##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-K

|                                            |  |                                                                                        
|------------------------------------------- |  | ---------------------------------------------------------------------------------------
|x                                           |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934    
|                                            |  |                                                                                        
|For the fiscal year ended December 31, 2002
|                                            |  |                                                                                        
|OR                                         
|                                            |  |                                                                                        
|o                                           |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

For the transition period from  to

Commission file number: 0-25508

RTW, INC.
(Exact name of registrant as specified in its charter)

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

8500 Normandale Lake Boulevard, Suite 1400
Bloomington, MN 55437
(Address of principal executive offices and zip code)

Registrants telephone number, including area code: (952) 893-0403

|                                                    |  |                                                                         
|--------------------------------------------------- |  | ------------------------------------------------------------------------
|Securities registered pursuant to 12(b) of the Act: |  | None                                                                    
|Securities registered pursuant to 12(g) of the Act: |  | Common Stock, no par value Series A Junior Participating Preferred Stock

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.

|    |   |  |    |  |  | 
|--- | - |  | -- |  |  | 
|Yes | X |  | No |  | 
|    |   |  |    | 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)

|    |  |  |    |   |  | 
|--- |  |  | -- | - |  | 
|Yes |  |  | No | X |  | 
|    |  |  |    |  

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

As of March 10, 2003, 5,099,746 shares of Common Stock, no par value, were
outstanding after giving effect to a one-for-two reverse stock split that was
effective November 22, 2002. As of March 10, 2003, assuming as fair value the
last sale price of $2.15 per share on The Nasdaq Stock Market, the aggregate
fair value of shares held by non-affiliates was approximately $8.2 million.

Documents incorporated by reference:

None





---

TABLE OF CONTENTS



|                                                   |                                                                                               |  |  |  |  |  |  | 
|-------------------------------------------------- | --------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                            
|                                                   | ITEM 1. BUSINESS                                                                             
|                                                   | ITEM 2. PROPERTIES                                                                           
|                                                   | ITEM 3. LEGAL PROCEEDINGS                                                                    
|                                                   | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|PART II                                           
|                                                   | ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                
|                                                   | ITEM 6. SELECTED FINANCIAL DATA                                                              
|                                                   | ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                   | ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                          
|                                                   | ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                          
|                                                   | ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 
|PART III                                          
|                                                   | ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                  
|                                                   | ITEM 11. EXECUTIVE COMPENSATION                                                              
|                                                   | ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                      
|                                                   | ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                      
|                                                   | ITEM 14. CONTROLS AND PROCEDURES                                                             
|PART IV                                           
|                                                   | ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K                    
|SIGNATURES                                        
|CERTIFICATION                                     
|EX-3.1 Amended Articles of Incorporation          
|EX-10.8 Description of 2003 Profit Sharing Plan   
|EX-10.10.2 Description of Reinsurance Agreement   
|EX-10.11 Minnesota Workers' Reinsurance Agreement 
|EX-10.12 Election Form for Reinsurance Agreement  
|EX-10.13 Description of Reinsurance Agreement 2003
|EX-10.14.5 Fifth Amendment to the Credit Agreement
|EX-10.14.6 Sixth Amendment to the Credit Agreement
|EX-11 Statement re: Computation of Net Income     
|EX-23 Consent of Ernst & Young LLP                
|EX-23.1 Consent of Deloitte & Touche LLP          
|EX-99.1 Certification Pursuant to 18 USC Sec. 1350



---



##### Table of Contents



TABLE OF CONTENTS

|         |  |                                                                                       |  |      |    | 
|-------- |  | ------------------------------------------------------------------------------------- |  | ---- | -- | 
|PART I   |  |                                                                                       |  | Page
|         |  |                                                                                       |  |     
|         |  |                                                                                       |  |     
|Item 1.  |  | Business                                                                              |  |      | 3  | 
|         |  | Executive Officers of the Registrant                                                  |  |      | 10 | 
|Item 2.  |  | Properties                                                                            |  |      | 10 | 
|Item 3.  |  | Legal Proceedings                                                                     |  |      | 10 | 
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                   |  |      | 10 | 
|PART II  |  |                                                                                       |  |      |    | 
|Item 5.  |  | Market for Registrants Common Equity and Related Stockholder Matters                 |  |      | 10 | 
|Item 6.  |  | Selected Financial Data                                                               |  |      | 10 | 
|Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results
of Operations |  |      | 11 | 
|Item 7A  |  | Quantitative and Qualitative Disclosures About Market Risk                            |  |      | 28 | 
|Item 8.  |  | Financial Statements and Supplementary Data                                           |  |      | 28 | 
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure  |  |      | 49 | 
|PART III |  |                                                                                       |  |      |    | 
|Item 10. |  | Directors and Executive Officers of the Registrant                                    |  |      | 49 | 
|Item 11. |  | Executive Compensation                                                                |  |      | 51 | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                        |  |      | 53 | 
|Item 13. |  | Certain Relationships and Related Transactions                                        |  |      | 54 | 
|PART IV  |  |                                                                                       |  |      |    | 
|Item 14. |  | Controls and Procedures                                                               |  |      | 54 | 
|Item 15. |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  |      | 54 | 
|         |  | Signatures                                                                            |  |      | 57 | 

2



---



##### Table of Contents






PART I




ITEM 1. BUSINESS

Overview

RTW, Inc. (the Company) provides comprehensive management products and
services to insured and self-insured employers for their workers compensation
programs in Minnesota, Wisconsin, South Dakota, Colorado, Michigan and Indiana.
The Company closed its regional offices in Missouri and Massachusetts in the
fourth quarter of 2001 and non-renewed substantially all policies in those
regions through December 31, 2002 and will run-off expiring policies in those
regions through February 2003. The Company has also obtained licenses but is
not operating (other than previously mentioned run-off business and claims
management associated with the run-off business) in Pennsylvania, Tennessee,
Maryland, Arkansas, Iowa, Florida, New Jersey, Georgia, North Carolina, Texas,
Missouri, Illinois, Kansas, Massachusetts, Connecticut, Rhode Island and
Oklahoma. The Company believes its proprietary management approach
substantially reduces wage replacement costs and medical expenses resulting
from workplace injuries. The Company focuses on controlling costs by returning
injured employees to work as soon as possible and by actively managing all
participants in the workers compensation system, including employers,
employees and medical care providers, as well as legal and judicial
participants in the workers compensation system. Elements of the Companys
management approach include:



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

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

Industry

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

Estimated insurance premiums totaled approximately $31.7 billion
nationwide in 2002. This $31.7 billion includes: (i) the traditional or
private residual market, estimated at $26.0 billion, including commercial
insurers and state-operated assigned risk pools established for high risk
employers, and (ii) state funds, estimated at $5.7 billion, operated in states
in order to increase competition and stabilize the market.

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

The Company believes that traditional workers compensation insurance
companies and workers compensation third party administrators are not as
effective as the Company in controlling loss costs. While traditional efforts,
including focusing on workplace safety and implementing certain medical cost
containment measures, have reduced costs in certain areas, the Company believes
these efforts have not had a significant effect on the overall system cost
because they have not focused effectively on controlling indemnity payments.
In the late 1990s as well as into the 2000s, traditional insurance companies
moved toward a more comprehensive management approach including

3



---



##### Table of Contents



return-to-work initiatives. The Company believes that while traditional
insurers have been somewhat successful in these initiatives, they have not
achieved the cost reductions and claim closure outcomes realized by the
Company.

The Companys Management Approach

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

The Company uses five-person operating teams to implement its proprietary
management approach. Each operating team handles all of the claims for a
specific group of employers and is accountable within the Company for the loss
experience of these employers. Each team generally consists of three nurses, a
statutory claims administrator, and an assistant claims administrator /
clerical support person. A teams nurses are responsible for evaluating the
medical condition of an injured employee and monitoring the employees medical
treatment. The claims administrators are responsible for determining the
eligibility of claims, paying benefits in a timely manner and following
statutory requirements for administration of claims. The operating teams meet
regularly to discuss strategies for managing difficult claims and to review
strategies and procedures that have been particularly successful in resolving
disputes.

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

Employers. Generally, each employer is assigned to an operating team
responsible for managing the relationship. Prior to accepting an employer,
members of an operating team may conduct an on-site risk assessment and explain
the Companys methods and procedures to the employer. The risk assessment
forms a part of the Companys underwriting process and includes evaluating the
employers willingness to follow the Companys procedures. For employers
insured by the Companys wholly-owned insurance subsidiary, American
Compensation Insurance Company (ACIC), the employer agrees, as part of the
insurance policy, to comply with the Companys early intervention methods and
to provide transitional, light-duty work for injured employees until such time
as they are able to resume their normal positions. To ensure that the
Companys early intervention techniques succeed, the Company requests prompt
notification from the employer of all injuries, typically 24 to 48 hours after
the employer learns of the injury.

Each operating team is responsible for managing its designated employers
workers compensation program, by training the employers personnel in the
Companys methods and procedures and managing all reported injuries for the
employer. The operating team meets with the employer, provides access to loss
reports detailing current claims, conducts an annual account review and
maintains active communication on open injuries. The Companys loss control
team or the operating team may make workplace safety recommendations or retain
a workplace safety-engineering firm to assist its employers in remedying work
conditions that the loss control team or the operating team determines
constitute an inappropriate risk. In addition, the operating team may
recommend to the Companys management the cancellation or non-renewal of the
policy for an employer that fails to comply with the Companys procedures.

Employees. The Company focuses on identifying injuries that have the
greatest potential to result in significant expenses and acts quickly to
control expenses resulting from these injuries. The Company has observed that
approximately 15% of all injuries result in 85% of all workers compensation
expenses and that early identification of, and intervention in, these cases can
lead to significant cost savings. Within 48 hours of being notified of an
injury, an operating team evaluates several factors, including the type of
injury, the employees injury history and whether the employee is absent from
work, to determine whether the injury is likely to involve significant expense.
In potentially high-cost cases, a member of the operating team intervenes
quickly by meeting with the injured employee to assess the injury, assisting
the injured employee in obtaining medical care and rehabilitation and

4



---



##### Table of Contents



developing a plan to get the employee back to work as soon as is
appropriate. If the employee cannot immediately return to his or her original
position, the employer is required to provide a transitional light-duty job
that is consistent with the limits defined by the employees medical care
provider. If the employee refuses this transitional position, the Company may
terminate indemnity payments, but is required to continue to provide
appropriate medical benefits.

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

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

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

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

Customers

The Company targets employers and associations that operate in industries
with relatively high workers compensation costs, including manufacturing,
retail, wholesale, health care and hospitality industries and employers with a
history of workers compensation claim costs higher than average in their
industry.

The Companys average annual premium per policy increased to $80,400 in
2002 from $56,800 in 2001 and $40,500 in 2000 due to focused aggressive
re-underwriting in 2001and 2000. The Companys ten largest customers accounted
for $6.2 million or 11.4% of the Companys premiums in force in 2002 compared
to $6.6 million or 7.8% of the Companys premiums in force in 2001 and $7.9
million or 7.9% of the Companys premiums in force in 2000. No customer
accounted for more than 5% of in force premiums in 2002, 2001 or 2000. The
Company renewed 46.1% of the policies scheduled to expire in 2002, whereas
56.5% and 66.2% were renewed in 2001 and 2000, respectively. The retention
rate in 2002 was decreased significantly by the closure of the Missouri and
Massachusetts regions.

Substantially all of the Companys employers are in its Minnesota,
Colorado and Michigan regions. In December 2001, the Company closed its
regional offices in Missouri (covering Missouri, Illinois and Kansas) and
Massachusetts (covering Massachusetts, Connecticut, New Hampshire, Rhode Island
and Maine). In 2002, the Company non-renewed substantially all of its policies
in its Missouri and Massachusetts regions and expects to complete run off of
remaining expiring policies in these regions through February 2003. In
addition to these states, the Company is also licensed in Pennsylvania,
Tennessee, Maryland, Arkansas, Iowa, Florida, New Jersey, Georgia, North
Carolina, Texas and Oklahoma. The Company currently has no intention to expand
operations beyond the present states in which it is operating.

5



---



##### Table of Contents



Products

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

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

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

In 2002, the Company began a strategic initiative to sell its workers
compensation products and services on a fee-for-service basis. This strategic
initiative extends the Companys workers compensation services to self-insured
employers and other alternative market non-risk products. The Company will
charge a fee to these customers based on the expected number of claims managed
or the time committed to the customer. This service product will provide a
non-insurance revenue line for the Company. In 2002, the Company had acquired
three customers totaling approximately $100,000 in annualized revenues.

Sales and Marketing

The Company sells its workers compensation products and services to
insured and self-insured employers through independent insurance agencies and
brokers, including several large national agencies. Agencies are paid
commissions which averaged 6.9% of the Companys gross premiums earned in 2002,
compared to 7.6% of the Companys gross premiums earned in 2001 and 7.9% of
gross premiums earned in 2000. The Companys ten highest producing agencies
accounted for $19.7 million or 36.3% of premiums in force in 2002, compared to
$24.8 million or 29.7% of premiums in force in 2001 and $27.2 million or 27.3%
of premiums in force in 2000. No agency accounted for more than 5.3% of
premiums in force in 2002, compared to 6.4% of premiums in force in 2001 and
6.5% of premiums in force in 2000. The Company continually markets its
products and services to its agencies to keep them aware of developments in the
Companys business. Each states underwriting team is responsible for
establishing and maintaining agency relationships.

Reinsurance

The Company shares the risks and benefits of the insurance it underwrites
through reinsurance. The Company purchases reinsurance to protect it from
potential losses in excess of the level management is willing to accept. From
1995 to 2002, the Companys primary reinsurance was excess of loss coverage
that limited its per-incident exposure.

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

In 2002, 2001 and 2000, the Company selected per occurrence levels in
Minnesota from the WCRA of $350,000, $330,000 and $310,000, respectively. In
2003, the selected per occurrence level excess of loss coverage under the WCRA
is $360,000.

In 2002, 2001 and 2000, the Company purchased non-Minnesota excess of loss
coverage primarily through General Cologne Reinsurance Corporation, rated A++
(Superior) by A.M. Best. The excess of loss policy in effect during 2002, 2001
and 2000 provided reinsurance from $300,000 per person per any one loss and up
to statutory limits per occurrence ultimate net loss for 2001, 2000 and 1999,
but coverage was capped at $20.0 million per occurrence ultimate net loss for
2002.

6



---



##### Table of Contents



In 2003, the Companys non-Minnesota per-incident excess of loss coverage
increased to $360,000, continues to be capped at $20.0 million per occurrence
and further excludes claims resulting from acts of terrorism. The Company
further decreased its retention in 2003 to $200,000 per-incident in 2003 by
purchasing increased excess of loss reinsurance to further reduce volatility in
the Companys financial results. This coverage was purchased from three
reinsurers.

The excess of loss policy in effect during 1998 and 1997 provided
reinsurance up to $9.5 million in excess of $500,000 per person per any one
loss and up to $40 million in excess of $10 million per occurrence ultimate net
loss for 2002. This excess of loss policy was effective January 1, 1997, and
replaced excess of loss policies that were terminated on December 31, 1996. In
1996, the non-Minnesota excess of loss policies provided reinsurance up to $9.5
million in excess of $500,000 per person per any one loss and up to $49.5
million in excess of $500,000 per occurrence ultimate net loss. Transatlantic
Reinsurance Company, rated A++ (Superior) by A.M. Best, is the only reinsurance
company that received more than 15% of the premiums paid for reinsurance
coverage under the 1996 excess of loss coverage.

For claims occurring on or after July 1, 1998, the Company purchased
excess of loss coverage through GE Reinsurance Corporation, rated A+ (Superior)
by A.M. Best that provides reinsurance up to $275,000 in excess of $25,000 in
all states except Minnesota. In Minnesota, the coverage is $255,000 in excess
of $25,000 for 1998, $265,000 in excess of $25,000 for 1999 and $275,000 in
excess of $25,000 for 2000 and 2001. This coverage was purchased to reduce risk
and volatility in the Companys operating performance. This contract was
terminated effective December 31, 2000; however, the policy was effective in
2001 for policies in force at December 31, 2000 through expiration, not to
exceed fifteen months after the effective termination date. Policies written
or renewed in 2002 and 2001 were not covered under this lower level excess of
loss reinsurance policy.

A.M. Best determines its ratings based on a comparative analysis of the
financial condition and operating performance of insurance companies. A.M.
Best ratings are based upon factors of concern to insureds and are not directed
toward the protection of investors. See Competition.

Competition

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

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

Insurance companies enter and exit the workers compensation market in
different states depending on their appraisal of current market conditions.
Many insurance companies stopped underwriting workers compensation insurance
during the early 1990s due to rising costs that were not matched by reductions
in statutory benefits or higher premium rates. In the mid to late 1990s, the
Company experienced increased market pressure as new insurance companies and
single line workers compensation insurance companies entered the market. In
2002, 2001 and 2000, many insurers withdrew from the markets in which the
Company operates as premium rates were insufficient to cover the cost of
benefits paid.

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

Another competitive factor results from the fact that some insured
employers will not purchase workers compensation products from insurance
companies with an A.M. Best rating less than A. In addition, certain
insurance companies that write umbrella policies will not provide coverage to
an employer if a portion of the employers underlying insurance policy, such as
the workers compensation portion, is written by an insurance

7



---



##### Table of Contents



company with a less than A rating. The Company believes that its B-
letter rating from A.M. Best will make it difficult, in certain instances, for
the Company to provide its products to certain employers. Historically, in
these instances, the Company competed by writing these employers using an A
rated insurers paper. This process, known as fronting, added additional cost
for ACIC but allowed the Company access to markets it may have otherwise not
been able to access. The Company does not currently have a fronting
arrangement in effect and believes that its ability to find a fronting company
at a reasonable cost in 2003 will be difficult.

The Companys insurance subsidiary was assigned an initial rating of B++
(Very Good) on a scale of A++ (Superior) to F (In Liquidation) on December 16,
1996. This rating was reaffirmed in April 1999 and June 2000. In June 2001,
however, based on 2000 financial results, A.M. Best downgraded the Companys
rating to B+ and, based on financial results in 2001, further downgraded that
rating to B- in February 2002. An A.M. Best rating is assigned after an
extensive quantitative and qualitative evaluation of the Companys financial
condition and operating performance. A.M. Best ratings are based upon factors
of concern to insureds and are not directed toward the protection of
investors. Furthermore, A.M. Best ratings are not ratings of the Company or
any of its securities. A.M. Best ratings include Secure Ratings, consisting of
A++ and A+ (Superior); A and A- (Excellent); B++ and B+ (Very Good); Vulnerable
or Unsecure Ratings, consisting of B and B- (Adequate); C++ and C+ (Fair); C
and C- (Marginal); D (Very Vulnerable); E (Under State Supervision); and F (In
Liquidation).

Data Management

During the period 1997 to 2002, the Company contracted with various
unrelated third-parties for certain computer information systems and other
software licenses. In 1996, the Company developed and implemented its own
proprietary claims management and medical fee adjudicating systems to manage
claims, audit medical fees, pay claims, provide reports to policyholders and
analyze claims data. These systems replaced third-party contracts for claims
management and medical fee adjudicating systems. In 1995, the Company
developed and implemented its own proprietary policy management system to
process insurance applications and issue policies and endorsements. This
system replaced a third-party contract for a policy management system. In
1999, the Company developed and implemented its own proprietary billing, cash
receipts, collections and agency commission systems. These systems replaced
third-party software systems purchased by the Company. These systems continue
to be upgraded and maintained by the Company. The Company continues to utilize
third party software to maintain financial information, prepare accounting
reports and financial statements and pay vendors. The Company also contracts
with a third-party provider of payroll services for payroll, benefit and human
resource software services. The Company utilizes other licensed software from
national vendors to maintain its financial records, file statutory statements
with insurance regulators and perform other general business.

Employees

The Company had 147 full-time employees at December 31, 2002. Of the
Companys employees, approximately 78 work in the Companys administrative and
financial functions and 69 serve on, provide service to or manage approximately
12 different operating teams. None of the Companys employees are subject to
collective bargaining agreements. The Company believes its employee relations
are good.

Regulation

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

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

8



---



##### Table of Contents



Company Information

The Company maintains a website at www.rtwi.com. Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q and periodic reports on Form 8-K (and any
amendments to these reports) will be available free of charge on the Companys
website as soon as reasonably practical but no later then September 30, 2003.

Executive Officers of the Registrant

The following are the executive officers of the Company at March 28, 2003:

|                      |  |     |    |          |  |                                                 
|--------------------- |  | --- | -- | -------- |  | ------------------------------------------------
|Name                  |  | Age |    | Position
|                      |  |     |    |         
|David C. Prosser      |  |     | 78 |          |  | Chairman of the Board                           
|J. Alexander Fjelstad |  |     | 51 |          |  | President and Chief Executive Officer           
|Alfred L. LaTendresse |  |     | 54 |          |  | Executive Vice President                        
|Jeffrey B. Murphy     |  |     | 41 |          |  | Chief Financial Officer, Treasurer and Secretary
|Patricia M. Sheveland |  |     | 44 |          |  | Vice President  Case and Claims Management     
|Keith D. Krueger      |  |     | 44 |          |  | Vice President  Underwriting and Sales         

David C. Prosser is the founder of the Company and current Chairman of the
Board since December 2001. Mr. Prosser was previously Chairman of the Board
through March 2000, served as President and Chief Executive Officer through
January 1998, and has been a Director of the Company since its formation in
1983. From 1965 through 1985, Mr. Prosser was the owner and President of
Vocational Personnel Services, Inc., which merged into the Company in 1986.

J. Alexander Fjelstad rejoined the Company in December 2001 as President
and Chief Executive Officer and Director after serving as President and Chief
Executive Officer of Headwater Systems, Inc., a manufacturer of radio frequency
identification devices, from March 1999 through December 2001. Mr. Fjelstad
initially joined the Company in 1989 as a Vice President, served as Chief
Operating Officer beginning in 1993 and became Chief Operating Officer -
Marketing and Underwriting in October 1996 through his departure in 1998. Mr.
Fjelstad was a Director of the Company from 1989 to February 1999. He is a
member of the American Institute for Property and Liability Underwriters and
holds the CPCU designation.

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

Jeffrey B. Murphy joined the Company in October 1994 as Controller and was
promoted to Chief Financial Officer in February 2000. Mr. Murphy was the
Corporate Controller and held other management positions for Midcontinent
Media, Inc. from 1989 to 1994. Prior to that time, Mr. Murphy served in
various financial audit positions with Grant Thornton LLP from 1983 to 1989.

Patricia M. Sheveland was appointed to Vice-President  Case and Claims
Management in January 2002. Ms. Sheveland joined the Company in April 1990 and
has held various management positions of increasing importance including
General Manager of Operations in the Colorado regional office and Director of
Operations for the Colorado, Michigan and Massachusetts regions. Prior to
joining the Company, Ms. Sheveland worked as an Occupational Nurse for Kmart
Corporation.

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

9



---



##### Table of Contents






ITEM 2. PROPERTIES

The following is a summary of properties leased by the Company at December 31, 2002:

|                                                                |  |                  |        |             |  |                |  | 
|--------------------------------------------------------------- |  | ---------------- | ------ | ----------- |  | -------------- |  | 
|                                                                |  | Area leased      |        |             |  |               
|Location and description                                        |  | (in square feet) |        | Termination
|                                                                |  |                  |        |            
|Bloomington, Minnesota; Headquarters and
Minnesota office space |  |                  | 26,301 |             |  | September 2007
|Denver, Colorado; Colorado office space                         |  |                  | 7,805  |             |  | April 2005    
|St. Louis, Missouri; Missouri office space                      |  |                  | 6,542  |             |  | September 2005
|Detroit, Michigan; Michigan office space                        |  |                  | 7,118  |             |  | May 2007      
|Grand Rapids, Michigan; Michigan satellite office               |  |                  | 4,631  |             |  | April 2006    




ITEM 3. LEGAL PROCEEDINGS

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




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None




PART II




ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

QUARTERLY STOCK PRICE COMPARISON AND DIVIDENDS

The Companys shares are publicly traded on The Nasdaq Stock Market under
the symbol RTWI. The Company effected a one-for-two reverse-split of its common
stock on November 22, 2002. The table below sets forth the range of high and
low sales prices for the Companys stock for each quarter during the past two
years. The Company had approximately 2,000 shareholders of its common stock at
the close of trading on March 1, 2003.

|             |  |      |  |   |         |  |         |   |      |         |  |         |      |  |  |   |       |  |  | 
|------------ |  | ---- |  | - | ------- |  | ------- | - | ---- | ------- |  | ------- | ---- |  |  | - | ----- |  |  | 
|             |  |      |  |   | First   |  | Second  |   |      | Third   |  | Fourth 
|Fiscal Year: |  |      |  |   | Quarter |  | Quarter |   |      | Quarter |  | Quarter
|             |  |      |  |   |         |  |         |   |      |         |  |         |      |  |  |  
|2002         |  | High |  | $ | 2.70    |  |         | $ | 3.74 |         |  | $       | 2.70 |  |  | $ | 2.54  | 
|             |  | Low  |  |   | 0.72    |  |         |   | 1.16 |         |  |         | 0.94 |  |  |   | 1.20  | 
|2001         |  | High |  |   | 11.88   |  |         |   | 5.28 |         |  |         | 3.84 |  |  |   | 11.24 | 
|             |  | Low  |  |   | 4.25    |  |         |   | 2.00 |         |  |         | 1.36 |  |  |   | 0.50  | 

The Company has never paid cash dividends on its common stock. The
Company currently intends to retain any and all income for use in its
business and does not anticipate paying cash dividends in the foreseeable
future. Any future determination as to payment of dividends will depend on
the financial condition and results of operations of the Company and such
other factors deemed relevant by the Board of Directors. Under the terms of
its credit agreement, the Company is prohibited from making dividend payments
without prior consent of the lender.




ITEM 6. SELECTED FINANCIAL DATA

The consolidated statements of operations data set forth below for each
of the three years in the period ended December 31, 2002, and the
consolidated balance sheet data at December 31, 2002 and 2001 are derived
from, and are qualified by reference to, the audited consolidated financial
statements included elsewhere in this Form 10-K. The consolidated statements
of operations data set forth below for the two years in the period ended
December 31, 1999, and the consolidated balance sheet data at December 31,
2000, 1999 and 1998, are derived from audited consolidated financial
statements not included herein. The information set forth below should be
read in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations and

10



---



##### Table of Contents



the Companys consolidated financial statements and related notes
included elsewhere in this Annual Report on Form 10-K.

|                                |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         | 
|------------------------------- |  | ------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | 
|                                |  | 1998                                  |         |   | 1999 |   |         | 2000 |  |   | 2001    |   |  | 2002 |        
|                                |  |                                       |         |   |      |   |         |      |  |   |         |   |  |      |        
|                                |  | (In thousands, except per share data)
|Total revenues                  |  | $                                     | 90,152  |   |      | $ | 77,812  |      |  | $ | 83,299  |   |  | $    | 95,723  |   |  | $ | 67,146  | 
|Income (loss) from operations   |  |                                       | (10,485 | ) |      |   | 8,357   |      |  |   | (14,780 | ) |  |      | (15,761 | ) |  |   | 10,325  | 
|Net income (loss)               |  |                                       | (7,081  | ) |      |   | 6,167   |      |  |   | (9,708  | ) |  |      | (25,215 | ) |  |   | 14,319  | 
|Basic income (loss) per share   |  |                                       | (1.19   | ) |      |   | 1.00    |      |  |   | (1.79   | ) |  |      | (4.89   | ) |  |   | 2.78    | 
|Diluted income (loss) per share |  |                                       | (1.19   | ) |      |   | 1.00    |      |  |   | (1.79   | ) |  |      | (4.89   | ) |  |   | 2.78    | 
|Premiums in force at year end   |  |                                       | 82,100  |   |      |   | 87,200  |      |  |   | 99,400  |   |  |      | 83,700  |   |  |   | 54,200  | 
|Total assets                    |  |                                       | 172,934 |   |      |   | 176,511 |      |  |   | 194,535 |   |  |      | 218,307 |   |  |   | 223,834 | 
|Notes payable                   |  |                                       | 2,461   |   |      |   |        |      |  |   | 7,000   |   |  |      | 4,500   |   |  |   | 1,250   | 
|Total shareholders equity      |  |                                       | 52,618  |   |      |   | 55,565  |      |  |   | 38,736  |   |  |      | 14,222  |   |  |   | 29,810  | 




ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RTW, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

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

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

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

On February 28, 2002, our A.M. Best financial rating was downgraded from a
Secure rating (B+) to an Unsecure rating (B-) as a result of the decrease in
statutory surplus in 2001 from $29.3 million at December 31, 2000 to $19.5
million at December 31, 2001 and our adverse development in 2001 and 2000 that
resulted in statutory operating losses in those years. Certain insurance
carriers that write umbrella policies will not provide coverage to an employer
if a portion of the employers underlying insurance policy, such as the
workers compensation portion, is written by a carrier with an unsecure rating.
Additionally, certain of our independent agents may be unwilling to sell our
insurance as a result of the downgrade. As a result, we believe that our B-
rating from A.M. Best will make it more difficult to provide our products to
certain employers. While we believe that the A.M. Best downgrade will result in
decreasing premiums in force, the ultimate effect of this downgrade is unknown
at this time.

