##### 



Exhibit 13 (THE MIDLAND COMPANY IMAGE) THE MIDLAND COMPANY
2004 ANNUAL REPORT MomentumSoaring to New Heights




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Company Profile The Midland Company is a highly focused provider of specialty insurance products and
services through its American Modern Insurance Group subsidiary, which contributes approximately 95
percent of the companys revenues. The company also maintains an investment in a niche river
transportation business, M/G Transport Services Inc. (M/G). American Modern is a leader in manufactured housing insurance products and services, and has
expanded with additional offerings to serve the motorcycle, watercraft, recreational vehicle,
collectible automobile and snowmobile markets. American Modern distributes its products and
services through diverse channels. The people, the products and the vision of The Midland Company focus on leveraging the
competitive advantage of specialty expertise. The company has a solid track record of fundamental strength and fundamental value. It
delivers this strength and value through its multiple company structure, its unique specialty
products, its expert claims service, and its deep relationships across diverse distribution
channels. The company also has a consistent record of increasing shareholder value. Midland stock has
outperformed all relevant indices over the past 5-, 10-, 15- and 20-year periods, and has steadily
increased book value over the same periods. Annual shareholder dividends have increased for 19
consecutive years. Headquartered in Cincinnati, Ohio, the Company has 1,139 associates, is licensed in all 50
states and enjoys an A+ (Superior) rating from A.M. Best. Total Return to Shareholders (BAR CHART) The Midland Companys Mission Statement To be an indispensable partner
to customers within chosen markets
by providing value-adding specialty
products and services delivered by
the best professionals in the
industry. TABLE OF CONTENTS  Financial Highlights
    
    
    1Letter to Shareholders
    
    
    2-5The Responsibility of Leadership
    
    
    6-7Driving Our Channels of Distribution
    
    
    8Building Momentum with ModernLINK
    
    
    9Property & Casualty, Financial Services
    
    
    10-11Customer & Claims Services
    
    
    12-13Revitalizing Customer Retention
    
    
    14Community Services
    
    
    15Investment Results
    
    
    16M/G Transport
    
    
    17Six Year Financial Summary Data
    
    
    18-19Private Securities Reform Act of 1995
Forward Looking Statements Disclosure
    
    
    20Managements Discussion and Analysis
    
    
    20-31Consolidated Statements of Income
    
    
    32Consolidated Balance Sheets
    
    
    33Consolidated Statements of Changes in
Shareholders Equity
    
    
    34Consolidated Statements of Cash Flows
    
    
    35Notes to Consolidated Financial Statements
    
    
    36-47Reports of Independent Registered Public Accounting Firm
    
    
    48-49Managements Assessment as to the Effectiveness
of Internal Control Over Financial Reporting
    
    
    48Quarterly Data and Other Information
    
    
    50Officers and Directors
    
    
    51
 Please refer to Forward Looking Statements
on page 20.




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SIX YEAR FINANCIAL SUMMARY DATA THE MIDLAND COMPANY AND SUBSIDIARIES For the Years Ended December 31,(Amounts in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    1999Income Statement DataRevenues:Insurance:Premiums earned
    
    $
    677,584
    
    
    $
    638,038
    
    
    $
    577,668
    
    
    $
    508,233
    
    
    $
    456,120
    
    
    $
    400,991Net
investment income (d)
    
    
    37,165
    
    
    
    33,279
    
    
    
    35,899
    
    
    
    34,198
    
    
    
    31,139
    
    
    
    25,524Net realized
investment gains (losses)(a)
    
    
    9,933
    
    
    
    4,566
    
    
    
    (6,900
    )
    
    
    2,023
    
    
    
    4,646
    
    
    
    3,486Other
insurance income(d)
    
    
    13,780
    
    
    
    14,064
    
    
    
    13,756
    
    
    
    12,971
    
    
    
    13,877
    
    
    
    11,210Transportation
    
    
    45,379
    
    
    
    28,240
    
    
    
    23,285
    
    
    
    34,826
    
    
    
    33,119
    
    
    
    31,327Total
    
    
    783,841
    
    
    
    718,187
    
    
    
    643,708
    
    
    
    592,251
    
    
    
    538,901
    
    
    
    472,538Costs and Expenses:Insurance:Losses and loss adjustment expenses
    
    
    348,611
    
    
    
    392,232
    
    
    
    341,015
    
    
    
    292,188
    
    
    
    240,680
    
    
    
    204,365Commissions and other policy
acquisition costs
    
    
    201,155
    
    
    
    177,622
    
    
    
    169,477
    
    
    
    145,777
    
    
    
    137,053
    
    
    
    114,212Operating
and administrative expenses(d)
    
    
    108,536
    
    
    
    87,714
    
    
    
    80,985
    
    
    
    80,316
    
    
    
    77,539
    
    
    
    76,926Transportation operating expenses
    
    
    43,266
    
    
    
    26,645
    
    
    
    22,641
    
    
    
    32,898
    
    
    
    28,828
    
    
    
    29,255Interest expense
    
    
    5,169
    
    
    
    3,742
    
    
    
    3,849
    
    
    
    4,368
    
    
    
    4,132
    
    
    
    4,067Total
    
    
    706,737
    
    
    
    687,955
    
    
    
    617,967
    
    
    
    555,547
    
    
    
    488,232
    
    
    
    428,825Income Before Federal Income Tax and
Cumulative Effect of Change in
Accounting Principle
    
    
    77,104
    
    
    
    30,232
    
    
    
    25,741
    
    
    
    36,704
    
    
    
    50,669
    
    
    
    43,713Provision for Federal Income Tax
    
    
    22,866
    
    
    
    6,956
    
    
    
    5,437
    
    
    
    9,482
    
    
    
    15,206
    
    
    
    12,534Income Before Cumulative Effect of Change
in Accounting Principle
    
    
    54,238
    
    
    
    23,276
    
    
    
    20,304
    
    
    
    27,222
    
    
    
    35,463
    
    
    
    31,179Cumulative Effect of Change
in Accounting Principle Net(c)
    
    
    
    
    
    
    
    
    
    
    (1,463
    )
    
    
    
    
    
    
    
    
    
    
    Net Income
    
    $
    54,238
    
    
    $
    23,276
    
    
    $
    18,841
    
    
    $
    27,222
    
    
    $
    35,463
    
    
    $
    31,179Basic Earnings (Losses) Per Share
of Common Stock(b) :Income Before Cumulative Effect of Change
in Accounting Principle
    
    $
    2.91
    
    
    $
    1.34
    
    
    $
    1.17
    
    
    $
    1.58
    
    
    $
    1.96
    
    
    $
    1.71Cumulative Effect of Change
in Accounting Principle(c)
    
    
    
    
    
    
    
    
    
    
    (0.08
    )
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    2.91
    
    
    $
    1.34
    
    
    $
    1.09
    
    
    $
    1.58
    
    
    $
    1.96
    
    
    $
    1.71Diluted Earnings (Losses) Per Share
of Common Stock(b) :Income Before Cumulative Effect of Change
in Accounting Principle
    
    $
    2.83
    
    
    $
    1.30
    
    
    $
    1.14
    
    
    $
    1.51
    
    
    $
    1.89
    
    
    $
    1.65Cumulative Effect of Change
in Accounting Principle(c)
    
    
    
    
    
    
    
    
    
    
    (0.08
    )
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    2.83
    
    
    $
    1.30
    
    
    $
    1.06
    
    
    $
    1.51
    
    
    $
    1.89
    
    
    $
    1.65Cash
Dividends Per Share of Common Stock(b)
    
    $
    .205
    
    
    $
    .190
    
    
    $
    .175
    
    
    $
    .160
    
    
    $
    .150
    
    
    $
    .135
 18THE MIDLAND COMPANY




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THE MIDLAND COMPANY AND SUBSIDIARIES For the Years Ended December 31,(Amounts in thousands, except per share data)
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000
    
    
    1999Balance Sheet DataTotal Cash and Marketable Securities
    
    $
    978,296
    
    
    $
    848,708
    
    
    $
    745,733
    
    
    $
    715,295
    
    
    $
    701,048
    
    
    $
    620,957Total Assets(d)
    
    
    1,364,684
    
    
    
    1,192,216
    
    
    
    1,101,136
    
    
    
    1,060,212
    
    
    
    998,987
    
    
    
    892,981Total Debt
    
    
    115,906
    
    
    
    95,842
    
    
    
