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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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FORM 10-Q



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



FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004.



OR



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



Commission File Number 1-7461



For the transition period from  to



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ACCEPTANCE INSURANCE COMPANIES INC.

(Exact name of registrant as specified in its charter)



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



Suite 1600, 300 West
Broadway

Council Bluffs, Iowa 51503

(Address of principal executive offices)

(Zip Code)



(712) 329-3600

Registrants Telephone Number, Including Area Code:



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



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



The number of shares of each class of the
Registrants common stock outstanding on August 9, 2004 was:



|                             |  |                          
|---------------------------- |  | -------------------------
|Class of Common Stock        |  | No. of Shares Outstanding
|Common Stock, $.40 Par Value |  | 14,221,882               



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



FORM 10-Q



TABLE OF
CONTENTS



|                              |  |               |  |                                                                                       |  |     
|----------------------------- |  | ------------- |  | ------------------------------------------------------------------------------------- |  | ----
|                              |  |               |  |                                                                                       |  | PAGE
|PART I.
FINANCIAL INFORMATION |  |              
|                              |  |               | 
|                              |  | Item 1.       |  | Financial Statements (unaudited):                                                     |  |     
|                              |  |               | 
|                              |  |               |  | Consolidated Balance Sheets March 31, 2004 and December 31, 2003                      |  | 3   
|                              |  |               | 
|                              |  |               |  | Consolidated Statements of Operations Three Months Ended March 31, 2004 and 2003      |  | 4   
|                              |  |               | 
|                              |  |               |  | Consolidated Statements of Cash Flows Three Months Ended March 31, 2004 and 2003      |  | 5   
|                              |  |               | 
|                              |  |               |  | Notes to Interim Consolidated Financial Statements                                    |  | 6   
|                              |  |               | 
|                              |  | Item 2.       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 20  
|                              |  |               | 
|                              |  | Item 3.       |  | Quantitative and Qualitative Disclosure about Market Risk                             |  | 27  
|                              |  |               | 
|                              |  | Item 4.       |  | Controls and Procedures                                                               |  | 28  
|                              | 
|PART II.
OTHER INFORMATION    |  |              
|                              |  |               | 
|                              |  | Item 1.       |  | Legal Proceedings                                                                     |  | 28  
|                              |  |               | 
|                              |  | Item 6.       |  | Exhibits and Reports on Form 8-K                                                      |  | 30  
|                              |  |              
|                              |  | Signatures    |  | 31                                                                                   
|                              |  |              
|                              |  | Exhibit Index |  | 32                                                                                   



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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)



The
Registrant did not obtain a review of the unaudited interim financial statements included in this Form 10-Q by an independent registered public accounting firm, although that review is required by Form 10-Q, because the Registrant has not yet
engaged an independent registered public accounting firm for 2004.



ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS (dollars in thousands except share data)



|                                                                                          |  |               |          |   |                  |   |          |  
|----------------------------------------------------------------------------------------- |  | ------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                          |  | March 31,2004 |          |   | December 31,2003 |  
|ASSETS                                                                                    |  |               |          |   |                  |   |          |  
|Cash and cash equivalents - parent company                                                |  | $             | 2,198    |   |                  | $ | 2,660    |  
|Restricted cash equivalents                                                               |  |               | 1,430    |   |                  |   | 1,481    |  
|Issue costs of Junior Subordinated Debentures                                             |  |               | 3,098    |   |                  |   | 3,131    |  
|Investment in common stock of AICI Capital Trust holding solely Junior Subordinated Notes |  |               | 3,353    |   |                  |   | 3,279    |  
|Other assets                                                                              |  |               | 340      |   |                  |   | 35       |  
|                                                                                          |  |               |          |   |                  |   |          |  
|                                                                                          |  |               | 10,419   |   |                  |   | 10,586   |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Insurance operations:                                                                     |  |               |          |   |                  |   |          |  
|Investments:                                                                              |  |               |          |   |                  |   |          |  
|Fixed maturities available-for-sale, at fair value                                        |  |               | 75,174   |   |                  |   | 74,340   |  
|Marketable equity securities available-for-sale, at fair value                            |  |               | 623      |   |                  |   | 1,053    |  
|Real estate                                                                               |  |               | 1,112    |   |                  |   | 1,654    |  
|                                                                                          |  |               |          |   |                  |   |          |  
|                                                                                          |  |               | 76,909   |   |                  |   | 77,047   |  
|Cash and cash equivalents                                                                 |  |               | 21,364   |   |                  |   | 27,583   |  
|Receivables, net                                                                          |  |               | 27,555   |   |                  |   | 29,719   |  
|Reinsurance recoverable on unpaid losses and loss adjustment expenses                     |  |               | 131,886  |   |                  |   | 136,527  |  
|Prepaid reinsurance premiums                                                              |  |               | 48       |   |                  |   | 59       |  
|Property and equipment, net of accumulated depreciation                                   |  |               | 741      |   |                  |   | 907      |  
|Other assets                                                                              |  |               | 802      |   |                  |   | 182      |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Insurance operations                                                                      |  |               | 259,305  |   |                  |   | 272,024  |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Total assets                                                                              |  | $             | 269,724  |   |                  | $ | 282,610  |  
|                                                                                          |  |               |          |   |                  |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)                                            |  |               |          |   |                  |   |          |  
|                                                                                          |  |              
|Accounts payable and accrued liabilities                                                  |  | $             | 5,772    |   |                  | $ | 5,781    |  
|Accrued interest on Junior Subordinated Debentures                                        |  |               | 13,970   |   |                  |   | 11,510   |  
|Junior Subordinated Debentures                                                            |  |               | 97,809   |   |                  |   | 97,809   |  
|                                                                                          |  |               |          |   |                  |   |          |  
|                                                                                          |  |               | 117,551  |   |                  |   | 115,100  |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Insurance operations:                                                                     |  |               |          |   |                  |   |          |  
|Losses and loss adjustment expenses                                                       |  |               | 235,191  |   |                  |   | 246,279  |  
|Unearned premiums                                                                         |  |               | 59       |   |                  |   | 73       |  
|Accounts payable and accrued liabilities                                                  |  |               | 15,936   |   |                  |   | 18,518   |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Insurance operations                                                                      |  |               | 251,186  |   |                  |   | 264,870  |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Total liabilities                                                                         |  |               | 368,737  |   |                  |   | 379,970  |  
|                                                                                          |  |               |          |   |                  |   |          |  
|Commitments and contingencies                                                             |  |               |          |   |                  |   |          |  
|                                                                                          |  |              
|Stockholders equity (deficit):                                                           |  |               |          |   |                  |   |          |  
|Preferred stock, no par value, 5,000,000 shares authorized, none issued                   |  |               |         |   |                  |   |         |  
|Common stock, $.40 par value, 40,000,000 shares authorized; 15,685,473 shares issued      |  |               | 6,274    |   |                  |   | 6,274    |  
|Capital in excess of par value                                                            |  |               | 199,660  |   |                  |   | 199,660  |  
|Accumulated other comprehensive income, net of tax                                        |  |               | 506      |   |                  |   | 517      |  
|Accumulated deficit                                                                       |  |               | (275,255 | ) |                  |   | (273,613 | )
|Treasury stock, at cost, 1,463,591 shares                                                 |  |               | (29,969  | ) |                  |   | (29,969  | )
|Contingent stock, 20,396 shares                                                           |  |               | (229     | ) |                  |   | (229     | )
|                                                                                          |  |               |          |   |                  |   |          |  
|Total stockholders equity (deficit)                                                      |  |               | (99,013  | ) |                  |   | (97,360  | )
|                                                                                          |  |               |          |   |                  |   |          |  
|Total liabilities and stockholders equity (deficit)                                      |  | $             | 269,724  |   |                  | $ | 282,610  |  
|                                                                                          |  |               |          |   |                  |   |          |  



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



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands except per share data)

THREE MONTHS ENDED MARCH 31, 2004 AND 2003



|                                    |  |      |        |   |                                |   |        |  
|----------------------------------- |  | ---- | ------ | - | ------------------------------ | - | ------ | -
|                                    |  | 2004 |        |   | 2003 (As Restated -See Note 2) |  
|Revenues:                           |  |      |        |   |                                |   |        |  
|Net investment income               |  | $    | 78     |   |                                | $ | 78     |  
|Net realized capital gains          |  |      |       |   |                                |   | 334    |  
|                                    |  |      |        |   |                                |   |        |  
|                                    |  |      | 78     |   |                                |   | 412    |  
|                                    |  |      |        |   |                                |   |        |  
|Insurance operations:               |  |      |        |   |                                |   |        |  
|Premiums earned                     |  |      | 139    |   |                                |   | 441    |  
|Net investment income               |  |      | 516    |   |                                |   | 984    |  
|Net realized capital gains          |  |      | 895    |   |                                |   | 120    |  
|                                    |  |      |        |   |                                |   |        |  
|                                    |  |      | 1,550  |   |                                |   | 1,545  |  
|                                    |  |      |        |   |                                |   |        |  
|                                    |  |      | 1,628  |   |                                |   | 1,957  |  
|                                    |  |      |        |   |                                |   |        |  
|Costs and expenses:                 |  |      |        |   |                                |   |        |  
|General and administrative expenses |  |      | 203    |   |                                |   | 236    |  
|                                    |  |      |        |   |                                |   |        |  
|Insurance operations:               |  |      |        |   |                                |   |        |  
|Losses and loss adjustment expenses |  |      |       |   |                                |   | 692    |  
|Expenses                            |  |      | 574    |   |                                |   | 2,324  |  
|                                    |  |      |        |   |                                |   |        |  
|                                    |  |      | 574    |   |                                |   | 3,016  |  
|                                    |  |      |        |   |                                |   |        |  
|                                    |  |      | 777    |   |                                |   | 3,252  |  
|                                    |  |      |        |   |                                |   |        |  
|Operating income (loss)             |  |      | 851    |   |                                |   | (1,295 | )
|                                    |  |      |        |   |                                |   |        |  
|Interest expense                    |  |      | (2,493 | ) |                                |   | (2,285 | )
|                                    |  |      |        |   |                                |   |        |  
|Loss before income taxes            |  |      | (1,642 | ) |                                |   | (3,580 | )
|                                    |  |     
|Income tax expense (benefit):       |  |      |        |   |                                |   |        |  
|Current                             |  |      |       |   |                                |   |       |  
|Deferred                            |  |      |       |   |                                |   |       |  
|                                    |  |      |        |   |                                |   |        |  
|                                    |  |      |       |   |                                |   |       |  
|                                    |  |      |        |   |                                |   |        |  
|Net loss                            |  | $    | (1,642 | ) |                                | $ | (3,580 | )
|                                    |  |      |        |   |                                |   |        |  
|Basic and diluted loss per share    |  | $    | (0.12  | ) |                                | $ | (0.25  | )



