |  |              |       |   |            |  
|                                              |  |              |        |   |            |  
|Loss from discontinued operations, net of tax |  | $            | (8,346 | ) |            | $
|                                              |  |              |        |   |            |  



13



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|10. |  | DISCONTINUED OPERATIONSINVESTMENTS
|--- |  | -----------------------------------



The amortized cost and related estimated fair values of investments in the accompanying consolidated balance sheets are as follows:



|                                          |  | AmortizedCost |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFairValue
|----------------------------------------- |  | ------------- | ------ | -------------------- | - | --------------------- |  | ------------------
|June 30, 2003:                            |  |               |        |                      |   |                       |  |                   
|Fixed maturities available-for-sale:      |  |               |        |                      |   |                       |  |                   
|U.S. Treasury and government securities   |  | $             | 52,759 |                      | $ | 828                   |  | $                 
|Other debt securities                     |  |               | 17,640 |                      |   | 410                   |  |                   
|                                          |  |               |        |                      |   |                       |  |                   
|                                          |  | $             | 70,399 |                      | $ | 1,238                 |  | $                 
|                                          |  |               |        |                      |   |                       |  |                   
|Marketable equity securitiescommon stock |  | $             | 1,970  |                      | $ | 2                     |  | $                 
|                                          |  |               |        |                      |   |                       |  |                   



|                                             |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFairValue
|-------------------------------------------- |  | ------------- | ------- | -------------------- | - | --------------------- |  | ------------------
|December 31, 2002:                           |  |               |         |                      |   |                       |  |                   
|Fixed maturities available-for-sale:         |  |               |         |                      |   |                       |  |                   
|U.S. Treasury and government securities      |  | $             | 59,744  |                      | $ | 1,472                 |  | $                 
|Other debt securities                        |  |               | 53,137  |                      |   | 1,198                 |  |                   
|                                             |  |               |         |                      |   |                       |  |                   
|                                             |  | $             | 112,881 |                      | $ | 2,670                 |  | $                 
|                                             |  |               |         |                      |   |                       |  |                   
|Marketable equity securitiespreferred stock |  | $             | 2,500   |                      | $ |                      |  | $                 
|                                             |  |               |         |                      |   |                       |  |                   
|Marketable equity securitiescommon stock    |  | $             | 5,952   |                      | $ | 69                    |  | $                 
|                                             |  |               |         |                      |   |                       |  |                   



As required by
insurance regulatory laws, certain fixed maturities with an estimated fair value of approximately $7.4 million at June 30, 2003 were deposited in trust with regulatory agencies. Additionally, at June 30, 2003, approximately $42.5 million of fixed
maturities available-for-sale and $13.2 million of cash equivalents were pledged to Clarendon to secure the Companys obligations under reinsurance agreements and approximately $11.7 million of fixed maturities available-for-sale and $106,000
of cash equivalents were pledged to McM to secure the Companys net obligations under the reinsurance agreements (See Note 15).



14



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|11. |  | DISCONTINUED OPERATIONSINSURANCE PREMIUMS
|--- |  | ------------------------------------------



Insurance premiums written and earned by the Companys insurance subsidiaries for the three and six months ended June 30, 2003 and 2002 were as
follows:



|                         |  | Three Months |     |   | Six Months |  
|------------------------ |  | ------------ | --- | - | ---------- | -
|                         |  | 2003         |     |   | 2002       |  
|Direct premiums written  |  | $            | (17 | ) |            | $
|Assumed premiums written |  |              | 155 |   |            |  
|Ceded premiums written   |  |              | (43 | ) |            |  
|                         |  |              |     |   |            |  
|Net premiums written     |  | $            | 95  |   |            | $
|                         |  |              |     |   |            |  
|Direct premiums earned   |  | $            | 8   |   |            | $
|Assumed premiums earned  |  |              | 162 |   |            |  
|Ceded premiums earned    |  |              | (68 | ) |            |  
|                         |  |              |     |   |            |  
|Net premiums earned      |  | $            | 102 |   |            | $
|                         |  |              |     |   |            |  



|12. |  | DISCONTINUED OPERATIONSREINSURANCE
|--- |  | -----------------------------------



The Companys insurance subsidiaries cede insurance to other companies under quota share, excess of loss, catastrophe and facultative treaties. The
reinsurance agreements are tailored to the various programs offered by the insurance subsidiaries. Reinsurance does not discharge the insurer from its obligations to its insured. If the reinsurer fails to meet its obligations, the ceding insurer
remains liable to pay the insured loss, but the reinsurer is liable to the ceding insurer to the extent of the reinsured portion of any loss.



The Company reinsures certain portions of business written by Clarendon, Redland, AIIC and ACIC (See Note 15). Under these reinsurance agreements, the
Company assumes business after Clarendon, Redland, AIIC, and ACIC cessions to outside reinsurers. However, the Company is contingently liable for any uncollectible amounts due from these outside reinsurers related to business produced and managed by
the Company.



As of December 31, 2002 the Company has
outstanding reinsurance recoverables from Constitution Insurance Company (CIC) of approximately $26.2 million and is contingently liable for AIIC and Redland reinsurance recoverables from CIC totaling approximately $2.8 million. CIC had
its financial strength rating lowered by A.M. Best from A- (Excellent) to B- (Fair) during the fourth quarter of 2002. In January 2003, in response to a request from CICs parent to withdraw from the rating process, A.M. Best withdrew its
financial strength rating of B- and assigned CIC and its parent an NR-3 rating (Rating Procedure Inapplicable). As of June 30, 2003 CIC continues to make payments to the Company for reinsurance billings and accordingly, no allowance for doubtful
accounts or liability has been established for these balances.



In September 2001 the Company initiated an arbitration proceeding to recover from a pool of solvent reinsurers sums the Company believes are due under a workers compensation insurance program of the Company principally written on
Redland. The Company is contingently liable to Redland for amounts due from these reinsurers. At December 31, 2002 the Company was contingently liable for approximately $20.4 million due from these reinsurers and approximately $5.1 million
conditionally paid by the reinsurers but was still subject to the outcome of the arbitration. On May 31, 2003, the arbitration panel found that there was no reason to relieve the reinsurers of their obligations under the



15



---

reinsurance contracts, made final the previous $5.1 million conditional payment from the reinsurers, ordered and awarded the payments of reinsurance
recoverables, plus interest, to Redland and AIC sought by AIC, subject to potential adjustments that may be made to amounts withheld and escrowed until any such adjustments are made. The award of the arbitration panel did not have a significant
impact on the Companys net loss for the six months ended June 30, 2003.