    90,401
    
    
    
    84,141
    
    
    
    85,045
    
    
    
    69,838Unearned Insurance Premiums
    
    
    390,447
    
    
    
    383,869
    
    
    
    406,311
    
    
    
    403,855
    
    
    
    357,185
    
    
    
    312,838Loss Reserves
    
    
    232,915
    
    
    
    204,833
    
    
    
    164,717
    
    
    
    148,674
    
    
    
    135,887
    
    
    
    133,713Shareholders Equity
    
    
    432,276
    
    
    
    356,058
    
    
    
    308,908
    
    
    
    291,876
    
    
    
    283,177
    
    
    
    258,002Book Value Per Share(b)
    
    $
    22.98
    
    
    $
    20.18
    
    
    $
    17.59
    
    
    $
    16.53
    
    
    $
    15.73
    
    
    $
    13.56Common Shares Outstanding(b)
    
    
    18,807
    
    
    
    17,643
    
    
    
    17,566
    
    
    
    17,660
    
    
    
    18,001
    
    
    
    19,032Other DataAMIGs Property and Casualty OperationsDirect and Assumed Written Premiums
    
    $
    722,394
    
    
    $
    663,972
    
    
    $
    588,243
    
    
    $
    555,548
    
    
    $
    500,984
    
    
    $
    472,041Net Written Premium
    
    
    671,985
    
    
    
    616,709
    
    
    
    561,515
    
    
    
    523,105
    
    
    
    471,336
    
    
    
    439,863Loss and Loss Adjustment Expense Ratio (GAAP)
    
    
    51.7
    %
    
    
    62.0
    %
    
    
    59.3
    %
    
    
    57.8
    %
    
    
    52.9
    %
    
    
    51.2
    %Underwriting Expense Ratio (GAAP)
    
    
    44.7
    %
    
    
    41.1
    %
    
    
    42.6
    %
    
    
    43.1
    %
    
    
    44.3
    %
    
    
    44.0
    %Combined Ratio (GAAP)
    
    
    96.4
    %
    
    
    103.1
    %
    
    
    101.9
    %
    
    
    100.9
    %
    
    
    97.2
    %
    
    
    95.2
    %M/G Transports Transportation OperationsNet Revenues
    
    $
    45,379
    
    
    $
    28,240
    
    
    $
    23,285
    
    
    $
    34,826
    
    
    $
    33,119
    
    
    $
    31,327Net Income
    
    
    1,090
    
    
    
    815
    
    
    
    296
    
    
    
    1,079
    
    
    
    1,809
    
    
    
    1,169Total Assets
    
    
    38,869
    
    
    
    30,990
    
    
    
    22,469
    
    
    
    24,952
    
    
    
    27,412
    
    
    
    30,564Shareholders Equity
    
    
    12,261
    
    
    
    11,446
    
    
    
    10,805
    
    
    
    10,509
    
    
    
    9,728
    
    
    
    10,919
   Footnotes:(a)
    
    Net Realized Investment Gains (Losses) in 2004, 2003, 2002 and 2001 include the effect
of SFAS 133 adjustments of $0.8 million, $0.8 million, $(0.2) million and $1.1 million,
respectively.(b)
    
    Previously reported share information has been adjusted to reflect a 2-for-1 stock
split effective July 17, 2002.(c)
    
    On January 1, 2002, the Company adopted SFAS 142 and recorded an impairment charge
related to goodwill of $1.5 million, net of tax of $0.8 million.(d)
    
    Certain prior year amounts have been reclassified to conform with current year
presentation. THE MIDLAND COMPANY 19




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MANAGEMENTS DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE MIDLAND COMPANY AND SUBSIDIARIESForward Looking Statements Certain statements made in this report are
forward-looking and are made pursuant to the safe
harbor provisions of the Securities Litigation Reform
Act of 1995. These statements include, but are not
limited to, certain discussions
relating to future revenue, underwriting income,
premium volume, investment income and other investment
results, business strategies, profitability, liquidity,
capital adequacy, anticipated capital expenditures and
business relationships, as well as any other statements
concerning the year 2005 and beyond. In some cases you
can identify forward-looking statements by such terms
as may, will, could, would, expect, plan,
intend, anticipate, believe, estimate,
project, predict, potential and similar
expressions or the negative versions of such
expressions. The forward-looking statements involve
risks and uncertainties that may cause results to
differ materially from those anticipated in those
statements. Factors that might cause results to differ
from those anticipated include, without limitation,
adverse weather conditions, changes in underwriting
results affected by adverse economic conditions,
fluctuations in the investment markets, changes in the
retail marketplace, changes in the laws or regulations
affecting the operations of the Company or its
subsidiaries, changes in the business tactics or
strategies of the Company, its subsidiaries or its
current or anticipated business partners, the financial
condition of the Companys business partners,
acquisitions or divestitures, changes in market forces,
litigation and the other risk factors that have been
identified in the Companys filings with the SEC, any
one of which might materially affect the operations of
the Company or its subsidiaries. Any forward-looking
statements speak only as of the date made. We undertake
no obligation to update any forward-looking statements
to reflect events or circumstances arising after the
date on which they are made. Introduction Prior to the 2004 annual report, the Company
discussed its operations through three reportable
segments: manufactured housing insurance, all other
insurance products and services and transportation.
However, as the Company has continued to grow its
non-manufactured housing insurance products,
managements analysis of its insurance business has
evolved in order to facilitate a more focused
examination of its varying insurance products. As a
result, the Company has divided its insurance products
into four distinct groups: personal lines property,
personal lines casualty, financial services, and all
other insurance products. The discussions of Results
of Operations and Liquidity, Capital Resources and
Changes in Financial Condition address these four
reportable insurance segments and our transportation
business. A summary description of the operations of
each of these segments is included below. Our personal lines property segment includes
primarily manufactured housing and site-built dwelling
insurance products. Approximately 44% of American
Moderns property and casualty and credit life gross
written premium relates to physical damage insurance
and related coverages on manufactured homes, generally
written for a term of 12 months with many coverages
similar to homeowners insurance policies. Our personal
lines casualty segment includes specialty insurance
products such as motorcycle, watercraft, recreational
vehicle, collector car and snowmobile. Our financial
services segment includes specialty insurance products
such as mortgage fire, collateral protection
and debt cancellation, which are sold to financial
service institutions or their customers. The all other
insurance segment includes products such as credit
life, long-haul truck physical damage, commercial,
excess and surplus lines and also includes the results
of our fee producing subsidiaries. Our specialty insurance operations are conducted
through our wholly-owned subsidiary, American Modern
Insurance Group, Inc. (American Modern) which controls
six property and casualty insurance companies, two
credit life insurance companies, three licensed
insurance agencies and three service companies. American
Modern is licensed, through its subsidiaries, to write
insurance premiums in all 50 states and the District of
Columbia. M/G Transport Services, Inc. and MGT Services,
Inc. (collectively M/G Transport) operates a fleet of
dry cargo barges for the movement of dry bulk
commodities such as petroleum coke, ores, barite, sugar
and other dry cargoes primarily on the lower
Mississippi River and its tributaries and manages river
transportation equipment owned by others on a fee based
arrangement. Overview of Recent Trends Motorcycle The combined ratio for the motorcycle product
improved to 102.3% in 2004 compared to 131.7% in 2003.
This was due primarily to rate increases and other
corrective underwriting actions. Rate increases
averaging 19% and 21% were approved by various states
insurance departments in 2004 and 2003, respectively.
These rate increases resulted in a 18.3% increase in
motorcycles net earned premium in 2004 and we expect
to experience a 14% increase in net earned premium
related to rate increases during 2005. In addition, we
have added expertise to our staff and have refined our
product offering to better match the needs of our
target market. As we expected, due to the underwriting
and rate actions, gross written premium decreased 16.5%
to $48.6 million in 2004 compared to $58.2 million in
2003. We believe that the motorcycle product is now
positioned to be profitable in the years ahead and
enhances our total product package offered to agents. Site-Built Dwelling Over the past several years, American Modern deemphasized its standard homeowner programs in
favor of its dwelling fire programs which have more restrictive coverages. American Modern
undertook a careful review of all of its site-built dwelling programs with the intent of targeting
those properties that fell outside the parameters of the standard homeowners insurance market. As
a result of these actions, American Modern is achieving positive growth from its dwelling fire
programs while experiencing the intended decrease in more standard homeowner programs. More
specifically, dwelling fire gross written premium increased 11.6% to $88.2 million in 2004 from
$79.0 million in 2003. Conversely, homeowner gross written premium decreased 94.6% to $0.2 million
in 2004 from $3.5 million in the prior year. The changes mentioned above, combined with the rate
increases achieved in recent years, have resulted in a combined ratio of 93.2% in 2004 as compared
to 108.1% in 2003. Rate increases averaging 10.0% and 8.4% were approved in 2004 and 2003,
respectively. These actions resulted in an 8.7% increase in net earned premium in 2004 and we
expect to experience a 9.7% increase in earned premium related to rate increases in 2005. 20 THE MIDLAND COMPANY