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



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)

THREE MONTHS ENDED MARCH 31, 2004 AND 2003



|                                                                              |  |      |         |   |                                |   |         |  
|----------------------------------------------------------------------------- |  | ---- | ------- | - | ------------------------------ | - | ------- | -
|                                                                              |  | 2004 |         |   | 2003 (As Restated -See Note 2) |  
|Cash flows from operating activities:                                         |  |      |         |   |                                |   |         |  
|Net loss                                                                      |  | $    | (1,642  | ) |                                | $ | (3,580  | )
|Adjustments to reconcile net loss to net cash from operating activities       |  |      | (5,912  | ) |                                |   | (19,867 | )
|                                                                              |  |      |         |   |                                |   |         |  
|Net cash from operating activities                                            |  |      | (7,554  | ) |                                |   | (23,447 | )
|                                                                              |  |      |         |   |                                |   |         |  
|Cash flows from investing activities:                                         |  |      |         |   |                                |   |         |  
|Proceeds from sales of investments available-for-sale                         |  |      | 3,170   |   |                                |   | 30,448  |  
|Proceeds from maturities of investments available-for-sale                    |  |      | 14,165  |   |                                |   | 3,880   |  
|Proceeds from sales of real estate                                            |  |      | 1,284   |   |                                |   |        |  
|Purchases of investments available-for-sale                                   |  |      | (17,914 | ) |                                |   |        |  
|Change in restricted cash and cash equivalents                                |  |      | 51      |   |                                |   |        |  
|Other, net                                                                    |  |      | 117     |   |                                |   | 1,442   |  
|                                                                              |  |      |         |   |                                |   |         |  
|Net cash from investing activities                                            |  |      | 873     |   |                                |   | 35,770  |  
|                                                                              |  |      |         |   |                                |   |         |  
|Net increase (decrease) in cash and cash equivalents                          |  |      | (6,681  | ) |                                |   | 12,323  |  
|                                                                              |  |     
|Cash and cash equivalents at beginning of period                              |  |      | 30,243  |   |                                |   | 20,048  |  
|                                                                              |  |      |         |   |                                |   |         |  
|Cash and cash equivalents at end of period *                                  |  | $    | 23,562  |   |                                | $ | 32,371  |  
|                                                                              |  |      |         |   |                                |   |         |  
|                                                                              |  |      |         |   |                                |   |         |  
|*  Cash and cash equivalents at end of period are comprised of the following: |  |      |         |   |                                |   |         |  
|Parent company                                                                |  | $    | 2,198   |   |                                | $ | 2,860   |  
|Insurance operations                                                          |  |      | 21,364  |   |                                |   | 29,511  |  
|                                                                              |  |      |         |   |                                |   |         |  
|                                                                              |  | $    | 23,562  |   |                                | $ | 32,371  |  
|                                                                              |  |      |         |   |                                |   |         |  



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



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ACCEPTANCE INSURANCE COMPANIES INC. AND SUBSIDIARIES



NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THREE MONTHS ENDED MARCH 31, 2004 AND 2003

(Columnar Amounts in Thousands Except Per Share Data)



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



Description of Operations  Acceptance Insurance Companies Inc. and subsidiaries (collectively the Company) has been a
provider of property and casualty insurance (Property and Casualty Segment).



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



Principles of Consolidation  The accompanying consolidated financial statements include the accounts of
the Company and its majority-owned subsidiaries, including Acceptance Insurance Company (AIC). All significant intercompany transactions have been eliminated. AIC has been reflected in the consolidated financial statements under the
caption Insurance Operations.



Basis of
Presentation  The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the
consolidated financial statements, the Company had a stockholders deficit of approximately $99.0 million and $97.4 million at March 31, 2004 and December 31, 2003, respectively. These factors among others indicate that there is substantial
doubt about the Companys ability to continue as a going concern.



The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. Additionally, the National Association of Insurance Commissioners has established risk-based capital (RBC) standards to measure the acceptable level of capital an insurer should maintain. As of
March 31, 2004 and December 31, 2003, AIC, the Companys only remaining insurance subsidiary, had negative statutory surplus resulting in RBC at a mandatory control level and is under an administrative Order of Supervision by the Nebraska
Department of Insurance (NEDOI). AIC is no longer authorized to write new or renewal business and may not perform other activities beyond the routine conduct of its runoff business. The Companys continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, the attainment of managements plans as discussed below and no further regulatory action by the NEDOI.



At this time, there can be no assurance as to what actions, if any, the
NEDOI will take in connection with the varying estimates of the Companys reserves and any further changes in estimates, if any. If the NEDOI does take action there can be no assurance as to when it may do so or how long it may take to complete
any such action.



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The NEDOI Director (Director) currently has the authority to increase regulatory control of
AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial condition of AIC. The Company believes that an Order of Rehabilitation would have a significant negative
impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company. If the NEDOI seeks and obtains an Order of Rehabilitation or Order of Liquidation, the Company will decide to take the course of action that
is in the best interests of the Company based on all relevant factors. The Company believes that its possible options will range from no action to filing bankruptcy depending on what type of order, if any, is sought and obtained by the NEDOI, what
actions the NEDOI takes pursuant to any such order and all other factors relevant to taking the actions that are in the best interests of the Company. The filing of a bankruptcy proceeding would constitute an event of default under the trust
agreement for the Junior Subordinated Debentures and Trust Preferred Securities (See Note 3).



Additionally, there is significant uncertainty as to whether AIC will be able to meet its future cash flow needs. A major portion of AICs investments are pledged (See Note 7) and AICs ability to meet its
cash flow needs will be highly dependent upon AICs ability to get significant amounts of pledged funds released. Additionally, AICs cash flows are significantly impacted by any changes in the expected payout of insurance losses and loss
adjustment expenses. AICs ability to meet its cash flow needs is also dependent upon the timely recovery of reinsurance balances, including the favorable resolution of balances currently in dispute (See Note 5). Based upon current estimates,
management of the Company believes AIC would likely have the ability to meet its cash flow needs through March 31, 2005 assuming the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC. There can be no
assurances considering the significant uncertainties that exist, that AIC will have the ability to meet its cash flow needs through March 31, 2005.



There is also significant uncertainty as to whether Acceptance Insurance Companies Inc. (AICI) will be able to meet its cash flow needs. AICI
has deferred interest payments on its Junior Subordinated Debentures (See Note 3), which in turn deferred the interest on the Trust Preferred Securities issued by AICI Capital Trust, as permitted by the trust agreement and indenture, and AICI has
disputed or denied payments of certain other liabilities and commitments. Based upon current estimates, management of the Company believes AICI would likely have the ability to meet its cash flow needs through March 31, 2005 assuming the NEDOI does
not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC. There can be no assurances considering the significant uncertainties that exist, that AICI will have the ability to meet its cash flow needs through March 31, 2005.
If the NEDOI obtains an Order of Rehabilitation or Order of Liquidation with respect to AIC, the Company believes that it is unlikely that AICI would be able to meet its short-term cash flow needs.



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Management has not adopted or contemplated to adopt a plan of liquidation; however, management may
contemplate or adopt such strategies that are believed to be in the best interests of the Company which strategy could include a bankruptcy filing in liquidation or reorganization. Managements current short-term business plan can be summarized
as follows:



| | (a) | minimize payments of losses and loss adjustment expenses;
| | --- | ---------------------------------------------------------



| | (b) | effectively manage the collection of reinsurance balances;
| | --- | ----------------------------------------------------------



| | (c) | maintain adequate liquidity to meet cash needs;
| | --- | -----------------------------------------------



| | (d) | reduce expenses required to manage the run-off of the property and casualty operations; and
| | --- | -------------------------------------------------------------------------------------------



| | (e) | preserve and, if possible, enhance Company assets.
| | --- | --------------------------------------------------



Unless these current short-term strategies are successful, the Company will not have the ability to implement any longer term strategies. The total focus
continues to be on successfully accomplishing the above short-term strategies. If the Company is able to meet these short-term objectives, management may consider several strategies. These strategies may include commutation of reinsurance treaties,
loss portfolio transfers, unwinding of trust balances and related items, sale of active and/or shell subsidiaries or other assets and other options that may be available. The Company may be required to accomplish certain of these strategies to meet
its short-term and long-term objectives. At this time, management is unable to determine if any of these strategies will be available and if so, under acceptable terms to both the Company and the NEDOI. As such, it is uncertain if the Company can
achieve its short-term or long-term objectives.



Even if the
Company is able to meet these short-term objectives, management believes it is unlikely the Company will be able to make its interest payments on the Junior Subordinated Debentures which have been deferred until no later than September 30, 2007 (See
Note 3).