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

11



---



##### Table of Contents



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

Financial Summary This financial summary presents our discussion and
analysis of the consolidated financial condition and results of operations of
RTW, Inc. This review should be read in conjunction with the Consolidated
Financial Statements at December 31, 2002.

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

|                                    |  |                         |        |  |      |   |         |      |  |   |        |  
|----------------------------------- |  | ----------------------- | ------ |  | ---- | - | ------- | ---- |  | - | ------ | -
|                                    |  | Year Ended December 31, |       
|                                    |  |                         |       
|                                    |  | 2002                    |        |  | 2001 |   |         | 2000 | 
|                                    |  |                         |        |  |      |   |         |      | 
|Gross premiums earned               |  | $                       | 62,506 |  |      | $ | 97,420  |      |  | $ | 95,878 |  
|Premiums earned                     |  |                         | 60,264 |  |      |   | 86,057  |      |  |   | 78,154 |  
|Total revenues                      |  |                         | 67,146 |  |      |   | 95,723  |      |  |   | 83,299 |  
|Claim and claim settlement expenses |  |                         | 40,533 |  |      |   | 80,103  |      |  |   | 72,429 |  
|Net income (loss)                   |  |                         | 14,319 |  |      |   | (25,215 | )    |  |   | (9,708 | )
|Diluted net income (loss) per share |  | $                       | 2.78   |  |      | $ | (4.89   | )    |  | $ | (1.79  | )

RTW reported a decrease in gross premiums earned to $62.5 million in 2002
from $97.4 million in 2001. Total revenues decreased significantly in 2002 to
$67.1 million from $95.7 million in 2001 due to a decrease in premiums in force
related primarily to our regional office closures.

We reported net income of $14.3 million in 2002 compared to net losses of
$25.2 million and $9.7 million in 2001 and 2000, respectively. We reported
basic and diluted net income per share of $2.78 in 2002 compared to basic and
diluted net losses per share of $4.89 and $1.79 in 2001 and 2000, respectively.
The primary factors affecting our 2002 operating results included the
following:



| |  |  | Our gross premiums earned decreased in 2002 from 2001, due primarily
to a 31.6% decrease in average premiums in force to $65.1 million for
2002 from $95.2 million in 2001;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Premiums earned decreased 30.0% in 2002 from 2001. Premiums earned
in 2001 were reduced by premiums ceded under a lower layer excess of
loss reinsurance agreement, effective for claims occurring on or after
July 1, 1998, that was in runoff in 2001. Premiums ceded in 2001
included $7.9 million in premiums ceded under this lower layer excess of
loss reinsurance agreement, compared to $13.4 million ceded in 2000. No
premiums were ceded under this agreement in 2002. Additionally, 2002
premiums ceded were reduced by $1.4 million resulting from a change in
cost related to excess of loss reinsurance in Minnesota;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  |  | Claim and claim settlement expenses decreased significantly to 67.3%
of premiums earned for 2002 from 93.1% for 2001. See further discussion
under Claim and Claim Settlement Expenses;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  |  | In our 2001 Report on Form 10-K/A, we revised the accounting for our contract with St. Paul Re
(SPR), which was originally accounted for under reinsurance accounting
standards using deposit accounting standards, and restated our 2001
financial statements. We further terminated this contract with SPR in
December 2002 and were refunded $28.8 million, resulting in a $1.0
million gain recorded in December 2002. Deposit accounting for this
contract required us to record a margin expense at 4.75% of premiums
ceded to SPR and interest income on the fund balance at an amount equal
to the quarter-end U.S. Treasury Bill rate less 25 basis points. The
deposit accounting change caused a decrease in premiums ceded and an
increase in investment income, claim and claim settlement expenses,
policy acquisition costs and general and administrative expenses from
the amounts originally reported in 2001. As a result, the accounting
for this contract increased net income by $354,000 in 2002 after
reducing interest income and the gain on termination by the margin
expense, and an increase in the 2001 net loss by $1.5 million; and
|
| |  |  | At December 31, 2001, we established a $14.5 million valuation
allowance against deferred tax assets resulting in a corresponding
increase in income tax expense. This valuation allowance decreased to
$6.6 million at December 31, 2002. The $7.9 million decrease in the
valuation allowance favorably affected our income tax expense in 2002.
See further discussion under Income Taxes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

We expect 2003 premiums in force to increase slightly from levels in 2002.
We also anticipate that we will

12



---



##### Table of Contents



continue to operate in an environment of premium rate increases in 2003; however, these rate increases will be
significantly lower than experienced in 2002, 2001 and 2000. We will focus on
achieving profitability in our remaining regional markets by: (i) aggressively
managing and closing claims, (ii) reviewing policy profitability at renewal and
removing unprofitable accounts, and (iii) aggressively managing policy
acquisition costs and general and administrative expenses.

In the following pages, we take a look at the 2002, 2001 and 2000
operating results for items in our Consolidated Statement of Operations and
also explain key balance sheet accounts in greater detail.

RESULTS OF OPERATIONS

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

|                                        |                            |                                        |                |        |                         |        |         |        |       |        |         |        |      |        | 
|--------------------------------------- | -------------------------- | -------------------------------------- | -------------- | ------ | ----------------------- | ------ | ------- | ------ | ----- | ------ | ------- | ------ | ---- | ------ | 
|                                        |                            |                                        |                |        | Year Ended December 31, |       
|                                        |                            |                                        |                |        |                         |       
|                                        |                            |                                        |                |        | 2002                    |        |         | 2001   |       |        | 2000    |       
|                                        |                            |                                        |                |        |                         |        |         |        |       |        |         |       
|Gross premiums earned                   |                            | $                                      | 62,506         |        |                         | $      | 97,420  |        |       | $      | 95,878  |       
|Premiums ceded                          |                            |                                        | (2,242         | )      |                         |        | (11,363 | )      |       |        | (17,724 | )     
|                                        |                            |                                        |                |        |                         |        |         |        |       |        |         |       
|                                        | Premiums earned            |                                        |                | 60,264 |                         |        |         | 86,057 |       |        |         | 78,154 |     
|Investment income                       |                            |                                        | 5,139          |        |                         |        | 6,415   |        |       |        | 5,752   |       
|Net realized investment gains (losses): |                            |                                        |                |        |                         |        |         |        |       |        |         |       
|                                        | Realized investment gains  |                                        |                | 1,930  |                         |        |         | 1,225  |       |        |         | 26     |     
|                                        | Realized investment losses |                                        |                | (209   | )                       |        |         | (62    | )     |        |         | (633   | )   
|                                        |                            |                                        |                |        |                         |        |         |        |       |        |         |       
|                                        |                            | Net realized investment gains (losses) |                |        | 1,721                   |        |         |        | 1,163 |        |         |        | (607 | )     
|Other income                            |                            |                                        | 22             |        |                         |        | 2,088   |        |       |        |        |       
|                                        |                            |                                        |                |        |                         |        |         |        |       |        |         |       
|                                        |                            |                                        | Total revenues |        | $                       | 67,146 |         |        | $     | 95,723 |         |        | $    | 83,299 | 
|                                        |                            |                                        |                |        |                         |        |         |        |       |        |         |       

|                                                 |                         |      |        |        |      |   |        |        |  |   |        |        | 
|------------------------------------------------ | ----------------------- | ---- | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|Premiums in force by regional office at year-end |                         | 2002 |        |        | 2001 |   |        | 2000   | 
|                                                 |                         |      |        |        |      |   |        |        | 
|Minnesota                                        |                         | $    | 23,000 |        |      | $ | 26,700 |        |  | $ | 33,800 |       
|Colorado                                         |                         |      | 11,800 |        |      |   | 13,100 |        |  |   | 16,000 |       
|Missouri                                         |                         |      | 700    |        |      |   | 10,300 |        |  |   | 13,400 |       
|Michigan                                         |                         |      | 18,000 |        |      |   | 21,700 |        |  |   | 18,600 |       
|Massachusetts                                    |                         |      | 700    |        |      |   | 11,900 |        |  |   | 17,600 |       
|                                                 |                         |      |        |        |      |   |        |        |  |   |        |       
|                                                 | Total premiums in force |      | $      | 54,200 |      |   | $      | 83,700 |  |   | $      | 99,400 | 
|                                                 |                         |      |        |        |      |   |        |        |  |   |        |       

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

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

Our premiums in force decreased 35.2% to $54.2 million at December 31,
2002 from $83.7 million at December 31, 2001 due to decreases in premiums in
force in all of our markets, but primarily the result of closing our Missouri
and Massachusetts regional offices. Average premiums in force decreased to
$65.1 million in 2002 from $95.2 million in 2001 and $90.9 million in 2000. In
order to improve profitability, we aggressively targeted policies that did not
meet our underwriting profit margin standards for non-renewal or
re-underwriting at increased rates at policy expiration in 2002, 2001 and 2000. Our average annual premium per policy increased to $80,400 in 2002 from
$56,800 in 2001 and $40,500 in 2000 as a result of the focused aggressive
re-underwriting in 2001 and 2000.

Our gross premiums earned decreased 35.8% to $62.5 million in 2002 from
$97.4 million in 2001. This decrease resulted primarily from: (i) the
decrease in average premiums in force, and (ii) final audit premiums which

13



---



##### Table of Contents



decreased gross premiums earned by $1.7 million in 2002 and increased
gross premiums earned by $1.8 million in 2001.

Gross premiums earned increased 1.6% to $97.4 million in 2001 from $95.9
million in 2000. This increase resulted from: (i) the increase in average
premiums in force, offset by (ii) a decrease in final audit premiums that
increased gross premiums earned by $1.8 million in 2001 compared to $5.5
million in 2000.

In 2002, 2001 and 2000, we were able to increase premium rates on renewing
policies an average of 9.0%, 18.5% and 11.7%, respectively. We have been able
to increase premium rates in our markets due to the following:



| |  |  | Many workers compensation insurers have withdrawn from the markets
in which we write premiums as profitability diminished in the workers
compensation insurance line;                                                                                                                                                                                                                                                                                                                                                                                                           
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Reinsurance rates for workers compensation insurers have increased
due to: (i) reductions in reinsurers surplus as a result of the
September 11, 2001 terrorist acts against the United States, (ii) recent
unprofitability resulting from highly competitive reinsurance pricing,
and (iii) settlements related to certain reinsurance treaties written in
the late 1990s. These rate increases have resulted in increased costs
for workers compensation insurers. Insurers, including RTW, have
raised premium rates to offset these increases in reinsurance premiums;
and
|
| |  |  | A number of workers compensation insurers financial ratings have
decreased due to reserve adjustments recorded in 2002, 2001 and 2000.                                                                                                                                                                                                                                                                                                                                                                                                                                          

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

Under our excess of loss reinsurance policies, we pay reinsurers to limit
our per-incident exposure and record this cost to premiums ceded as a reduction
of gross premiums earned. In Minnesota, we are required to purchase excess of
loss coverage for our Minnesota policies from the Minnesota Workers
Compensation Reinsurance Association (WCRA). In 2002, we ceded Minnesota
claims in excess of $350,000 per occurrence to the WCRA; in 2001 and 2000, we
ceded Minnesota claims in excess of $330,000 and $310,000, respectively to the
WCRA. The per-occurrence coverage level increased to $360,000 in 2003. In our
non-Minnesota states, we maintained excess of loss coverage with a per-incident
exposure of $300,000 since 1999. We purchased this non-Minnesota coverage from
a single reinsurer. In 2002, the non-Minnesota excess of loss coverage no
longer included statutory limit coverage and was capped at $20.0 million per
occurrence and further excluded claims resulting from acts of terrorism. In
2003, our non-Minnesota per-incident excess of loss coverage increased to
$360,000, continues to be capped at $20.0 million per occurrence and further
excludes claims resulting from acts of terrorism. We further decreased our
retention to $200,000 per-incident in all our regions in 2003 by purchasing
increased excess of loss reinsurance in order to further reduce volatility in
our results. This coverage was purchased from three reinsurers.

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

14



---



##### Table of Contents



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

|                     |                                      |                                                      |                |   |                         |        |      |   |        |         |   |   |         |         |  
|-------------------- | ------------------------------------ | ---------------------------------------------------- | -------------- | - | ----------------------- | ------ | ---- | - | ------ | ------- | - | - | ------- | ------- | -
|                     |                                      |                                                      |                |   | Year Ended December 31,
|                     |                                      |                                                      |                |   |                        
|                     |                                      |                                                      |                |   | 2002                    |        | 2001 |   | 2000  
|                     |                                      |                                                      |                |   |                         |        |      |   |       
|Premiums ceded, net: |                                      |                                                      |                |   |                         |        |      |   |        |         |   |  
|                     | Excess of loss reinsurance premiums: |                                                      |                |   |                         |        |      |   |        |         |   |   |        
|                     |                                      | $25,000 to $300,000 excess of loss policy            |                | $ |                        |        |      | $ | (7,297 | )       |   | $ | (13,442 | )      
|                     |                                      | WCRA and other non-Minnesota excess of loss policies |                |   | (2,242                  | )      |      |   | (4,066 | )       |   |   | (4,282  | )      
|                     |                                      |                                                      |                |   |                         |        |      |   |        |         |   |  
|                     |                                      |                                                      | Premiums ceded |   | $                       | (2,242 | )    |   | $      | (11,363 | ) |   | $       | (17,724 | )
|                     |                                      |                                                      |                |   |                         |        |      |   |        |         |   |  

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

Premiums ceded to reinsurers decreased to $11.4 million in 2001 from $17.7
million in 2000. The decrease in premiums ceded resulted primarily from the
run-off of premiums ceded under our $25,000 to $300,000 policy.

2003 Outlook: The 2003 outlook for premiums in force, gross premiums earned
and premiums ceded include the following factors:



| |  |  | We expect that our B- A.M. Best rating and the final runoff of in
force premiums in our Massachusetts and Missouri regions will put
downward pressure on premiums in force in 2003. Premium rates are
expected to be relatively flat on new and renewing policies as we filed
our rates at the high end in each region in which we operate in 2002,
leaving little room to further increase rates in 2003. Premium rate increases realized in 2002 will continue to
favorably affect profitability on each account in 2003 as we earn more premium on those policies. We expect to
further improve our agency relationships in 2003 resulting in new
business increases primarily in our Minnesota and Michigan regions.
Overall, we expect premiums in force to increase only slightly;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Our 2002 gross premiums earned include $7.9 million in premiums
earned from our Missouri and Massachusetts regions that were in runoff
in 2002. Premiums earned in these regions are expected to be less than
$100,000 in 2003. Additionally, we expect our average premiums in force
to decrease significantly in 2003 compared to 2002. Overall, we expect
gross premiums earned to decrease significantly in 2003; and                                                                                                                                                                                                                                                                                                                                                               
|
| |  |  | Premiums ceded under excess of loss policies will increase
significantly as a percent of gross premiums earned when compared to the
results attained for 2002. This increase is the result of two factors:
(i) our cost for excess of loss reinsurance coverage in our
non-Minnesota regions increased substantially for 2003 while our
Minnesota cost decreased only slightly, and (ii) we decreased our
retention to $200,000 in all our regions in 2003 by purchasing increased
excess of loss coverage in order to further reduce volatility in our
results.                                                                                                                                                                                                                        

Investment Income and Net Realized Investment Gains (Losses):Our investment
income includes earnings on our investment portfolio and interest on our
deposit receivable. Our net realized investment gains (losses), displayed
separately on our accompanying Consolidated Statements of Operations, include
gains and losses from sales of securities. Through January 2001, we invested
entirely in U.S. domiciled investment-grade taxable and tax-exempt fixed
maturity investments. In February 2001, we repositioned our portfolio, sold
our tax-exempt securities, and purchased taxable securities to take advantage
of our net operating loss carry-forward generated in 2000 and to maximize the
after-tax yield of our investment portfolio. We realized investment gains
totaling $1.1 million as a result of this repositioning. In February 2002, we
sold certain securities within the portfolio and realized investment gains
totaling $1.5 million to increase statutory surplus. In September 2002, we
sold our corporate securities to further reduce risk in our portfolio and
realized net investment gains of $354,000 in the third quarter of 2002.
Further recognition of realized investment gains and losses will depend on
sales of our investments, if any, to meet our short-term cash requirements or
as we replace securities to manage our portfolio returns. We currently invest
entirely in U.S. domiciled investment-grade taxable fixed maturity investments
and classify our investments as available-for-sale. We intend to hold our
available-for-sale investments to maturity, but may sell them before maturity
in response to tax planning considerations, changes in interest rates, changes
in prepayment risk and changes in funding sources or terms, or to address
liquidity needs. Our primary investment objective is to maintain a

15



---



##### Table of Contents



diversified,
high-quality, fixed-investment portfolio structured to maximize our after-tax
investment income without taking inappropriate credit risk. For further discussion of investments, see
the Investments section of this Managements Discussion and Analysis.

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

Investment income increased to $6.4 million in 2001 from $5.8 million in
2000. Investment income increased as a result of repositioning our portfolio
entirely into taxable securities that earn a higher pre-tax rate of return
offset by a reduction in our invested assets to $89.2 million at December 31,
2001 from $96.8 million at December 31, 2000 and further includes interest on
our deposit receivable totaling $518,000 for 2001. Invested assets decreased
due to decreased operating cash flow, resulting primarily from: (i) the
difference in timing between the receipt of premiums, the payment of premiums
ceded under our reinsurance agreements, the payment of claim and claim
settlement expenses and the recovery of paid claim and claim settlement
expenses under our reinsurance programs, and (ii) net cash provided by
investment income. Tax-adjusted investment yields were 6.1% in 2001 compared
to 6.6% in 2000. The investment yields realized in future periods will be
affected by yields attained on new investments.

Net realized investment gains were $1.7 million in 2002 that resulted from
sales of securities in February 2002 as well as repositioning out of corporate
securities in September 2002. Net realized investment gains were $1.2 million
in 2001 and resulted primarily from our portfolio repositioning out of taxable
securities in February 2001. Net realized investment losses were $607,000 in
2000 and included $500,000 for the write-down of a security whose decrease in
value was deemed other than temporary.

2003 Outlook: Barring significant changes in interest rates or operational
cash flows, we expect that income from our investment portfolio for 2003 will
be affected by the following:



| |  |  | The increase in our funds available for investment as a result of the
$28.8 million of cash received in December 2002 from terminating the St.
Paul Re contract;                                                                                                                                                                                                                                                                                                                                                                                              
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We earned $736,000 in interest on our deposit receivable in 2002.
There will be no interest earned on the deposit in 2003 due to our
terminating the St. Paul Re contract;                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  |  | Funds from our operating cash flows and investment cash flows
historically provided growth in our investment portfolio; however, these
net cash flows will decrease as we focused on closing claims from prior
years, years in which premiums were higher and more claims were
reported, paying to close those claims. Cash flows for 2003 are
expected to be adversely affected by decreases in cash flows resulting
from claim payments on claims from 2002 and prior years exceeding cash
flows from our premiums as we reduce our premiums earned in 2003;
|
| |  |  | Further recognition of realized investment gains and losses will
depend on sales of our investments, if any, to meet our short-term cash
requirements or as we replace securities to manage our portfolio
returns; and                                                                                                                                                                                                                                                                                                                                        
|
| |  |  | New and renegotiated reinsurance treaties may affect our future cash
flow and future investment income.                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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

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

16



---



##### Table of Contents



Claim and Claim Settlement Expenses:Claim expenses refer to medical and
indemnity benefits that we paid or expect to pay to claimants for events that
have occurred. The costs of investigating, resolving and processing these

claims are referred to as claim settlement expenses. We record these expenses,
net of amounts recoverable under reinsurance contracts, to claim and claim
settlement expenses in the accompanying Consolidated Statements of Operations.

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

We experienced a significant decrease in the estimated number of ultimate
claims for 2002 compared to 2001 and 2000. The number of estimated ultimate
claims by accident year decreased to approximately 11,500 in 2002 from 22,100
in 2001 and 28,300 in 2000. The net decrease correlates directly to: (i) the
decrease in premiums in force, and (ii) the re-underwriting that we completed
with respect to our in force policies in 2000 and 2001. The gross and net
average estimated cost per claim totaled approximately $5,500 and $4,900 in
2002 compared to $4,500 and $3,400 in 2001 and $4,000 and 2,400 in 2000,
respectively. The increases in gross and net average estimated cost per claim
are primarily the result of increases in severity, (i.e., the average cost of a claim),
caused mainly by inflationary pressures. The trend of increasing severity is
attributable to a combination of factors that include increasing medical costs
and increasing indemnity payments (reimbursements to injured workers for lost
wages) per claim. We have also observed a decline in the number of claims being
reported over the last several years. The declining frequency of claims
contributes to the increasing severity trend because the frequency decline has
been concentrated in less expensive claims (claims involving less time-off from
work and less severe injuries).

The number of claims reported but unpaid (open claims) and the approximate
average gross and net reserves on these claims each period was: 2002  1,381
claims, $9,700 average gross reserve, $9,000 average net reserve; 2001  670
claims, $26,900 average gross reserve, $17,500 average net reserve; and 2000 -
344 claims, $46,400 average gross reserve, $9,600 average net reserve. The
average gross and net reserves per claim are less in 2002 than in 2001 and 2000
as the open claims include newly reported claims from the later half of 2002, including
many with much lower severity that have not had time to close, as
well as new claims that are anticipated but not yet reported. The remaining
open claims from 2001 and 2000 are primarily claims with significant injury
characteristics resulting in the increase in outstanding average gross and net
reserves per claim.

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



| |  |  | Gross premiums earned decreased significantly due to: (i) decreased
premiums in force, and (ii) final audit premium reductions totaling $1.7
million in 2002 compared to an increase in premiums earned due to final
audits of $1.8 million in 2001, resulting in corresponding decreases in
claim and claim settlement expenses and a distorted percent of gross
premiums earned;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | The 2002 results include an $8.4 million decrease in prior years
reserves for unpaid claim and claim settlement expenses compared to the
2001 results which include a $7.7 million increase in prior years
reserves for unpaid claim and claim settlement expenses. Our estimate
for unpaid claim and claim settlement expenses decreased in 2002 due to
the following: (i) in March 2002, the Minnesota State legislature
changed the way the commissioner will assess self-insured employers and
insurers for estimated liabilities and administrative expenses of the
States Special Compensation Fund (SCF). The assessment changed from
being paid by the insurer on indemnity payment basis to an assessment charged
on premium to the policyholder. We decreased our recorded accrual to
reflect this legislative change, (ii) the frequency of claims reported
in 2002 for 2001 and prior years was less than anticipated when we
determined our liability in 2001, (iii) we overestimated the liability
for our mandatory participation in state and national assigned risk pool
operating results for states in which we operate in 2001 and reversed
that excess in 2002, and (iv) our estimate of the liability for unpaid
claim and claim settlement expenses is difficult and volatile due to our
relatively limited historical claim data and small claim population;
|
| |  |  | We recorded estimates of ceded paid and unpaid claim and claim
settlement expenses under our $25,000 to $300,000 excess of loss
reinsurance agreement totaling $15.2 million in 2001 resulting in a
corresponding reduction in 2001 claim and claim settlement expenses. No
such benefit was recorded in 2002;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|

17



---



##### Table of Contents





| |  |  | We increased renewal premium rates an average of 9.0% in 2002 and
18.5% in 2001 compared to premium rates for the same periods in 2001 and
2000, respectively, reversing a trend of continued rate declines during
years prior to 2000. Increases in premium rates have the effect of
reducing the ratio of claim and claim settlement expenses to gross
premiums earned as losses do not increase with premium rate increases;
and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Claim costs continued to reflect increasing medical and indemnity
costs in accident year 2002 as compared to accident year 2001 resulting
from inflationary pressures.                                                                                                                                                                                                                                                             

Claim and claim settlement expenses increased to $80.1 million in 2001
from $72.4 million in 2000. As a percent of premiums earned, claim and claim
settlement expenses increased slightly to 93.1% in 2001 from 92.7% in 2000.
These changes are due to the following:



| |  |  | The 2001 results include a $7.7 million increase in prior years
reserves for unpaid claim and claim settlement expenses compared to the
2000 results which include a $15.9 million increase in prior years
reserves for unpaid claim and claim settlement expenses. Our estimate
for unpaid claim and claim settlement expenses increased in 2001 due to
the following: (i) we increased the estimated liability for second
injury funds and our mandatory participation in state and national
assigned risk pool operating results for states in which we operate,
(ii) our estimate of the liability for unpaid claim and claim settlement
expenses is difficult and volatile due to our relatively limited
historical claim data and small claim population, and (iii) we increased
the estimated liability for claims in our closed Missouri and
Massachusetts regions;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We recorded estimates of ceded paid and unpaid claim and claim
settlement expenses under our $25,000 to $300,000 excess of loss
reinsurance agreement totaling $15.2 million in 2001 including $400,000
amortized from a deferred retrospective reinsurance gain resulting in a
corresponding reduction in 2001 claim and claim settlement expenses.
These amounts compare to our 2000 results which include an estimate of
ceded paid and unpaid claim and claim settlement expenses totaling $21.8
million and $400,000 amortized from the deferred retrospective reinsurance
gain;                                                                                                                                                                                                                                                                                        
|
| |  |  | We increased renewal premium rates an average of 18.5% in 2001 and
11.7% in 2000 compared to premium rates for the same periods in 2000 and
1999, respectively, reversing a trend of continued rate declines during
years prior to 2000. Increases in premium rates have the effect of
reducing the ratio of claim and claim settlement expenses to gross
premiums earned as losses do not increase with premium rate increases;
and                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| |  |  | Claim costs continued to increase in 2001, 2000 and 1999 due to
increasing medical and indemnity costs. These increases were offset
somewhat by the effects of provider agreements that we negotiated during
1998.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

2003 Outlook:We expect that claim and claim settlement expenses will be
affected by the following factors:



| |  |  | Claim costs will continue to be affected by: (i) increases in medical
and indemnity costs resulting from inflationary changes, (ii) severity
experienced in future periods in our policy holder base, (iii) changes
resulting from increases in operating efficiency and effectiveness
realized through enhancements to our internal processes and procedures,
including changes to our proprietary computer systems, and (iv)
legislative changes that affect benefits payable under workers
compensation laws;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Increases in premium rates, if any in 2003, will result in increasing
premiums earned without a corresponding increase in claim and claim
settlement expenses, ultimately decreasing claim and claim settlement
expense as a percent of premiums earned. Changes in premium rates due
to legislative changes in estimated loss costs, increased competition
and improving customer loss experience may offset rate improvements; and                                                                             
|
| |  |  | Continued application of our claims management technology and methods
to all open claims.                                                                                                                                                                                                                                                                                                                                                                                                                        

The ultimate result of the above factors on 2003 claim and claim settlement
expenses as a percent of premiums earned is unknown at this time.

Policy Acquisition Costs:Policy acquisition costs are costs directly related
to writing an insurance policy and consist of commissions, state premium taxes,
underwriting personnel costs and expenses, sales and marketing costs and other
underwriting expenses less ceding commissions from our reinsurers. Ceding
commissions are amounts that reinsurers pay to us for placing reinsurance with
them. Under our 1992 to 1994 quota share reinsurance agreement,

18



---



##### Table of Contents



the ceding
commission is adjusted to the extent that actual claim and claim settlement
expenses vary from levels specified in the agreements.