The Company has other reinsurance recoverables and is contingently liable for AIIC and Redland reinsurance recoverables that are currently being disputed or payments have been delayed pending audit of the
Companys records. The Company believes the reinsurers will be required to pay amounts due and, accordingly, a liability has not been established for these reinsurance recoveries. However, the ultimate outcome of these items cannot be predicted
at this time.



|13. |  | DISCONTINUED OPERATIONSREGULATORY MATTERS
|--- |  | ------------------------------------------



AGIC was placed into rehabilitation by the District Court of Lancaster County, Nebraska on December 20, 2002. Effective as of December 20, 2002, AGIC and
its subsidiaries ceased to be under the control of the Company and are not included as consolidated subsidiaries of the Company.



The only remaining consolidated insurance company of AICI is AIC. The Director entered an administrative Order of Supervision with respect to AIC on
December 20, 2002 and AIC is currently operating pursuant to that Order.



The National Association of Insurance Commissioners has established risk-based capital (RBC) standards. RBC standards are designed to measure the acceptable level of capital an insurer should have, based
on the inherent and specific risks of each insurer. As of June 30, 2003 and December 31, 2002, AIC had negative surplus, resulting in a RBC at the mandatory control level. Under the mandatory control level, the Director may take such actions as
necessary to place AIC under regulatory control under the Nebraska Insurers Supervision, Rehabilitation, and Liquidation Act. Since AIC is currently in run-off, the Director is permitted to allow AIC to continue its run-off under supervision of the
NEDOI. While AIC is currently in supervision, the Director currently has the authority to increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change
in the financial condition of AIC. The Company believes increased regulatory control of AIC would have a significant negative impact on the Company.



Under the Order of Supervision, AIC is required to pay all costs incurred by the Supervisor, AIC may not accept or renew any insurance business and may
not perform any activities beyond those that are routine in the day-to-day conduct of its runoff business without prior approval of the Director or Supervisor. Additionally, any transactions with affiliates or former affiliates require prior
approval of the Director or Supervisor. AICI does not expect to have access to any surplus note interest payments or dividend payments from AIC, as these payments would require Nebraska Department of Insurance approval.



16



---

|14. |  | DISCONTINUED OPERATIONSBUSINESS SEGMENTS
|--- |  | -----------------------------------------



Segment insurance premiums earned and segment underwriting earnings (loss) for the three and six months ended June 30, 2003 and 2002 are as follows:



|                             |  | Three Months          |        |   | Six Months                    |  
|---------------------------- |  | --------------------- | ------ | - | ----------------------------- | -
|                             |  | AgriculturalInsurance |        |   | Property andCasualtyInsurance |  
|2003                         |  |                       |        |   |                               |  
|Insurance premiums earned    |  | $                     |       |   |                               | $
|                             |  |                       |        |   |                               |  
|Underwriting earnings (loss) |  | $                     |       |   |                               | $
|                             |  |                       |        |   |                               |  
|                             |  |                       |        |   |                               |  
|2002                         |  |                       |        |   |                               |  
|Insurance premiums earned    |  | $                     | 28,830 |   |                               | $
|                             |  |                       |        |   |                               |  
|Underwriting earnings (loss) |  | $                     | (404   | ) |                               | $
|                             |  |                       |        |   |                               |  



|15. |  | DISCONTINUED OPERATIONSSALE OF SUBSIDIARIES AND PROPERTY AND CASUALTY BUSINESS AND RELATED GUARANTEES
|--- |  | ------------------------------------------------------------------------------------------------------



The Company sold its wholly owned subsidiary, Redland Insurance Company
(Redland), to Clarendon National Insurance Company (Clarendon) effective as of July 1, 2000. The sale was a cash transaction of approximately $10.9 million based upon the market value of Redland after the divestiture of
various assets, including the Redland subsidiaries, to a wholly owned subsidiary of Acceptance Insurance Companies Inc. The transaction included the appointment of other Company subsidiaries as a producer and administrator for the business the
Company wrote through Clarendon and Redland. The Company also reinsures certain portions of the business written by Clarendon and Redland. At June 30, 2003, approximately $42.5 million of fixed maturities available-for-sale and $13.2 million of cash
equivalents were placed in a trust and pledged to Clarendon to secure the Companys obligations under reinsurance agreements. Under these reinsurance agreements, the Company assumes business from Clarendon and Redland after cessions to outside
reinsurers (Clarendon Reinsurers). The Company is contingently liable for any uncollectible amounts due from Clarendon Reinsurers related to this business. At June 30, 2003, Clarendon and Redland reinsurance recoverables from Clarendon
Reinsurers, which are not included on the consolidated balance sheets of the Company, totaled approximately $98 million.



The amounts pledged to Clarendon were used to secure the issuance of a $20.6 million Redland letter of credit to the California Department of Insurance
related to bond requirements resulting from the Companys workers compensation business written on Redland paper (Bond Requirements).



In March 2003, the Company and Clarendon agreed to a Master Collateral Agreement (MCA) which supercedes previous agreements with respect to
the minimum pledged assets to be included in the trust, the methodology for releasing these pledged assets from the trust and use of the trust account for collateral for the issuance of letter of credits to the California Department of Insurance.
Additionally, the Company has agreed to take whatever action may be reasonably necessary to permit Clarendon, in accordance with the MCA, to increase the Redland letter of credit amount by approximately $29 million.



17



---

In general, the minimum amount to be included in the trust account is based upon the greater of 1)
certain percentages of loss and loss adjustment expense reserves assumed by the Company from Clarendon and Redland and reinsurance recoverables from Clarendon Reinsurers for which the Company is contingently liable or 2) 70% of the Bond
Requirements.