Recent Statements of Financial Accounting
Standards  In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities, which the Company adopted in 2003 with no impact to the consolidated financial statements. In December 2003, the FASB revised
FIN No. 46 (FIN 46R) and deferred its adoption for variable interest entities (VIEs) that meet certain criteria until the first quarter of 2004. FIN 46R clarified the definition of a variable interest such that only the
holder of a variable interest can ever be the VIEs primary beneficiary. Only primary beneficiaries are permitted to consolidate VIEs. Therefore, FIN 46R does not permit consolidation of VIEs in which a company has voting control but is not the
primary beneficiary. The AICI Capital Trust that is liable for the Companys Trust Preferred Securities meets the definition of a VIE. Under FIN 46R, the Company is not the primary beneficiary in the AICI Capital Trust. For this reason, the
Company may no longer consolidate the AICI Capital Trust, even though the Company is the sole owner of the voting equity of these entities.



With the adoption of FIN No. 46R, effective January 1, 2004, prior periods were restated for comparability. The effect of adoption was to increase the
Companys long-term debt and accrued interest by approximately $3.3 million with a corresponding increase in the investment in common stock of AICI Capital Trust of an equal amount. In addition, investment income and interest expense were
increased by approximately $74,000 and $68,000 for the three months ended March 31, 2004, and 2003, respectively.



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



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|2. | RESTATEMENT AND RECLASSIFICATION OF FINANCIAL STATEMENTS
|-- | --------------------------------------------------------



Subsequent to the issuance of the Companys March 31, 2003 consolidated financial statements, the Company determined that SFAS No. 144 was not
properly applied to the March 31, 2003 consolidated financial statement presentation. The accounting policy the Company previously used classified the Companys property and casualty operations as discontinued operations due to its inability to
write new business under the Order of Supervision.



Under the
provisions of SFAS No. 144 a component of an entity is deemed to be disposed of if both of the following conditions are met: (a) the operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the
entity as a result of the disposal transaction and (b) the entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. EITF Topic No. D-104, Clarification of Transition Guidance
in Paragraph 51 of FASB Statement No. 144 clarifies that when a component of an entity will be abandoned through the liquidation or run-off of operations, that component should not be reported as a discontinued operation in accordance with
FASB 144 until all operations, including run-off operations, cease. The Company originally concluded that the Property and Casualty Segment had been discontinued when the NEDOI placed AIC in supervision. Although the Company is no longer
writing property and casualty insurance policies, managing the run-off of the liabilities resulting from that business has been determined to be a continuing operation of the Company under SFAS No. 144 until all such run-off ceases. Therefore, the
Companys consolidated financial statements for March 31, 2003 have been restated from amounts previously reported to reflect the property and casualty operations as continuing operations of the Company.



Additionally, subsequent to the issuance of the March 31, 2003 financial
statements, the Company determined that the consolidated statements of cash flows did not include cash flows from discontinued operations. The March 31, 2003 consolidated cash flows previously reported solely reflected cash flows from continuing
operations.



9



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##### Table of Contents

A summary of the significant effects of the restatement is as follows:



Consolidated Statement of Operations



|                                                       |  |                      |        |   |            |   |        |  
|------------------------------------------------------ |  | -------------------- | ------ | - | ---------- | - | ------ | -
|                                                       |  | March 31, 2003       |       
|                                                       |  | AsPreviouslyReported |        |   | AsRestated |  
|Insurance premiums earned                              |  | $                    |       |   |            | $ | 441    |  
|Net investment income                                  |  |                      |       |   |            |   | 984    |  
|Net realized capital gains (losses)                    |  |                      |       |   |            |   | 120    |  
|Insurance losses and loss adjustment expenses          |  |                      |       |   |            |   | 692    |  
|Insurance expenses                                     |  |                      |       |   |            |   | 2,324  |  
|Operating income (loss)                                |  |                      | 108    |   |            |   | (1,295 | )
|Loss before income taxes and discontinued operations   |  |                      | (2,109 | ) |            |   | (3,580 | )
|Income (loss) from discontinued operations, net of tax |  |                      | (1,471 | ) |            |   |       |  
|Net loss                                               |  |                      | (3,580 | ) |            |   | (3,580 | )
|Income (loss) per share:                               |  |                      |        |   |            |   |        |  
|Loss from continuing operations                        |  |                      | (0.15  | ) |            |   | (0.25  | )
|Income (loss) from discontinued operations             |  |                      | (0.10  | ) |            |   |       |  
|Net loss                                               |  |                      | (0.25  | ) |            |   | (0.25  | )



Consolidated Statement of Cash
Flows



|                                                     |  |                      |       |   |            |   |         |  
|---------------------------------------------------- |  | -------------------- | ----- | - | ---------- | - | ------- | -
|                                                     |  | March 31, 2003       |      
|                                                     |  | AsPreviouslyReported |       |   | AsRestated |  
|Net cash from operating activities                   |  | $                    | (447  | ) |            | $ | (23,447 | )
|Net cash from investing activities                   |  |                      | 204   |   |            |   | 35,770  |  
|Net cash from financing activities                   |  |                      |      |   |            |   |        |  
|                                                     |  |                      |       |   |            |   |         |  
|Net increase (decrease) in cash and cash equivalents |  |                      | (243  | ) |            |   | 12,323  |  
|                                                     |  |                     
|Cash and cash equivalents at beginning of year       |  |                      | 3,103 |   |            |   | 20,048  |  
|                                                     |  |                      |       |   |            |   |         |  
|Cash and cash equivalents at end of year             |  | $                    | 2,860 |   |            | $ | 32,371  |  
|                                                     |  |                      |       |   |            |   |         |  



The restatement of
the consolidated statement of operations had no impact to the previously reported net loss and there was no impact to the previously reported stockholders equity. Certain other reclassifications of the prior years financial statements
were made to conform to the 2004 presentation.



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##### Table of Contents

|3. | JUNIOR SUBORDINATED DEBENTURES OF THE COMPANY
|-- | ---------------------------------------------



In August 1997, AICI Capital Trust, a Delaware business trust organized by the Company (the Issuer Trust) issued 3.795 million shares or
$94.875 million aggregate liquidation amount of its 9% Preferred Securities (liquidation amount $25 per Preferred Security). The Company owns all of the common securities (the Common Securities) of the Issuer Trust. The Preferred
Securities represent preferred undivided beneficial interests in the Issuer Trusts assets. The assets of the Issuer Trust consist solely of the Companys 9% Junior Subordinated Debentures due in 2027, which were issued in August 1997 in
an amount equal to the total of the Preferred Securities and the Common Securities. Distributions on the Preferred Securities and Junior Subordinated Debentures are cumulative, accrue from the date of issuance and are payable quarterly in arrears.
The Junior Subordinated Debentures are subordinate and junior in right of payment to all senior indebtedness of the Company and are subject to certain events of default. The issue costs on the Junior Subordinated Debentures are being amortized over
the term of the debt.



Effective January 1, 2004, the Company
adopted FIN 46R. FIN 46R required the Company to deconsolidate the AICI Capital Trust. As a result of the adoption of FIN 46R, the Company now reports $97.8 million of the Companys Junior Subordinated Debentures, which were issued to the AICI
Capital Trust, on its consolidated balance sheet. The effect of the adoption increased the Companys long-term debt by approximately $2.9 million. Additionally, investment income and interest expense were increased by approximately $68,000 for
the three months ended March 31, 2003.



Effective November 18,
2002, the Company elected to defer payment of interest on its Junior Subordinated Debentures, as permitted by the trust agreement and indenture, beginning with the interest payment date on December 31, 2002 until not later than September 30, 2007.
The interest payments on the Preferred Securities will be deferred for a corresponding period. As of March 31, 2004 approximately $14.0 million of accrued interest had been deferred. See Note 1 regarding managements expectations regarding the
Companys ability to pay such interest payments.



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##### Table of Contents

|4. | INSURANCE OPERATIONS - INVESTMENTS
|-- | ----------------------------------



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



|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|------------------------------------------- |  | -------------------- | ------ | -------------------- | - | --------------------- |  | ------------------ | --- |  | - | ------
|                                            |  | Cost orAmortizedCost |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFairValue
|March 31, 2004:                             |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|Fixed maturities available-for-sale:        |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|U.S. Treasury and government securities     |  | $                    | 56,948 |                      | $ | 506                   |  | $                  | 35  |  | $ | 57,419
|Other debt securities                       |  |                      | 17,608 |                      |   | 192                   |  |                    | 45  |  |   | 17,755
|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|                                            |  | $                    | 74,556 |                      | $ | 698                   |  | $                  | 80  |  | $ | 75,174
|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|Marketable equity securities - common stock |  | $                    | 735    |                      | $ |                      |  | $                  | 112 |  | $ | 623   
|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|                                            |  |                      |        |                     
|                                            |  | Cost orAmortizedCost |        | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFairValue
|December 31, 2003:                          |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|Fixed maturities available-for-sale:        |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|U.S. Treasury and government securities     |  | $                    | 57,969 |                      | $ | 376                   |  | $                  | 25  |  | $ | 58,320
|Other debt securities                       |  |                      | 15,770 |                      |   | 253                   |  |                    | 3   |  |   | 16,020
|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|                                            |  | $                    | 73,739 |                      | $ | 629                   |  | $                  | 28  |  | $ | 74,340
|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       
|Marketable equity securities - common stock |  | $                    | 1,137  |                      | $ | 15                    |  | $                  | 99  |  | $ | 1,053 
|                                            |  |                      |        |                      |   |                       |  |                    |     |  |   |       