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

|                                                                                                                          |                          |   |                         |       |      |   |       |        |  |   |       |        | 
|------------------------------------------------------------------------------------------------------------------------- | ------------------------ | - | ----------------------- | ----- | ---- | - | ----- | ------ |  | - | ----- | ------ | 
|                                                                                                                          |                          |   | Year Ended December 31,
|                                                                                                                          |                          |   |                        
|                                                                                                                          |                          |   | 2002                    |       | 2001 |   | 2000 
|                                                                                                                          |                          |   |                         |       |      |   |      
|Commission expense                                                                                                        |                          | $ | 4,321                   |       |      | $ | 7,378 |        |  | $ | 7,537 |       
|Premium tax expense                                                                                                       |                          |   | 1,048                   |       |      |   | 1,888 |        |  |   | 1,933 |       
|Other policy acquisition costs                                                                                            |                          |   | 935                     |       |      |   | 4,463 |        |  |   | 4,207 |       
|Ceding commissions resulting from adjustments to claim and
claim settlement estimates for our 1992 to 1994 accident years |                          |   |                        |       |      |   | 261   |        |  |   | 460   |       
|                                                                                                                          |                          |   |                         |       |      |   |       |        |  |   |       |       
|                                                                                                                          | Policy acquisition costs |   | $                       | 6,304 |      |   | $     | 13,990 |  |   | $     | 14,137 | 
|                                                                                                                          |                          |   |                         |       |      |   |       |        |  |   |       |       

Policy acquisition costs decreased to $6.3 million in 2002 from $14.0
million in 2001 and $14.1 million in 2000. As a percent of gross premiums
earned, policy acquisition costs decreased to 10.1% in 2002 compared to 14.4%
in 2001 and 14.7% in 2000. The decrease in 2002 reflects the following:



| |  |  | Gross premiums earned decreased significantly in 2002 compared to
2001 and 2000 resulting in corresponding decreases in policy acquisition
costs;                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Commission expense decreased to 6.9% of gross premiums earned in 2002
from 7.6% in 2001 and 7.9% in 2000. The decreased commission
percentages in 2002 and 2001 are the result of: (i) a focus on reducing
commissions paid on new business in our non-Minnesota regions, and (ii)
increased renewal premiums on which we pay lower commission rates in all
our states. In 2002, our renewal business, on which we pay lower commission rates, significantly outpaced our new business. In all
of our markets, we believe the commission rates we pay are marketplace
competitive;     
|
| |  |  | Premium tax expense decreased slightly to 1.7% of gross premiums
earned in 2002 from 1.9% of gross premiums earned in 2001 and 2.0% in
2000;                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  |  | Other policy acquisition costs decreased to 1.5% of gross premiums
earned in 2002 compared to 4.6% in 2001 and 4.4% in 2000. Other policy
acquisition costs reflect the benefit of the following: (i)
improvements in our underwriting organizational structure resulting in a
$1.1 million decrease in personnel costs, overhead costs and marketing
costs, (ii) an $851,000 reduction in an estimated accrual for second
injury funds compared to recording an adjustment for those funds in
2001, and (iii) a general decrease related to the decrease in gross
premiums earned; and
|
| |  |  | We incurred ceding commission expense resulting from adjustments to
claim and claim settlement expense estimates for 1992 to 1994 totaling
$260,000 in 2001 and $460,000 in 2000. No such expense was recorded in
2002.                                                                                                                                                                                                                                                                                                                                                                

2003 Outlook:We expect that policy acquisition costs in 2003 will increase as
a percent of gross premiums earned to levels consistent with 2001 and 2000 as
we expect no second injury fund accrual reversals in 2003.

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

Our general and administrative expenses decreased to $10.0 million in 2002
from $17.4 million in 2001 and $11.5 million in 2000. As a percent of gross
premiums earned, general and administrative expenses decreased to 16.0% in 2002
from 17.9% in 2001 and increased from 12.0% in 2000. General and
administrative expenses decreased in 2002 as follows: (i) general and
administrative expenses included costs related to operating our Missouri and
Massachusetts offices in 2001; no such expense was recorded in 2002, (ii) we
recorded $1.4 million in margin expenses related to our St. Paul Re contract
offset by a $1.0 million gain recorded on the termination of the contract in
2002 compared to $2.0 million recorded in margin expenses in 2001 on the
contract, (iii) we recorded $2.0 million in restructuring charges related to
closing our regional offices in Missouri and Massachusetts and closing
satellite offices in Brainerd, Minnesota and Overland Park, Kansas in 2001; no
such costs were recorded in 2002, (iv) assessments by state Insurance
Guarantee Associations (IGA) totaling $266,000 in 2002 compared to $1.1 million
in 2001 and $236,000 in 2000, (v) we incurred one-time business repositioning
costs totaling $470,000 in 2001, (vi) we recorded bonuses of $864,000 in 2002
compared to $204,000 in 2001, and (vi) we expensed $270,000 in leasehold
improvement write-offs related to rebuilding our Minnesota and home office
leased space in

19



---



##### Table of Contents



2002. After adjusting for these items, general and
administrative expenses increased as a percent of gross premiums earned to
13.1% in 2002 from 11.9% in 2001 and 11.8% in 2000. These increases reflect:



| |  |  | General and administrative expenses increased as a percent of
premiums earned, after adjusting for restructuring charges, IGA
assessments and one-time charges as we had less revenue relative to our
fixed operating costs and expenses. We aggressively managed personnel
and other operating costs and expenses during 2002 to appropriately
align operating expenses with revenues. All expenses continue to be
managed aggressively and reduced where appropriate;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | A reduction and renegotiation of our Corporate and Minnesota office
space that resulted in a decrease in related office expenses beginning
in October 2002; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  |  | During the fourth quarter of 2001, we recorded pre-tax restructuring
charges totaling $2.0 million to general and administrative expenses in
the Consolidated Statements of Operations. These charges included costs
associated with our decision to close our Missouri and Massachusetts
regional offices, as well as our Brainerd, Minnesota and Overland Park,
Kansas satellite offices. We anticipated that 38 employees in our
regional offices, 17 employees in our satellite offices and 2 employees
in our Home Office would be affected by these closures. The
restructuring charge amount included $715,000 of severance pay and
benefits of which $106,000 was paid in 2001 and the remainder was paid
in 2002. Additionally, the restructuring charge included office and
equipment lease costs totaling $684,000 of which $80,000 was paid in
2001 and an additional $195,000 was paid in 2002, and furniture and
equipment disposals and other costs totaling $600,000, of which $53,000
was disposed in 2001 and the remainder was disposed in 2002. The
remaining accrual balance for severance pay and benefits, office and
equipment lease costs and furniture and equipment disposals and other costs was $409,000 and $1.8 million at
December 31, 2002 and 2001 respectively.

2003 Outlook:We expect that general and administrative expenses will be
affected by the following:



| |  |  | We have historically managed personnel and other operating costs and
expenses to keep operating expenses in line with revenues. All expenses
will continue to be aggressively managed and reduced where appropriate;                                                                   
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We have no plans to open additional state offices in 2003 and expect
to further reduce overhead costs in 2003 as a result of our office
closures in 2001 and runoff in 2002. We will continually monitor
reported claim counts for 2003 and re-examine staffing needs as
necessary; and
|
| |  |  | We reduced and renegotiated lease costs for our Corporate and
Minnesota office space and expect that related office expenses will
decrease in 2003.                                                                                                                                    

Interest Expense:We incurred interest charges on our Term Loan in 2002, 2001
and 2000.

The Term Loan accrues interest, payable quarterly. We may elect to pay an
adjusted LIBOR or bank reference rate on the Term Loan. We paid interest at
rates ranging from 4.61% to 5.33% on the outstanding balance of our Term Loan
in 2002 compared to 6.50% to 8.83% in 2001. Interest expense decreased to
$163,000 in 2002 from $511,000 in 2001 as a result of the decrease in interest
rates, $3.3 million in principal payments in 2002 and $2.5 million in principal
payments in 2001.

We paid interest at rates ranging from 6.50% to 8.83% on the outstanding
balance of our Term Loan in 2001 compared to 8.68% to 9.34% in 2000. Interest
expense decreased to $511,000 in 2001 from $667,000 in 2000 as a result of the
change in interest rates and $2.5 million in principal payments on the note in
2001.

2003 Outlook:Interest expense is expected to decrease in 2003 as a result of
the $3.3 million in principal payments made in 2002. Total interest expense is
expected to decrease to approximately $55,000 in 2003 from $163,000 in 2002 as
a result of principal reductions in 2002. The remaining principal is due in
2003.

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

20



---



##### Table of Contents



unpaid claim and claim
settlement expenses, limitations on the deductibility of unearned premium
reserves and limitations on deductions for bad debt reserves.

In assessing the realizability of deferred tax assets, we consider whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. We consider recent operating results, the scheduled
reversal of deferred tax liabilities, projected future taxable income and tax
planning strategies in making this assessment. At December 31, 2001, we
established a $14.5 million valuation allowance (allowance) against deferred
tax assets resulting in a corresponding increase in income tax expense as a
result of this analysis. This allowance decreased by $7.9 million to $6.6
million at December 31, 2002 as a result of the income we earned in 2002 and
federal tax refunds totaling $3.8 million resulting from a change in Federal
tax law. We expect any remaining deferred tax assets, net of the allowance, at
December 31, 2002, to be realized as a result of the future income and the
reversal of existing taxable temporary differences. No allowance was provided
against the deferred tax assets in 2000.

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

Income tax benefit for the year ended December 31, 2002 included the
following: (i) a $3.8 million benefit from carrying back our 2001 loss five
years under the tax law change, (ii) a $4.0 million benefit resulting from
reducing the allowance as we realized favorable claim reserve development in
2002, and (iii) a further benefit as we offset current year earnings by losses
carried forward from 2000. The income tax benefit for 2002 included the items recorded in the third quarter as well as a $1.0 million benefit from
reducing the allowance related to recognizing a $3.0 million benefit from the
SCF. After excluding the effects of the benefits from reducing the allowance,
income tax expense was $3.8 million for 2002 compared to an income tax benefit
of $5.6 million for 2001. As a percent of income before income taxes, the
income tax expense before any benefit from reducing the allowance was 37.1% of
the income before income taxes in 2002 compared to 34.5% and 37.2% of the net
loss before income taxes in 2001 and 2000, respectively.

2003 Outlook:Income tax expense will vary based on: (i) the income from
operations we recognize for 2003, and (ii) the changes in our analysis of the
valuation allowance necessary during 2003. The ultimate change is unknown at
this time.

INVESTMENTS

Our portfolio of fixed maturity securities at December 31, 2002 included only
U.S. government securities (59.0%), mortgage-backed securities (39.8%), and
asset-backed securities (1.2%). Our portfolio is managed by an independent
investment manager to maximize our after-tax investment income without taking
inappropriate credit risk. In September 2002 we sold our corporate securities
to reduce risk in our portfolio resulting in a $354,000 gain. In February
2002, we sold select securities within the portfolio and realized an additional
investment gain totaling $1.5 million to increase our statutory surplus. In
February 2001, we recognized gains totaling $1.1 million as we repositioned our
portfolio by selling our tax-exempt securities and repurchased taxable fixed
maturity investments to increase our after-tax yield. We conservatively manage
our fixed maturity portfolio, investing only in investment grade (BBB or better
rating from Standard and Poors) securities of U.S. domiciled issuers. All
securities in our portfolio were rated AAA at December 31, 2002. We do not
invest in derivative securities.

Operating cash flows consist of the deficit or excess of premiums
collected over claim and claim settlement expenses paid reduced by payments for
reinsurance premiums as well as other operating expenses paid. Investment cash
flows consist of income on existing investments and proceeds from sales and
maturities of investments. Prior to 1999, we generated positive net cash flows
from operations due, in part, to timing differences between the receipt of
premiums and the payment of claim and claim settlement expenses. These net
cash flows decreased significantly in 2001, 2000 and 1999 as we focused on
closing old claims by paying earlier to close those claims. Combined with
relatively flat premiums in force in 1998, 1999 and 2000 and decreasing
premiums since that time, our cash flows from differences in timing have
decreased. Additionally, as we lowered our reinsurance retention levels to
$25,000 in mid-1998, we decreased our current period cash flows as a result of
pre-funding quarterly reinsurance premiums under that agreement. Reinsurance
reimbursements from our $25,000 to $300,000 excess of loss reinsurance
agreement offset similar payments to claimants for those years in 2002. Our
investment portfolio decreased $7.8 million to $81.4 million at December 31,
2002 from $89.2 million at December 31, 2001, as a result of these factors.
The cash balance at December 31, 2002 included $28.8 million received from St.
Paul Re from terminating the

21



---



##### Table of Contents



contract late in December 2002. We invested this
cash in January 2003. We expect that cash will decrease in 2003 as we pay
claims for 2002 and prior years, years in which we earned higher premiums and
incurred a higher number of claims reported while 2003 premiums earned are
expected to decrease.

We record investments on our balance sheet at fair value, with the
corresponding appreciation or depreciation from amortized cost recorded in
shareholders equity as other comprehensive income, net of taxes. Because
value is based on the relationship between the portfolios stated yields and
prevailing market yields at any given time, interest rate fluctuations can have
a swift and significant impact on the carrying value of these securities. As a
result of classifying our securities as available-for-sale, and thus carrying
them at fair value, we expect to encounter adjustments in shareholders equity
as market interest rates and other factors change. In 2000, we recorded a
$500,000 write-down of a security held in our portfolio as we deemed its
decline in fair value to be other than temporary in nature. This security was
sold in January 2002 and the proceeds exceeded the adjusted cost basis
resulting in a net realized gain of $300,000. Prevailing market interest rates
decreased since December 31, 2001, and when combined with the sale of select
securities to realize gains to increase statutory surplus, resulted in a $3.4
million unrealized gain on investments in 2002 compared to a $1.4 million
unrealized gain in 2001.

UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES AND REINSURANCE RECOVERABLES

At December 31, 2002, the liability for unpaid claim and claim settlement
expenses totaled $181.3 million and reinsurance recoverables on unpaid claim
and claim settlement expenses totaled $91.8 million, resulting in net reserves
totaling $89.4 million. The net reserve at December 31, 2001 totaled $91.2
million and included the liability for unpaid claim and claim settlement
expenses totaling $181.3 million net of reinsurance recoverables on unpaid
claim and claim settlement expenses of $90.1 million.

Accounting for workers compensation insurance operations requires us to
estimate the liability for unpaid claim and claim settlement expenses
(reserves) and the related reinsurance recoverables, (together, the net
reserves) at each balance sheet date. Our reserves represent the estimated
total unpaid cost of claim and claim settlement expenses, which cover events
that occurred in 2002 and prior years. These reserves reflect our estimates of
the total costs of claims that were reported, but not yet paid, and the cost of
claims incurred but not yet reported (IBNR). For reported claims, we establish
reserves on a case basis. For IBNR claims, we calculate the difference
between: (i) projected ultimate claim and claim settlement expenses as
determined using generally accepted actuarial standards, and (ii) case reserves
and carry the difference as the IBNR reserve. By using both estimates of
reported claims and IBNR claims, we estimate the ultimate net reserves for
unpaid claim and claim settlement expenses.

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

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

Estimating the effect that inflation will have on the ultimate cost of
claims is a major risk factor in our workers compensation reserve estimates.
Future earnings will be affected by reserve development associated with any
changes in our inflation assumptions. Estimates for the 2002 and 2001 accident
years represent the majority of the uncertainty because these claims have the
lowest proportionate amount of paid loss as of December 31, 2002.

22



---



##### Table of Contents



Our reserve
estimates are most sensitive to changes in the assumption about inflation for
the 2002 and 2001 accident years. Each one percent (1%) increase or decrease
in the inflation rate for both of these accident years would increase or
decrease our loss reserve estimates at December 31, 2002 and 2001 by
approximately $348,000 and $290,000, respectively.

Our independent actuary provides management with an opinion regarding the
acceptable range for adequate statutory reserves based on generally accepted
actuarial guidelines. We record our net reserves by considering a range of
estimates bounded by the high and low point of the range. Within that range,
we record our best estimate. We focus in our decision process on improving our
financial strength ratings and expect to remain a market for workers
compensation insurance in all market conditions. In 2002,we established
recorded reserves in the upper half of the actuarys range. The ultimate
actual liability may be higher or lower than reserves established.

Our reserves are primarily undiscounted; however, we discounted reserves
for selected claims that have fixed and determinable future payments at rates
ranging from 3.5% to 8.0% in 2002 and 2001. The discount rates in 2002 and
2001 are subject to change as market interest rates change. We use the same
rates for Generally Accepted Accounting Principles as we do for Statutory
Accounting in determining our liability. We also reduce the unpaid claim and
claim settlement expenses for estimated amounts of subrogation.

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

After taking into account all relevant factors, we believe our reserves
for unpaid claim and claim settlement expenses and reinsurance recoverables on
unpaid claim and claim settlement expenses at December 31, 2002 are adequate to
cover the ultimate net costs of claim and claim settlement expenses at that
date. The ultimate cost of claim and claim settlement expenses may differ
materially from the established reserves, particularly when claims may not be
settled for many years. Establishing appropriate reserves is an inherently
uncertain process and there can be no certainty that currently established
reserves will prove adequate in light of subsequent actual experience. See
Notes 1 and 5 in the accompanying Consolidated Financial Statements. The
following two tables reconcile the beginning and ending insurance reserves,
displayed individually for each of the last three years.

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

|                                                        |                                                                           |              |                 |         |                         |        |      |         |        |         |   |         |        |         | 
|------------------------------------------------------- | ------------------------------------------------------------------------- | ------------ | --------------- | ------- | ----------------------- | ------ | ---- | ------- | ------ | ------- | - | ------- | ------ | ------- | 
|                                                        |                                                                           |              |                 |         | Year Ended December 31,
|                                                        |                                                                           |              |                 |         |                        
|                                                        |                                                                           |              |                 |         | 2002                    |        | 2001 |         | 2000  
|                                                        |                                                                           |              |                 |         |                         |        |      |         |       
|Gross Reserves for Claim and Claim Settlement Expenses: |                                                                           |              |                 |         |                         |        |      |         |        |         |   |        
|                                                        | Gross reserves for claim and claim settlement expenses,
beginning of year |              | $               | 181,310 |                         |        | $    | 128,841 |        |         | $ | 99,831  |       
|                                                        | Provision increases for claim and claim settlement expenses:              |              |                 |         |                         |        |      |         |        |         |   |         |       
|                                                        |                                                                           | Current year |                 |         | 56,117                  |        |      |         | 97,510 |         |   |         | 87,203 |        
|                                                        |                                                                           | Prior years  |                 |         | 3,593                   |        |      |         | 31,224 |         |   |         | 17,930 |        
|                                                        |                                                                           |              |                 |         |                         |        |      |         |        |         |   |        
|                                                        |                                                                           |              | Total provision |         |                         | 59,710 |      |         |        | 128,734 |   |         |        | 105,133 | 
|                                                        | Payments for claim and claim settlement expenses:                         |              |                 |         |                         |        |      |         |        |         |   |         |       
|                                                        |                                                                           | Current year |                 |         | 13,715                  |        |      |         | 27,024 |         |   |         | 30,190 |        
|                                                        |                                                                           | Prior years  |                 |         | 46,043                  |        |      |         | 49,241 |         |   |         | 45,933 |        
|                                                        |                                                                           |              |                 |         |                         |        |      |         |        |         |   |        
|                                                        |                                                                           |              | Total payments  |         |                         | 59,758 |      |         |        | 76,265  |   |         |        | 76,123  | 
|                                                        |                                                                           |              |                 |         |                         |        |      |         |        |         |   |        
|                                                        | Gross reserves for claim and claim settlement expenses, end of year       |              | $               | 181,262 |                         |        | $    | 181,310 |        |         | $ | 128,841 |       
|                                                        |                                                                           |              |                 |         |                         |        |      |         |        |         |   |        

23



---



##### Table of Contents



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

|                                                      |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |        |        |        |        | 
|----------------------------------------------------- | ------------------------------------------------------------------------ | ----------------------------------------------------------------- | ------------------------------------------------------- | --------------- | ------ | ----------------------- | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | 
|                                                      |                                                                          |                                                                   |                                                         |                 |        | Year Ended December 31,
|                                                      |                                                                          |                                                                   |                                                         |                 |        |                        
|                                                      |                                                                          |                                                                   |                                                         |                 |        | 2002                    |        | 2001   |        | 2000  
|                                                      |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |       
|Net Reserves for Claim and Claim Settlement Expenses: |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |       
|                                                      | Net reserves for claim and claim settlement expenses,
beginning of year  |                                                                   | $                                                       | 91,195          |        |                         | $      | 66,996 |        |        | $      | 58,652 |       
|                                                      | Plus: Deferred retrospective reinsurance gain, beginning of year         |                                                                   |                                                         | 449             |        |                         |        | 849    |        |        |        | 1,249  |       
|                                                      | Provision increases (decreases) for claim and claim settlement expenses: |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |        |       
|                                                      |                                                                          |                                                                   | Current year                                            |                 |        | 49,621                  |        |        |        | 73,557 |        |        |        | 56,900 |       
|                                                      |                                                                          |                                                                   | Prior years                                             |                 |        | (8,356                  | )      |        |        | 7,731  |        |        |        | 15,929 |       
|                                                      |                                                                          |                                                                   | Write-off of reinsurance recoverable                    |                 |        | (332                    | )      |        |        | (785   | )      |        |        |       |       
|                                                      |                                                                          |                                                                   | Amortization of deferred retrospective reinsurance gain |                 |        | (400                    | )      |        |        | (400   | )      |        |        | (400   | )     
|                                                      |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |       
|                                                      |                                                                          |                                                                   |                                                         | Total provision |        |                         | 40,533 |        |        |        | 80,103 |        |        |        | 72,429 | 
|                                                      | Payments for claim and claim settlement expenses:                        |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |        |       
|                                                      |                                                                          | Current year                                                      |                                                         |                 | 13,715 |                         |        |        | 25,062 |        |        |        | 28,154 |       
|                                                      |                                                                          | Prior years                                                       |                                                         |                 | 28,973 |                         |        |        | 31,242 |        |        |        | 36,331 |       
|                                                      |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |       
|                                                      |                                                                          |                                                                   |                                                         | Total payments  |        |                         | 42,688 |        |        |        | 56,304 |        |        |        | 64,485 | 
|                                                      | Less: Deferred retrospective reinsurance gain, end of year               |                                                                   |                                                         | (49             | )      |                         |        | (449   | )      |        |        | (849   | )     
|                                                      |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |       
|                                                      |                                                                          | Net reserves for claim and claim settlement expenses, end of year |                                                         | $               | 89,440 |                         |        | $      | 91,195 |        |        | $      | 66,996 |       
|                                                      |                                                                          |                                                                   |                                                         |                 |        |                         |        |        |        |        |        |       

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



|                                                                |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|--------------------------------------------------------------- | ------------------------------------------------------------- | ----------------- | - | ------------ | ------ | ---- | - | ------- | ------ | ---- | - | ------- | ------ | ---- | - | ------ | ------- | -- | - | ------ | ------ | -- | - | ------ | ------- | --
|                                                                |                                                               |                   |   | December 31,
|                                                                |                                                               |                   |   |             
|                                                                |                                                               |                   |   | 2002         |        | 2001 |   | 2000    |        | 1999 |   | 1998    |        | 1997
|                                                                |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |     
|Loss Reserve Development:                                       |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |       
|                                                                | Gross reserves for unpaid
claim and claim
settlement expenses |                   | $ | 181,262      |        |      | $ | 181,310 |        |      | $ | 128,841 |        |      | $ | 99,831 |         |    | $ | 97,269 |        |    | $ | 61,069 |        
|                                                                | Reinsurance recoverables                                      |                   |   | 91,822       |        |      |   | 90,115  |        |      |   | 61,845  |        |      |   | 41,179 |         |    |   | 21,403 |        |    |   | 5,374  |        
|                                                                |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |       
|                                                                | Net reserves for unpaid
claim and claim
settlement expenses   |                   | $ | 89,440       |        |      | $ | 91,195  |        |      | $ | 66,996  |        |      | $ | 58,652 |         |    | $ | 75,866 |        |    | $ | 55,695 |        
|                                                                |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |       
|                                                                | Paid (cumulative) as of:                                      |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |        
|                                                                |                                                               | One year later    |   |              |        |      |   | $       | 30,285 |      |   | $       | 32,028 |      |   | $      | 35,932  |    |   | $      | 34,380 |    |   | $      | 27,737  |   
|                                                                |                                                               | Two years later   |   |              |        |      |   |         |        |      |   |         | 43,823 |      |   |        | 48,069  |    |   |        | 49,958 |    |   |        | 42,046  |   
|                                                                |                                                               | Three years later |   |              |        |      |   |         |        |      |   |         |        |      |   |        | 54,360  |    |   |        | 56,376 |    |   |        | 49,671  |   
|                                                                |                                                               | Four years later  |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        | 60,453 |    |   |        | 53,814  |   
|                                                                |                                                               | Five years later  |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        | 56,140  |   
|                                                                |                                                               | Six years later   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Seven years later |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Eight years later |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Nine years later  |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Ten years later   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|Reserves re-estimated as of:                                    |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |       
|                                                                |                                                               | End of year       |   | $            | 89,440 |      |   | $       | 91,195 |      |   | $       | 66,996 |      |   | $      | 58,652  |    |   | $      | 75,866 |    |   | $      | 55,695  |   
|                                                                |                                                               | One year later    |   |              |        |      |   |         | 82,839 |      |   |         | 74,727 |      |   |        | 74,181  |    |   |        | 67,753 |    |   |        | 66,674  |   
|                                                                |                                                               | Two years later   |   |              |        |      |   |         |        |      |   |         | 71,202 |      |   |        | 76,502  |    |   |        | 77,205 |    |   |        | 61,075  |   
|                                                                |                                                               | Three years later |   |              |        |      |   |         |        |      |   |         |        |      |   |        | 75,321  |    |   |        | 78,331 |    |   |        | 68,065  |   
|                                                                |                                                               | Four years later  |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        | 78,772 |    |   |        | 69,474  |   
|                                                                |                                                               | Five years later  |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        | 69,595  |   
|                                                                |                                                               | Six years later   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Seven years later |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Eight years later |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Nine years later  |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|                                                                |                                                               | Ten years later   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |        |         |   
|Initial reserves in excess of
(less than) re-estimated
reserves |                                                               |                   |   |              |        |      |   |         |        |      |   |         |        |      |   |        |         |    |   |        |        |    |   |       
|                                                                |                                                               | Amount            |   |              |        |      |   | $       | 8,356  |      |   | $       | (4,206 | )    |   | $      | (16,669 | )  |   | $      | (2,906 | )  |   | $      | (13,900 | ) 
|                                                                |                                                               | Percent           |   |              |        |      |   |         | 9.2    | %    |   |         | (6.3   | )%   |   |        | (28.4   | )% |   |        | (3.8   | )% |   |        | (25.0   | )%

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                |                                                               |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |       |       |   
|--------------------------------------------------------------- | ------------------------------------------------------------- | ----------------- | - | ------------ | ------ | ---- | - | ------ | ------ | ---- | - | ------ | ------ | - | - | ------ | ----- | - | - | ----- | ----- | --
|                                                                |                                                               |                   |   | December 31,
|                                                                |                                                               |                   |   |             
|                                                                |                                                               |                   |   | 1996         |        | 1995 |   | 1994   |        | 1993 |   | 1992  
|                                                                |                                                               |                   |   |              |        |      |   |        |        |      |   |       
|Loss Reserve Development:                                       |                                                               |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |      
|                                                                | Gross reserves for unpaid
claim and claim
settlement expenses |                   | $ | 49,256       |        |      | $ | 37,138 |        |      | $ | 28,165 |        |   | $ | 13,279 |       |   | $ | 2,688 |      
|                                                                | Reinsurance recoverables                                      |                   |   | 6,183        |        |      |   | 8,312  |        |      |   | 13,902 |        |   |   | 9,593  |       |   |   | 1,886 |      
|                                                                |                                                               |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |      
|                                                                | Net reserves for unpaid
claim and claim
settlement expenses   |                   | $ | 43,073       |        |      | $ | 28,826 |        |      | $ | 14,263 |        |   | $ | 3,686  |       |   | $ | 802   |      
|                                                                |                                                               |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |      
|                                                                | Paid (cumulative) as of:                                      |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |       |      
|                                                                |                                                               | One year later    |   | $            | 19,439 |      |   | $      | 8,595  |      |   | $      | 4,639  |   |   | $      | 1,436 |   |   | $     | 583   |   
|                                                                |                                                               | Two years later   |   |              | 28,173 |      |   |        | 12,894 |      |   |        | 6,476  |   |   |        | 2,150 |   |   |       | 678   |   
|                                                                |                                                               | Three years later |   |              | 33,438 |      |   |        | 15,521 |      |   |        | 7,863  |   |   |        | 2,348 |   |   |       | 815   |   
|                                                                |                                                               | Four years later  |   |              | 36,904 |      |   |        | 16,869 |      |   |        | 8,569  |   |   |        | 2,654 |   |   |       | 856   |   
|                                                                |                                                               | Five years later  |   |              | 38,919 |      |   |        | 18,020 |      |   |        | 9,046  |   |   |        | 2,816 |   |   |       | 925   |   
|                                                                |                                                               | Six years later   |   |              | 39,770 |      |   |        | 18,714 |      |   |        | 9,396  |   |   |        | 2,847 |   |   |       | 951   |   
|                                                                |                                                               | Seven years later |   |              |        |      |   |        | 19,200 |      |   |        | 9,564  |   |   |        | 2,932 |   |   |       | 920   |   
|                                                                |                                                               | Eight years later |   |              |        |      |   |        |        |      |   |        | 9,738  |   |   |        | 2,985 |   |   |       | 928   |   
|                                                                |                                                               | Nine years later  |   |              |        |      |   |        |        |      |   |        |        |   |   |        | 2,972 |   |   |       | 951   |   
|                                                                |                                                               | Ten years later   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |       | 885   |   
|Reserves re-estimated as of:                                    |                                                               |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |      
|                                                                |                                                               | End of year       |   | $            | 43,073 |      |   | $      | 28,826 |      |   | $      | 14,263 |   |   | $      | 3,686 |   |   | $     | 802   |   
|                                                                |                                                               | One year later    |   |              | 39,988 |      |   |        | 20,751 |      |   |        | 12,789 |   |   |        | 3,784 |   |   |       | 1,075 |   
|                                                                |                                                               | Two years later   |   |              | 43,484 |      |   |        | 18,469 |      |   |        | 9,318  |   |   |        | 3,416 |   |   |       | 1,008 |   
|                                                                |                                                               | Three years later |   |              | 41,451 |      |   |        | 19,796 |      |   |        | 8,984  |   |   |        | 2,782 |   |   |       | 950   |   
|                                                                |                                                               | Four years later  |   |              | 45,959 |      |   |        | 19,389 |      |   |        | 9,669  |   |   |        | 2,861 |   |   |       | 912   |   
|                                                                |                                                               | Five years later  |   |              | 47,147 |      |   |        | 21,254 |      |   |        | 9,692  |   |   |        | 2,972 |   |   |       | 949   |   
|                                                                |                                                               | Six years later   |   |              | 47,126 |      |   |        | 22,568 |      |   |        | 10,330 |   |   |        | 2,927 |   |   |       | 964   |   
|                                                                |                                                               | Seven years later |   |              |        |      |   |        | 22,388 |      |   |        | 11,675 |   |   |        | 3,106 |   |   |       | 926   |   
|                                                                |                                                               | Eight years later |   |              |        |      |   |        |        |      |   |        | 11,234 |   |   |        | 3,818 |   |   |       | 945   |   
|                                                                |                                                               | Nine years later  |   |              |        |      |   |        |        |      |   |        |        |   |   |        | 3,555 |   |   |       | 951   |   
|                                                                |                                                               | Ten years later   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |       | 949   |   
|Initial reserves in excess of
(less than) re-estimated
reserves |                                                               |                   |   |              |        |      |   |        |        |      |   |        |        |   |   |        |       |   |   |      
|                                                                |                                                               | Amount            |   | $            | (4,053 | )    |   | $      | 6,438  |      |   | $      | 3,029  |   |   | $      | 131   |   |   | $     | (147  | ) 
|                                                                |                                                               | Percent           |   |              | (9.4   | )%   |   |        | 22.3   | %    |   |        | 21.2   | % |   |        | 3.6   | % |   |       | (18.3 | )%

The table above represents the development of balance sheet net reserves
for 1992 through 2002. The top three rows of the table reconcile gross
reserves to net reserves for unpaid claim and claim settlement expenses
recorded at the balance sheet date for each of the indicated years.

