##### Table of Contents









SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-K

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|   |  | For the fiscal year ended December 31,
    2003                                             
|  
|or
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|   |  | For the transition period
    from           to                                             

Commission file number: 0-25508

RTW, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Minnesota                                                          |  | 41-1440870                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

8500 Normandale Lake Boulevard,
Suite 1400

Bloomington, MN 55437


(Address of principal executive offices and
zip code)


Registrants telephone number, including
area code:

(952) 893-0403


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

None


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

Common Stock, no par value


Series A Junior Participating Preferred
Stock


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

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

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

As of March 10, 2004, 5,131,162 shares
of Common Stock, no par value, were outstanding. As of
March 10, 2004, assuming as fair value the last sale price
of $5.99 per share on The Nasdaq Stock Market, the
aggregate fair value of shares held by non-affiliates was
approximately $22.6 million.

Documents incorporated by reference:

The Companys Proxy Statement for its annual
meeting of shareholders to be held in June 2004, a definitive
copy of which will be filed with the Securities and Exchange
Commission within 120 days of December 31, 2003, is
incorporated by reference in Part III of this Report on
Form 10-K.



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TABLE OF CONTENTS

|                                               |          |                                          |                                                                                           |      |    |    | 
|---------------------------------------------- | -------- | ---------------------------------------- | ----------------------------------------------------------------------------------------- | ---- | -- | -- | 
|                                               |          |                                          |                                                                                           | Page
|                                               |          |                                          |                                                                                           |     
|PART I                                        
|                                               | Item 1.  |                                          | Business                                                                                  |      |    | 2  | 
|                                               |          | Executive Officers of the
    Registrant |                                                                                           |      | 9  |   
|                                               | Item 2.  |                                          | Properties                                                                                |      |    | 10 | 
|                                               | Item 3.  |                                          | Legal Proceedings                                                                         |      |    | 10 | 
|                                               | Item 4.  |                                          | Submission of Matters to a
    Vote of Security Holders                                   |      |    | 10 | 
|PART II                                       
|                                               | Item 5.  |                                          | Market for Registrants
    Common Equity and Related Stockholder Matters                 |      |    | 11 | 
|                                               | Item 6.  |                                          | Selected Financial Data                                                                   |      |    | 11 | 
|                                               | Item 7.  |                                          | Managements Discussion
    and Analysis of Financial Condition and Results of Operations |      |    | 12 | 
|                                               | Item 7A. |                                          | Quantitative and Qualitative
    Disclosures About Market Risk                            |      |    | 34 | 
|                                               | Item 8.  |                                          | Financial Statements and
    Supplementary Data                                           |      |    | 35 | 
|                                               | Item 9.  |                                          | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure  |      |    | 58 | 
|                                               | Item 9A. |                                          | Controls and Procedures                                                                   |      |    | 58 | 
|PART III                                      
|                                               | Item 10. |                                          | Directors and Executive
    Officers of the Registrant                                    |      |    | 59 | 
|                                               | Item 11. |                                          | Executive Compensation                                                                    |      |    | 59 | 
|                                               | Item 12. |                                          | Security Ownership of
    Certain Beneficial Owners and Management                        |      |    | 59 | 
|                                               | Item 13. |                                          | Certain Relationships and
    Related Transactions                                        |      |    | 59 | 
|                                               | Item 14. |                                          | Principal Accountant Fees
    and Services                                                |      |    | 59 | 
|PART IV                                       
|                                               | Item 15. |                                          | Exhibits, Financial
    Statement Schedules, and Reports on Form 8-K                      |      |    | 59 | 
|                                               |          | Signatures                               |                                                                                           |      | 62 |   
|Employment Agreement - Jeffrey B. Murphy      
|Description of the 2004 Profit Sharing Program
|Description of the Reinsurance Agreement      
|Election Form                                 
|Description of the Reinsurance Agreement      
|Statement Re: Computation of Income Per Share 
|Code of Ethics and Business Conduct           
|Consent of Ernst and Young LLP                
|Certification of CEO Pursuant to Section 302  
|Certification of CFO Pursuant to Section 302  
|Certification Pursuant to Section 906         



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##### Table of Contents






PART I






|        |         
|------- | --------
|Item 1. | Business

Overview

RTW, Inc. (Company) and its wholly-owned
insurance subsidiary, American Compensation Insurance Company
(ACIC), provide comprehensive disability management products and
services to insured and self-insured employers for their
workers compensation programs in Minnesota, Wisconsin,
South Dakota, Colorado, Michigan and Indiana. The Company closed
its regional offices in Missouri and Massachusetts in 2001,
non-renewed all policies in those regions in 2002 and completed
run-off of all policies by February 2003. The Company is also
licensed but is not operating (other than previously mentioned
run-off business and claims management associated
with the run-off business) in Pennsylvania,
Tennessee, Maryland, Arkansas, Iowa, Florida, New Jersey,
Georgia, North Carolina, Texas, Missouri, Illinois, Kansas,
Massachusetts, Connecticut, Rhode Island and Oklahoma. The
Company believes its proprietary management approach to
workers compensation substantially reduces
wage-replacement costs and medical expenses resulting from
workplace injuries. The Company focuses on controlling costs by
safely returning injured employees to work as soon as possible
and by actively managing all participants in the workers
compensation system, including employers, employees, medical
care providers and the legal and judicial participants in the
workers compensation system. Elements of the
Companys management approach include:



| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | thorough evaluation of potential customers;                                            
|
| |  | active training of customers management and
    employees in the Companys procedures;
|
| |  | prompt identification of potentially high-cost
    injuries; and                       
|
| |  | rapid intervention in, and intensive management
    of, potentially high-cost injuries.

The Company has developed two proprietary
management systems: (i) the RTW SOLUTION®, designed to
lower employers workers compensation costs and
return injured employees to work as soon as possible; and
(ii) ID15®, designed to identify those injured
employees who are likely to get stuck in the workers
compensation system. The Company also uses traditional
workers compensation management techniques to control
medical costs including designated health care providers,
medical fee schedule review, utilization review and doctor peer
review.

Industry

Workers compensation benefits are mandated
and regulated by each state. Every state requires employers to
provide wage-replacement and medical benefits to workplace
accident victims regardless of fault. Virtually all employers in
the United States are required to either: (a) purchase
workers compensation insurance from a private insurance
carrier; (b) obtain coverage from a state managed fund; or
(c) if permitted by their state, to be self-insured.
Workers compensation laws generally mandate two types of
benefits for injured employees: (i) indemnity payments that
consist of temporary wage-replacement or permanent disability
payments; and (ii) medical benefits that include payment
for expenses related to injury diagnosis, treatment and
rehabilitation, if necessary. On an industry-wide basis,
indemnity payments represent approximately 45% of benefits paid,
while medical benefits account for the remaining 55%.

Estimated workers compensation insurance
premiums total approximately $31.7 billion nationwide. This
amount includes: (i) the traditional or private residual
market, estimated at $26.0 billion, including commercial
insurers and state-operated assigned risk pools established for
high risk employers; and (ii) state funds, estimated at
$5.7 billion, operated in states to increase competition
and stabilize the market.

Indemnity payments, established by state
legislative action, have risen, in part because of higher wage
levels and increased state mandated benefits. Medical expenses
have increased due to the general rise in the cost of health
care and the statutory requirement that employers provide
coverage for all compensable medical costs, without any
co-payment by the employee. The Company believes the most
significant factor affecting the cost of workers
compensation results from incentives in the system for injured
employees to remain away

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from work and to continue collecting indemnity
payments and receiving medical treatment beyond the point that
is necessary.


The Company believes that traditional
workers compensation insurance companies and workers
compensation third party administrators are not as effective as
the Company in controlling loss costs. While traditional
efforts, including focusing on workplace safety and implementing
certain medical cost containment measures, have reduced costs in
certain areas, the Company believes these efforts have not had a
significant effect on the overall system cost because they have
not focused effectively on controlling indemnity payments. In
the late 1990s as well as into the 2000s,
traditional insurance companies moved toward a more
comprehensive management approach including return-to-work
initiatives. The Company believes that while traditional
insurers have been somewhat successful in these initiatives,
they have not realized the cost reductions and claim closure
outcomes achieved by the Company.

The Companys Management
Approach

The Company seeks to control workers
compensation costs through a proprietary management approach
that is specifically designed for the workers compensation
system. The Companys management strategy seeks to reduce
workers compensation costs by intervening early in an
employees injury and intensely managing all participants
in the workers compensation system, including employers,
injured employees, medical care providers and legal and judicial
participants. By intervening early, the Company promptly
identifies cases that have the potential to result in
significant expenses and acts to control these expenses before
they are incurred or get out of hand. The Company focuses on
controlling indemnity payments for lost wages by quickly and
safely returning injured employees to work. As part of this
strategy, the Company attempts to return an injured employee to
his or her original position, if the employee is able, or to
place the employee in a transitional, light-duty position until
the employee is able to resume his or her former position. By
promptly returning an employee to work, the Company has found
that not only indemnity payments, but also medical expenses per
injury, are substantially reduced. In addition, the Company uses
other management techniques to control medical costs including
contracting with provider networks, designating health care
providers, medical fee schedule review, utilization review and
doctor peer review.

The Company delivers its services through
operating teams. Each operating team manages all of the claims
and is accountable for the loss experience for a specific group
of employers. Each team includes licensed nurses, a statutory
claims administrator and an assistant claim administrator,
clerical support person. A teams nurses are responsible
for evaluating the medical condition of an injured employee and
monitoring the employees medical treatment. The claim
administrators are responsible for determining the eligibility
of claims, paying benefits in a timely manner and following
statutory requirements for administering the claims. The
operating teams meet regularly to discuss strategies for
managing difficult claims and review strategies and procedures
that have been particularly successful in resolving disputes.

The following sections summarize the
Companys approach to managing the various participants in
the workers compensation system.

Employers.Prior to
accepting an employer, operating team members may conduct an
on-site risk assessment and explain the Companys methods
and procedures to the employer. The risk assessment forms a part
of the Companys underwriting process and includes
evaluating the employers willingness to follow the
Companys procedures. For employers insured by ACIC, the
employer agrees, as part of the insurance policy, to comply with
the Companys early intervention methods and to provide
transitional, light-duty work for injured employees until such
time as they are able to resume their normal positions. To
ensure that the Companys early intervention techniques
succeed, the Company requests prompt notification (typically
twenty-four to forty-eight hours of the injury) from the
employer.

Each operating team is responsible for managing
its employers workers compensation program, by
training the employers personnel in the Companys
methods and procedures and managing all reported injuries for
the employer. The operating team meets with each employer,
provides access to loss reports detailing current claims,
conducts an annual account review and maintains active
communication on open injuries. The Companys loss control
team or the operating team may make workplace safety recommenda-

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tions or retain a workplace safety-engineering
firm to assist its employers in remedying work conditions that
the loss control team or the operating team determines
constitute an inappropriate risk. In addition, the operating
team may recommend to the Companys underwriting team
cancellation or non-renewal of the policy for an employer that
fails to comply with the Companys procedures.


Employees.The
Company focuses on identifying injuries that have the greatest
potential to result in significant expenses and acts quickly to
control expenses resulting from these injuries. The Company has
observed that approximately 15% of all injuries result in 85% of
all workers compensation expenses and that early
identification of, and intervention in, these cases can lead to
significant cost savings. Within 48 hours of being notified
of an injury, an operating team evaluates several factors,
including the type of injury, the employees injury history
and whether the employee is absent from work, to determine
whether the injury is likely to involve significant expense. In
potentially high-cost cases, a member of the operating team
intervenes quickly by meeting with the injured employee to
assess the injury, assisting the injured employee in obtaining
medical care and rehabilitation and developing a plan to get the
employee back to work as soon as appropriate. If the employee
cannot immediately return to his or her original position, the
employer is required to provide a transitional light-duty job
that is consistent with the limits defined by the
employees medical care provider. If the employee refuses
this transitional position, the Company may terminate indemnity
payments, but is required to continue to provide appropriate
medical benefits.

Medical Care
Providers.The operating teams
actively assess each injury, monitor and manage the medical
treatment and review the medical expenses of each
employees injury. Each injury report is reviewed by one of
the Companys licensed nurses. The licensed nurse contacts
the physician treating employees in cases that involve days off
from work or injuries that could involve significant expense. In
these cases, the physician is asked to provide his or her
diagnosis, plan of treatment and assess the employees
physical capabilities for transitional, light-duty work. The
Company contracts with consulting physicians to assess
questionable treatment plans for injured employees. These
physicians then discuss injured employee treatment plans with
the employees medical care providers. The goal is to
ensure both an accurate diagnosis and treatment of the injury
and an understanding of the nature and extent of the limits the
diagnosis places on the employees ability to return to
work in either the original job or a transitional, light-duty
position. The operating team also monitors the health care
provided to the injured employee to ensure that the employee
receives proper treatment for the injury and that the employee
does not receive services or procedures that are excessive,
unnecessary or unrelated to the injury. In addition, when the
operating team believes the diagnosis of an injury or the
proposed rehabilitation treatment is not appropriate, the
operating team will arrange for a second opinion with an
independent medical examiner.

A medical cost management team reviews all bills
submitted by medical care providers to determine if the amounts
charged for the treatments are appropriate according to
statutory and other negotiated fee schedules, including fee
schedules negotiated through provider organizations.

In many states, including Minnesota, the Company
cannot require that an injured employee go to a specific
physician or seek treatment from a specific provider.
Nevertheless, the Company attempts to assist the injured
employee in selecting appropriate medical care providers. In
Colorado and Michigan (for the first ten days after the injury),
the Company can require that injured employees go to a physician
within a designated network of medical care providers.

Legal and Judicial
Participants.The Company seeks to
limit the number of disputes with injured employees by
intervening early. As part of its early intervention process,
the Company identifies injuries that are not work related and
denies the claim. The Company may also deny a claim for
indemnity payments when it determines that no further payments
are appropriate (for example, when an employee has been offered
transitional, light-duty work and has refused it). In these and
other sets of circumstances, the employee may engage a lawyer to
represent his or her interests. Generally, if the parties are
unable to resolve the matter, the workers compensation law
mandates arbitration, subject to judicial review. For cases that
involve adversarial proceedings, the Company engages one of
several lawyers who are familiar with the Companys
philosophy and actively seeks to resolve the dispute with the
employees attorney.

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Customers

For insured business, the Company targets
employers and associations that operate in industries with
relatively high workers compensation costs, including
manufacturing, retail, wholesale, health care and hospitality
industries and employers with a history of workers
compensation claim costs higher than average in their industry.
The Companys alternative non-risk business focuses on all
customers in need of the services the Company can provide.

The Companys average annual premium per
policy increased slightly to $85,400 in 2003 from $80,400 in
2002 and significantly from $56,800 in 2001. The increase is due
to focused aggressive re-underwriting in 2002 and 2001. The
Companys ten largest customers accounted for
$5.7 million or 9.8% of the Companys premiums in
force in 2003 compared to $6.2 million or 11.4% in 2002 and
$6.6 million or 7.8% in 2001. No single customer accounted
for more than 5% of in force premiums in 2003, 2002 or 2001. The
Company renewed 66.0% of the policies scheduled to expire in
2003, whereas 46.1% and 56.5% were renewed in 2002 and 2001,
respectively. The retention rate in 2003 improved from 2002 and
2001 due to the fact that the Company had no office closures in
2003 and its re-underwriting was limited to non-renewing
$8.0 million of Professional Employer Organization business
in Michigan.

Substantially all of the Companys employers
are in its Minnesota, Colorado and Michigan regions. In December
2001, the Company closed its regional offices in Missouri
(covering Missouri, Illinois and Kansas) and Massachusetts
(covering Massachusetts, Connecticut, New Hampshire, Rhode
Island and Maine). In 2002, the Company non-renewed all
insurance policies and completed run off of all policies in
these regions by February 2003. In addition to these states, the
Company is also licensed in Pennsylvania, Tennessee, Maryland,
Arkansas, Iowa, Florida, New Jersey, Georgia, North
Carolina, Texas, Indiana, South Dakota, Wisconsin and Oklahoma.
The Company currently has no intention to expand its risk-based
products beyond the present states in which it is operating but
is looking outside its core regions to expand its non-risk
products.

Products

Substantially all of the Companys
workers compensation products and services are
guaranteed-cost insurance policies. Under a guaranteed-cost
policy, the customer purchases an insurance policy underwritten
by ACIC and pays a premium based on the employers
aggregate payroll. The Company assumes responsibility for the
indemnity and medical costs associated with the employers
workers compensation injuries and works closely with the
employer in managing the employers workers
compensation program.

The Company determines the premium to be charged
an employer based on several factors, including: (i) the
expected dollar loss per $100 of payroll for the employers
industry; (ii) the employers experience modifier, a
measurement of the difference between the employers past
claims experience and its industry average; (iii) an upward
or downward adjustment to the premium based on the
Companys assessment of the risks associated with providing
coverage for the employer; and (iv) competitive market
prices. An employers expected dollar loss and experience
modifier are each determined by an independent rating agency
established or adopted by its state, based on a three-year
average of the claims experience of the employer and its
industry.

In addition to standard guaranteed-cost policies,
the Company offers, on a limited basis, a deductible
guaranteed-cost policy under which the employer is responsible
for all medical and indemnity expenses up to a specific dollar
amount, while the Company is responsible for medical and
indemnity expenses over that level. The Company provides the
same comprehensive management services for the deductible
guaranteed-cost policies and the standard guaranteed-cost
policies.

In 2002, the Company began a strategic initiative
to sell its workers compensation products and services on
a fee-for-service basis. This strategic initiative extends the
Companys workers compensation services to
self-insured employers and other alternative market non-risk
products. The Company charges a fee to these customers based on
the expected number of claims managed or the time committed to
the customer. This service product provides a non-insurance
revenue line for the Company. At December 31, 2003, the
Company had 12 customers totaling approximately $250,000 in
annualized revenues related to this initiative.

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Sales and Marketing

The Company sells its workers compensation
products and services to insured and self-insured employers
through independent insurance agencies and brokers, including
several large national agencies. Agency commissions averaged
7.3% of the Companys gross premiums earned in 2003,
compared to 6.9% in 2002 and 7.6% in 2001. The Companys
ten highest producing agencies accounted for $22.9 million
or 39.3% of premiums in force in 2003, compared to
$19.7 million or 36.3% in 2002 and $24.8 million or
29.7% in 2001. No agency accounted for more than 6.0% of
premiums in force in 2003, compared to 5.3% in 2002 and 6.4% in
2001. The Company continually markets its products and services
to its agencies to keep them aware of developments in the
Companys business. Each states underwriting team is
responsible for establishing and maintaining agency
relationships.

Reinsurance

The Company shares the risks and benefits of the
insurance it underwrites through reinsurance. The Company
purchases reinsurance to protect it from potential losses in
excess of the level management is willing to accept. From 1995
to 2003, the Companys primary reinsurance was excess of
loss coverage that limited its per-incident exposure.

Under excess of loss policies, the
Company pays the reinsurer a percentage of the Companys
gross premiums earned, and the reinsurer agrees to assume all
risks relating to injuries over a specific dollar amount on a
per occurrence basis. Excess of loss coverage in Minnesota is
provided by a state established organization, the Minnesota
Workers Compensation Reinsurance Association (WCRA). In
non-Minnesota states, excess of loss coverage is purchased
through private reinsurers.

The following table summarizes our reinsurance
coverage (all losses ceded on a per occurrence basis):

|               |      |                    |                    |                               |         |             |  |          |                                          
|-------------- | ---- | ------------------ | ------------------ | ----------------------------- | ------- | ----------- |  | -------- | -----------------------------------------
|               |      |                    |                    |                              
|               |      |                    |                    | Covers Losses Per Occurrence:
|               |      |                    |                    |                              
|               |      |                    |                    | In Excess of:                 |         | Limited to:
|               |      |                    |                    |                               |         |            
|Minnesota:     |      |                    |                    |                               |         |             |  |         
|               | 2003 |                    | WCRA               |                               | $       | 360,000     |  |          | Statutory limit                          
|               |      | Various reinsurers |                    | $                             | 200,000 |             |  | $360,000
|               | 2002 |                    | WCRA               |                               | $       | 350,000     |  |          | Statutory limit                          
|               | 2001 |                    | WCRA               |                               | $       | 330,000     |  |          | Statutory limit                          
|              
|Non-Minnesota: |      |                    |                    |                               |         |             |  |         
|               | 2003 |                    | Various reinsurers |                               | $       | 200,000     |  |          | $20.0 million excluding acts of terrorism
|               | 2002 |                    | Various reinsurers |                               | $       | 300,000     |  |          | $20.0 million                            
|               | 2001 |                    | Various reinsurers |                               | $       | 300,000     |  |          | Statutory limit                          

The Company decreased its retention in 2003 to
further reduce volatility in its operating results.

In 1998, the Company purchased excess of loss
coverage through GE Reinsurance Corporation that provided
reinsurance for claims occurring on or after July 1, 1998,
for policies with effective dates prior to January 1, 2001,
up to $275,000 in excess of $25,000 in all states except
Minnesota. In Minnesota, the coverage was $255,000 in excess of
$25,000 for 1998, $265,000 in excess of $25,000 for 1999 and
$275,000 in excess of $25,000 for 2000 and 2001. This coverage
was purchased to reduce risk and volatility in the
Companys operating performance. Although this contract was
terminated effective December 31, 2000, it remained
effective in 2001 for policies in force at December 31,
2000 through expiration, not to exceed fifteen months after
December 31, 2000. Policies written or renewed with
effective dates after January 1, 2001 were not covered
under this lower level excess of loss reinsurance policy.

The Company annually reviews the financial
stability of its reinsurers. This review includes a ratings
analysis of each reinsurer participating in an existing
reinsurance contract or from whom we have a

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recoverable. The following details the
Companys reinsurers and the current A.M. Best rating
assigned to each as of March 15, 2004:


|                                        |  |                  |     | 
|--------------------------------------- |  | ---------------- | --- | 
|Reinsurer                               |  | A.M. Best Rating
|                                        |  |                 
|GE Reinsurance Corporation              |  |                  | A   | 
|General Reinsurance Corporation         |  |                  | A++ | 
|Everest Reinsurance Company             |  |                  | A+  | 
|Platinum Underwriters Reinsurance, Inc. |  |                  | A   | 
|Continental Casualty Company            |  |                  | A   | 
|SCOR Reinsurance Company                |  |                  | B++ | 
|Transatlantic Reinsurance Company       |  |                  | A++ | 

Based on this review at December 31, 2003,
the Company believes its reinsurance balances are collectible
and expects its reinsurers to honor their obligations. Further,
the Company is not aware of any developments with respect to
these reinsurers that would result in uncollectible reinsurance
balances. In the event that these reinsurers are unable to honor
their obligations to the Company due to insolvency or otherwise,
the Company will be required to pay these obligations itself and
the result could have a material adverse effect on the
Companys future results of operations and financial
condition.

Competition

The workers compensation industry is highly
competitive. The Company competes with insurance companies,
managed health care organizations and state sponsored insurance
pools for its insured products and with Third Party
Administrators for its fee-for-service business. Unlike the
Company, which offers only workers compensation products
and services, these competitors may offer additional products
and services to employers, including other forms of insurance.
As a consequence, these competitors may have certain advantages
in pricing their workers compensation products. In
addition, certain of these competitors are offering a management
approach similar to that offered by the Company. Many of the
Companys competitors have greater financial and operating
resources than the Company.

Competitive factors in the industry include
premium rates, level of service and ability to reduce claims
expense. The Company believes that its workers
compensation insurance products are competitively priced and its
premium rates are typically lower than those for customers
assigned to state sponsored risk pools. The Company also
believes that its level of service and its ability to reduce
claims are strong competitive factors that have enabled it to
retain existing customers and attract new customers.

Insurance companies enter and exit states
workers compensation markets depending on their appraisal
of current market conditions. Many insurance companies stopped
underwriting workers compensation insurance during the
early 1990s due to rising costs that were not matched by
reductions in statutory benefits or higher premium rates. In the
mid to late 1990s, the Company experienced increased
market pressure as new insurance companies and single line
workers compensation insurance companies entered the
market. In 2003, 2002 and 2001, many insurers withdrew from the
markets in which the Company operates, as premium rates were
insufficient to cover the cost of benefits paid.

Insurance companies compete with the Company
primarily for insured customers that have lower past claims
experience or lower experience modifiers. As a
result, the Company experiences increased competition on its
renewing workers compensation policies as a result of
reducing customers experience modifiers and it expects to
continue to experience this competition.

Another competitive factor results from the fact
that some insured employers will not purchase workers
compensation products from insurance companies with an A.M. Best
rating less than A. In addition, certain insurance
companies that write umbrella policies will not provide coverage
to an employer if a portion of the employers underlying
insurance policy, such as the workers compensation
portion, is written by an insurance company with a less than
A rating. The Company believes that its B+ rating
from A.M. Best may make it difficult for the Company to
provide its products to certain employers. Historically, in
these instances, the

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Company competed by writing these employers using
an A rated insurers paper. This process,
known as fronting, added additional cost for ACIC but allowed
the Company access to markets it may have otherwise not been
able to access. The Company does not currently have a fronting
arrangement in effect and believes that its ability to find a
fronting company at a reasonable cost in 2004 will be difficult.


The Companys insurance subsidiary was
assigned a rating of B+ (Very Good, Secure) on a scale of A++
(Superior) to F (In Liquidation) on March 9, 2004. This
represented an upgrade from a B rating assigned on
April 1, 2003 and a B- rating assigned by
A.M. Best in February 2002. A.M. Best assigns a rating
after quantitatively and qualitatively evaluating the
Companys financial condition and operating performance.
Furthermore, A.M. Best ratings are not ratings of the
Company or any of its securities.

Data Management

In 1995, the Company developed and implemented
its own proprietary policy management system to process
insurance applications and issue and endorse policies. In 1996,
the Company developed and implemented its own proprietary case
and claims management and medical fee adjudicating systems to
manage claims, audit medical fees, pay claims, provide reports
to policyholders and analyze claims data. In 1999, the Company
developed and implemented its own proprietary billing, cash
receipts, collections and agency commission systems. These
systems continue to be maintained and upgraded by the Company.
The Company continues to utilize third-party software to
maintain financial information, prepare accounting reports and
financial statements and pay vendors. The Company also contracts
with a third-party provider of payroll services for payroll,
benefit and human resource software services. The Company
utilizes other licensed software from national vendors to
maintain its financial records, file statutory statements with
insurance regulators and perform other general business.

Employees

The Company had 134 full-time employees at
December 31, 2003. Approximately 69 worked in the
Companys administrative and financial functions and
65 served on, provided service to or managed approximately
nine operating teams. None of the Companys employees are
subject to collective bargaining agreements. The Company
believes its employee relations are good.

Regulation

The Companys insurance subsidiary is
regulated by governmental agencies in the states in which it
operates, and will be subject to regulation in any state in
which it provides workers compensation products and
services in the future. State regulatory agencies have broad
administrative power over all aspects of the Companys
workers compensation business, including premium rates,
benefit levels, policy forms, dividend payments, capital
adequacy and the amount and type of its investments. These
regulations are primarily intended to protect covered employees
and policyholders rather than the insurance company. Both the
legislation covering insurance companies and the regulations
adopted by state agencies are subject to change.

Workers compensation coverage is a creation
of state law, subject to change by state legislature, and is
influenced by the political processes in each state. Several
states have mandated that employers receive coverage only from
state operated funds. New laws affecting the workers
compensation system in Minnesota, Colorado and Michigan and any
other state where the Company may operate, including laws that
require all employers to participate in state sponsored funds or
that mandate premium reductions, could have a material adverse
effect on the Company.

Company Information

The Company maintains a website at
www.rtwi.com. Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q and periodic reports on Form 8-K
(and any amendments to these reports) are available free of
charge on the Companys website.

8



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##### Table of Contents






Executive Officers of the Registrant

The following are the executive officers of the
Company at March 15, 2004:

|                      |  |     |    |          |  |                                                                               
|--------------------- |  | --- | -- | -------- |  | ------------------------------------------------------------------------------
|Name                  |  | Age |    | Position
|                      |  |     |    |         
|John O. Goodwyne      |  |     | 65 |          |  | Chairman of the Board                                                         
|Jeffrey B. Murphy     |  |     | 42 |          |  | President, Chief Executive Officer and Director                               
|Alfred L. LaTendresse |  |     | 55 |          |  | Executive Vice President, Chief Financial
    Officer, Treasurer and Secretary
|Keith D. Krueger      |  |     | 45 |          |  | Vice President  Insured Products and
    Assistant Secretary                 
|David M. Dietz        |  |     | 37 |          |  | Vice President  Alternative Products                                         
|Patricia M. Sheveland |  |     | 45 |          |  | Vice President  Case and Claims
    Management                               

John O. Goodwyne became Chairman of the Board in
December 2003. Mr. Goodwyne joined the Companys Board
of Directors in December 2001 and has served as a Director of
the Company since that time. Since 1974, Mr. Goodwyne has
been the owner and President of J N Johnson
Sales & Service Inc., a local contractor for fire
protection systems and distributor of fire extinguishers. In
addition, since 1982, he has been owner and President of Low
Voltage Contractors Inc., a leading local contractor for
installation and service of fire alarm, security and nurse call
systems.

Jeffrey B. Murphy joined the Company in October
1994 as Controller. Mr. Murphy was promoted to Chief
Financial Officer in February 2000 and named President and Chief
Executive Officer in December 2003. Mr. Murphy was further
nominated to the Board in March 2004. Mr. Murphy was the
Corporate Controller and held other management positions for
Midcontinent Media, Inc. from 1989 to 1994. Prior to that
time, Mr. Murphy served in various financial audit
positions with Grant Thornton LLP from 1983 to 1989.
Mr. Murphy was elected a Director of the Company in March
2004.

Alfred L. LaTendresse rejoined the Company in
December 2001 as Executive Vice President and further assumed
the roles of Chief Financial Officer, Treasurer and Secretary in
December 2003. Mr. LaTendresse served as Chief Operations
Officer and Chief Financial Officer for Headwater
Systems, Inc., a radio frequency identification technology
company, from June 1999 to December 2001. Mr. LaTendresse
initially joined the Company as Chief Financial Officer in 1990
and later became Secretary and Treasurer. Mr. LaTendresse
departed from the Company in December 1998. Mr. LaTendresse
served as a Director of the Company from July 1993 until January
1995 and from December 2001 to March 2004. Mr. LaTendresse
is a member of the American Institute of Certified Public
Accountants and the Minnesota Society of Certified Public
Accountants.

Keith D. Krueger joined the Company in September
1998 as the Director of Underwriting and Pricing for the
Companys Minnesota regional office. He was promoted to
Director of Underwriting Services for the Companys Home
Office in October 1999 and served in this capacity until being
promoted to Vice President  Underwriting and Sales in
March 2002 (later renamed Vice President  Insured
Products in December 2003). Prior to joining the Company,
Mr. Krueger was a Commercial Lines Underwriting Manager for
Citizens Security Mutual Insurance from June 1997 to August
1998. From March 1995 to May 1997, Mr. Krueger was Vice
President  Underwriting and Marketing for American
West Insurance. He is a member of the American Institute for
Property and Liability Underwriters and holds the CPCU
designation.

David M. Dietz joined the Company in July 2002 as
the Director of Self-Insured Services in the Companys Home
Office and was promoted to Vice President 
Alternative Products in December 2003. Mr. Dietz came to
the Company with fourteen years of experience in the insurance
industry. Prior to joining the Company, Mr. Dietz served as
Senior Vice President, Marketing and Technical Sales for
Benfield Blanch, Inc. from September 2000 to July 2002.
Mr. Dietz also served in various management roles for EBI
Companies, Citizens Management, Inc., TIG Insurance and
Sentry Insurance from 1989 to 2000.