The following table
shows the investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in an unrealized loss position, at March 31, 2004:



|                                            |  |                     |       |                   |   |           |  |                  |     |           |   |                  |  |   |       |  |   |    
|------------------------------------------- |  | ------------------- | ----- | ----------------- | - | --------- |  | ---------------- | --- | --------- | - | ---------------- |  | - | ----- |  | - | ---
|                                            |  | Less Than 12 Months |       | 12 Months or More |   | Total    
|                                            |  | FairValue           |       | UnrealizedLosses  |   | FairValue |  | UnrealizedLosses |     | FairValue |   | UnrealizedLosses
|Fixed maturities available-for-sale:        |  |                     |       |                   |   |           |  |                  |     |           |   |                  |  |   |       |  |   |    
|U.S. Treasury and government securities     |  | $                   | 6,256 |                   | $ | 35        |  | $                |    |           | $ |                 |  | $ | 6,256 |  | $ | 35 
|Other debt securities                       |  |                     | 955   |                   |   | 45        |  |                  |    |           |   |                 |  |   | 955   |  |   | 45 
|                                            |  |                     |       |                   |   |           |  |                  |     |           |   |                  |  |   |       |  |   |    
|                                            |  |                     | 7,211 |                   |   | 80        |  |                  |    |           |   |                 |  |   | 7,211 |  |   | 80 
|Marketable equity securities - common stock |  |                     |      |                   |   |          |  |                  | 622 |           |   | 112              |  |   | 622   |  |   | 112
|                                            |  |                     |       |                   |   |           |  |                  |     |           |   |                  |  |   |       |  |   |    
|Total temporarily impaired securities       |  | $                   | 7,211 |                   | $ | 80        |  | $                | 622 |           | $ | 112              |  | $ | 7,833 |  | $ | 192
|                                            |  |                     |       |                   |   |           |  |                  |     |           |   |                  |  |   |       |  |   |    



Management has
reviewed these securities and the related unrealized losses and believes these are not other-than-temporarily impaired. The unrealized losses on marketable equity securities  common stock relates to three investments and the aggregate fair
value of these securities has increased by approximately 52% from March 31, 2003 to March 31, 2004 resulting in a decrease in unrealized losses of approximately $213,000.



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##### Table of Contents

As required by insurance regulatory laws, certain fixed maturities with an estimated fair value of
approximately $7.6 million at March 31, 2004 were deposited in trust with regulatory agencies. Additionally, at March 31, 2004, approximately $43.3 million of fixed maturities available-for-sale and $248,000 of cash equivalents were pledged to
Clarendon National Insurance Company (Clarendon) to secure the Companys obligations under reinsurance agreements and approximately $12.0 million of fixed maturities available-for-sale and $66,000 of cash equivalents were pledged to
McM Corporation (McM) to secure the Companys net obligations under the reinsurance agreements (See Note 7).



|5. | INSURANCE OPERATIONS  REINSURANCE
|-- | ----------------------------------



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



The Company reinsures certain
portions of the Companys business issued by Clarendon, Redland Insurance Company (Redland), Acceptance Indemnity Insurance Company (AIIC) and Acceptance Casualty Insurance Company (ACIC). Under these
reinsurance agreements, the Company assumed business after Clarendon, Redland, AIIC, and ACIC cessions to outside reinsurers (See Note 7). However, the Company is contingently liable for any uncollectible amounts due from these outside reinsurers
related to business produced and managed by the Company.



At
December 31, 2003, PMA Reinsurance Group (PMA) accounts for approximately 13% of the Companys outstanding reinsurance recoverables and reinsurance balances for which the Company is contingently liable (collectively Total
Reinsurance Balances). PMA had its financial strength lowered by A.M. Best from A- (Excellent) to B++ (Very Good) in the fourth quarter of 2003. As of December 31, 2003 the Company has outstanding reinsurance recoverables from PMA of
approximately $26.1 million and is contingently liable for AIIC and Redland reinsurance recoverables from PMA totaling approximately $9.0 million. With the exception of outstanding questions related to specific claims, as of March 31, 2004 PMA
continues to make regular payments to the Company for reinsurance billings and accordingly, no specific allowances for doubtful accounts or liability has been established for these balances.



At December 31, 2003, Gerling Global Reinsurance Corp. (Gerling)
accounts for approximately 13% of the Total Reinsurance Balances. Gerling had its financial strength rating lowered by A.M. Best from A- (Excellent) to B- (Fair) during the fourth quarter of 2002. In January 2003, in response to a request from
Gerlings parent to withdraw from the rating process, A.M. Best withdrew its financial strength rating of B- and assigned Gerling and its parent an NR-3 rating (Rating Procedure Inapplicable). As of December 31, 2003 the Company has outstanding
reinsurance recoverables from Gerling of approximately $35.1 million and is contingently liable for AIIC and Redland reinsurance recoverables from Gerling totaling approximately $1.7 million. As of March 31, 2004 Gerling continues to make regular
payments to the Company for reinsurance billings and accordingly, no specific allowance for doubtful accounts or liability has been established for these balances.



The Company has reinsurance recoverables and is contingently liable for AIIC and Redland reinsurance recoverables that are
currently being disputed or payments have been delayed pending resolution of outstanding inquiries. While the Company believes the reinsurers will be required to pay amounts due under the terms of the reinsurance agreements and, accordingly, a
liability has not been established for these reinsurance recoveries, the ultimate outcome cannot be predicted at this time.



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##### Table of Contents

|6. | INSURANCE OPERATIONS  REGULATORY MATTERS
|-- | -----------------------------------------



As of March 31, 2004 and December 31, 2003, the only remaining consolidated insurance company of AICI is AIC. The Director entered an administrative Order
of Supervision with respect to AIC on December 20, 2002 and AIC is currently operating pursuant to that Order. AICs total statutory policyholders deficit was approximately $59.6 million and $61.3 million as of March 31, 2004 and December
31, 2003. The statutory deficit at March 31, 2004 and December 31, 2003 was significantly impacted by the non-admission under statutory accounting principles of pledged investments totaling approximately $55.1 million and $57.5 million, respectively
(See Note 7).



The National Association of Insurance
Commissioners has established risk-based capital (RBC) standards. RBC standards are designed to measure the acceptable level of capital an insurer should have, based on the inherent and specific risks of each insurer. As of March 31,
2004 and December 31, 2003, AIC had negative statutory surplus, resulting in a RBC at the mandatory control level. Under the mandatory control level, the Director may take such actions as necessary to place AIC under regulatory control under the
Nebraska Insurers Supervision, Rehabilitation, and Liquidation Act. Since AIC is currently in run-off, the Director is permitted to allow AIC to continue its run-off under supervision of the NEDOI. While AIC is currently in supervision, the Director
has the authority to increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an Order of Liquidation, with or without a change in the financial condition of AIC. The Company believes that an Order
of Rehabilitation would have a significant negative impact on the Company and that an Order of Liquidation would have a material adverse effect on the Company (See Note 1).



Under the Order of Supervision, AIC is required to pay all costs incurred by the Supervisor, AIC may not accept or renew any
insurance business and may not perform any activities beyond those that are routine in the day-to-day conduct of its runoff business without prior approval of the Director or Supervisor. Additionally, any transactions with affiliates or former
affiliates require prior approval of the Director or Supervisor.



|7. | INSURANCE OPERATIONS  SALE OF SUBSIDIARIES AND PROPERTY AND CASUALTY BUSINESS AND RELATED GUARANTEES
|-- | -----------------------------------------------------------------------------------------------------



The Company sold its wholly owned subsidiary, Redland, to Clarendon
effective as of July 1, 2000. The sale was a cash transaction of approximately $10.9 million based upon the market value of Redland after the divestiture of various assets, including the Redland subsidiaries, to a wholly owned subsidiary of
Acceptance Insurance Companies Inc. The transaction included the appointment of other Company subsidiaries as a producer and administrator for the business the Company wrote through Clarendon and Redland. The Company also reinsures certain portions
of the Companys business issued by Clarendon and Redland. At March 31, 2004, approximately $43.3 million of fixed maturities available-for-sale and $248,000 of cash equivalents were placed in a trust and pledged to Clarendon to secure the
Companys obligations under reinsurance agreements. Under these reinsurance agreements, the Company assumed business from Clarendon and Redland after cessions to outside reinsurers (Clarendon Reinsurers). At March 31, 2004,
Clarendon and Redland reinsurance recoverables from Clarendon Reinsurers, totaled approximately $77 million (See Note 5). The Company is contingently liable for any uncollectible amounts due from Clarendon Reinsurers related to this business.



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



As of July 1, 2001, the Company sold two
wholly owned insurance companies to McM. The two companies, AIIC and ACIC, underwrote primarily property and casualty insurance. The Company



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##### Table of Contents

reinsures certain portions of the Companys business issued by AIIC and ACIC. As of March 31, 2004
approximately $12.0 million of fixed maturities available-for-sale and $66,000 of cash equivalents were placed in a trust and pledged to McM to secure the Companys net obligations under the reinsurance agreements. Under these reinsurance
agreements, the Company assumed business from AIIC and ACIC after cessions to outside reinsurers (AIIC Reinsurers). At March 31, 2004, AIIC and ACIC reinsurance recoverables from AIIC Reinsurers, totaled approximately $25 million (See
Note 5). The Company is contingently liable for any uncollectible amounts due from AIIC Reinsurers related to this business.



The Companys off-balance sheet obligations for the Clarendon and AIIC Reinsurers total approximately $102 million. The Company has guaranteed the
performance of these Clarendon and AIIC Reinsurers. If these Clarendon and AIIC Reinsurers do not meet their obligations, whether or not due to their ability or willingness to pay, the Company will be obligated. The timing for the reinsurers
performance of these obligations is currently not known and the amounts will become due from the reinsurers as the underlying direct claim payments are made. Additionally, the $102 million is an estimate of unpaid ceded losses and loss adjustment
expenses on Redland, Clarendon, AIIC and ACIC, and are subject to considerable estimation judgment due to the inherent uncertainty in projecting ultimate claim amounts that will be reported and settled over a period of many years.



|8. | NET LOSS PER SHARE
|-- | ------------------



The net loss per basic and diluted share for the three months ended March 31, 2004 and 2003 were as follows:



|                                           |  |      |        |   |      |   |        |  
|------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                           |  | 2004 |        |   | 2003 |  
|Net loss                                   |  | $    | (1,642 | ) |      | $ | (3,580 | )
|                                           |  |      |        |   |      |   |        |  
|Weighted average common shares outstanding |  |      | 14,201 |   |      |   | 14,201 |  
|                                           |  |      |        |   |      |   |        |  
|Basic and diluted loss per share:          |  | $    | (0.12  | ) |      | $ | (0.25  | )



Stock options were not
included in the above calculations for the three months ended March 31, 2004 and 2003 due to their antidilutive nature.