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

The lower portion of the table shows the re-estimated amount of the
previously recorded net reserves, based on experience as of the end of each
succeeding year. The estimate is either increased or decreased as more
information becomes known about the frequency and severity of claims for
individual years. For example, for the 1998 calendar

24



---



##### Table of Contents



year valued as of
December 31, 2002, we paid $60.5 million of the currently estimated $78.8
million of claim and claim settlement expenses that were incurred through the
end of 1998; thus, the difference, an estimated $18.3 million of claim and
claim settlement expenses incurred through 1998, remained unpaid as of December
31, 2002.

The initial reserves in excess of (less than) re-estimated reserves rows
represent the aggregate change in the estimates over all prior years. For
example, the 1998 reserve developed a $2.9 million net deficiency over the
course of the succeeding years. The net amount has been included in income and
the changes have been recorded in the period identified. The cumulative net
deficiencies in 2000 and 1999 are the result of reserve development inherent in
the uncertainty in establishing reserves and anticipated loss trends. As
discussed above, due to our relatively limited historical claim data and small
claim population, our estimate of the liability for net reserves is difficult
and volatile. As discussed further below, the reserve redundancy in 2001 is
the result of accrual reversals resulting from changes in methods of assessing
second injury funds, lower frequency in claims reported from the estimate at
December 31, 2001, and reductions in amounts expected to be incurred for our
participation in mandatory state and national assigned risk pools.

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

The following table is derived from the loss reserve development table and
summarizes the effect of reserve re-estimates, net of reinsurance, on calendar
year operations for the same ten-year period ended December 31, 2002. The
total of each column details the amount of reserve re-estimates made in the
indicated calendar year and shows the accident years to which the re-estimates
are applicable. The amounts in the total accident year column represent the
cumulative reserve re-estimates for the indicated accident year (000s):



|               |       |  |                                                             |       |      |  |      |        |      |  |      |         |      |  |   |       |   |  |   |         |   |  |   |       |  
|-------------- | ----- |  | ----------------------------------------------------------- | ----- | ---- |  | ---- | ------ | ---- |  | ---- | ------- | ---- |  | - | ----- | - |  | - | ------- | - |  | - | ----- | -
|               |       |  | Effect of Reserve Re-estimates on Calendar Year Operations:
|               |       |  |                                                            
|               |       |  | 2002                                                        |       | 2001 |  | 2000 |        | 1999 |  | 1998 |         | 1997
|               |       |  |                                                             |       |      |  |      |        |      |  |      |         |     
|Accident Year: |       |  |                                                             |       |      |  |      |        |      |  |      |         |      |  |   |       |   |  |   |         |   |  |   |      
|               | 1992  |  | $                                                           | 2     |      |  | $    | (6     | )    |  | $    | (19     | )    |  | $ | 38    |   |  | $ | (15     | ) |  | $ | (37   | )
|               | 1993  |  |                                                             | 261   |      |  |      | (706   | )    |  |      | (160    | )    |  |   | 7     |   |  |   | (96     | ) |  |   | (42   | )
|               | 1994  |  |                                                             | 178   |      |  |      | (633   | )    |  |      | (459    | )    |  |   | (68   | ) |  |   | (574    | ) |  |   | 413   |  
|               | 1995  |  |                                                             | (261  | )    |  |      | 31     |      |  |      | (1,227  | )    |  |   | 430   |   |  |   | (642    | ) |  |   | 1,948 |  
|               | 1996  |  |                                                             | (159  | )    |  |      | 126    |      |  |      | (2,643  | )    |  |   | 1,626 |   |  |   | (2,169  | ) |  |   | 803   |  
|               | 1997  |  |                                                             | (142  | )    |  |      | (221   | )    |  |      | (2,482  | )    |  |   | 3,566 |   |  |   | (7,483  | ) |  |   |       |  
|               | 1998  |  |                                                             | (320  | )    |  |      | 283    |      |  |      | (2,462  | )    |  |   | 2,514 |   |  |   |         |   |  |   |       |  
|               | 1999  |  |                                                             | 1,622 |      |  |      | (1,195 | )    |  |      | (6,077  | )    |  |   |       |   |  |   |         |   |  |   |       |  
|               | 2000  |  |                                                             | 2,344 |      |  |      | (5,410 | )    |  |      |         |      |  |   |       |   |  |   |         |   |  |   |       |  
|               | 2001  |  |                                                             | 4,831 |      |  |      |        |      |  |      |         |      |  |   |       |   |  |   |         |   |  |   |       |  
|               |       |  |                                                             |       |      |  |      |        |      |  |      |         |      |  |   |       |   |  |   |         |   |  |   |      
|               | Total |  | $                                                           | 8,356 |      |  | $    | (7,731 | )    |  | $    | (15,529 | )    |  | $ | 8,113 |   |  | $ | (10,979 | ) |  | $ | 3,085 |  
|               |       |  |                                                             |       |      |  |      |        |      |  |      |         |      |  |   |       |   |  |   |         |   |  |   |      

[Additional columns below]

[Continued from above table, first column(s) repeated]

|               |       |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              |        |  
|-------------- | ----- |  | ----------------------------------------------------------- | ----- | -------- |  | ---- | ----- | ---- |  | ---- | ---- | - |  | - | ---- | - |  | ------------ | ------ | -
|               |       |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  | Cumulative  
|               |       |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  | Re-estimates
|               |       |  | Effect of Reserve Re-estimates on Calendar Year Operations: |       | for each
|               |       |  |                                                             |       | Accident
|               |       |  | 1996                                                        |       | 1995     |  | 1994 |       | 1993 |  | Year
|               |       |  |                                                             |       |          |  |      |       |      |  |     
|Accident Year: |       |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              |       
|               | 1992  |  | $                                                           | 38    |          |  | $    | 58    |      |  | $    | 67   |   |  | $ | (273 | ) |  | $            | (147   | )
|               | 1993  |  |                                                             | 596   |          |  |      | 310   |      |  |      | (165 | ) |  |   |      |   |  |              | 5      |  
|               | 1994  |  |                                                             | 2,837 |          |  |      | 1,106 |      |  |      |      |   |  |   |      |   |  |              | 2,800  |  
|               | 1995  |  |                                                             | 4,604 |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | 4,883  |  
|               | 1996  |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | (2,416 | )
|               | 1997  |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | (6,762 | )
|               | 1998  |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | 15     |  
|               | 1999  |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | (5,850 | )
|               | 2000  |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | (3,066 | )
|               | 2001  |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              | 4,831  |  
|               |       |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              |       
|               | Total |  | $                                                           | 8,075 |          |  | $    | 1,474 |      |  | $    | (98  | ) |  | $ | (273 | ) |  | $            | (5,507 | )
|               |       |  |                                                             |       |          |  |      |       |      |  |      |      |   |  |   |      |   |  |              |       

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

The 2001 results include a $7.7 million increase in prior years reserves
for unpaid claim and claim settlement expenses compared to the 2000 results which include a $15.9 million
increase in prior years reserves for unpaid claim and claim settlement
expenses. Our estimate for unpaid claim and claim settlement expenses
increased in 2001 due to the following: (i) we increased the estimated
liability for second injury funds and our mandatory participation in state and
national assigned risk pool operating results for states in which we operate,
(ii) our estimate of the liability for unpaid claim and claim settlement
expenses is difficult and volatile due to our relatively limited

25



---



##### Table of Contents



historical
claim data and small claim population, and (iii) we increased the estimated
liability for claims in our closed Missouri and Massachusetts regions;

LIQUIDITY AND CAPITAL RESOURCES

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

Our primary sources of cash from operations are premiums collected and
investment income. Our investment portfolio is also a source of liquidity,
through the sale of readily marketable fixed maturity investments. Our primary
cash requirements consist of payments for: (i) claim and claim settlement
expenses, (ii) reinsurance, (iii) policy acquisition costs, (iv) general and
administrative expenses, (v) capital expenditures, (vi) income taxes, and (vii)
debt service or principal repayment on our Term Loan. Prior to 1999, we
generated positive net cash from operations due, in part, to timing differences
between the receipt of premiums and the payment of claim and claim settlement
expenses. As we lowered our reinsurance retention levels to $25,000 beginning
in mid-1998 through runoff in 2001, we decreased our current period cash flows
as a result of pre-funding quarterly premiums under that agreement. In 2002,
the reinsurance reimbursements from our $25,000 to $300,000 excess of loss
reinsurance agreement offset similar payments to claimants for those years.
This trend will continue into 2003. Cash decreased for the remainder of 2002
as: (i) we paid claims for 2002 and prior years, years in which we earned
higher premiums and incurred a higher number of claims reported while 2002
premiums in force and premiums earned decreased, and (ii) amounts paid under
our St. Paul Re contract resulted in net cash outflows for most of 2002 until
contract termination in December 2002. In 2003, we expect that cash and
investments will decrease from levels at December 31, 2002 as we pay claims for
2002 and prior years, years in which we earned higher premiums and incurred a
higher number of claims reported while 2003 premiums earned are expected to
decrease. Available cash is invested in either short-term cash and cash
equivalents or longer-term available-for-sale securities pending future
payments for such expenses as medical and indemnity benefits and other
operating expenses. Cash and cash equivalents consist of cash and a money
market fund that invest primarily in short-term government securities.

Cash provided by operating activities for 2002 was $25.4 million. This is
primarily a result of net income of $14.3 million and a decrease in deposits
receivable of $17.6 million and depreciation and amortization expense of
$962,000 offset by realized capital gains totaling $1.7 million, and a decrease
of $4.2 million in accrued expenses and other liabilities. Net cash provided
by investing activities was $10.8 million due to $75.5 million in proceeds from
sales of securities offset by $64.3 million in purchases of securities and
$630,000 in purchases of fixed assets. Net cash used in financing activities
was $3.3 million due to principal payments on our note payable in 2002.

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

State insurance regulations limit distributions, including dividends, from
our insurance subsidiary to us. The maximum amount of dividends that can be
paid by ACIC to us in any year is equal to the greater of: (i) 10% of ACICs
statutory surplus as of the end of the previous fiscal year, or (ii) the
statutory net gain from operations (not including realized capital gains) of
ACIC in its most recent fiscal year. Based on this limitation, the maximum
dividend that ACIC could pay to us in 2003, without regulatory approval, is
approximately $2.7 million. (See Note 9 of Notes to Consolidated Financial
Statements.) ACIC has never paid a dividend to us and we intend to retain
capital in the insurance subsidiary.

On September 15, 1998, our Board of Directors approved a share repurchase
program authorizing us to repurchase, from time to time, up to $4,000,000 of
RTW, Inc. common stock. We repurchased 41,324 shares in 2002 for approximately
$78,000, 5,000 shares in 2001 for approximately $9,000 and 329,750 shares for
approximately $2.7 million through 2000. We repurchased these shares on
the open market or through private transactions based upon market conditions
and availability. The repurchased shares will be used for employee stock
option and purchase plans and other corporate purposes.

26



---



##### Table of Contents



Investments held as statutory deposits and pledged as collateral do not
have an adverse effect on our liquidity. We believe that cash flow generated
by our operations and our cash and investment balances will be sufficient to
fund continuing operations, principal and interest payments and capital
expenditures for the next 12 months.

INTEREST RATE RISK

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

An increase of 100 basis points in prevailing interest rates would reduce
the fair value of our interest rate sensitive instruments by approximately $3.6
million.

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

NAIC RISK-BASED CAPITAL STANDARDS

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

REGULATION

Our insurance subsidiary is subject to substantial regulation by governmental
agencies in the states in which we operate, and will be subject to such
regulation in any state in which we provide workers compensation products and
services in the future. State regulatory agencies have broad administrative
power with respect to all aspects of our business, including premium rates,
benefit levels, policy forms, dividend payments, capital adequacy and the
amount and type of investments. These regulations are primarily intended to
protect covered employees and policyholders rather than the insurance company.
Both the legislation covering insurance companies and the regulations adopted
by state agencies are subject to change. At December 31, 2002, our insurance
subsidiary was licensed to do business in Minnesota, South Dakota, Wisconsin,
Colorado, Missouri, Illinois, Kansas, Michigan, Indiana, Massachusetts,
Connecticut, Rhode Island, Pennsylvania, Tennessee, Maryland, Arkansas, Iowa,
Florida, Georgia, New Jersey, North Carolina, Texas and Oklahoma.

In March 1998, the NAIC adopted the Codification of Statutory Accounting
Principles (the Codification). The Codification is intended to standardize
regulatory accounting and reporting to state insurance departments and became
effective January 1, 2001. Statutory accounting principles, however, will
continue to be established by individual state laws and permitted practices.
The State of Minnesota required adoption of the Codification for preparing
statutory financial statements for financial periods occurring on or after
January 1, 2001. Adoption of the Codification increased our statutory capital
and surplus by approximately $1.9 million on January 1, 2001.

EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board (FASB) has issued SFAS No. 141,
Business Combinations; SFAS No. 142, Goodwill and Other Intangible Assets;
SFAS No. 143, Accounting for Asset Retirement Obligations; SFAS No. 144,
Accounting for Impairment or Disposal of Long-Lived Assets; SFAS No. 145,
Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statements
No. 13, and Technical Correction; and SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities since July 2001. After reviewing
these pronouncements, we have determined that adoption of these statements is not
expected to have an effect on our consolidated results of operations and
financial position.

27



---



##### Table of Contents



FORWARD-LOOKING STATEMENTS

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




ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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




ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO FINANCIAL STATEMENTS

|                     |                                                                                                |      |  |    | 
|-------------------- | ---------------------------------------------------------------------------------------------- | ---- |  | -- | 
|FINANCIAL STATEMENTS |                                                                                                | Page
|                     | Independent Auditors Reports                                                                  |      |  | 29 | 
|                     | Consolidated Balance Sheets  December 31, 2002 and 2001                                       |      |  | 31 | 
|                     | Consolidated Statements of Operations  Years Ended December 31, 2002, 2001 and 2000           |      |  | 32 | 
|                     | Consolidated Statements of Shareholders Equity  Years Ended December 31, 2002, 2001 and 2000 |      |  | 33 | 
|                     | Consolidated Statements of Cash Flows  Years Ended December 31, 2002, 2001 and 2000           |      |  | 34 | 
|                     | Notes to Consolidated Financial Statements  Years Ended December 31, 2002, 2001 and 2000      |      |  | 35 | 

28



---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

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

We have audited the accompanying consolidated balance sheets of RTW, Inc.
(the Company) as of December 31, 2002 and 2001, and the related consolidated
statements of operations, stockholders equity and cash flows for the years
then ended. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits. The financial statements of the
Company for the year ended December 31, 2000, were audited by other auditors
whose report dated February 9, 2001 (March 28, 2001 as to Note 6) expressed
an unqualified opinion on those statements and included an emphasis paragraph
that stated the establishment of claim and claim settlement expense reserves
is an inherently uncertain process.

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

In our opinion, the 2002 and 2001 financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of RTW, Inc. at December 31, 2002 and 2001, and the consolidated results of its
operations and its cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States.

/s/ ERNST & YOUNG LLP

March 25, 2003
Minneapolis, Minnesota

29



---



##### Table of Contents



REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota

We have audited the accompanying consolidated statements of operations,
shareholders equity, and cash flows of RTW, Inc. and subsidiary (the Company)
for the year ended December 31, 2000. These consolidated financial statements
are the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audit.

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

As described in Note 5, the establishment of claim and claim settlement expense
reserves is an inherently uncertain process.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
the Company for the year ended December 31, 2000, in conformity with accounting
principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
February 9, 2001
(March 28, 2001 as to Note 6)

30



---



##### Table of Contents



RTW, INC.
Consolidated Balance Sheets
December 31, 2002 and 2001
(In Thousands, Except Share Data)

|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |        |         | 
|---------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------- | ------ | ------- | ---- | ------- | ------ | ------- | 
|                                                                 |                                                                                                                    |                                            |         | 2002   |         | 2001
|                                                                 |                                                                                                                    |                                            |         |        |         |     
|ASSETS                                                           |                                                                                                                    |                                            |         |       
|Investments at fair value, amortized cost of $77,994 and $87,809 |                                                                                                                    | $                                          | 81,410  |        |         | $    | 89,166  |       
|Cash and cash equivalents                                        |                                                                                                                    |                                            | 36,288  |        |         |      | 3,425   |       
|Accrued investment income                                        |                                                                                                                    |                                            | 695     |        |         |      | 1,133   |       
|Premiums receivable, less allowance of $220 and $436             |                                                                                                                    |                                            | 3,537   |        |         |      | 6,665   |       
|Deposit receivable                                               |                                                                                                                    |                                            |        |        |         |      | 17,635  |       
|Reinsurance recoverables:                                        |                                                                                                                    |                                            |         |        |         |      |         |       
|                                                                 | On unpaid claim and claim settlement expenses                                                                      |                                            |         | 91,822 |         |      |         | 90,115 |        
|                                                                 | On paid claim and claim settlement expenses                                                                        |                                            |         | 2,109  |         |      |         | 3,039  |        
|Deferred policy acquisition costs                                |                                                                                                                    |                                            | 736     |        |         |      | 1,214   |       
|Furniture and equipment, net                                     |                                                                                                                    |                                            | 1,619   |        |         |      | 1,824   |       
|Other assets                                                     |                                                                                                                    |                                            | 5,618   |        |         |      | 4,091   |       
|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |       
|                                                                 |                                                                                                                    | Total assets                               |         | $      | 223,834 |      |         | $      | 218,307 | 
|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |       
|LIABILITIES AND SHAREHOLDERS EQUITY                             |                                                                                                                    |                                            |         |       
|Unpaid claim and claim settlement expenses                       |                                                                                                                    | $                                          | 181,262 |        |         | $    | 181,310 |       
|Unearned premiums                                                |                                                                                                                    |                                            | 7,130   |        |         |      | 9,738   |       
|Accrued expenses and other liabilities                           |                                                                                                                    |                                            | 4,382   |        |         |      | 8,537   |       
|Notes payable                                                    |                                                                                                                    |                                            | 1,250   |        |         |      | 4,500   |       
|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |       
|                                                                 |                                                                                                                    | Total liabilities                          |         |        | 194,024 |      |         |        | 204,085 | 
|Commitments and contingencies                                    |                                                                                                                    |                                            |        |        |         |      |        |       
|Shareholders equity:                                            |                                                                                                                    |                                            |         |        |         |      |         |       
|                                                                 | Undesignated stock, no par value; authorized 4,750,000 shares;
none issued or outstanding                          |                                            |         |       |         |      |         |       |        
|                                                                 | Series A Junior Participating Preferred Stock, no par value;
authorized 250,000 shares; none issued or outstanding |                                            |         |       |         |      |         |       |        
|                                                                 | Common stock, no par value; authorized 12,500,000 shares;
issued and outstanding 5,115,000 and 5,151,000 shares    |                                            |         | 20,619 |         |      |         | 20,688 |        
|                                                                 | Retained earnings (deficit)                                                                                        |                                            |         | 6,971  |         |      |         | (7,348 | )      
|                                                                 | Accumulated other comprehensive income                                                                             |                                            |         | 2,220  |         |      |         | 882    |        
|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |       
|                                                                 |                                                                                                                    | Total shareholders equity                 |         |        | 29,810  |      |         |        | 14,222  | 
|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |       
|                                                                 |                                                                                                                    | Total liabilities and shareholders equity |         | $      | 223,834 |      |         | $      | 218,307 | 
|                                                                 |                                                                                                                    |                                            |         |        |         |      |         |       

See notes to consolidated financial statements.

31



---



##### Table of Contents



RTW, INC.
Consolidated Statements of Operations
Years Ended December 31, 2002, 2001 and 2000
(In Thousands, Except Share and Per Share Data)

|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |           |        |         |  
|------------------------------------ | --------------------------------------- | -------------------------- | -------------------------------------- | --------- | ------ | ------ | ------- | --------- | ------- | ------- | ------ | --------- | ------ | ------- | -
|                                     |                                         |                            |                                        |           | 2002   |        | 2001    |           | 2000   
|                                     |                                         |                            |                                        |           |        |        |         |           |        
|Revenues:                            |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Gross premiums earned                   |                            | $                                      | 62,506    |        |        | $       | 97,420    |         |         | $      | 95,878    |       
|                                     | Premiums ceded                          |                            |                                        | (2,242    | )      |        |         | (11,363   | )       |         |        | (17,724   | )     
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     |                                         | Premiums earned            |                                        |           | 60,264 |        |         |           | 86,057  |         |        |           | 78,154 |        
|                                     | Investment income                       |                            |                                        | 5,139     |        |        |         | 6,415     |         |         |        | 5,752     |       
|                                     | Net realized investment gains (losses): |                            |                                        |           |        |        |         |           |         |         |        |           |       
|                                     |                                         | Realized investment gains  |                                        |           | 1,930  |        |         |           | 1,225   |         |        |           | 26     |        
|                                     |                                         | Realized investment losses |                                        |           | (209   | )      |         |           | (62     | )       |        |           | (633   | )      
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     |                                         |                            | Net realized investment gains (losses) |           |        | 1,721  |         |           |         | 1,163   |        |           |        | (607    | )
|                                     | Other income                            |                            |                                        | 22        |        |        |         | 2,088     |         |         |        |          |       
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     |                                         | Total revenues             |                                        |           | 67,146 |        |         |           | 95,723  |         |        |           | 83,299 |        
|Expenses:                            |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Claim and claim settlement expenses     |                            |                                        | 40,533    |        |        |         | 80,103    |         |         |        | 72,429    |       
|                                     | Policy acquisition costs                |                            |                                        | 6,304     |        |        |         | 13,990    |         |         |        | 14,137    |       
|                                     | General and administrative expenses     |                            |                                        | 9,984     |        |        |         | 17,391    |         |         |        | 11,513    |       
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     |                                         | Total expenses             |                                        |           | 56,821 |        |         |           | 111,484 |         |        |           | 98,079 |        
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     |                                         |                            | Income (loss) from operations          |           |        | 10,325 |         |           |         | (15,761 | )      |           |        | (14,780 | )
|                                     | Interest expense                        |                            |                                        | 163       |        |        |         | 511       |         |         |        | 667       |       
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Income (loss) before income taxes       |                            |                                        | 10,162    |        |        |         | (16,272   | )       |         |        | (15,447   | )     
|                                     | Income tax (benefit) expense            |                            |                                        | (4,157    | )      |        |         | 8,943     |         |         |        | (5,739    | )     
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|Net income (loss)                    |                                         | $                          | 14,319                                 |           |        | $      | (25,215 | )         |         | $       | (9,708 | )        
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|Income (loss) per share:             |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Basic income (loss) per share           |                            | $                                      | 2.78      |        |        | $       | (4.89     | )       |         | $      | (1.79     | )     
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Diluted income (loss) per share         |                            | $                                      | 2.78      |        |        | $       | (4.89     | )       |         | $      | (1.79     | )     
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|Weighted average shares outstanding: |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Basic shares outstanding                |                            |                                        | 5,146,000 |        |        |         | 5,152,000 |         |         |        | 5,428,000 |       
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          
|                                     | Diluted shares outstanding              |                            |                                        | 5,154,000 |        |        |         | 5,152,000 |         |         |        | 5,428,000 |       
|                                     |                                         |                            |                                        |           |        |        |         |           |         |         |        |          

See notes to consolidated financial statements.