Patricia M. Sheveland was appointed to Vice
President  Case and Claims Management in January
2002. Ms. Sheveland joined the Company in April 1990 and
has held various management positions of

9



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##### Table of Contents



increasing importance including General Manager
of Operations in the Colorado regional office and Director of
Operations for the Colorado, Michigan and Massachusetts regions.
Prior to joining the Company, Ms. Sheveland worked as an
Occupational Nurse for Kmart Corporation.







|        |           
|------- | ----------
|Item 2. | Properties

The following is a summary of properties leased
by the Company at December 31, 2003:

|                                                                    |  |                 |        |             |  |  |                | 
|------------------------------------------------------------------- |  | --------------- | ------ | ----------- |  |  | -------------- | 
|                                                                    |  | Area Leased (in |        |            
|Location and Description                                            |  | Square Feet)    |        | Termination
|                                                                    |  |                 |        |            
|Bloomington, Minnesota; Headquarters and
    Minnesota office space |  |                 | 26,301 |             |  |  | September 2007 | 
|Denver, Colorado; Colorado office space                             |  |                 | 7,825  |             |  |  | April 2005     | 
|St. Louis, Missouri; Missouri office space                          |  |                 | 6,542  |             |  |  | September 2005 | 
|Detroit, Michigan; Michigan office space                            |  |                 | 7,118  |             |  |  | May 2007       | 
|Grand Rapids, Michigan; Michigan office space                       |  |                 | 4,631  |             |  |  | April 2006     | 






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

In the ordinary course of administering its
workers compensation management program, the Company is
routinely involved in adjudicating claims resulting from
workplace injuries. The Company is not involved in any legal or
administrative claims that it believes are likely to have a
material adverse effect on the Companys operations or
financial condition.






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

On December 11, 2003, the Company held its
2003 Annual Meeting of Shareholders. The first item of business
was a vote to elect three directors to fill director terms that
expired in 2003. David C. Prosser, J. Alexander Fjelstad
and John O. Goodwyne were elected as directors of the Company
until the Annual Meeting of Shareholders in 2006, or until their
respective successors are duly elected and qualified.
Shareholders present in person or proxy at the annual meeting
voted for each director as follows:

|                      |  |  |           |  |  |  |           | 
|--------------------- |  |  | --------- |  |  |  | --------- | 
|David C. Prosser      |  |  | FOR:      |  |  |  | 4,881,905 | 
|                      |  |  | WITHHELD: |  |  |  | 61,456    | 
|J. Alexander Fjelstad |  |  | FOR:      |  |  |  | 3,763,042 | 
|                      |  |  | WITHHELD: |  |  |  | 1,180,319 | 
|John O. Goodwyne      |  |  | FOR:      |  |  |  | 4,882,644 | 
|                      |  |  | WITHHELD: |  |  |  | 60,717    | 

On December 17, 2003, Mr. Fjelstad
resigned as a director of the Company.

The second item of business to come before the
meeting was a vote to approve of Ernst & Young LLP as
Independent Auditors of the Company for the year ended
December 31, 2003. Shareholders present in person or proxy
at the annual meeting voted as follows:

|         |  |  |           | 
|-------- |  |  | --------- | 
|FOR:     |  |  | 4,912,031 | 
|AGAINST: |  |  | 23,904    | 
|ABSTAIN: |  |  | 7,426     | 

Accordingly, Ernst & Young LLP was
elected as Independent Auditors of the Company for the year
ended December 31, 2003.

10



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##### Table of Contents



The third item of business to come before the
meeting was a vote to amend the RTW, Inc. 1995 Employee
Stock Purchase Plan to increase by 50,000 the number of shares
authorized under the plan. Shareholders present in person or
proxy at the annual meeting voted as follows:

|         |  |  |           | 
|-------- |  |  | --------- | 
|FOR:     |  |  | 2,638,880 | 
|AGAINST: |  |  | 1,142,927 | 
|ABSTAIN: |  |  | 31,844    | 

Accordingly, the number of shares authorized
under the RTW, Inc. 1995 Employee Stock Purchase Plan was
increased by 50,000 shares.




PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Quarterly Stock Price Comparison and
Dividends

The Companys shares are publicly traded on
The Nasdaq Stock Market under the symbol RTWI. The Company
effected a one-for-two reverse-split of its common stock on
November 22, 2002. The table below sets forth the range of
high and low sales prices for the Companys stock for each
quarter during the past two years, as adjusted for the
reverse-split. The Company had approximately
2,000 shareholders of its common stock at the close of
trading on March 1, 2004.

|             |  |         |  |         |      |         |  |         |      |  |  |   |      |  |  |   |      | 
|------------ |  | ------- |  | ------- | ---- | ------- |  | ------- | ---- |  |  | - | ---- |  |  | - | ---- | 
|             |  | First   |  | Second  |      | Third   |  | Fourth 
|Fiscal Year: |  | Quarter |  | Quarter |      | Quarter |  | Quarter
|             |  |         |  |         |      |         |  |        
|2003         |  | High    |  | $       | 3.01 |         |  | $       | 4.37 |  |  | $ | 4.00 |  |  | $ | 7.60 | 
|             |  | Low     |  |         | 1.79 |         |  |         | 2.38 |  |  |   | 3.45 |  |  |   | 3.78 | 
|2002         |  | High    |  |         | 2.70 |         |  |         | 3.74 |  |  |   | 2.70 |  |  |   | 2.54 | 
|             |  | Low     |  |         | 0.72 |         |  |         | 1.16 |  |  |   | 0.94 |  |  |   | 1.20 | 

The Company has never paid cash dividends on its
common stock. The Company currently intends to retain any and
all income for use in its business and does not anticipate
paying cash dividends in the foreseeable future. Any future
determination as to payment of dividends will depend on the
financial condition and results of operations of the Company and
such other factors deemed relevant by the Board of Directors.






|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The consolidated statements of operations data
set forth below for each of the three years in the period ended
December 31, 2003, and the consolidated balance sheet data
at December 31, 2003 and 2002 are derived from, and are
qualified by reference to, the audited consolidated financial
statements included elsewhere in this Annual Report on
Form 10-K. The consolidated statements of operations data
set forth below for the two years in the period ended
December 31, 2000, and the consolidated balance sheet data
at December 31, 2001, 2000 and 1999, are derived from
audited consolidated financial statements not included herein.
The information set forth below should be read in conjunction
with Managements Discussion and

11



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##### Table of Contents



Analysis of Financial Condition and Results of
Operations and the Companys consolidated financial
statements and related notes included elsewhere in this Annual
Report on Form 10-K.


|                                |  |                                       |         |      |  |      |         |      |  |      |         |   |  |   |         |   |  |   |         | 
|------------------------------- |  | ------------------------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - |  | - | ------- | 
|                                |  | 2003                                  |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                |  |                                       |         |      |  |      |         |      |  |     
|                                |  |                                      
|                                |  | (In thousands, except per share data)
|Total revenues                  |  | $                                     | 51,558  |      |  | $    | 67,146  |      |  | $    | 95,723  |   |  | $ | 83,299  |   |  | $ | 77,812  | 
|Income (loss) from operations   |  |                                       | 6,635   |      |  |      | 10,325  |      |  |      | (15,761 | ) |  |   | (14,780 | ) |  |   | 8,357   | 
|Net income (loss)               |  |                                       | 6,999   |      |  |      | 14,319  |      |  |      | (25,215 | ) |  |   | (9,708  | ) |  |   | 6,167   | 
|Basic income (loss) per share   |  |                                       | 1.37    |      |  |      | 2.78    |      |  |      | (4.89   | ) |  |   | (1.79   | ) |  |   | 1.00    | 
|Diluted income (loss) per share |  |                                       | 1.32    |      |  |      | 2.78    |      |  |      | (4.89   | ) |  |   | (1.79   | ) |  |   | 1.00    | 
|Premiums in force at year end   |  |                                       | 58,100  |      |  |      | 54,200  |      |  |      | 83,700  |   |  |   | 99,400  |   |  |   | 87,200  | 
|Total assets                    |  |                                       | 202,168 |      |  |      | 223,834 |      |  |      | 218,307 |   |  |   | 194,535 |   |  |   | 176,511 | 
|Notes payable                   |  |                                       |        |      |  |      | 1,250   |      |  |      | 4,500   |   |  |   | 7,000   |   |  |   |        | 
|Total shareholders equity      |  |                                       | 35,587  |      |  |      | 29,810  |      |  |      | 14,222  |   |  |   | 38,736  |   |  |   | 55,565  | 






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

RTW, INC.

MANAGEMENTS DISCUSSION AND ANALYSIS
OF

FINANCIAL CONDITION AND RESULTS OF
OPERATIONS


Overview

The
Company RTW, Inc.
(RTW) and its wholly-owned insurance subsidiary, American
Compensation Insurance Company (ACIC), provide disability
management services to employers. Collectively, we,
our and us refer to these entities in
this Managements Discussion and Analysis of
Financial Condition and Results of Operations.

We have developed two proprietary management
systems: (i) the RTW SOLUTION®, designed to lower
employers workers compensation costs and return
injured employees to work as soon as possible; and
(ii) ID15®, designed to identify those injured
employees who are likely to become inappropriately dependent on
the workers compensation system. We currently provide
workers compensation management services to employers
insured through our insurance subsidiary, to self-insured
employers on a fee-for-service basis and on a consulting basis
charging hourly fees.

During 2003, we operated primarily in Minnesota,
Colorado and Michigan. In 2001, we closed our regional offices
in Missouri (which served Missouri, Illinois and Kansas)
and Massachusetts (which served Massachusetts, Connecticut, New
Hampshire, Rhode Island and Maine). Collectively, these regional
offices had remaining premiums in force totaling
$1.4 million at December 31, 2002. We completed
running off this business in February 2003.

On March 9, 2004, our A.M. Best financial
rating was upgraded from B (Fair, Vulnerable) to B+ (Very
Good, Secure) as a result of: (i) our continued profitable
operating performance in 2003; and (ii) improved
capitalization in ACIC as statutory surplus increased to
$33.0 million at December 31, 2003 from
$26.8 million at December 31, 2002 due to our earnings
in 2003. We believe that our B+ rating from A.M. Best may make
it difficult to provide our products to certain employers.

Additional information about RTW is available on
our website, www.rtwi.com.

Challenges, risks, uncertainties and
trends We derive our
revenue almost entirely from workers compensation
insurance premiums and investment income including gains and
losses from sales of securities. A small portion of our revenue
is derived from non-insurance workers compensation
services. We are subject to the

12



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##### Table of Contents



challenges, risks, uncertainties and trends that
affect the workers compensation property and casualty
insurance sector of our economy including the following:




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Workers compensation is a state
    regulated industry:Workers
    Compensation is governed and regulated by state governmental
    agencies. We are and will be subject to state regulation in any
    state in which we provide workers compensation products
    and services, now and in the future. State regulatory agencies
    have broad administrative power with respect to all aspects of
    our business, including premium rates, benefit levels, policy
    forms, dividend payments, capital adequacy and the amount and
    type of investments. Legislation covering insurance companies
    and the regulations adopted by state agencies are subject to
    change and any change may adversely affect our operations.
|
| |  | Workers compensation claims and related
    expenses can be volatile.Workers compensation is a long-tailed property and
    casualty insurance line. Claims for a given year are open on
    average for twelve to thirteen years and it is not unusual for
    workers compensation insurers to have claims open for
    thirty or more years. We have operated our insurance company
    since 1992 and therefore have limited experience
    (12 years), and accordingly, are subject to volatility. See
    further discussion under Claim and Claim Settlement
    Expenses.                                                                                                                                                        
|
| |  | Workers compensation is subject to
    inflationary pressures.Workers
    compensation is subject to both medical and wage inflation. The
    cost of medical care has increased in recent years faster than
    inflation, in excess of 10%. This has resulted in reduced
    profitability in the workers compensation insurance line.
    New medical procedures could evolve and new legal theories
    developed that could cause older claims to re-open and increase
    expense. See further discussion under Claim and Claim
    Settlement Expenses.                                                                                                                                                                           
|
| |  | Workers compensation pricing is
    cyclical.In 2003, we were able to
    increase premium rates on renewing policies 1.4%. This compares
    to rate increases of 9.0%, 18.5% and 11.7% realized in 2002,
    2001 and 2000, respectively. These increases came after many
    years of pricing decreases that unfavorably affected the
    industry in the late 1990s. If we are unable to maintain
    rate increases, our profit margin will be adversely affected.
    See further discussion under Premiums in Force and Gross
    Premiums Earned.                                                                                                                                                                                 
|
| |  | Reinsurance costs for workers
    compensation have increased.Reinsurance costs for the entire sector increased over the prior
    year continuing a pattern of cost increases beginning in 2001.
    These higher costs, if not recovered through increased pricing
    from our customers, will adversely affect our profit margin. See
    further discussion under Premiums Ceded.                                                                                                                                                                                                                                                                                                                                                     
|
| |  | Low interest rates reduce our investment
    income.Interest rates for investment
    grade instruments are at historic lows. Our investment income is
    directly affected by the interest rate at which we invest our
    free cash flow. The current rate environment has contributed to
    a significant mortgage refinancing boom, resulting in prepayment
    of our mortgage backed investments and an increase in our cash
    on hand in ACIC. A continuation of this trend and environment
    will adversely affect our investment income. See further
    discussion under Investment Income and Net Realized
    Investment Gains.                                                                                           

Significant Accounting Policies Our significant accounting policies
are summarized in Note 1  Summary of
Significant Accounting Policies to our accompanying
Consolidated Financial Statements. Our significant accounting
policies include those policies related to our accounting for:
(i) premiums earned; (ii) unpaid claim and claim
settlement expenses, including reserves for incurred but not
reported claims; (iii) policy acquisition costs;
(iv) deferred income taxes; and (v) investments. These
accounting policies are further discussed in detail within each
section of this Managements Discussion and Analysis
of Financial Condition and Results of Operations.

Off-Balance Sheet Arrangements We do not have any Off-Balance Sheet
Arrangements.

Financial
Summary This financial
summary presents our discussion and analysis of the consolidated
financial condition and results of operations of RTW, Inc.
This review should be read in conjunction with the Consolidated
Financial Statements at December 31, 2003.

13



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##### Table of Contents



The following table provides an overview of our
key operating results (000s, except per share amounts):

|                                    |  |                         |        |      |  |      |        |  |  |   |         |  
|----------------------------------- |  | ----------------------- | ------ | ---- |  | ---- | ------ |  |  | - | ------- | -
|                                    |  |                        
|                                    |  | Year Ended December 31,
|                                    |  |                        
|                                    |  | 2003                    |        | 2002 |  | 2001
|                                    |  |                         |        |      |  |     
|Gross premiums earned               |  | $                       | 54,431 |      |  | $    | 62,506 |  |  | $ | 97,420  |  
|Premiums earned                     |  |                         | 46,290 |      |  |      | 60,264 |  |  |   | 86,057  |  
|Total revenues                      |  |                         | 51,558 |      |  |      | 67,146 |  |  |   | 95,723  |  
|Claim and claim settlement expenses |  |                         | 27,256 |      |  |      | 40,533 |  |  |   | 80,103  |  
|Net income (loss)                   |  |                         | 6,999  |      |  |      | 14,319 |  |  |   | (25,215 | )
|Diluted income (loss) per share     |  | $                       | 1.32   |      |  | $    | 2.78   |  |  | $ | (4.89   | )

RTW reported a decrease in gross premiums earned
to $54.4 million in 2003 from $62.5 million in 2002.
Total revenues decreased in 2003 to $51.6 million from
$67.1 million in 2002 due to a decrease in premiums in
force related primarily to our regional office closures and
non-renewing insurance policies for Professional Employer
Organizations (PEOs) in Michigan.

We reported net income of $7.0 million in
2003 compared to net income of $14.9 million in 2002 and a
net loss of $25.2 million in 2001. We reported basic and
diluted income per share of $1.37 and $1.32, respectively, in
2003 compared to basic and diluted income per share of $2.78 in
2002 and basic and diluted net loss per share of $4.89 in 2001.
The primary factors affecting our 2003 operating results
included the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Gross premiums earned decreased 12.9% in 2003
    from 2002 due primarily to a 17.7% decrease in average premiums
    in force to $53.6 million for 2003 from $65.1 million
    in 2002. See further discussion under Premiums In Force
    and Gross Premiums Earned;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Premiums earned decreased 23.2% in 2003 from
    2002. Premiums earned in 2003 reflect: (i) the decrease in
    premiums in force as a result of the 2002 run-off policies in
    our discontinued regions and from our actions in removing
    unprofitable accounts; (ii) an increase in premiums ceded
    as our cost of excess of loss increased significantly in 2003;
    and (iii) additional ceded premiums as we lowered
    retentions in all our regions to $200,000 to reduce volatility
    in our operating results. Additionally, in 2003, premiums ceded
    increased by $92,000 resulting from a change in cost related to
    excess of loss reinsurance in Minnesota compared to a
    $1.4 million decrease in excess of loss premiums ceded in
    2002;
|
| |  | In addition to the factors affecting premiums
    earned, total revenues also declined as net realized investment
    gains decreased to $685,000 in 2003 from $1.7 million in
    2002;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Claim and claim settlement expenses decreased to
    58.8% of premiums earned for 2003 from 67.3% for 2002. See
    further discussion under Claim and Claim Settlement
    Expenses; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | At December 31, 2003, we maintained a
    $3.6 million valuation allowance against deferred tax
    assets. This allowance was originally established at
    December 31, 2001 at $14.5 million, and was decreased
    by $7.9 million in 2002 and $3.0 million in 2003. The
    $3.0 million and $7.9 million decreases in the
    valuation allowance favorably affected our income tax expense in
    2003 and 2002, respectively. See further discussion under
    Income Taxes.                                                                                                                                                                                                                                                                                         

We expect 2004 premiums in force to increase from
levels in 2003. We also anticipate that we will continue to
realize slight premium rate increases in 2004, consistent with
those realized in 2003 but significantly lower than experienced
in 2002. We further expect to increase alternative, non-risk
revenue in 2004. We will focus on achieving profitability in our
markets by: (i) aggressively managing and closing claims;
(ii) reviewing policy profitability at renewal and removing
unprofitable accounts; and (iii) aggressively managing
policy acquisition costs and general and administrative expenses.

In the following pages, we take a look at the
2003, 2002 and 2001 operating results for items in our
Consolidated Statement of Operations and also explain key
balance sheet accounts in greater detail.

14



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##### Table of Contents



Results of Operations

Total revenues:Our
total revenues include premiums earned, investment income, net
realized investment gains and other income. The following table
summarizes the components of our revenues and premiums in force
(000s):

|                               |                            |                               |                |        |     |        |        |        |       |        |         |        |       |        | 
|------------------------------ | -------------------------- | ----------------------------- | -------------- | ------ | --- | ------ | ------ | ------ | ----- | ------ | ------- | ------ | ----- | ------ | 
|                               |                            |                              
|                               |                            | Year Ended December 31,      
|                               |                            |                              
|                               |                            | 2003                          |                | 2002   |     | 2001  
|                               |                            |                               |                |        |     |       
|Gross premiums earned          |                            | $                             | 54,431         |        |     | $      | 62,506 |        |       | $      | 97,420  |       
|Premiums ceded                 |                            |                               | (8,141         | )      |     |        | (2,242 | )      |       |        | (11,363 | )     
|                               |                            |                               |                |        |     |        |        |        |       |        |         |       
|                               | Premiums earned            |                               |                | 46,290 |     |        |        | 60,264 |       |        |         | 86,057 |      
|Investment income              |                            |                               | 4,474          |        |     |        | 5,139  |        |       |        | 6,415   |       
|Net realized investment gains: |                            |                               |                |        |     |        |        |        |       |        |         |       
|                               | Realized investment gains  |                               |                | 685    |     |        |        | 1,930  |       |        |         | 1,225  |      
|                               | Realized investment losses |                               |                |       |     |        |        | (209   | )     |        |         | (62    | )    
|                               |                            |                               |                |        |     |        |        |        |       |        |         |       
|                               |                            | Net realized investment gains |                |        | 685 |        |        |        | 1,721 |        |         |        | 1,163 |       
|Other income                   |                            |                               | 109            |        |     |        | 22     |        |       |        | 2,088   |       
|                               |                            |                               |                |        |     |        |        |        |       |        |         |       
|                               |                            |                               | Total revenues |        | $   | 51,558 |        |        | $     | 67,146 |         |        | $     | 95,723 | 
|                               |                            |                               |                |        |     |        |        |        |       |        |         |       

|                                                 |               |                         |   |        |        |      |   |        |        |  |   |        |        | 
|------------------------------------------------ | ------------- | ----------------------- | - | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|                                                 |               | 2003                    |   | 2002   |        | 2001
|                                                 |               |                         |   |        |        |     
|Premiums in force by regional office at year-end |               |                         |   |        |        |      |   |        |        |  |   |       
|                                                 | Minnesota     |                         | $ | 32,000 |        |      | $ | 23,000 |        |  | $ | 26,700 |       
|                                                 | Colorado      |                         |   | 13,000 |        |      |   | 11,800 |        |  |   | 13,100 |       
|                                                 | Michigan      |                         |   | 13,100 |        |      |   | 18,000 |        |  |   | 21,700 |       
|                                                 | Missouri      |                         |   |       |        |      |   | 700    |        |  |   | 10,300 |       
|                                                 | Massachusetts |                         |   |       |        |      |   | 700    |        |  |   | 11,900 |       
|                                                 |               |                         |   |        |        |      |   |        |        |  |   |       
|                                                 |               | Total premiums in force |   | $      | 58,100 |      |   | $      | 54,200 |  |   | $      | 83,700 | 
|                                                 |               |                         |   |        |        |      |   |        |        |  |   |       

Premiums In Force and Gross Premiums
Earned:Premiums on workers
compensation insurance policies are our largest source of
revenue. Premiums earned are the gross premiums earned by us on
in force workers compensation policies, net of the effects
of ceded premiums under reinsurance agreements.

The premium we charge a policyholder is a
function of its payroll, industry and prior workers
compensation claims experience. In underwriting a policy, we
receive policyholder payroll estimates for the ensuing year. We
record premiums written on an installment basis matching our
billing to the policyholder and earn premiums on a daily basis
over the life of each insurance policy based on the payroll
estimate. We record the excess of premiums billed over premiums
earned for each policy as unearned premiums on our balance
sheet. When a policy expires, we audit employer payrolls for the
policy period and adjust the estimated payroll and the
policyholders premium to its actual value. The result is a
final audit adjustment recorded to premiums earned
when the adjustment becomes known. Final audit premiums
recognized during the period include billed final audit premiums
plus (or minus) the change in estimate for premiums on unexpired
and expired unaudited policies.

Our premiums in force increased 7.2% to
$58.1 million at December 31, 2003 from
$54.2 million at December 31, 2002. Premiums in force
in our Minnesota and Colorado regions grew $9.0 million and
$1.2 million, respectively, in 2003. The increases in the
Minnesota and Colorado regions were offset by a
$4.9 million decrease in Michigan, resulting primarily from
our non-renewal of approximately $8.0 million of PEO
business, partially offset by new business written. We also
completed run-off of the remaining policies in our Missouri and
Massachusetts regions in February 2003. Average premiums in
force decreased to $53.6 million in 2003 from
$65.1 million in 2002 and $95.2 million in 2001. In
order to improve profitability, we aggressively targeted
policies that did not meet our underwriting profit margin
standards for non-renewal or

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re-underwriting at increased rates at policy
expiration in 2003, 2002 and 2001. Our average annual premium
per policy increased to $85,400 in 2003 from $80,400 in 2002 and
$56,800 in 2001 as a result of the focused aggressive
re-underwriting in those years.


Our gross premiums earned decreased 12.9% to
$54.4 million in 2003 from $62.5 million in 2002. This
decrease resulted primarily from: (i) the decrease in
average premiums in force; offset by (ii) final audit
premiums which increased gross premiums earned by $323,000 in
2003, compared to a $1.7 million decrease in 2002.

Gross premiums earned decreased 35.8% to
$62.5 million in 2002 from $97.4 million in 2001. This
decrease resulted from: (i) the decrease in average
premiums in force; and (ii) final audit premiums which
decreased gross premiums earned by $1.7 million in 2002
compared to a $1.8 million increase in 2001.

In 2003, 2002 and 2001, we were able to increase
premium rates on renewing policies an average of 1.4%, 9.0% and
18.5%, respectively. We have been able to increase premium rates
in our markets due to the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Many workers compensation insurers have
    withdrawn from the markets in which we write premiums as
    profitability diminished in the workers compensation
    insurance line;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Reinsurance rates for workers compensation
    insurers have increased due to: (i) reductions in
    reinsurers surplus as a result of the September 11,
    2001 terrorist acts against the United States; (ii) recent
    unprofitability resulting from highly competitive reinsurance
    pricing; (iii) settlements related to certain reinsurance
    treaties written in the late 1990s; (iv) five major
    reinsurers leaving the market in 2003; and (v) low
    investment yields. These rate increases have resulted in
    increased costs for workers compensation insurers.
    Insurers, including RTW, have raised premium rates to offset
    these increases in reinsurance premiums; and
|
| |  | A number of workers compensation
    insurers financial ratings decreased due to reserve
    adjustments recorded in 2003, 2002 and 2001 resulting in a
    reduced capacity and creditworthiness of those insurers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

Premiums Ceded:Reinsurance agreements allow us to share certain risks with
other insurance companies. We purchase reinsurance to protect us
from potential losses in excess of the level we are willing to
accept. We expect the companies to which we have ceded
reinsurance to honor their obligations. In the event that these
companies are unable to honor their obligations to us, we will
be required to pay these obligations ourselves. We are not aware
of any developments with respect to our reinsurers that would
result in uncollectible reinsurance balances.

Under our excess of loss reinsurance policies, we
pay reinsurers to limit our per-incident exposure and record
this cost to premiums ceded as a reduction of gross premiums
earned. In Minnesota, we are required to purchase excess of loss
coverage for our Minnesota policies from the Minnesota
Workers Compensation Reinsurance Association (WCRA). The
following table summarizes our reinsurance coverage (all losses
ceded on a per occurrence basis):

|               |      |                    |                    |                               |         |             |  |          |                                          
|-------------- | ---- | ------------------ | ------------------ | ----------------------------- | ------- | ----------- |  | -------- | -----------------------------------------
|               |      |                    |                    |                              
|               |      |                    |                    | Covers Losses Per Occurrence:
|               |      |                    |                    |                              
|               |      |                    |                    | In Excess of:                 |         | Limited to:
|               |      |                    |                    |                               |         |            
|Minnesota:     |      |                    |                    |                               |         |             |  |         
|               | 2003 |                    | WCRA               |                               | $       | 360,000     |  |          | Statutory limit                          
|               |      | Various reinsurers |                    | $                             | 200,000 |             |  | $360,000
|               | 2002 |                    | WCRA               |                               | $       | 350,000     |  |          | Statutory limit                          
|               | 2001 |                    | WCRA               |                               | $       | 330,000     |  |          | Statutory limit                          
|Non-Minnesota: |      |                    |                    |                               |         |             |  |         
|               | 2003 |                    | Various reinsurers |                               | $       | 200,000     |  |          | $20.0 million excluding acts of terrorism
|               | 2002 |                    | Various reinsurers |                               | $       | 300,000     |  |          | $20.0 million                            
|               | 2001 |                    | Various reinsurers |                               | $       | 300,000     |  |          | Statutory limit                          

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We decreased our retention in 2003 to further
reduce volatility in our operating results.

The following table summarizes the components of
premiums ceded (000s):

|                |                                      |                                                          |                |      |        |        |   |   |        |        |   |   |        |         |  
|--------------- | ------------------------------------ | -------------------------------------------------------- | -------------- | ---- | ------ | ------ | - | - | ------ | ------ | - | - | ------ | ------- | -
|                |                                      |                                                         
|                |                                      | Year Ended December 31,                                 
|                |                                      |                                                         
|                |                                      | 2003                                                     |                | 2002 |        | 2001  
|                |                                      |                                                          |                |      |        |       
|Premiums ceded: |                                      |                                                          |                |      |        |        |   |   |        |        |   |  
|                | Excess of loss reinsurance premiums: |                                                          |                |      |        |        |   |   |        |        |   |   |       
|                |                                      | WCRA and other non-Minnesota excess of loss
    policies |                | $    | (8,141 | )      |   | $ | (2,242 | )      |   | $ | (4,066 | )      
|                |                                      | $25,000 to $300,000 excess of loss policy                |                |      |       |        |   |   |       |        |   |   | (7,297 | )      
|                |                                      |                                                          |                |      |        |        |   |   |        |        |   |  
|                |                                      |                                                          | Premiums ceded |      | $      | (8,141 | ) |   | $      | (2,242 | ) |   | $      | (11,363 | )
|                |                                      |                                                          |                |      |        |        |   |   |        |        |   |  

Premiums ceded to reinsurers increased to
$8.1 million in 2003 from $2.2 million in 2002. The
increase in premiums ceded, resulted primarily from:
(i) our cost for excess of loss reinsurance coverage in our
non-Minnesota regions increased substantially in 2003 while our
Minnesota cost decreased only slightly; (ii) we decreased
our retention to $200,000 in all our regions in 2003 by
purchasing increased excess of loss coverage in order to further
reduce volatility in our operating results; and (iii) the
2003 results include a $92,000 increase in excess of loss
premiums ceded resulting from a change in estimated reinsurance
cost for the WCRA compared to a $1.4 million decrease in
excess of loss premiums ceded in 2002.

Premiums ceded to reinsurers decreased to
$2.2 million in 2002 from $11.4 million in 2001. The
decrease in premiums ceded resulted from: (i) a
$7.3 million reduction in premiums ceded under our $25,000
to $300,000 excess of loss reinsurance policy; (ii) a
$1.4 million reduction in excess of loss premiums ceded
resulting from a change in estimated reinsurance cost for
Minnesota excess of loss coverage; and (iii) a decrease in
gross premiums earned offset by an increase in non-Minnesota
excess of loss costs in 2002.

2004 Outlook:The
2004 outlook for premiums in force, gross premiums earned and
premiums ceded include the following factors:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Premium rates are expected to increase only
    slightly on new and renewing policies as we filed our rates at
    the high end in each region in which we operated in 2003 and
    2002, leaving little room to further increase rates in 2004. We
    expect to continue to improve and add to our agency
    relationships in 2004. Coupled with an improved A.M. Best
    rating, we expect to increase premiums in force in 2004 with new
    business increases occurring primarily in our Minnesota and
    Michigan regions;
|
| |  | Our 2004 gross premiums earned will move in
    the same direction as our premiums in force, lagging slightly as
    premiums are earned over the term of the insurance
    policy; and                                                                                                                                                                                                                                                                                                                                             
|
| |  | Premiums ceded under excess of loss policies will
    increase significantly as a percent of gross premiums earned
    when compared to the results attained for 2003. We have
    established a $200,000 retention in all our regions in 2004. The
    cost of excess of loss reinsurance has increased at all
    retention levels and for all regions in 2004.                                                                                                                                                                   

Investment Income and Net Realized Investment
Gains:Our investment income includes
earnings on our investment portfolio and, in 2002 and 2001,
interest on our deposit receivable. Our net realized investment
gains, displayed separately on our accompanying Consolidated
Statements of Operations, include gains and losses from sales of
securities. In 2003, we sold certain securities within the
portfolio to take advantage of favorable interest rates and
realized investment gains totaling $685,000. In 2002 and 2001,
we sold certain securities within the portfolio and realized
investment gains totaling $1.9 million and
$1.2 million, respectively, as we repositioned the
portfolio. Recognition of realized investment gains and losses
in the future would depend on sales of our investments, if any,
to meet our short-term cash requirements or as we replace
securities to manage our portfolio returns.

At December 31, 2003 and 2002, we were
invested entirely in U.S. domiciled investment-grade
taxable fixed maturity investments. We also held significant
cash and cash equivalents totaling $39.7 million and
$36.3 million at December 31, 2003 and 2002,
respectively. In December 2002, we received $28.8 million

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from terminating our contract with St. Paul
RE (SPR). This amount was reinvested in January and February
2003. In order to reduce the near term interest rate risk on the
portfolio, we built our cash position throughout 2003 by holding
cash received on mortgage-backed security prepayments and
through sales of securities in September 2003 with the
expectation that interest rates will rise in the near term.
Subsequent to December 31, 2003, we began to diversify our
portfolio by investing in tax-exempt municipal securities to
take advantage of the tax benefits of those securities and
interest rate spreads. We classify our investments as
available-for-sale. We intend to hold our available-for-sale
investments to maturity, but may sell them before maturity in
response to tax planning considerations, changes in interest
rates, changes in prepayment risk and changes in funding sources
or terms, or to address liquidity needs. Our primary investment
objective is to maintain a diversified, high-quality,
fixed-investment portfolio structured to maximize our after-tax
investment income without taking inappropriate credit risk. For
further discussion of investments, see the
Investments section of this Managements
Discussion and Analysis.