As of July 1, 2001, the Company sold two wholly
owned insurance companies to McM Corporation, a Raleigh, North Carolina based insurance holding company (McM). The two companies, Acceptance Indemnity Insurance Company (AIIC) and Acceptance Casualty Insurance Company
(ACIC), underwrote primarily Property and Casualty Segment insurance. The Company reinsures certain portions of the business written by AIIC and ACIC. As of June 30, 2003 approximately $11.7 million of fixed maturities available-for-sale
and $106,000 of cash equivalents were placed in a trust and pledged to McM to secure the Companys net obligations under the reinsurance agreements. Under these reinsurance agreements, the Company assumes business from AIIC and ACIC after
cessions to outside reinsurers (AIIC Reinsurers). The Company is contingently liable for any uncollectible amounts due from AIIC Reinsurers related to this business. At June 30, 2003, AIIC and ACIC reinsurance recoverables from AIIC
Reinsurers, which are not included on the consolidated balance sheets of the Company, totaled approximately $38 million.



|16. |  | DISCONTINUED OPERATIONSACQUISITION OF IGF CROP INSURANCE ASSETS
|--- |  | ----------------------------------------------------------------



On June 6, 2001 the Company completed the acquisition of substantially all crop insurance assets and the assumption of certain crop insurance and
reinsurance liabilities of Symons International Group, Inc. and affiliates including IGF Insurance Company (collectively referred to as IGF). The Company paid approximately $27.4 million at closing and agreed to make deferred payments of
up to an additional $9.0 million, which included amounts for non-competition agreements, prospective reinsurance agreements, and property and equipment. Additionally, the Company reimbursed IGF for certain costs related to the 2001 crop season. The
Company funded the acquisition with internally generated resources, including proceeds from the sale of certain property and casualty assets. During 2000, IGFs gross crop insurance premiums, including MPCI subsidies, totaled approximately $241
million and the Companys gross crop insurance premiums for the same period totaled approximately $434 million.



The acquisition was accounted for by the purchase method of accounting and, accordingly, the consolidated statements of operations include the acquired
crop results beginning June 6, 2001. The assets acquired and recognition of liabilities directly related to the acquisition of $34.2 million and $6.8 million, respectively, were recorded at estimated fair values as determined by the Companys
management. The Companys purchase price allocation included $18.3 million of goodwill and $10.1 million of intangible assets. The assets acquired and recognition of liabilities directly related to the acquisition and the allocation of the
purchase price was revised in the second quarter of 2002 based upon final determination of fair values. During the third and fourth quarters of 2002, it was determined that the intangible asset related to non-competition agreements and goodwill were
impaired and these assets were written down to zero.



18



---

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



The following discussion and analysis of financial condition and results of operations of the Company and its consolidated subsidiaries should be read in conjunction with
the Companys Interim Consolidated Financial Statements and the notes thereto included elsewhere herein.



Forward-Looking Information



Except for
the historical information contained in this Quarterly Report on Form 10-Q, matters discussed herein may constitute forward-looking information within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking
information reflects the Companys current best estimates regarding future operations, but, as these are only estimates, actual results may differ materially from such estimates.



A variety of events, most of which are outside the control of the Company, cannot be accurately predicted and may materially impact
estimates of future operations. Important among such factors are changes in state and federal regulations, decisions by regulators including any increased regulatory control over Acceptance Insurance Company, changes in the reinsurance market,
including the ability and willingness of reinsurers to pay claims, changes in tax laws, financial market performance, changes in federal policies or court decisions affecting coverages, changes in the rate of inflation, interest rates and general
economic conditions.



The only remaining consolidated insurance subsidiary of
AICI at June 30, 2003, AIC, is regulated by the Nebraska Department of Insurance (NEDOI). AIC is currently under supervision by the NEDOI. The Director currently has the authority to increase regulatory control of AIC by requesting an
appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial condition of AIC. The Company believes that an Order of Rehabilitation would have a significant negative impact on the
Company and that an Order of Liquidation would have a material adverse effect on the Company.



In August 2003, the NEDOI orally informed the Company of the results of a draft report regarding AICs loss and loss adjustment expense reserves at December 31, 2002 prepared by an outside actuary engaged by the
NEDOI in connection with the NEDOIs triennial examination of AIC. The NEDOI informed the Company of the range of estimated adequate loss reserves for AIC at December 31, 2002 determined by the NEDOIs outside actuary in the draft report.
This range of estimated reserves, including the lower amount of the estimate, is significantly higher than the estimate of adequate loss reserves at December 31, 2002 determined by the Company and the independent actuary engaged by the Company to
review the Companys loss reserving process and reserve estimates. The Company has not yet received the final written report of the NEDOIs outside actuary. Although the Company believes it will receive this final written report during the
third quarter of 2003, there can be no assurance as to when it will receive the report.



Upon receipt of the report by the NEDOIs outside actuary, the Company will review fully this report. Upon completion of this review, the Company will decide to take the course of action that is in the best interests of the Company
based all relevant factors, including any reasonable basis for protesting the report and what action, if any, is taken by the NEDOI. At this time, there can be no assurance as to what actions, if any, the NEDOI will take in connection with this
report. If the NEDOI does take action there can be no assurance as to when it may do so or how long it may take to complete any such action; however, the Company believes that if the NEDOI takes any action, it would initiate such action during the
third or fourth quarter of 2003. The Director currently has the authority to increase regulatory



19



---

control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial
condition of AIC and regardless of the reserve estimate by the NEDOIs outside actuary. The Company believes that an Order of Rehabilitation would have a significant negative impact on the Company and that an Order of Liquidation would have a
material adverse effect on the Company. If the NEDOI seeks and obtains an Order of Rehabilitation or Order of Liquidation, the Company will decide to take the course of action that is in the best interests of the Company based on all relevant
factors. The Company believes that its possible options will range from no action to filing bankruptcy depending on what type of order, if any, is sought and obtained by the NEDOI, what actions the NEDOI takes pursuant to any such order and all
other factors relevant to taking the actions that are in the best interests of the Company. The filing of a bankruptcy proceeding would constitute an event of default under the trust agreement for the Trust Preferred Securities.