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##### Table of Contents

|9. | OTHER COMPREHENSIVE INCOME
|-- | --------------------------



Other comprehensive income determined in accordance with SFAS No. 130 for the three months ended March 31, 2004 and 2003 are as follows:



|                                                                                     |  |      |        |   |      |   |        |  
|------------------------------------------------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                                                                     |  | 2004 |        |   | 2003 |  
|Net loss                                                                             |  | $    | (1,642 | ) |      | $ | (3,580 | )
|Unrealized holding gains (losses) of investments, net of reclassification adjustment |  |      | (11    | ) |      |   | 23     |  
|Income tax expense (benefit)                                                         |  |      |       |   |      |   |       |  
|                                                                                     |  |      |        |   |      |   |        |  
|                                                                                     |  |      | (11    | ) |      |   | 23     |  
|                                                                                     |  |      |        |   |      |   |        |  
|Other comprehensive loss                                                             |  | $    | (1,653 | ) |      | $ | (3,557 | )
|                                                                                     |  |      |        |   |      |   |        |  



|10. | STOCK-BASED COMPENSATION
|--- | ------------------------



The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (SFAS No. 123),
Accounting for Stock-Based Compensation, establishing financial accounting and reporting standards for stock-based compensation plans. As permitted by SFAS No. 123, the Company continues to use the method prescribed by the Accounting
Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. Companies using APB 25 are required to make pro forma footnote disclosures of net income and earnings per share as if the fair value method of
accounting, as defined in SFAS No. 123, had been applied.



The
Company has adopted the pro forma footnote disclosure only provisions under SFAS No. 123, as amended by SFAS No. 148. Had compensation cost for the Companys stock-based compensation plans been determined based on the fair value at the grant
dates for awards under those plans consistent with the method of SFAS No. 123, as amended by SFAS No. 148, the Companys net loss and net loss per share would have been as indicated below:



|                                                         |  |      |        |   |      |   |        |  
|-------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                                                         |  | 2004 |        |   | 2003 |  
|Net loss:                                                |  |      |        |   |      |   |        |  
|As reported                                              |  | $    | (1,642 | ) |      | $ | (3,580 | )
|Fair value based method compensation expense, net of tax |  |      | 57     |   |      |   | 150    |  
|                                                         |  |      |        |   |      |   |        |  
|Pro forma                                                |  | $    | (1,699 | ) |      | $ | (3,730 | )
|                                                         |  |      |        |   |      |   |        |  
|Net loss per share:                                      |  |      |        |   |      |   |        |  
|As reported                                              |  | $    | (0.12  | ) |      | $ | (0.25  | )
|Pro forma                                                |  |      | (0.12  | ) |      |   | (0.26  | )



The difference between
the net loss, as reported, and the pro forma net loss relates to total stock-based employee compensation expense determined under the fair value based method.



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##### Table of Contents

|11. | EMPLOYEE BENEFITS AND INCENTIVES
|--- | --------------------------------



The Company expects to incur a total of approximately $1.1 million of employee termination benefits related to 27 employees, comprised primarily of
retention and severance amounts. Approximately $107,000 and $179,000 of employee termination benefits have been expensed in insurance operations  insurance expenses during the three months ended March 31, 2004 and 2003, respectively. During
the three months ended March 31, 2004 approximately $133,000 of termination benefits were paid and as of March 31, 2004 the Company has an accrued liability of approximately $528,000.



In order to induce employees of AIC to remain in the employment of AIC, AICI has agreed to pay each employee a retention
bonus in the event AIC would be unable to meet this obligation. Additionally, AICI has agreed to guarantee certain amounts due under employment agreements with the Chief Executive Officer and Chief Financial Officer. During the second quarter of
2003, AICI agreed to guarantee these obligations under the retention and employment agreements by establishing an appropriate trust with a bank whereby the amount of such guarantees, totaling approximately $1.1 million, have been deposited in such
trust account. The amounts held in the trust account at March 31, 2004, totaling approximately $1.0 million, are presented as restricted cash equivalents on the Companys consolidated balance sheet.



During the second quarter of 2003, the Company established an incentive
bonus plan. The purpose of the incentive bonus plan is to protect and enhance the interest of creditors and stockholders by providing all employees with meaningful incentives. The incentive bonus plan establishes that up to 20% of an incentive bonus
pool, determined based upon value added criteria detailed in the agreement, would be allocated and paid to employees based upon established allocation percentages. As of March 31, 2004, the criteria established within the agreement have not been met
and the Company is unable to estimate any amounts that may become due and, as such, no amounts have been accrued.



|12. | LEGAL PROCEEDINGS
|--- | -----------------



Class Action Complaint



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



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



17



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##### Table of Contents

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



On August 6, 2001, the Magistrate Judge granted Plaintiffs Motion for Class Certification. Plaintiffs fact discovery was concluded July 31,
2002 in accordance with a schedule established by the Court. On September 16, 2002 Plaintiffs sought the Courts permission to reinstate certain previously dismissed claims under Section 11 and 15 of the Securities Act. The Court denied
Plaintiffs request in its entirety on February 27, 2003. The Company filed a motion to decertify the class and a motion for summary judgment. On March 31, 2004, the Court granted the defendants motion for summary judgment in full,
dismissing all of the plaintiffs remaining claims against all of the remaining defendants, and denied all other pending motions as moot. The plaintiffs have appealed the Courts decision.



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



Takings Claim



On December 9, 2003, the
Company filed a complaint against the United States of America. The complaint was filed in the United States Court of Federal Claims as discussed in the following two paragraphs.



In November 2002, the Company and Rain and Hail L.L.C. (Rain and Hail) entered into a letter of intent under
which Rain and Hail agreed to purchase certain insurance assets of AGIC, a wholly owned subsidiary of the Company. Such assets were reinsured by, and subject to the oversight of, the FCIC. The transaction was subject to the approval of the Office of
Risk Management, or the Risk Management Agency (the RMA). Ross J. Davidson, the Administrator of the RMA, advised that he would not approve the proposed sale of assets from the Company to Rain and Hail. The RMA subsequently enjoined AGIC
from writing any new or renewal business. The Company alleges that the RMAs actions rendered valueless the insurance business of AGIC.



The Company also alleges that in rejecting the proposed transaction between the Company and Rain and Hail, the RMA effected a taking of the Companys
property (i.e., the AGIC insurance assets) for public use without just compensation in violation of the Fifth Amendment to the United States Constitution. The Company seeks relief for its damages for the fair market value of the AGIC
insurance assets in an amount of not less than $21.5 million, reasonable attorneys fees and expert witness costs pursuant to 42 U.S.C. § 4654(c) with interest from the date of taking and such further relief the Court deems appropriate. On
February 9, 2004 the United States filed a motion to dismiss the Companys complaint and the Company filed a response to the motion to dismiss. The Court held a hearing



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regarding the motion to dismiss and response and has the motion under advisement. The ultimate outcome of
this action cannot be predicted at this time and, accordingly, the Company currently is unable to determine the potential effect of this litigation on its consolidated financial position, results of operations or cash flows.



Granite Re Action



On April 15, 2004, Granite Reinsurance Company, LTD. (Granite
Re) filed an action against the Company in the United States District Court for the Southern District of Indiana styled Granite Reinsurance Company, Ltd. v. Acceptance Insurance Companies, Inc., (S.D. Indiana, Case. No.
1:04-cv-0670-SEB-VSS) (the Granite Re Action). In the Granite Re Action, Granite Re alleges the Company breached certain alleged obligations under a reinsurance treaty entered into between the parties on June 6, 2001. Specifically,
Granite Re alleges the Company breached an alleged obligation to pay Granite Re $3.0 million annually for a three year period, or a total of $9.0 million, for reinsurance. The Company filed a timely motion to dismiss the complaint in the Granite Re
Action arguing Granite Re filed the complaint in the wrong forum. Granite Re has yet to respond to the motion. The Company expects to vigorously defend the Granite Re Action. The ultimate outcome of this action cannot be predicted at this time and
the Company currently is unable to determine the potential effect of this litigation on its financial position, results of operations or cash flows.



Buchanan Action



In July 2004, P. Thompson Buchanan, the former President and a 40% shareholder of USAG Insurance Services, Inc., a Texas corporation 60% owned by Growers,
filed an Original Petition in the District Court, Lubbock County, Texas against the Company, Growers and certain officers and directors of the Company styled Buchanan v. Martin, et al., No. 2004-527 (District Court, Lubbock County, Texas). In
the Original Petition, Buchanan alleges he suffered damage because he allegedly was wrongfully terminated from his employment and not paid a severance. Mr. Buchanan further alleges he suffered a business loss as a result of alleged
misrepresentations and other alleged misconduct. Mr. Buchanan claims losses in an amount not less than $13,000,000. The Company has engaged counsel and intends to vigorously defend this proceeding. The ultimate outcome of this action cannot be
predicted at this time and the Company currently is unable to determine the potential effect of this litigation on its financial position, results of operations or cash flows.



|13. | COMMITMENTS AND CONTINGENCIES
|--- | -----------------------------



Pursuant to a May 1999 agreement with RMA, for a period of time AIC became the nominal holder of the Companys Standard Reinsurance Agreement. The
agreement expressly provided that it would not affect any liabilities among AGIC, AIC and other Company affiliates, and, the Company does not believe AIC has any obligations as a result of this agreement. Nevertheless, the future conduct of RMA with
respect to the May 1999 agreement is uncertain and the cost of defeating even a baseless RMA allegation involving the May 1999 agreement could be material to the Company.