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THE MIDLAND COMPANY AND SUBSIDIARIESManufactured Housing Although the manufactured housing industry
continues to be depressed, American Moderns gross
written premium related to this product increased 4.3%
to $334.1 million in 2004 from $320.2 million in 2003.
This increase was primarily the result of rate
increases combined with the conversion of
selected agents business from our competitors.
Rate increases averaging 4.5% and 5.5% were approved in
2004 and 2003, respectively. These actions resulted in
a 4.5% increase in net earned premium in 2004 and we
expect to experience a 3.6% increase in earned premium
related to rate increases in 2005. The manufactured
housing combined ratio remained constant at 94.9% in
2004 and 2003. Growth of Other Products Gross written premiums related to American
Moderns other property and casualty specialty
insurance products (excluding manufactured housing,
site-built dwelling and motorcycle) increased
collectively by 23.7% to $251.3 million in 2004
compared to $203.2 million in the prior year. The
mortgage fire, collateral protection and the excess and
surplus lines products are primarily driving this
growth. Commercial Liability Run-off In September 2001, American Modern exited the
manufactured housing park and dealer commercial
liability business. We have no outstanding unearned
premium related to this business. During 2003, we
experienced higher than expected losses related to this
line. Due to the adverse development, American Modern
strengthened reserves in the latter part of 2003 to
address the future run-off claims. In 2004, American
Modern has experienced favorable development in the
claims settled for the year and believes that the loss
exposure is adequately reserved for the remainder of
the run-off period. Other Developments In October 2004, the New York State Attorney
General brought suit against Marsh & McLennan
Companies, Inc., alleging among other things, that the
firm had manipulated the insurance market through
specified conduct. The New York State Attorney General
also stated that the evidence implicates certain
insurance companies. We are not party to any of the
litigation and have not received any subpoena or
information requests from the New York State Attorney
General. At this time we have no reason to believe that
our operations involve conduct that is the subject of
the complaint. In response to the New York State action, many
Departments of Insurance and some Attorneys General
have requested information from insurance companies and
brokers, both general and targeted to specific
entities. We have received general requests for
information from the North Carolina and Oklahoma
Departments of Insurance and anticipate receiving
additional general requests. Once the Departments of
Insurance receive the information requested, new
regulations may be created that could impact our
business, but the Attorneys General and the
Departments actions concern an evolving area of the
law and we can give no assurance regarding its
consequences for the industry or for our business. Overview of Property and Casualty
Underwriting Results For the year 2004, American Moderns property and
casualty combined ratio (losses and expenses as a
percent of earned premium) decreased to 96.4% compared
to 103.1% in the prior year. The decrease in the
combined ratio is due to the significant decreases in
losses related to the motorcycle and site-built
dwelling products combined with the
favorable development of claims related to our
discontinued commercial lines products. RESULTS OF OPERATIONSYEAR ENDED DECEMBER 31, 2004 COMPAREDTO YEAR ENDED DECEMBER 31, 2003 InsuranceOverview of Premium Volume The following chart shows American Moderns gross
written premium, net written premium and net earned
premium by business segment for the years ended
December 31, 2004 and 2003 (in millions): December 31, 2004Gross
    
    
    Net
    
    
    NetWritten
    
    
    Written
    
    
    EarnedBusiness Segment
    
    Premium
    
    
    Premium
    
    
    PremiumPersonal Lines Property
    
    $
    424.7
    
    
    $
    398.5
    
    
    $
    400.9Personal Lines Casualty
    
    
    111.3
    
    
    
    109.6
    
    
    
    119.2Financial Services
    
    
    101.5
    
    
    
    99.2
    
    
    
    86.8All Other Insurance
    
    
    117.0
    
    
    
    77.6
    
    
    
    70.7Total
    
    $
    754.5
    
    
    $
    684.9
    
    
    $
    677.6
 December 31, 2003Gross
    
    
    Net
    
    
    NetWritten
    
    
    Written
    
    
    EarnedBusiness Segment
    
    Premium
    
    
    Premium
    
    
    PremiumPersonal Lines Property
    
    $
    404.8
    
    
    $
    383.3
    
    
    $
    407.8Personal Lines Casualty
    
    
    125.6
    
    
    
    124.5
    
    
    
    117.6Financial Services
    
    
    65.9
    
    
    
    63.1
    
    
    
    54.7All Other Insurance
    
    
    83.8
    
    
    
    57.7
    
    
    
    57.9Total
    
    $
    680.1
    
    
    $
    628.6
    
    
    $
    638.0
 Personal Lines Property The following chart is an overview of the results
of operations of the companys personal lines property
segment (in 000s). December 31,2004
    
    
    2003
    
    
    ChangePersonal Lines PropertyDirect and AssumedWritten Premiums
    
    $
    424,656
    
    
    $
    404,811
    
    
    
    4.9
    %Net Written Premiums
    
    $
    398,525
    
    
    $
    383,255
    
    
    
    4.0
    %Net Earned Premium
    
    $
    400,929
    
    
    $
    407,816
    
    
    
    (1.7
    )%Service Fees
    
    
    5,615
    
    
    
    5,484
    
    
    
    2.4
    %Total Revenues
    
    $
    406,544
    
    
    $
    413,300
    
    
    
    (1.6
    )%Income Before Taxes
    
    $
    47,418
    
    
    $
    34,849
 THE MIDLAND COMPANY 21




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES The combined ratio for the personal lines
property segment was 94.3% in 2004 compared to 97.3% in
2003. The results from this segment are driven
primarily by the manufactured housing and site-built
dwelling products. Although the manufactured housing
industry continues to be depressed, American Moderns
gross written premium related to this product increased
4.3% to $334.1 million in 2004 from $320.2 million in
2003. This increase was primarily the result of rate
increases combined with the strategic conversion of
targeted books of business (where we obtain a book of
business or future renewals from an agent). Site-built
dwelling gross written premiums increased 7.2% to $88.4
million in 2004 compared to $82.5 million in 2003. The manufactured housing combined ratio, including
catastrophe losses, remained constant at 94.9% in 2004
and in 2003. However, excluding catastrophe losses for
both years, the combined ratio improved to 86.0% in
2004 from 88.0% in 2003. This improvement was due
primarily to rate increases combined with improved
underwriting. The site-built dwelling combined ratio
improved to 93.2% in 2004 compared to 108.1% in 2003.
The 2003 combined ratio was negatively impacted by the
run-off of the homeowner programs combined with higher
catastrophe losses related to the California brush
fires. Personal Lines Casualty The following chart is an overview of the results
of operations of the companys personal lines casualty
segment (in 000s). December 31,2004
    
    
    2003
    
    
    ChangePersonal Lines CasualtyDirect and AssumedWritten Premiums
    
    $
    111,325
    
    
    $
    125,629
    
    
    
    (11.4
    )%Net Written Premiums
    
    $
    109,565
    
    
    $
    124,501
    
    
    
    (12.0
    )%Net Earned Premium
    
    $
    119,151
    
    
    $
    117,568
    
    
    
    1.3
    %Service Fees
    
    
    2,281
    
    
    
    2,226
    
    
    
    2.5
    %Total Revenues
    
    $
    121,432
    
    
    $
    119,794
    
    
    
    1.4
    %Income (Loss) Before Taxes
    
    $
    4,987
    
    
    $
    (11,452
    )
 Gross written premiums for our casualty products
decreased due primarily to the planned decrease in
motorcycle premiums as American Modern took the
necessary corrective actions to position the motorcycle
product for profitability. Rate increases averaging 19%
and 21% were approved by various states insurance
departments in 2004 and 2003, respectively. In
addition, we have added expertise to our staff and have
refined our product offering to better match the needs
of our target market. As a result of these actions, the
combined ratio for the motorcycle product improved to
102.3% in 2004 compared to 131.7% in 2003. Financial Services The following chart is an overview of the results
of operations of the companys financial services
insurance segment (in 000s). December 31,2004
    