As disclosed in the Companys Form 10-K for the year ended December 31, 2002 under Part
I, Item 1. Business, Loss and Loss Adjustment Expense Reserves, in monitoring reserve adequacy the Company reviews historical data and other data and, as additional experience and data become available, revises estimates of reserves. The liability
estimate established represents managements best estimate based on currently available evidence, including an analysis prepared by an independent actuary engaged by the Company. Even with such extensive analyses, however, the Company believes
its ultimate liability may vary significantly from such estimates. The Company annually obtains an independent review of its loss reserving process and reserve estimates as part of the annual audit of its financial statements by a professional
actuary, PricewaterhouseCoopers LLP, who is independent of the Company and its auditors. This independent review was obtained as of December 31, 2002.



Additionally, there is significant uncertainty as to whether AIC will be able to meet its future cash flow needs. A major portion of AICs investments are pledged to
states and to acquirers of former Company affiliates and AICs ability to meet its cash flow needs will be highly dependent upon AICs ability to get significant amounts of pledged funds released. Additionally, AICs cash flows are
significantly impacted by any changes in the expected payout of insurance losses and loss adjustment expenses. AICs ability to meet its cash flow needs is also dependent upon the timely recovery of reinsurance balances, including the favorable
resolution of balances currently in dispute. While based upon current estimates AIC would likely have the ability to meet its cash flow needs through June 30, 2004 if the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with
respect to AIC, there can be no assurances considering the significant uncertainties that exist.



There is also significant uncertainty as to whether AICI will be able to meet its cash flow needs. AICI has deferred interest payments on its Junior Subordinated Debentures, which in turn deferred the interest on the
Trust Preferred Securities issued by AICI Capital Trust, as permitted by the trust agreement and indenture, and has disputed or denied payments of certain other liabilities and commitments. While based upon current estimates AICI would likely have
the ability to meet its cash flow needs through June 30, 2004 if the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC, there can be no assurances considering the significant uncertainties that exist. If
the NEDOI obtains an Order of Rehabilitation or Order of Liquidation with respect to AIC, the Company believes that AICI may not be able to meet its cash flow needs.



Forward-looking information set forth herein does not take into account any impact from the various factors noted above which may affect
future results.



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Results of Operations



Three and Six Months Ended June 30, 2003

Compared to Three and Six Months
Ended June 30, 2002



The Companys net loss increased to $11.1 million,
or $0.78 per share, and $14.6 million, or $1.03 per share, for the three and six months ended June 30, 2003, respectively, from $5.2 million, or $0.36 per share, and $9.5 million, or $.66 per share, for the three and six months ended June 30, 2002,
respectively. Loss before income taxes and discontinued operations were approximately $2.7 million and $2.3 million for the three months ended June 30, 2003 and 2002, respectively. Loss before income taxes and discontinued operations were
approximately $4.8 million and $4.7 million for the six months ended June 30, 2003 and 2002, respectively.



During the first quarter of 2003, the Company sold its office building and certain contents in Council Bluffs, Iowa. The proceeds included approximately $204,000 of cash and a note receivable with a fair value of
approximately $1.3 million and the sale resulted in a gain of approximately $334,000. During the three and six months ended June 30, 2002 the income tax benefit from continuing operations was approximately $815,000 and $1.6 million, respectively.
During the three and six months ended June 30, 2003 there was no income tax benefit or expense as the change in valuation allowance offset the deferred tax benefit.



The loss from discontinued operations, net of tax, increased to $8.3 million and $9.8 million during the three and six months ended June 30,
2003 from $3.6 million and $6.4 million for the three and six months ended June 30, 2002, respectively. Included in the discontinued operations was the underwriting loss for the Property and Casualty Segment of $9.4 million and $6.5 million for the
three months ended June 30, 2003 and 2002, respectively, and $11.7 million and $8.3 million for the six months ended June 30, 2003 and 2002, respectively. The underwriting loss for the Agricultural Segment was zero and $404,000 for the three months
ended June 30, 2003, respectively, and zero and $4.2 million for the six months ended June 30, 2003 and 2002, respectively. The Company was not impacted in the first and second quarters of 2003 and does not expect to be materially impacted by the
discontinued operations of the Agricultural Segment in the future.



During the
six months ended June 30, 2002 the estimated profit share in the Agricultural Segment for the 2001 crop year was reestimated at $81.2 million on a MPCI retained pool of $498.5 million, or 16.3% as compared to an estimated profit share recorded at
December 31, 2001 of $86.2 million on a MPCI retained pool of $499.4 million, or 17.3%. The first quarter 2002 results included $5.4 million of the decrease in estimated profit share. This reduction in estimated profit share for the six months ended
June 30, 2002 was partially offset by a related reduction in private MPCI reinsurance costs totaling approximately $1.8 million. The primary factor impacting the estimated MPCI profit share was excessive rain in cotton producing areas in the
Southeastern United States, which delayed processing of the 2001 cotton harvest into 2002 and damaged the cotton before it could be processed, combined with lower commodity prices for cotton.



During the past several years, the Company discontinued or sold all remaining Property and
Casualty Segment business. In March 2001, the Company sold a significant portion of its property and casualty business to Insurance Corporation of Hannover and in May 2001, the Company sold several of the remaining lines of business to McM
Corporation and to American Reliable Insurance Company (See Sale of Subsidiaries and Property and Casualty Segment Business and Related Guarantees). Accordingly, the net premiums earned in the Property and Casualty Segment decreased from



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approximately $6.3 million for the six months ended June 30, 2002 to $543,000 for the six months ended June 30, 2003.



The Companys Property and Casualty Segment had an underwriting loss of approximately
$9.4 million and $11.7 million for the three and six months ended June 30, 2003, respectively. The results for the second quarter of 2003 included a reserve strengthening of approximately $7.7 million, primarily as a result of higher than expected
loss adjustment expenses for general liability claims and higher than expected losses for workers compensation claims. Additionally, the six months ended June 30, 2003 results include a reserve strengthening of approximately $692,000 recorded
in the first quarter of 2003, primarily for auto liability claims.