Investment income decreased to $4.5 million
in 2003 from $5.1 million in 2002. After excluding $736,000
of interest earned on our deposit receivable from SPR in 2002,
for which there was no equivalent amount earned in 2003,
investment income increased slightly to $4.5 million in
2003 from $4.4 million in 2002. Investment income increased
slightly as average invested assets increased to
$96.0 million in 2003 from $77.9 in 2002. This increase in
investment income resulting from the increase in assets invested
was offset by a decrease in interest rates during 2003. Interest
rates declined early in the year, reaching a low point in June
2003 before returning to beginning of the year levels by
December 2003. Approximately $20.3 million of
mortgage-backed securities in our investment portfolio were
repaid earlier than expected due to the significant consumer
mortgage refinancing that occurred in 2003. The funds that came
available could not be reinvested at comparable rates, causing
the book investment yield to decline from 2002. Our book
investment yield, excluding cash and cash equivalents, declined
to 4.6% at December 31, 2003 from 4.9% at December 31,
2002. The investment yields realized in future periods will be
affected by yields attained on new investments.

Investment income decreased to $5.1 million
in 2002 from $6.4 million in 2001. Investment income
decreased as our invested assets decreased to $81.4 million
at December 31, 2002 from $89.2 million at
December 31, 2001 and our investment yields decreased as we
moved out of corporate securities in 2002 and reinvested in
lower yielding securities due to changes in market interest
rates and our desire to lower risk by buying higher rated
government and mortgage-backed securities. This decrease was
partially offset by an increase in interest earned on our
deposit receivable to $736,000 in 2002 from $518,000 in 2001.
Our invested assets decreased due to decreases in operating cash
flow in 2002 and 2001, resulting primarily from:
(i) reduced premiums in force and premiums written;
(ii) timing differences between paying premiums ceded and
recovering paid claim and claim settlement expenses;
(iii) the receipt of premiums and the payment of claim and
claim settlement expenses; and (iv) net cash provided by
lower investment income. Investment yields decreased to 4.9% for
2002 from 6.1% for 2001. The investment yields realized in
future periods would be affected by yields attained on new
investments.

2004 Outlook:We
expect that income from our investment portfolio for 2004 will
be affected by the following:



| |   |                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Our investment in tax-exempt municipal bonds will
    reduce investment income and favorably affect net income as
    investment yields will be lower on a pre-tax basis but will be
    higher on a tax-adjusted basis;                                 
|
| |  | We expect interest rates to increase in 2004. The
    timing of any such rate increases in unknown at this time. We
    intend to invest our excess cash into higher yielding
    investments in 2004 as the rates increase;                             
|
| |  | Cash flows for 2004 are expected to be adversely
    affected by decreases in cash flows resulting from claim
    payments on claims from 2003 and prior years offset by cash
    flows from our premiums as we increase our premiums earned in
    2004;

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| |   |                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Recognition of realized investment gains and
    losses will depend on sales of our investments, if any, to meet
    our short-term cash requirements or as we reposition our
    portfolio to further manage our portfolio returns; and
|
| |  | New and renegotiated reinsurance treaties may
    affect our future cash flow and future investment income.                                                                                                                             

Other Income:We
recorded and received a refund totaling $2.1 million from
the WCRA in 2001. The WCRA periodically reviews its surplus
position and refunds excess surplus to its members. This refund
represents our share of the excess surplus of the WCRA at
December 31, 2000. No such refunds were received in 2002 or
2003. We do, however, expect that fee-for service revenues will
increase in 2004 from the $109,000 and $22,000 realized in 2003
and 2002, respectively.

Total Expenses:Our
expenses include claim and claim settlement expenses, policy
acquisition costs, general and administrative expenses, interest
expense and income taxes.

Claim and Claim Settlement
Expenses:Claim expenses refer to
medical and indemnity benefits that we have paid or expect to
pay to claimants for events that have occurred. The costs of
investigating, resolving and processing these claims are
referred to as claim settlement expenses. We record these
expenses, net of amounts recoverable under reinsurance
contracts, to claim and claim settlement expenses in the
accompanying Consolidated Statements of Operations.

Claim and claim settlement expenses are our
largest expense and result in our largest liability. We
establish reserves that reflect our estimates of the total claim
and claim settlement expenses we will ultimately have to pay
under our workers compensation insurance policies. These
include claims that have been reported but not settled and
claims that have been incurred but not yet reported to us. For
further discussion of reserve determination, see the
Unpaid Claim and Claim Settlement Expenses and Reinsurance
Recoverables section of this Managements Discussion
and Analysis.

We experienced a decrease in the estimated number
of ultimate claims for 2003 compared to 2002 and 2001. The
number of estimated ultimate claims by accident year decreased
to approximately 9,600 in 2003 from 11,500 in 2002 and 22,100 in
2001. The net decrease correlates directly to: (i) the
decrease in gross earned premiums; and (ii) the
re-underwriting that we completed with respect to our in force
policies in 2002 and 2001. The gross and net average estimated
cost per claim (which includes both claim and claim settlement
expenses) totaled approximately $5,000 and $4,200 in 2003
compared to $5,500 and $4,900 in 2002 and $4,500 and $3,400 in
2001, respectively. The 2003 decrease in gross and net average
estimated cost per claim is primarily the result of our improved
ability to manage cases and claims offset by increases in
severity (i.e., the average cost of a claim) caused mainly by
inflationary pressures. The trend of increasing severity is
attributable to a combination of factors that include increasing
medical costs and increasing indemnity payments (reimbursements
to injured workers for lost wages) per claim. We have also
observed a decline in the number of claims being reported over
the last several years. The declining frequency of claims
contributes to the increasing severity trend because the
frequency decline has been concentrated in less expensive claims
(claims involving less time-off from work and less severe
injuries).

The number of claims reported but unpaid (open
claims) and the approximate average gross and net reserves on
these claims each period was: 2003  1,115 claims,
$28,400 average gross reserve, $21,400 average net reserve;
2002  339 claims, $72,800 average gross reserve,
$55,900 average net reserve; and 2001  300 claims,
$89,500 average gross reserve, $44,500 average net reserve. The
average gross and net reserves per claim are less in 2003 than
in 2002 and 2001 as the open claims include newly reported
claims from the later half of 2003, including many with much
lower severity that have not had time to close, as well as new
claims that are incurred but not yet reported. The remaining
open claims from 2002 and 2001 are primarily claims with
significant injury characteristics resulting in the increase in
outstanding average gross and net reserves per claim.

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##### Table of Contents



2003 Compared to
2002:Claim and claim settlement
expenses decreased significantly to $27.3 million in 2003
from $40.5 million in 2002. As a percent of premiums
earned, claim and claim settlement expenses decreased to 58.9%
in 2003 from 67.3% in 2002. These changes are due to the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The decrease in gross premiums earned as
    discussed above under Premiums In Force and Gross Premiums
    Earned;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|
| |  | The 2003 results include a $6.7 million
    decrease in prior years reserves for unpaid claim and
    claim settlement expenses compared to the 2002 results which
    include an $8.4 million decrease in prior years
    reserves. Our estimate for unpaid claim and claim settlement
    expenses decreased in 2003 due to the following: (i) our
    ability to manage and close claims has improved over our
    historical experience; (ii) the re-underwriting of our book
    of business has resulted in claims with profiles different than
    experienced historically; (iii) the frequency of claims
    reported in 2003 for 2002 and prior years was less than
    anticipated when we determined our liability in 2002; and
    (iv) our estimate of the liability for unpaid claim and
    claim settlement expenses is volatile due to our relatively
    limited twelve-year historical claim data and our small claim
    population;
|
| |  | Claim and claims settlement expenses decreased in
    total due to the overall decrease in average premiums in force
    and decreased as a percent of gross premiums earned as premium
    rate increases realized in 2002 and 2003 flow through 2003
    premium earned; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Claim costs continued to reflect increasing
    medical and indemnity costs in accident year 2003 as compared to
    accident year 2002 resulting from inflationary pressures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

2002 Compared to
2001:Claim and claim settlement
expenses decreased significantly to $40.5 million in 2002
from $80.1 million in 2001. As a percent of premiums
earned, claim and claim settlement expenses decreased to 67.3%
in 2002 from 93.1% in 2001. These changes are due to the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The decrease in gross premiums earned as
    discussed above under Premiums In Force and Gross Premiums
    Earned;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | The 2002 results include an $8.4 million
    decrease in prior years reserves for unpaid claim and
    claim settlement expenses compared to the 2001 results which
    include a $7.7 million increase in prior years
    reserves. Our estimate for unpaid claim and claim settlement
    expenses decreased in 2002 due to the following: (i) in
    March 2002, the Minnesota State legislature changed the way the
    commissioner assessed self-insured employers and insurers for
    estimated liabilities and administrative expenses of the
    Minnesota Special Compensation Fund. The assessment changed from
    being paid by the insurer on an indemnity payment basis to an
    assessment charged on premium to the policyholder. We decreased
    our recorded accrual in 2002 to reflect this legislative change;
    (ii) the frequency of claims reported in 2002 for 2001 and
    prior years was less than anticipated when we determined our
    liability in 2001; (iii) we overestimated the liability for
    our mandatory participation in state and national assigned risk
    pool operating results for states in which we operate in 2001
    and reversed that excess in 2002; and (iv) our estimate of
    the liability for unpaid claim and claim settlement expenses is
    volatile due to our relatively limited historical claim data and
    small claim population;
|
| |  | We recorded estimates of ceded paid and unpaid
    claim and claim settlement expenses under our $25,000 to
    $300,000 excess of loss reinsurance agreement totaling
    $15.2 million in 2001 resulting in a corresponding
    reduction in 2001 claim and claim settlement expenses. No such
    benefit was recorded in 2002;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|
| |  | We increased renewal premium rates an average of
    9.0% in 2002 and 18.5% in 2001 compared to premium rates for the
    same periods in 2001 and 2000, respectively, reversing a trend
    of continued rate declines during years prior to 2000. Increases
    in premium rates have the effect of reducing the ratio of claim
    and claim settlement expenses to gross premiums earned as losses
    do not increase with premium rate increases; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Claim costs continued to reflect increasing
    medical and indemnity costs in accident year 2002 as compared to
    accident year 2001 resulting from inflationary pressures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

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2004 Outlook:We
expect that claim and claim settlement expenses will be affected
by the following factors:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Claim costs will continue to be affected by:
    (i) increases in medical and indemnity costs resulting from
    inflationary changes; (ii) severity experienced in future
    periods in our policyholder base; (iii) changes resulting
    from increases in operating efficiency and effectiveness
    realized through enhancements to our internal processes and
    procedures, including changes to our proprietary computer
    systems; and (iv) legislative changes that affect benefits
    payable under workers compensation laws;
|
| |  | Increases in premium rates, if any in 2004, will
    result in increasing premiums earned without a corresponding
    increase in claim and claim settlement expenses, ultimately
    decreasing claim and claim settlement expense as a percent of
    premiums earned. Changes in premium rates due to legislative
    changes in estimated loss costs, increased competition and
    improving customer loss experience may offset rate
    improvements; and                                                                                
|
| |  | Continued application of our claims management
    technology and methods to all open claims.                                                                                                                                                                                                                                                                                                                                                                                                                                                   

At this time, we do not know the ultimate result
of these factors on 2004 claim and claim settlement expenses as
a percent of premiums earned.

Policy Acquisition
Costs:Policy acquisition costs are
costs directly related to writing an insurance policy and
consist of commissions, state premium taxes, underwriting
personnel costs and expenses, sales and marketing costs and
other underwriting expenses, less ceding commissions from our
reinsurers. Ceding commissions are amounts that reinsurers pay
to us for placing reinsurance with them.

The following table summarizes policy acquisition
costs (000s):

|                                                                                                                                  |                                 |                                |        |       |       |      |       |       |       |   |       |        |        | 
|--------------------------------------------------------------------------------------------------------------------------------- | ------------------------------- | ------------------------------ | ------ | ----- | ----- | ---- | ----- | ----- | ----- | - | ----- | ------ | ------ | 
|                                                                                                                                  |                                 |                               
|                                                                                                                                  |                                 | Year Ended December 31,       
|                                                                                                                                  |                                 |                               
|                                                                                                                                  |                                 | 2003                           |        | 2002  |       | 2001
|                                                                                                                                  |                                 |                                |        |       |       |     
|Commission expense                                                                                                                |                                 | $                              | 4,000  |       |       | $    | 4,321 |       |       | $ | 7,378 |       
|Premium tax expense                                                                                                               |                                 |                                | 997    |       |       |      | 1,048 |       |       |   | 1,888 |       
|Other policy acquisition costs                                                                                                    |                                 |                                | 3,381  |       |       |      | 935   |       |       |   | 4,463 |       
|                                                                                                                                  |                                 |                                |        |       |       |      |       |       |       |   |       |       
|                                                                                                                                  | Direct policy acquisition costs |                                |        | 8,378 |       |      |       | 6,304 |       |   |       | 13,729 |       
|Ceding commissions resulting from adjustments to
    claim and claim settlement estimates for our 1992 to 1994
    accident years |                                 |                                |       |       |       |      |      |       |       |   | 261   |       
|Ceding commission on excess of loss reinsurance                                                                                   |                                 |                                | (1,500 | )     |       |      |      |       |       |   |      |       
|                                                                                                                                  |                                 |                                |        |       |       |      |       |       |       |   |       |       
|                                                                                                                                  |                                 | Total policy acquisition costs |        | $     | 6,878 |      |       | $     | 6,304 |   |       | $      | 13,990 | 
|                                                                                                                                  |                                 |                                |        |       |       |      |       |       |       |   |       |       

Under certain of our excess of loss reinsurance
policies, the reinsurer returns a portion of the premiums we
cede as ceding commissions to reimburse us for our cost of
placing and managing these policies. Ceding commissions received
under these excess of loss reinsurance policies totaled
$1.5 million in 2003 and reduced our policy acquisition
costs. No similar ceding commissions existed in 2002 or 2001.
Excluding the effect of ceding commissions, policy acquisition
costs increased to $8.4 million in 2003 from
$6.3 million in 2002 and decreased from $13.7 million
in 2001. As a percent of gross premiums earned, policy
acquisition costs increased to 15.4% in 2003 compared to 10.1%
in 2002 and 14.1% in 2001. The increase in 2003 reflects the
following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Gross premiums earned decreased significantly in
    2003 compared to 2002 and 2001 resulting in corresponding
    decreases in policy acquisition costs;                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Commission expense increased to 7.3% of gross
    premiums earned in 2003 from 6.9% in 2002 and decreased from
    7.6% in 2001. The increased commission percent in 2003 is the
    result of our new business growth in 2003 on which we pay higher
    first-year commission rates. In 2002, our renewal business, on
    which we pay lower commission rates, significantly outpaced our
    new business. In all of our markets, we believe the commission
    rates we pay are marketplace competitive;

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Premium tax expense increased slightly to 1.8% of
    gross premiums earned in 2003 from 1.7% of gross premiums earned
    in 2002 and decreased slightly from 1.9% in 2001; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  | Other policy acquisition costs were affected by
    the following: (i) in 2003, we recorded a $1.5 million
    increase in other policy acquisition costs reflecting a
    reallocation of 2002 mandatory reinsurance pool expenses; we
    were not assessed any reallocation in 2002; (ii) in 2002,
    Michigan changed the basis of its second injury fund assessment
    from a claims based assessment to a premium based assessment,
    resulting in an $851,000 benefit in 2002 compared to no benefit
    received in 2003; (iii) in 2002, we received a $541,000
    favorable adjustment from a state data collection agency
    resulting from our significant decrease in premiums; and
    (iv) a general decrease related to the decrease in gross
    premiums earned.

2004 Outlook:We
expect that policy acquisition costs in 2004 will remain
relatively flat as a percent of gross premiums earned compared
to 2003 after adjusting for the reallocation of mandatory
reinsurance pool expenses.

General and Administrative
Expenses:Our general and
administrative expenses include personnel costs, office rent,
certain state administrative charges based on premiums and other
costs and expenses not specific to claim and claim settlement
expenses or policy acquisition costs.

Our general and administrative expenses increased
to $10.8 million in 2003 from $10.0 million in 2002
and decreased from $17.4 million in 2001. As a percent of
gross premiums earned, general and administrative expenses
increased to 19.8% in 2003 from 16.0% in 2002 and 17.9% in 2001.
General and administrative expenses increased in 2003 and
decreased in 2002 as follows:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | General and administrative expenses increased in
    2003 from 2002 levels. Significant changes include (i) the
    reversal of a previously recorded contingent reinsurance
    commission resulting in $375,000 in expense in 2003;
    (ii) $217,000 in expenses related to severance and
    relocation in 2003; (iii) increased professional fees; and
    (iv) costs associated with investing in the necessary staff
    and infrastructure to position us for growth;                                                                                 
|
| |  | General and administrative expenses declined
    significantly in 2002 from 2001 due to the following:
    (i) $2.0 million of restructuring charges related to
    office closures recorded in 2001, while no offices were closed
    in 2002; (ii) $400,000 of net margin expense was recorded
    in 2002 related to our St. Paul RE contract compared to
    $2.0 million in 2001; and (iii) a decrease to $266,000
    of Insurance Guarantee Association (IGA) assessments in 2002
    compared to $1.1 million of such IGA assessments in
    2001; and
|
| |  | General and administrative expenses increased as
    a percent of premiums earned, after adjusting for restructuring
    charges, IGA assessments and one-time charges as we had less
    revenue relative to our fixed operating costs and expenses. We
    aggressively managed personnel and other operating costs and
    expenses during 2003 to appropriately align operating expenses
    with revenues. All expenses continue to be managed aggressively
    and reduced where appropriate.                                                           

2004 Outlook:We
expect that general and administrative expenses will be affected
by the following:



| |   |                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------
| |  | All expenses will continue to be aggressively
    managed and reduced where appropriate;                     
|
| |  | We have no plans to open additional offices in
    2004;                                                     
|
| |  | We will continually monitor reported claim counts
    in 2004 and re-examine staffing needs as necessary; and
|
| |  | We will make appropriate investments in
    infrastructure to position us for the future.                    

Interest Expense:We
incurred interest charges on our Term Loan in 2003, 2002 and
2001. We originally borrowed $8.0 million under the Term
Loan in March 2000 and paid the remaining amount due in
September 2003.

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The Term Loan accrued interest, payable
quarterly. We paid interest at rates ranging from 4.03% to 4.66%
on the outstanding balance of our Term Loan in 2003 compared to
4.61% to 5.33% in 2002. Interest expense decreased to $48,000 in
2003 from $163,000 in 2002 as a result of the decrease in
interest rates, $1.3 million in principal payments in 2003
and $3.3 million in principal payments in 2002.

We paid interest at rates ranging from 4.61% to
5.33% on the outstanding balance of our Term Loan in 2002
compared to 6.50% to 8.83% in 2001. Interest expense decreased
to $163,000 in 2002 from $511,000 in 2001 as a result of the
change in interest rates and $3.3 million in principal
payments in 2002.

2004 Outlook:We
expect to incur no interest charges in 2004.

Income Taxes:We
incur federal income taxes on our combined service organization
operations (RTW) and insurance operations (ACIC). We incur state
income taxes on the results of our service organizations
operations and incur premium taxes in lieu of state income taxes
for substantially all of our insurance operations. In certain
instances, we may incur state income taxes on our insurance
operations. Additionally, certain provisions of the Internal
Revenue Code adversely affect our taxable income by accelerating
recognition and payment of income taxes. Adjustments to book
income generating current tax assets and liabilities include
limitations on the deductibility of unpaid claim and claim
settlement expenses, limitations on the deductibility of
unearned premium reserves, limitations on deductions for bad
debt reserves and the acceleration of expensing policy
acquisition costs.

In assessing the realizability of deferred tax
assets, we consider whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
We consider recent operating results, the scheduled reversal of
deferred tax liabilities, projected future taxable income and
tax planning strategies in making this assessment. At
December 31, 2001, we established a $14.5 million
valuation allowance (allowance) against deferred tax assets
resulting in a corresponding increase in income tax expense. In
2002, the valuation allowance decreased by $7.9 million to
$6.6 million as we were able to carry-back our 2001
operating loss five years resulting in a $3.8 million tax
refund, the reversal of certain deferred tax items and use of
the 2000 operating loss carry forward to offset income in 2002.
This allowance further decreased by $3.0 million in 2003 to
$3.6 million as we used the remaining 2001 operating loss
carry forward to offset the income we earned in 2003 and further
evaluated the asset we expect to realize based on our projected
taxable income and available tax planning strategies. We expect
any remaining deferred tax assets, net of the allowance, at
December 31, 2003, to be realized as a result of the future
income and the reversal of existing taxable temporary
differences.

Under the first provision of the Job Creation and
Worker Assistance Act of 2002, signed into law in March 2002, we
were allowed to carry-back our 2001 net operating loss for five
years, to 1996, instead of two years under previous law. We
filed our tax return in September 2002, and received a refund
totaling approximately $3.3 million as a result of this
Federal legislative change from carrying-back our 2001 loss. An
additional $475,000 receivable was recorded that related to the
carry-back that resulted from revising our financial statements
for 2001.

Income tax benefit for the year ended
December 31, 2003 included a $3.0 million benefit
resulting from reducing the allowance as we offset current year
earnings by losses carried forward from 2001 and $384,000 in
alternative minimum tax expense. Income tax benefit for the year
ended December 31, 2002 included the following: (i) a
$3.8 million benefit from carrying back our 2001 loss five
years under the tax law change; (ii) a $4.0 million
benefit resulting from reducing the allowance as we realized
favorable claim reserve development in 2002; and (iii) a
further benefit as we offset current year earnings by losses
carried forward from 2000. After excluding the effects of the
benefits from reducing the allowance, income tax expense was
$2.3 million for 2003 compared to income tax expense of
$3.8 million for 2002. As a percent of income before income
taxes, the income tax expense before any benefit from reducing
the allowance was 34.4% of the income before income taxes in
2003 compared to 37.1% in 2002 and 34.5% of the net loss before
income taxes in 2001.

2004 Outlook:Income
tax expense will vary based on: (i) the income from
operations we earn in 2004; (ii) the amount of tax-exempt
income we earn in 2004; and (iii) the changes in the
valuation allowance necessary during 2004. The ultimate change
is unknown at this time.

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Investments

Our portfolio of fixed maturity securities
included only U.S. government securities (62.1%),
mortgage-backed securities (36.6%), and asset-backed securities
(1.3%) at December 31, 2003. Our portfolio is managed by an
independent investment manager to maximize our after-tax
investment income without taking inappropriate credit risk. In
2003, we sold certain securities within the portfolio to take
advantage of favorable interest rates and realized investment
gains totaling $685,000. In 2002, we sold certain securities
within the portfolio to reduce risk and realized investment
gains totaling $1.9 million. We conservatively manage our
fixed maturity portfolio, investing only in investment grade
(BBB or better rating from Standard and Poors) securities
of U.S. domiciled issuers. All securities in our portfolio
were rated AAA at December 31, 2003. We do not invest in
derivative securities.

Operating cash flows consist of the deficit or
excess of premiums collected over claim and claim settlement
expenses paid reduced by payments for reinsurance premiums as
well as other operating expenses paid. Investment cash flows
consist of income on existing investments and proceeds from
sales and maturities of investments. Prior to 1999, we generated
positive net cash flows from operations due, in part, to timing
differences between the receipt of premiums and the payment of
claim and claim settlement expenses. These net cash flows
decreased significantly in 2001, 2000 and 1999 as we focused on
closing old claims by paying earlier to close those claims.
Combined with relatively flat premiums in force in 1998, 1999
and 2000 and decreasing premiums since that time, our cash flows
from differences in timing have decreased. Additionally, as we
lowered our reinsurance retention levels to $25,000 in mid-1998,
we decreased our current period cash flows as a result of
pre-funding quarterly reinsurance premiums under
that agreement. Reinsurance reimbursements from our $25,000 to
$300,000 excess of loss reinsurance agreement offset similar
payments to claimants for those years in 2003. Our investment
portfolio decreased $2.2 million to $79.2 million at
December 31, 2003 from $81.4 million at
December 31, 2002, as a result of these factors. The cash
balance at December 31, 2002 included $28.8 million
received from St. Paul RE (SPR) from terminating a contract
late in December 2002. We invested this cash in January and
February 2003. During 2003, interest rates declined, leading to
significant mortgage refinancing by consumers, resulting in
prepayment or early redemption of our mortgage-backed
securities. At December 31, 2003 our cash balance was
$39.7 million. We expect that our investments and cash and
cash equivalents will decrease in 2004 as we pay claims for 2003
and prior years, years in which we earned higher premiums and
incurred a higher number of claims reported.

We record investments on our balance sheet at
fair value, with the corresponding appreciation or depreciation
from amortized cost recorded in shareholders equity as
other comprehensive income, net of taxes. Because value is based
on the relationship between the portfolios stated yields
and prevailing market yields at any given time, interest rate
fluctuations can have a swift and significant impact on the
carrying value of these securities. As a result of classifying
our securities as available-for-sale, and thus carrying them at
fair value, we expect to encounter adjustments in
shareholders equity as market interest rates and other
factors change. Prevailing market interest rates increased
slightly since December 31, 2002, and when combined with
the sale of select securities to realize gains, resulted in a
$1.5 million unrealized gain on investments in 2003
compared to a $3.4 million unrealized gain in 2002.

Unpaid Claim and Claim Settlement Expenses and
Reinsurance Recoverables

At December 31, 2003, the liability for
unpaid claim and claim settlement expenses totaled
$150.0 million and reinsurance recoverables on unpaid claim
and claim settlement expenses totaled $71.5 million,
resulting in net reserves totaling $78.6 million. The net
reserve at December 31, 2002 totaled $89.4 million and
included the liability for unpaid claim and claim settlement
expenses totaling $181.3 million net of reinsurance
recoverables on unpaid claim and claim settlement expenses of
$91.8 million.

Accounting for workers compensation
insurance operations requires us to estimate the liability for
unpaid claim and claim settlement expenses
(reserves) and the related reinsurance recoverables,
(together, the net reserves) at each balance sheet
date. Our reserves represent the estimated total unpaid cost of
claim and claim settlement expenses, which cover events that
occurred in 2003 and prior years. These reserves reflect our
estimates of the total costs of claims that were reported, but
not yet paid, and the cost of claims incurred but

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not yet reported (IBNR). For reported claims, we
establish reserves on a case basis. For IBNR claims,
we calculate the difference between: (i) projected ultimate
claim and claim settlement expenses as determined using
generally accepted actuarial standards; and (ii) case
reserves and carry the difference as the IBNR reserve. By using
both estimates of reported claims and IBNR claims, we estimate
the ultimate net reserves for unpaid claim and claim settlement
expenses.


The amount by which estimated net reserves,
measured subsequently by reference to payments and additional
estimates, differ from those originally reported for a period is
known as development. Development is unfavorable (or
deficient) when losses ultimately settle for more than the
levels at which they were reserved or subsequent estimates
indicate a basis for reserve increases on open claims.
Development is favorable (redundant) when losses ultimately
settle for less than the amount reserved or subsequent estimates
indicate a basis for reducing loss reserves on open claims.
Favorable or unfavorable development of loss reserves is
reflected in earnings in the year recognized.

Both internal and independent external actuaries
review net reserves for adequacy on a periodic basis. This
review assumes that past experience, adjusted for the effects of
current events and anticipated trends, is an appropriate basis
for predicting future events. When reviewing net reserves,
actuaries analyze historical data and estimate the effect of
various factors on estimated ultimate reserves including:
(i) trends in general economic conditions, including the
effects of medical and wage inflation; (ii) estimates of
trends in claims frequency and severity; (iii) our and
industry historical loss experience; and (iv) legislative
enactments, legal developments and changes in social and
political attitudes. Variables in the reserve estimation process
can be affected by both internal and external events, including
changes in claims handling procedures, economic inflation, legal
trends and legislative changes. Many of these items are not
directly quantifiable, particularly on a prospective basis.
There is no precise method for subsequently evaluating the
effect of any specific factor on the adequacy of reserves
because the eventual deficiency or redundancy is affected by
many factors. Additionally, there may be significant reporting
lags between the occurrence of the loss and the time it is
actually reported to the insurer. Due to our commencing
operations in 1992, we have limited historical data to estimate
our reserves for unpaid claim and claim settlement expenses and,
accordingly, we supplement our experience with external industry
data, as adjusted, to reflect anticipated differences between
our results and the industry.

Estimating the effect that inflation will have on
the ultimate cost of claims is a major risk factor in our
workers compensation reserve estimates. Future earnings
will be affected by reserve development associated with any
changes in our inflation assumptions. Estimates for the 2003 and
2002 accident years represent the majority of the uncertainty
because these claims have the lowest proportionate amount of
paid loss as of December 31, 2003 and represent
approximately fifty-five percent (55%) of our net outstanding
reserves. Our reserve estimates are most sensitive to changes in
the assumption about inflation for the 2003 and 2002 accident
years. Each one percent (1%) increase or decrease in the medical
inflation rate for these accident years would increase or
decrease our net loss reserve estimates at December 31,
2003 by approximately $390,000.

Our independent actuary provides management with
an opinion regarding the acceptable range for adequate statutory
reserves based on generally accepted actuarial guidelines. We
record our net reserves by considering a range of estimates
bounded by the high and low point of the range. Within that
range, we record our estimate. We focus in our decision process
on improving our financial strength ratings and expect to remain
a market for workers compensation insurance in all market
conditions. In 2003 we established recorded reserves in the
upper half of the actuarys range. The ultimate actual
liability may be higher or lower than reserves established.

Our reserves are primarily undiscounted. We
discounted reserves for selected claims that have fixed and
determinable future payments, however, at rates ranging from
3.5% to 8.0% in 2003 and 2002. The discount rates in 2003 and
2002 are subject to change as market interest rates change. We
use the same rates for Generally Accepted Accounting Principles
as we do for Statutory Accounting Practices in determining our
liability. We also reduce the unpaid claim and claim settlement
expenses for estimated amounts of subrogation.

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We continually monitor loss development trends
and data to establish adequate premium rates and reasonable loss
reserve estimates. Loss reserves, which are based on estimates,
are inherently uncertain and represent a significant risk to the
business that we attempt to mitigate by continually improving
and refining our workers compensation claims processing
practices and by employing actuarial estimation methods.

After taking into account all relevant factors,
we believe our reserves for unpaid claim and claim settlement
expenses and reinsurance recoverables on unpaid claim and claim
settlement expenses at December 31, 2003 are adequate to
cover the ultimate net costs of claim and claim settlement
expenses at that date. The ultimate cost of claim and claim
settlement expenses may differ materially from the established
reserves, particularly when claims may not be settled for many
years. Establishing appropriate reserves is an inherently
uncertain process and there can be no certainty that currently
established reserves will prove adequate in light of subsequent
actual experience. See Notes 1 and 5 in the accompanying
Consolidated Financial Statements. The following two tables
reconcile the beginning and ending insurance reserves, displayed
individually for each of the last three years.