32



---



##### Table of Contents



RTW, INC.
Consolidated Statements of Shareholders Equity
Years Ended December 31, 2002, 2001 and 2000
(In Thousands)

|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        |  |         |       |  | 
|---------------------------- | ------------------- | --------------------------------------- | ------------------------------------- | -------------------- | ------- | ------ |  | ------ | ------- | ------------- | ------- | -------- | ------- | ------------- | ------ | ----- | - | ----------- | ------ |  | ------- | ----- |  | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   | Accumulated |        |  |         |      
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   | Other       |        |  |         |      
|                             |                     |                                         |                                       |                      |         |        |  |        |         | Comprehensive |         | Retained |         | Comprehensive |        | Total
|                             |                     |                                         |                                       |                      |         | Common |  | Income |         | Earnings      |         | Income   |         | Shareholders'
|                             |                     |                                         |                                       |                      |         | Stock  |  | (Loss) |         | (Deficit)     |         | (Loss)   |         | Equity       
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |              
|Balance at January 1, 2000   |                     | $                                       | 30,808                                |                      |         |        |  |        |         | $             | 27,575  |          |         | $             | (2,818 | )     |   | $           | 55,565 | 
|                             | Comprehensive loss: |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        |  |        
|                             |                     | Net loss                                |                                       |                      |        |        |  | $      | (9,708  | )             |         |          | (9,708  | )             |        |       |  |             |        |  | (9,708  | )    
|                             |                     | Other comprehensive income, net of tax: |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        |  |         |      
|                             |                     |                                         | Change in unrealized investment gains |                      |         |       |  |        |         | 3,022         |         |          |         |              |        |       |   | 3,022       |        |  |         | 3,022 | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     |                                         |                                       | Comprehensive loss   |         |        |  |        |         | $             | (6,686  | )        |         |               |        |       |   |             |        |  |         |       |  | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     | Retirement of common stock              |                                       |                      | (10,268 | )      |  |        |         |               |         |          |        |               |        |       |  |             |        |  | (10,268 | )    
|                             |                     | Issuance of shares under ESPP           |                                       |                      | 125     |        |  |        |         |               |         |          |        |               |        |       |  |             |        |  | 125     |      
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|Balance at December 31, 2000 |                     |                                         | 20,665                                |                      |         |        |  |        |         |               | 17,867  |          |         |               | 204    |       |   |             | 38,736 | 
|                             | Comprehensive loss: |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        |  |        
|                             |                     | Net loss                                |                                       |                      |        |        |  | $      | (25,215 | )             |         |          | (25,215 | )             |        |       |  |             |        |  | (25,215 | )    
|                             |                     | Other comprehensive income, net of tax: |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        |  |         |      
|                             |                     |                                         | Change in unrealized investment gains |                      |         |       |  |        |         | 678           |         |          |         |              |        |       |   | 678         |        |  |         | 678   | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     |                                         |                                       | Comprehensive loss   |         |        |  |        |         | $             | (24,537 | )        |         |               |        |       |   |             |        |  |         |       |  | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     | Retirement of common stock              |                                       |                      | (10     | )      |  |        |         |               |         |          |        |               |        |       |  |             |        |  | (10     | )    
|                             |                     | Issuance of shares under ESPP           |                                       |                      | 33      |        |  |        |         |               |         |          |        |               |        |       |  |             |        |  | 33      |      
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|Balance at December 31, 2001 |                     |                                         | 20,688                                |                      |         |        |  |        |         |               | (7,348  | )        |         |               | 882    |       |   |             | 14,222 | 
|Comprehensive income:        |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     | Net income                              |                                       |                      |        |        |  | $      | 14,319  |               |         |          | 14,319  |               |        |       |  |             |        |  | 14,319  |      
|                             |                     | Other comprehensive income, net of tax: |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        |  |         |      
|                             |                     |                                         | Change in unrealized investment gains |                      |         |       |  |        |         | 1,338         |         |          |         |              |        |       |   | 1,338       |        |  |         | 1,338 | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     |                                         |                                       | Comprehensive income |         |        |  |        |         | $             | 15,657  |          |         |               |        |       |   |             |        |  |         |       |  | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|                             |                     | Retirement of common stock              |                                       |                      | (79     | )      |  |        |         |               |         |          |        |               |        |       |  |             |        |  | (79     | )    
|                             |                     | Issuance of shares under ESPP           |                                       |                      | 10      |        |  |        |         |               |         |          |        |               |        |       |  |             |        |  | 10      |      
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 
|Balance at December 31, 2002 |                     | $                                       | 20,619                                |                      |         |        |  |        |         | $             | 6,971   |          |         | $             | 2,220  |       |   | $           | 29,810 | 
|                             |                     |                                         |                                       |                      |         |        |  |        |         |               |         |          |         |               |        |       |   |             |        | 

See notes to consolidated financial statements.

33



---



##### Table of Contents



RTW, INC.
Consolidated Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000
(In Thousands)

|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |         |        |         |        |  
|------------------------------------------------- | ------------------------------------------------------------------------------------ | -------------------------------------- | --------------------------------------------- | --------------------------------------------------- | ------ | ------ | ------ | ------- | ------ | ------- | ------ | ------- | ------ | ------- | ------ | -
|                                                  |                                                                                      |                                        |                                               |                                                     |        | 2002   |        | 2001    |        | 2000   
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |        
|Cash flows from operating activities:             |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  | Net income (loss)                                                                    |                                        | $                                             | 14,319                                              |        |        | $      | (25,215 | )      |         | $      | (9,708  | )     
|                                                  | Adjustments to reconcile net income (loss) to net
cash used in operating activities: |                                        |                                               |                                                     |        |        |        |         |        |         |        |         |       
|                                                  |                                                                                      | Net realized investment (gains) losses |                                               |                                                     | (1,721 | )      |        |         | (1,163 | )       |        |         | 607    |        
|                                                  |                                                                                      | Depreciation and amortization          |                                               |                                                     | 963    |        |        |         | 1,690  |         |        |         | 1,397  |        
|                                                  |                                                                                      | Deferred income taxes                  |                                               |                                                     |       |        |        |         | 8,776  |         |        |         | (1,371 | )      
|                                                  |                                                                                      | Changes in assets and liabilities:     |                                               |                                                     |        |        |        |         |        |         |        |         |        |        
|                                                  |                                                                                      |                                        | Deposit receivable                            |                                                     |        | 17,635 |        |         |        | (17,635 | )      |         |        |        |       
|                                                  |                                                                                      |                                        | Amounts due from reinsurers                   |                                                     |        | (777   | )      |         |        | (29,014 | )      |         |        | (20,638 | )     
|                                                  |                                                                                      |                                        | Unpaid claim and claim settlement expenses    |                                                     |        | (48    | )      |         |        | 52,469  |        |         |        | 29,010  |       
|                                                  |                                                                                      |                                        | Unearned premiums, net of premiums receivable |                                                     |        | 520    |        |         |        | 744     |        |         |        | (1,002  | )     
|                                                  |                                                                                      |                                        | Other, net                                    |                                                     |        | (5,511 | )      |         |        | 2,832   |        |         |        | (7,167  | )     
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  |                                                                                      |                                        |                                               | Net cash provided by (used in) operating activities |        |        | 25,380 |         |        |         | (6,516 | )       |        |         | (8,872 | )
|Cash flows from investing activities:             |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  | Maturities of investments                                                            |                                        |                                               |                                                    |        |        |        |        |        |         |        | 510     |       
|                                                  | Purchases of available-for-sale investments                                          |                                        |                                               | (64,320                                             | )      |        |        | (83,341 | )      |         |        |        |       
|                                                  | Proceeds from sales of available-for-sale investments                                |                                        |                                               | 75,482                                              |        |        |        | 92,839  |        |         |        | 14,594  |       
|                                                  | Purchases of furniture and equipment                                                 |                                        |                                               | (630                                                | )      |        |        | (379    | )      |         |        | (1,015  | )     
|                                                  | Disposals of furniture and equipment                                                 |                                        |                                               | 270                                                 |        |        |        | 872     |        |         |        | 51      |       
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  |                                                                                      |                                        |                                               | Net cash provided by investing activities           |        |        | 10,802 |         |        |         | 9,991  |         |        |         | 14,140 |  
|Cash flows from financing activities:             |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  | Proceeds from notes payable                                                          |                                        |                                               |                                                    |        |        |        |        |        |         |        | 8,000   |       
|                                                  | Payments on notes payable                                                            |                                        |                                               | (3,250                                              | )      |        |        | (2,500  | )      |         |        | (1,000  | )     
|                                                  | Issuance of common stock under ESPP                                                  |                                        |                                               | 10                                                  |        |        |        | 33      |        |         |        | 125     |       
|                                                  | Retirement of common stock                                                           |                                        |                                               | (79                                                 | )      |        |        | (10     | )      |         |        | (10,268 | )     
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  | Net cash used in financing activities                                                |                                        |                                               | (3,319                                              | )      |        |        | (2,477  | )      |         |        | (3,143  | )     
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|Net increase in cash and cash equivalents         |                                                                                      |                                        | 32,863                                        |                                                     |        |        | 998    |         |        |         | 2,125  |        
|Cash and cash equivalents at beginning of year    |                                                                                      |                                        | 3,425                                         |                                                     |        |        | 2,427  |         |        |         | 302    |        
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|Cash and cash equivalents at end of year          |                                                                                      | $                                      | 36,288                                        |                                                     |        | $      | 3,425  |         |        | $       | 2,427  |        
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|Supplemental disclosure of cash flow information: |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  | Cash paid (received) during the year for:                                            |                                        |                                               |                                                     |        |        |        |         |        |         |        |         |       
|                                                  |                                                                                      | Interest                               |                                               | $                                                   | 138    |        |        | $       | 641    |         |        | $       | 458    |        
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        
|                                                  |                                                                                      | Income tax (refunds) payments          |                                               | $                                                   | (2,976 | )      |        | $       | (1,559 | )       |        | $       | 802    |        
|                                                  |                                                                                      |                                        |                                               |                                                     |        |        |        |         |        |         |        |        

See notes to consolidated financial statements.

34



---



##### Table of Contents



RTW, INC.
Notes to Consolidated Financial Statements
Years Ended December 31, 2002, 2001, and 2000

Note 1  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

We benefit from our ability to reduce workers compensation costs and
provide employers the ability to control their workers compensation programs.
Our insurance subsidiary is domiciled in Minnesota and is licensed in
Minnesota, Colorado, Missouri, Michigan, Massachusetts, Illinois, Kansas,
Connecticut, Wisconsin, Rhode Island, Florida, Iowa, Indiana, Arkansas,
Pennsylvania, Tennessee, South Dakota, Maryland, Georgia, New Jersey, North
Carolina, Texas and Oklahoma. We wrote policies primarily in Minnesota,
Colorado and Michigan during 2002. In the fourth quarter of 2001, we announced
that we would close our regional offices in Missouri and Massachusetts.
Beginning February 2002, we began to non-renew all insurance policies in our
Missouri and Massachusetts regions and will run off any remaining expiring
policies in these regions through March 2003. We operate in a single business
segment, workers compensation products and services.

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

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

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

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

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

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

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

We continually monitor the difference between investment cost and fair
value for each of our securities. If any security experienced a decline in
value that is determined to be other than temporary, we would reduce the
securitys carrying value for the decline and record a realized loss in the
Consolidated Statements of Operations. In 2000, we recorded $500,000 against a
security whose decline in value was determined to be other than temporary. No
securities were reduced for declines in fair value in 2002 or 2001.

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

Fair Value of Financial Instruments A number of our significant assets and
liabilities (including reinsurance recoverables, deferred policy acquisition
costs, furniture and equipment and unpaid claim and claim settlement expenses)
are not considered financial instruments for disclosure purposes. Our premiums
receivable and other assets and liabilities that are considered financial
instruments are generally of a short-term nature. Our term loan bears a
floating interest rate. The carrying values of these instruments approximate
their fair values. The carrying values and fair values of investments are
disclosed in Note 3.

35



---



##### Table of Contents



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

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

Depreciation We depreciate furniture and equipment on a straight-line basis
over the estimated useful lives of the assets (five to ten years). Accumulated
depreciation was $4.0 million at December 31, 2002 and $3.7 million at December
31, 2001.

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

Our Unpaid claim and claim settlement expenses represent reserves
established for the estimated total unpaid cost of claim and claim settlement
expenses for insured events that occurred on or prior to each balance sheet
date. The reserves are primarily undiscounted; however, we discounted selected
claims that have fixed or determinable future payments by $438,000 in 2002 and
$482,000 in 2001 using discount factors ranging from 3.5% to 8.0%. These
reserves reflect our estimates of the total cost of claims that were reported,
but not yet paid, and the cost of claims incurred but not yet reported. Our
estimates consider such variables as past loss experience, current claim trends
and prevailing social, economic and legal environments. We have a limited
amount of historical data to use in estimating our reserves for unpaid claim
and claim settlement expenses because we commenced operations in 1992. As a
result, we supplement our experience with external industry data, as adjusted
to reflect anticipated differences between our results and the industry. We
reduce the unpaid claim and claim settlement expenses for estimated amounts of
subrogation.

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

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

Note 2  INCOME PER SHARE

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

36



---



##### Table of Contents



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

|                                            |                                  |   |           |       |      |   |           |   |  |   |           |   | 
|------------------------------------------- | -------------------------------- | - | --------- | ----- | ---- | - | --------- | - |  | - | --------- | - | 
|                                            |                                  |   | 2002      |       | 2001 |   | 2000     
|                                            |                                  |   |           |       |      |   |          
|Net income (loss) (000s)                   |                                  | $ | 14,319    |       |      | $ | (25,215   | ) |  | $ | (9,708    | )
|                                            |                                  |   |           |       |      |   |           |   |  |   |           |  
|Basic weighted average shares outstanding   |                                  |   | 5,146,000 |       |      |   | 5,152,000 |   |  |   | 5,428,000 |  
|                                            | Effect of dilutive stock options |   |           | 8,000 |      |   |           |  |  |   |           |  | 
|                                            |                                  |   |           |       |      |   |           |   |  |   |           |  
|Diluted weighted average shares outstanding |                                  |   | 5,154,000 |       |      |   | 5,152,000 |   |  |   | 5,428,000 |  
|                                            |                                  |   |           |       |      |   |           |   |  |   |           |  
|Basic income (loss) per share               |                                  | $ | 2.78      |       |      | $ | (4.89     | ) |  | $ | (1.79     | )
|                                            |                                  |   |           |       |      |   |           |   |  |   |           |  
|Diluted income (loss) per share             |                                  | $ | 2.78      |       |      | $ | (4.89     | ) |  | $ | (1.79     | )
|                                            |                                  |   |           |       |      |   |           |   |  |   |           |  

Options to purchase 1.5 million shares of common stock at prices ranging
from $1.98 to $38.67 were outstanding during 2001 and options to purchase 1.2
million shares of common stock at prices ranging from $5.33 to $38.67 were
outstanding in 2000 but excluded from the computation of diluted IPS due to our
2001 and 2000 net losses. Diluted weighted average shares outstanding would
have increased by 4,000 shares and 8,000 shares in 2001 and 2000, respectively,
had these shares not been anti-dilutive in the computation.

Note 3  INVESTMENTS

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

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

|                           |                   |      |           |        |            |        |            |       |       |   |           |      |   |   |        |        | 
|-------------------------- | ----------------- | ---- | --------- | ------ | ---------- | ------ | ---------- | ----- | ----- | - | --------- | ---- | - | - | ------ | ------ | 
|                           |                   |      |           |        |            |        | Gross      |       | Gross |   | Estimated
|                           |                   |      | Amortized |        | Unrealized |        | Unrealized |       | Fair 
|2001                       |                   | Cost |           | Gains  |            | Losses |            | Value
|                           |                   |      |           |        |            |        |            |      
|U.S. government securities |                   | $    | 25,921    |        |            | $      | 524        |       |       | $ | (108      | )    |   | $ | 26,337 |       
|Corporate securities       |                   |      | 16,908    |        |            |        | 317        |       |       |   | (67       | )    |   |   | 17,158 |       
|Asset-backed securities    |                   |      | 506       |        |            |        | 4          |       |       |   |          |      |   |   | 510    |       
|Mortgage-backed securities |                   |      | 44,474    |        |            |        | 812        |       |       |   | (125      | )    |   |   | 45,161 |       
|                           |                   |      |           |        |            |        |            |       |       |   |           |      |   |   |        |       
|                           | Total investments |      | $         | 87,809 |            |        | $          | 1,657 |       |   | $         | (300 | ) |   | $      | 89,166 | 
|                           |                   |      |           |        |            |        |            |       |       |   |           |      |   |   |        |       

Statutory Deposits Included in investments are U.S. government securities on
deposit with various regulatory authorities, as required by law, with a fair
value of $27.7 million and $18.6 million at December 31, 2002 and 2001,
respectively.

Additionally, included in investments are U.S. government securities pledged as
collateral against a letter of credit provided to an insurer, with a fair value
of $4.3 million and $2.6 million at December 31, 2002 and December 31, 2001.

Fixed Maturities by Maturity Date The following table presents the amortized
cost and fair value of investments by contractual maturity at December 31,
2002. Actual maturities may differ from those stated as a result of calls and
prepayments (000s):

|                                                   |                   |      |           |        |      |   |           |        | 
|-------------------------------------------------- | ----------------- | ---- | --------- | ------ | ---- | - | --------- | ------ | 
|                                                   |                   |      |           |        |      |   | Estimated
|                                                   |                   |      | Amortized |        | Fair
|Maturing In:                                       |                   | Cost |           | Value 
|                                                   |                   |      |           |       
|One year or less                                   |                   | $    | 5,663     |        |      | $ | 5,754     |       
|Over one year through five years                   |                   |      | 16,821    |        |      |   | 17,446    |       
|Over five years through ten years                  |                   |      | 10,834    |        |      |   | 11,529    |       
|Over ten years                                     |                   |      | 13,154    |        |      |   | 14,309    |       
|Mortgage-backed securities with various maturities |                   |      | 31,522    |        |      |   | 32,372    |       
|                                                   |                   |      |           |        |      |   |           |       
|                                                   | Total investments |      | $         | 77,994 |      |   | $         | 81,410 | 
|                                                   |                   |      |           |        |      |   |           |       

37



---



##### Table of Contents



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

|                               |                   |   |       |       |      |   |       |       |  |   |       |       | 
|------------------------------ | ----------------- | - | ----- | ----- | ---- | - | ----- | ----- |  | - | ----- | ----- | 
|                               |                   |   | 2002  |       | 2001 |   | 2000 
|                               |                   |   |       |       |      |   |      
|Fixed maturity investments     |                   | $ | 4,221 |       |      | $ | 5,599 |       |  | $ | 5,519 |      
|Interest on deposit receivable |                   |   | 736   |       |      |   | 518   |       |  |   |      |      
|Short-term investments         |                   |   | 144   |       |      |   | 286   |       |  |   | 185   |      
|Other                          |                   |   | 38    |       |      |   | 12    |       |  |   | 48    |      
|                               |                   |   |       |       |      |   |       |       |  |   |       |      
|                               | Investment income |   | $     | 5,139 |      |   | $     | 6,415 |  |   | $     | 5,752 | 
|                               |                   |   |       |       |      |   |       |       |  |   |       |      

Note 4  REINSURANCE

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

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

We ceded Minnesota claims in excess of $350,000, $330,000 and $310,000 per
occurrence during 2002, 2001 and 2000, respectively, to the Minnesota Workers
Compensation Reinsurance Association (WCRA). In our non-Minnesota states, our
per-incident exposure was $300,000 in 2002, 2001 and 2000. We purchased this
non-Minnesota coverage from a single reinsurer.

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

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

|                                                      |  |      |        |      |  |   |        | 
|----------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------ | 
|                                                      |  | 2002 |        | 2001
|                                                      |  |      |        |     
|Excess of loss reinsurance through various reinsurers |  | $    | 91,822 |      |  | $ | 90,115 | 

38



---



##### Table of Contents



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

|                                     |        |                                         |   |         |        |      |   |         |        |  |   |         |        | 
|------------------------------------ | ------ | --------------------------------------- | - | ------- | ------ | ---- | - | ------- | ------ |  | - | ------- | ------ | 
|                                     |        |                                         |   | 2002    |        | 2001 |   | 2000   
|                                     |        |                                         |   |         |        |      |   |        
|Premiums written:                    |        |                                         |   |         |        |      |   |         |        |  |   |        
|                                     | Direct |                                         | $ | 59,898  |        |      | $ | 94,703  |        |  | $ | 95,566  |       
|                                     | Ceded  |                                         |   | (2,242  | )      |      |   | (11,363 | )      |  |   | (17,724 | )     
|                                     |        |                                         |   |         |        |      |   |         |        |  |   |        
|                                     |        | Net premiums written                    |   | $       | 57,656 |      |   | $       | 83,340 |  |   | $       | 77,842 | 
|                                     |        |                                         |   |         |        |      |   |         |        |  |   |        
|Claim and claim settlement expenses: |        |                                         |   |         |        |      |   |         |        |  |   |        
|                                     | Direct |                                         | $ | 60,109  |        |      | $ | 128,734 |        |  | $ | 105,133 |       
|                                     | Ceded  |                                         |   | (19,576 | )      |      |   | (48,631 | )      |  |   | (32,704 | )     
|                                     |        |                                         |   |         |        |      |   |         |        |  |   |        
|                                     |        | Net claim and claim settlement expenses |   | $       | 40,533 |      |   | $       | 80,103 |  |   | $       | 72,429 | 
|                                     |        |                                         |   |         |        |      |   |         |        |  |   |        

The reinsurance recoverable on paid claim and claim settlement expenses
consists primarily of receivables from paid claim and claim settlement expenses
that were submitted to but not yet reimbursed by reinsurers at December 31,
2002 and 2001.

Note 5  UNPAID CLAIM AND CLAIM SETTLEMENT EXPENSES

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

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

|                           |                                                         |                |         |         |        |      |         |         |        |   |         |         |        | 
|-------------------------- | ------------------------------------------------------- | -------------- | ------- | ------- | ------ | ---- | ------- | ------- | ------ | - | ------- | ------- | ------ | 
|                           |                                                         |                |         | 2002    |        | 2001 |         | 2000   
|                           |                                                         |                |         |         |        |      |         |        
|Balance at January 1       |                                                         | $              | 181,310 |         |        | $    | 128,841 |         |        | $ | 99,831  |        
|                           | Less reinsurance recoverables                           |                |         | (90,115 | )      |      |         | (61,845 | )      |   |         | (41,179 | )     
|                           | Plus deferred gain on retrospective reinsurance         |                |         | 449     |        |      |         | 849     |        |   |         | 1,249   |       
|                           |                                                         |                |         |         |        |      |         |         |        |   |         |        
|Net balance at January 1   |                                                         |                | 91,644  |         |        |      | 67,845  |         |        |   | 59,901  |        
|Incurred related to:       |                                                         |                |         |         |        |      |         |         |        |   |         |        
|                           | Current year                                            |                |         | 49,621  |        |      |         | 73,557  |        |   |         | 56,900  |       
|                           | Prior years                                             |                |         | (8,356  | )      |      |         | 7,731   |        |   |         | 15,929  |       
|                           | Write-off of reinsurance recoverable                    |                |         | (332    | )      |      |         | (785    | )      |   |         |        |       
|                           | Amortization of deferred retrospective reinsurance gain |                |         | (400    | )      |      |         | (400    | )      |   |         | (400    | )     
|                           |                                                         |                |         |         |        |      |         |         |        |   |         |        
|                           |                                                         | Total incurred |         |         | 40,533 |      |         |         | 80,103 |   |         |         | 72,429 | 
|Paid related to:           |                                                         |                |         |         |        |      |         |         |        |   |         |        
|                           | Current year                                            |                |         | 13,715  |        |      |         | 25,062  |        |   |         | 28,154  |       
|                           | Prior years                                             |                |         | 28,973  |        |      |         | 31,242  |        |   |         | 36,331  |       
|                           |                                                         |                |         |         |        |      |         |         |        |   |         |        
|                           |                                                         | Total paid     |         |         | 42,688 |      |         |         | 56,304 |   |         |         | 64,485 | 
|                           |                                                         |                |         |         |        |      |         |         |        |   |         |        
|Net balance at December 31 |                                                         |                | 89,489  |         |        |      | 91,644  |         |        |   | 67,845  |        
|                           | Plus reinsurance recoverables                           |                |         | 91,822  |        |      |         | 90,115  |        |   |         | 61,845  |       
|                           | Plus deferred gain on retrospective reinsurance         |                |         | (49     | )      |      |         | (449    | )      |   |         | (849    | )     
|                           |                                                         |                |         |         |        |      |         |         |        |   |         |        
|Balance at December 31     |                                                         | $              | 181,262 |         |        | $    | 181,310 |         |        | $ | 128,841 |        
|                           |                                                         |                |         |         |        |      |         |         |        |   |         |        

Changes in estimates of unpaid claim and claim settlement expenses for
prior years decreased the provision for claim and claim settlement expenses by
$8.4 million in 2002 and increased the provision for claim and claim settlement
expenses by $7.7 million in 2001 and by $15.9 million in 2000.

Our estimate for unpaid claim and claim settlement expenses decreased in
2002 due to the following: (i) in March 2002, the Minnesota State legislature
changed the way the commissioner will assess self-insured employers and
insurers for estimated liabilities and administrative expenses of the States
Special Compensation Fund (SCF). The assessment changed from being paid by the
insurer on indemnity payments to an assessment charged on

39



---



##### Table of Contents



premium to the policyholder. We decreased our recorded accrual to reflect
this legislative change, (ii) the frequency of claims reported in 2002 for 2001
and prior years was less than anticipated when we determined our liability in
2001, (iii) we overestimated the liability for our mandatory participation in
state and national assigned risk pool operating results for states in which we
operate in 2001 and reversed that excess in 2002, and (iv) our estimate of the
liability for unpaid claim and claim settlement expenses is difficult and
volatile due to our relatively limited historical claim data and small claim
population.

Note 6  NOTES PAYABLE

In March 2000, we borrowed $8.0 million under a term loan agreement to fund the
repurchase of common stock from certain of our shareholders. We paid $1.0
million in principal on the term loan in 2000, an additional $2.5 million in
2001 and $3.3 million in 2002. The term loan accrues interest, payable
quarterly. We may elect to pay an adjusted LIBOR or bank reference rate on the
term loan (adjusted LIBOR was 4.66% and 8.22% at December 31, 2002 and 2001,
respectively). The remaining term loan is payable in 2003.

The amended term loan is collateralized by the stock of ACIC and is
subject to restrictive financial covenants that require maintaining minimum
financial ratios, including (i) debt coverage, (ii) net worth, (iii)
statutory surplus, (iv) net earnings, (v) risk based capital and (vi)
investment grade ratings. The agreement also restricts dividends, purchases
and redemptions or retirements of common stock.

At December 31, 2002, we failed to meet a financial covenant of the term
loan. We paid an additional $250,000 in principal in March 2003 and the
covenant was waived in March 2003. Under the waiver, term loan principal
payments were adjusted for a waiver of the financial covenant under the term
loan agreement. The remaining term loan balance is due in 2003.