The
Companys Property and Casualty Segment had an underwriting loss of approximately $6.5 million and $8.3 million for the three months and six months ended June 30, 2002, respectively. The results for the three months and six months ended June
30, 2002 included a reserve strengthening of approximately $6.0 million and $6.8 million, respectively. The reserve development for the three months ended June 30, 2002 was comprised of approximately $5.9 million of negative reserve development
attributable to the general liability and commercial multi-peril lines of business primarily in recent accident years and $650,000 of uncollectible reinsurance recoveries, partially offset by positive reserve development in other lines of business.



While the Company has discontinued its Property and Casualty Segment business,
its operating results may continue to be significantly impacted by the Property and Casualty Segment. Significant factors that may impact future results include the adequacy of the Companys estimate of loss and loss adjustment expense
reserves, the recoverability of the Companys reinsurance recoverables and the recoverability of certain reinsurance recoverables of previously owned subsidiaries for which the Company is contingently liable, and the ability to meet the cash
flow needs of AIC. See Sale of Subsidiaries and Property and Casualty Segment Business and Related Guarantees and Liquidity and Capital Resources.



During the six months ended June 30, 2003 the Company impaired approximately $300,000 of property and equipment related to the write-off of
crop related property and equipment assets net of expected proceeds. These items were assets of Acceptance Insurance Company (AIC) but were not being utilized by any operations of the companies in the consolidated group.



The Companys net investment income related to discontinued operations declined from
approximately $2.0 million and $3.5 million for the three and six months ended June 30, 2002, respectively, to approximately $835,000 and $1.8 million for the three and six months ended June 30, 2003, respectively. This decrease in investment income
was primarily a result of the continuing decline in the size of the investment portfolio.



During the three and six months ended June 30, 2002 the income tax benefit from discontinued operations was approximately $1.9 million and $3.3 million, respectively. During the three and six months ended June 30,
2003 there was no income tax benefit or expense from discontinued operations as the change in valuation allowance offset the deferred tax benefit.



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Liquidity and Capital Resources



The Company has included a discussion of the liquidity and capital resources requirement of the Company and the Companys insurance
subsidiary.



The CompanyParent Only



As an insurance holding company, the AICIs assets consist primarily of the equity
interest in AIC, a surplus note issued by AIC and investments held at the holding company level. The Companys liquidity needs are primarily to service debt and pay operating expenses.



At June 30, 2003 the Company has $1.5 million in cash and cash equivalents and $1.1 million
of restricted cash and cash equivalents. The Company also holds a surplus note for $20 million issued by AIC, bearing interest at the rate of 9% per annum payable quarterly. The Company does not expect to have access to any surplus note interest
payments or dividend payments from AIC as these payments would require NEDOI approval as AIC is currently under the supervision of the NEDOI.



During the first quarter of 2003, the Company sold its office building and certain contents in Council Bluffs, Iowa. The proceeds included approximately $204,000 of cash
and a note receivable with a fair value of approximately $1.3 million.



In
August 1997, AICI Capital Trust, a Delaware business trust organized by the Company (the Issuer Trust) issued 3.795 million shares or $94.875 million aggregate liquidation amount of its 9% Preferred Securities (liquidation amount $25 per
Preferred Security). The Company owns all of the common securities (the Common Securities) of the Issuer Trust. The Preferred Securities represent preferred undivided beneficial interests in the Issuer Trusts assets. The assets of
the Issuer Trust consist solely of the Companys 9% Junior Subordinated Debentures due in 2027, which were issued in August 1997 in an amount equal to the total of the Preferred Securities and the Common Securities.



Distributions on the Preferred Securities and Junior Subordinated Debentures are cumulative,
accrue from the date of issuance and are payable quarterly in arrears. The Junior Subordinated Debentures are subordinate and junior in right of payment to all senior indebtedness of the Company and are subject to certain events of default and can
be called at par value after September 30, 2002, all as described in the Junior Debenture Indenture. At June 30, 2003 and December 31, 2002 the Company had Preferred Securities of $94.875 million outstanding at a weighted average interest cost of
9.2%.



During April 2002 the Company paid $2.1 million of interest on the
Junior Subordinated Debentures. The distribution of interest for the second quarter of 2002 was due and paid in July 2002. Effective November 18, 2002, the Company elected to defer payment of interest on its Junior Subordinated Debentures, as
permitted by the trust agreement and indenture, beginning with the interest payment date on December 31, 2002 until not later than September 30, 2007. The interest payments on the Preferred Securities will be deferred for a corresponding period. As
of June 30, 2003 approximately $6.6 million of accrued interest had been deferred.



There is significant uncertainty as to whether the Company will be able to meet its cash flow needs. As noted above, the Company has deferred interest payments on its Trust Preferred Securities and additionally, the Company has disputed or
denied payment of certain other liabilities and commitments. While based upon current estimates AICI would likely have the ability to meet its cash flow needs through June 30, 2004 if the NEDOI does not obtain an Order of Rehabilitation or Order of
Liquidation with respect to AIC, there can be no assurances considering the significant uncertainties that exist. If



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the NEDOI obtains an Order of Rehabilitation or Order of Liquidation with respect to AIC, the Company believes that AICI may not be able to meet its cash
flow needs.



Acceptance Insurance Company



The Companys only remaining consolidated insurance subsidiary at June 30, 2003 is AIC.
The principal liquidity needs of AIC are to fund losses and loss adjustment expense payments and operating expenses related to the run-off of its operations. The available sources to fund these requirements are cash flows from the Companys
investment activities.



The Companys investment portfolio is primarily
comprised of fixed maturities and cash equivalents. At June 30, 2003, approximately $67.6 million of fixed maturity securities and cash equivalents were placed in a trust and pledged in order to secure the Companys obligations under
reinsurance agreements. The agreements provide for the release of the pledged securities as the obligations under the reinsurance agreements decrease. However, if the Company is unsuccessful in obtaining the release of pledged securities, the
Companys liquidity would suffer a significant negative impact. See Sale of Subsidiaries and Property and Casualty Segment Business and Related Guarantees for additional information. Additionally, as required by insurance regulatory
laws, certain fixed maturity securities with an estimated fair value of approximately $7.4 million at June 30, 2003 were deposited in trust with regulatory agencies.