    
    2003
    
    
    ChangeFinancial ServicesDirect and AssumedWritten Premiums
    
    $
    101,510
    
    
    $
    65,929
    
    
    
    54.0
    %Net Written Premiums
    
    $
    99,230
    
    
    $
    63,112
    
    
    
    57.2
    %Net Earned Premium
    
    $
    86,803
    
    
    $
    54,742
    
    
    
    58.6
    %Total Revenues
    
    $
    86,803
    
    
    $
    54,742
    
    
    
    58.6
    %Income Before Taxes
    
    $
    6,991
    
    
    $
    6,797
 The increase in gross written premiums for our
financial services insurance products was driven by the
collateral protection and mortgage fire products which
increased $27.3 million and $6.6 million, respectively,
compared to the prior year. The collateral protection
product benefited from the assumption of a $17.6
million book of business during the second quarter of
2004. Profitability remained relatively flat in 2004
compared to 2003. All Other Insurance The following chart is an overview of the results
of operations of the companys other insurance segment
(in 000s). December 31,2004
    
    
    2003
    
    
    ChangeAll Other InsuranceDirect and AssumedWritten Premiums
    
    $
    117,005
    
    
    $
    83,721
    
    
    
    39.8
    %Net Written Premiums
    
    $
    77,584
    
    
    $
    57,779
    
    
    
    34.3
    %Net Earned Premium
    
    $
    70,710
    
    
    $
    57,918
    
    
    
    22.1
    %Agency Revenues
    
    
    5,562
    
    
    
    6,215
    
    
    
    (10.5
    )%Service Fees
    
    
    133
    
    
    
    159
    
    
    
    (16.4
    )%Total Revenues
    
    $
    76,405
    
    
    $
    64,292
    
    
    
    18.8
    %Income (Loss) Before Taxes
    
    $
    12,396
    
    
    $
    (3,501
    )
 American Moderns excess and surplus lines and
credit life products were the primary drivers of the
increase in gross written premiums in 2004 compared to
2003. A large percentage of credit life gross written
premium is ceded to an insurance affiliate of the
producing agent. The improvement in profitability in 2004 compared
to 2003 is due primarily to the actions taken to
address the run-off of our manufactured housing park
and dealer commercial liability business which we
exited in 2001. During 2003, the run-off of this
previously exited business reduced pre-tax income by
$12.1 million, or $0.44 per share (diluted). In 2004,
the runoff of these discontinued lines increased
pre-tax income by $2.9 million, or $0.10 per share
(diluted). 22 THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIESCombined InsuranceInsurance Investment Income and Realized Capital Gains Although net investment income is allocated to
segments and product lines, the investment portfolio is
generally managed as a whole and therefore is more
meaningfully discussed in total. Net investment income
increased to $37.2
million in 2004 from $33.3 million in 2003. This
increase is due primarily to the increase in the size
of the portfolio. The increase in portfolio size was
due primarily to the investment of $24 million in
proceeds related to the public stock offering, the
investment of $24 million related to the issuance of
junior subordinated debt securities and positive cash
flow generated from operations. Reinvestment rates
continue to be depressed due to the current low
interest rate environment. The annualized pre-tax
equivalent investment yield, on a cost basis, of the
Companys fixed income portfolio was 5.3% in 2004
compared to 5.5% in 2003. Realized investment gains and losses are comprised
of three items: capital gains and losses from the sale
of securities, derivatives features of certain
convertible securities and other-than-temporary
impairments. The following chart shows the gain or loss
from these sources as well as their impact on diluted
earnings per share (amounts in $000s except per share
amounts): December 31, 2004Pre-Tax
    
    
    After-Tax
    
    
    EarningsGain (Loss)
    
    
    Gain (Loss)
    
    
    Per ShareCapital Gains
    
    $
    9,169
    
    
    $
    5,960
    
    
    $
    0.31Derivatives
    
    
    764
    
    
    
    497
    
    
    
    0.03Other-Than-TemporaryImpairments
    
    
    
    
    
    
    
    
    
    
    Net RealizedInvestment Gains
    
    $
    9,933
    
    
    $
    6,457
    
    
    $
    0.34
 December 31, 2003Pre-Tax
    
    
    After-Tax
    
    
    EarningsGain (Loss)
    
    
    Gain (Loss)
    
    
    Per ShareCapital Gains
    
    $
    5,665
    
    
    $
    3,682
    
    
    $
    0.21Derivatives
    
    
    799
    
    
    
    519
    
    
    
    0.03Other-Than-Temporary
Impairments
    
    
    (1,898
    )
    
    
    (1,233
    )
    
    

    (0.07
    )Net RealizedInvestment Gains
    
    $
    4,566
    
    
    $
    2,968
    
    
    $
    0.17
 Derivatives relate to the equity conversion
features attributable to the convertible preferred
stocks and convertible debentures held by American
Modern. The Companys investment portfolio does not
currently include any other types of derivative
investments. Insurance Losses and Loss Adjustment Expenses (LAE) Overall, American Moderns losses and loss
adjustment expenses decreased 11.1% in 2004 to $348.6
million from $392.2 million in 2003. As mentioned in
the segment discussions above, the decrease was due to
improved underwriting results for the site-built
dwelling, motorcycle and discontinued commercial
liability products. The overall decrease in losses and
loss adjustment expense occurred despite catastrophe
losses increasing to $46.0 million in 2004 compared
with $37.2 million in 2003. In 2004, the Company experienced $17.6 million of
favorable development related to its loss reserves
recorded at the end of 2003. The development was due
primarily to claims settling in 2004 for less than the
case basis reserve amounts recorded at the end of 2003.
The manufactured housing and discontinued commercial
lines products accounted for approximately 50% of this
favorable development with the remainder spread over
various insurance products. The Company does not intend
to change its reserving methodology in 2005, but will
continue to monitor the development of its case basis
loss reserves. Insurance Commissions and Other Policy Acquisition Costs American Moderns commissions and other policy
acquisition costs increased 13.2% in 2004 to $201.2
million from $177.6 million in 2003. This increase is
attributable to the growth in net earned premium
combined with the increase in performance-based
commission expense as a result of the significantly
improved underwriting results achieved in 2004 compared
to 2003. The fluctuations in performance-based
commission expense are attributable, in part, to
American Moderns Pay for Performance commission
policy with agents representing the Company which
reduces the up-front commission paid but rewards
favorable underwriting and growth performance with a
higher performance-based commission. Operating and Administrative Expenses American Moderns insurance operating and
administrative expenses increased 23.7% to $108.5
million in 2004 compared to $87.7 million in 2003.
These increases correspond with the increase in
revenues combined with increases related to employee
incentive plans, depreciation expenses related to
modernLINK®, our proprietary information
systems and web enablement initiative, and an increase
in employee healthcare expenses. Transportation M/G Transport, Midlands transportation
subsidiary, increased revenues to $45.4 million in
2004 compared to $28.2 million in 2003. Income
before taxes also increased to $1.7 million in 2004
as compared to $1.3 million in 2003. The increase in
revenues was due primarily to an increase in tonnage
hauled related to petroleum coke, coal and barite.
The increase in transportation expenses is
commensurate with the increase in tonnage hauled
plus additional costs due to changes in shipping
patterns experienced during the year. THE MIDLAND COMPANY 23




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES RESULTS OF OPERATIONSYEAR ENDED DECEMBER 31, 2003 COMPAREDTO YEAR ENDED DECEMBER 31, 2002 InsuranceOverview of Premium Volume The following chart shows American Moderns gross
written premium, net written premium and net earned
premium by business segment for the years ended
December 31, 2003 and 2002 (in millions): December 31, 2003Gross
    
    
    Net
    
    
    NetWritten
    
    
    Written
    
    
    EarnedBusiness Segment
    
    Premium
    
    
    Premium
    
    
    PremiumPersonal Lines Property
    
    $
    404.8
    
    
    $
    383.3
    
    
    $
    407.8Personal Lines Casualty
    
    
    125.6
    
    
    
    124.5
    
    
    
    117.6Financial Services
    
    
    65.9
    
    
    
    63.1
    
    
    
    54.7All Other Insurance
    
    
    83.8
    
    
    