Note 7  INCOME TAXES

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

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

|          |         |                                      |   |        |        |      |   |       |       |  |   |        |        |  
|--------- | ------- | ------------------------------------ | - | ------ | ------ | ---- | - | ----- | ----- |  | - | ------ | ------ | -
|          |         |                                      |   | 2002   |        | 2001 |   | 2000 
|          |         |                                      |   |        |        |      |   |      
|Current:  |         |                                      |   |        |        |      |   |       |       |  |   |       
|          | Federal |                                      | $ | (3,521 | )      |      | $ |      |       |  | $ | (320   | )     
|          | State   |                                      |   | 85     |        |      |   | 242   |       |  |   | 100    |       
|          |         |                                      |   |        |        |      |   |       |       |  |   |       
|          |         | Total current tax (benefit) expense  |   |        | (3,436 | )    |   |       | 242   |  |   |        | (220   | )
|Deferred: |         |                                      |   |        |        |      |   |       |       |  |   |       
|          | Federal |                                      |   | (721   | )      |      |   | 8,585 |       |  |   | (5,558 | )     
|          | State   |                                      |   |       |        |      |   | 116   |       |  |   | 39     |       
|          |         |                                      |   |        |        |      |   |       |       |  |   |       
|          |         | Total deferred tax (benefit) expense |   |        | (721   | )    |   |       | 8,701 |  |   |        | (5,519 | )
|          |         |                                      |   |        |        |      |   |       |       |  |   |       
|          |         | Income tax (benefit) expense         |   | $      | (4,157 | )    |   | $     | 8,943 |  |   | $      | (5,739 | )
|          |         |                                      |   |        |        |      |   |       |       |  |   |       

40



---



##### Table of Contents



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

|                                                                     |                                                                         |                              |       |        |        |      |        |        |       |   |        |      |        |  
|-------------------------------------------------------------------- | ----------------------------------------------------------------------- | ---------------------------- | ----- | ------ | ------ | ---- | ------ | ------ | ----- | - | ------ | ---- | ------ | -
|                                                                     |                                                                         |                              |       | 2002   |        | 2001 |        | 2000  
|                                                                     |                                                                         |                              |       |        |        |      |        |       
|Federal income tax expense (benefit) at 35%                          |                                                                         | $                            | 3,557 |        |        | $    | (5,695 | )      |       | $ | (5,406 | )   
|Increase (reduction) in income tax expense (benefit) resulting from: |                                                                         |                              |       |        |        |      |        |        |       |   |        |     
|                                                                     | State income taxes, net of federal income tax benefit                   |                              |       | 242    |        |      |        | 228    |       |   |        | 58   |       
|                                                                     | Non-deductible investment amortization and
tax-exempt investment income |                              |       | 18     |        |      |        | (48    | )     |   |        | (814 | )     
|                                                                     | Deferred income tax valuation allowance                                 |                              |       | (7,927 | )      |      |        | 14,560 |       |   |        |     |       
|                                                                     | Other                                                                   |                              |       | (47    | )      |      |        | (102   | )     |   |        | 423  |       
|                                                                     |                                                                         |                              |       |        |        |      |        |        |       |   |        |     
|                                                                     |                                                                         | Income tax (benefit) expense |       | $      | (4,157 | )    |        | $      | 8,943 |   |        | $    | (5,739 | )
|                                                                     |                                                                         |                              |       |        |        |      |        |        |       |   |        |     

Differences between the tax basis of assets and liabilities and their
reported amounts in the Consolidated Financial Statements that will result in
taxable or deductible amounts in future years are called temporary differences.
The tax effects of temporary differences that gave rise to net deferred tax
assets, included within other assets, are as follows (000s):

|                                           |                          |                                                    |                     |        |       |        |       |        |        |         |  
|------------------------------------------ | ------------------------ | -------------------------------------------------- | ------------------- | ------ | ----- | ------ | ----- | ------ | ------ | ------- | -
|                                           |                          |                                                    |                     |        | 2002  |        | 2001 
|                                           |                          |                                                    |                     |        |       |        |      
|Unpaid claim and claim settlement expenses |                          | $                                                  | 6,452               |        |       | $      | 6,038 |       
|Net operating loss carry-forward           |                          |                                                    | 2,598               |        |       |        | 6,925 |       
|Accrued second injury funds                |                          |                                                    | 483                 |        |       |        | 2,670 |       
|Unearned premiums                          |                          |                                                    | 889                 |        |       |        | 935   |       
|Office closure costs                       |                          |                                                    | 145                 |        |       |        | 380   |       
|Retrospective reinsurance                  |                          |                                                    | 17                  |        |       |        | 158   |       
|Other                                      |                          |                                                    | 235                 |        |       |        | 652   |       
|                                           |                          |                                                    |                     |        |       |        |       |       
|                                           | Deferred tax assets      |                                                    |                     | 10,819 |       |        |       | 17,758 |       
|Net unrealized gain on securities          |                          |                                                    | (1,196              | )      |       |        | (475  | )     
|Deferred policy acquisition costs          |                          |                                                    | (756                | )      |       |        | (427  | )     
|Depreciation                               |                          |                                                    | (234                | )      |       |        | (296  | )     
|                                           |                          |                                                    |                     |        |       |        |       |       
|                                           | Deferred tax liabilities |                                                    |                     | (2,186 | )     |        |       | (1,198 | )     
|                                           |                          |                                                    |                     |        |       |        |       |       
|                                           |                          | Net deferred tax assets before valuation allowance |                     |        | 8,633 |        |       |        | 16,560 |        
|                                           |                          |                                                    | Valuation allowance |        |       | (6,633 | )     |        |        | (14,560 | )
|                                           |                          |                                                    |                     |        |       |        |       |       
|                                           |                          | Net deferred tax asset                             |                     | $      | 2,000 |        |       | $      | 2,000  |        
|                                           |                          |                                                    |                     |        |       |        |       |       

In assessing the realizability of deferred tax assets, we consider recent
operating results, the scheduled reversal of deferred tax liabilities,
projected future taxable income and tax planning strategies. At December 31,
2001, we established a $14.5 million valuation allowance against deferred tax
assets resulting in a corresponding adjustment to income tax expense as a
result of this analysis. In 2002, the valuation allowance decreased to $6.6
million as we were able to carry back our 2001 operating loss five years
resulting in a tax refund and the reversal of certain deferred tax items and
utilization of the 2000 operating loss carry forward to offset income in 2002.
We expect the remaining deferred tax asset, net of the valuation allowance, at
December 31, 2002 to be realized as a result of income and the reversal of
existing taxable temporary differences in the future. Deferred tax assets are
included in other assets on the Consolidated Balance Sheet.

We have net operating loss carry-forwards available totaling approximately
$7.6 million that expire in 2020.

Income taxes receivable were approximately $793,000 and $83,000 at
December 31, 2002 and 2001, respectively, and are included in other assets.

Note 8  EMPLOYEE BENEFITS AND PLANS

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

1995 Employee Stock Purchase Plan The ESPP provides employees the opportunity
to purchase shares of our stock at 85% of the fair value based on the lesser of
the beginning or ending share price for each plan year as set forth in the
plan. In May 1998, the shares reserved for distribution under the plan were
increased from 37,500 to

41



---



##### Table of Contents



100,000 shares. The ESPP terminates in ten years and will be carried out in
phases, each consisting of one year or a different period of time approved by
the Board of Directors. Any employee completing two weeks of service prior to
commencing a phase of the plan may participate. Employees may elect to
contribute from $10 to 10% of monthly salary to the plan through payroll
withholdings. The following summarizes shares purchased and purchase prices
for each phase in the most recent three years completed through 2002:

|                                          |  |           |        |          |  |   |      | 
|----------------------------------------- |  | --------- | ------ | -------- |  | - | ---- | 
|                                          |  | Shares    |        | Purchase
|Phase:                                    |  | Purchased |        | Price   
|                                          |  |           |        |         
|Beginning April 1999, expiring April 2000 |  |           | 19,577 |          |  | $ | 6.38 | 
|Beginning April 2000, expiring April 2001 |  |           | 9,490  |          |  |   | 3.40 | 
|Beginning April 2001, expiring April 2002 |  |           | 5,047  |          |  |   | 1.90 | 

The eighth one-year phase began in April 2002 and expires in April 2003.

Our liability for employee contributions withheld at December 31, 2002 and
2001 for the purchase of shares in April 2003 and April 2002 under the ESPP was
$51,000 and $39,000, respectively.

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

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

|                           |          |  |           |          |               |   |          |       |          |  |         |          |          |   |       |       | 
|-------------------------- | -------- |  | --------- | -------- | ------------- | - | -------- | ----- | -------- |  | ------- | -------- | -------- | - | ----- | ----- | 
|                           |          |  | Qualified |          | Non-Qualified
|                           |          |  |           |          |              
|                           |          |  |           |          |               |   | Weighted |       |          |  |         |          | Weighted
|                           |          |  |           |          |               |   | Average  |       |          |  |         |          | Average 
|                           |          |  | Option    |          | Exercise      |   | Option   |       | Exercise
|                           |          |  | Shares    |          | Price         |   | Shares   |       | Price   
|                           |          |  |           |          |               |   |          |       |         
|Balance, January 1, 2000   |          |  | 511,772   |          |               | $ | 13.36    |       |          |  | 263,226 |          |          | $ | 13.31 |      
|                           | Granted  |  |           | 77,750   |               |   |          | 10.26 |          |  |         |         |          |   |       |      | 
|                           | Canceled |  |           | (268,792 | )             |   |          | 13.42 |          |  |         |         |          |   |       |      | 
|                           |          |  |           |          |               |   |          |       |          |  |         |          |          |   |       |      
|Balance, December 31, 2000 |          |  | 320,730   |          |               |   | 12.56    |       |          |  | 263,226 |          |          |   | 13.31 |      
|                           | Granted  |  |           | 46,000   |               |   |          | 4.93  |          |  |         | 217,500  |          |   |       | 1.98  | 
|                           | Canceled |  |           | (74,340  | )             |   |          | 10.71 |          |  |         |         |          |   |       |      | 
|                           |          |  |           |          |               |   |          |       |          |  |         |          |          |   |       |      
|Balance, December 31, 2001 |          |  | 292,390   |          |               |   | 11.83    |       |          |  | 480,726 |          |          |   | 8.19  |      
|                           | Granted  |  |           | 25,500   |               |   |          | 2.48  |          |  |         | 112,500  |          |   |       | 2.40  | 
|                           | Canceled |  |           | (180,819 | )             |   |          | 12.24 |          |  |         | (266,351 | )        |   |       | 12.60 | 
|                           |          |  |           |          |               |   |          |       |          |  |         |          |          |   |       |      
|Balance, December 31, 2002 |          |  | 137,071   |          |               | $ | 9.54     |       |          |  | 326,875 |          |          | $ | 2.60  |      
|                           |          |  |           |          |               |   |          |       |          |  |         |          |          |   |       |      

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

42



---



##### Table of Contents



The following table summarizes the options outstanding and exercisable at December 31, 2002:

|                             |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |   |       |  |  |  | 
|---------------------------- | --------------- | ------- |  | ---- | ------------------- | ----- | ------------------- | --------- | -------- | ----- | --------------- |  | -------- |  | ------- |  |  | - | ----- |  |  |  | 
|                             |                 |         |  |      | Options Outstanding |       | Options Exercisable
|                             |                 |         |  |      |                     |       |                    
|                             |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |   |       |  | 
|                             |                 |         |  |      | Number              |       | Weighted Average    |           | Number   |       | WeightedAverage
|                             |                 |         |  |      | of                  |       | Contractual         |           | Exercise |       | of              |  | Exercise
|Exercise Price Range         |                 | Options |  | Life |                     | Price |                     | Options   |          | Price
|                             |                 |         |  |      |                     |       |                     |           |          |      
|Qualified stock options:     |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |   |       | 
|                             | $21.50 - $38.67 |         |  |      | 4,375               |       |                     | 3.7 years |          | $     | 28.86           |  |          |  | 4,375   |  |  | $ | 28.86 | 
|                             | 14.00 - 17.33   |         |  |      | 39,696              |       |                     | 5.4 years |          |       | 15.15           |  |          |  | 39,696  |  |  |   | 15.15 | 
|                             | 8.75 - 10.75    |         |  |      | 38,000              |       |                     | 7.1 years |          |       | 10.55           |  |          |  | 25,585  |  |  |   | 10.54 | 
|                             | 2.20 - 4.50     |         |  |      | 55,000              |       |                     | 8.9 years |          |       | 3.25            |  |          |  | 9,833   |  |  |   | 3.91  | 
|                             |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |  
|                             | $2.20 - $38.67  |         |  |      | 137,071             |       |                     | 7.2 years |          | $     | 9.54            |  |          |  | 79,489  |  |  | $ | 13.03 | 
|                             |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |  
|Non-qualified
stock options: |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |   |       | 
|                             | $31.75          |         |  |      | 5,000               |       |                     | 4.1 years |          | $     | 31.75           |  |          |  | 5,000   |  |  | $ | 31.75 | 
|                             | 1.98 - 5.33     |         |  |      | 321,875             |       |                     | 9.0 years |          |       | 2.15            |  |          |  | 126,041 |  |  |   | 2.17  | 
|                             |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |  
|                             | $1.98 - $31.75  |         |  |      | 326,875             |       |                     | 8.9 years |          | $     | 2.60            |  |          |  | 131,041 |  |  | $ | 3.30  | 
|                             |                 |         |  |      |                     |       |                     |           |          |       |                 |  |          |  |         |  |  |  

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

|                                      |             |  |      |        |      |  |      |         |   |  |   |         |  
|------------------------------------- | ----------- |  | ---- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                      |             |  | 2002 |        | 2001 |  | 2000
|                                      |             |  |      |        |      |  |     
|Net income (loss):                    |             |  |      |        |      |  |      |         |   |  |   |        
|                                      | As reported |  | $    | 14,319 |      |  | $    | (25,215 | ) |  | $ | (9,708  | )
|                                      | Pro forma   |  |      | 13,998 |      |  |      | (25,702 | ) |  |   | (10,507 | )
|Basic net income (loss) per share:    |             |  |      |        |      |  |      |         |   |  |   |        
|                                      | As reported |  |      | 2.78   |      |  |      | (4.89   | ) |  |   | (1.79   | )
|                                      | Pro forma   |  |      | 2.72   |      |  |      | (4.99   | ) |  |   | (1.94   | )
|Dilutive net income (loss) per share: |             |  |      |        |      |  |      |         |   |  |   |        
|                                      | As reported |  |      | 2.78   |      |  |      | (4.89   | ) |  |   | (1.79   | )
|                                      | Pro forma   |  |      | 2.72   |      |  |      | (4.99   | ) |  |   | (1.94   | )

The weighted average fair value of options granted under the ESPP and 1994
Stock Plan during 2002, 2001 and 2000 is estimated at $2.94, $2.19 and $4.48,
respectively, on the date of grant using the Black-Scholes option-pricing model
with the following assumptions: no dividend yield; volatility of 125.6% in
2002, 182.8% in 2001 and 64.6% in 2000; risk-free interest rates ranging from
1.66% to 7.70%; and an expected life of 1 to 5 years.

Employment Contracts We entered into one-year employment agreements with our
Chairman, David C. Prosser, President and Chief Executive Officer, J. Alexander
Fjelstad III, and Executive Vice President, Alfred L. LaTendresse beginning
December 13, 2001. Under these agreements, each receives a base salary,
subject to review annually for increase by our Board of Directors. Mr. Prosser
receives $250,000 which includes $30,000 for his services as Chairman of the
Board and $220,000 in base salary. Mr. Fjelstad receives a base salary of
$275,000 and Mr. LaTendresse a base salary of $200,000. In addition to base
salary, each is eligible for bonuses and expense reimbursements. We also
provide these individuals with health, dental, life and disability insurance
consistent with that provided to other officers and employees. Additionally,
Mr. Fjelstad and Mr. LaTendresse were each granted 100,000 non-qualified
options at $1.98 per share on December 13, 2001. Mr. Prosser was granted
100,000 non-qualified options on February 6, 2002 at $2.42 per share.

Employment agreements with Carl B. Lehmann, our former President and Chief
Executive Officer expired during 2001 and Mr. Lehmann terminated his employment
with us on December 12, 2001. Under supplemental agreements with Mr. Lehmann
in 2000 and 2001, we paid him stay bonuses of $200,000 on January 15, 2001
and $100,000 on June 30, 2001.

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

43



---



##### Table of Contents





| |  | 401(k) Retirement Component We sponsor a defined contribution retirement
component under Section 401(k) of the Internal Revenue Code for eligible
employees. Our contributions are discretionary and are based on
contributions made by employees. Expense recognized for 2002, 2001 and 2000
was $220,000, $316,000 and $152,000, respectively.
| |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  | Employee Stock Ownership Component We maintain an ESOP for our qualified
employees. Our contributions are discretionary. We may contribute cash or
shares of our common stock. No expense was recorded in 2002, 2001 or 2000.                                                                                                                   

Other Employee Benefit Plans We maintained bonus plans in 2002, 2001 and 2000
under which all employees, including officers, were eligible for a bonus based,
in part, on our operating results. These bonuses aggregated $864,000, $204,000
and $951,000 in 2002, 2001 and 2000, respectively.

Note 9  SHAREHOLDERS EQUITY

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

On September 15, 1998, our Board of Directors approved a share repurchase
program authorizing the repurchase of up to $4.0 million of RTW, Inc. common
stock. We may repurchase shares on the open market or through private
transactions depending upon market conditions and availability. Through
December 31, 2002 we repurchased approximately 376,000 shares for $2.7 million.
We will use the repurchased shares for employee stock option and purchase
plans and other corporate purposes.

On March 28, 2000, we repurchased 709,285 shares, outside the share
repurchase program, from a group consisting of David C. Prosser, RTWs founder
and who at the time was a director, certain members of his family, and J.
Alexander Fjelstad, who at the time was a former director and former executive
of RTW (together, the Prosser Selling Group). We paid $10.38 per share, as
well as legal and other costs, totaling approximately $7.7 million to
repurchase the shares. After completing the transaction, the combined
ownership of Mr. Prosser, members of his family and Mr. Fjelstad was reduced
from approximately 52% to 46%. In December 2001, Mr. Fjelstad returned to RTW
as President and Chief Executive Officer and a director (see Note 8).

In connection with the repurchase, Mr. Prosser retired from the Company,
resigned as Chairman and was paid $225,000 as a termination benefit. He
remained a member of our Board of Directors. In December 2001, Mr. Prosser
returned to RTW as Chairman of the Board (see Note 8).

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

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

44



---



##### Table of Contents



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

Under Minnesota insurance law regulating the payment of dividends by ACIC,
any such payments must be an amount deemed prudent by ACICs Board of Directors
and, unless otherwise approved by the Commissioner of the Minnesota Department
of Commerce (Commissioner), must be paid solely from the adjusted earned
surplus of ACIC. Adjusted earned surplus means the earned surplus as
determined in accordance with  accounting practices (unassigned
funds), less 25% of the amount of such earned surplus that is attributable to
unrealized capital gains. Further, without approval of the Commissioner, ACIC
may not pay a dividend in any calendar year which, when combined with dividends
paid in the preceding twelve months, exceeds the greater of (i) 10% of ACICs
statutory capital and surplus at the prior year end or (ii) 100% of ACICs
statutory net gain from operations (not including realized capital gains) for
the prior calendar year. For 2002, dividends in excess of approximately $2.7
million would require prior consent of the Commissioner.

Statutory Surplus and Statutory Net Income (Loss) Our insurance subsidiary is
required to file financial statements with state regulatory agencies. The
accounting principles used to prepare the statutory financial statements follow
prescribed accounting practices that differ from GAAP. Statutory
policyholders surplus at December 31, 2002 and 2001, and statutory net income
(loss) for the years ended December 31, 2002, 2001 and 2000 are as follows
(000s):

|     |  |               |        |            |  |   |         |  
|---- |  | ------------- | ------ | ---------- |  | - | ------- | -
|     |  | Statutory     |        | Statutory 
|     |  | Policyholders |        | Net Income
|     |  | Surplus       |        | (Loss)    
|     |  |               |        |           
|2002 |  | $             | 26,820 |            |  | $ | 12,064  |  
|2001 |  |               | 19,542 |            |  |   | (14,074 | )
|2000 |  |               |        |            |  |   | (16,600 | )

In March 1998, the National Association of Insurance Commissioners
adopted the Codification of Statutory Accounting Principles (the
Codification). The Codification standardized regulatory accounting and
reporting to state insurance departments and became effective January 1,
2001. Statutory accounting principles, however, will continue to be
established by individual state laws and permitted practices. The State of
Minnesota required adoption of the Codification for preparing statutory
financial statements for financial periods occurring on or after January 1,
2001. Adoption of the Codification increased our statutory capital and
surplus by approximately $1.9 million at December 31, 2001.

Note 10  COMMITMENTS AND CONTINGENCIES

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

Future minimum (base) rental payments required under the leases, as of December 31, 2002, are as follows (000s):

|     |  |   |       | 
|---- |  | - | ----- | 
|2003 |  | $ | 1,260 | 
|2004 |  |   | 1,276 | 
|2005 |  |   | 1,147 | 
|2006 |  |   | 933   | 
|2007 |  |   | 583   | 

Rent expense, including contingent rentals, was $1.3 million, $2.0 million
and $2.1 million for 2002, 2001 and 2000, respectively.

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

45



---



##### Table of Contents



Note 11  ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

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

|                                                                 |                                                             |                                           |                                         |       |       |       |      |       |       |     |        |       |       |       | 
|---------------------------------------------------------------- | ----------------------------------------------------------- | ----------------------------------------- | --------------------------------------- | ----- | ----- | ----- | ---- | ----- | ----- | --- | ------ | ----- | ----- | ----- | 
|                                                                 |                                                             |                                           |                                         |       | 2002  |       | 2001 |       | 2000 
|                                                                 |                                                             |                                           |                                         |       |       |       |      |       |      
|Accumulated other comprehensive income (loss), beginning of year |                                                             | $                                         | 882                                     |       |       | $     | 204  |       |       | $   | (2,818 | )    
|Changes in comprehensive income (loss) arising during the year:  |                                                             |                                           |                                         |       |       |       |      |       |       |     |        |      
|                                                                 | Net unrealized investment gains                             |                                           |                                         | 3,780 |       |       |      | 2,211 |       |     |        | 3,972 |      
|                                                                 | Less: Adjustment for net realized investment gains (losses) |                                           |                                         | 1,721 |       |       |      | 1,163 |       |     |        | (607  | )    
|                                                                 |                                                             |                                           |                                         |       |       |       |      |       |       |     |        |      
|                                                                 |                                                             | Change in net unrealized investment gains |                                         |       | 2,059 |       |      |       | 1,048 |     |        |       | 4,579 |      
|                                                                 |                                                             | Income tax expense                        |                                         |       | 721   |       |      |       | 370   |     |        |       | 1,557 |      
|                                                                 |                                                             |                                           |                                         |       |       |       |      |       |       |     |        |      
|                                                                 |                                                             |                                           | Other comprehensive income for the year |       |       | 1,338 |      |       |       | 678 |        |       |       | 3,022 | 
|                                                                 |                                                             |                                           |                                         |       |       |       |      |       |       |     |        |      
|Accumulated other comprehensive income, end of year              |                                                             | $                                         | 2,220                                   |       |       | $     | 882  |       |       | $   | 204    |      
|                                                                 |                                                             |                                           |                                         |       |       |       |      |       |       |     |        |      

Note 12  RESTRUCTURING CHARGES

During 2001, we recorded pre-tax restructuring charges totaling $2.0 million to
general and administrative expenses in the Consolidated Statement of
Operations. These charges included costs associated with our decision to close
our Missouri and Massachusetts regional offices, as well as our Brainerd,
Minnesota and Overland Park, Kansas satellite offices. We anticipated that 38
employees in our regional offices, 17 employees in our satellite offices and 2
employees in our Home Office would be affected by these closures. The
restructuring charge included $715,000 of severance pay and benefits, of which
$106,000 was paid by December 31, 2001 and the remainder of which was paid,
primarily early, in 2002. Additionally, the restructuring charge included
office and equipment lease costs totaling $684,000 of which $80,000 was paid by
December 31, 2001 with an additional $195,000 paid in 2002 and furniture and
equipment disposals and other costs totaling $600,000 of which $53,000 had been
disposed of by December 31, 2001, the remainder of which was disposed of in
2002. At December 31, 2001, the remaining accrual for severance pay and
benefits, office and equipment lease costs and furniture and equipment
disposals and other costs was $1.8 million. The accrual decreased to $409,000
at December 31, 2002 and primarily included amounts related to future lease
payments.

Note 13  TERMINATION OF DEPOSIT CONTRACT

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

Note 14  QUARTERLY RESULTS OF OPERATIONS (Unaudited)

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

46



---



##### Table of Contents



The following tables present unaudited quarterly results of operations for the
eight quarters ended December 31, 2002:

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

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

|                                                                                                      |  |   |       |  |  |   |     |  |  |   |       |  |  |   |       | 
|----------------------------------------------------------------------------------------------------- |  | - | ----- |  |  | - | --- |  |  | - | ----- |  |  | - | ----- | 
|Changes in estimated reinsurance costs                                                                |  | $ |      |  |  | $ | 669 |  |  | $ | 350   |  |  | $ |      | 
|Realized gains on repositioning our investment portfolio                                              |  |   | 1,451 |  |  |   |    |  |  |   | 354   |  |  |   |      | 
|Changes in estimates for unpaid claim and claim
settlement expenses on claims reported in prior years |  |   | 3,000 |  |  |   |    |  |  |   | 1,250 |  |  |   | 4,106 | 
|Second injury fund accrual adjustments                                                                |  |   |      |  |  |   |    |  |  |   |      |  |  |   | 851   | 
|Gain recorded on termination of St. Paul Re contract                                                  |  |   |      |  |  |   |    |  |  |   |      |  |  |   | 957   | 
|Change in recorded deferred income tax
valuation allowance                                            |  |   |      |  |  |   |    |  |  |   | 1,296 |  |  |   | 6,001 | 

47



---



##### Table of Contents



|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |        |        | 
|------------------------------- | ----------------------------------- | ------------------------------------- | ------- | ------- | ------ | ------- | ------ | ------- | ------ | ------- | ------ | ------ | ------ | - | ------- | ------ | ------ | 
|                                |                                     |                                       |         | First   |        | Second  |        | Third   |        | Fourth 
|                                |                                     |                                       |         | Quarter |        | Quarter |        | Quarter |        | Quarter
|                                |                                     |                                       |         |         |        |         |        |         |        |        
|2001                            |                                     | (In thousands, except per share data)
|Premiums in force               |                                     | $                                     | 104,100 |         |        | $       | 99,400 |         |        | $       | 89,400 |        |        | $ | 83,700  |       
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|Revenues:                       |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|                                | Gross premiums earned               |                                       | $       | 26,123  |        |         | $      | 25,803  |        |         | $      | 23,419 |        |   | $       | 22,075 |       
|                                | Premiums ceded                      |                                       |         | (4,114  | )      |         |        | (3,238  | )      |         |        | (2,476 | )      |   |         | (1,535 | )     
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|                                |                                     | Premiums earned                       |         |         | 22,009 |         |        |         | 22,565 |         |        |        | 20,943 |   |         |        | 20,540 | 
|                                | Investment income                   |                                       |         | 1,457   |        |         |        | 1,736   |        |         |        | 1,594  |        |   |         | 1,628  |       
|                                | Net realized investment losses      |                                       |         | 1,079   |        |         |        | 28      |        |         |        | 25     |        |   |         | 31     |       
|                                | Other income                        |                                       |         | 2,088   |        |         |        |        |        |         |        |       |        |   |         |       |       
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|                                |                                     | Total revenues                        |         |         | 26,633 |         |        |         | 24,329 |         |        |        | 22,562 |   |         |        | 22,199 | 
|Expenses:                       |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|                                | Claim and claim settlement expenses |                                       |         | 18,990  |        |         |        | 19,828  |        |         |        | 16,032 |        |   |         | 25,253 |       
|                                | Policy acquisition costs            |                                       |         | 3,626   |        |         |        | 3,565   |        |         |        | 3,147  |        |   |         | 3,652  |       
|                                | General and administrative expenses |                                       |         | 2,816   |        |         |        | 4,339   |        |         |        | 3,776  |        |   |         | 6,460  |       
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|                                |                                     | Total expenses                        |         |         | 25,432 |         |        |         | 27,732 |         |        |        | 22,955 |   |         |        | 35,365 | 
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|Income (loss) from operations   |                                     | $                                     | 1,201   |         |        | $       | (3,403 | )       |        | $       | (393   | )      |        | $ | (13,166 | )     
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|Net income (loss)               |                                     | $                                     | 777     |         |        | $       | (2,335 | )       |        | $       | (339   | )      |        | $ | (23,318 | )     
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|Basic income (loss) per share   |                                     | $                                     | 0.15    |         |        | $       | (0.45  | )       |        | $       | (0.07  | )      |        | $ | (4.53   | )     
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       
|Diluted income (loss) per share |                                     | $                                     | 0.15    |         |        | $       | (0.45  | )       |        | $       | (0.07  | )      |        | $ | (4.53   | )     
|                                |                                     |                                       |         |         |        |         |        |         |        |         |        |        |        |   |         |       

The following represent pre-tax adjustments recorded during each quarter of 2001 that affected reported net income:

|                                                                                                         |  |   |        |   |  |   |        |   |  |   |   |  |  |   |         |  
|-------------------------------------------------------------------------------------------------------- |  | - | ------ | - |  | - | ------ | - |  | - | - |  |  | - | ------- | -
|Realized gains on repositioning the investment portfolio                                                 |  | $ | 1,079  |   |  | $ |       |   |  | $ |  |  |  | $ | 1,079   |  
|Refund received from the Minnesota WCRA                                                                  |  |   | 2,088  |   |  |   |       |   |  |   |  |  |  |   | 2,088   |  
|Changes in estimates for unpaid claim and claim
settlement expenses on claims reported in prior years    |  |   | (3,550 | ) |  |   | (1,905 | ) |  |   |  |  |  |   | (2,276  | )
|Change in estimate for unpaid claim and claim settlement
expenses on claims reported in the current year |  |   |       |   |  |   | (2,142 | ) |  |   |  |  |  |   | (8,124  | )
|Restructuring charge for Missouri and Massachusetts
regional office closures                             |  |   |       |   |  |   |       |   |  |   |  |  |  |   | (1,999  | )
|Deferred income tax valuation allowance                                                                  |  |   |       |   |  |   |       |   |  |   |  |  |  |   | (14,560 | )

48



---



##### Table of Contents






ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

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

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

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

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

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




PART III




ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The Companys Amended Articles of Incorporation require the Company to be
managed by or under the direction of a Board of Directors of not less than
three or more than twelve directors, with the actual number of directors
determined by the Board of Directors. The Board has resolved to have eight
directors effective upon the election of directors at the Annual Meeting of
Shareholders. Directors are elected at the Annual Meeting of Shareholders,
except that vacancies on the Board of Directors between Annual Meetings and
newly created directorships can be filled by vote of a majority of the
directors then in office. Pursuant to the terms of the Companys Amended
Articles of Incorporation, directors are divided into three classes, with the
term of one class expiring each year. As the term of each class expires, the
successors to the directors in that class are elected for a term of three
years.