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



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



Overview



Acceptance Insurance Companies Inc.s (AICI) tangible assets are comprised of approximately $2.2 million in cash and cash equivalents and
$1.4 million of restricted cash equivalents. Additionally, AICI has an investment in its subsidiary, Acceptance Insurance Company (AIC). AICI may also benefit from proceeds, if any, related to its complaint against the United States of
America (See Part II Other Information, Item 1. Legal Proceedings) and proceeds, if any, related to the sale of any of its shell subsidiaries or other assets. AICIs short-term strategy is to reduce expenses and maintain adequate
short-term liquidity while preserving and, if possible, enhancing assets. There is significant uncertainty as to whether or not AICI will be able to achieve the objectives under its short-term strategy. If AICI is unable to achieve these objectives
or believes that other strategies or objectives are in the best interest of the Company, the Company will decide to take the course of action that is in the best interests of the Company based upon all relevant factors, which action may include
filing bankruptcy either in liquidation or reorganization.



AICI currently does not have access to the assets of its wholly owned subsidiary, AIC. AIC is regulated by the Nebraska Department of Insurance (NEDOI). The NEDOI Director (Director) entered an administrative Order
of Supervision with respect to AIC on December 20, 2002 and AIC currently is operating pursuant to that Order. AICs total statutory policyholders deficit was approximately $59.6 million at March 31, 2004.



The Companys short-term strategy related to AIC is to minimize
payments of losses and loss adjustment expenses, effectively manage the collection of reinsurance balances, maintain adequate short-term liquidity and reduce expenses. There is significant uncertainty as to whether or not AIC will be able to achieve
the objectives under its short-term strategy. If AIC is unable to achieve these objectives, the Company believes that the Director may increase regulatory control of AIC by requesting an appropriate court to enter an Order of Rehabilitation or an
Order of Liquidation. Even if AIC achieves these objectives, the Director currently has the authority to increase regulatory control of AIC. The Company believes that an Order of Rehabilitation would have a significant negative impact on the Company
and that an Order of Liquidation would have a material adverse effect on the Company.



If the Company is able to meet these short-term objectives, the Company may consider several strategies. These strategies may include commutation of reinsurance treaties, loss portfolio transfers, unwinding of trust
balances and related items, sale of active and/or shell subsidiaries or other assets and other options that may be available. The Company may be required to accomplish certain of these strategies to meet its short-term and long-term objectives. At
this time, the Company is unable to determine if any of these strategies will be available and if so, under acceptable terms to both the Company and the NEDOI. As such, it is uncertain if the Company can achieve its short-term or long-term
objectives.



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Restatement and Reclassification of Financial Statements



Subsequent to the issuance of the Companys March 31, 2003 consolidated
financial statements, the Company determined that SFAS No. 144 was not properly applied to the March 31, 2003 consolidated financial statement presentation. The accounting policy the Company previously used classified the Companys property and
casualty operations as discontinued operations due to its inability to write new business under the Order of Supervision.



Under the provisions of SFAS No. 144 a component of an entity is deemed to be disposed of if both of the following conditions are met: (a) the operations
and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction and (b) the entity will not have any significant continuing involvement in the operations of the
component after the disposal transaction. EITF Topic No. D-104, Clarification of Transition Guidance in Paragraph 51 of FASB Statement No. 144 clarifies that when a component of an entity will be abandoned through the liquidation or
run-off of operations, that component should not be reported as a discontinued operation in accordance with FASB 144 until all operations, including run-off operations, cease. The Company originally concluded that the Property and Casualty
Segment had been discontinued when the NEDOI placed AIC in supervision. Although the Company is no longer writing property and casualty insurance policies, managing the run-off of the liabilities resulting from that business has been determined to
be a continuing operation of the Company under SFAS No. 144 until all such run-off ceases. Therefore, the Companys consolidated financial statements for March 31, 2003 have been restated from amounts previously reported to reflect the property
and casualty operations as continuing operations of the Company.



Additionally, subsequent to the issuance of the March 31, 2003 financial statements, the Company determined that the consolidated statements of cash flows did not include cash flows from discontinued operations. The March 31, 2003
consolidated cash flows previously reported solely reflected cash flows from continuing operations.



The restatement of the consolidated statement of operations had no impact to the previously reported net loss and there was no impact to the previously
reported stockholders equity. Certain other reclassifications of the prior years financial statements were made to conform to the 2004 presentation.



Forward-Looking Information



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



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



The Companys consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in the consolidated financial statements, as of March 31, 2004 and December 31, 2003, the Company had a stockholders deficit of approximately $99.0 million and $97.4
million, respectively.



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Additionally, the National Association of Insurance Commissioners has established risk-based capital
(RBC) standards to measure the acceptable level of capital an insurer should maintain. As of March 31, 2004 and December 31, 2003, AIC, the Companys only remaining insurance subsidiary, had negative statutory surplus resulting in
risk based capital at a mandatory control level and is under an administrative Order of Supervision by the NEDOI. AIC is no longer authorized to write new or renewal business and may not perform other activities beyond the routine conduct of its
runoff business. These factors among others indicate that there is substantial doubt about the Companys ability to continue as a going concern.



The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the
amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Companys continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet
its obligations on a timely basis, the attainment of managements plans as discussed below and no further regulatory action by the NEDOI.



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



Additionally, there is significant uncertainty as to whether
AIC will be able to meet its future cash flow needs. A major portion of AICs investments are pledged and AICs ability to meet its cash flow needs will be highly dependent upon AICs ability to get significant amounts of pledged
funds released. Additionally, AICs cash flows are significantly impacted by any changes in the expected payout of insurance losses and loss adjustment expenses. AICs ability to meet its cash flow needs is also dependent upon the timely
recovery of reinsurance balances, including the favorable resolution of balances currently in dispute. Based upon current estimates management of the Company believes AIC would likely have the ability to meet its cash flow needs through March 31,
2005 assuming the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC. There can be no assurances considering the significant uncertainties that exist that AIC will have the ability to meet its cash flow
needs through March 31, 2005.



There is also significant
uncertainty as to whether Acceptance Insurance Companies Inc. (AICI) will be able to meet its cash flow needs. AICI has deferred interest payments on its Junior Subordinated Debentures, which in turn deferred the interest on the Trust
Preferred Securities issued by AICI Capital Trust, as permitted by the trust agreement and indenture, and AICI has disputed or denied payments of certain other liabilities and commitments. Based upon current estimates management of the Company
believes AICI would likely have the ability to meet its cash flow needs through March 31, 2005 assuming the NEDOI does not obtain an Order of Rehabilitation or Order of Liquidation with respect to AIC. There can be no assurances considering the
significant uncertainties that exist, that AICI will have the ability to meet its cash flow needs through March 31, 2005. It is unlikely that AICI will be able to meet its long-term cash flow needs if either its short-term or long-term strategies
are unsuccessful. If AICI is not able to meet its cash flow needs in the future, the Company will decide to take the course of action that is in the best interests of the Company based upon all relevant factors, which action may



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include filing bankruptcy. Additionally, if the NEDOI obtains an Order of Rehabilitation or Order of
Liquidation with respect to AIC, the Company believes that it is unlikely that AICI would be able to meet its cash flow needs.



Management has not adopted or contemplated to adopt a plan of liquidation; however, management may contemplate or adopt such strategies that are believed
to be in the best interests of the Company which strategy could include a bankruptcy filing in liquidation or reorganization. Managements current short-term business plan can be summarized as follows:



| | a) | minimize payments of losses and loss adjustment expenses;
| | -- | ---------------------------------------------------------



| | b) | effectively manage the collection of reinsurance balances;
| | -- | ----------------------------------------------------------



| | c) | maintain adequate liquidity to meet cash needs;
| | -- | -----------------------------------------------



| | d) | reduce expenses required to manage the run-off of the property and casualty operations; and
| | -- | -------------------------------------------------------------------------------------------



| | e) | preserve and, if possible, enhance Company assets.
| | -- | --------------------------------------------------



Unless these current short-term strategies are successful, the Company will not have the ability to implement any longer term strategies. The total focus
continues to be on successfully accomplishing the above short-term strategies. If the Company is able to meet these short-term objectives, management may consider several strategies. These strategies may include commutation of reinsurance treaties,
loss portfolio transfers, unwinding of trust balances and related items, sale of active and/or shell subsidiaries or other assets and other options that may be available. The Company may be required to accomplish certain of these strategies to meet
its short-term or long-term objectives. At this time, management is unable to determine if any of these strategies will be available and if so, under acceptable terms to both the Company and the NEDOI. As such, it is uncertain if the Company can
achieve either its short-term or long-term objectives.



Even
if the Company is able to meet these objectives, management believes it is unlikely the Company will be able to make its interest payments on the Preferred Securities which have been deferred until no later than September 30, 2007.



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



Results of Operations



Three Months Ended March 31, 2004

Compared to Three Months Ended March 31, 2003



The Companys net loss decreased to $1.6 million, or $0.12 per share,
for the three months ended March 31, 2004 from $3.6 million, or $0.25 per share, for the three months ended March 31, 2003.



The Companys revenue decreased from $2.0 million during the three months ended March 31, 2003 to $1.6 million during the three months ended March
31, 2004. The decline in revenues was primarily due to a $302,000 decrease in premiums earned, a $468,000 decrease in total net investment income partially offset by a $441,000 increase in total net realized capital gains. The premiums earned and
net investment income of the insurance operations continue to decline as the Company continues to manage the run-off of its property and casualty operations.



During the first quarter of 2003, the Company sold its office building and certain contents in Council Bluffs, Iowa. The proceeds included
approximately $204,000 of cash and a note receivable with a fair value of approximately $1.3 million and the sale resulted in a gain of approximately $334,000. During the first quarter of 2004, the Company sold Florida real estate for approximately
$1.3 million of cash, realizing capital gains of approximately $742,000 in its insurance operations.