The following table sets forth reserves on a
gross (before reinsurance) basis (000s):

|                                                            |                                                                               |                         |                 |         |         |        |   |         |        |        |   |         |        |         | 
|----------------------------------------------------------- | ----------------------------------------------------------------------------- | ----------------------- | --------------- | ------- | ------- | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------- | 
|                                                            |                                                                               |                        
|                                                            |                                                                               | Year Ended December 31,
|                                                            |                                                                               |                        
|                                                            |                                                                               | 2003                    |                 | 2002    |         | 2001  
|                                                            |                                                                               |                         |                 |         |         |       
|Gross Reserves for Claim and Claim Settlement
    Expenses: |                                                                               |                         |                 |         |         |        |   |         |        |        |   |        
|                                                            | Gross reserves for claim and claim settlement
    expenses, beginning of year |                         | $               | 181,262 |         |        | $ | 181,310 |        |        | $ | 128,841 |       
|                                                            | Provision increases (decreases) for claim
    and claim settlement expenses:  |                         |                 |         |         |        |   |         |        |        |   |         |       
|                                                            |                                                                               | Current year            |                 |         | 42,777  |        |   |         | 56,117 |        |   |         | 97,510 |        
|                                                            |                                                                               | Prior years             |                 |         | (21,846 | )      |   |         | 3,593  |        |   |         | 31,224 |        
|                                                            |                                                                               |                         |                 |         |         |        |   |         |        |        |   |        
|                                                            |                                                                               |                         | Total provision |         |         | 20,931 |   |         |        | 59,710 |   |         |        | 128,734 | 
|                                                            | Payments for claim and claim settlement expenses:                             |                         |                 |         |         |        |   |         |        |        |   |         |       
|                                                            |                                                                               | Current year            |                 |         | 11,075  |        |   |         | 13,715 |        |   |         | 27,024 |        
|                                                            |                                                                               | Prior years             |                 |         | 41,074  |        |   |         | 46,043 |        |   |         | 49,241 |        
|                                                            |                                                                               |                         |                 |         |         |        |   |         |        |        |   |        
|                                                            |                                                                               |                         | Total payments  |         |         | 52,149 |   |         |        | 59,758 |   |         |        | 76,265  | 
|                                                            |                                                                               |                         |                 |         |         |        |   |         |        |        |   |        
|                                                            | Gross reserves for claim and claim settlement
    expenses, end of year       |                         | $               | 150,044 |         |        | $ | 181,262 |        |        | $ | 181,310 |       
|                                                            |                                                                               |                         |                 |         |         |        |   |         |        |        |   |        

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The following table sets forth reserves on a net
(after reinsurance) basis (000s):

|                                                          |                                                                              |                                                                       |                 |        |        |        |   |        |        |        |   |        |        |        | 
|--------------------------------------------------------- | ---------------------------------------------------------------------------- | --------------------------------------------------------------------- | --------------- | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                                          |                                                                              |                                                                      
|                                                          |                                                                              | Year Ended December 31,                                              
|                                                          |                                                                              |                                                                      
|                                                          |                                                                              | 2003                                                                  |                 | 2002   |        | 2001  
|                                                          |                                                                              |                                                                       |                 |        |        |       
|Net Reserves for Claim and Claim Settlement
    Expenses: |                                                                              |                                                                       |                 |        |        |        |   |        |        |        |   |       
|                                                          | Net reserves for claim and claim settlement
    expenses, beginning of year  |                                                                       | $               | 89,440 |        |        | $ | 91,195 |        |        | $ | 66,996 |       
|                                                          | Plus: Deferred retrospective reinsurance gain,
    beginning of year         |                                                                       |                 | 49     |        |        |   | 449    |        |        |   | 849    |       
|                                                          | Provision increases (decreases) for claim
    and claim settlement expenses: |                                                                       |                 |        |        |        |   |        |        |        |   |        |       
|                                                          |                                                                              | Current year                                                          |                 |        | 33,954 |        |   |        | 49,621 |        |   |        | 73,557 |       
|                                                          |                                                                              | Prior years                                                           |                 |        | (6,698 | )      |   |        | (8,356 | )      |   |        | 7,731  |       
|                                                          |                                                                              | Write-off of reinsurance recoverable                                  |                 |        |       |        |   |        | (332   | )      |   |        | (785   | )     
|                                                          |                                                                              | Amortization of deferred retrospective
    reinsurance gain           |                 |        |       |        |   |        | (400   | )      |   |        | (400   | )     
|                                                          |                                                                              |                                                                       |                 |        |        |        |   |        |        |        |   |       
|                                                          |                                                                              |                                                                       | Total provision |        |        | 27,256 |   |        |        | 40,533 |   |        |        | 80,103 | 
|                                                          | Payments for claim and claim settlement expenses:                            |                                                                       |                 |        |        |        |   |        |        |        |   |        |       
|                                                          |                                                                              | Current year                                                          |                 |        | 10,761 |        |   |        | 13,715 |        |   |        | 25,062 |       
|                                                          |                                                                              | Prior years                                                           |                 |        | 27,357 |        |   |        | 28,973 |        |   |        | 31,242 |       
|                                                          |                                                                              |                                                                       |                 |        |        |        |   |        |        |        |   |       
|                                                          |                                                                              |                                                                       | Total payments  |        |        | 38,118 |   |        |        | 42,688 |   |        |        | 56,304 | 
|                                                          | Less: Deferred retrospective reinsurance gain,
    end of year               |                                                                       |                 | (49    | )      |        |   | (49    | )      |        |   | (449   | )     
|                                                          |                                                                              |                                                                       |                 |        |        |        |   |        |        |        |   |       
|                                                          |                                                                              | Net reserves for claim and claim settlement
    expenses, end of year |                 | $      | 78,578 |        |   | $      | 89,440 |        |   | $      | 91,195 |       
|                                                          |                                                                              |                                                                       |                 |        |        |        |   |        |        |        |   |       

The following loss reserve development table sets
forth the change, over time, of gross reserves established for
claim and claim settlement expenses at the end of the last ten
years. The following gross loss

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reserve development table is cumulative and,
therefore, ending balances should not be added since the amount
at the end of each calendar year includes activity for both
current and prior years (000s):


|                          |                                                                     |                   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |        |  
|------------------------- | ------------------------------------------------------------------- | ----------------- | - | ------- | ------- | ---- | - | ------- | ------- | ---- | - | ------- | ------- | ---- | - | ------- | ------- | ---- | - | ------ | ------- | ---- | - | ------ | ------- | -- | - | ------ | ------- | -- | - | ------ | ------ | -- | - | ------ | ------ | - | - | ------ | ------ | - | - | ------ | ------ | -
|                          |                                                                     |                  
|                          |                                                                     | December 31,     
|                          |                                                                     |                  
|                          |                                                                     | 2003              |   | 2002    |         | 2001 |   | 2000    |         | 1999 |   | 1998    |         | 1997 |   | 1996    |         | 1995 |   | 1994   |         | 1993
|                          |                                                                     |                   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |     
|                          |                                                                     |                  
|                          |                                                                     | (000s)          
|Loss Reserve Development: |                                                                     |                   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |       
|                          | Gross reserves for unpaid claim and claim
    settlement expenses   |                   | $ | 150,044 |         |      | $ | 181,262 |         |      | $ | 181,310 |         |      | $ | 128,841 |         |      | $ | 99,831 |         |      | $ | 97,269 |         |    | $ | 61,069 |         |    | $ | 49,256 |        |    | $ | 37,138 |        |   | $ | 28,165 |        |   | $ | 13,279 |       
|                          | Paid (cumulative) as of:                                            |                   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |       
|                          |                                                                     | One year later    |   |         |         |      |   | $       | 41,075  |      |   | $       | 46,043  |      |   | $       | 49,241  |      |   | $      | 45,933  |      |   | $      | 37,062  |    |   | $      | 28,315  |    |   | $      | 20,529 |    |   | $      | 10,032 |   |   | $      | 7,625  |   |   | $      | 4,065  |  
|                          |                                                                     | Two years later   |   |         |         |      |   |         |         |      |   |         | 73,086  |      |   |         | 74,681  |      |   |        | 67,442  |      |   |        | 56,031  |    |   |        | 42,889  |    |   |        | 29,841 |    |   |        | 15,306 |   |   |        | 10,899 |   |   |        | 6,390  |  
|                          |                                                                     | Three years later |   |         |         |      |   |         |         |      |   |         |         |      |   |         | 90,484  |      |   |        | 78,244  |      |   |        | 65,664  |    |   |        | 50,558  |    |   |        | 35,370 |    |   |        | 18,415 |   |   |        | 13,261 |   |   |        | 7,392  |  
|                          |                                                                     | Four years later  |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        | 85,754  |      |   |        | 70,631  |    |   |        | 54,835  |    |   |        | 38,880 |    |   |        | 19,964 |   |   |        | 14,449 |   |   |        | 8,284  |  
|                          |                                                                     | Five years later  |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        | 73,979  |    |   |        | 57,261  |    |   |        | 41,029 |    |   |        | 21,289 |   |   |        | 15,126 |   |   |        | 8,754  |  
|                          |                                                                     | Six years later   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        | 59,012  |    |   |        | 41,980 |    |   |        | 22,117 |   |   |        | 15,650 |   |   |        | 8,839  |  
|                          |                                                                     | Seven years later |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        | 42,728 |    |   |        | 22,702 |   |   |        | 15,952 |   |   |        | 9,032  |  
|                          |                                                                     | Eight years later |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        | 23,020 |   |   |        | 16,226 |   |   |        | 9,182  |  
|                          |                                                                     | Nine years later  |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        | 16,332 |   |   |        | 9,204  |  
|                          |                                                                     | Ten years later   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        | 9,255  |  
|                          | Reserves re-estimated as of:                                        |                   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |       
|                          |                                                                     | End of year       |   | $       | 150,044 |      |   | $       | 181,262 |      |   | $       | 181,310 |      |   | $       | 128,841 |      |   | $      | 99,831  |      |   | $      | 97,269  |    |   | $      | 61,069  |    |   | $      | 49,256 |    |   | $      | 37,138 |   |   | $      | 28,165 |   |   | $      | 13,279 |  
|                          |                                                                     | One year later    |   |         |         |      |   |         | 159,415 |      |   |         | 183,923 |      |   |         | 160,065 |      |   |        | 118,205 |      |   |        | 85,384  |    |   |        | 72,443  |    |   |        | 44,862 |    |   |        | 26,086 |   |   |        | 23,486 |   |   |        | 13,083 |  
|                          |                                                                     | Two years later   |   |         |         |      |   |         |         |      |   |         | 166,738 |      |   |         | 168,222 |      |   |        | 130,120 |      |   |        | 95,696  |    |   |        | 64,499  |    |   |        | 48,233 |    |   |        | 22,295 |   |   |        | 16,774 |   |   |        | 11,281 |  
|                          |                                                                     | Three years later |   |         |         |      |   |         |         |      |   |         |         |      |   |         | 157,251 |      |   |        | 137,002 |      |   |        | 101,893 |    |   |        | 73,031  |    |   |        | 44,587 |    |   |        | 24,111 |   |   |        | 15,776 |   |   |        | 9,258  |  
|                          |                                                                     | Four years later  |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        | 129,819 |      |   |        | 107,522 |    |   |        | 75,554  |    |   |        | 50,552 |    |   |        | 23,054 |   |   |        | 16,545 |   |   |        | 9,180  |  
|                          |                                                                     | Five years later  |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        | 103,064 |    |   |        | 79,398  |    |   |        | 52,063 |    |   |        | 26,485 |   |   |        | 16,274 |   |   |        | 9,392  |  
|                          |                                                                     | Six years later   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        | 76,610  |    |   |        | 54,327 |    |   |        | 27,237 |   |   |        | 18,243 |   |   |        | 9,120  |  
|                          |                                                                     | Seven years later |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        | 53,047 |    |   |        | 28,411 |   |   |        | 18,949 |   |   |        | 9,963  |  
|                          |                                                                     | Eight years later |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        | 28,533 |   |   |        | 19,485 |   |   |        | 10,283 |  
|                          |                                                                     | Nine years later  |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        | 19,969 |   |   |        | 10,198 |  
|                          |                                                                     | Ten years later   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        | 10,695 |  
|                          | Initial reserves in excess of (less than)
    re-estimated reserves |                   |   |         |         |      |   |         |         |      |   |         |         |      |   |         |         |      |   |        |         |      |   |        |         |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |       
|                          |                                                                     | Amount            |   |         |         |      |   | $       | 21,847  |      |   | $       | 14,572  |      |   | $       | (28,410 | )    |   | $      | (29,988 | )    |   | $      | (5,795  | )  |   | $      | (15,541 | )  |   | $      | (3,791 | )  |   | $      | 8,605  |   |   | $      | 8,196  |   |   | $      | 2,584  |  
|                          |                                                                     | Percent           |   |         |         |      |   |         | 12.1    | %    |   |         | 8.0     | %    |   |         | (22.1   | )%   |   |        | (30.0   | )%   |   |        | (6.0    | )% |   |        | (25.4   | )% |   |        | (7.7   | )% |   |        | 23.2   | % |   |        | 29.1   | % |   |        | 19.5   | %

The table above represents the development of
balance sheet gross reserves for 1993 through 2003. The upper
portion of the table shows the cumulative amount paid with
respect to the previously recorded reserves as of the end of
each succeeding year. The lower portion of the table shows the
re-estimated amount of the previously recorded gross reserves,
based on experience as of the end of each succeeding year. The
estimate is either increased or decreased as more information
becomes known about the frequency and severity of claims for
individual years.

The initial reserves in excess of (less
than) re-estimated reserves rows represent the aggregate
change in the estimates over all prior years. For example, the
1998 reserve developed a $5.8 million net deficiency over
the course of the succeeding years.

In evaluating this information, it should be
noted that each amount includes the total of all changes in
amounts for prior periods. For example, the amount of redundancy
(deficiency) to losses settled in 2002, but incurred in
1999, is included in the cumulative redundancy
(deficiency) amounts in 1999, 2000 and 2001. This

28



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##### Table of Contents



table does not present accident or policy year
development data, which certain readers may be more accustomed
to analyzing. Conditions and trends that have affected
development of the reserves in the past may not necessarily
occur in the future. Accordingly, it may not be appropriate to
extrapolate redundancies or deficiencies based on this table.


The following loss reserve development table sets
forth the change, over time, of net reserves established for
claim and claim settlement expenses at the end of the last ten
years. The following net loss reserve development table is
cumulative and, therefore, ending balances should not be added
since the amount at the end of each calendar year includes
activity for both current and prior years (000s):

|                          |                                                                     |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |       |  
|------------------------- | ------------------------------------------------------------------- | ----------------- | - | ------- | ------ | ---- | - | ------- | ------ | ---- | - | ------- | ------ | ---- | - | ------- | ------ | ---- | - | ------ | ------- | ---- | - | ------ | ------ | -- | - | ------ | ------- | -- | - | ------ | ------ | -- | - | ------ | ------ | - | - | ------ | ------ | - | - | ------ | ----- | -
|                          |                                                                     |                  
|                          |                                                                     | December 31,     
|                          |                                                                     |                  
|                          |                                                                     | 2003              |   | 2002    |        | 2001 |   | 2000    |        | 1999 |   | 1998    |        | 1997 |   | 1996    |        | 1995 |   | 1994   |         | 1993
|                          |                                                                     |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |     
|Loss Reserve Development: |                                                                     |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |       
|                          | Gross reserves for unpaid claim and claim
    settlement expenses   |                   | $ | 150,044 |        |      | $ | 181,262 |        |      | $ | 181,310 |        |      | $ | 128,841 |        |      | $ | 99,831 |         |      | $ | 97,269 |        |    | $ | 61,069 |         |    | $ | 49,256 |        |    | $ | 37,138 |        |   | $ | 28,165 |        |   | $ | 13,279 |      
|                          | Reinsurance recoverables                                            |                   |   | 71,466  |        |      |   | 91,822  |        |      |   | 90,115  |        |      |   | 61,845  |        |      |   | 41,179 |         |      |   | 21,403 |        |    |   | 5,374  |         |    |   | 6,183  |        |    |   | 8,312  |        |   |   | 13,902 |        |   |   | 9,593  |      
|                          |                                                                     |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |       
|                          | Net reserves for unpaid claim and claim
    settlement expenses     |                   | $ | 78,578  |        |      | $ | 89,440  |        |      | $ | 91,195  |        |      | $ | 66,996  |        |      | $ | 58,652 |         |      | $ | 75,866 |        |    | $ | 55,695 |         |    | $ | 43,073 |        |    | $ | 28,826 |        |   | $ | 14,263 |        |   | $ | 3,686  |      
|                          |                                                                     |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |       
|                          | Paid (cumulative) as of:                                            |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |      
|                          |                                                                     | One year later    |   |         |        |      |   | $       | 27,357 |      |   | $       | 30,285 |      |   | $       | 32,028 |      |   | $      | 35,932  |      |   | $      | 34,380 |    |   | $      | 27,737  |    |   | $      | 19,439 |    |   | $      | 8,595  |   |   | $      | 4,639  |   |   | $      | 1,436 |  
|                          |                                                                     | Two years later   |   |         |        |      |   |         |        |      |   |         | 43,825 |      |   |         | 43,823 |      |   |        | 48,069  |      |   |        | 49,958 |    |   |        | 42,046  |    |   |        | 28,173 |    |   |        | 12,894 |   |   |        | 6,476  |   |   |        | 2,150 |  
|                          |                                                                     | Three years later |   |         |        |      |   |         |        |      |   |         |        |      |   |         | 49,531 |      |   |        | 54,360  |      |   |        | 56,376 |    |   |        | 49,671  |    |   |        | 33,438 |    |   |        | 15,521 |   |   |        | 7,863  |   |   |        | 2,348 |  
|                          |                                                                     | Four years later  |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        | 58,113  |      |   |        | 60,453 |    |   |        | 53,814  |    |   |        | 36,904 |    |   |        | 16,869 |   |   |        | 8,569  |   |   |        | 2,654 |  
|                          |                                                                     | Five years later  |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        | 63,278 |    |   |        | 56,140  |    |   |        | 38,919 |    |   |        | 18,020 |   |   |        | 9,046  |   |   |        | 2,816 |  
|                          |                                                                     | Six years later   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        | 57,903  |    |   |        | 39,770 |    |   |        | 18,714 |   |   |        | 9,396  |   |   |        | 2,847 |  
|                          |                                                                     | Seven years later |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        | 40,530 |    |   |        | 19,200 |   |   |        | 9,564  |   |   |        | 2,932 |  
|                          |                                                                     | Eight years later |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        | 19,530 |   |   |        | 9,738  |   |   |        | 2,985 |  
|                          |                                                                     | Nine years later  |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        | 9,857  |   |   |        | 2,972 |  
|                          |                                                                     | Ten years later   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        | 3,005 |  
|                          | Reserves re-estimated as of:                                        |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |      
|                          |                                                                     | End of year       |   | $       | 78,578 |      |   | $       | 89,440 |      |   | $       | 91,195 |      |   | $       | 66,996 |      |   | $      | 58,652  |      |   | $      | 75,866 |    |   | $      | 55,695  |    |   | $      | 43,073 |    |   | $      | 28,826 |   |   | $      | 14,263 |   |   | $      | 3,686 |  
|                          |                                                                     | One year later    |   |         |        |      |   |         | 82,403 |      |   |         | 82,839 |      |   |         | 74,727 |      |   |        | 74,181  |      |   |        | 67,753 |    |   |        | 66,674  |    |   |        | 39,988 |    |   |        | 20,751 |   |   |        | 12,789 |   |   |        | 3,784 |  
|                          |                                                                     | Two years later   |   |         |        |      |   |         |        |      |   |         | 79,545 |      |   |         | 71,202 |      |   |        | 76,502  |      |   |        | 77,205 |    |   |        | 61,075  |    |   |        | 43,484 |    |   |        | 18,469 |   |   |        | 9,318  |   |   |        | 3,416 |  
|                          |                                                                     | Three years later |   |         |        |      |   |         |        |      |   |         |        |      |   |         | 71,911 |      |   |        | 75,321  |      |   |        | 78,331 |    |   |        | 68,065  |    |   |        | 41,451 |    |   |        | 19,796 |   |   |        | 8,984  |   |   |        | 2,782 |  
|                          |                                                                     | Four years later  |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        | 77,443  |      |   |        | 78,772 |    |   |        | 69,474  |    |   |        | 45,959 |    |   |        | 19,389 |   |   |        | 9,669  |   |   |        | 2,861 |  
|                          |                                                                     | Five years later  |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        | 80,522 |    |   |        | 69,595  |    |   |        | 47,147 |    |   |        | 21,254 |   |   |        | 9,692  |   |   |        | 2,972 |  
|                          |                                                                     | Six years later   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        | 69,926  |    |   |        | 47,126 |    |   |        | 22,568 |   |   |        | 10,330 |   |   |        | 2,927 |  
|                          |                                                                     | Seven years later |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        | 46,969 |    |   |        | 22,388 |   |   |        | 11,675 |   |   |        | 3,106 |  
|                          |                                                                     | Eight years later |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        | 22,342 |   |   |        | 11,234 |   |   |        | 3,818 |  
|                          |                                                                     | Nine years later  |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        | 11,327 |   |   |        | 3,555 |  
|                          |                                                                     | Ten years later   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        | 3,571 |  
|                          | Initial reserves in excess of (less than)
    re-estimated reserves |                   |   |         |        |      |   |         |        |      |   |         |        |      |   |         |        |      |   |        |         |      |   |        |        |    |   |        |         |    |   |        |        |    |   |        |        |   |   |        |        |   |   |        |      
|                          |                                                                     | Amount            |   |         |        |      |   | $       | 7,397  |      |   | $       | 11,650 |      |   | $       | (4,915 | )    |   | $      | (18,791 | )    |   | $      | (4,656 | )  |   | $      | (14,231 | )  |   | $      | (3,896 | )  |   | $      | 6,484  |   |   | $      | 2,936  |   |   | $      | 115   |  
|                          |                                                                     | Percent           |   |         |        |      |   |         | 8.3    | %    |   |         | 12.8   | %    |   |         | (7.3   | )%   |   |        | (32.0   | )%   |   |        | (6.1   | )% |   |        | (25.6   | )% |   |        | (9.0   | )% |   |        | 22.5   | % |   |        | 20.6   | % |   |        | 3.1   | %

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The table above represents the development of
balance sheet net reserves for 1993 through 2003. The top three
rows of the table reconcile gross reserves to net reserves for
unpaid claim and claim settlement expenses recorded at the
balance sheet date for each of the indicated years.

The upper portion of the table shows the
cumulative amount paid with respect to the previously recorded
reserves as of the end of each succeeding year.

The lower portion of the table shows the
re-estimated amount of the previously recorded net reserves,
based on experience as of the end of each succeeding year. The
estimate is either increased or decreased as more information
becomes known about the frequency and severity of claims for
individual years. For example, for the 1998 calendar year valued
as of December 31, 2003, we paid $63.3 million of the
currently estimated $80.5 million of claim and claim
settlement expenses that were incurred through the end of 1998.
Thus, the difference, an estimated $17.2 million of claim
and claim settlement expenses incurred through 1998, remained
unpaid as of December 31, 2003.

The initial reserves in excess of (less
than) re-estimated reserves rows represent the aggregate
change in the estimates over all prior years. For example, the
1998 reserve developed a $4.7 million net deficiency over
the course of the succeeding years. The net amount has been
included in income and the changes have been recorded in the
period identified. The cumulative net deficiencies in 2000 and
1999 are the result of reserve development inherent in the
uncertainty in establishing reserves and anticipated loss
trends. As discussed above, due to our relatively limited
historical claim data and small claim population, our estimate
of the liability for net reserves is difficult and volatile. As
discussed further below, the reserve redundancy in 2001 is the
result of accrual reversals resulting from changes in methods of
assessing second injury funds, lower frequency in claims
reported from the estimate at December 31, 2001, and
reductions in amounts expected to be incurred for our
participation in mandatory state and national assigned risk
pools.

In evaluating this information, it should be
noted that each amount includes the total of all changes in
amounts for prior periods. For example, the amount of redundancy
to losses settled in 2002, but incurred in 1999, will be
included in the cumulative redundancy (deficiency) amounts
in 1999, 2000, and 2001. This table does not present accident or
policy year development data, which certain readers may be more
accustomed to analyzing. Conditions and trends that have
affected development of the reserves in the past may not
necessarily occur in the future. Accordingly, it may not be
appropriate to extrapolate redundancies or deficiencies based on
this table.

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The following table is derived from the loss
reserve development table and summarizes the effect of reserve
re-estimates, net of reinsurance, on calendar year operations
for the same ten-year period ended December 31, 2003. The
total of each column details the amount of reserve re-estimates
made in the indicated calendar year and shows the accident years
to which the re-estimates are applicable. The amounts in the
total accident year column represent the cumulative reserve
re-estimate (increase) decrease for the indicated accident year
(000s):

|               |       |                                                             |   |              |   |      |   |       |   |      |   |        |   |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   |        |  
|-------------- | ----- | ----------------------------------------------------------- | - | ------------ | - | ---- | - | ----- | - | ---- | - | ------ | - | ---- | - | ------- | - | ---- | - | -------- | - | ------------- | - | ------- | - |  | - | ----- | - |  | - | ----- |  |  | - | ----- |  |  | - | ---- | - |  | - | ------ | -
|               |       |                                                             |   | Cumulative  
|               |       | Effect of Reserve Re-Estimates on Calendar Year Operations: |   | Re-Estimates
|               |       |                                                             |   | for Each    
|               |       | 2003                                                        |   | 2002         |   | 2001 |   | 2000  |   | 1999 |   | 1998   |   | 1997 |   | 1996    |   | 1995 |   | Pre-1995 |   | Accident Year
|               |       |                                                             |   |              |   |      |   |       |   |      |   |        |   |      |   |         |   |      |   |          |   |              
|Accident Year: |       |                                                             |   |              |   |      |   |       |   |      |   |        |   |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   |       
|               | 1992  |                                                             |   | (30          | ) |      |   | 2     |   |      |   | (6     | ) |      |   | (19     | ) |      |   | 38       |   |               |   | (15     | ) |  |   | (37   | ) |  |   | 38    |  |  |   | 58    |  |  |   | (206 | ) |  |   | (177   | )
|               | 1993  |                                                             |   | 14           |   |      |   | 261   |   |      |   | (706   | ) |      |   | (160    | ) |      |   | 7        |   |               |   | (96     | ) |  |   | (42   | ) |  |   | 596   |  |  |   | 310   |  |  |   | (165 | ) |  |   | 19     |  
|               | 1994  |                                                             |   | (77          | ) |      |   | 178   |   |      |   | (633   | ) |      |   | (459    | ) |      |   | (68      | ) |               |   | (574    | ) |  |   | 413   |   |  |   | 2,837 |  |  |   | 1,106 |  |  |   |      |   |  |   | 2,723  |  
|               | 1995  |                                                             |   | 139          |   |      |   | (261  | ) |      |   | 31     |   |      |   | (1,227  | ) |      |   | 430      |   |               |   | (642    | ) |  |   | 1,948 |   |  |   | 4,604 |  |  |   |       |  |  |   |      |   |  |   | 5,022  |  
|               | 1996  |                                                             |   | 111          |   |      |   | (159  | ) |      |   | 126    |   |      |   | (2,643  | ) |      |   | 1,626    |   |               |   | (2,169  | ) |  |   | 803   |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | (2,305 | )
|               | 1997  |                                                             |   | (488         | ) |      |   | (142  | ) |      |   | (221   | ) |      |   | (2,482  | ) |      |   | 3,566    |   |               |   | (7,483  | ) |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | (7,250 | )
|               | 1998  |                                                             |   | (1,419       | ) |      |   | (320  | ) |      |   | 283    |   |      |   | (2,462  | ) |      |   | 2,514    |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | (1,404 | )
|               | 1999  |                                                             |   | (372         | ) |      |   | 1,622 |   |      |   | (1,195 | ) |      |   | (6,077  | ) |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | (6,022 | )
|               | 2000  |                                                             |   | 1,413        |   |      |   | 2,344 |   |      |   | (5,410 | ) |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | (1,653 | )
|               | 2001  |                                                             |   | 4,003        |   |      |   | 4,831 |   |      |   |        |   |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | 8,834  |  
|               | 2002  |                                                             |   | 3,404        |   |      |   |       |   |      |   |        |   |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   | 3,404  |  
|               |       |                                                             |   |              |   |      |   |       |   |      |   |        |   |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   |       
|               | Total |                                                             | $ | 6,698        |   |      | $ | 8,356 |   |      | $ | (7,731 | ) |      | $ | (15,529 | ) |      | $ | 8,113    |   |               | $ | (10,979 | ) |  | $ | 3,085 |   |  | $ | 8,075 |  |  | $ | 1,474 |  |  | $ | (371 | ) |  | $ | (1,191 | )
|               |       |                                                             |   |              |   |      |   |       |   |      |   |        |   |      |   |         |   |      |   |          |   |               |   |         |   |  |   |       |   |  |   |       |  |  |   |       |  |  |   |      |   |  |   |       

The 2003 results include a $6.7 million
decrease in prior years reserves for unpaid claim and
claim settlement expenses compared to the 2002 results which
include an $8.4 million decrease in prior years
reserves for unpaid claim and claim settlement expenses. Our
estimate for unpaid claim and claim settlement expenses
decreased in 2003 due to the following: (i) the frequency
of claims reported in 2003 for 2002 and prior years was less
than anticipated when we determined our liability in 2002; and
(ii) our estimate of the liability for unpaid claim and
claim settlement expenses is difficult and volatile due to our
relatively limited historical claim data and small claim
population.

The 2002 results include an $8.4 million
decrease in prior years reserves for unpaid claim and
claim settlement expenses compared to the 2001 results which
include a $7.7 million increase in prior years
reserves for unpaid claim and claim settlement expenses. Our
estimate for unpaid claim and claim settlement expenses
decreased in 2002 due to the following: (i) in March 2002,
the Minnesota State legislature changed the way the commissioner
assessed self-insured employers and insurers for estimated
liabilities and administrative expenses of the Minnesota Special
Compensation Fund. The assessment changed from being paid by the
insurer on indemnity payment basis to an assessment charged on
premium to the policyholder. We decreased our recorded accrual
to reflect this legislative change; (ii) the frequency of
claims reported in 2002 for 2001 and prior years was less than
anticipated when we determined our liability in 2001;
(iii) we overestimated the liability for our mandatory
participation in state and national assigned risk pool operating
results for states in which we operate in 2001 and reversed that
excess in 2002; and (iv) our estimate of the liability for
unpaid claim and claim settlement expenses is difficult and
volatile due to our relatively limited historical claim data and
small claim population.

Liquidity and Capital Resources

Liquidity refers to our ability to generate
sufficient cash flows to meet the short- and long-term cash
requirements of our operations. Capital resources represent
those funds deployed or available to be deployed to support our
business operations.

Our primary sources of cash from operations are
premiums collected, reimbursements under reinsurance contracts
and investment income. Our investment portfolio is also a source
of liquidity, through the sale of

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readily marketable fixed maturity investments.
Our primary cash requirements consist of payments for:
(i) claim and claim settlement expenses;
(ii) reinsurance; (iii) policy acquisition costs;
(iv) general and administrative expenses; (v) capital
expenditures; and (vi) income taxes. We generate cash from
or use cash in operations based on timing differences between
the receipt of premiums and the payment of claim and claim
settlement expenses. Selected reinsurance retention levels also
use cash as a result of pre-funding premiums under
the policies or provide cash upon reimbursement of claim
payments. In 2003 and 2002, reinsurance reimbursements from our
$25,000 to $300,000 excess of loss reinsurance agreement, which
began in mid 1998 and ran-off in 2001, offset similar payments
to claimants for those years. This trend will continue in 2004.
We further expect that cash and investments will remain at
levels reported at December 2003 in 2004. Available cash is
invested in either short-term cash and cash equivalents or
longer-term available-for-sale securities pending future
payments for such expenses as medical and indemnity benefits and
other operating expenses. Cash and cash equivalents consist of
cash and a money market fund that invest primarily in short-term
government securities.


Cash provided by operating activities was
$4.4 million for 2003. This is primarily a result of net
income of $7.0 million, a decrease in amounts due from
reinsurers of $21.6 million, a decrease of
$3.0 million in accrued expenses and other liabilities, a
$2.1 million increase in unearned premiums, net of premiums
receivable and depreciation expense of $1.2 million offset
by a decrease of $31.2 million in unpaid claim and claim
settlement expenses and net realized investment gains totaling
$685,000. Net cash provided by investing activities was $212,000
due to $27.6 million in proceeds from sales of securities
and $5.7 million in maturities of investments offset by
$32.9 million in purchases of securities and $175,000 in
purchases of fixed assets. Net cash used in financing activities
was $1.2 million due primarily to principal payments on our
note payable in 2003.

Our need for additional capital is primarily the
result of regulations that require certain ratios of regulatory
or statutory capital to premiums written in our insurance
subsidiary as defined by state regulatory bodies and insurance
rating agencies. Raising additional permanent capital, while
difficult in the current environment in which we operate, would
stabilize our ratio of premium to capital and provide a solid
base for the future growth of our insurance subsidiary. As an
alternative to raising additional capital, additional
reinsurance would have the effect of reducing the ratio of
premiums to capital and may be used to satisfy state regulatory
requirements.