Each director will remain in office through his or her stated term or
until a successor is elected or he or she resigns. Information about the
directors is set forth below. Unless otherwise indicated, each director has
been engaged in his or her present occupation as set forth below, or has been
an officer with the organization indicated, for more than five years.

|                           |  |                                                                 |  |       |          |              |  |              |      | 
|-------------------------- |  | --------------------------------------------------------------- |  | ----- | -------- | ------------ |  | ------------ | ---- | 
|                           |  | Principal Occupation                                            |  |       | Director |              |  | Year Current
|Name and Age               |  | and Other Directorships                                         |  | Since |          | Term Expires
|                           |  |                                                                 |  |       |          |             
|J. Alexander Fjelstad (51) |  | See the section entitled Executive Officers
of the Registrant |  |       | 2001     |              |  |              | 2003 | 

49



---



##### Table of Contents



|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |              |  |              |      | 
|-------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----- | -------- | ------------ |  | ------------ | ---- | 
|                           |  | Principal Occupation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |  |       | Director |              |  | Year Current
|Name and Age               |  | and Other Directorships                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |  | Since |          | Term Expires
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|John O. Goodwyne (64)      |  | Director of the Company; Owner and President
since 1974 of J N Johnson Sales & Service Inc.,
a local contractor for fire protection systems and
distributor of fire extinguishers, as well as owner
and President since 1982 of Low Voltage
Contractors Inc., a leading local contractor for
installation and service of fire alarm, security and
nurse call systems.                                                                                                                                                                                                                                            |  |       | 2001     |              |  |              | 2003 | 
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|Gregory D. Koschinska (57) |  | Director of the Company; Retired Partner at
Larson, Allen, Weishair & Co., a regional Public Accounting and consulting firm,
Mr. Koschinsha also serves on the advisory board for
two entrepreneurial companies, and is an
Executive Fellow for the University of St. Thomas
Graduate School of Business. Mr. Koschinska is a
member of the American Institute of Certified
Public Accountants and the Minnesota Society of
Certified Public Accountants.                                                                                                                                                        |  |       | 2001     |              |  |              | 2004 | 
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|Vina L. Marquart (51)      |  | Director of the Company; Public Health Nurse for
Carver County, Minnesota; Ms. Marquart was
employed by the Company from 1983 to March 2002.
Ms. Marquart joined the Company as a Nurse
Case Manager. Most recently, Ms. Marquart was the
Vice President of Human Resources from February
2000 until March 2002. Prior to that time, she held
various management positions within the Company
including Operations Manager, General Manager of
the Minnesota office and National Director of Case
and Claims Management.                                                                                         |  |       | 2002     |              |  |              | 2004 | 
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|David C. Prosser (78)      |  | See the section entitled Executive Officers
of the Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       | 1983     |              |  |              | 2003 | 
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|Alfred L. LaTendresse (54) |  | See the section entitled Executive Officers
of the Registrant                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       | 2001     |              |  |              | 2005 | 
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|William J. Deters (66)     |  | Director of the Company; Mr. Deters is currently a
director for four entrepreneurial companies and
an executive coach. Mr. Deters founded Apartment
Search Inc. and served as its President and Chief
Executive Officer from March 1986 through its sale
to Times Mirror in December 1996. He also served
as Vice Chairman to Apartment Search Inc. in its
transition to Times Mirror from December 1996 to
December 1997. Prior to that time, Mr. Deters also
founded or co-founded and served in executive
capacities for several companies including North
Atlantic Technologies, Inc. and Great Places, Inc. |  |       | 2002     |              |  |              | 2005 | 
|                           |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |       |          |             
|John W. Prosser (40)       |  | Director of the Company; Owner and President of
Automotive Concepts, Inc. since 1988.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |  |       | 2002     |              |  |              | 2005 | 

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

50



---



##### Table of Contents






ITEM 11. EXECUTIVE COMPENSATION

The following table shows, for the fiscal years ending December 31, 2002,
2001 and 2000, the cash compensation paid by the Company, as well as certain
other compensation paid or accrued for those years, to David C. Prosser, the
Companys Chairman of the Board, to J. Alexander Fjelstad, the Companys
President and Chief Executive Officer, and each of three other most highly
compensated executive officers of the Company in office at the end of fiscal
year 2002 whose total cash compensation for the year exceeded $100,000
(together with Mr. Prosser and Mr. Fjelstad, the Named Executive Officers) in
all capacities in which they served:

Summary Compensation Table

|                               |                         |      |      |        |  |           |                     |             |                  |           |        |        |  |  |              |        |  |   |       |       | 
|------------------------------ | ----------------------- | ---- | ---- | ------ |  | --------- | ------------------- | ----------- | ---------------- | --------- | ------ | ------ |  |  | ------------ | ------ |  | - | ----- | ----- | 
|                               |                         |      |      |        |  |           |                     |             |                  |           |        |        |  |  | Long term    |        |  |   |      
|                               |                         |      |      |        |  |           |                     |             |                  |           |        |        |  |  | Compensation |        |  |   |      
|                               |                         |      |      |        |  |           |                     |             |                  |           |        |        |  |  | Awards       |        |  |   |      
|                               |                         |      |      |        |  |           |                     |             |                  |           |        |        |  |  |              |        |  |   |      
|                               |                         |      |      |        |  |           | Annual Compensation |             | Securities       |           |        |        | 
|                               |                         |      |      |        |  |           |                     |             | Underlying       | All Other
|Name and Principal Position    |                         | Year |      | Salary |  | Bonus (1) |                     | Options (#) | Compensation (2)
|                               |                         |      |      |        |  |           |                     |             |                 
|David C. Prosser               |                         |      | 2002 |        |  | $         | 262,500             |             |                  | $         |       |        |  |  | 100,000      |        |  | $ |      |      
|Chairman of the Board          |                         |      | 2001 |        |  |           |                    |             |                  |           |       |        |  |  | 2,500        |        |  |   |      |      
|                               |                         |      | 2000 |        |  |           | 275,000             |             |                  |           |       |        |  |  |             |        |  |   |      |      
|J. Alexander Fjelstad          |                         |      | 2002 |        |  |           | 275,000             |             |                  |           |       |        |  |  |             |        |  |   | 5,500 |      
|President and Chief Executive  |                         |      | 2001 |        |  |           | 13,750              |             |                  |           |       |        |  |  | 100,000      |        |  |   |      |      
|                               | Officer                 |      |      | 2000   |  |           |                     |            |                  |           |        |       |  |  |              |       |  |   |       |      | 
|Alfred L. LaTendresse          |                         |      | 2002 |        |  |           | 201,200             |             |                  |           | 30,000 |        |  |  |             |        |  |   | 5,500 |      
|Executive Vice President       |                         |      | 2001 |        |  |           |                    |             |                  |           |       |        |  |  | 100,000      |        |  |   |      |      
|                               |                         |      | 2000 |        |  |           |                    |             |                  |           |       |        |  |  |             |        |  |   |      |      
|Jeffrey B. Murphy              |                         |      | 2002 |        |  |           | 169,724             |             |                  |           |       |        |  |  |             |        |  |   | 5,092 |      
|Chief Financial Officer,       |                         |      | 2001 |        |  |           | 159,750             |             |                  |           | 16,000 |        |  |  | 25,000       |        |  |   | 5,100 |      
|                               | Secretary and Treasurer |      |      | 2000   |  |           |                     | 148,000     |                  |           |        | 4,252  |  |  |              | 20,000 |  |   |       | 2,284 | 
|Patricia M. Sheveland          |                         |      | 2002 |        |  |           | 145,350             |             |                  |           |       |        |  |  | 7,500        |        |  |   |      |      
|Vice President Case and Claims |                         |      | 2001 |        |  |           | 147,680             |             |                  |           | 31,892 |        |  |  | 7,500        |        |  |   | 3,192 |      
|                               | Management              |      |      | 2000   |  |           |                     | 121,588     |                  |           |        | 59,184 |  |  |              | 2,500  |  |   |       | 1,410 | 



---

|(1) |  | Bonuses for 2002 include (i) $30,000 in a start bonus paid to Mr.
LaTendresse.                                                                                       
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | Bonuses for 2001 include (i) $16,000 in a discretionary bonus paid to Mr.
Murphy; and (ii) $31,892 paid to Ms. Sheveland under the Companys 2000
Gain Sharing Program.
|   
|    |  | Bonuses for 2000 include $4,252 and $59,184 paid to Mr. Murphy and Ms.
Sheveland respectively, under the Companys 2000 Gain Sharing Program.                          
|   
|(2) |  | All other compensation for 2002 includes matching 401(k) contributions of
$5,500, $5,500, and $5,092 for Mr. Fjelstad, Mr. LaTendresse and Mr.
Murphy, respectively.   
|   
|    |  | All other compensation for 2001 includes matching 401(k) contributions of
$5,100 and $3,192 for Mr. Murphy and Ms. Sheveland, respectively.                            
|   
|    |  | All other compensation for 2000 includes matching 401(k) contributions of
$2,284, and $1,410 for Mr. Murphy and Ms. Sheveland, respectively.                           

Stock Options

The following table summarizes all option grants under the Companys 1994
Stock Plan made during the fiscal year ended December 31, 2002 to the Named
Executive Officers:

Option Grants in 2002

|                      |  |                   |         |                            |  |            |      |            |  |    |      |     |  |  |           |                     |  |                            |         |  |  |  |         | 
|--------------------- |  | ----------------- | ------- | -------------------------- |  | ---------- | ---- | ---------- |  | -- | ---- | --- |  |  | --------- | ------------------- |  | -------------------------- | ------- |  |  |  | ------- | 
|                      |  |                   |         |                            |  |            |      |            |  |    |      |     |  |  |           |                     |  | Potential Realizable Value
|                      |  | Individual Grants |         | at Assumed Annual Rates of
|                      |  |                   |         | Stock Price Appreciation  
|                      |  |                   |         |                            |  | % of Total |      |            |  |    |      |     |  |  |           | for Option Term (1)
|                      |  | Options           |         | Options                    |  | Exercise   |      | Expiration |  |   
|Name                  |  | Granted           |         | Granted                    |  | Price      |      | Date       |  | 5% |      | 10%
|                      |  |                   |         |                            |  |            |      |            |  |    |      |    
|David C. Prosser      |  |                   | 100,000 |                            |  |            | 72.5 | %          |  | $  | 2.42 |     |  |  | 2/6/2007  |                     |  | $                          | 152,192 |  |  |  | 385,686 | 
|Patricia M. Sheveland |  |                   | 7,500   |                            |  |            | 5.4  | %          |  |    | 2.60 |     |  |  | 4/24/2012 |                     |  |                            | 12,263  |  |  |  | 31,078  | 



---

|(1) |  | Potential realized values shown above represent the potential gains based
upon annual compound price appreciation of 5% and 10% from the date of
grant through the full option term. The actual value realized, if any, on
stock option exercises will be dependent on overall market conditions and
the future performance of the Company and its common stock. There is no
assurance that the actual value realized will approximate the amounts
reflected in this table.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

51



---



##### Table of Contents



The following table summarizes option exercises during the fiscal year
ended December 31, 2002 by the Named Executive Officers, and the value of their
unexercised options at December 31, 2002:

Aggregated Option Exercises
and Option Values at December 31, 2002

|                            |  |              |   |          |  |             |   |               |  |                              |        |                          |  |  |        |  |  |                      |   |  |  |  |   | 
|--------------------------- |  | ------------ | - | -------- |  | ----------- | - | ------------- |  | ---------------------------- | ------ | ------------------------ |  |  | ------ |  |  | -------------------- | - |  |  |  | - | 
|                            |  |              |   |          |  |             |   |               |  |                              |        |                          |  |  |        |  |  | Value of Unexercised
|                            |  |              |   |          |  |             |   |               |  | Number of Unexercised        |        | In-the-Money Options    
|                            |  |              |   |          |  |             |   |               |  | Options at December 31, 2002 |        | at December 31, 2002 (1)
|                            |  | Shares       |   |          |  |             |   |               |  |                             
|                            |  | Acquired on  |   | Value    |  | Exercisable |   | Unexercisable |  | Exercisable                  |        | Unexercisable           
|Name and Principal Position |  | Exercise (#) |   | Realized |  | Shares      |   | Shares        |  | Shares                       |        | Shares                  
|                            |  |              |   |          |  |             |   |               |  |                              |        |                         
|David C. Prosser            |  |              |  |          |  |             |  |               |  |                              | 42,500 |                          |  |  | 60,000 |  |  |                      |  |  |  |  |  | 
|J. Alexander Fjelstad       |  |              |  |          |  |             |  |               |  |                              | 40,000 |                          |  |  | 60,000 |  |  |                      |  |  |  |  |  | 
|Alfred L. LaTendresse       |  |              |  |          |  |             |  |               |  |                              | 40,000 |                          |  |  | 60,000 |  |  |                      |  |  |  |  |  | 
|Jeffrey B. Murphy           |  |              |  |          |  |             |  |               |  |                              | 37,290 |                          |  |  | 16,667 |  |  |                      |  |  |  |  |  | 
|Patricia M. Sheveland       |  |              |  |          |  |             |  |               |  |                              | 16,581 |                          |  |  | 5,833  |  |  |                      |  |  |  |  |  | 



---

|(1) |  | The value of unexercised options is calculated by determining the
difference between the fair market value of the shares underlying the
options at December 31, 2002 and the exercise price of the options. Fair
market value was determined based on a per share price of $1.68, which is
the closing price for the Companys common stock on December 31, 2002, the
last trading day in the Companys fiscal year.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Employment and Severance Agreements.

The Company does not have written employment agreements with its officers
other than Mr. Prosser, the Chairman of the Board, Mr. Fjelstad, the President
and Chief Executive Officer and Mr. LaTendresse, the Companys Executive Vice
President. The Company entered into employment agreements with each of these
officers providing each with a base salary, subject to review annually for
increase by the Board of Directors. Mr. Prosser receives a $250,000 salary
that includes $30,000 for his services as Chairman of the Board and $220,000 in
base salary. Mr. Fjelstad receives a base salary of $275,000 and Mr.
LaTendresse a base salary of $200,000. In addition to base salary, each is
eligible for bonuses and expense reimbursements. The Company also provides
these individuals with health, dental, life and disability insurance consistent
with that provided to other officers and employees. Additionally, Mr. Fjelstad
and Mr. LaTendresse were each granted 100,000 non-qualified options at $1.98
per share on December 13, 2001. Mr. Prosser was granted 100,000 non-qualified
options on February 6, 2002 at $1.42 per share. These agreements were extended
in March 2003 through March 31, 2004.

The Company adopted the RTW, Inc. Senior Management Change in Control
Severance Pay Plan under which officers of the Company will be entitled to
receive a payment equal to nine months salary plus unpaid bonuses, insurance
benefits and outplacement counseling costs if, within twelve months of a change
in control, the officers employment is terminated without cause or the officer
terminates employment for good reason. Good reason is defined in the plan to
include any adverse change in a participants status or position as a senior
management employee of the Company, a reduction in base salary, or failure to
continue any material benefit plan.

52



---



##### Table of Contents






ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table includes information as of March 1, 2003 concerning
the beneficial ownership of common stock of the Company by: (i) the only
shareholders known to the Company to hold more than five percent of the common
stock of the Company, (ii) each Named Executive Officer (as defined below under
Executive Compensation and Other Information), (iii) each current director of
the Company, and (iv) all executive officers and directors of the Company as a
group. Unless otherwise indicated, all beneficial owners have sole voting and
investment power over the shares held.

|                                                                               |  |        |           |             |  |             |         |       |  |       |       |            |  |  |           |  |  |  |      |  
|------------------------------------------------------------------------------ |  | ------ | --------- | ----------- |  | ----------- | ------- | ----- |  | ----- | ----- | ---------- |  |  | --------- |  |  |  | ---- | -
|                                                                               |  |        |           |             |  | Acquirable  |         |       |  |       |       |            |  |  |           |  |  | 
|                                                                               |  | Common |           | within      |  | Shares held |         |       |  |       |       | Percentage
|Name                                                                           |  | Stock  |           | 60 days (1) |  | by ESOP     |         | Total |  | Owned
|                                                                               |  |        |           |             |  |             |         |       |  |      
|David C. Prosser
20645 Radisson Road
Shorewood, MN 55331                       |  |        | 832,836   | (2)         |  |             | 42,500  |       |  |       |      |            |  |  | 875,334   |  |  |  | 17.0 | %
|The Kaufmann Fund, Inc.
140 East 45th Street, 43rd Floor
New York, NY 10017    |  |        | 538,050   | (3)         |  |             |        |       |  |       |      |            |  |  | 538,050   |  |  |  | 10.6 | %
|Dimensional Fund Advisors
1299 Ocean Avenue, 11th Floor
Santa Monica, CA 90401 |  |        | 412,100   | (4)         |  |             |        |       |  |       |      |            |  |  | 412,100   |  |  |  | 8.1  | %
|Pamela Prosser Snyder
10515 South Shore Drive
Plymouth, MN 55441               |  |        | 407,606   | (5)         |  |             |        |       |  |       |      |            |  |  | 407,606   |  |  |  | 8.0  | %
|John W. Prosser
6358 Oxbow Bend
Chanhassen, MN 55317                           |  |        | 290,317   | (6)         |  |             | 833     |       |  |       |      |            |  |  | 291,150   |  |  |  | 5.7  | %
|J. Alexander Fjelstad                                                          |  |        | 50,121    | (7)         |  |             | 40,000  |       |  |       |      |            |  |  | 90,121    |  |  |  | 1.8  | %
|Vina L. Marquart                                                               |  |        | 64,225    |             |  |             | 833     |       |  |       |      |            |  |  | 65,058    |  |  |  | 1.3  | %
|Alfred L. LaTendresse                                                          |  |        | 21,750    | (8)         |  |             | 40,000  |       |  |       |      |            |  |  | 61,750    |  |  |  | 1.2  | %
|Jeffrey B. Murphy                                                              |  |        | 3,157     |             |  |             | 37,290  |       |  |       | 295   |            |  |  | 40,742    |  |  |  | *    |  
|Patricia M. Sheveland                                                          |  |        |          |             |  |             | 16,581  |       |  |       | 2,737 |            |  |  | 19,318    |  |  |  | *    |  
|William J. Deters                                                              |  |        | 4,700     |             |  |             | 833     |       |  |       |      |            |  |  | 5,533     |  |  |  | *    |  
|Gregory C. Koschinska                                                          |  |        | 2,500     |             |  |             | 2,500   |       |  |       |      |            |  |  | 5,000     |  |  |  | *    |  
|Keith D. Krueger                                                               |  |        | 100       |             |  |             | 4,750   |       |  |       | 29    |            |  |  | 4,879     |  |  |  | *    |  
|John O. Goodwyne                                                               |  |        | 500       |             |  |             | 2,500   |       |  |       |      |            |  |  | 3,000     |  |  |  | *    |  
|All Executive Officers and
Directors as a Group (11 persons)                   |  |        | 1,270,204 | (2),(7),(8) |  |             | 188,620 |       |  |       | 3,061 |            |  |  | 1,461,885 |  |  |  | 27.6 | %



---

|*   |  | Indicates ownership of less than one percent.                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(1) |  | Includes options to purchase shares that are or will become exercisable
within 60 days of March 10, 2003.                                                                                                                                                                                                                                                                                                                                                                                             
|   
|(2) |  | Includes 25,970 shares owned by the David C. and Margaret F. Prosser
Foundation of which Mr. Prosser is President and for which he serves as
trustee and 134,882 shares held jointly by Mr. Prosser with his wife.
Also includes 15,849 shares held in by the David C. Prosser 1995 Unitrust,
44,950 shares held by the David C. Prosser 1996 Unitrust, and 174,679
shares held by the David C. Prosser 1997 Unitrust. Mr. Prossers daughter
is the trustee of each of the above-mentioned Unitrusts.
|   
|(3) |  | Based on a Schedule 13G dated February 14, 2003 filed with the Securities
and Exchange Commission.                                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(4) |  | Based on a Schedule 13G dated February 12, 2003 filed with the Securities
and Exchange Commission.                                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(5) |  | Includes: (i) 11,114 shares held in trust for Thomas C. Prossers four
children, (ii) 54,000 shares held by the Pamela Prosser Snyder Irrevocable
Trust, (iii) 15,849 shares held in by the David C. Prosser 1995 Unitrust,
44,950 shares held by the David C. Prosser 1996 Unitrust, and 174,679
shares held by the David C. Prosser 1997 Unitrust for which Ms. Snyder is
the trustee.                                                                                                              
|   
|(6) |  | Includes: (i) 31,725 shares owned by Polly Jane Wolner Childrens Trust,
and (ii) 5,775 shares owned by Polly J. Wolner 1994 Irrevocable Trust for
which John W. Prosser acts as trustee. John W. Prosser disclaims any
beneficial ownership for shares held by these trusts.                                                                                                                                                                                                                         
|   
|(7) |  | Includes 9,990 shares held by irrevocable trusts for the benefit of Mr.
Fjelstads minor children, with respect to which Mr. Fjelstad disclaims
beneficial ownership.                                                                                                                                                                                                                                                                                                                                 
|   
|(8) |  | Includes 11,500 shares owned by Mr. LaTendresses wife and 5,250 shares
held by irrevocable trusts for Mr. LaTendresses minor children, with
respect to which Mr. LaTendresse disclaims beneficial ownership.                                                                                                                                                                                                                                                                                        

53



---



##### Table of Contents






ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

On March 28, 2000, the Company repurchased 709,285 shares from a group
consisting of David C. Prosser, the Companys founder and a director, certain
members of his family, and J. Alexander Fjelstad, who at the time was a former
director and former executive of the Company (together, the Prosser Selling
Group). The Company paid $10.38 per share, as well as legal and other costs,
totaling approximately $7.7 million to repurchase the shares. After completing
the transaction, the combined ownership of Mr. Prosser, members of his family
and Mr. Fjelstad was reduced from approximately 52% to 46%. In December 2001,
Mr. Fjelstad returned to the Company as President and Chief Executive Officer
and a director.

In connection with the repurchase, Mr. Prosser retired from the Company,
resigned as Chairman and was paid $225,000 as a termination benefit. He
remained a member of the Board of Directors. Additionally, at closing, each
member of the Prosser Selling Group entered into a two year standstill and
voting agreement under which each agreed, among other things, not to acquire
additional securities of the Company and not to initiate or support certain
initiatives designed to effect fundamental changes in the Companys policy or
structure. The two-year voting and standstill agreements expired March 6,
2002. In December 2001, Mr. Prosser returned to the Company as Chairman of the
Board.




ITEM 14. CONTROLS AND PROCEDURES



| | a) |  | Evaluation of Disclosure Controls and Procedures                                                                                                                                                                                                                                                                                                                                                                                                                   
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |    |  | The Companys Chief Executive Officer, J. Alexander Fjelstad, and Chief
Financial Officer, Jeffrey B. Murphy, have reviewed the Companys
disclosure controls and procedures within 90 days prior to the filing of
this report. Based upon this review, these officers believe that the
Companys disclosure controls and procedures are effective in ensuring
that material information related to the Company is made known to them by
others within the Company.
|
| | b) |  | Changes in Internal Controls                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |    |  | There were no significant changes in the Companys internal controls or in
other factors that could significantly affect these controls during the
year covered by this report or from the end of the reporting period to the
date of this Report on Form 10-K.                                                                                                                                                                                                    




PART IV




ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K



| | (a) |  | Documents filed as Part of this Report
| | --- |  | --------------------------------------

| |     |  |  |                                                                                                                                                             
| | --- |  |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) |  |  | Financial Statements. The following consolidated financial statements of the Company are set forth on pages 29 through 48 of Part II, Item 8 of this Report.

|                                                                                              
|----------------------------------------------------------------------------------------------
|Independent Auditors Reports                                                                 
|Consolidated Balance Sheets  December 31, 2002 and 2001                                      
|Consolidated Statements of Operations  Years Ended December 31, 2002, 2001 and 2000          
|Consolidated Statements of Shareholders Equity  Years Ended December 31, 2002, 2001 and 2000
|Consolidated Statements of Cash Flows  Years Ended December 31, 2002, 2001 and 2000          
|Notes to Consolidated Financial Statements  Years Ended December 31, 2002, 2001 and 2000     

| |     |  |  |                                                                          
| | --- |  |  | -------------------------------------------------------------------------
| | (2) |  |  | Financial Statement Schedules for the Three Years Ended December 31, 2002

|                                                                                                |  |      |      | 
|----------------------------------------------------------------------------------------------- |  | ---- | ---- | 
|                                                                                                |  | Page
|                                                                                                |  |     
|Independent Auditors Reports on Schedules for the Years Ended
December 31, 2002, 2001 and 2000 |  |      | S-1  | 
|Schedule I  Summary of Investments                                                             |  |      | S-3  | 
|Schedule II  Condensed Financial Information (Parent Company)                                  |  |      | S-4  | 
|Schedule III  Supplemental Information Concerning Insurance Operations                         |  |      | S-8  | 
|Schedule IV  Reinsurance                                                                       |  |      | S-9  | 
|Schedule V  Valuation and Qualifying Accounts                                                  |  |      | S-10 | 

54



---



##### Table of Contents





|    |  | All other schedules are omitted because they are not applicable or the
required information is presented in the Financial Statements or the
notes thereto.                                               
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Listing of Reports on Form 8-K                                                                                                                                                                           
|   
|    |  | On October 7, 2002, the Company filed a Current Report on Form 8-K dated
October 7, 2002 to report that it had engaged Ernst & Young LLP as the
independent certified public accountants for the Company.
|   
|    |  | On November 12, 2002, the Company filed a Current Report on Form 8-K
dated November 7, 2002 to report that it effected, on November 22, 2002,
a one-for-two reverse stock split of its common stock.     