    57.7
    
    
    
    57.9Total
    
    $
    680.1
    
    
    $
    628.6
    
    
    $
    638.0
 December 31, 2002Gross
    
    
    Net
    
    
    NetWritten
    
    
    Written
    
    
    EarnedBusiness Segment
    
    Premium
    
    
    Premium
    
    
    PremiumPersonal Lines Property
    
    $
    386.5
    
    
    $
    370.6
    
    
    $
    386.4Personal Lines Casualty
    
    
    109.8
    
    
    
    108.9
    
    
    
    92.6Financial Services
    
    
    44.8
    
    
    
    43.1
    
    
    
    40.7All Other Insurance
    
    
    93.9
    
    
    
    50.7
    
    
    
    58.0Total
    
    $
    635.0
    
    
    $
    573.3
    
    
    $
    577.7
 Personal Lines Property (000s) December 31,2003
    
    
    2002
    
    
    ChangeDirect and AssumedWritten Premiums
    
    $
    404,811
    
    
    $
    386,510
    
    
    
    4.7
    %Net Written Premiums
    
    $
    383,255
    
    
    $
    370,652
    
    
    
    3.4
    %Net Earned Premium
    
    $
    407,816
    
    
    $
    386,418
    
    
    
    5.5
    %Service Fees
    
    
    5,484
    
    
    
    6,097
    
    
    
    (10.1
    )%Total Revenues
    
    $
    413,300
    
    
    $
    392,515
    
    
    
    5.3
    %Income Before Taxes
    
    $
    34,849
    
    
    $
    17,912
 Manufactured housing gross written premiums
increased 5.3% to $320.2 million in 2003 from $304.1
million in 2002. This increase was primarily the result
of rate increases approved in 2003 and 2002, which were
partially offset by a decline in in-force policies. The
manufactured housing combined ratio decreased to 94.8%
in 2003 from 101.1% in 2002. This improvement was due
to rate increases and a decline in the fire loss ratio
related to this product. Gross written premiums from American Moderns
ongoing site-built dwelling programs increased 68.2% to
$79.0 million in 2003 from $47.0 million in 2002.
Conversely, gross written premiums from de-emphasized
site-built programs decreased 89.7% to $3.5 million in
2003 from $33.9 million in the prior year. The overall
site-built dwelling combined ratio improved slightly to
108.1% in 2003 compared to 111.6% in 2002. Personal Lines Casualty (000s) December 31,2003
    
    
    2002
    
    
    ChangeDirect and AssumedWritten Premiums
    
    $
    125,629
    
    
    $
    109,839
    
    
    
    14.4
    %Net Written Premiums
    
    $
    124,501
    
    
    $
    108,874
    
    
    
    14.4
    %Net Earned Premium
    
    $
    117,568
    
    
    $
    92,584
    
    
    
    27.0
    %Service Fees
    
    
    2,226
    
    
    
    918
    
    
    
    142.5
    %Total Revenues
    
    $
    119,794
    
    
    $
    93,502
    
    
    
    28.1
    %Income (Loss) Before Taxes
    
    $
    (11,452
    )
    
    $
    1,012
 The increase in gross written premiums for
American Moderns personal lines casualty business was
related to the watercraft and recreational vehicle
products. Profitability for the personal lines casualty
products was negatively impacted by the motorcycle
product. The combined ratio for motorcycle increased to
131.7% in 2003 compared to 109.7% in 2002. Financial Services (000s) December 31,2003
    
    
    2002
    
    
    ChangeDirect and AssumedWritten Premiums
    
    $
    65,929
    
    
    $
    44,766
    
    
    
    47.3
    %Net Written Premiums
    
    $
    63,112
    
    
    $
    43,076
    
    
    
    46.5
    %Net Earned Premium
    
    $
    54,742
    
    
    $
    40,648
    
    
    
    34.7
    %Total Revenues
    
    $
    54,742
    
    
    $
    40,648
    
    
    
    34.7
    %Income Before Taxes
    
    $
    6,797
    
    
    $
    3,198
 Gross written premiums for American Moderns
financial services products increased in 2003 compared
to 2002 due primarily to the mortgage fire and
collateral protection products. The increase in
profitability was due primarily to the mortgage fire
product which achieved a combined ratio of 80.7% in
2003 compared to 90.3% in 2002. All Other Insurance (000s) December 31,2003
    
    
    
    2002
    
    ChangeDirect and AssumedWritten Premiums
    
    $
    83,721
    
    
    $
    93,859
    
    
    
    (10.8
    )%Net Written Premiums
    
    $
    57,779
    
    
    $
    50,742
    
    
    
    13.9
    %Net Earned Premium
    
    $
    57,918
    
    
    $
    58,028
    
    
    
    (0.2
    )%Agency Revenues
    
    
    6,215
    
    
    
    6,665
    
    
    
    (6.6
    )%Service Fees
    
    
    159
    
    
    
    2Total Revenues
    
    $
    64,292
    
    
    $
    64,695
    
    
    
    (0.7
    )%Income (Loss) Before Taxes
    
    $
    (3,501
    )
    
    $
    12,538
 Gross written premiums for all other insurance
products were impacted by a $21.1 million increase in
excess and surplus lines business offset by $30.6
million decrease in the credit life business. Credit
life gross written premium decreased due to industry
regulatory actions which mandated a monthly pay product
on real estate secured loans rather than an upfront
single premium. This change decreased gross written
premium by 63.9% in 2003 due to the shorter term, but
had little impact on net earned premium. Net earned
premium actually increased 24 THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIES
slightly over the prior year due to additional
volume. A large percentage of our credit life business
is ultimately ceded back to an insurance affiliate of
the producing agent. Profitability for our other insurance products was
negatively impacted in 2003 by the adverse development
of our discontinued manufactured housing park and
dealer commercial liability business and the related
strengthening of reserves in 2003 to address the
run-off claims. Combined InsuranceInsurance Investment Income and Realized Capital Gains Although net investment income is allocated to
segments and product lines, the investment portfolio is
generally managed as a whole and therefore is more
meaningfully discussed in total. Both the cost and
market value of American Moderns investment portfolio
increased in 2003, whereas net investment income
(before taxes and excluding net realized investment
gains and losses) decreased 7.0% to $33.0 million in
2003 from $35.5 million in 2002. This decrease was due
to the depressed interest rate environment which was
adversely affecting reinvestment rates relative to the
Companys fixed income portfolio. The annualized
pre-tax equivalent investment yield on American
Moderns fixed income investments was 5.5% in 2003 as
compared to 6.0% in 2002. Our realized investment gains and losses are
comprised of three items: capital gains and losses from
the sale of securities, derivative features of certain
convertible securities and other-than-temporary
impairments. American Moderns after-tax net realized
capital gains (losses) from the sale of securities
increased to $3.7 million, $0.20 per share
(diluted) in 2003 from a loss in 2002 of $(1.3)
million, $(0.07) per share (diluted). After-tax income from derivatives, which are
included on a pre-tax basis in net realized capital
gains (losses), amounted to $0.5 million, $0.03 per
share (diluted) in 2003. This compares to an after-tax
loss in 2002 of $(0.2) million, $(0.01) per share
diluted. Also included in net realized capital gains
(losses) in 2003 were after-tax losses of $(1.2)
million, $(0.07) per share (diluted), resulting from
the write-down (other-than-temporary impairment) of
several lower rated securities in American Moderns
investment portfolio. This compares to after-tax
impairment losses of $(3.0) million, $(0.17) per share
(diluted) in 2002. Insurance Losses and Loss Adjustment Expenses (LAE) American Moderns losses and loss adjustment
expenses increased 15.0% in 2003 to $392.2 million from
$341.0 million in 2002. This increase was the result of
increases in catastrophe losses, motorcycle losses,
losses from the discontinued commercial lines product
that we exited in 2001 and the strengthening in 2003 of
the property and casualty incurred but not reported
loss reserves (IBNR). During 2003, American Moderns
property and casualty operations incurred losses of
$12.0 million related to prior years. The $12 million
of adverse development pertaining to prior years is
attributable to claims that had been incurred in prior
years but reported for the first time in 2003, rather
than reserve adjustments to known claims. As discussed,
such claims were concentrated in our previously exited
commercial liability product (part of our Other
Insurance segment). We incurred approximately $6
million more in
claims than we had previously expected relative to
this product in 2003. The majority of such claims came
from accident years 2001 and 2002 and were reported for
the first time during 2003. This higher than expected
level of new claims and their severity caused us to
refine our assumption as to future claims severity from
this product. This refinement in our assumptions led us to increase our
incurred but not reported claims reserve, which
resulted in an additional expense of $6 million in
2003. The first indication of the increase in severity
came to our attention in 2003 at which time, in
consultation with our actuaries, we provided the
additional level of reserve. As this product line has
been exited for several years now, we do not anticipate
this business will result in the same level of
development volatility in future periods as was
experienced in 2003. Catastrophe losses were $37.5 million on a pre-tax
basis in 2003 compared to $32.6 million in 2002 Insurance Commissions, Other Policy Acquisition
Costs and  Operating and Administrative Expenses American Moderns commissions and other policy
acquisition costs and operating and administrative
expenses increased 5.9% in 2003 to $265.3 million from
$250.5 million in 2002. This increase is attributable
to the growth in net earned premium and increases in
depreciation expense and compensation expense related
to performance based stock awards. These decreases were
offset by decreases in commission expense and legal
expenses. With respect to commission expense, in 2003
American Modern made significant progress in the
implementation of the Pay for Performance program. As
a result, performance-based commissions were lower in
2003 since the Company experienced a higher level of
losses. Transportation Transportation revenues increased 21.0% in 2003
to $28.2 million from $23.3 million in 2002. Income
before taxes also increased to $1.3 million in 2003 as
compared to $0.4 million in 2002. The increase in
revenues and income before taxes was due primarily to
the increase in affreightment revenues from one
revenue source that was regained in 2003. LIQUIDITY, CAPITAL RESOURCES AND
CHANGES IN FINANCIAL CONDITION Consolidated OperationsAggregate Contractual Obligations
and Off Balance Sheet Arrangements We have certain obligations and commitments to
make future payments under contracts. As of December
31, 2004, the aggregate obligations on a consolidated
basis were as follows (amounts in 000s): Payments Due By PeriodLess Than
    