State insurance regulations limit distributions,
including dividends, from our insurance subsidiary to us. The
maximum amount of dividends that can be paid by ACIC to us in
any year is equal to the greater of: (i) 10% of ACICs
statutory surplus as of the end of the previous fiscal year; or
(ii) the statutory net gain from operations (not including
realized capital gains) of ACIC in its most recent fiscal year.
Based on this limitation, the maximum dividend that ACIC could
pay to us in 2004, without regulatory approval, is approximately
$3.3 million. (See Note 9 of Notes to Consolidated
Financial Statements.) ACIC has never paid a dividend to us and
we intend to retain capital in our insurance subsidiary.

On September 15, 1998, our Board of
Directors approved a share repurchase program authorizing us to
repurchase, from time to time, up to $4,000,000 of
RTW, Inc. common stock. We repurchased 18,619 shares
in 2003 for approximately $37,000, 41,324 shares in 2002
for approximately $78,000 and 334,750 shares for
approximately $2.7 million through 2001. We repurchased
these shares on the open market or through private transactions
based upon market conditions and availability. The repurchased
shares will be used for employee stock option and purchase plans
and other corporate purposes.

At December 31, 2003, investments of
$21.9 million were held as statutory deposits and pledged
as collateral. This did not have an adverse effect on our
liquidity. We believe that cash flow generated by our operations
and our cash and investment balances will be sufficient to fund
continuing operations, and capital expenditures for the next
12 months.

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Contractual Obligations

Our contractual obligations consist solely of
operating leases for our facilities. Future minimum
(base) rental payments required under the leases, as of
December 31, 2003, are as follows (000s):

|     |  |   |       | 
|---- |  | - | ----- | 
|2004 |  | $ | 1,280 | 
|2005 |  |   | 1,151 | 
|2006 |  |   | 931   | 
|2007 |  |   | 580   | 

Interest Rate Risk

Our fixed maturity investments are subject to
interest rate risk. Increases and decreases in prevailing
interest rates generally translate into decreases and increases
in the fair value of these instruments. Also, fair values of
interest rate sensitive instruments may be affected by the
credit worthiness of the issuer, prepayment options, relative
values of alternative instruments, the liquidity of the
instrument and other general market conditions. We regularly
evaluate interest rate risk in order to evaluate the
appropriateness of our investments.

An increase of 100 basis points in
prevailing interest rates would reduce the fair value of our
interest rate sensitive instruments by approximately
$3.9 million.

The effect of interest rate risk on potential
near-term fair value was determined based on commonly used
models. The models project the impact of interest rate changes
on factors such as duration, prepayments, put options and call
options. Fair value was determined based on the net present
value of cash flows or duration estimates, using a
representative set of likely future interest rate scenarios.

NAIC Risk-Based Capital Standards

The National Association of Insurance
Commissioners (NAIC) has risk-based capital standards to
determine the capital requirements of a property and casualty
insurance carrier based upon the risks inherent in its
operations. These standards require computing a risk-based
capital amount that is compared to a carriers actual total
adjusted capital. The computation involves applying factors to
various financial data to address four primary risks: asset
risk, insurance underwriting risk, credit risk and off-balance
sheet risk. These standards provide for regulatory intervention
when the percent of total adjusted capital to authorized control
level risk-based capital is below certain levels. Based upon the
risk-based capital standards, our percent of total adjusted
capital is in excess of authorized control level risk-based
capital.

Regulation

Our insurance subsidiary is subject to
substantial regulation by governmental agencies in the states in
which we operate, and will be subject to such regulation in any
state in which we provide workers compensation products
and services in the future. State regulatory agencies have broad
administrative power with respect to all aspects of our
business, including premium rates, benefit levels, policy forms,
dividend payments, capital adequacy and the amount and type of
investments. These regulations are primarily intended to protect
covered employees and policyholders rather than the insurance
company. Both the legislation covering insurance companies and
the regulations adopted by state agencies are subject to change.
At December 31, 2003, our insurance subsidiary was licensed
to do business in Minnesota, South Dakota, Wisconsin, Colorado,
Missouri, Illinois, Kansas, Michigan, Indiana,
Massachusetts, Connecticut, Rhode Island, Pennsylvania,
Tennessee, Maryland, Arkansas, Iowa, Florida, Georgia, New
Jersey, North Carolina, Texas and Oklahoma.

In March 1998, the NAIC adopted the Codification
of Statutory Accounting Principles (Codification). Codification
is intended to standardize regulatory accounting and reporting
to state insurance departments and became effective
January 1, 2001. Statutory accounting principles, however,
will continue to be established by individual state laws and
permitted practices. The State of Minnesota required adoption of
Codification for preparing statutory financial statements for
financial periods occurring on or after January 1, 2001.
Adoption

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of the Codification increased our statutory
capital and surplus by approximately $1.9 million on
January 1, 2001.


Effect of Recent Accounting
Pronouncements

The Financial Accounting Standards Board
(FASB) has issued SFAS No. 148, Accounting
for Stock-Based Compensation  an Amendment of
FASB 123; SFAS No. 149, Amendment of
Statement 133 on Derivative Instruments and Hedging
Activities; and SFAS No. 150, Accounting
for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. The Emerging Issues Task Force
(EITF) of the FASB issued EITF 03-1, The Meaning
of Other-Than-Temporary Impairment and Its Application to
Certain Investments. After reviewing these pronouncements,
we have determined that adoption of these statements is not
expected to have an effect on our consolidated results of
operations and financial position, except as follows:



| |   |                                                                                                                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | SFAS No. 148, Accounting for
    Stock-Based Compensation  an Amendment of
    FASB 123 requires additional disclosures in our
    financial statements, but does not affect our consolidated
    results of operation and financial position at December 31,
    2003 and for the year then ended.                    
|
| |  | EITF 03-1, The Meaning of
    Other-Than-Temporary Impairment and Its Application to Certain
    Investments requires additional disclosures in our
    financial statements, but does not affect our consolidated
    results of operation and financial position at December 31,
    2003 and for the year then ended.

Forward-Looking Statements

Information included in this Report on
Form 10-K which can be identified by the use of
forward-looking terminology such as may,
will, expect, anticipate,
estimate, or continue or the negative
thereof or other variations thereon or comparable terminology
constitutes forward-looking information. The following important
factors, among others, in some cases have affected and in the
future could affect our actual results and could cause our
actual financial performance to differ materially from that
expressed in any forward-looking statement: (i) our ability
to retain renewing policies and write new business with a B+
(Very Good, Secure) rating from A.M. Best; (ii) our ability
to extend our workers compensation services to
self-insured employers and other alternative markets;
(iii) our ability to continue to increase pricing on
insured products in the markets in which we remain;
(iv) the ability of our reinsurers to honor their
obligations to us; (v) our ability to accurately predict
claim development; (vi) our ability to provide our
proprietary products and services to self-insured parties
successfully; (vii) our ability to manage both our existing
claims and new claims in an effective manner; (viii) our
experience with claims frequency and severity; (ix) medical
inflation; (x) competition and the regulatory environment
in which we operate; (xi) general economic and business
conditions; (xii) our ability to obtain and retain
reinsurance at a reasonable cost; (xiii) changes in
workers compensation regulation by states, including
changes in mandated benefits or insurance company regulation;
(xiv) interest rate changes; and (xv) other factors as
noted in our other filings with the SEC. This discussion of
uncertainties is by no means exhaustive but is designed to
highlight important factors that may affect our future
performance.






| |          |                                                               
| | -------- | --------------------------------------------------------------
| | Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

Information with respect to Disclosures about
Market Risk is contained in the Section entitled
Managements Discussion and Analysis of Financial
Condition and Results of Operations  Interest Rate
Risk under Item 7 of this Annual Report on
Form 10-K and is incorporated herein by reference.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

INDEX TO FINANCIAL STATEMENTS

Financial Statements

|                                                                                                       |  |      |    | 
|------------------------------------------------------------------------------------------------------ |  | ---- | -- | 
|                                                                                                       |  | Page
|                                                                                                       |  |     
|Report of Independent Auditors                                                                         |  |      | 36 | 
|Consolidated Balance Sheets 
    December 31, 2003 and 2002                                           |  |      | 37 | 
|Consolidated Statements of Operations 
    Years Ended December 31, 2003, 2002 and 2001               |  |      | 38 | 
|Consolidated Statements of Shareholders
    Equity  Years Ended December 31, 2003, 2002 and
    2001 |  |      | 39 | 
|Consolidated Statements of Cash Flows 
    Years Ended December 31, 2003, 2002 and 2001               |  |      | 40 | 
|Notes to Consolidated Financial
    Statements  Years Ended December 31, 2003, 2002
    and 2001      |  |      | 41 | 

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REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Shareholders 
 RTW, Inc. 
 Minneapolis. Minnesota

We have audited the accompanying consolidated
balance sheets of RTW, Inc. (the Company) as of
December 31, 2003 and 2002, and the related consolidated
statements of operations, stockholders equity and cash
flows for each of the three years in the period ended
December 31, 2003. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of RTW, Inc. at
December 31, 2003 and 2002, and the consolidated results of
its operations and its cash flows for each of the three years in
the period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States.



| |                       
| | ----------------------
| | /s/ ERNST & YOUNG, LLP

January 23, 2004

Minneapolis, Minnesota


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RTW, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2003 and 2002


|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |        |         | 
|-------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------ | ------- | - | ------- | ------ | ------- | 
|                                                                     |                                                                                                                            | 2003                                       |         | 2002  
|                                                                     |                                                                                                                            |                                            |         |       
|                                                                     |                                                                                                                            |                                           
|                                                                     |                                                                                                                            | (In thousands, except                     
|                                                                     |                                                                                                                            | share data)                               
|ASSETS                                                              
|Investments at fair value, amortized cost of
    $77,674 and $77,994 |                                                                                                                            | $                                          | 79,171  |        |         | $ | 81,410  |       
|Cash and cash equivalents                                            |                                                                                                                            |                                            | 39,650  |        |         |   | 36,288  |       
|Accrued investment income                                            |                                                                                                                            |                                            | 769     |        |         |   | 695     |       
|Premiums receivable, less allowance of $225 and
    $220             |                                                                                                                            |                                            | 3,482   |        |         |   | 3,537   |       
|Reinsurance recoverables:                                            |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                     | On unpaid claim and claim settlement expenses                                                                              |                                            |         | 71,466 |         |   |         | 91,822 |        
|                                                                     | On paid claim and claim settlement expenses                                                                                |                                            |         | 854    |         |   |         | 2,109  |        
|Deferred policy acquisition costs                                    |                                                                                                                            |                                            | 926     |        |         |   | 736     |       
|Furniture and equipment, net                                         |                                                                                                                            |                                            | 1,242   |        |         |   | 1,619   |       
|Other assets                                                         |                                                                                                                            |                                            | 4,608   |        |         |   | 5,618   |       
|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                     |                                                                                                                            | Total assets                               |         | $      | 202,168 |   |         | $      | 223,834 | 
|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                    
|LIABILITIES AND SHAREHOLDERS
    EQUITY                            
|Unpaid claim and claim settlement expenses                           |                                                                                                                            | $                                          | 150,044 |        |         | $ | 181,262 |       
|Unearned premiums                                                    |                                                                                                                            |                                            | 9,180   |        |         |   | 7,130   |       
|Accrued expenses and other liabilities                               |                                                                                                                            |                                            | 7,357   |        |         |   | 4,382   |       
|Notes payable                                                        |                                                                                                                            |                                            |        |        |         |   | 1,250   |       
|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                     |                                                                                                                            | Total liabilities                          |         |        | 166,581 |   |         |        | 194,024 | 
|Commitments and contingencies                                        |                                                                                                                            |                                            |        |        |         |   |        |       
|Shareholders equity:                                                |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                     | Undesignated stock, no par value; authorized
    4,750,000 shares; none issued or outstanding                              |                                            |         |       |         |   |         |       |        
|                                                                     | Series A Junior Participating Preferred
    Stock, no par value; authorized 250,000 shares; none issued
    or outstanding |                                            |         |       |         |   |         |       |        
|                                                                     | Common stock, no par value; authorized
    12,500,000 shares; issued and outstanding 5,125,000 and
    5,115,000 shares    |                                            |         | 20,644 |         |   |         | 20,619 |        
|                                                                     | Retained earnings                                                                                                          |                                            |         | 13,970 |         |   |         | 6,971  |        
|                                                                     | Accumulated other comprehensive income                                                                                     |                                            |         | 973    |         |   |         | 2,220  |        
|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                     |                                                                                                                            | Total shareholders equity                 |         |        | 35,587  |   |         |        | 29,810  | 
|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |       
|                                                                     |                                                                                                                            | Total liabilities and shareholders equity |         | $      | 202,168 |   |         | $      | 223,834 | 
|                                                                     |                                                                                                                            |                                            |         |        |         |   |         |       

See notes to consolidated financial statements.

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RTW, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

Years Ended December 31, 2003, 2002 and
2001


|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |           |         |         |  
|------------------------------------ | ----------------------------------- | --------------------------- | --------------------------------- | --------- | ------ | ----- | - | --------- | ------ | ------ | - | --------- | ------- | ------- | -
|                                     |                                     | 2003                        |                                   | 2002      |        | 2001 
|                                     |                                     |                             |                                   |           |        |      
|                                     |                                     |                            
|                                     |                                     | (In thousands, except share
|                                     |                                     | and per share data)        
|Revenues:                            |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     | Gross premiums earned               |                             | $                                 | 54,431    |        |       | $ | 62,506    |        |        | $ | 97,420    |        
|                                     | Premiums ceded                      |                             |                                   | (8,141    | )      |       |   | (2,242    | )      |        |   | (11,363   | )      
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     | Premiums earned             |                                   |           | 46,290 |       |   |           | 60,264 |        |   |           | 86,057  |        
|                                     | Investment income                   |                             |                                   | 4,474     |        |       |   | 5,139     |        |        |   | 6,415     |        
|                                     | Net realized investment gains:      |                             |                                   |           |        |       |   |           |        |        |   |           |        
|                                     |                                     | Realized investment gains   |                                   |           | 685    |       |   |           | 1,930  |        |   |           | 1,225   |        
|                                     |                                     | Realized investment losses  |                                   |           |       |       |   |           | (209   | )      |   |           | (62     | )      
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     |                             | Net realized investment gains     |           |        | 685   |   |           |        | 1,721  |   |           |         | 1,163   |  
|                                     | Other income                        |                             |                                   | 109       |        |       |   | 22        |        |        |   | 2,088     |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     | Total revenues              |                                   |           | 51,558 |       |   |           | 67,146 |        |   |           | 95,723  |        
|Expenses:                            |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     | Claim and claim settlement expenses |                             |                                   | 27,256    |        |       |   | 40,533    |        |        |   | 80,103    |        
|                                     | Policy acquisition costs            |                             |                                   | 6,878     |        |       |   | 6,304     |        |        |   | 13,990    |        
|                                     | General and administrative expenses |                             |                                   | 10,789    |        |       |   | 9,984     |        |        |   | 17,391    |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     | Total expenses              |                                   |           | 44,923 |       |   |           | 56,821 |        |   |           | 111,484 |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     |                             | Income (loss) from operations     |           |        | 6,635 |   |           |        | 10,325 |   |           |         | (15,761 | )
|                                     | Interest expense                    |                             |                                   | 48        |        |       |   | 163       |        |        |   | 511       |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     |                             | Income (loss) before income taxes |           |        | 6,587 |   |           |        | 10,162 |   |           |         | (16,272 | )
|                                     | Income tax (benefit) expense        |                             |                                   | (412      | )      |       |   | (4,157    | )      |        |   | 8,943     |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     |                                     |                             | Net income (loss)                 |           | $      | 6,999 |   |           | $      | 14,319 |   |           | $       | (25,215 | )
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|Income (loss) per share:             |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     | Basic income (loss) per share       |                             | $                                 | 1.37      |        |       | $ | 2.78      |        |        | $ | (4.89     | )      
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     | Diluted income (loss) per share     |                             | $                                 | 1.32      |        |       | $ | 2.78      |        |        | $ | (4.89     | )      
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|Weighted average shares outstanding: |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     | Basic shares outstanding            |                             |                                   | 5,114,000 |        |       |   | 5,146,000 |        |        |   | 5,152,000 |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          
|                                     | Diluted shares outstanding          |                             |                                   | 5,296,000 |        |       |   | 5,154,000 |        |        |   | 5,152,000 |        
|                                     |                                     |                             |                                   |           |        |       |   |           |        |        |   |          

See notes to consolidated financial statements.

38



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RTW, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS
EQUITY

Years Ended December 31, 2003, 2002 and
2001


|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        |  |         |        |   | 
|---------------------------- | ---------------------------- | ---------------------------------------------- | ------------------------------------- | -------------------- | --- | --------- |  | ------------- | ------- | ------------- | ------- | - | ------- | - | ----- |  | - | ------ | ------ |  | ------- | ------ | - | 
|                             |                              |                                                |                                       |                      |     |           |  | Accumulated   |         |              
|                             |                              |                                                |                                       | Comprehensive        |     | Retained  |  | Other         |         | Total        
|                             |                              | Common                                         |                                       | Income               |     | Earnings  |  | Comprehensive |         | Shareholders
|                             |                              | Stock                                          |                                       | (Loss)               |     | (Deficit) |  | Income        |         | Equity       
|                             |                              |                                                |                                       |                      |     |           |  |               |         |              
|                             |                              |                                               
|                             |                              | (In thousands)                                
|Balance at January 1, 2001   |                              | $                                              | 20,665                                |                      |     |           |  |               |         | $             | 17,867  |   |         | $ | 204   |  |   | $      | 38,736 | 
|                             | Comprehensive income (loss): |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        |  |        
|                             |                              | Net loss                                       |                                       |                      |    |           |  | $             | (25,215 | )             |         |   | (25,215 | ) |       |  |  |        |        |  | (25,215 | )     
|                             |                              | Other comprehensive income, net of tax:        |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        |  |         |       
|                             |                              |                                                | Change in unrealized investment gains |                      |     |          |  |               |         | 678           |         |   |         |  |       |  |   | 678    |        |  |         | 678    |  
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              |                                                |                                       | Comprehensive loss   |     |           |  |               |         | $             | (24,537 | ) |         |   |       |  |   |        |        |  |         |        |   | 
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              | Retirement of common stock                     |                                       |                      | (10 | )         |  |               |         |               |         |   |        |   |       |  |  |        |        |  | (10     | )     
|                             |                              | Issuance of shares under ESPP                  |                                       |                      | 33  |           |  |               |         |               |         |   |        |   |       |  |  |        |        |  | 33      |       
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|Balance at December 31, 2001 |                              |                                                | 20,688                                |                      |     |           |  |               |         |               | (7,348  | ) |         |   | 882   |  |   |        | 14,222 | 
|                             | Comprehensive income:        |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        |  |        
|                             |                              | Net income                                     |                                       |                      |    |           |  | $             | 14,319  |               |         |   | 14,319  |   |       |  |  |        |        |  | 14,319  |       
|                             |                              | Other comprehensive income, net of tax:        |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        |  |         |       
|                             |                              |                                                | Change in unrealized investment gains |                      |     |          |  |               |         | 1,338         |         |   |         |  |       |  |   | 1,338  |        |  |         | 1,338  |  
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              |                                                |                                       | Comprehensive income |     |           |  |               |         | $             | 15,657  |   |         |   |       |  |   |        |        |  |         |        |   | 
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              | Retirement of common stock                     |                                       |                      | (79 | )         |  |               |         |               |         |   |        |   |       |  |  |        |        |  | (79     | )     
|                             |                              | Issuance of shares under ESPP                  |                                       |                      | 10  |           |  |               |         |               |         |   |        |   |       |  |  |        |        |  | 10      |       
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|Balance at December 31, 2002 |                              |                                                | 20,619                                |                      |     |           |  |               |         |               | 6,971   |   |         |   | 2,220 |  |   |        | 29,810 | 
|Comprehensive income (loss): |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              | Net income                                     |                                       |                      |    |           |  | $             | 6,999   |               |         |   | 6,999   |   |       |  |  |        |        |  | 6,999   |       
|                             |                              | Other comprehensive income (loss), net of tax: |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        |  |         |       
|                             |                              |                                                | Change in unrealized investment gains |                      |     |          |  |               |         | (1,247        | )       |   |         |  |       |  |   | (1,247 | )      |  |         | (1,247 | )
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              |                                                |                                       | Comprehensive income |     |           |  |               |         | $             | 5,752   |   |         |   |       |  |   |        |        |  |         |        |   | 
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|                             |                              | Retirement of common stock                     |                                       |                      | (37 | )         |  |               |         |               |         |   |        |   |       |  |  |        |        |  | (37     | )     
|                             |                              | Stock options exercised                        |                                       |                      | 19  |           |  |               |         |               |         |   |        |   |       |  |  |        |        |  | 19      |       
|                             |                              | Issuance of shares under ESPP                  |                                       |                      | 43  |           |  |               |         |               |         |   |        |   |       |  |  |        |        |  | 43      |       
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 
|Balance at December 31, 2003 |                              | $                                              | 20,644                                |                      |     |           |  |               |         | $             | 13,970  |   |         | $ | 973   |  |   | $      | 35,587 | 
|                             |                              |                                                |                                       |                      |     |           |  |               |         |               |         |   |         |   |       |  |   |        |        | 

See notes to consolidated financial statements.

39



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##### Table of Contents



RTW, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

Years Ended December 31, 2003, 2002 and
2001


|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |         |        |         |        |  
|------------------------------------------------- | ------------------------------------------------------------------------------------------------------ | ---------------------------------- | --------------------------------------------- | ------------------------------------------------------- | ----- | ------- | ------ | ------- | ------ | ------ | ------ | ------- | ------ | ------- | ------ | -
|                                                  |                                                                                                        | 2003                               |                                               | 2002                                                    |       | 2001   
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |        
|                                                  |                                                                                                        |                                   
|                                                  |                                                                                                        | (In thousands)                    
|Cash flows from operating activities:             |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  | Net income (loss)                                                                                      |                                    | $                                             | 6,999                                                   |       |         | $      | 14,319  |        |        | $      | (25,215 | )     
|                                                  | Adjustments to reconcile net income (loss) to net
    cash provided by (used in) operating activities: |                                    |                                               |                                                         |       |         |        |         |        |        |        |         |       
|                                                  |                                                                                                        | Net realized investment gains      |                                               |                                                         | (685  | )       |        |         | (1,721 | )      |        |         | (1,163 | )      
|                                                  |                                                                                                        | Depreciation and amortization      |                                               |                                                         | 1,191 |         |        |         | 963    |        |        |         | 1,690  |        
|                                                  |                                                                                                        | Deferred income taxes              |                                               |                                                         | (828  | )       |        |         | (721   | )      |        |         | 8,701  |        
|                                                  |                                                                                                        | Changes in assets and liabilities: |                                               |                                                         |       |         |        |         |        |        |        |         |        |        
|                                                  |                                                                                                        |                                    | Deposit receivable                            |                                                         |       |        |        |         |        | 17,635 |        |         |        | (17,635 | )     
|                                                  |                                                                                                        |                                    | Reinsurance recoverables                      |                                                         |       | 21,611  |        |         |        | (777   | )      |         |        | (29,014 | )     
|                                                  |                                                                                                        |                                    | Unpaid claim and claim settlement expenses    |                                                         |       | (31,218 | )      |         |        | (48    | )      |         |        | 52,469  |       
|                                                  |                                                                                                        |                                    | Unearned premiums, net of premiums receivable |                                                         |       | 2,105   |        |         |        | 520    |        |         |        | 744     |       
|                                                  |                                                                                                        |                                    | Other, net                                    |                                                         |       | 5,200   |        |         |        | (4,790 | )      |         |        | 2,907   |       
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  |                                                                                                        |                                    |                                               | Net cash provided by (used in) operating
    activities |       |         | 4,375  |         |        |        | 25,380 |         |        |         | (6,516 | )
|Cash flows from investing activities:             |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  | Maturities of investments                                                                              |                                    |                                               | 5,650                                                   |       |         |        |        |        |        |        |        |       
|                                                  | Purchases of available-for-sale investments                                                            |                                    |                                               | (32,903                                                 | )     |         |        | (64,320 | )      |        |        | (83,341 | )     
|                                                  | Proceeds from sales of available-for-sale
    investments                                              |                                    |                                               | 27,618                                                  |       |         |        | 75,482  |        |        |        | 92,839  |       
|                                                  | Purchases of furniture and equipment                                                                   |                                    |                                               | (175                                                    | )     |         |        | (630    | )      |        |        | (379    | )     
|                                                  | Disposals of furniture and equipment                                                                   |                                    |                                               | 22                                                      |       |         |        | 270     |        |        |        | 872     |       
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  |                                                                                                        |                                    |                                               | Net cash provided by investing activities               |       |         | 212    |         |        |        | 10,802 |         |        |         | 9,991  |  
|Cash flows from financing activities:             |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  | Payments on notes payable                                                                              |                                    |                                               | (1,250                                                  | )     |         |        | (3,250  | )      |        |        | (2,500  | )     
|                                                  | Stock options exercised                                                                                |                                    |                                               | 19                                                      |       |         |        |        |        |        |        |        |       
|                                                  | Issuance of common stock under ESPP                                                                    |                                    |                                               | 43                                                      |       |         |        | 10      |        |        |        | 33      |       
|                                                  | Retirement of common stock                                                                             |                                    |                                               | (37                                                     | )     |         |        | (79     | )      |        |        | (10     | )     
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  |                                                                                                        |                                    |                                               | Net cash used in financing activities                   |       |         | (1,225 | )       |        |        | (3,319 | )       |        |         | (2,477 | )
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|Net increase in cash and cash equivalents         |                                                                                                        |                                    | 3,362                                         |                                                         |       |         | 32,863 |         |        |        | 998    |        
|Cash and cash equivalents at beginning of year    |                                                                                                        |                                    | 36,288                                        |                                                         |       |         | 3,425  |         |        |        | 2,427  |        
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|Cash and cash equivalents at end of year          |                                                                                                        | $                                  | 39,650                                        |                                                         |       | $       | 36,288 |         |        | $      | 3,425  |        
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|Supplemental disclosure of cash flow information: |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  | Cash paid (received) during the year for:                                                              |                                    |                                               |                                                         |       |         |        |         |        |        |        |         |       
|                                                  |                                                                                                        | Interest                           |                                               | $                                                       | 27    |         |        | $       | 138    |        |        | $       | 641    |        
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        
|                                                  |                                                                                                        | Income tax payments (refunds)      |                                               | $                                                       | 115   |         |        | $       | (2,976 | )      |        | $       | (1,559 | )      
|                                                  |                                                                                                        |                                    |                                               |                                                         |       |         |        |         |        |        |        |        

See notes to consolidated financial statements.

40



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##### Table of Contents



RTW, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

Years Ended December 31, 2003, 2002, and
2001




|         |                                               
|-------- | ----------------------------------------------
|Note 1  | Summary of Significant Accounting
    Policies

Organization
RTW, Inc. (RTW) provides insured and fee-for-service
workers compensation products and services to employers.
Insurance products are written for employers through RTWs
wholly-owned insurance subsidiary, American Compensation
Insurance Company (ACIC). Collectively, we,
our and us will refer to these entities
in these Notes to Consolidated Financial Statements.

We benefit from our ability to reduce
workers compensation costs and provide employers the
ability to control their workers compensation programs.
Our insurance subsidiary is domiciled in Minnesota and is
licensed in twenty-three states. We wrote business primarily in
Minnesota, Colorado and Michigan during 2003. In 2002, we
non-renewed all insurance policies in our Missouri and
Massachusetts regions and completed our run-off of all policies
in these regions by February 2003. We operate in a single
business segment, workers compensation products and
services.

The following explains the accounting policies we
use to arrive at some of the more significant amounts in our
financial statements.

Accounting
Principles We prepare our
financial statements in accordance with accounting principles
generally accepted in the United States of America (GAAP).

Consolidation
Our consolidated financial statements include the accounts of
RTW and ACIC. We eliminate all inter-company accounts and
transactions in consolidation.

Use of
Estimates We make
estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and
liabilities at the financial statement date and the recorded
amounts of revenues and expenses during the reporting period.
Our most significant estimates are those relating to our
reinsurance recoverables on unpaid claim and claim settlement
expenses, unpaid claim and claim settlement expenses, income
taxes, deferred income taxes and an accrual for premium
adjustments. We continually review our estimates and assumptions
and make adjustments as necessary. Our actual results could vary
significantly from the estimates we make.

Investments
We invest entirely in fixed maturity investments and classify
our investments as available-for-sale.

Available-for-Sale
Investments:Our available-for-sale
investments are carried at fair value with changes in unrealized
gains or losses, net of deferred taxes, reported as other
comprehensive income. The fair values of our investments are
determined based upon quoted market prices as obtained through
commercial pricing services or brokers who provide estimated
fair values.

Realized Investment Gains and
Losses:Net realized investment gains
and losses are identified separately in our Consolidated
Statements of Operations. Cost of investments sold is determined
by the specific identification method.

We continually monitor the difference between
investment cost and fair value for each of our securities. If
any security experiences a decline in value that is determined
to be other than temporary, we reduce the securitys
carrying value for the decline and record a realized loss in the
Consolidated Statements of Operations. No securities were
reduced for declines in fair value in 2003, 2002 or 2001.

Cash and Cash
Equivalents We consider
all highly liquid investments with maturities of three months or
less when purchased to be cash equivalents.

Fair Value of Financial
Instruments A number of
our significant assets and liabilities (including reinsurance
recoverables, deferred policy acquisition costs, furniture and
equipment and unpaid claim and claim settlement expenses) are
not considered financial instruments for disclosure purposes.
Our premiums

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

receivable and other assets and liabilities that
are considered financial instruments are generally of a
short-term nature. The carrying values of these instruments
approximate their fair values. The carrying values and fair
values of investments are disclosed in Note 3.

Deferred Policy Acquisition
Costs The costs directly
related to writing an insurance policy are referred to as policy
acquisition costs and consist of commissions, state premium
taxes and other direct underwriting expenses. Although these
costs arise when we issue a policy, we defer certain costs,
principally commissions and state premium taxes. These costs are
amortized to expense as premium revenue is recognized and are
reported net of ceding commissions in the Consolidated Statement
of Operations.

If deferred policy acquisition costs were to
exceed the sum of unearned premiums net of reinsurance and
related anticipated investment income less expected claim and
claim settlement expenses, we would immediately expense the
excess costs.

Depreciation
We depreciate furniture and equipment on a straight-line basis
over the estimated useful life of the asset (five to ten years).
Furniture and equipment are recorded at cost less accumulated
depreciation of $4.4 million and $4.0 million at
December 31, 2003 and 2002 respectively.

Income
Taxes We compute all
income tax amounts using the liability method. Under this
method, deferred tax assets and liabilities are recognized for
the expected tax consequences of temporary differences between
the tax bases of assets and liabilities and their reported
amounts using presently enacted tax rates. Deferred tax assets
are recognized for tax credit and net operating loss
carry-forwards, reduced by a valuation allowance which is
established when it is more likely than not that
some portion or all of the deferred tax assets will not be
realized. The effect on deferred tax assets and liabilities of a
change in tax rates or regulations is recognized in income in
the period that includes the enactment date.

Unpaid Claim and Claim Settlement
Expenses Claim expenses
refer to amounts that we paid or expect to pay to claimants for
insured events that have occurred. The costs of investigating,
resolving and processing claims are referred to as claim
settlement expenses. We record these expenses, net of amounts
recoverable under reinsurance contracts, as Claim and
claim settlement expenses in the Consolidated Statements
of Operations.

Our Unpaid claim and claim settlement
expenses represent reserves established for the estimated
total unpaid cost of claim and claim settlement expenses for
insured events that occurred on or prior to each balance sheet
date. The reserves are primarily undiscounted; however, we
discounted selected claims that have fixed or determinable
future payments by $505,000 in 2003 and $438,000 in 2002 using
discount factors ranging from 3.5% to 8.0%. These reserves
reflect our estimates of the total cost of claims that were
reported, but not yet paid, and the cost of claims incurred but
not yet reported. Our estimates consider such variables as past
loss experience, current claim trends and prevailing social,
economic and legal environments. We have a limited amount of
historical data to use in estimating our reserves for unpaid
claim and claim settlement expenses because we commenced
operations in 1992. As a result, we supplement our experience
with external industry data, as adjusted to reflect anticipated
differences between our results and the industry. We reduce the
unpaid claim and claim settlement expenses for estimated amounts
of subrogation.