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The Companys total costs and expenses decreased from $3.3 million for the three months ended March
31, 2003 to $777,000 for the three months ended March 31, 2004. The results for the first quarter of 2003 included a reserve strengthening of approximately $692,000, primarily for auto liability claims. Additionally, expenses in the insurance
operations declined as the Companys continues to manage the run-off of its property and casualty operations.



Liquidity and Capital Resources



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



The Company - Parent Only



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



At March 31, 2004 the Company has $2.2 million in cash and cash equivalents
and $1.4 million of restricted cash equivalents. The Company also holds a surplus note for $20 million issued by AIC, bearing interest at the rate of 9% per annum payable quarterly. The Company does not expect to have access to any surplus note
interest payments or dividend payments from AIC, as these payments would require NEDOI approval as AIC is currently under the supervision of the NEDOI.



During the first quarter of 2003, the Company sold its office building and certain contents in Council Bluffs, Iowa. The proceeds included approximately
$204,000 of cash and a note receivable with a fair value of approximately $1.3 million and the sale resulted in a gain of approximately $334,000. During the fourth quarter of 2003, the Company sold the note receivable for approximately $1.2 million
and the sale resulted in a loss of approximately $83,000.



In
order to induce employees of AIC to remain in the employment of AIC, AICI has agreed to pay each employee a retention bonus in the event AIC would be unable to meet this obligation. Additionally, AICI has agreed to guarantee certain amounts due
under employment agreements with the Chief Executive Officer and Chief Financial Officer. During the second quarter of 2003, AICI agreed to guarantee these obligations by establishing an appropriate trust with a bank whereby the amount of such
guarantees, totaling approximately $1.1 million, have been deposited in such trust account. The amounts held in the trust account at March 31, 2004, totaling approximately $1.0 million, are presented as restricted cash equivalents on the
Companys consolidated balance sheets.



In August 1997,
AICI Capital Trust, a Delaware business trust organized by the Company (the Issuer Trust) issued 3.795 million shares or $94.875 million aggregate liquidation amount of its 9% Preferred Securities (liquidation amount $25 per Preferred
Security). The Company owns all of the common securities (the Common Securities) of the Issuer Trust. The Preferred Securities represent preferred undivided beneficial interests in the Issuer Trusts assets. The assets of the Issuer
Trust consist solely of the Companys 9% Junior Subordinated Debentures due in 2027, which were issued in August 1997 in an amount equal to the total of the Preferred Securities and the Common Securities. Distributions on the Preferred
Securities and Junior Subordinated Debentures are cumulative, accrue from the date of issuance and are payable quarterly in arrears. The Junior Subordinated Debentures are subordinate and junior in right of payment to all senior indebtedness of the
Company and are subject to certain events of default. The issue costs on the Junior Subordinated Debentures are being amortized over the term of the debt.



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Effective November 18, 2002, the Company elected to defer payment of interest on its Junior Subordinated
Debentures, as permitted by the trust agreement and indenture, beginning with the interest payment date on December 31, 2002 until not later than September 30, 2007. The interest payments on the Preferred Securities will be deferred for a
corresponding period. As of March 31, 2004 approximately $14.0 million of accrued interest had been deferred. See Note 1 regarding managements expectations regarding the Companys ability to pay such interest payments.



There is significant uncertainty as to whether the Company will be able to
meet its cash flow needs. As noted above, the Company has deferred interest payments on its Trust Preferred Securities and additionally, the Company has disputed or denied payment of certain other liabilities and commitments. While based upon
current estimates management of the Company believes AICI would likely have the ability to meet its cash flow needs through March 31, 2005, there can be no assurances considering the significant uncertainties that exist. It is unlikely that AICI
will be able to meet its long-term cash flow needs if either its short-term or long-term strategies are unsuccessful. If AICI is not able to meet its cash flow needs in the future, the Company will decide to take the course of action that is in the
best interest of the Company based upon all relevant factors, which action may include filing bankruptcy.



Acceptance Insurance Company



The Companys only consolidated insurance subsidiary at March 31, 2004 is AIC. The principal liquidity needs of AIC are to fund losses and loss
adjustment expense payments and operating expenses related to the run-off of its property and casualty operations. The available sources to fund these requirements are cash flows from the Companys investment activities, of which at March 31,
2004 approximately 84% and 1% of AICs fixed maturity securities and cash and cash equivalents, respectively, are pledged to states and to acquirers of former Company affiliates.



AICs investment portfolio is primarily comprised of fixed maturities and cash equivalents. At March 31, 2004,
approximately $55.6 million of fixed maturity securities and cash equivalents were placed in a trust and pledged in order to secure AICs obligations under reinsurance agreements. The agreements provide for the release of the pledged securities
as the obligations under the reinsurance agreements decrease. However, if AIC is unsuccessful in obtaining the release of pledged securities, AICs liquidity would suffer a significant negative impact. See Off-Balance Sheet
Arrangements for additional information. Additionally, as required by insurance regulatory laws, certain fixed maturity securities with an estimated fair value of approximately $7.6 million at March 31, 2004 were deposited in trust with
regulatory agencies.



There is significant uncertainty as to
whether AIC will be able to meet its future cash flow needs. As noted above, a major portion of AICs investments are pledged and AICs ability to meet its cash flow needs will be highly dependent upon AICs ability to get significant
amounts of pledged funds released. Additionally, AICs cash flows are significantly impacted by any changes in the expected payout of insurance losses and loss adjustment expenses. AICs ability to meet its cash flow needs is also
dependent upon the timely recovery of reinsurance balances, including the favorable resolution of balances currently in dispute. Based upon current estimates management of the Company believes AIC would likely have the ability to meet its cash flow
needs through March 31, 2005. There can be no assurances considering the significant uncertainties that exist that AIC will have the ability to meet its cash flow needs through March 31, 2005. Based upon current agreements that are in place,
primarily related to amounts pledged under the trust agreements, it is unlikely that AIC will be able to meet its long term cash flow needs without changes to existing agreements, commutation of reinsurance agreements or other strategies, if
available.



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Changes in Financial Condition



The Companys stockholders deficit increased by approximately $1.7 million from December 31, 2003 to March 31,
2004. The principal component of this increase was a net loss of $1.6 million for the three months ended March 31, 2004.



Consolidated Cash Flows



Cash used by operating activities was approximately $7.6 and $23.4 million during the three months ended March 31, 2004 and 2003, respectively. The
Company expects negative cash flows from operating activities as the Company runs off its property and casualty operations. See The Parent  Company Only and Acceptance Insurance Company regarding uncertainties of the
Company to meet its ongoing cash flow needs.



Off-Balance
Sheet Arrangements



The Company sold its wholly owned
subsidiary, Redland Insurance Company (Redland), to Clarendon National Insurance Company (Clarendon) effective as of July 1, 2000. The sale was a cash transaction of approximately $10.9 million based upon the market value of
Redland after the divestiture of various assets, including the Redland subsidiaries, to a wholly owned subsidiary of Acceptance Insurance Companies Inc. The transaction included the appointment of other Company subsidiaries as a producer and
administrator for the business the Company wrote through Clarendon and Redland. The Company also reinsures certain portions of the Companys business issued by Clarendon and Redland. At March 31, 2004, approximately $43.3 million of fixed
maturities available-for-sale and $248,000 of cash equivalents were placed in a trust and pledged to Clarendon to secure the Companys obligations under reinsurance agreements. Under these reinsurance agreements, the Company assumed business
from Clarendon and Redland after cessions to outside reinsurers (Clarendon Reinsurers). At March 31, 2004, Clarendon and Redland reinsurance recoverables from Clarendon Reinsurers totaled approximately $77 million. The Company is
contingently liable for any uncollectible amounts due from Clarendon Reinsurers related to this business.



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



As of July 1, 2001, the Company sold two wholly owned insurance companies to McM Corporation, a Raleigh, North Carolina based insurance holding company
(McM). The two companies, Acceptance Indemnity Insurance Company (AIIC) and Acceptance Casualty Insurance Company (ACIC), underwrote primarily Property and Casualty Segment insurance. The Company reinsures certain
portions of the Companys business issued by AIIC and ACIC. As of March 31, 2004 approximately $12.0 million of fixed maturities available-for-sale and $66,000 of cash equivalents were placed in a trust and pledged to McM to secure the
Companys net obligations under the reinsurance agreements. Under these reinsurance agreements, the Company assumed business from AIIC and ACIC after cessions to outside reinsurers (AIIC Reinsurers). At March 31, 2004, AIIC and ACIC
reinsurance recoverables from AIIC Reinsurers totaled approximately $25 million. The Company is contingently liable for any uncollectible amounts due from AIIC Reinsurers related to this business.



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The Companys off-balance sheet obligations for the Clarendon and AIIC Reinsurers total
approximately $102 million (Off-Balance Sheet Obligations). The Company has guaranteed the performance of these Clarendon and AIIC Reinsurers. If these Clarendon and AIIC Reinsurers do not meet their obligations, whether or not due to
their ability or willingness to pay, the Company will be obligated. The timing for the reinsurers performance of these obligations is currently not known and the amounts will become due from the reinsurers as the underlying direct claim
payments are made. Additionally, the $102 million is an estimate of unpaid ceded losses and loss adjustment expenses on Redland, Clarendon, AIIC and ACIC, and are subject to considerable estimation judgment due to the inherent uncertainty in
projecting ultimate claim amounts that will be reported and settled over a period of many years.



At December 31, 2003, PMA Reinsurance Group (PMA) accounts for approximately 7.0% of the Companys Off-Balance Sheet Obligations. PMA had
its financial strength lowered by A.M. Best from A- (Excellent) to B++ (Very Good) in the fourth quarter of 2003. With the exception of outstanding questions related to specific claims, as of March 31, 2004 PMA continues to make regular payments to
the Company for reinsurance billings and accordingly, no specific liability has been established for these balances.