There is significant uncertainty as to whether AIC will be able to meet its future cash flow needs. As noted above, a major portion of
AICs investments are pledged and AICs ability to meet its cash flow needs will be highly dependent upon AICs ability to get significant amounts of pledged funds released. Additionally, AICs cash flows are significantly
impacted by any changes in the expected payout of insurance losses and loss adjustment expenses. AICs ability to meet its cash flow needs is also dependent upon the timely recovery of reinsurance balances, including the favorable resolution of
balances currently in dispute. While based upon current estimates AIC would likely have the ability to meet its cash flow needs through June 30, 2004 if the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to
AIC, there can be no assurances considering the significant uncertainties that exist.



Changes in Financial Condition



The Companys
stockholders deficit increased by approximately $14.5 million from December 31, 2002 to June 30, 2003. The principal component of this increase was a net loss of $14.6 million for the six months ended June 30, 2003.



Consolidated Cash Flows



Cash used by operating activities was approximately $699,000 and $2.8 million during the six months ended June 30, 2003 and 2002,
respectively. The Company expects negative cash flows from operating activities as the Company runs off its operations. See The ParentCompany Only and Acceptance Insurance Company regarding uncertainties of the Company
to meet its ongoing cash flow needs.



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Sale of Subsidiaries and Property and Casualty Segment Business and Related Guarantees



The Company sold its wholly owned insurance subsidiary, Redland Insurance Company
(Redland), to Clarendon National Insurance Company (Clarendon) effective as of July 1, 2000. The sale was a cash transaction of approximately $10.9 million based upon the market value of Redland after the divestiture of
various assets, including the Redland subsidiaries, to a wholly owned subsidiary of AICI. The transaction included the appointment of other Company subsidiaries as a producer and administrator for the business the Company wrote through Clarendon and
Redland. The Company also reinsures certain portions of the business written by Clarendon and Redland. At June 30, 2003, approximately $42.5 million of fixed maturities available-for-sale and $13.2 million of cash equivalents were placed in a trust
and pledged to Clarendon to secure the Companys obligations under reinsurance agreements. Under these reinsurance agreements, the Company assumes business from Clarendon and Redland after cessions to outside reinsurers (Clarendon
Reinsurers). The Company is contingently liable for any uncollectible amounts due from Clarendon Reinsurers related to this business. At June 30, 2003, Clarendon and Redland reinsurance recoverables from Clarendon Reinsurers, which are not
included on the balance sheet of the Company, totaled approximately $98 million.



The amounts pledged to Clarendon were used to secure the issuance of a $20.6 million Redland letter of credit to the California Department of Insurance related to bond requirements resulting from the Companys workers
compensation business written on Redland paper (Bond Requirements).



In March 2003, the Company and Clarendon agreed to a Master Collateral Agreement (MCA) which supercedes previous agreements with respect to the minimum pledged assets to be included in the trust, the methodology for releasing
these pledged assets from the trust and use of the trust account for collateral for the issuance of letters of credit to the California Department of Insurance. Additionally, the Company has agreed to take whatever action may be reasonably necessary
to permit Clarendon, in accordance with the MCA, to increase the Redland letter of credit amount by approximately $29 million.



In general, the minimum amount to be included in the trust account is based upon the greater of 1) certain percentages of loss and loss adjustment expense reserves
assumed by the Company from Clarendon and Redland and reinsurance recoverables from Clarendon Reinsurers for which the Company is contingently liable or 2) 70% of the Bond Requirements.



As of July 1, 2001, the Company sold two wholly owned insurance companies to McM Corporation (McM), a Raleigh, North Carolina
based insurance holding company. The two companies, Acceptance Indemnity Insurance Company (AIIC) and Acceptance Casualty Insurance Company (ACIC), underwrote primarily Property and Casualty Segment insurance. The Company
reinsures certain portions of the business written by AIIC and ACIC. As of June 30, 2003 approximately $11.7 million of fixed maturities available-for-sale and $106,000 of cash equivalents were placed in a trust and pledged to McM to secure the
Companys net obligations under the reinsurance agreements. Under these reinsurance agreements, the Company assumes business from AIIC and ACIC after cessions to outside reinsurers (AIIC Reinsurers). The Company is contingently
liable for any uncollectible amounts due from AIIC Reinsurers related to this business. At June 30, 2003, AIIC and ACIC reinsurance recoverables from AIIC Reinsurers, which are not included on the balance sheet of the Company, totaled approximately
$38 million.



Acquisition of IGF Crop Insurance Assets



On June 6, 2001 the Company completed the acquisition of substantially
all crop insurance assets and the assumption of certain crop insurance and reinsurance liabilities of Symons International Group, Inc. and affiliates including IGF Insurance Company (collectively referred to as IGF). The Company paid



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approximately $27.4 million at closing and agreed to make deferred payments of up to an additional $9.0 million, which included amounts for non-competition
agreements, prospective reinsurance agreements, and property and equipment. Additionally, the Company reimbursed IGF for certain costs related to the 2001 crop season. The Company funded the acquisition with internally generated resources, including
proceeds from the sale of certain property and casualty assets. During 2000, IGFs gross crop insurance premiums, including MPCI subsidies, totaled approximately $241 million and the Companys gross crop insurance premiums for the same
period totaled approximately $434 million.



The acquisition was accounted for
by the purchase method of accounting and, accordingly, the statements of operations include the acquired crop results beginning June 6, 2001. The assets acquired and recognition of liabilities directly related to the acquisition of $34.2 million and
$6.8 million, respectively, were recorded at estimated fair values as determined by the Companys management. The Companys purchase price allocation included $18.3 million of goodwill and $10.1 million of intangible assets. The assets
acquired and recognition of liabilities directly related to the acquisition and the allocation of the purchase price was revised in the second quarter of 2002 based upon final determination of fair values. During 2002, it was determined that the
intangible asset related to non-competition agreements and goodwill were impaired and these assets were written down to zero.



Item 3. Quantitative and Qualitative Disclosure about Market Risk



The Companys consolidated balance sheets include a significant amount of assets and liabilities whose fair value are subject to market risk. Market risk is the risk of loss arising from adverse changes in market
interest rates or prices. The Company currently has interest rate risk as it relates to its fixed maturity securities and equity price risk as it relates to its marketable equity securities. The Companys market risk sensitive instruments are
entered into for purposes other than trading.