We believe our reserves for unpaid claim and
claim settlement expenses are adequate to cover the ultimate
costs of claim and claim settlement expenses. The ultimate cost
of claim and claim settlement expenses may differ from the
established reserves, particularly when claims may not be
settled for many years. Reserves for unpaid claim and claim
settlement expenses and assumptions used in their development
are continually reviewed. We record adjustments to prior
estimates of unpaid claim and claim settlement expenses, which
may be material, in operations in the year in which the
adjustments are made.

Premiums
Earned Premiums on
workers compensation insurance policies are our largest
source of revenue. The premium we charge a policyholder is a
function of its payroll, industry and prior workers

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

compensation claims experience. In underwriting a
policy, we receive policyholder payroll estimates for the
ensuing year. We record premiums written on an installment
basis, matching billing to the policyholder, and earn premiums
on a daily basis over the life of each insurance policy based on
the payroll estimate. We record the excess of premiums billed
over premiums earned for each policy as unearned premiums on our
balance sheet. When a policy expires, we audit employer payrolls
for the policy period and adjust the estimated payroll and the
policyholders premium to its actual value. The result is a
final audit adjustment recorded to premiums earned
when the adjustment becomes known. We also estimate the final
audit amount to be billed on unexpired and expired unaudited
policies and record a final audit receivable included in
premiums receivable on the balance sheet. Final audit premiums
recognized during the period include billed final audit premiums
plus (or minus) the change in estimate for final audit premiums
on unexpired and expired unaudited policies.

Stock-Based
Compensation Had we
calculated compensation expense for our option grants under the
1994 Stock Plan and stock issuances under the ESPP based on the
fair value method described in SFAS No. 123,
Accounting for Stock-Based Compensation, our net
(loss) income and basic and dilutive net (loss) income per share
would approximate the following pro forma amounts (in
000s, except per share data):

|                                  |             |      |   |       |  |      |   |        |  |  |   |         |  
|--------------------------------- | ----------- | ---- | - | ----- |  | ---- | - | ------ |  |  | - | ------- | -
|                                  |             | 2003 |   | 2002  |  | 2001
|                                  |             |      |   |       |  |     
|Net income (loss):                |             |      |   |       |  |      |   |        |  |  |   |        
|                                  | As reported |      | $ | 6,999 |  |      | $ | 14,319 |  |  | $ | (25,215 | )
|                                  | Pro forma   |      |   | 6,814 |  |      |   | 14,110 |  |  |   | (25,532 | )
|Basic income (loss) per share:    |             |      |   |       |  |      |   |        |  |  |   |        
|                                  | As reported |      |   | 1.37  |  |      |   | 2.78   |  |  |   | (4.89   | )
|                                  | Pro forma   |      |   | 1.33  |  |      |   | 2.74   |  |  |   | (4.96   | )
|Dilutive income (loss) per share: |             |      |   |       |  |      |   |        |  |  |   |        
|                                  | As reported |      |   | 1.32  |  |      |   | 2.78   |  |  |   | (4.89   | )
|                                  | Pro forma   |      |   | 1.29  |  |      |   | 2.74   |  |  |   | (4.96   | )

The weighted average fair value of options
granted under the ESPP and 1994 Stock Plan during 2003, 2002 and
2001 is estimated at $1.48, $2.94 and $2.19, respectively, on
the date of grant using the Black-Scholes option-pricing model
with the following assumptions: no dividend yield; volatility of
115.3% to 131.5% in 2003, 125.6% in 2002 and 182.8% in 2001;
risk-free interest rates ranging from 1.05% to 7.70%; and an
expected life of 1 to 5 years.

Effect of Recent Accounting
Pronouncements In 2003,
the Financial Accounting Standards Board (FASB) issued
SFAS No. 148, Accounting for Stock-Based
Compensation  an Amendment of FASB 123.
The standard requires additional disclosures in our financial
statements, but does not affect our consolidated results of
operation and financial position at December 31, 2003 and
for the year then ended.

The Emerging Issues Task Force (EITF) of the
FASB has issued EITF 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments. The disclosure provisions of this rule, which
are addressed in Note 3, require tabular presentation of
certain information regarding investment securities with gross
unrealized losses.



|         |                 
|-------- | ----------------
|Note 2  | Income Per Share

Basic income (loss) per share (IPS) is
computed by dividing net income (loss) by the weighted average
number of common shares outstanding for the period. Diluted IPS
is computed by dividing net income (loss) by the weighted
average number of common shares and dilutive securities
outstanding for the period. Dilutive securities consist of stock
options. Dilutive securities are considered outstanding from the
date of grant, after applying the treasury stock method for
determining the dilutive effect.

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following is a reconciliation of the
numerators and denominators of basic and diluted income (loss)
per share:

|                                            |                                  |      |           |         |  |      |           |       |  |   |           |   | 
|------------------------------------------- | -------------------------------- | ---- | --------- | ------- |  | ---- | --------- | ----- |  | - | --------- | - | 
|                                            |                                  | 2003 |           | 2002    |  | 2001
|                                            |                                  |      |           |         |  |     
|Net income (loss) (000s)                   |                                  | $    | 6,999     |         |  | $    | 14,319    |       |  | $ | (25,215   | )
|                                            |                                  |      |           |         |  |      |           |       |  |   |           |  
|Basic weighted average shares outstanding   |                                  |      | 5,114,000 |         |  |      | 5,146,000 |       |  |   | 5,152,000 |  
|                                            | Effect of dilutive stock options |      |           | 182,000 |  |      |           | 8,000 |  |   |           |  | 
|                                            |                                  |      |           |         |  |      |           |       |  |   |           |  
|Diluted weighted average shares outstanding |                                  |      | 5,296,000 |         |  |      | 5,154,000 |       |  |   | 5,152,000 |  
|                                            |                                  |      |           |         |  |      |           |       |  |   |           |  
|Basic income (loss) per share               |                                  | $    | 1.37      |         |  | $    | 2.78      |       |  | $ | (4.89     | )
|                                            |                                  |      |           |         |  |      |           |       |  |   |           |  
|Diluted income (loss) per share             |                                  | $    | 1.32      |         |  | $    | 2.78      |       |  | $ | (4.89     | )
|                                            |                                  |      |           |         |  |      |           |       |  |   |           |  

Options to purchase 1.5 million shares of
common stock at prices ranging from $1.98 to $38.67 were
outstanding during 2001 but excluded from computing diluted IPS
due to our 2001 net loss. Diluted weighted average shares
outstanding would have increased by 4,000 shares in 2001
had these shares not been anti-dilutive in the computation.



|         |            
|-------- | -----------
|Note 3  | Investments

Valuation of
Investments The following
tables present amortized cost, gross unrealized gains and losses
and estimated fair values of our available-for-sale securities
(000s):

|                           |                   |           |        |            |  |            |       |           |  |   |      |      |   |   |        |        | 
|-------------------------- | ----------------- | --------- | ------ | ---------- |  | ---------- | ----- | --------- |  | - | ---- | ---- | - | - | ------ | ------ | 
|                           |                   |           |        | Gross      |  | Gross      |       | Estimated
|                           |                   | Amortized |        | Unrealized |  | Unrealized |       | Fair     
|2003                       |                   | Cost      |        | Gains      |  | Losses     |       | Value    
|                           |                   |           |        |            |  |            |       |          
|U.S. government securities |                   | $         | 48,152 |            |  | $          | 1,158 |           |  | $ | (155 | )    |   | $ | 49,155 |       
|Asset-backed securities    |                   |           | 1,008  |            |  |            | 3     |           |  |   |     |      |   |   | 1,011  |       
|Mortgage-backed securities |                   |           | 28,514 |            |  |            | 509   |           |  |   | (18  | )    |   |   | 29,005 |       
|                           |                   |           |        |            |  |            |       |           |  |   |      |      |   |   |        |       
|                           | Total investments |           | $      | 77,674     |  |            | $     | 1,670     |  |   | $    | (173 | ) |   | $      | 79,171 | 
|                           |                   |           |        |            |  |            |       |           |  |   |      |      |   |   |        |       

|                           |                   |           |        |            |  |            |       |           |  |   |     |     |   |   |        |        | 
|-------------------------- | ----------------- | --------- | ------ | ---------- |  | ---------- | ----- | --------- |  | - | --- | --- | - | - | ------ | ------ | 
|                           |                   |           |        | Gross      |  | Gross      |       | Estimated
|                           |                   | Amortized |        | Unrealized |  | Unrealized |       | Fair     
|2002                       |                   | Cost      |        | Gains      |  | Losses     |       | Value    
|                           |                   |           |        |            |  |            |       |          
|U.S. government securities |                   | $         | 45,463 |            |  | $          | 2,581 |           |  | $ | (21 | )   |   | $ | 48,023 |       
|Asset-backed securities    |                   |           | 1,009  |            |  |            | 6     |           |  |   |    |     |   |   | 1,015  |       
|Mortgage-backed securities |                   |           | 31,522 |            |  |            | 861   |           |  |   | (11 | )   |   |   | 32,372 |       
|                           |                   |           |        |            |  |            |       |           |  |   |     |     |   |   |        |       
|                           | Total investments |           | $      | 77,994     |  |            | $     | 3,448     |  |   | $   | (32 | ) |   | $      | 81,410 | 
|                           |                   |           |        |            |  |            |       |           |  |   |     |     |   |   |        |       

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The gross unrealized losses and fair value of our
investments aggregated by the length of time that individual
securities have been in a continuous unrealized loss position
are as follows (000s):

|                                            |                   |               |        |               |  |       |      |            |   |            |   |             |  |   |   |   |  |   |        |        |  |   |      |      |  
|------------------------------------------- | ----------------- | ------------- | ------ | ------------- |  | ----- | ---- | ---------- | - | ---------- | - | ----------- |  | - | - | - |  | - | ------ | ------ |  | - | ---- | ---- | -
|                                            |                   |               |        |               |  |       |      |           
|                                            |                   | Less Than     |        | Greater Than  |  |       |      |           
|                                            |                   | Twelve Months |        | Twelve Months |  |       |      |           
|                                            |                   |               |        |               |  |       |      |           
|                                            |                   |               |        | Gross         |  |       |      | Gross      |   |            |   | Total Gross
|                                            |                   | Fair          |        | Unrealized    |  | Fair  |      | Unrealized |   | Total Fair |   | Unrealized 
|                                            |                   | Value         |        | Losses        |  | Value |      | Losses     |   | Value      |   | Losses     
|                                            |                   |               |        |               |  |       |      |            |   |            |   |            
|U.S. government securities                  |                   | $             | 15,172 |               |  | $     | (155 | )          |   | $          |  |             |  | $ |  |   |  | $ | 15,172 |        |  | $ | (155 | )   
|Mortgage-backed and asset-backed securities |                   |               | 2,450  |               |  |       | (18  | )          |   |            |  |             |  |   |  |   |  |   | 2,420  |        |  |   | (18  | )   
|                                            |                   |               |        |               |  |       |      |            |   |            |   |             |  |   |   |   |  |   |        |        |  |   |      |     
|                                            | Total investments |               | $      | 17,622        |  |       | $    | (173       | ) |            | $ |            |  |   | $ |  |  |   | $      | 17,622 |  |   | $    | (173 | )
|                                            |                   |               |        |               |  |       |      |            |   |            |   |             |  |   |   |   |  |   |        |        |  |   |      |     

The gross unrealized loss in all cases is the
result of a decline in interest rates and not as a result of a
deterioration of the credit quality of the issuers. All issues
carry a credit quality of AAA (Standard & Poors). We
have the ability to hold all of these securities to maturity. We
consider all relevant facts and circumstances in evaluating
whether the impairment of a security is other than temporary.
Relevant facts and circumstances considered include:
(i) the length of time the fair value has been below cost;
(ii) the financial position and access to capital of the
issuer, including the current and future impact of any specific
events; and (iii) our ability and intent to hold the
security to maturity or until it recovers in value. To the
extent we determine that a security is deemed to be other than
temporarily impaired, the difference between amortized cost and
fair value would be charged to earnings.

Deposits
Included in investments are U.S. government securities on
deposit with various regulatory authorities, as required by law,
with a fair value of $21.9 million and $27.7 million
at December 31, 2003 and 2002, respectively.

Additionally, included in investments are
U.S. government securities pledged as collateral against a
letter of credit provided to an insurer, with a fair value of
$4.1 million and $4.3 million at December 31,
2003 and December 31, 2002.

Fixed Maturities by Maturity
Date The following table
presents the amortized cost and fair value of investments by
contractual maturity at December 31, 2003. Actual
maturities may differ from those stated as a result of calls and
prepayments (000s):

|             |                                                    |                   |   |            |        |  |   |        |        | 
|------------ | -------------------------------------------------- | ----------------- | - | ---------- | ------ |  | - | ------ | ------ | 
|             |                                                    | Amortized         |   | Estimated 
|             |                                                    | Cost              |   | Fair Value
|             |                                                    |                   |   |           
|Maturing in: |                                                    |                   |   |            |        |  |   |       
|             | One year or less                                   |                   | $ | 11,365     |        |  | $ | 11,447 |       
|             | Over one year through five years                   |                   |   | 10,377     |        |  |   | 10,677 |       
|             | Over five years through ten years                  |                   |   | 14,594     |        |  |   | 14,695 |       
|             | Over ten years                                     |                   |   | 12,824     |        |  |   | 13,347 |       
|             | Mortgage-backed securities with various maturities |                   |   | 28,514     |        |  |   | 29,005 |       
|             |                                                    |                   |   |            |        |  |   |       
|             |                                                    | Total investments |   | $          | 77,674 |  |   | $      | 79,171 | 
|             |                                                    |                   |   |            |        |  |   |       

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Investment
Income Investment income
includes income from the following sources (000s):

|                               |                   |      |       |       |  |      |       |       |  |   |       |       | 
|------------------------------ | ----------------- | ---- | ----- | ----- |  | ---- | ----- | ----- |  | - | ----- | ----- | 
|                               |                   | 2003 |       | 2002  |  | 2001
|                               |                   |      |       |       |  |     
|Fixed maturity investments     |                   | $    | 4,346 |       |  | $    | 4,221 |       |  | $ | 5,599 |      
|Interest on deposit receivable |                   |      |      |       |  |      | 736   |       |  |   | 518   |      
|Short-term investments         |                   |      | 128   |       |  |      | 144   |       |  |   | 286   |      
|Other                          |                   |      |      |       |  |      | 38    |       |  |   | 12    |      
|                               |                   |      |       |       |  |      |       |       |  |   |       |      
|                               | Investment income |      | $     | 4,474 |  |      | $     | 5,139 |  |   | $     | 6,415 | 
|                               |                   |      |       |       |  |      |       |       |  |   |       |      



|         |            
|-------- | -----------
|Note 4  | Reinsurance

Our financial statements reflect the effects of
ceded reinsurance transactions. We purchase reinsurance to
protect us from potential losses in excess of the level we are
willing to accept. Our primary reinsurance is excess of loss
coverage that limits our per-incident exposure.

We report reinsurance related balances on a
gross basis on the balance sheet, resulting in
reinsurance recoverable amounts on unpaid and on paid claim and
claim settlement expenses recorded as assets. We estimate
amounts recoverable from reinsurers in a manner consistent with
the claim liability associated with the reinsured policy.

The following table summarizes our reinsurance
coverage (all losses ceded on a per occurrence basis):

|               |      |                    |                    |                               |         |             |  |          |                                          
|-------------- | ---- | ------------------ | ------------------ | ----------------------------- | ------- | ----------- |  | -------- | -----------------------------------------
|               |      |                    |                    |                              
|               |      |                    |                    | Covers Losses Per Occurrence:
|               |      |                    |                    |                              
|               |      |                    |                    | In Excess of:                 |         | Limited to:
|               |      |                    |                    |                               |         |            
|Minnesota:     |      |                    |                    |                               |         |             |  |         
|               | 2003 |                    | WCRA               |                               | $       | 360,000     |  |          | Statutory limit                          
|               |      | Various reinsurers |                    | $                             | 200,000 |             |  | $360,000
|               | 2002 |                    | WCRA               |                               | $       | 350,000     |  |          | Statutory limit                          
|               | 2001 |                    | WCRA               |                               | $       | 330,000     |  |          | Statutory limit                          
|              
|Non-Minnesota: |      |                    |                    |                               |         |             |  |         
|               | 2003 |                    | Various reinsurers |                               | $       | 200,000     |  |          | $20.0 million excluding acts of terrorism
|               | 2002 |                    | Various reinsurers |                               | $       | 300,000     |  |          | $20.0 million                            
|               | 2001 |                    | Various reinsurers |                               | $       | 300,000     |  |          | Statutory limit                          

We decreased our retention in 2003 to further
reduce volatility in our operating results.

For claims occurring after June 30, 1998, we
further limited our per incident exposure by purchasing excess
of loss coverage for losses from $25,000 to the lesser of
$300,000 or the WCRA selected retention level in Minnesota and
from $25,000 to $300,000 in other states from a single
reinsurer. This agreement was finalized after its effective date
and activity occurring from July 1, 1998 through
September 30, 1998 was recorded on a retrospective basis
resulting in the deferral of a gain totaling $2.0 million
at December 31, 1998. We amortized $400,000 of the deferred
gain as a reduction of claim and claim settlement expenses in
each of 2002, 2001 and 2000 and $740,000 in 1999 resulting in an
un-amortized deferred gain of $49,000 at December 31, 2003.
The deferred gain is being amortized into income using the
effective interest rate inherent in the amounts paid to the
reinsurer and the estimated timing and amounts of recoveries
from the reinsurer. Activity occurring on or after
October 1, 1998 is recorded prospectively. This contract
was terminated effective December 31, 2000; however, the
policy was effective in 2001 for policies in force at
December 31, 2000 through expiration, not to exceed fifteen
months after the effective termination date. Policies written or
renewing after December 31, 2000 are not covered under this
lower level excess of loss reinsurance policy.

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Reinsurance contracts do not relieve us from our
obligations to policyholders. We expect reinsurers to which we
have ceded reinsurance to honor their obligations. Failure of
these reinsurers to honor their obligations could result in
losses to us. We do not anticipate any such losses and
accordingly, no provision for amounts deemed uncollectible are
included in our financial statements. We attempt to minimize our
exposure to significant losses from reinsurer insolvency by
monitoring the financial condition of our reinsurers. The
reinsurance recoverable on unpaid claim and claim settlement
expenses associated with reinsurers are as follows (000s):

|                                                          |  |      |        |      |  |   |        | 
|--------------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | 
|                                                          |  | 2003 |        | 2002
|                                                          |  |      |        |     
|Excess of loss reinsurance through various
    reinsurers |  | $    | 71,466 |      |  | $ | 91,822 | 

The effect of ceded reinsurance on premiums
written and claim and claim settlement expenses are as follows
(000s):

|                                     |        |                                         |   |        |        |      |   |         |        |  |   |         |        | 
|------------------------------------ | ------ | --------------------------------------- | - | ------ | ------ | ---- | - | ------- | ------ |  | - | ------- | ------ | 
|                                     |        | 2003                                    |   | 2002   |        | 2001
|                                     |        |                                         |   |        |        |     
|Premiums written:                    |        |                                         |   |        |        |      |   |         |        |  |   |        
|                                     | Direct |                                         | $ | 56,468 |        |      | $ | 59,898  |        |  | $ | 94,703  |       
|                                     | Ceded  |                                         |   | (8,141 | )      |      |   | (2,242  | )      |  |   | (11,363 | )     
|                                     |        |                                         |   |        |        |      |   |         |        |  |   |        
|                                     |        | Net premiums written                    |   | $      | 48,327 |      |   | $       | 57,656 |  |   | $       | 83,340 | 
|                                     |        |                                         |   |        |        |      |   |         |        |  |   |        
|Claim and claim settlement expenses: |        |                                         |   |        |        |      |   |         |        |  |   |        
|                                     | Direct |                                         | $ | 20,932 |        |      | $ | 60,109  |        |  | $ | 128,734 |       
|                                     | Ceded  |                                         |   | 6,324  |        |      |   | (19,576 | )      |  |   | (48,631 | )     
|                                     |        |                                         |   |        |        |      |   |         |        |  |   |        
|                                     |        | Net claim and claim settlement expenses |   | $      | 27,256 |      |   | $       | 40,533 |  |   | $       | 80,103 | 
|                                     |        |                                         |   |        |        |      |   |         |        |  |   |        

During 2003, the Company re-evaluated and lowered
its estimate for excess of loss unpaid claim and claim
settlement expenses by $15.1 million, which inures to the
benefit of our reinsurers. Excluding the effect of this benefit,
our ceded losses to reinsurers would have been $8.8 million.

The reinsurance recoverable on paid claim and
claim settlement expenses consists primarily of receivables from
paid claim and claim settlement expenses that were submitted but
not yet reimbursed by reinsurers at December 31, 2003
and 2002.



|         |                                               
|-------- | ----------------------------------------------
|Note 5  | Unpaid Claim and Claim Settlement
    Expenses

As described in Note 1, we establish unpaid
claim and claim settlement expense reserves on reported and
unreported claims for insured losses. The establishment of
appropriate reserves is an inherently uncertain process.
Furthermore, estimating ultimate reserves is difficult due to
our relatively limited historical claim data and small claim
population. Estimates are further complicated by the extended
periods of time that elapse between the date the loss occurs and
the date the loss is reported and ultimately settled. Reserve
estimates are regularly reviewed and updated, using the most
current information available. Any resulting adjustments, which
may be material, are reflected in current operations.

47



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##### Table of Contents



RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following table represents a reconciliation
of beginning and ending unpaid claim and claim settlement
expense reserves for each of the last three years (000s):

|                           |                                                             |                |         |         |        |      |         |         |        |   |         |         |        | 
|-------------------------- | ----------------------------------------------------------- | -------------- | ------- | ------- | ------ | ---- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                           |                                                             | 2003           |         | 2002    |        | 2001
|                           |                                                             |                |         |         |        |     
|Balance at January 1       |                                                             | $              | 181,262 |         |        | $    | 181,310 |         |        | $ | 128,841 |        
|                           | Less reinsurance recoverables                               |                |         | (91,822 | )      |      |         | (90,115 | )      |   |         | (61,845 | )     
|                           | Plus deferred gain on retrospective reinsurance             |                |         | 49      |        |      |         | 449     |        |   |         | 849     |       
|                           |                                                             |                |         |         |        |      |         |         |        |   |         |        
|Net balance at January 1   |                                                             |                | 89,489  |         |        |      | 91,644  |         |        |   | 67,845  |        
|Incurred related to:       |                                                             |                |         |         |        |      |         |         |        |   |         |        
|                           | Current year                                                |                |         | 33,954  |        |      |         | 49,621  |        |   |         | 73,557  |       
|                           | Prior years                                                 |                |         | (6,698  | )      |      |         | (8,356  | )      |   |         | 7,731   |       
|                           | Write-off of reinsurance recoverable                        |                |         |        |        |      |         | (332    | )      |   |         | (785    | )     
|                           | Amortization of deferred retrospective
    reinsurance gain |                |         |        |        |      |         | (400    | )      |   |         | (400    | )     
|                           |                                                             |                |         |         |        |      |         |         |        |   |         |        
|                           |                                                             | Total incurred |         |         | 27,256 |      |         |         | 40,533 |   |         |         | 80,103 | 
|Paid related to:           |                                                             |                |         |         |        |      |         |         |        |   |         |        
|                           | Current year                                                |                |         | 10,761  |        |      |         | 13,715  |        |   |         | 25,062  |       
|                           | Prior years                                                 |                |         | 27,357  |        |      |         | 28,973  |        |   |         | 31,242  |       
|                           |                                                             |                |         |         |        |      |         |         |        |   |         |        
|                           |                                                             | Total paid     |         |         | 38,118 |      |         |         | 42,688 |   |         |         | 56,304 | 
|                           |                                                             |                |         |         |        |      |         |         |        |   |         |        
|Net balance at December 31 |                                                             |                | 78,627  |         |        |      | 89,489  |         |        |   | 91,644  |        
|                           | Plus reinsurance recoverables                               |                |         | 71,466  |        |      |         | 91,822  |        |   |         | 90,115  |       
|                           | Plus deferred gain on retrospective reinsurance             |                |         | (49     | )      |      |         | (49     | )      |   |         | (449    | )     
|                           |                                                             |                |         |         |        |      |         |         |        |   |         |        
|Balance at December 31     |                                                             | $              | 150,044 |         |        | $    | 181,262 |         |        | $ | 181,310 |        
|                           |                                                             |                |         |         |        |      |         |         |        |   |         |        

Changes in estimates of unpaid claim and claim
settlement expenses for prior years decreased the provision for
claim and claim settlement expenses by $6.7 million in 2003
and $8.4 million in 2002 and increased the provision for
claim and claim settlement expenses by $7.7 million in 2001.

Our estimate for unpaid claim and claim
settlement expenses decreased in 2003 due to the following:
(i) the frequency of claims reported in 2003 for 2002 and
prior years was less than anticipated when we determined our
liability in 2002; and (ii) our estimate of the liability
for unpaid claim and claim settlement expenses is difficult and
volatile due to our relatively limited historical claim data and
small claim population.

Our estimate for reinsurance receivables
decreased in 2003 due to: (i) the re-evaluation and
lowering of our estimate for gross unpaid claim and claim
settlement expenses by $15.1 million; and
(ii) payments and the related recoveries on prior year
ceded claim and claim settlement expenses.



|         |              
|-------- | -------------
|Note 6  | Notes Payable

In March 2000, we borrowed $8.0 million
under a term loan agreement to fund the repurchase of common
stock from certain of our shareholders. We paid
$1.0 million in principal on the term loan in 2000, an
additional $2.5 million in 2001, $3.3 million in 2002
and the remaining $1.2 million in 2003. We paid interest at
an adjusted LIBOR rate on the term loan (adjusted LIBOR was
4.66% at December 31, 2002). The term loan was paid in full
in September 2003.

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##### Table of Contents



RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|         |             
|-------- | ------------
|Note 7  | Income Taxes

Income tax expense (benefit) consists of the
following (000s):

|          |         |                                      |   |      |      |      |   |        |        |   |   |       |       | 
|--------- | ------- | ------------------------------------ | - | ---- | ---- | ---- | - | ------ | ------ | - | - | ----- | ----- | 
|          |         | 2003                                 |   | 2002 |      | 2001
|          |         |                                      |   |      |      |     
|Current:  |         |                                      |   |      |      |      |   |        |        |   |   |      
|          | Federal |                                      | $ | 288  |      |      | $ | (3,521 | )      |   | $ |      |      
|          | State   |                                      |   | 128  |      |      |   | 85     |        |   |   | 242   |      
|          |         |                                      |   |      |      |      |   |        |        |   |   |      
|          |         | Total current tax (benefit) expense  |   |      | 416  |      |   |        | (3,436 | ) |   |       | 242   | 
|Deferred: |         |                                      |   |      |      |      |   |        |        |   |   |      
|          | Federal |                                      |   | (828 | )    |      |   | (721   | )      |   |   | 8,585 |      
|          | State   |                                      |   |     |      |      |   |       |        |   |   | 116   |      
|          |         |                                      |   |      |      |      |   |        |        |   |   |      
|          |         | Total deferred tax (benefit) expense |   |      | (828 | )    |   |        | (721   | ) |   |       | 8,701 | 
|          |         |                                      |   |      |      |      |   |        |        |   |   |      
|          |         | Income tax (benefit) expense         |   | $    | (412 | )    |   | $      | (4,157 | ) |   | $     | 8,943 | 
|          |         |                                      |   |      |      |      |   |        |        |   |   |      

Our income tax (benefit) expense differs from the
federal statutory rate as follows (000s):

|                                                                         |                                                                             |                              |       |        |      |      |       |        |        |   |        |        |       | 
|------------------------------------------------------------------------ | --------------------------------------------------------------------------- | ---------------------------- | ----- | ------ | ---- | ---- | ----- | ------ | ------ | - | ------ | ------ | ----- | 
|                                                                         |                                                                             | 2003                         |       | 2002   |      | 2001
|                                                                         |                                                                             |                              |       |        |      |     
|Federal income tax expense (benefit) at 35%                              |                                                                             | $                            | 2,305 |        |      | $    | 3,557 |        |        | $ | (5,695 | )     
|Increase (reduction) in income tax expense
    (benefit) resulting from: |                                                                             |                              |       |        |      |      |       |        |        |   |        |       
|                                                                         | State income taxes, net of federal income tax
    benefit                   |                              |       | 79     |      |      |       | 242    |        |   |        | 228    |      
|                                                                         | Non-deductible investment amortization and
    tax-exempt investment income |                              |       | 11     |      |      |       | 18     |        |   |        | (48    | )    
|                                                                         | Deferred income tax valuation allowance                                     |                              |       | (3,060 | )    |      |       | (7,927 | )      |   |        | 14,560 |      
|                                                                         | Other                                                                       |                              |       | 253    |      |      |       | (47    | )      |   |        | (102   | )    
|                                                                         |                                                                             |                              |       |        |      |      |       |        |        |   |        |       
|                                                                         |                                                                             | Income tax (benefit) expense |       | $      | (412 | )    |       | $      | (4,157 | ) |        | $      | 8,943 | 
|                                                                         |                                                                             |                              |       |        |      |      |       |        |        |   |        |       

Differences between the tax basis of assets and
liabilities and their reported amounts in the Consolidated
Financial Statements that will result in taxable or deductible
amounts in future years are called temporary

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

differences. The tax effects of temporary
differences that give rise to net deferred tax assets, included
within other assets, are as follows (000s):

|                                           |                          |                                                    |                     |        |       |        |        |        |       |        |  
|------------------------------------------ | ------------------------ | -------------------------------------------------- | ------------------- | ------ | ----- | ------ | ------ | ------ | ----- | ------ | -
|                                           |                          | 2003                                               |                     | 2002  
|                                           |                          |                                                    |                     |       
|Unpaid claim and claim settlement expenses |                          | $                                                  | 5,988               |        |       | $      | 6,452  |       
|Net operating loss carry-forward           |                          |                                                    |                    |        |       |        | 2,598  |       
|Accrued second injury funds                |                          |                                                    | 90                  |        |       |        | 483    |       
|Unearned premiums                          |                          |                                                    | 1,877               |        |       |        | 889    |       
|Office closure costs                       |                          |                                                    | 88                  |        |       |        | 145    |       
|Retrospective reinsurance                  |                          |                                                    | 17                  |        |       |        | 17     |       
|Other                                      |                          |                                                    | 642                 |        |       |        | 235    |       
|                                           |                          |                                                    |                     |        |       |        |        |       
|                                           | Deferred tax assets      |                                                    |                     | 8,702  |       |        |        | 10,819 |      
|Net unrealized gain on securities          |                          |                                                    | (524                | )      |       |        | (1,196 | )     
|Deferred policy acquisition costs          |                          |                                                    | (894                | )      |       |        | (756   | )     
|Depreciation                               |                          |                                                    | (211                | )      |       |        | (234   | )     
|                                           |                          |                                                    |                     |        |       |        |        |       
|                                           | Deferred tax liabilities |                                                    |                     | (1,629 | )     |        |        | (2,186 | )    
|                                           |                          |                                                    |                     |        |       |        |        |       
|                                           |                          | Net deferred tax assets before valuation allowance |                     |        | 7,073 |        |        |        | 8,633 |       
|                                           |                          |                                                    | Valuation allowance |        |       | (3,573 | )      |        |       | (6,633 | )
|                                           |                          |                                                    |                     |        |       |        |        |       
|                                           |                          | Net deferred tax asset                             |                     | $      | 3,500 |        |        | $      | 2,000 |       
|                                           |                          |                                                    |                     |        |       |        |        |       

In assessing the realizability of deferred tax
assets, we consider recent operating results, the scheduled
reversal of deferred tax liabilities, projected future taxable
income and tax planning strategies. At December 31, 2001,
we established a $14.5 million valuation allowance against
deferred tax assets resulting in a corresponding adjustment to
income tax expense. In 2002, the valuation allowance decreased
by $7.9 million to $6.6 million as we were able to
carry-back our 2001 operating loss five years resulting in a
$3.8 million tax refund, the reversal of certain deferred
tax items and use of the 2000 operating loss carry forward to
offset income in 2002. This allowance further decreased by
$3.0 million in 2003 to $3.6 million as we used the
remaining 2001 operating loss carry forward to offset the income
we earned in 2003 and further evaluated the asset we expect to
realize based on our projected taxable income and available tax
planning strategies. We expect the remaining deferred tax asset,
net of the valuation allowance, at December 31, 2003 to be
realized as a result of income and the reversal of existing
taxable temporary differences in the future. Deferred tax assets
are included in other assets on the Consolidated Balance Sheets.