At December 31, 2003, Gerling Global Reinsurance Corp. (Gerling) accounts for approximately 1.3% of the Companys Off-Balance Sheet
Obligations. Gerling had its financial strength rating lowered by A.M. Best from A- (Excellent) to B- (Fair) during the fourth quarter of 2002. In January 2003, in response to a request from Gerlings parent to withdraw from the rating process,
A.M. Best withdrew its financial strength rating of B- and assigned Gerling and its parent an NR-3 rating (Rating Procedure Inapplicable). As of March 31, 2004 Gerling continues to make regular payments to the Company for reinsurance billings and
accordingly, no specific liability has been established for these balances.



Item 3. Quantitative and Qualitative Disclosure about Market Risk



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



At March 31, 2004 and December 31, 2003 the Company had $75.2 million and $74.3 million, respectively, of fixed maturity investments that were subject to
market risk. At March 31, 2004 and December 31, 2003 the Company had $623,000 and $1.1 million, respectively, of marketable equity securities that were subject to market risk. The Companys investment strategy is to manage the duration of the
portfolio relative to the duration of the liabilities while managing interest rate risk.



The Company uses two models to analyze the sensitivity of its market risk assets. For its fixed maturity securities, the Company uses duration modeling to calculate changes in fair value. For its marketable equity
securities, the Company uses a hypothetical 20% decrease in the fair value of these securities. Actual results may differ from the hypothetical results assumed in this disclosure due to possible actions taken by management to mitigate adverse
changes in fair value and because fair values of securities may be affected by credit concerns of the issuer, prepayment speeds, liquidity of the security and other general market conditions. The sensitivity analysis duration model used by the
Company produces a loss in fair value of $1.1 million and $587,000 on its fixed maturity securities as of March 31, 2004 and December 31, 2003, respectively, based on a 100 basis point increase in interest rates. The hypothetical 20% decrease in
fair value of the Companys marketable equity securities produces a loss in fair value of $125,000 and $211,000 as of March 31, 2004 and December 31, 2003, respectively.



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Item 4. Controls and Procedures



Based on their evaluation at the end of the period covered by this Form 10-Q, the Companys President and Chief Executive Officer (the CEO) and the Chief Financial Officer and Treasurer (the CFO) have concluded
the Companys disclosure controls and procedures are effective. In 2003 the Company eliminated its internal audit department. The Company did, however, establish a Financial Disclosure and Internal Control Procedures committee
during 2003. There have been no significant changes in the Companys internal controls or in other factors, including the elimination of the internal audit department, that could significantly affect these controls subsequent to the date of the
evaluation.



As more fully described in Note 2 to the
consolidated financial statements, subsequent to the issuance of its consolidated financial statements for the year ended December 31, 2002, the Company determined that the Companys property and casualty insurance business should not have been
presented as discontinued operations. As a result, the accompanying consolidated statements of operations and cash flows for the three months ended March 31, 2003 have been restated to present the results of operations and cash flows as components
of continuing operations. The Company established the Financial Disclosure and Internal Control Procedures committee to further improve its internal control processes and procedures around financial reporting and public disclosures.



PART II. OTHER INFORMATION



Item 1. Legal Proceedings



Class Action Complaint



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



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



On
March 2, 2001, the Court entered an order dismissing all claims alleging violations of Section 11 of the Securities Act, and dismissing the Companys Directors, financial underwriters, independent accountants and others as defendants in this
action. The Court also ruled that certain of Plaintiffs allegations regarding the remaining defendants alleged failure to properly report contingent losses attributable to the Montrose decision did not state a claim under Section
10b and Rule 10b-5. In two



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subsequent rulings, the Court and Magistrate Judge clarified the March 2 ruling to specify which of
Plaintiffs Montrose-related allegations failed to state a Section 10b and Rule 10b-5 claim. These three rulings reduced the litigation to a claim that the Company and three of its former officers, during the period from August 14, 1997
to November 16, 1999, failed to disclose adequately information about various aspects of the Companys operations, including information relating to the Companys exposure after January 1, 1997 to losses resulting from the Montrose
decision. Nevertheless, Plaintiffs continue to seek compensatory damages, reasonable costs and expenses incurred in this action and such other and such further relief as the Court may deem proper.



On August 6, 2001, the Magistrate Judge granted Plaintiffs Motion for
Class Certification. Plaintiffs fact discovery was concluded July 31, 2002 in accordance with a schedule established by the Court. On September 16, 2002 Plaintiffs sought the Courts permission to reinstate certain previously dismissed
claims under Section 11 and 15 of the Securities Act. The Court denied Plaintiffs request in its entirety on February 27, 2003. The Company filed a motion to decertify the class and a motion for summary judgment. On March 31, 2004, the Court
granted the defendants motion for summary judgment in full, dismissing all of the plaintiffs remaining claims against all of the remaining defendants, and denied all other pending motions as moot. The plaintiffs have appealed the
Courts decision.



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



Takings Claim



Acceptance Insurance Companies Inc. Litigation (United States Court of Federal Claims) On December 9, 2003, the Company filed a complaint against
the United States of America. The complaint was filed in the United States Court of Federal Claims.



In November 2002, the Company and Rain and Hail L.L.C. (Rain and Hail) entered into a letter of intent under which Rain and Hail agreed to
purchase certain insurance assets of American Growers Insurance Company (AGIC), a wholly owned subsidiary of the Company. Such assets were reinsured by, and subject to the oversight of, the Federal Crop Insurance Corporation (the
FCIC). The transaction was subject to the approval of the Office of Risk Management, or the Risk Management Agency (the RMA). Ross J. Davidson, the Administrator of the RMA, advised that he would not approve the proposed sale
of assets from the Company to Rain and Hail. The RMA subsequently enjoined AGIC from writing any new or renewal business. The Company alleges that the RMAs actions rendered valueless the insurance business of AGIC.



The Company also alleges that in rejecting the proposed transaction between
the Company and Rain and Hail, the RMA effected a taking of the Companys property (i.e., the AGIC insurance assets) for public use without just compensation in violation of the Fifth Amendment to the United States Constitution. The
Company seeks relief for its damages for the fair market value of the AGIC insurance assets in an amount of not less than $21.5 million, reasonable attorneys fees and expert witness costs pursuant to 42 U.S.C. § 4654(c) with interest from
the date of taking and such further relief the Court deems appropriate. On February 9, 2004 the United States filed a motion to dismiss the Companys complaint and the Company filed a response to the motion to dismiss. The Court held a hearing
regarding the motion to dismiss and response and has the motion under advisement. The ultimate outcome of this action cannot be predicted at this time and, accordingly, the Company currently is unable to determine the potential effect of this
litigation on its consolidated financial position, results of operations or cash flows.



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Granite Re Action



On April 15, 2004, Granite Reinsurance Company, LTD. (Granite Re) filed an action against the Company in the
United States District Court for the Southern District of Indiana styled Granite Reinsurance Company, Ltd. v. Acceptance Insurance Companies, Inc., (S.D. Indiana, Case. No. 1:04-cv-0670-SEB-VSS) (the Granite Re Action). In the
Granite Re Action, Granite Re alleges the Company breached certain alleged obligations under a reinsurance treaty entered into between the parties on June 6, 2001. Specifically, Granite Re alleges the Company breached an alleged obligation to pay
Granite Re $3.0 million annually for a three year period, or a total of $9.0 million, for reinsurance. The Company filed a timely motion to dismiss the complaint in the Granite Re Action arguing Granite Re filed the complaint in the wrong forum.
Granite Re has yet to respond to the motion. The Company expects to vigorously defend the Granite Re Action. The ultimate outcome of this action cannot be predicted at this time and the Company currently is unable to determine the potential effect
of this litigation on its financial position, results of operations or cash flows.



Buchanan Action



In
July 2004, P. Thompson Buchanan, the former President and a 40% shareholder of USAG Insurance Services, Inc., a Texas corporation 60% owned by Growers, filed an Original Petition in the District Court, Lubbock County, Texas against the Company,
Growers and certain officers and directors of the Company styled Buchanan v. Martin, et al., No. 2004-527 (District Court, Lubbock County, Texas). In the Original Petition, Buchanan alleges he suffered damage because he allegedly was
wrongfully terminated from his employment and not paid a severance. Mr. Buchanan further alleges he suffered a business loss as a result of alleged misrepresentations and other alleged misconduct. Mr. Buchanan claims losses in an amount not less
than $13,000,000. The Company has engaged counsel and intends to vigorously defend this proceeding. The ultimate outcome of this action cannot be predicted at this time and the Company currently is unable to determine the potential effect of this
litigation on its financial position, results of operations or cash flows.



Item 6. Exhibits and Reports on Form 8-K



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



See Exhibit Index.



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



No Form 8-K have been filed during the last fiscal quarter of the period covered by this Report



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SIGNATURES



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



|                                    |  |                                       |  |                           
|----------------------------------- |  | ------------------------------------- |  | --------------------------
|ACCEPTANCE INSURANCE COMPANIES INC. |  |                                      
|                                    |  |                                      
|By                                  |  | /s/ John E. Martin                    |  | Dated:     August 10, 2004
|                                    |  | John E. Martin                        |  |                           
|                                    |  | President and Chief Executive Officer |  |                           
|                                    |  |                                      
|By                                  |  | /s/ Gary N. Thompson                  |  | Dated:     August 10, 2004
|                                    |  | Gary N. Thompson                      |  |                           
|                                    |  | Chief Financial Officer and Treasurer |  |                           



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ACCEPTANCE INSURANCE COMPANIES INC.

QUARTERLY REPORT ON FORM 10-Q

NINE MONTHS ENDED SEPTEMBER 30, 2003



EXHIBIT INDEX



|       |  |                                                                                                                                                  
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------
|NUMBER |  | EXHIBIT DESCRIPTION                                                                                                                              
|31.1   |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                              
|       | 
|31.2   |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                              
|       | 
|32.1   |  | Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|       | 
|32.2   |  | Certification of Chief Financial Officer Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 



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