    
    25
    
    
    AfterTotal
    
    
    1 Year
    
    

    Years
    
    
    5 YearsLong-term debt
    
    $
    82,729
    
    
    $
    15,532
    
    
    $
    43,197
    
    
    $
    24,000Other notes payable
    
    
    33,177
    
    
    
    33,177
    
    
    
    
    
    
    
    Annual commitments
under non-cancelable leases
    
    
    7,141
    
    
    
    1,232
    
    
    
    2,893
    
    
    
    3,016Purchase obligations
    
    
    16,756
    
    
    
    13,158
    
    
    
    3,598
    
    
    
    Other obligations
    
    
    616
    
    
    
    616Insurance
policy loss reserves
    
    
    232,915
    
    
    
    121,116
    
    
    
    95,495
    
    
    
    16,304Total
    
    $
    373,334
    
    
    $
    184,831
    
    
    $
    145,183
    
    
    $
    43,320
 The table above excludes contracts and agreements
that relate to maintenance and service agreements
which, individually and in the aggregate, are not
material to the Companys THE MIDLAND COMPANY 25




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES
operations or financial condition and are
terminable by the Company with minimal advance
notice and little or no cost to the Company. The insurance policy loss reserve payment
projections in the above table are based on actuarial
assumptions. The actual payments will vary, in both
amount and time periods, from the estimated amounts
represented in this table. See further discussion
regarding insurance policy loss reserves under the
Critical Accounting Policies section. The Company has entered into a contract to
purchase certain transportation equipment in 2005 for
$9.4 million. However, the Company, in all likelihood,
will replace this purchase contract with an operating
lease agreement which will spread the cash obligations
over several years. Also included in the above table is an operating
lease arrangement relating to the lease of 20 barges
used in the transportation operations. The lease was
entered into in 1999 and its term is for 15 years. The
barges can be purchased after 12 years at a
predetermined price and, at the end of the lease period
in 2014, the company can either return the barges or
purchase the equipment at fair market value. The
15-year lease period was more attractive at that time
than the traditional 5-year financing term for
conventional long-term debt. As of December 31, 2004
future lease payments required under this operating
lease arrangement are (000s): 2005  $544; 2006
through 2009  $2,198; after 5 years
 $3,014. M/G Transports operating cash flow is
currently sufficient to pay the financial obligations
under this agreement. Other Items No shares were repurchased in the open market
under the Companys share repurchase program during
2004 and a total of 586,000 shares remain authorized
for repurchase under terms of this authority. On April
29, 2004, the Companys Board of Directors approved a
two-year extension to the share repurchase program that
will run through the date of the Boards second
quarterly meeting in 2006. The resolution does not
require the repurchase of shares, but rather gives
management discretion to make purchases based on market
conditions and the Companys capital requirements. The share repurchase program pertains exclusively
to shares to be purchased on the open market. This
program specifically excludes shares repurchased in
connection with stock incentive plans. The Company may
periodically repurchase stock awarded to associates in
connection with stock incentive programs. Such
repurchase transactions essentially accommodate
associates funding of the exercise price and any tax
liabilities arising from the exercise or receipt of
equity based incentive awards. During 2004, the Company
repurchased approximately $2.9 million of treasury
shares in connection with associate stock incentive
programs. We paid dividends to our shareholders of $3.7
million during 2004, $3.3 million in 2003 and $3.0
million in 2002. We expect that our existing cash and other
liquid investments, coupled with future operating
cash flows and our short-term borrowing capacity,
will meet our operating cash requirements for the
next 12 months. Holding Company Operations Midland and American Modern are holding companies
which rely primarily on dividends and management fees
from subsidiaries to assist in servicing debt, paying
operating expenses and paying dividends to the
respective shareholders. The payment of dividends to
these holding companies from American Moderns
insurance subsidiaries is restricted by state
regulatory agencies. Such restrictions, however, have
not had, and are not expected to have, a significant
impact on our, or American Moderns, liquidity or our
and American Moderns ability to meet our respective
long or short-term operating, financing or capital
obligations. Midland has a commercial paper program under which
qualified purchasers may invest in the short-term
unsecured notes of Midland. As of December 31, 2004, we
had $4.2 million of commercial paper debt outstanding,
$3.5 million of which represented notes held either
directly or indirectly by our executive officers and
directors. The effective annual yield paid to all
participants in this program was 2.3% as of December
31, 2004, a rate that is considered to be competitive
with the market rates offered for similar instruments.
As of December 31, 2004, Midland also had $79.0 million
of conventional short-term credit lines available at
costs not exceeding prime borrowing rates, of which
$29.0 million was outstanding. These lines of credit
contain minimal covenants and are typically drawn and
repaid over periods ranging from two weeks to three
months. We also have a mortgage obligation related to
the financing of our corporate headquarters building.
As of December 31, 2004, the outstanding balance of
this mortgage was $14.8 million. This mortgage
obligation includes normal and customary debt covenants
for instruments of this type. Monthly principal and
interest payments are required until maturity in
December 2005. The effective interest rate on this
obligation is 6.8%. On October 21, 2003 Midland filed a shelf
registration statement with the Securities and Exchange
Commission. This registration statement will allow the
Company to offer from time to time up to $150.0 million
in various types of securities, including debt,
preferred stock and common stock. On February 5, 2004,
Midland sold 1,150,000 shares of its common stock
authorized by this shelf registration. The net
proceeds received of $25.1 million were used to
increase the capital base of its insurance subsidiaries
to provide for future growth and for other general
corporate purposes. During the second quarter of 2004, Midland,
through wholly owned trusts, issued $24.0 million of
junior subordinated debt securities ($12.0 million on
April 29 and $12.0 million on May 26). These
transactions were part of the Companys participation
in pooled trust preferred offerings. The proceeds from
these transactions are available to fund future growth
and for general corporate purposes. The debt issues
have 30-year terms and are callable any time after five
years at the Companys option. The interest related to
the debt is variable in nature. The debt contains
certain provisions which are typical and customary for
this type of security. 26 THE MIDLAND COMPANY