Income taxes receivable were approximately
$492,000 and $793,000 at December 31, 2003 and 2002,
respectively, and are included in other assets.



|         |                            
|-------- | ---------------------------
|Note 8  | Employee Benefits and Plans

Stock Based
Compensation We account
for our stock-based compensation plans, the RTW, Inc. 1995
Employee Stock Purchase Plan and Trust (ESPP) and the 1994
Stock Plan, using Accounting Principles Board Opinion
No. 25 (APB 25), Accounting for Stock Issued to
Employees, and related Interpretations. Under APB 25,
compensation cost for stock options is measured as the excess,
if any, of the quoted market price of our stock at the date of
the grant over the amount an employee must pay to acquire the
stock.

1995 Employee Stock Purchase Plan The ESPP provides employees the
opportunity to purchase shares of our stock at 85% of the fair
value based on the lesser of the beginning or ending share price
for each plan year as set forth in the plan. In 2003, the shares
reserved for distribution under the plan were increased from
100,000 to 150,000 shares. The ESPP terminates in ten years
and will be carried out in phases, each consisting

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

of one year or a different period of time
approved by the Board of Directors. Any employee completing two
weeks of service prior to commencing a phase of the plan may
participate. Employees may elect to contribute from $10 to 10%
of monthly salary to the plan through payroll withholdings. The
following summarizes shares purchased and purchase prices for
each phase in the most recent three years completed through 2003:

|                                          |  |           |        |          |  |   |      | 
|----------------------------------------- |  | --------- | ------ | -------- |  | - | ---- | 
|                                          |  | Shares    |        | Purchase
|Phase:                                    |  | Purchased |        | Price   
|                                          |  |           |        |         
|Beginning April 2000, expiring April 2001 |  |           | 9,490  |          |  | $ | 3.40 | 
|Beginning April 2001, expiring April 2002 |  |           | 5,047  |          |  |   | 1.90 | 
|Beginning April 2002, expiring April 2003 |  |           | 20,649 |          |  |   | 2.07 | 

The eighth one-year phase began in April 2003 and
expires in April 2004.

Our liability for employee contributions withheld
at December 31, 2003 and 2002 for the purchase of shares in
April 2004 and April 2003 under the ESPP was $47,000 and
$51,000, respectively.

1994 Stock Plan The 1994 Stock Plan provides for
awards of qualified and non-qualified stock options. In July
1998, the Board of Directors increased the shares reserved for
distribution under the plan to 1,000,000. Option price, option
term, vesting provisions and other limits and restrictions are
determined at the time of grant by the Board of Directors or, if
established, by a separate committee. The exercise price for all
options granted was the market price of the common stock at the
date of grant.

Options granted, exercised, canceled and
outstanding under the 1994 Stock Plan are as follows:

|                           |           |           |         |               |   |        |       |          |  |  |         |          |   |   |       |       | 
|-------------------------- | --------- | --------- | ------- | ------------- | - | ------ | ----- | -------- |  |  | ------- | -------- | - | - | ----- | ----- | 
|                           |           |           |         |              
|                           |           | Qualified |         | Non-Qualified
|                           |           |           |         |              
|                           |           |           |         | Weighted      |   |        |       | Weighted
|                           |           |           |         | Average       |   |        |       | Average 
|                           |           | Option    |         | Exercise      |   | Option |       | Exercise
|                           |           | Shares    |         | Price         |   | Shares |       | Price   
|                           |           |           |         |               |   |        |       |         
|Balance, January 1, 2001   |           |           | 320,730 |               |   | $      | 12.56 |          |  |  | 263,226 |          |   | $ | 13.31 |      
|                           | Granted   |           |         | 46,000        |   |        |       | 4.93     |  |  |         | 217,500  |   |   |       | 1.98  | 
|                           | Canceled  |           |         | (74,340       | ) |        |       | 10.71    |  |  |         |         |   |   |       |      | 
|                           |           |           |         |               |   |        |       |          |  |  |         |          |   |   |       |      
|Balance, December 31, 2001 |           |           | 292,390 |               |   |        | 11.83 |          |  |  | 480,726 |          |   |   | 8.19  |      
|                           | Granted   |           |         | 25,500        |   |        |       | 2.48     |  |  |         | 112,500  |   |   |       | 2.40  | 
|                           | Canceled  |           |         | (180,819      | ) |        |       | 12.24    |  |  |         | (266,351 | ) |   |       | 12.60 | 
|                           |           |           |         |               |   |        |       |          |  |  |         |          |   |   |       |      
|Balance, December 31, 2002 |           |           | 137,071 |               |   |        | 9.54  |          |  |  | 326,875 |          |   |   | 2.60  |      
|                           | Granted   |           |         | 155,500       |   |        |       | 2.19     |  |  |         | 12,500   |   |   |       | 3.13  | 
|                           | Exercised |           |         | (8,000        | ) |        |       | 2.22     |  |  |         |         |   |   |       |      | 
|                           | Canceled  |           |         | (9,052        | ) |        |       | 9.62     |  |  |         | (80,000  | ) |   |       | 2.20  | 
|                           |           |           |         |               |   |        |       |          |  |  |         |          |   |   |       |      
|Balance, December 31, 2003 |           |           | 275,519 |               |   | $      | 5.60  |          |  |  | 259,375 |          |   | $ | 2.75  |      
|                           |           |           |         |               |   |        |       |          |  |  |         |          |   |   |       |      

Each of the qualified stock options expires ten
years from the date of grant and substantially all are subject
to continued employment with us. Each of the non-qualified
options expires ten years from the date of grant with the
exception of certain options granted to the founder of the
Company which expire five years from the date of grant. Certain
of the options are subject to vesting provisions that restrict
exercise of the option.

51



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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following table summarizes the options
outstanding and exercisable at December 31, 2003:

|                             |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 
|---------------------------- |  | ------------------- | ------- | ------------------- |  | -------- | --------- | -------- |  | -------- | ----- |  |  |  | ------- |  |  | - | ----- | 
|                             |  |                     |         |                     |  |         
|                             |  | Options Outstanding |         |                    
|                             |  |                     |         | Options Exercisable
|                             |  |                     |         |                     |  |         
|                             |  |                     |         | Weighted Average    |  |          |           | Weighted
|                             |  | Number              |         |                     |  | Number   |           | Average 
|                             |  | of                  |         | Contractual         |  | Exercise |           | of       |  | Exercise
|Exercise Price Range         |  | Options             |         | Life                |  | Price    |           | Options  |  | Price   
|                             |  |                     |         |                     |  |          |           |          |  |         
|Qualified stock options:     |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 
|$14.00 - $38.67              |  |                     | 40,019  |                     |  |          | 4.2 years |          |  | $        | 16.61 |  |  |  | 40,019  |  |  | $ | 16.61 | 
|8.75 -  10.75                |  |                     | 36,500  |                     |  |          | 6.1 years |          |  |          | 10.55 |  |  |  | 36,500  |  |  |   | 10.55 | 
|2.19 -   4.50                |  |                     | 199,000 |                     |  |          | 8.8 years |          |  |          | 2.48  |  |  |  | 100,416 |  |  |   | 4.91  | 
|                             |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 
|$ 2.19 - $38.67              |  |                     | 275,519 |                     |  |          | 7.8 years |          |  | $        | 5.60  |  |  |  | 176,935 |  |  | $ | 8.72  | 
|                             |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 
|Non-qualified stock options: |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 
|$31.75                       |  |                     | 5,000   |                     |  |          | 3.1 years |          |  | $        | 31.75 |  |  |  | 5,000   |  |  | $ | 31.75 | 
|1.98 -   5.33                |  |                     | 254,375 |                     |  |          | 8.0 years |          |  |          | 2.18  |  |  |  | 204,373 |  |  |   | 2.22  | 
|                             |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 
|$ 1.98 - $31.75              |  |                     | 259,375 |                     |  |          | 7.9 years |          |  | $        | 2.75  |  |  |  | 209,373 |  |  | $ | 2.92  | 
|                             |  |                     |         |                     |  |          |           |          |  |          |       |  |  |  |         |  |  |   |       | 

Employment Contracts We entered into a one-year employment
agreement with our President and Chief Executive Officer,
Jeffrey B. Murphy beginning December 17, 2003. Under this
agreement, Mr. Murphy receives a base salary of $250,000,
subject to review annually for increase by our Board of
Directors. In addition to base salary, Mr. Murphy is
eligible for bonuses, expense reimbursements and health, dental,
life and disability insurance consistent with that provided to
other officers and employees. Additionally, Mr. Murphy was
granted 100,000 non-qualified options at $6.00 per share on
March 12, 2004.

Combined Retirement
Plan We combine our 401(k)
Retirement Plan and Employee Stock Ownership Plan (ESOP) into a
single KSOP retirement plan. The KSOP retains the features of
each separate component except for eligibility and vesting
provisions. Under the plan, employees become eligible to
participate in the plan on the first day of the month after
beginning employment and attaining age 21.



| |                                                                                                                                                                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 401(k) Retirement
    Component We sponsor a
    defined contribution retirement component under
    Section 401(k) of the Internal Revenue Code for eligible
    employees. Our contributions are discretionary and are based on
    contributions made by employees. Expense recognized for 2003,
    2002 and 2001 was $204,000, $220,000 and $316,000, respectively.
|
| | Employee Stock Ownership
    Component We maintain an
    ESOP for our qualified employees. Our contributions are
    discretionary. We may contribute cash or shares of our common
    stock. No contributions were made or expense recorded in 2003,
    2002 or 2001.                                                                                                

Other Employee Benefit
Plans We maintained bonus
plans in 2003, 2002 and 2001 under which all employees,
including officers, were eligible for a bonus based on our
operating results. These bonuses aggregated $941,000, $864,000
and $204,000 in 2003, 2002 and 2001, respectively.



|         |                     
|-------- | --------------------
|Note 9  | Shareholders Equity

On November 7, 2002 our Board of Directors
approved a one-for-two reverse stock split in order to remedy
the minimum bid requirement for continued listing on the Nasdaq
National Market. The reverse stock split was effective to
shareholders of record on the close of business on
November 22, 2002. All share and per share amounts in these
Consolidated Financial Statements have been adjusted to reflect
the effect of the stock split.

On September 15, 1998, our Board of
Directors approved a share repurchase program authorizing the
repurchase of up to $4.0 million of RTW, Inc. common
stock. We may repurchase shares on the open market

52



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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

or through private transactions depending upon
market conditions and availability. Through December 31,
2003 we repurchased approximately 385,000 shares for
$2.7 million. We will use the repurchased shares for
employee stock option and purchase plans and other corporate
purposes.

Shareholder Rights Plan In April 1997, we adopted a
shareholder rights plan and declared a dividend of one right for
each outstanding share of common stock to shareholders of record
at the close of business on June 30, 1997. The rights
become exercisable only after any person or group (the Acquiring
Person) becomes the beneficial owner of 15% or more of the
voting power of our common stock. Certain shares held by our
Chairman Emeritus, David C. Prosser, and his wife are excluded
from the computation for determining whether a person is an
Acquiring Person. Each right entitles its registered holder to
purchase from us one one-hundredth share of a new Series A
Junior Participating Preferred Stock, no par value, at a price
of $85 per one one-hundredth share, subject to adjustment.
If any Acquiring Person acquires beneficial ownership of 15% or
more of our voting power, each right will entitle its holder
(other than such Acquiring Person) to purchase, at the then
current purchase price of the right, that number of shares of
our common stock having a market value of two times the purchase
price of the right, subject to certain possible adjustments. In
addition, if we are acquired in a merger or other business
combination transaction, each right will entitle its holder to
purchase, at the then current purchase price of the right, that
number of common shares of the acquiring company having a market
value of two times the purchase price of the right. Following
the acquisition of a beneficial ownership of 15% or more of our
outstanding common stock by any Acquiring Person and prior to an
acquisition by any Acquiring Person of 50% or more of our
outstanding common stock, our Board of Directors may exchange
the outstanding rights (other than rights owned by such
Acquiring Person), in whole or in part, at an exchange ratio of
one share of common stock, or one one-hundredth share of
Preferred Stock (or equivalent securities) per right, subject to
adjustment. We may redeem the rights, in whole, at
$.001 per right, at any time prior to an acquisition by any
Acquiring Person of 15% or more of our outstanding common stock
and prior to the expiration of the rights. The rights expire on
April 17, 2007, unless extended or earlier redeemed by us.

Dividend
Restrictions Dividends are
paid as determined by our Board of Directors. No cash dividends
have ever been paid by us.

Our ability to pay cash dividends to shareholders
may depend upon the amount of dividends received from our
insurance subsidiary. ACICs ability to pay dividends is
restricted by law or subject to approval of the insurance
regulatory authorities of Minnesota.

Under Minnesota insurance law regulating the
payment of dividends by ACIC, any such payments must be an
amount deemed prudent by ACICs Board of Directors and,
unless otherwise approved by the Commissioner of the Minnesota
Department of Commerce (Commissioner), must be paid solely from
the adjusted earned surplus of ACIC. Adjusted earned surplus
means the earned surplus as determined in accordance with
statutory accounting practices (unassigned funds), less 25% of
the amount of such earned surplus that is attributable to
unrealized capital gains. Further, without approval of the
Commissioner, ACIC may not pay a dividend in any calendar year
which, when combined with dividends paid in the preceding
twelve months, exceeds the greater of: (i) 10% of
ACICs statutory capital and surplus at the prior year end;
or (ii) 100% of ACICs statutory net gain from
operations (not including realized capital gains) for the prior
calendar year. For 2004, dividends in excess of approximately
$3.3 million would require prior consent of the
Commissioner.

Statutory Surplus and Statutory Net Income
(Loss) Our insurance
subsidiary is required to file financial statements with state
regulatory agencies. The accounting principles used to prepare
the statutory financial statements follow prescribed accounting
practices that differ from GAAP. Statutory capital and surplus at

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

December 31, 2003 and 2002, and statutory
net income (loss) for the years ended December 31, 2003,
2002 and 2001 are as follows (000s):

|     |  |             |        |            |  |   |         |  
|---- |  | ----------- | ------ | ---------- |  | - | ------- | -
|     |  | Statutory   |        | Statutory 
|     |  | Capital and |        | Net Income
|     |  | Surplus     |        | (Loss)    
|     |  |             |        |           
|2003 |  | $           | 33,033 |            |  | $ | 6,103   |  
|2002 |  |             | 26,820 |            |  |   | 12,064  |  
|2001 |  |             |        |            |  |   | (14,074 | )



|          |                              
|--------- | -----------------------------
|Note 10  | Commitments and Contingencies

Operating
Leases We conduct our
operations in leased office facilities under operating lease
agreements. The agreements provide for monthly base lease
payments plus contingent rentals based on an allocable portion
of certain operating expenses incurred by the lessor.

Future minimum (base) rental payments
required under the leases, as of December 31, 2003, are as
follows (000s):

|     |  |   |       | 
|---- |  | - | ----- | 
|2004 |  | $ | 1,280 | 
|2005 |  |   | 1,151 | 
|2006 |  |   | 931   | 
|2007 |  |   | 580   | 

Rent expense, including contingent rentals, was
$1.0 million, $1.3 million and $2.0 million for
2003, 2002 and 2001, respectively.

In the ordinary course of administering our
workers compensation programs, we are routinely involved
in the adjudication of claims resulting from workplace injuries.
We are not involved in any legal or administrative claims that
we believe are likely to have a material adverse effect on our
financial condition or results of operations.

Note 11  Accumulated Other
Comprehensive Income

Our accumulated other comprehensive income
includes only unrealized gains and losses on investments
classified as available-for-sale. Changes in accumulated other
comprehensive income and other comprehensive income (loss) were
as follows (000s):

|                                                                    |                                                                 |                                           |                                                |        |        |        |       |       |       |       |     |       |       |     | 
|------------------------------------------------------------------- | --------------------------------------------------------------- | ----------------------------------------- | ---------------------------------------------- | ------ | ------ | ------ | ----- | ----- | ----- | ----- | --- | ----- | ----- | --- | 
|                                                                    |                                                                 | 2003                                      |                                                | 2002   |        | 2001  
|                                                                    |                                                                 |                                           |                                                |        |        |       
|Accumulated other comprehensive income, beginning
    of year       |                                                                 | $                                         | 2,220                                          |        |        | $      | 882   |       |       | $     | 204 |      
|Changes in comprehensive income (loss) arising
    during the year: |                                                                 |                                           |                                                |        |        |        |       |       |       |       |     |      
|                                                                    | Net unrealized investment (losses) gains                        |                                           |                                                | (1,234 | )      |        |       | 3,780 |       |       |     | 2,211 |      
|                                                                    | Less: Adjustment for net realized investment
    (losses) gains |                                           |                                                | 685    |        |        |       | 1,721 |       |       |     | 1,163 |      
|                                                                    |                                                                 |                                           |                                                |        |        |        |       |       |       |       |     |      
|                                                                    |                                                                 | Change in net unrealized investment gains |                                                |        | (1,919 | )      |       |       | 2,059 |       |     |       | 1,048 |    
|                                                                    |                                                                 | Income tax (benefit) expense              |                                                |        | (672   | )      |       |       | 721   |       |     |       | 370   |    
|                                                                    |                                                                 |                                           |                                                |        |        |        |       |       |       |       |     |      
|                                                                    |                                                                 |                                           | Other comprehensive (loss) income for the year |        |        | (1,247 | )     |       |       | 1,338 |     |       |       | 678 | 
|                                                                    |                                                                 |                                           |                                                |        |        |        |       |       |       |       |     |      
|Accumulated other comprehensive income, end of
    year             |                                                                 | $                                         | 973                                            |        |        | $      | 2,220 |       |       | $     | 882 |      
|                                                                    |                                                                 |                                           |                                                |        |        |        |       |       |       |       |     |      

54



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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Note 12  Restructuring
Charges

During 2001, we recorded pre-tax restructuring
charges totaling $2.0 million to general and administrative
expenses in the Consolidated Statement of Operations. These
charges included costs associated with our decision to close our
Missouri and Massachusetts regional offices, as well as our
Brainerd, Minnesota and Overland Park, Kansas satellite
offices. We anticipated that 38 employees in our regional
offices, 17 employees in our satellite offices and
2 employees in our Home Office would be affected by these
closures. The restructuring charge included $715,000 of
severance pay and benefits, of which $106,000 was paid by
December 31, 2001 and the remainder of which was paid,
primarily in early 2002. Additionally, the restructuring charge
included office and equipment lease costs totaling $684,000 of
which $80,000 was paid by December 31, 2001 with an
additional $195,000 paid in 2002 and furniture and equipment
disposals and other costs totaling $600,000 of which $53,000 had
been disposed of by December 31, 2001, the remainder of
which was disposed of in 2002. At December 31, 2003 and
2002, the remaining accrual included amounts related to future
lease payments totaling $248,000 and $409,000, respectively.

Note 13  Termination of
Deposit Contract

In June 2001, we entered into an agreement with
St. Paul RE effective January 1, 2001. Key provisions
of this agreement included ceding 50% of the subject net earned
premium to SPR in exchange for various levels of paid claim
reimbursement through several loss corridors as defined in the
agreement. In December 2002, we negotiated the termination of
this agreement with SPR. In connection with the termination, we
received $28.8 million in cash in December 2002
representing a return of all deposits made under the agreement
less claim reimbursements for claims paid through December 2002.
In 2002, we recorded a gain on the termination totaling
$1.0 million representing the difference between the
deposit receivable balance and the amount received from SPR.

Note 14  Quarterly Results of
Operations (Unaudited)

Quarterly revenues are affected by:
(i) premiums in force at the beginning of the quarter;
(ii) new policies written in the quarter; (iii) final
audit premiums recognized during the quarter; and (iv) our
policy renewal rate in the quarter. Historically, a majority of
new policies written and policy renewals have occurred in the
first, second and fourth quarters.

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The following tables present unaudited quarterly
results of operations for the eight quarters ended
December 31, 2003:

|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |        |        | 
|------------------------ | ----------------------------------- | ------------------------------------- | ------ | ------- | ------ | ------- | ------ | ------- | ------ | - | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                         |                                     | First                                 |        | Second  |        | Third   |        | Fourth 
|2003                     |                                     | Quarter                               |        | Quarter |        | Quarter |        | Quarter
|                         |                                     |                                       |        |         |        |         |        |        
|                         |                                     |                                      
|                         |                                     | (In thousands, except per share data)
|Premiums in force        |                                     | $                                     | 48,700 |         |        | $       | 50,300 |         |        | $ | 57,400 |        |        | $ | 58,100 |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|Revenues:                |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|                         | Gross premiums earned               |                                       | $      | 13,022  |        |         | $      | 12,566  |        |   | $      | 13,728 |        |   | $      | 15,115 |       
|                         | Premiums ceded                      |                                       |        | (1,900  | )      |         |        | (1,721  | )      |   |        | (2,049 | )      |   |        | (2,471 | )     
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|                         |                                     | Premiums earned                       |        |         | 11,122 |         |        |         | 10,845 |   |        |        | 11,679 |   |        |        | 12,644 | 
|                         | Investment income                   |                                       |        | 1,242   |        |         |        | 1,167   |        |   |        | 1,067  |        |   |        | 998    |       
|                         | Net realized investment gains       |                                       |        |        |        |         |        |        |        |   |        | 685    |        |   |        |       |       
|                         | Other income                        |                                       |        | 28      |        |         |        | 28      |        |   |        | 23     |        |   |        | 30     |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|                         |                                     | Total revenues                        |        |         | 12,392 |         |        |         | 12,040 |   |        |        | 13,454 |   |        |        | 13,672 | 
|Expenses:                |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|                         | Claim and claim settlement expenses |                                       |        | 8,194   |        |         |        | 5,704   |        |   |        | 6,421  |        |   |        | 6,937  |       
|                         | Policy acquisition costs            |                                       |        | 1,035   |        |         |        | 2,765   |        |   |        | 1,484  |        |   |        | 1,594  |       
|                         | General and administrative expenses |                                       |        | 2,286   |        |         |        | 2,656   |        |   |        | 2,542  |        |   |        | 3,305  |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|                         |                                     | Total expenses                        |        |         | 11,515 |         |        |         | 11,125 |   |        |        | 10,447 |   |        |        | 11,836 | 
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|Income from operations   |                                     | $                                     | 877    |         |        | $       | 915    |         |        | $ | 3,007  |        |        | $ | 1,836  |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|Net income               |                                     | $                                     | 564    |         |        | $       | 639    |         |        | $ | 3,133  |        |        | $ | 2,663  |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|Basic income per share   |                                     | $                                     | 0.11   |         |        | $       | 0.12   |         |        | $ | 0.61   |        |        | $ | 0.52   |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       
|Diluted income per share |                                     | $                                     | 0.11   |         |        | $       | 0.12   |         |        | $ | 0.59   |        |        | $ | 0.49   |       
|                         |                                     |                                       |        |         |        |         |        |         |        |   |        |        |        |   |        |       

The following represent pre-tax adjustments
recorded during each quarter of 2003 that affected reported net
income:

|                                                                                                          |  |   |     |  |  |   |        |   |  |   |       |  |  |   |       |  
|--------------------------------------------------------------------------------------------------------- |  | - | --- |  |  | - | ------ | - |  | - | ----- |  |  | - | ----- | -
|Realized gains on repositioning our investment
    portfolio                                              |  | $ |    |  |  | $ |       |   |  | $ | 685   |  |  | $ |      |  
|Changes in estimates for unpaid claim and claim
    settlement expenses on claims reported in prior years |  |   | 300 |  |  |   | 2,400  |   |  |   | 2,000 |  |  |   | 2,000 |  
|Pool reapportionment charge                                                                               |  |   |    |  |  |   | (1,451 | ) |  |   |      |  |  |   |      |  
|Severance and moving costs                                                                                |  |   |    |  |  |   |       |   |  |   |      |  |  |   | (217  | )
|Contingent commission reversal                                                                            |  |   |    |  |  |   |       |   |  |   |      |  |  |   | (375  | )
|Change in recorded deferred income tax valuation
    allowance                                            |  |   |    |  |  |   |       |   |  |   | 1,200 |  |  |   | 1,860 |  

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RTW, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |        |        |        | 
|------------------------ | ----------------------------------- | -------------------------------------- | -------------- | --------- | ------ | ------- | ------ | ------- | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | 
|                         |                                     | First                                  |                | Second    |        |         |        |        
|                         |                                     | Quarter                                |                | Quarter   |        | Third   |        | Fourth 
|2002                     |                                     | (Revised)                              |                | (Revised) |        | Quarter |        | Quarter
|                         |                                     |                                        |                |           |        |         |        |        
|                         |                                     |                                       
|                         |                                     | (In thousands, except per share data) 
|Premiums in force        |                                     | $                                      | 68,800         |           |        | $       | 59,100 |         |        | $      | 60,200 |        |        | $      | 54,200 |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|Revenues:                |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|                         | Gross premiums earned               |                                        | $              | 17,843    |        |         | $      | 14,367  |        |        | $      | 15,668 |        |        | $      | 14,628 |       
|                         | Premiums ceded                      |                                        |                | (878      | )      |         |        | 14      |        |        |        | (562   | )      |        |        | (816   | )     
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|                         |                                     | Premiums earned                        |                |           | 16,965 |         |        |         | 14,381 |        |        |        | 15,106 |        |        |        | 13,812 |       
|                         |                                     | Investment income                      |                |           | 1,423  |         |        |         | 1,403  |        |        |        | 1,227  |        |        |        | 1,086  |       
|                         |                                     | Net realized investment gains (losses) |                |           | 1,451  |         |        |         | (12    | )      |        |        | 354    |        |        |        | (72    | )     
|                         |                                     | Other income                           |                |           |       |         |        |         |       |        |        |        |       |        |        |        | 22     |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|                         |                                     |                                        | Total revenues |           |        | 19,839  |        |         |        | 15,772 |        |        |        | 16,687 |        |        |        | 14,848 | 
|Expenses:                |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|                         | Claim and claim settlement expenses |                                        |                | 11,681    |        |         |        | 11,330  |        |        |        | 10,255 |        |        |        | 7,267  |       
|                         | Policy acquisition costs            |                                        |                | 2,186     |        |         |        | 1,608   |        |        |        | 1,814  |        |        |        | 696    |       
|                         | General and administrative expenses |                                        |                | 3,230     |        |         |        | 2,413   |        |        |        | 2,386  |        |        |        | 1,955  |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|                         |                                     | Total expenses                         |                |           | 17,097 |         |        |         | 15,351 |        |        |        | 14,455 |        |        |        | 9,918  |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|Income from operations   |                                     | $                                      | 2,742          |           |        | $       | 421    |         |        | $      | 2,232  |        |        | $      | 4,930  |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|Net income               |                                     | $                                      | 2,659          |           |        | $       | 208    |         |        | $      | 3,393  |        |        | $      | 8,059  |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|Basic income per share   |                                     | $                                      | 0.52           |           |        | $       | 0.04   |         |        | $      | 0.66   |        |        | $      | 1.57   |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       
|Diluted income per share |                                     | $                                      | 0.52           |           |        | $       | 0.04   |         |        | $      | 0.66   |        |        | $      | 1.57   |       
|                         |                                     |                                        |                |           |        |         |        |         |        |        |        |        |        |        |        |       

The following represent pre-tax adjustments
recorded during each quarter of 2002 that affected reported net
income:

|                                                                                                          |  |   |       |  |  |   |     |  |  |   |       |  |  |   |       | 
|--------------------------------------------------------------------------------------------------------- |  | - | ----- |  |  | - | --- |  |  | - | ----- |  |  | - | ----- | 
|Changes in estimated reinsurance costs                                                                    |  | $ |      |  |  | $ | 669 |  |  | $ | 350   |  |  | $ |      | 
|Realized gains on repositioning our investment
    portfolio                                              |  |   | 1,451 |  |  |   |    |  |  |   | 354   |  |  |   |      | 
|Changes in estimates for unpaid claim and claim
    settlement expenses on claims reported in prior years |  |   | 3,000 |  |  |   |    |  |  |   | 1,250 |  |  |   | 4,106 | 
|Second injury fund accrual adjustments                                                                    |  |   |      |  |  |   |    |  |  |   |      |  |  |   | 851   | 
|Gain recorded on termination of St. Paul RE
    contract                                                  |  |   |      |  |  |   |    |  |  |   |      |  |  |   | 957   | 
|Change in recorded deferred income tax valuation
    allowance                                            |  |   |      |  |  |   |    |  |  |   | 1,296 |  |  |   | 6,631 | 

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

On September 12, 2002, Deloitte &
Touche LLP (D&T) resigned as the independent
certified public accountants for the Company. D&T
concurrently indicated that the Companys assigned Audit
Partner had terminated his employment with D&T and that the
Company no longer fit its client profile.

D&Ts reports on the Companys
financial statements for the years ended December 31, 2001
and 2000 did not contain an adverse opinion or a disclaimer of
opinion, and were not qualified or modified as to uncertainty,
audit scope, or accounting principles. During the past two
fiscal years and the subsequent interim period preceding the
resignation of D&T, there were no disagreements with D&T
on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which
disagreement(s), if not resolved to the satisfaction of D&T,
would have caused it to make reference to the subject matter of
the disagreement(s) in connection with its report for such
periods.

Effective October 7, 2002, at the
recommendation of the Audit Committee, the Company engaged
Ernst & Young LLP (E&Y) as the independent
certified public accountants for the Company. During the two
most recent fiscal years and through October 7, 2002, the
Company did not consult with E&Y with respect to the
application of accounting principles to a specific transaction,
either completed or proposed, or the type of audit opinion that
might be rendered on the consolidated financial statements of
RTW, or any other matters or reportable events as set forth in
Items 304 (a) (2) (i) and (ii) of the
Securities and Exchange Commissions Regulation S-K.

In June 2001, we entered into an agreement with
St. Paul RE (SPR) effective January 1, 2001 in order to
reduce our net premium to surplus leverage ratio and maintain a
secure financial strength rating for our insurance subsidiary as
disclosed in Note 13  Termination of Deposit
Contract.

At the time we entered into this agreement, we
evaluated whether or not this agreement contained the necessary
attributes to be accounted for as reinsurance. Evaluating
contracts of this type requires significant judgment about
possible future events. Based on our evaluation, we concluded
that this agreement satisfied the necessary requirements to be
accounted for as reinsurance. Our independent public accountants
(D&T) and reinsurance brokers agreed with our conclusion at
that time. In consultation with E&Y, we determined that our
original conclusion to record the agreement under reinsurance
accounting standards was incorrect and have restated the
accounting for the agreement since inception using accounting
standards defined in Statement of Position 98-7
(SOP 98-7), Insurance Deposit Accounting. D&T
maintained its position with respect to the original accounting
for the transaction and withdrew its opinion on the 2001
financial statements in February 2003. E&Y subsequently
audited those financial statements and issued a report that did
not contain an adverse opinion or a disclaimer of opinion, and
was not qualified or modified as to uncertainty, audit scope, or
accounting principles.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

(a) Evaluation of Disclosure Controls and
Procedures



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Companys Chief Executive Officer,
    Jeffrey B. Murphy, and Chief Financial Officer, Alfred L.
    LaTendresse, have reviewed the Companys disclosure
    controls and procedures prior to the filing of this report.
    Based upon this review, these officers believe that the
    Companys disclosure controls and procedures are effective
    in ensuring that material information related to the Company is
    made known to them by others within the Company.

(b) Changes in Internal Controls



| |                                                                                                                                                                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | There were no significant changes in the
    Companys internal controls or in other factors that could
    significantly affect these controls during the year covered by
    this report or from the end of the reporting period to the date
    of this Annual Report on Form 10-K.

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PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

Information with respect to Directors is
contained in the Section entitled Election of
Directors in the Companys 2004 Proxy Statement and
is incorporated herein by reference.

Information with respect to Executive Officers is
included in PART I of this Annual Report on Form 10-K.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

Information required under this item is contained
in the Section entitled Executive Compensation and Other
Information in the Companys 2004 Proxy Statement and
is incorporated herein by reference.






|         |                                                                   
|-------- | ------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management

Information required under this item is contained
in the Section entitled Security Ownership of Principal
Shareholders and Management in the Companys 2004
Proxy Statement and is incorporated herein by reference.