55



---



##### Table of Contents





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

|        |  |                                                                                                                                              
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|3.1     |  | Amended Articles of Incorporation                                                                                                            
|3.2     |  | Amended Bylaws (1)                                                                                                                           
|4.1     |  | Form of Rights Agreement dated April 17, 1997 between RTW, Inc. and
Norwest Bank Minnesota National Association (2)                          
|10.1*   |  | Employment agreement and stock option agreement between RTW, Inc.
and David C. Prosser dated December 13, 2001 (7)                           
|10.2*   |  | Employment agreement and stock option agreement between RTW, Inc.
and J. Alexander Fjelstad III dated December 13, 2001 (7)                  
|10.3*   |  | Employment agreement and stock option agreement between RTW, Inc.
and Alfred L. LaTendresse dated December 13, 2001 (7)                      
|10.4*   |  | Amended RTW, Inc. 1995 Employee Stock Purchase Plan (4)                                                                                      
|10.5*   |  | Amended RTW, Inc. 1994 Stock Plan (4)                                                                                                        
|10.6    |  | Contract between RTW and ACIC dated January 1, 1992 (5)                                                                                      
|10.7    |  | Service Agreement between RTW and ACIC dated February 1, 1992 (5)                                                                            
|10.8*   |  | Description of the 2003 Profit Sharing Program                                                                                               
|10.9    |  | Reinsurance contract between ACIC and First Excess and Reinsurance
Corporation (GE Reinsurance Corporation) effective July 1, 1998 (3)       
|10.10   |  | Endorsement No. 2 to the reinsurance contract between ACIC and
General Reinsurance Corporation (3)                                           
|10.10.1 |  | Description of the Reinsurance Agreement for 2002 between ACIC and
General Reinsurance Corporation effective January 1, 2002 (7)             
|10.10.2 |  | Description of the Reinsurance Agreement for 2003 between ACIC and
General Reinsurance Corporation effective January 1, 2003                 
|10.11   |  | Minnesota Workers Compensation Reinsurance Association reinsurance
agreement                                                                
|10.12   |  | Election form for 2003 Minnesota Workers Compensation Reinsurance
Association reinsurance agreement                                         
|10.13   |  | Description of the Reinsurance Agreement for 2003 between ACIC and
Everest Re/Platinum Re effective January 1, 2003                          
|10.14   |  | Credit Agreement by and between RTW, Inc. and U.S. Bank National
Association dated March 31, 2000 (6)                                        
|10.14.1 |  | First Amendment to the Credit Agreement by and between RTW, Inc. and
U.S. Bank National Association dated May 4, 2000 (6)                    
|10.14.2 |  | Second Amendment to the Credit Agreement by and between RTW, Inc.
and U.S. Bank National Association dated March 28, 2001 (6)                
|10.14.3 |  | Third Amendment to the Credit Agreement by and between RTW, Inc. and
U.S. Bank National Association dated September 29, 2001 (7)             
|10.14.4 |  | Fourth Amendment to the Credit Agreement by and between RTW, Inc.
and U.S. Bank National Association dated March 27, 2002 (7)                
|10.14.5 |  | Fifth Amendment to the Credit Agreement by and between RTW, Inc. and
U.S. Bank National Association dated December 17, 2002                  
|10.14.6 |  | Sixth Amendment to the Credit Agreement by and between RTW, Inc. and
U.S. Bank National Association dated March 25, 2003                     
|11      |  | Statement, re: Computation of Net Income Per Share                                                                                           
|21      |  | Subsidiaries of the Registrant: The Company has one wholly-owned
subsidiary, American Compensation Insurance Company, a Minnesota
corporation
|23      |  | Consent of Ernst and Young LLP                                                                                                               
|23.1    |  | Consent of Deloitte & Touche LLP                                                                                                             
|24      |  | Power of Attorney, included in Signature page                                                                                                
|99.1    |  | Certification Pursuant to 18 U.S.C. § 1350, as Adopted Pursuant to §
906 of the Sarbanes-Oxley Act of 2002                                   



---

|(1) |  | Incorporated by reference to the Companys Registration Statement on Form
S-1 (Reg. No. 33-89164).                    
|--- |  | ----------------------------------------------------------------------------------------------------------------------
|(2) |  | Incorporated by reference to the Companys Registration Statement on Form
8-A filed April 25, 1997 (File No. 0-25508).
|(3) |  | Incorporated by reference to the Companys 1998 Report on Form 10-K.                                                  
|(4) |  | Incorporated by reference to the Companys Registration Statement on Form
S-8 (Reg. No. 333-81408).                   
|(5) |  | Incorporated by reference to the Companys Registration Statement on Form
SB-2 (Reg. No. 33-2002C).                   
|(6) |  | Incorporated by reference to the Companys 2000 Report on Form 10-K.                                                  
|(7) |  | Incorporated by reference to the Companys 2001 Report on Form 10-K/A.                                                

56



---



##### Table of Contents






SIGNATURES

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

|                     |  |                                      
|-------------------- |  | -------------------------------------
|                     |  | RTW, INC.                            
|                     |  |                                      
|Date: March 28, 2003 |  | By /s/ J. Alexander Fjelstad         
|                     |  |                                      
|                     |  | J. Alexander Fjelstad                
|                     |  | President and Chief Executive Officer
|                     |  | (Principal Executive Officer)        

Signatures and Power of Attorney

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

|               |  |                                                 
|-------------- |  | ------------------------------------------------
|Date           |  | Signature and Title                             
|               |  |                                                 
|               |  |                                                 
|March 28, 2003 |  | By /s/ David C. Prosser                         
|               |  |                                                 
|               |  | David C. Prosser                                
|               |  | Chairman of the Board                           
|               |  |                                                 
|March 28, 2003 |  | By /s/ J. Alexander Fjelstad                    
|               |  |                                                 
|               |  | J. Alexander Fjelstad                           
|               |  | President and Chief Executive Officer           
|               |  | (Principal Executive Officer)                   
|               |  |                                                 
|March 28, 2003 |  | By /s/ Jeffrey B. Murphy                        
|               |  |                                                 
|               |  | Jeffrey B. Murphy                               
|               |  | Secretary, Treasurer and Chief Financial Officer
|               |  | (Principal Financial and Accounting Officer)    
|               |  |                                                 
|March 28, 2003 |  | By /s/ Gregory D. Koschinska                    
|               |  |                                                 
|               |  | Gregory D. Koschinska                           
|               |  | Director                                        
|               |  |                                                 
|March 28, 2003 |  | By /s/ John O. Goodwyne                         
|               |  |                                                 
|               |  | John O. Goodwyne                                
|               |  | Director                                        
|               |  |                                                 
|March 28, 2003 |  | By /s/ Alfred L. LaTendresse                    
|               |  |                                                 
|               |  | Alfred L. LaTendresse                           
|               |  | Executive Vice President and Director           
|               |  |                                                 
|March 28, 2003 |  | By /s/ William J. Deters                        
|               |  |                                                 
|               |  | William J. Deters                               
|               |  | Director                                        
|               |  |                                                 
|March 28, 2003 |  | By /s/ John W. Prosser                          
|               |  |                                                 
|               |  | John W. Prosser                                 
|               |  | Director                                        
|               |  |                                                 
|March 28, 2003 |  | By /s/ Vina L. Marquart                         
|               |  |                                                 
|               |  | Vina L. Marquart                                
|               |  | Director                                        

57



---



##### Table of Contents






CERTIFICATION OF PRESIDENT AND CHIEF EXECUTIVE OFFICER

I, J. Alexander Fjelstad, President and Chief Executive Officer, certify that:



| | 1. |  | I have reviewed this Annual Report on Form 10-K of RTW, Inc.;                                                                                                                                                                                                                                                           
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this Annual Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this Annual Report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other financial
information included in this Annual Report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this Annual Report;                   
|
| | 4. |  | The Registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
have:                                                                                                   



| | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the Registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this Annual Report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the Registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this Annual Report (the Evaluation
Date); and                                                                                                  
|
| | c) |  | presented in this Annual Report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;                                                                                                                        



| | 5. |  | The Registrants other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrants auditors and the
audit committee of Registrants Board of Directors (or persons
performing the equivalent functions):
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the Registrants
ability to record, process, summarize and report financial data
and have identified for the Registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
Registrants internal controls; and                                                                                                                                        



| | 6. |  | The Registrants other certifying officer and I have indicated in
this Annual Report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                      |  |    |  |                                      
|--------------------- |  | -- |  | -------------------------------------
|Dated: March 28, 2003 |  | By |  | /s/ J. Alexander Fjelstad            
|                      |  |    |  |                                      
|                      |  |    |  | J. Alexander Fjelstad                
|                      |  |    |  | President and Chief Executive Officer
|                      |  |    |  | (Principal Executive Officer)        

58



---



##### Table of Contents



CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Jeffrey B. Murphy, Chief Financial Officer, certify that:



| | 1. |  | I have reviewed this Annual Report on Form 10-K of RTW, Inc.;                                                                                                                                                                                                                                                           
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 2. |  | Based on my knowledge, this Annual Report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this Annual Report;
|
| | 3. |  | Based on my knowledge, the financial statements, and other financial
information included in this Annual Report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Registrant as of, and for, the periods presented in
this Annual Report;                   
|
| | 4. |  | The Registrants other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and
have:                                                                                                   



| | a) |  | designed such disclosure controls and procedures to
ensure that material information relating to the Registrant,
including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in
which this Annual Report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the Registrants
disclosure controls and procedures as of a date within 90 days
prior to the filing date of this Annual Report (the Evaluation
Date); and                                                                                                  
|
| | c) |  | presented in this Annual Report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;                                                                                                                        



| | 5. |  | The Registrants other certifying officer and I have disclosed, based
on our most recent evaluation, to the Registrants auditors and the
audit committee of Registrants Board of Directors (or persons
performing the equivalent functions):
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or operation
of internal controls which could adversely affect the Registrants
ability to record, process, summarize and report financial data
and have identified for the Registrants auditors any material
weaknesses in internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves
management or other employees who have a significant role in the
Registrants internal controls; and                                                                                                                                        



| | 6. |  | The Registrants other certifying officer and I have indicated in
this Annual Report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                      |  |    |  |                                             
|--------------------- |  | -- |  | --------------------------------------------
|Dated: March 28, 2003 |  | By |  | /s/ Jeffrey B. Murphy                       
|                      |  |    |  |                                             
|                      |  |    |  | Jeffrey B. Murphy                           
|                      |  |    |  | Chief Financial Officer                     
|                      |  |    |  | (Principal Financial and Accounting Officer)

59



---



##### Table of Contents



INDEPENDENT AUDITORS REPORT

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

We have audited the consolidated financial statements of RTW, Inc. as of December 31, 2002 and 2001 and for each of the two years in the period ended December 31, 2002, and have issued our report thereon dated March 25, 2003. Our audits also included the 2002 and 2001 financial statement schedules listed in Item 14(a)(2) of this Report on Form 10-K. These schedules are the responsibility of the Companys management. Our responsibility is to express an opinion
based on our audits.

In our opinion, the 2002 and 2001 financial statement schedules referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

March 25, 2003
Minneapolis, Minnesota

S-1



---



##### Table of Contents



INDEPENDENT AUDITORS REPORT

To the Board of Directors and Shareholders
RTW, Inc.
Minneapolis, Minnesota

We have audited the consolidated financial statements of RTW, Inc. and
subsidiary (the Company) for the year ended December 31, 2000, and have issued
our report thereon dated February 9, 2001 (March 28, 2001 as to Note 6). Our
audit also included the consolidated financial statement schedules listed in
Item 15(a)(2) of this Report on Form 10-K. These consolidated financial
statement schedules are the responsibility of the Companys management. Our
responsibility is to express an opinion based on our audit. In our opinion,
such consolidated financial statement schedules, when considered in relation to
the basic consolidated financial statements taken as a whole, present fairly in
all material respects the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
February 9, 2001



S-2



---



##### Table of Contents



SCHEDULE I

RTW, INC.
SUMMARY OF INVESTMENTS
December 31, 2002
(In thousands)

|                   |                     |                                                               |                   |       |           |        |      |   |                |        |  |   |             |        | 
|------------------ | ------------------- | ------------------------------------------------------------- | ----------------- | ----- | --------- | ------ | ---- | - | -------------- | ------ |  | - | ----------- | ------ | 
|                   |                     |                                                               |                   |       |           |        |      |   |                |        |  |   | Amount at  
|                   |                     |                                                               |                   |       |           |        |      |   |                |        |  |   | which shown
|                   |                     |                                                               |                   |       | Amortized |        | Fair |   | in the balance
|Type of investment |                     | Cost                                                          |                   | Value |           | sheet 
|                   |                     |                                                               |                   |       |           |       
|Fixed maturities:  |                     |                                                               |                   |       |           |        |      |   |                |        |  |  
|                   | Available-for-sale: |                                                               |                   |       |           |        |      |   |                |        |  |   |            
|                   |                     | Corporate securities                                          |                   | $     |          |        |      | $ |               |        |  | $ |            |       
|                   |                     | Mortgage backed securities                                    |                   |       | 31,522    |        |      |   | 32,372         |        |  |   | 32,372      |       
|                   |                     | Asset backed securities                                       |                   |       | 1,009     |        |      |   | 1,015          |        |  |   | 1,015       |       
|                   |                     | United States government, government agencies and authorities |                   |       | 45,463    |        |      |   | 48,023         |        |  |   | 48,023      |       
|                   |                     |                                                               |                   |       |           |        |      |   |                |        |  |  
|                   |                     |                                                               | Total Investments |       | $         | 77,994 |      |   | $              | 81,410 |  |   | $           | 81,410 | 
|                   |                     |                                                               |                   |       |           |        |      |   |                |        |  |  

S-3



---



##### Table of Contents



SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Balance Sheets
December 31, 2002 and 2001
(In thousands)

|                                         |                                      |        |        |       |  |      |        |       |  | 
|---------------------------------------- | ------------------------------------ | ------ | ------ | ----- |  | ---- | ------ | ----- |  | 
|                                         |                                      |        |        | 2002  |  | 2001
|                                         |                                      |        |        |       |  |     
|                                         |                                      | ASSETS |        |       |  |      |        |       |  | 
|Cash and cash equivalents                |                                      | $      | 321    |       |  | $    | 82     |      
|Furniture and equipment, net             |                                      |        | 1,619  |       |  |      | 1,824  |      
|Investment in and advances to subsidiary |                                      |        | 31,516 |       |  |      | 19,867 |      
|Deferred income tax asset                |                                      |        |       |       |  |      | 351    |      
|Other assets                             |                                      |        | 441    |       |  |      | 753    |      
|                                         |                                      |        |        |       |  |      |        |      
|                                         |                                      | $      | 33,897 |       |  | $    | 22,877 |      
|                                         |                                      |        |        |       |  |      |        |      
|                                         | LIABILITIES AND SHAREHOLDERS EQUITY |        |        |       |  |      |        |       | 
|Accrued expenses and other liabilities   |                                      | $      | 2,837  |       |  | $    | 4,155  |      
|Notes payable                            |                                      |        | 1,250  |       |  |      | 4,500  |      
|                                         |                                      |        |        |       |  |      |        |      
|                                         | Total liabilities                    |        |        | 4,087 |  |      |        | 8,655 | 
|Shareholders equity                     |                                      |        | 29,810 |       |  |      | 14,222 |      
|                                         |                                      |        |        |       |  |      |        |      
|                                         |                                      | $      | 33,897 |       |  | $    | 22,877 |      
|                                         |                                      |        |        |       |  |      |        |      

See notes to condensed financial statements.

S-4



---



##### Table of Contents



SCHEDULE II

RTW, INC.

Condensed Financial Information of the Registrant
Statements of Operations
Years Ended December 31, 2002, 2001 and 2000
(In thousands)

|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |        |        | 
|----------------------------------------------------------------------------- | ----------------------------------- | ---------------------- | ------ | ------ | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                              |                                     |                        |        | 2002   |        | 2001 |         | 2000  
|                                                                              |                                     |                        |        |        |        |      |         |       
|Revenues:                                                                     |                                     |                        |        |        |        |      |         |        |        |   |         |       
|                                                                              | Intercompany fee income             |                        | $      | 20,020 |        |      | $       | 28,419 |        |   | $       | 27,929 |       
|                                                                              | Service fee revenue                 |                        |        | 22     |        |      |         |       |        |   |         |       |       
|                                                                              | Investment income                   |                        |        | 19     |        |      |         | 15     |        |   |         | 24     |       
|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |       
|                                                                              |                                     | Total revenues         |        |        | 20,061 |      |         |        | 28,434 |   |         |        | 27,953 | 
|Expenses:                                                                     |                                     |                        |        |        |        |      |         |        |        |   |         |       
|                                                                              | General and administrative expenses |                        |        | 16,907 |        |      |         | 25,424 |        |   |         | 24,180 |       
|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |       
|                                                                              |                                     | Income from operations |        |        | 3,154  |      |         |        | 3,010  |   |         |        | 3,773  | 
|Interest expense                                                              |                                     |                        | 163    |        |        |      | 511     |        |        |   | 667     |       
|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |       
|Income before income taxes and equity in
undistributed net loss of subsidiary |                                     |                        | 2,991  |        |        |      | 2,499   |        |        |   | 3,106   |       
|                                                                              | Income tax expense                  |                        |        | 1,213  |        |      |         | 928    |        |   |         | 1,367  |       
|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |       
|Income loss before equity in undistributed net income
(loss) of subsidiary    |                                     |                        | 1,778  |        |        |      | 1,571   |        |        |   | 1,739   |       
|Equity in undistributed net income (loss) of subsidiary                       |                                     |                        | 12,541 |        |        |      | (26,786 | )      |        |   | (11,447 | )     
|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |       
|Net income (loss)                                                             |                                     | $                      | 14,319 |        |        | $    | (25,215 | )      |        | $ | (9,708  | )     
|                                                                              |                                     |                        |        |        |        |      |         |        |        |   |         |       

See notes to condensed financial statements.

S-5



---



##### Table of Contents



SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Statements of Cash Flows
Years Ended December 31, 2002, 2001 and 2000
(In thousands)

|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |         |        |        |        |  
|---------------------------------------------------- | --------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ------------------------------------------- | --------------------------------------------------- | ------ | ------- | ------ | ------ | ------- | ------ | ------ | ------- | ------ | ------ | ------ | -
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        | 2002    |        | 2001   |         | 2000  
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |       
|CASH FLOWS FROM OPERATING ACTIVITIES:                |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     | Reconciliation of net income (loss) to net cash provided by operating
activities: |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |         |       
|                                                     |                                                                                   | Net income (loss)                                                                        |                                             | $                                                   | 14,319 |         |        | $      | (25,215 | )      |        | $       | (9,708 | )     
|                                                     |                                                                                   | Adjustments to reconcile net income (loss) to net
cash provided by operating activities: |                                             |                                                     |        |         |        |        |         |        |        |         |        |       
|                                                     |                                                                                   |                                                                                          | Depreciation and amortization               |                                                     |        | 605     |        |        |         | 1,203  |        |         |        | 1,295  |       
|                                                     |                                                                                   |                                                                                          | Equity in net (income) loss from subsidiary |                                                     |        | (12,541 | )      |        |         | 26,786 |        |         |        | 11,447 |       
|                                                     |                                                                                   |                                                                                          | Deferred income taxes                       |                                                     |        | 351     |        |        |         | (629   | )      |         |        | (52    | )     
|                                                     |                                                                                   |                                                                                          | Changes in assets and liabilities:          |                                                     |        |         |        |        |         |        |        |         |        |        |       
|                                                     |                                                                                   |                                                                                          |                                             | Accrued expenses and other liabilities              |        |         | (1,318 | )      |         |        | 1,043  |         |        |        | 1,483  |  
|                                                     |                                                                                   |                                                                                          |                                             | Other, net                                          |        |         | 1,610  |        |         |        | 346    |         |        |        | 2,892  |  
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     |                                                                                   |                                                                                          |                                             | Net cash provided by operating activities           |        |         | 3,026  |        |         |        | 3,534  |         |        |        | 7,357  |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     | Investment in and advances to subsidiary                                          |                                                                                          |                                             | 892                                                 |        |         |        | (1,896 | )       |        |        | (2,924  | )     
|                                                     | Purchases of furniture and equipment                                              |                                                                                          |                                             | (630                                                | )      |         |        | (379   | )       |        |        | (1,015  | )     
|                                                     | Disposals of furniture and equipment                                              |                                                                                          |                                             | 270                                                 |        |         |        | 972    |         |        |        | 51      |       
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     |                                                                                   |                                                                                          |                                             | Net cash provided by (used in) investing activities |        |         | 532    |        |         |        | (1,303 | )       |        |        | (3,888 | )
|CASH FLOWS FROM FINANCING ACTIVITIES:                |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     | Proceeds from notes payable                                                       |                                                                                          |                                             |                                                    |        |         |        |       |         |        |        | 8,000   |       
|                                                     | Payments on notes payable                                                         |                                                                                          |                                             | (3,250                                              | )      |         |        | (2,500 | )       |        |        | (1,000  | )     
|                                                     | Issuance of common stock under ESPP                                               |                                                                                          |                                             | 10                                                  |        |         |        | 33     |         |        |        | 125     |       
|                                                     | Retirement of common stock                                                        |                                                                                          |                                             | (79                                                 | )      |         |        | (10    | )       |        |        | (10,268 | )     
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     |                                                                                   |                                                                                          |                                             | Net cash used in financing activities               |        |         | (3,319 | )      |         |        | (2,477 | )       |        |        | (3,143 | )
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |                                                                                   |                                                                                          | 239                                         |                                                     |        |         | (246   | )      |         |        | 326    |        
|CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR       |                                                                                   |                                                                                          | 82                                          |                                                     |        |         | 328    |        |         |        | 2      |        
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|CASH AND CASH EQUIVALENTS AT END OF YEAR             |                                                                                   | $                                                                                        | 321                                         |                                                     |        | $       | 82     |        |         | $      | 328    |        
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:    |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     | Cash paid during the year for:                                                    |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |         |       
|                                                     |                                                                                   | Interest                                                                                 |                                             | $                                                   | 138    |         |        | $      | 641     |        |        | $       | 458    |       
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        
|                                                     |                                                                                   | Income tax payments                                                                      |                                             | $                                                   | 298    |         |        | $      | 325     |        |        | $       | 73     |       
|                                                     |                                                                                   |                                                                                          |                                             |                                                     |        |         |        |        |         |        |        |        

See notes to condensed financial statements.

S-6



---



##### Table of Contents



SCHEDULE II

RTW, INC.
Condensed Financial Information of the Registrant
Notes to Condensed Financial Statements
Years Ended December 31, 2002, 2001 and 2000

NOTE 1  ACCOUNTING POLICIES

The accompanying condensed financial information should be read in conjunction
with the consolidated financial statements and notes included in the RTW, Inc.
(RTW) 2002 Annual Report.

NOTE 2  RECLASSIFICATIONS

Certain amounts in the 2001 Financial Statements have been reclassified to
conform with the financial presentation in 2002.

NOTE 3  RELATED PARTY TRANSACTIONS

RTW provides American Compensation Insurance Company (ACIC) with management
services, including preparing and submitting filings, maintaining books and
records, collecting premiums, administering and adjudicating claims, and
performing other administrative services. RTW receives 10% of ACICs gross
premiums earned each month for these services, which amounted to $6.4 million,
$9.9 million and $9.7 million for the years ended December 31, 2002, 2001 and
2000, respectively. In addition, RTW receives 15% of ACICs gross premiums
earned for claims administration during the year in which the premiums are
earned and a total of 4% of gross premiums earned in subsequent years which
amounted to $13.6 million, $18.6 million and $18.1 million for the years ended
December 31, 2002, 2001 and 2000, respectively.

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

Amounts due from (to) ACIC related to the above transactions are included in
the balance sheet account caption Investment in and advances to subsidiary
and totaled approximately $3.0 million and $3.8 million at December 31, 2002
and 2001, respectively.

S-7



---



##### Table of Contents



SCHEDULE III

RTW, INC.
SUPPLEMENTAL INFORMATION CONCERNING INSURANCE OPERATIONS
(In thousands)

|     |  |             |       |              |  |              |         |          |  |          |     |            |  |         |       |              |  |                      |        |             |  |                     |       |                 |  |   |        |  |  |   |        |   |  |   |        |  |  |   |        |  |  |   |        |  |  |   |        | 
|---- |  | ----------- | ----- | ------------ |  | ------------ | ------- | -------- |  | -------- | --- | ---------- |  | ------- | ----- | ------------ |  | -------------------- | ------ | ----------- |  | ------------------- | ----- | --------------- |  | - | ------ |  |  | - | ------ | - |  | - | ------ |  |  | - | ------ |  |  | - | ------ |  |  | - | ------ | 
|     |  |             |       |              |  | (Column C)   |         |          |  |          |     |            |  |         |       |              |  |                      |        |             |  |                     |       | Claim and claim |  |   |        |  |  |   |        |   |  |   |        |  |  |   |        | 
|     |  |             |       |              |  | Reserves for |         |          |  |          |     |            |  |         |       |              |  |                      |        | Investment  |  | settlement expenses |       | Amortization    |  |   |        |  |  |   |        |   |  |   |        | 
|     |  | Deferred    |       | unpaid claim |  | Discount,    |         |          |  |          |     |            |  |         |       | income and   |  | incurred related to: |        | of deferred |  | Paid claim          |       |                 |  |   |        |  |  |  
|     |  | policy      |       | and claim    |  | if any,      |         |          |  |          |     |            |  |         |       | net realized |  |                      |        | policy      |  | and claim           |       | Other           |  |   |        | 
|     |  | acquisition |       | settlement   |  | deducted in  |         | Unearned |  | Earned   |     | investment |  | Current |       | Prior        |  | acquisition          |        | settlement  |  | operating           |       | Premiums        | 
|Year |  | costs       |       | expenses     |  | column C     |         | premiums |  | premiums |     | gains      |  | year    |       | years        |  | costs                |        | expenses    |  | expenses            |       | written         | 
|     |  |             |       |              |  |              |         |          |  |          |     |            |  |         |       |              |  |                      |        |             |  |                     |       |                
|2002 |  | $           | 736   |              |  | $            | 181,262 |          |  | $        | 438 |            |  | $       | 7,130 |              |  | $                    | 60,264 |             |  | $                   | 6,816 |                 |  | $ | 48,889 |  |  | $ | (8,356 | ) |  | $ | 6,304  |  |  | $ | 42,688 |  |  | $ | 9,984  |  |  | $ | 57,656 | 
|2001 |  | $           | 1,214 |              |  | $            | 181,310 |          |  | $        | 482 |            |  | $       | 9,738 |              |  | $                    | 86,057 |             |  | $                   | 7,563 |                 |  | $ | 72,372 |  |  | $ | 7,731  |   |  | $ | 13,990 |  |  | $ | 56,304 |  |  | $ | 17,391 |  |  | $ | 83,340 | 
|2000 |  |             |       |              |  |              |         |          |  |          |     |            |  |         |       |              |  | $                    | 78,154 |             |  | $                   | 5,077 |                 |  | $ | 56,500 |  |  | $ | 15,929 |   |  | $ | 14,137 |  |  | $ | 64,485 |  |  | $ | 11,513 |  |  | $ | 77,842 | 

S-8



---



##### Table of Contents



SCHEDULE IV

RTW, INC.
REINSURANCE
Years ended December 31, 2002, 2001 and 2000
(In thousands)

|            |                                  |        |                 |           |            |           |          |        |            |        |   |   |  |  |           |        |  |  |  |      |  
|----------- | -------------------------------- | ------ | --------------- | --------- | ---------- | --------- | -------- | ------ | ---------- | ------ | - | - |  |  | --------- | ------ |  |  |  | ---- | -
|            |                                  |        | Premiums earned |           |            |           |         
|            |                                  |        |                 |           | Percentage
|            |                                  |        |                 |           |            |           | Ceded to |        | Assumed    |        |   |   |  |  | of amount
|            |                                  |        |                 |           |            |           | other    |        | from other |        |   |   |  |  | assumed  
|Description |                                  | Direct |                 | companies |            | companies |          | Net    |            | to net
|            |                                  |        |                 |           |            |           |          |        |            |       
|2002        |                                  |        |                 |           |            |           |          |        |            |        |   |   |  |  |           |        |  |  |  |     
|            | PREMIUMS  Workers Compensation |        | $               | 62,506    |            |           | $        | 2,242  |            |        | $ |  |  |  | $         | 60,264 |  |  |  | 0.00 | %
|2001        |                                  |        |                 |           |            |           |          |        |            |        |   |   |  |  |           |        |  |  |  |     
|            | PREMIUMS  Workers Compensation |        | $               | 97,420    |            |           | $        | 11,363 |            |        | $ |  |  |  | $         | 86,057 |  |  |  | 0.00 | %
|2000        |                                  |        |                 |           |            |           |          |        |            |        |   |   |  |  |           |        |  |  |  |     
|            | PREMIUMS  Workers Compensation |        | $               | 95,878    |            |           | $        | 17,724 |            |        | $ |  |  |  | $         | 78,154 |  |  |  | 0.00 | %

S-9



---



##### Table of Contents



SCHEDULE V

RTW, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 2002, 2001 and 2000
(In thousands)

|            |                                 |           |            |          |            |          |            |            |  |           |   |   |            |  |   |     |  |  |   |     | 
|----------- | ------------------------------- | --------- | ---------- | -------- | ---------- | -------- | ---------- | ---------- |  | --------- | - | - | ---------- |  | - | --- |  |  | - | --- | 
|            |                                 |           |            |          |            |          | Additions  |            |  |           |   |   |            |  |  
|            |                                 |           |            |          |            |          |            |            |  |           |   |   |            |  |  
|            |                                 |           | Balance at |          | Charged to |          | Charged to |            |  |           |   |   | Balance at
|            |                                 |           | beginning  |          | costs and  |          | other      |            |  |           |   |   | end       
|Description |                                 | of period |            | expenses |            | accounts |            | Write-offs |  | of period
|            |                                 |           |            |          |            |          |            |            |  |          
|2002        |                                 |           |            |          |            |          |            |            |  |           |   |   |            |  |   |     |  |  |   |    
|            | Allowance for Doubtful Accounts |           | $          | 436      |            |          | $          | 98         |  |           | $ |  |            |  | $ | 314 |  |  | $ | 220 | 
|2001        |                                 |           |            |          |            |          |            |            |  |           |   |   |            |  |   |     |  |  |   |    
|            | Allowance for Doubtful Accounts |           | $          | 569      |            |          | $          | 530        |  |           | $ |  |            |  | $ | 663 |  |  | $ | 436 | 
|2000        |                                 |           |            |          |            |          |            |            |  |           |   |   |            |  |   |     |  |  |   |    
|            | Allowance for Doubtful Accounts |           | $          | 519      |            |          | $          | 599        |  |           | $ |  |            |  | $ | 549 |  |  | $ | 569 | 

S-10