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THE MIDLAND COMPANY AND SUBSIDIARIESInvestment in Marketable Securities The market value of Midlands consolidated
investment portfolio (comprised primarily of the
investment holdings of American Modern) increased 14.8%
from $846.3 million at December 31, 2003, to $971.4
million at December 31, 2004. This increase was due to
positive cash flow from operations in 2004 combined
with the investment of $24.0 million in net proceeds
derived from the public stock offering and the
investment of $24.0 million related to the issuance of
junior subordinated debt securities. The unrealized
appreciation in the market value of securities held
increased $1.5 million at December 31, 2004 compared to
year end 2003. The increase in the unrealized
appreciation was due to a $4.1 million increase in
unrealized appreciation related to the equity portfolio
offset by a $2.6 million decrease in unrealized
appreciation pertaining to the fixed income portfolio.
Midlands largest equity holding, 2.5 million shares of
U.S. Bancorp, increased to $77.1 million as of December
31, 2004 from $73.3 million as of December 31, 2003. Securities with unrealized gains and losses by
category (equity and debt) and by time frame are
summarized in the chart below (amounts in 000s): Unrealized Gain (Loss) as of December 31, 2004Unrealized
    
    
    Fair
    
    
    # ofGain (Loss)
    
    
    Value
    
    
    PositionsFixed Income SecuritiesTotal held in a gain position
    
    $
    26,154
    
    
    $
    617,580
    
    
    
    737Held in a loss position
for less than 3 months
    
    
    (302
    )
    
    
    76,482
    
    
    
    75Held in a loss position
for more than 3 months
and less than 9 months
    
    
    (398
    )
    
    
    51,031
    
    
    
    43Held in a loss position
for more than 9 months
and less than 18 months
    
    
    (192
    )
    
    
    14,182
    
    
    
    15Held in a loss position
for more than 18 months
    
    
    (137
    )
    
    
    2,890
    
    
    
    7Fixed income total
    
    $
    25,125
    
    
    $
    762,165
    
    
    
    877Equity SecuritiesTotal held in a gain position
    
    $
    91,343
    
    
    $
    187,321
    
    
    
    174Held in a loss position
for less than 3 months
    
    
    (115
    )
    
    
    6,595
    
    
    
    19Held in a loss position
for more than 3 months
and less than 9 months
    
    
    (214
    )
    
    
    3,909
    
    
    
    8Held in a loss position
for more than 9 months
and less than 18 months
    
    
    (66
    )
    
    
    2,027
    
    
    
    6Held in a loss position
for more than 18 months
    
    
    
    
    
    
    
    
    
    
    Equity total
    
    $
    90,948
    
    
    $
    199,852
    
    
    
    207Total per above
    
    $
    116,073
    
    
    $
    962,017
    
    
    
    1,084Accrued interest and
dividends
    
    
    
    
    
    
    9,421Total per balance sheet
    
    $
    116,073
    
    
    $
    971,438
 Based on the above valuations and the application
of our other-than-temporary impairment policy criteria,
which is more fully discussed in the Critical
Accounting Policies section below, we believe the
declines in fair value are temporary at December 31,
2004. However, the facts and circumstances related to
these securities may change in future periods, which
could result in other-than-temporary impairment in
future periods. The average duration of the Companys debt
security investment portfolio as of December 31, 2004
was 4.4 years which management believes provides
adequate asset/liability matching. Insurance American Modern generates cash inflows primarily
from insurance premium, investment income, proceeds
from the sale of marketable securities and maturities
of debt security investments. The principal cash
outflows for the insurance operations relate to the
payment of claims, commissions, premium taxes,
operating expenses, capital expenditures, income taxes,
interest on debt, dividends and inter-company
borrowings and the purchase of marketable securities.
In each of the periods presented, funds generated from
the insurance operating activities were used primarily
to purchase investment grade marketable securities,
accounting for the majority of the cash used in
investing activities. The amounts expended for the development costs
capitalized in connection with the development of
modernLINK®, our proprietary information
systems and web enablement initiative, amounted to $5.8
million in 2004 and a total of $18.7 million from
inception in 2000 through December 31, 2004. The
initiative is being designed, developed and implemented
in periodic phases to ensure its cost effectiveness and
functionality. This project may involve future cash
expenditures of $5.0 million to $8.0 million annually
over the next five years, with additional spending
thereafter to expand system compatibility and
functionality. A portion of such expenditures will be
capitalized and amortized over the useful life.
However, actual costs may be more or less than what we
estimate. The cost of the development and
implementation is expected to be funded
out of operating cash flow. Significant changes to
the technology interface between American Modern and
its distribution channel participants and
policyholders, while unlikely, could significantly
disrupt or alter its distribution channel
relationships. If the new information systems are
ultimately deemed ineffective, it could result in an
impairment charge to our capitalized costs. The
unamortized balance of modernLINK®s
software development costs was $9.9 million at December
31, 2004. American Modern has a $72.0 million long-term
credit facility available on a revolving basis at
various rates. As of December 31, 2004, there was $36.0
million outstanding under these facilities. During the first quarter of 2002, American Modern
entered into an interest rate swap agreement with a
consortium of three banks. Under the terms of this
agreement, the floating interest rate related to $30.0
million outstanding under American Moderns long-term
credit facility has been effectively fixed at 5.6%
until December 1, 2005, the maturity date. The fair
value of this agreement as of December 31, 2004 was
$(0.4) million and is included in other payables and
accruals. THE MIDLAND COMPANY 27




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES Accounts receivable is primarily comprised of
premium due from both policyholders and agents. In the
case of receivables due directly from policyholders,
policies are cancelable in the event of non-payment and
thus offer minimal credit exposure. Approximately 65%
of American Moderns accounts receivables relate to
premium due directly from policyholders as of December
31, 2004. In the case of receivables due from agents,
American Modern has extended payment terms that are
customary and normal in the insurance industry.
Management monitors its credit exposure with its agents
and related concentrations on a regular basis. However,
as collectibility of such receivables is dependent upon
the financial stability of the agent, American Modern
cannot assure collections in full. Where management
believes appropriate, American Modern has provided a
reserve for such exposures. Accounts receivable
increased $20.0 million to $114.0 million at December
31, 2004 compared to $94.0 million at year end 2003.
The increase is due primarily to an increase in
premiums written. Reinsurance recoverables and prepaid reinsurance
premium consisted of the following amounts (amounts in
000s): As of December 31,2004
    
    
    2003Prepaid reinsurance premiums
    
    $
    40,215
    
    
    $
    40,084Reinsurance recoverableunpaid losses
    
    
    37,873
    
    
    
    25,838Reinsurance recoverablepaid losses
    
    
    9,638
    
    
    
    5,068Total
    
    $
    87,726
    
    
    $
    70,990
 The increase in reinsurance recoverables of $16.6
million at December 31, 2004 compared to 2003 is
attributable primarily to increased recoverables from
catastrophe reinsurers related to the Florida
hurricanes and from our excess and surplus lines
business. The increase of $28.1 million in insurance loss
reserves was due to the growth in the property and
casualty products combined with a $6.3 million increase
in catastrophe case basis reserves. Insurance commissions payable increased $14.9
million due primarily to a $13.2 million increase in
performance-based commissions compared to last year
end. Funds held under reinsurance agreements and
reinsurance payables increased $4.5 million due
primarily to growth related to an agent that generates
our excess and surplus lines business. The $22.0 million increase in other payables and
accruals is due primarily to an increase in
transportation payables, accrued incentives for
associates and payables related to investment
purchases at year end. Cash flow from the insurance operations is
expected to remain sufficiently positive to meet
American Moderns future operating requirements and to
provide for reasonable dividends to Midland. Transportation M/G Transport generates its cash inflows primarily
from affreightment revenue. Its primary outflows of
cash relate to the payment of barge charter costs, debt
service obligations, operating expenses, income taxes,
dividends to Midland and the acquisition of capital
equipment. Like the insurance operations, cash flow
from the transportation subsidiaries is expected to
remain sufficiently positive to meet future operating
requirements. The transportation subsidiaries entered into a
fifteen-year lease in 1999 for transportation
equipment. Aggregate rental payments under this
operating lease over the next ten years will
approximate $5.8 million. In 2003, M/G Transport adopted the provisions of
FASB Interpretation No. 46 (FIN 46), Consolidation of
Variable Interest Entities, and capitalized an
operating lease related to certain transportation
equipment. The recorded asset value was subsequently
determined to be in excess of its fair market value and
impairment charges of $0.8 million (pre-tax) and $0.5
million (pre-tax) were recorded in 2004 and 2003,
respectively. Later in 2004, the Company sold the
transportation equipment for $1.7 million and
recognized a pre-tax gain of $0.2 million. The Company
used the proceeds from this sale to eliminate the debt
related to the equipment. As of December 31, 2004, the transportation
subsidiaries have $7.9 million of collateralized
equipment obligations outstanding. OTHER MATTERS Comprehensive Income The differences between our net income and
comprehensive income are changes in unrealized gains on
marketable securities, changes in the fair value of the
interest rate swap agreement and additional minimum
liability requirements related to our defined benefit
pension plans. For the years ended December 31, 2004,
2003 and 2002, such changes increased or (decreased), net of
related income tax effects, by the following amounts
(amounts in 000s): 2004
    