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

Information required under this item is contained
in the Section entitled Certain Transactions in the
Companys 2004 Proxy Statement and is incorporated herein
by reference.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

Information required under this item is contained
in the Section entitled Principal Accountant Fees and
Services in the Companys 2004 Proxy Statement and is
incorporated herein by reference.




PART IV






|         |                                                                     
|-------- | --------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules,
    and Reports on Form 8-K

(a) Documents filed as Part of this
Report



| |     |                                                                                                                                                                            
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Financial
    Statements.The following consolidated
    financial statements of the Company are set forth on
    pages 36 through 57 of Part II, Item 8 of
    this Report.



| |                                                                                                       
| | ------------------------------------------------------------------------------------------------------
| | Independent Auditors Reports                                                                         
|
| | Consolidated Balance Sheets 
    December 31, 2003 and 2002                                          
|
| | Consolidated Statements of Operations 
    Years Ended December 31, 2003, 2002 and 2001              
|
| | Consolidated Statements of Shareholders
    Equity  Years Ended December 31, 2003, 2002 and
    2001
|
| | Consolidated Statements of Cash Flows 
    Years Ended December 31, 2003, 2002 and 2001              
|
| | Notes to Consolidated Financial
    Statements  Years Ended December 31, 2003, 2002
    and 2001     

59



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##### Table of Contents





| |                                                                                  
| | ---------------------------------------------------------------------------------
| | (2) Financial Statement Schedules for the
    Three Years Ended December 31, 2003

|                                                                                                    |  |      |     | 
|--------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                    |  | Page
|                                                                                                    |  |     
|Independent Auditors Reports on Schedules
    for the Years Ended December 31, 2003, 2002 and 2001 |  |      | S-1 | 
|Schedule I  Summary of Investments                                                                 |  |      | S-2 | 
|Schedule II  Condensed Financial
    Information (Parent Company)                                  |  |      | S-3 | 
|Schedule III  Supplemental
    Information Concerning Insurance Operations                         |  |      | S-7 | 
|Schedule IV  Reinsurance                                                                           |  |      | S-8 | 
|Schedule V  Valuation and
    Qualifying Accounts                                                  |  |      | S-9 | 



| |                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | All other schedules are omitted because they are
    not applicable or the required information is presented in the
    Financial Statements or the notes thereto.

(b) Listing of Reports on
Form 8-K



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company filed the following Current reports
    on Form 8-K during the quarter ended December 31, 2004
    and through March 19, 2004:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | The Company filed a Current Report on
    Form 8-K dated October 22, 2003 pursuant to
    Item 12 of Form 8-K, Disclosure of Results of
    Operations and Financial Condition, under which RTW, Inc.
    furnished a press release, issued on October 22, 2003,
    disclosing material non-public information regarding its results
    of operations for the quarter ended September 30, 2003.                                                                                                                                                                                                                                      
|
| | The Company filed a Current Report on
    Form 8-K dated December 17, 2003 pursuant to
    Item 5 of Form 8-K, Other Events, under which
    RTW, Inc. furnished a press release, issued on
    December 17, 2003, disclosing material non-public
    information regarding naming Jeffrey B. Murphy as Chief
    Executive Officer and electing John O. Goodwyne as Chairman of
    the Board.                                                                                                                                                                                                                                        
|
| | The Company filed a Current Report on
    Form 8-K dated February 11, 2004 pursuant to
    Item 12 of Form 8-K, Disclosure of Results of
    Operations and Financial Condition, under which RTW, Inc.
    furnished a press release, issued on February 11, 2004,
    disclosing material non-public information regarding its results
    of operations for the quarter ended December 31, 2003.                                                                                                                                                                                                                                     
|
| | The Company filed a Current Report on
    Form 8-K dated March 9, 2004 pursuant to Item 5
    of Form 8-K, Other Events, under which RTW, Inc.
    furnished a press release, issued on March 9, 2004,
    disclosing material non-public information reporting that A.M.
    Best Co. (Best) increased the financial strength rating of
    American Compensation Insurance Company (ACIC), a subsidiary of
    RTW, Inc., to B+ (Very Good, Secure) from B (Fair,
    Vulnerable).                                                                                                                                                   
|
| | The Company filed a Current Report on
    Form 8-K dated March 12, 2004 pursuant to Item 5
    of Form 8-K, Other Events, under which RTW, Inc.
    furnished a press release, issued on March 12, 2004,
    disclosing material non-public information reporting that it has
    been awarded a three-year contract with the Minnesota Assigned
    Risk Plan (Plan). Under the terms of the contract, RTW will
    provide policy issuance and claims management services to
    twenty-five percent (25%) of the Plan policyholders on a
    fee-for-service basis. The contract also has a mutual two-year
    extension provision.

60



---



##### Table of Contents



(c) Listing of Exhibits (* indicates
compensatory plan)

| |        |  |  |                                                                                                                                                      
| | ------ |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
| | 3.1    |  |  | Amended Articles of Incorporation(7)                                                                                                                 
| | 3.2    |  |  | Amended Bylaws(1)                                                                                                                                    
| | 4.1    |  |  | Form of Rights Agreement dated April 17,
    1997 between RTW, Inc. and Norwest Bank Minnesota National
    Association(2)                           
| | 10.1*  |  |  | Employment agreement between RTW, Inc. and
    Jeffrey B. Murphy dated March 12, 2004                                                                
| | 10.2*  |  |  | Amended RTW, Inc. 1995 Employee Stock
    Purchase Plan(4)                                                                                           
| | 10.3*  |  |  | Amended RTW, Inc. 1994 Stock Plan(4)                                                                                                                 
| | 10.4   |  |  | Contract between RTW and ACIC dated
    January 1, 1992(5)                                                                                           
| | 10.5   |  |  | Service Agreement between RTW and ACIC dated
    February 1, 1992(5)                                                                                 
| | 10.6*  |  |  | Description of the 2004 Profit Sharing Program                                                                                                       
| | 10.7   |  |  | Reinsurance contract between ACIC and First
    Excess and Reinsurance Corporation (GE Reinsurance Corporation)
    effective July 1, 1998(3)        
| | 10.8   |  |  | Endorsement No. 2 to the reinsurance
    contract between ACIC and General Reinsurance Corporation(3)                                                
| | 10.8.1 |  |  | Description of the Reinsurance Agreement for 2002
    between ACIC and General Reinsurance Corporation effective
    January 1, 2002(6)              
| | 10.8.2 |  |  | Description of the Reinsurance Agreement for 2003
    between ACIC and General Reinsurance Corporation effective
    January 1, 2003(7)              
| | 10.8.3 |  |  | Description of the Reinsurance Agreement for 2004
    between ACIC and General Reinsurance Corporation effective
    January 1, 2004                 
| | 10.9   |  |  | Minnesota Workers Compensation Reinsurance
    Association reinsurance agreement(7)                                                                 
| | 10.10  |  |  | Election form for the 2004 Minnesota
    Workers Compensation Reinsurance Association reinsurance
    agreement                                     
| | 10.11  |  |  | Description of the Reinsurance Agreement for 2003
    between ACIC and Everest Re/ Platinum Re effective
    January 1, 2003(7)                      
| | 10.12  |  |  | Description of the Reinsurance Agreement for 2004
    between ACIC and various reinsurers effective January 1,
    2004                              
| | 11     |  |  | Statement re: Computation of Income Per Share                                                                                                        
| | 14     |  |  | Code of Ethics                                                                                                                                       
| | 21     |  |  | Subsidiaries of the Registrant: The Company has
    one wholly-owned subsidiary, American Compensation Insurance
    Company, a Minnesota corporation
| | 23     |  |  | Consent of Ernst & Young, LLP                                                                                                                        
| | 24     |  |  | Power of Attorney, included in Signature page                                                                                                        
| | 31.1   |  |  | Certification of President and Chief Executive
    Officer                                                                                           
| | 31.2   |  |  | Certification of Chief Financial Officer                                                                                                             
| | 32     |  |  | Certification Pursuant to 18 U.S.C.
    § 1350, Adopted Pursuant to § 906 of the
    Sarbanes-Oxley Act of 2002                                      



---



|    |                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to the Companys
    Registration Statement on Form S-1 (Reg. No. 33-89164).                        
|   
|(2) | Incorporated by reference to the Companys
    Registration Statement on Form 8-A filed April 25, 1997
    (File No. 0-25508).
|   
|(3) | Incorporated by reference to the Companys
    1998 Annual Report on Form 10-K.                                               
|   
|(4) | Incorporated by reference to the Companys
    Registration Statement on Form S-8 (Reg.
    No. 333-81408).                   
|   
|(5) | Incorporated by reference to the Companys
    Registration Statement on Form SB-2 (Reg.
    No. 33-2002C).                   
|   
|(6) | Incorporated by reference to the Companys
    2001 Annual Report on Form 10-K/ A.                                            
|   
|(7) | Incorporated by reference to the Companys
    2002 Annual Report on Form 10-K.                                               

61



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##### Table of Contents






SIGNATURES

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



| |          
| | ---------
| | RTW, INC.



| |    |                      
| | -- | ---------------------
| | By | /s/ JEFFREY B. MURPHY

| |                                                    
| | ---------------------------------------------------
| |                                                    
| | Jeffrey B. Murphy                                  
| | President, Chief Executive Officer and
    Director
| | (Principal Executive Officer)                      

Date: March 28, 2004

Signatures and Power of Attorney

Pursuant to the requirements of the Securities
Exchange Act of 1934, this Report has been signed by the
following persons on behalf of the Registrant, in the
capacities, and on the dates, indicated. Each person whose
signature appears below constitutes and appoints Jeffrey B.
Murphy and Alfred L. LaTendresse as his true and lawful
attorney-in-fact and agents, each acting alone, with full power
of substitutions and re-substitution, for him and in his name,
place, and stead, in any and all capacities, to sign any or all
amendments to this Annual Report on Form 10-K and to file
the same, with the exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange
Commission.

|          |  |                                                |  |                                                                                                                                     |  |               
|--------- |  | ---------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------- |  | --------------
|          |  |                                                |  |                                                                                                                                    
|Signature |  | Title                                          |  | Date                                                                                                                               
|          |  |                                                |  |                                                                                                                                    
|By:       |  | /s/ JOHN O. GOODWYNEJohn O. Goodwyne           |  | Chairman of the Board                                                                                                               |  | March 28, 2004
|         
|By:       |  | /s/ JEFFREY B. MURPHYJeffrey B. Murphy         |  | President, Chief Executive Officer
    and Director (Principal Executive Officer)                                                   |  | March 28, 2004
|         
|By:       |  | /s/ ALFRED L. LATENDRESSEAlfred L. LaTendresse |  | Executive Vice President,
    Chief Financial Officer, Treasurer
    and Secretary (Principal Financial
    and Accounting Officer) |  | March 28, 2004
|         
|By:       |  | /s/ DAVID C. PROSSERDavid C. Prosser           |  | Chairman Emeritus of the Board                                                                                                      |  | March 28, 2004
|         
|By:       |  | /s/ GREGORY D. KOSCHINSKAGregory D. Koschinska |  | Director                                                                                                                            |  | March 28, 2004
|         
|By:       |  | /s/ WILLIAM J. DETERSWilliam J. Deters         |  | Director                                                                                                                            |  | March 28, 2004
|         
|By:       |  | /s/ JOHN W. PROSSERJohn W. Prosser             |  | Director                                                                                                                            |  | March 28, 2004
|         
|By:       |  | /s/ VINA L. MARQUARTVina L. Marquart           |  | Director                                                                                                                            |  | March 28, 2004

62



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Shareholders

RTW, Inc.


Minneapolis, Minnesota


We have audited the consolidated financial
statements of RTW, Inc. as of December 31, 2003 and
2002 and for each of the three years in the period ended
December 31, 2003, and have issued our report thereon dated
January 23, 2004. Our audits also included the financial
statement schedules listed in Item 15(a)(2) of this Report
on Form 10-K. These schedules are the responsibility of the
Companys management. Our responsibility is to express an
opinion based on our audits.

In our opinion, the financial statement schedules
referred to above, when considered in relation to the basic
consolidated financial statements taken as a whole, present
fairly in all material respects the information set forth
therein.



| |                       
| | ----------------------
| | /s/ ERNST & YOUNG, LLP

Minneapolis, Minnesota

January 23, 2004


S-1



---



##### Table of Contents



SCHEDULE I

RTW, INC.

SUMMARY OF INVESTMENTS

December 31, 2003


|                   |                     |                                                                   |                   |       |        |                |  |   |        |        |  |   |        |        | 
|------------------ | ------------------- | ----------------------------------------------------------------- | ----------------- | ----- | ------ | -------------- |  | - | ------ | ------ |  | - | ------ | ------ | 
|                   |                     |                                                                   |                   |       |        | Amount at     
|                   |                     |                                                                   |                   |       |        | Which Shown   
|                   |                     | Amortized                                                         |                   | Fair  |        | in the Balance
|Type of investment |                     | Cost                                                              |                   | Value |        | Sheet         
|                   |                     |                                                                   |                   |       |        |               
|                   |                     |                                                                  
|                   |                     | (In thousands)                                                   
|Fixed maturities:  |                     |                                                                   |                   |       |        |                |  |   |        |        |  |  
|                   | Available-for-sale: |                                                                   |                   |       |        |                |  |   |        |        |  |   |       
|                   |                     | Corporate securities                                              |                   | $     |       |                |  | $ |       |        |  | $ |       |       
|                   |                     | Mortgage backed securities                                        |                   |       | 28,514 |                |  |   | 29,005 |        |  |   | 29,005 |       
|                   |                     | Asset backed securities                                           |                   |       | 1,008  |                |  |   | 1,011  |        |  |   | 1,011  |       
|                   |                     | United States government, government agencies and
    authorities |                   |       | 48,152 |                |  |   | 49,155 |        |  |   | 49,155 |       
|                   |                     |                                                                   |                   |       |        |                |  |   |        |        |  |  
|                   |                     |                                                                   | Total Investments |       | $      | 77,674         |  |   | $      | 79,171 |  |   | $      | 79,171 | 
|                   |                     |                                                                   |                   |       |        |                |  |   |        |        |  |  

S-2



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##### Table of Contents



SCHEDULE II

RTW, INC.

CONDENSED FINANCIAL INFORMATION OF THE
REGISTRANT

BALANCE SHEETS


December 31, 2003 and 2002


|                                         |                   |                |        |       |  |   |        |       | 
|---------------------------------------- | ----------------- | -------------- | ------ | ----- |  | - | ------ | ----- | 
|                                         |                   | 2003           |        | 2002 
|                                         |                   |                |        |      
|                                         |                   |               
|                                         |                   | (In thousands)
|ASSETS                                  
|Cash and cash equivalents                |                   | $              | 100    |       |  | $ | 321    |      
|Furniture and equipment, net             |                   |                | 1,242  |       |  |   | 1,619  |      
|Investment in and advances to subsidiary |                   |                | 36,100 |       |  |   | 31,516 |      
|Other assets                             |                   |                | 443    |       |  |   | 441    |      
|                                         |                   |                |        |       |  |   |        |      
|                                         |                   | $              | 37,885 |       |  | $ | 33,897 |      
|                                         |                   |                |        |       |  |   |        |      
|LIABILITIES AND SHAREHOLDERS
    EQUITY
|Accrued expenses and other liabilities   |                   | $              | 2,298  |       |  | $ | 2,837  |      
|Notes payable                            |                   |                |       |       |  |   | 1,250  |      
|                                         |                   |                |        |       |  |   |        |      
|                                         | Total liabilities |                |        | 2,298 |  |   |        | 4,087 | 
|Shareholders equity                     |                   |                | 35,587 |       |  |   | 29,810 |      
|                                         |                   |                |        |       |  |   |        |      
|                                         |                   | $              | 37,885 |       |  | $ | 33,897 |      
|                                         |                   |                |        |       |  |   |        |      

See notes to condensed financial statements.

S-3



---



##### Table of Contents



SCHEDULE II

RTW, INC.

CONDENSED FINANCIAL INFORMATION OF THE
REGISTRANT

STATEMENTS OF OPERATIONS


Years Ended December 31, 2003, 2002 and
2001


|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |        |         |  
|----------------------------------------------------------- | ----------------------------------- | --------------------------------------------------------------------------------- | ----- | ------ | ------ | ---- | ------ | ------ | ------ |  | ------- | ------ | ------- | -
|                                                            |                                     | 2003                                                                              |       | 2002   |        | 2001
|                                                            |                                     |                                                                                   |       |        |        |     
|                                                            |                                     |                                                                                  
|                                                            |                                     | (In thousands)                                                                   
|Revenues:                                                   |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            | Intercompany fee income             |                                                                                   | $     | 16,617 |        |      | $      | 19,998 |        |  | $       | 28,419 |        
|                                                            | Service fee revenue                 |                                                                                   |       | 109    |        |      |        | 22     |        |  |         |       |        
|                                                            | Investment income                   |                                                                                   |       | 2      |        |      |        | 41     |        |  |         | 15     |        
|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            |                                     | Total revenues                                                                    |       |        | 16,728 |      |        |        | 20,061 |  |         |        | 28,434  |  
|Expenses:                                                   |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            | General and administrative expenses |                                                                                   |       | 15,898 |        |      |        | 16,907 |        |  |         | 25,424 |        
|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            |                                     | Income from operations                                                            |       |        | 830    |      |        |        | 3,154  |  |         |        | 3,010   |  
|                                                            | Interest expense                    |                                                                                   |       | 48     |        |      |        | 163    |        |  |         | 511    |        
|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            |                                     | Income before income taxes and equity in
    undistributed net loss of subsidiary |       |        | 782    |      |        |        | 2,991  |  |         |        | 2,499   |  
|                                                            | Income tax expense                  |                                                                                   |       | 91     |        |      |        | 1,213  |        |  |         | 928    |        
|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            |                                     | Income loss before equity in undistributed net
    income (loss) of subsidiary    |       |        | 691    |      |        |        | 1,778  |  |         |        | 1,571   |  
|Equity in undistributed net income (loss) of
    subsidiary |                                     |                                                                                   | 6,308 |        |        |      | 12,541 |        |        |  | (26,786 | )     
|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       
|                                                            |                                     | Net income (loss)                                                                 |       | $      | 6,999  |      |        | $      | 14,319 |  |         | $      | (25,215 | )
|                                                            |                                     |                                                                                   |       |        |        |      |        |        |        |  |         |       

See notes to condensed financial statements.

S-4



---



##### Table of Contents



SCHEDULE II

RTW, INC.

CONDENSED FINANCIAL INFORMATION OF THE
REGISTRANT

STATEMENTS OF CASH FLOWS


Years Ended December 31, 2003, 2002 and
2001


|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |        |         |        |       |        |  
|-------------------------------------------------------- | ----------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------- | ------------------------------------------- | -------------------------------------- | ------------------------------------------------------- | ------ | ------ | ------ | ------ | ------- | ------ | ------ | ------- | ------ | ----- | ------ | -
|                                                         |                                                                                                 | 2003                                                                                         |                                             | 2002                                   |                                                         | 2001  
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |       
|                                                         |                                                                                                 |                                                                                             
|                                                         |                                                                                                 | (In thousands)                                                                              
|Cash Flows from Operating
    Activities:                |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         | Reconciliation of net income (loss) to net cash
    (used in) provided by operating activities: |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |        |        
|                                                         |                                                                                                 | Net income (loss)                                                                            |                                             | $                                      | 6,999                                                   |        |        | $      | 14,319 |         |        | $      | (25,215 | )     
|                                                         |                                                                                                 | Adjustments to reconcile net income (loss) to net
    cash provided by operating activities: |                                             |                                        |                                                         |        |        |        |        |         |        |        |         |       
|                                                         |                                                                                                 |                                                                                              | Depreciation                                |                                        |                                                         | 551    |        |        |        | 605     |        |        |         | 1,203  |      
|                                                         |                                                                                                 |                                                                                              | Equity in net (income) loss from subsidiary |                                        |                                                         | (6,308 | )      |        |        | (12,541 | )      |        |         | 26,786 |      
|                                                         |                                                                                                 |                                                                                              | Deferred income taxes                       |                                        |                                                         |       |        |        |        | 351     |        |        |         | (629   | )    
|                                                         |                                                                                                 |                                                                                              | Changes in assets and liabilities:          |                                        |                                                         |        |        |        |        |         |        |        |         |        |      
|                                                         |                                                                                                 |                                                                                              |                                             | Accrued expenses and other liabilities |                                                         |        | (539   | )      |        |         | (1,318 | )      |         |        | 1,043 |       
|                                                         |                                                                                                 |                                                                                              |                                             | Other, net                             |                                                         |        | (1,271 | )      |        |         | 1,610  |        |         |        | 346   |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        | Net cash (used in) provided by operating
    activities |        |        | (568   | )      |         |        | 3,026  |         |        |       | 3,534  |  
|Cash Flows from Investing
    Activities:                |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         | Investment in and advances to subsidiary                                                        |                                                                                              |                                             | 1,725                                  |                                                         |        |        | 892    |        |         |        | (1,896 | )      
|                                                         | Purchases of furniture and equipment                                                            |                                                                                              |                                             | (175                                   | )                                                       |        |        | (630   | )      |         |        | (379   | )      
|                                                         | Disposals of furniture and equipment                                                            |                                                                                              |                                             | 22                                     |                                                         |        |        | 270    |        |         |        | 972    |        
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        | Net cash provided by (used in) investing
    activities |        |        | 1,572  |        |         |        | 532    |         |        |       | (1,303 | )
|Cash Flows from Financing
    Activities:                |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         | Payments on notes payable                                                                       |                                                                                              |                                             | (1,250                                 | )                                                       |        |        | (3,250 | )      |         |        | (2,500 | )      
|                                                         | Stock options exercised                                                                         |                                                                                              |                                             | 19                                     |                                                         |        |        |       |        |         |        |       |        
|                                                         | Issuance of common stock under ESPP                                                             |                                                                                              |                                             | 43                                     |                                                         |        |        | 10     |        |         |        | 33     |        
|                                                         | Retirement of common stock                                                                      |                                                                                              |                                             | (37                                    | )                                                       |        |        | (79    | )      |         |        | (10    | )      
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        | Net cash used in financing activities                   |        |        | (1,225 | )      |         |        | (3,319 | )       |        |       | (2,477 | )
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|Net (Decrease) Increase in Cash and Cash
    Equivalents |                                                                                                 |                                                                                              | (221                                        | )                                      |                                                         |        | 239    |        |        |         | (246   | )     
|Cash and Cash Equivalents at Beginning of
    Year       |                                                                                                 |                                                                                              | 321                                         |                                        |                                                         |        | 82     |        |        |         | 328    |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|Cash and Cash Equivalents at End of
    Year             |                                                                                                 | $                                                                                            | 100                                         |                                        |                                                         | $      | 321    |        |        | $       | 82     |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|Supplemental Disclosure of Cash Flow
    Information:    |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         | Cash paid (received) during the year for:                                                       |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |        |        
|                                                         |                                                                                                 | Interest                                                                                     |                                             | $                                      | 27                                                      |        |        | $      | 138    |         |        | $      | 641     |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       
|                                                         |                                                                                                 | Income tax (refunds) payments                                                                |                                             | $                                      | (9                                                      | )      |        | $      | 298    |         |        | $      | 325     |       
|                                                         |                                                                                                 |                                                                                              |                                             |                                        |                                                         |        |        |        |        |         |        |       

See notes to condensed financial statements.

S-5



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##### Table of Contents



SCHEDULE II

RTW, INC.

CONDENSED FINANCIAL INFORMATION OF THE
REGISTRANT

NOTES TO CONDENSED FINANCIAL
STATEMENTS


Years Ended December 31, 2003, 2002 and
2001




|         |                    
|-------- | -------------------
|Note 1  | Accounting Policies

The accompanying condensed financial information
should be read in conjunction with the consolidated financial
statements and notes included in the RTW, Inc.
(RTW) 2003 Annual Report on Form 10-K.



|         |                           
|-------- | --------------------------
|Note 2  | Related Party Transactions

RTW provides American Compensation Insurance
Company (ACIC) with management services, including
preparing and submitting filings, maintaining books and records,
collecting premiums, administering and adjudicating claims, and
performing other administrative services. RTW receives 10% of
ACICs gross premiums earned each month for these services,
which amounted to $5.4 million, $6.4 million and
$9.9 million for the years ended December 31, 2003,
2002 and 2001, respectively. In addition, RTW receives 15% of
ACICs gross premiums earned for claims administration
during the year in which the premiums are earned and a total of
4% of gross premiums earned in subsequent years which amounted
to $11.2 million, $13.6 million and $18.6 million
for the years ended December 31, 2003, 2002 and 2001,
respectively.

RTW files a consolidated federal tax return with
ACIC. Taxes are allocated between the companies based on a tax
allocation agreement under which allocation is made primarily on
a separate return basis for taxes incurred with current credit
for any net operating losses or other items utilized in the
consolidated tax return. This allocation is settled annually
after completing and filing the federal tax return.

Amounts due from (to) ACIC related to the
above transactions are included in the balance sheet account
caption Investment in and advances to subsidiary and
totaled approximately $1.3 million and $3.0 million at
December 31, 2003 and 2002, respectively.

S-6



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##### Table of Contents



SCHEDULE III

RTW, INC.

SUPPLEMENTAL INFORMATION CONCERNING INSURANCE
OPERATIONS

|     |  |                |       |              |  |              |         |          |  |          |     |              |  |                      |       |              |  |             |        |            |  |           |       |          |  |   |        |  |  |   |        |   |  |   |        |  |  |   |        |  |  |   |        |  |  |   |        | 
|---- |  | -------------- | ----- | ------------ |  | ------------ | ------- | -------- |  | -------- | --- | ------------ |  | -------------------- | ----- | ------------ |  | ----------- | ------ | ---------- |  | --------- | ----- | -------- |  | - | ------ |  |  | - | ------ | - |  | - | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|     |  |                |       | (Column C)   |  |              |         |          |  |          |     |              |  |                      |       |              |  |             |        |            |  |          
|     |  |                |       | Reserves for |  |              |         |          |  |          |     |              |  | Claim and claim      |       |              |  |             |        |            |  |          
|     |  |                |       | Unpaid       |  |              |         |          |  |          |     | Investment   |  | settlement expenses  |       | Amortization |  | Paid        |        |            |  |          
|     |  | Deferred       |       | Claim and    |  | Discount, if |         |          |  |          |     | Income and   |  | incurred related to: |       | of Deferred  |  | Claim and   |        |            |  |          
|     |  | Policy         |       | Claim        |  | Any,         |         |          |  |          |     | Net Realized |  |                      |       | Policy       |  | Claim       |        | Other      |  |          
|     |  | Acquisition    |       | Settlement   |  | Deducted in  |         | Unearned |  | Earned   |     | Investment   |  | Current              |       | Prior        |  | Acquisition |        | Settlement |  | Operating |       | Premiums
|Year |  | Costs          |       | Expenses     |  | Column C     |         | Premiums |  | Premiums |     | Gains        |  | Year                 |       | Years        |  | Costs       |        | Expenses   |  | Expenses  |       | Written 
|     |  |                |       |              |  |              |         |          |  |          |     |              |  |                      |       |              |  |             |        |            |  |           |       |         
|     |  |               
|     |  | (In thousands)
|2003 |  | $              | 926   |              |  | $            | 150,044 |          |  | $        | 505 |              |  | $                    | 9,180 |              |  | $           | 46,290 |            |  | $         | 5,157 |          |  | $ | 33,954 |  |  | $ | (6,698 | ) |  | $ | 6,878  |  |  | $ | 38,478 |  |  | $ | 10,789 |  |  | $ | 48,340 | 
|2002 |  | $              | 736   |              |  | $            | 181,262 |          |  | $        | 438 |              |  | $                    | 7,130 |              |  | $           | 60,264 |            |  | $         | 6,816 |          |  | $ | 48,889 |  |  | $ | (8,356 | ) |  | $ | 6,304  |  |  | $ | 42,688 |  |  | $ | 9,984  |  |  | $ | 57,656 | 
|2001 |  | $              | 1,214 |              |  | $            | 181,310 |          |  | $        | 482 |              |  | $                    | 9,738 |              |  | $           | 86,057 |            |  | $         | 7,563 |          |  | $ | 72,372 |  |  | $ | 7,731  |   |  | $ | 13,990 |  |  | $ | 56,304 |  |  | $ | 17,391 |  |  | $ | 95,795 | 

S-7



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##### Table of Contents



SCHEDULE IV

RTW, INC.

REINSURANCE

Years ended December 31, 2003, 2002 and
2001


|            |                                  |                 |   |            |  |            |   |        |  |           |   |   |  |  |   |        |  |  |  |       | 
|----------- | -------------------------------- | --------------- | - | ---------- |  | ---------- | - | ------ |  | --------- | - | - |  |  | - | ------ |  |  |  | ----- | 
|            |                                  |                 |   |           
|            |                                  | Premiums Earned |   |           
|            |                                  |                 |   | Percentage
|            |                                  |                 |   | Ceded to   |  | Assumed    |   |        |  | of Amount
|            |                                  |                 |   | Other      |  | from Other |   |        |  | Assumed  
|Description |                                  | Direct          |   | Companies  |  | Companies  |   | Net    |  | to Net   
|            |                                  |                 |   |            |  |            |   |        |  |          
|            |                                  |                
|            |                                  | (In thousands) 
|2003        |                                  |                 |   |            |  |            |   |        |  |           |   |   |  |  |   |        |  |  |  |      
|            | PREMIUMS  Workers Compensation |                 | $ | 54,431     |  |            | $ | 8,141  |  |           | $ |  |  |  | $ | 46,290 |  |  |  | 0.00% | 
|2002        |                                  |                 |   |            |  |            |   |        |  |           |   |   |  |  |   |        |  |  |  |      
|            | PREMIUMS  Workers Compensation |                 | $ | 62,506     |  |            | $ | 2,242  |  |           | $ |  |  |  | $ | 60,264 |  |  |  | 0.00% | 
|2001        |                                  |                 |   |            |  |            |   |        |  |           |   |   |  |  |   |        |  |  |  |      
|            | PREMIUMS  Workers Compensation |                 | $ | 97,420     |  |            | $ | 11,363 |  |           | $ |  |  |  | $ | 86,057 |  |  |  | 0.00% | 

S-8



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##### Table of Contents



SCHEDULE V

RTW, INC.

VALUATION AND QUALIFYING ACCOUNTS

Years ended December 31, 2003, 2002 and
2001


|            |                                 |                |   |            |  |            |   |            |  |            |   |   |  |  |   |     |  |  |   |     | 
|----------- | ------------------------------- | -------------- | - | ---------- |  | ---------- | - | ---------- |  | ---------- | - | - |  |  | - | --- |  |  | - | --- | 
|            |                                 |                |   |            |  |            |   |           
|            |                                 |                |   | Additions  |  |            |   |           
|            |                                 |                |   |            |  |            |   |           
|            |                                 | Balance at     |   | Charged to |  | Charged to |   |            |  | Balance at
|            |                                 | beginning      |   | costs and  |  | other      |   |            |  | end of    
|Description |                                 | of period      |   | expenses   |  | accounts   |   | Write-offs |  | period    
|            |                                 |                |   |            |  |            |   |            |  |           
|            |                                 |               
|            |                                 | (In thousands)
|2003        |                                 |                |   |            |  |            |   |            |  |            |   |   |  |  |   |     |  |  |   |    
|            | Allowance for Doubtful Accounts |                | $ | 220        |  |            | $ | 507        |  |            | $ |  |  |  | $ | 502 |  |  | $ | 225 | 
|2002        |                                 |                |   |            |  |            |   |            |  |            |   |   |  |  |   |     |  |  |   |    
|            | Allowance for Doubtful Accounts |                | $ | 436        |  |            | $ | 98         |  |            | $ |  |  |  | $ | 314 |  |  | $ | 220 | 
|2001        |                                 |                |   |            |  |            |   |            |  |            |   |   |  |  |   |     |  |  |   |    
|            | Allowance for Doubtful Accounts |                | $ | 569        |  |            | $ | 530        |  |            | $ |  |  |  | $ | 663 |  |  | $ | 436 | 

S-9