At June 30, 2003 and December
31, 2002 the Company had $71.6 million and $114.7 million, respectively, of fixed maturity investments that were subject to market risk. At June 30, 2003 and December 31, 2002 the Company had $1.6 million and $7.3 million, respectively, of
marketable equity securities that were subject to market risk. The Companys investment strategy is to manage the duration of the portfolio relative to the duration of the liabilities while managing interest rate risk.



The Company uses two models to analyze the sensitivity of its market risk assets. For its
fixed maturity securities, the Company uses duration modeling to calculate changes in fair value. For its marketable equity securities, the Company uses a hypothetical 20% decrease in the fair value of these securities. Actual results may differ
from the hypothetical results assumed in this disclosure due to possible actions taken by management to mitigate adverse changes in fair value and because fair values of securities may be affected by credit concerns of the issuer, prepayment speeds,
liquidity of the security and other general market conditions. The sensitivity analysis duration model used by the Company produces a loss in fair value of $601,000 and $1.6 million on its fixed maturity securities as of June 30, 2003 and December
31, 2002, respectively, based on a 100 basis point increase in interest rates. The hypothetical 20% decrease in fair value of the Companys marketable equity securities produces a loss in fair value of $323,000 and $1.5 million as of June 30,
2003 and December 31, 2002, respectively.



Item 4. Controls and Procedures



Based on their
evaluation, the Companys President and Chief Executive Officer (the CEO) and the Chief Financial Officer and Treasurer (the CFO) have concluded the Companys disclosure controls and procedures are effective. During
2002 the Company downsized its internal audit department. In 2003 the Company eliminated its internal audit department. The Company did, however, establish a



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Financial Disclosure and Internal Control Procedures committee during 2003. There have been no significant changes in the Companys internal
controls or in other factors, including the elimination of the internal audit department, that could significantly affect these controls subsequent to the date of the evaluation.



Limitations on the Effectiveness of Controls



Company management, including the CEO and CFO, does not expect that the Companys disclosure controls and internal controls will
prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or
mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.



The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



CEO and CFO Certifications



Appearing as Exhibits 31.1 and 31.2 are Certifications of the CEO and the CFO. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of
2002 (the Section 302 Certifications). This Item of this report, which you are currently reading, is the information concerning the Evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the
Section 302 Certifications for a more complete understanding of the topics presented.



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PART II. OTHER INFORMATION



Item 1. Legal Proceedings



Acceptance
Insurance Companies Securities Litigation (USDC, Nebraska, Master File No. 8:99CV547). In December 1999 the Company was sued in the United States District Court for the District of Nebraska. Plaintiffs alleged the Company knowingly and
intentionally understated the Companys liabilities in order to maintain the market price of the Companys common stock at artificially high levels and made untrue statements of material fact, and sought compensatory damages, interest,
costs and attorney fees. In February 2000 other plaintiffs sued the Company in the same Court, alleging the Company intentionally understated liabilities in a registration statement filed in conjunction with the Companys Trust Preferred
Securities.



The Court consolidated these suits in April 2000 and Plaintiffs
subsequently filed a consolidated class action complaint. Plaintiffs sought to represent a class consisting of all persons who purchased either Company common stock between March 10, 1998 and November 16, 1999, or AICI Capital Trust Preferred
Securities between the July 29, 1997 public offering and November 25, 1999. In the consolidated complaint Plaintiffs alleged violation of Section 11 of the Securities Act of 1933 through misrepresentation or omission of a material fact in the
registration statement for the Trust Preferred Securities, and violation of Section 10b of the Securities Exchange Act of 1934 and Rule 10b5 of the U.S. Securities and Exchange Commission through failure to disclose material information
between March 10, 1998 and November 16, 1999. The Company, three of its former officers, the Companys Directors and independent accountants and other individuals, as well as the financial underwriters for the Companys Trust Preferred
Securities, were defendants in the consolidated action.



On March 2, 2001, the
Court entered an order dismissing all claims alleging violations of Section 11 of the Securities Act, and dismissing the Companys Directors, financial underwriters, independent accountants and others as defendants in this action. The Court
also ruled that certain of Plaintiffs allegations regarding the remaining defendants alleged failure to properly report contingent losses attributable to the Montrose decision did not state a claim under Section 10b and Rule
10b-5. In two subsequent rulings, the Court and Magistrate Judge clarified the March 2 ruling to specify which of Plaintiffs Montrose-related allegations failed to state a Section 10b and Rule 10b-5 claim. These three rulings reduced
the litigation to a claim that the Company and three of its former officers, during the period from August 14, 1997 to November 16, 1999, failed to disclose adequately information about various aspects of the Companys operations, including
information relating to the Companys exposure after January 1, 1997 to losses resulting from the Montrose decision. Nevertheless, Plaintiffs continue to seek compensatory damages, reasonable costs and expenses incurred in this action
and such other and such further relief as the Court may deem proper.



On August
6, 2001, the Magistrate Judge granted Plaintiffs Motion for Class Certification. Plaintiffs fact discovery was concluded July 31, 2002 in accordance with a schedule established by the Court. On September 16, 2002 Plaintiffs sought the
Courts permission to reinstate certain previously dismissed claims under Section 11 and 15 of the Securities Act. The Court denied Plaintiffs request in its entirety on February 27, 2003; Plaintiffs asked the Court to reconsider this
decision and the Court has not ruled on that request. On March 31, 2003, however, the Court established a schedule for the submission during May 2003 of briefs regarding the Companys proposed motion to decertify the class. The Court also
established a schedule concluding in August 2003 for submission of briefs regarding both parties anticipated motions for summary judgment. The Company has filed a motion to decertify the class and a motion for summary judgment. No hearings
have been scheduled with respect to either motion.



The Company intends to
continue vigorously contesting this action and believes Plaintiffs allegations are without merit. Nevertheless, the ultimate outcome of this action cannot be predicted at this time and the Company currently is unable to determine the potential
effect of this litigation on its consolidated financial position, results of operations or cash flows.



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Reinsurance Arbitration. In September 2001 the Company initiated an arbitration proceeding to recover from
a pool of solvent reinsurers sums the Company believes are due under a workers compensation insurance program of the Company principally written on Redland. The Company is contingently liable to Redland for amounts due from these reinsurers.
At December 31, 2002 the Company was contingently liable for approximately $20.4 million due from these reinsurers and approximately $5.1 million conditionally paid by the reinsurers but was still subject to the outcome of the arbitration. On May
31, 2003, the arbitration panel found that there was no reason to relieve the reinsurers of their obligations under the reinsurance contracts, made final the previous $5.1 million conditional payment from the reinsurers, ordered and awarded the
payments of reinsurance recoverables, plus interest, to Redland and AIC sought by AIC, subject to potential adjustments that may be made to amounts withheld and escrowed until any such adjustments are made. The award of the arbitration panel did not
have a significant impact on the Companys net loss for the six months ended June 30, 2003.



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



The Registrants Annual Meeting of shareholders was held on June 12, 2003, and the following matters were submitted to a vote of shareholders at such Annual Meeting.



At the Annual Meeting, four Directors nominees were elected by shareholders to serve as
Directors until the next Annual Meeting of shareholders, and until their successors are named. The number of votes for each such Director and the number of votes withheld for each Director are set forth below:



|Name                   |  | Number of VotesFor |  | Withheld
|---------------------- |  | ------------------ |  | --------
|Edward W. Elliott, Jr. |  | 10,847,285         |  | 104,517 
|John E. Martin         |  | 10,697,991         |  | 253,811 
|R. L. Richards         |  | 10,847,258         |  | 104,544 
|Doug T. Valassis       |  | 10,846,485         |  | 105,317 



Also submitted to shareholders at such
Annual Meeting was a proposal to ratify the appointment of Deloitte and Touche LLP as the Companys principal independent public accountants for 2003. The voting results of such proposal are as follows:



|FOR     |  | 10,885,834
|------- |  | ----------
|AGAINST |  | 56,266    
|ABSTAIN |  | 9,702     



Item 5. Other Information



As reported in the
Companys proxy statement for its Annual Meeting of Stockholders held on June 12, 2003, in 2003 the Companys Executive and Compensation Committee (the Committee) recommended creation of an incentive bonus plan providing for
the allocation of an incentive bonus pool among all persons who are officers or Associates of the Company, AIC or both. The incentive bonus pool is to be an amount that could range from zero to $18,950,000 depending on whether and to what extent the
performance-related goals set forth in the plan are achieved. These goals are based on specified objective criteria related to the achievement of the Companys business strategy. Under the Committees recommendation, the Companys
Board of Directors or other committee authorized by the Board for that purpose, are responsible for interpreting and administering the incentive bonus plan. In April 2003 the Companys Board of Directors approved the Committees
recommendations and directed the incentive bonus plan proposed by the Committee be implemented. See Note 7 to the Consolidated Financial Statements accompanying this Form 10-Q, the Companys proxy statement under III. Information About The
Company, Directors and Executive Officers -Employment Agreements and



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Termination of Employment Agreements and -Executive and Compensation Committee Report and the employment agreements of Mr. Martin and Mr. Thompson at
Exhibits 10.1 and 10.2, respectively, to the Companys Form 10-Q for the quarter ended March 31, 2003.



Also as reported in the Companys proxy statement, in order to retain Associates necessary to implement the Companys business plan and maximize the financial performance of the Company and AIC to the
material benefit of all policyholders, creditors, stockholders and others, the Committee also recommended, after evaluation of various alternatives, that the Company guarantee the performance by AIC of its retention bonus obligations under retention
agreements previously entered into with those Associates and performance of specified obligations under the employment agreements of Mr. Martin and Mr. Thompson, and establish and fund an appropriate trust to assure the performance of these
obligations, or take a combination of those and other actions in the best interest of all Company creditors and stockholders. The Board of Directors approved this recommendation in April 2003 and directed management to present to the Committee for
consideration such guarantees, trust agreements or other necessary and appropriate documents. See Note 7 to the Consolidated Financial Statements accompanying this Form 10-Q, the Companys proxy statement under III. Information About The
Company, Directors and Executive Officers -Employment Agreements and Termination of Employment Agreements and -Executive and Compensation Committee Report and the employment agreements of Mr. Martin and Mr. Thompson at Exhibits 10.1 and 10.2,
respectively, to the Companys Form 10-Q for the quarter ended March 31, 2003.



On July 1, 2003 the Companys financial institution bond that provided the Company with $4 million of fidelity insurance expired. Due primarily to the financial condition of the Company, the Company was unable to renew the financial
institution bond or obtain similar coverage beyond July 1, 2003.



Item 6. Exhibits and Reports on Form 8-K



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



See Exhibit Index.



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



The following Current Reports on Form 8-K have been filed during the last fiscal quarter of the period covered by this Report:



|Item                  |  | Financial StatementsFiled |  | Date ofReport 
|--------------------- |  | ------------------------- |  | --------------
|Item 5. Other Events. |  | No                        |  | April 21, 2003



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SIGNATURES



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



|ACCEPTANCE INSURANCE COMPANIES INC. |  |                                                       
|----------------------------------- |  | ------------------------------------------------------
|                                    |  |                                                       
|By                                  |  | /s/ John E. Martin                                    
|                                    |  | John E. Martin President and Chief Executive Officer  
|                                    |  |                                                       
|By                                  |  | /s/ Gary N. Thompson                                  
|                                    |  | Gary N. Thompson Chief Financial Officer and Treasurer



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---

ACCEPTANCE INSURANCE COMPANIES INC.

QUARTERLY REPORT ON FORM 10-Q

SIX MONTHS ENDED JUNE 30, 2003



EXHIBIT INDEX



|NUMBER |  | EXHIBIT DESCRIPTION                                                                                                                              
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|       | 
|3.1    |  | Acceptance Insurance Companies Inc. Amended By-Law adopted on June 12, 2003.                                                                     
|       | 
|31.1   |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                              
|       | 
|31.2   |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                              
|       | 
|32.1   |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|       | 
|32.2   |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 



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