    
    2003
    
    
    2002Changes in:Net unrealized
capital gains
    
    $
    966
    
    
    $
    25,237
    
    
    $
    3,379Fair value of interest rate
swap hedge
    
    
    651
    
    
    
    332
    
    
    
    (1,264
    )Additional minimum
pension liability
    
    
    (2,045
    )
    
    
    313
    
    
    
    (417
    )Total
    
    $
    (428
    )
    
    $
    25,882
    
    
    $
    1,698
 Net unrealized investment gains in equity
securities (net of income tax effects) increased $2.7
million in 2004 and $25.5 million in 2003 and decreased
by $6.5 million in 2002. For fixed income securities,
net unrealized gains decreased $1.7 million in 2004 and
$0.3 million in 2003 and increased by $10.1 million in
2002. Changes in net unrealized gains on marketable
securities result from both market conditions and
realized gains recognized in a reporting period. The
after-tax fair value of the interest rate swap
agreement varies according to the current interest rate
environment relative to the fixed rate of the swap
agreement. Changes in the additional minimum pension
liability are actuarially determined based on the
funded status of the plans and current actuarial
assumptions. Critical Accounting Policies Our discussion and analysis of our financial
condition and results of operations are based upon our
consolidated financial statements, which have been
prepared in accordance with accounting principles
generally accepted in the United States of America.
The preparation of these financial statements requires
us to make estimates, assumptions and judgments that
affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosures of
contingent assets and liabilities. We regularly
evaluate our critical accounting policies, assumptions
and estimates, including those related to insurance
revenue and expense recognition, loss reserves,
reinsurance levels and 28 THE MIDLAND COMPANY




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THE MIDLAND COMPANY AND SUBSIDIARIES valuation and impairment of intangible assets such as goodwill. We base our estimates on
historical experience and on various assumptions that we believe to be reasonable under the
circumstances. This process forms the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions. We believe the following critical accounting policies require significant judgments and
estimates in the preparation of our consolidated financial statements. Insurance Revenue and Expense Recognition Premiums for physical damage and other property and casualty related coverages, net of premium
ceded to reinsurers, are recognized as income on a pro-rata basis over the lives of the policies.
Credit accident and health and credit life premiums are recognized as income over the lives of the
policies in proportion to the amount of insurance protection provided. American Modern generally
does not consider anticipated investment income in determining premium deficiencies (if any) on
short-term contracts. Policy acquisition costs, primarily commission expenses and premium taxes,
are capitalized and expensed over the terms of the related policies on the same basis as the
related premiums are earned. Selling and administrative expenses that are not primarily related to
premiums written are expensed as incurred. Insurance Policy Loss Reserves American Moderns reserve for insurance losses is based on past experience of settling
known claims as well as estimating those not yet reported. While management believes the amounts
are fairly stated, the ultimate liability, once fully developed, may be more than or less than that
provided. Management and its actuaries, both internal and external, regularly review these
liabilities and adjustments are made as necessary in the current period. Management does not
foresee any significant change in the manner in which it records its reserve for insurance losses. The following table provides additional detail surrounding the Companys insurance policy loss
reserves at December 31, 2004 and 2003 (amounts in 000s): December 31,2004
    
    
    2003Gross case base loss reserves:Personal lines property
    
    $
    47,052
    
    
    $
    43,717Personal lines casualty
    
    
    33,590
    
    
    
    31,341Financial services
    
    
    12,004
    
    
    
    5,814All other insurance
    
    
    53,669
    
    
    
    45,839Gross loss
reserves incurred but not reported
    
    
    64,783
    
    
    
    55,366Outstanding checks and drafts
    
    
    21,817
    
    
    
    22,756Total insurance loss reserves
    
    $
    232,915
    
    
    $
    204,833
 The recorded insurance loss reserves at the balance sheet date represent the Companys best
estimate, based on historical patterns and other assumptions, of its liabilities at that date.
Management, along with the Companys internal actuaries, periodically reviews the level of loss
reserves against actual loss development. This retrospective review is the primary criteria used in
refining the levels of loss reserves recorded in the financial statements. Additionally, management
compares the Companys estimate of loss reserves to ranges prepared by its external consulting
actuaries to ensure that such estimates are within the actuaries acceptable range. The external
actuaries perform an extensive review of loss reserves at year end using generally accepted actuarial
guidelines along with reviews throughout the year to ensure that the recorded loss reserves appear
reasonable. At December 31, 2004, loss reserves, net of reinsurance recoverables, for our property
and casualty companies totaled $166.3 million. The Companys estimate was affirmed by the
actuaries estimated range for net loss reserves of $152.7 million to $168.7 million. While management believes the amounts are fairly stated, the ultimate liability, once fully
developed, may be more than or less than the recorded amount. Management believes that the
likelihood that actual loss development patterns will differ significantly from past experience is
low given the short-tail, property oriented nature of the Companys business. However, if the
ultimate pay outs would significantly exceed the expected amounts, the Company has several
potential options to utilize in order to satisfy the additional obligations. For example, the
Company could liquidate a portion of its investment portfolio or draw on conventional short-term
credit lines available, at costs not exceeding prime rates. The Company believes either of these
options would be sufficient to meet any increases in required loss payments. Slowness to recognize or respond to new or unexpected loss patterns, such as those caused by
the risk factors listed in the Companys Safe Harbor Statement, could lead to a shortage in
reserves, which would lead to a higher loss and loss expense ratio; each percentage point increase
in the loss and loss expense ratio would reduce income before taxes by $6.8 million based on 2004
earned premiums. Reinsurance Risks In order to limit its exposure to certain levels of risks, the Company cedes varying
portions of its written premiums to other insurance companies. As such, the Company limits its loss
exposure to that portion of the insurable risk it retains. In addition, the Company pays a
percentage of earned premiums to reinsurers in return for coverage against catastrophic losses.
However, if a reinsurer fails to honor its obligations, American Modern could suffer additional
losses as the reinsurance contracts do not relieve American Modern of its obligations to
policyholders. American Modern and its independent reinsurance brokers regularly conduct market security
evaluations of both its current and prospective reinsurers. Such evaluations include a complete
review of each reinsurers financial condition along with an assessment of credit risk
concentrations arising from similar geographic regions, activities or economic characteristics of
the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The
specific evaluation procedures include, but are not limited to, reviewing the periodic financial
statements and ratings assigned to each reinsurer from rating agencies such as S&P, Moodys and
A.M. Best. During 2004, more than 85% of the Companys catastrophe reinsurers had an A.M. Best or
S&P rating of A or higher. In addition, American Modern may, in some cases, require reinsurers to establish trust funds
and maintain letters of credit to further minimize possible exposures. All reinsurance amounts owed
to American Modern are current and management believes that no allowance for uncollectible accounts
related to this recoverable is necessary. Management also believes there is no significant
concentration of credit risk arising from any single reinsurer. The Company also assumes a limited amount of business on certain reinsurance contracts.
Related premiums and loss reserves are recorded based on records supplied by the ceding companies. THE MIDLAND COMPANY 29




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES Other-Than-Temporary Impairment of Investment Securities American Modern invests in various securities including U.S. Government securities,
corporate debt securities, and corporate stocks. Investment securities in general are exposed to
various risks such as interest rate, credit, and overall market volatility. Due to the level of
risk associated with these securities, it is reasonably possible that changes in the value of
investment securities will occur in the near term and that such changes could be material. In order to identify other-than-temporary impairments, we conduct quarterly comprehensive
reviews of individual portfolio holdings that have a market value less than their respective
carrying value. As part of our review for other-than-temporary impairment, we track the respective
carrying values and market values for all individual securities with an unrealized loss. We, with
the assistance of our external professional money managers, apply both quantitative and qualitative
criteria in our evaluation, including facts specific to each individual investment such as, but not
limited to, the length of time the fair value has been below the carrying value, the extent of the
decline, our intent to sell or hold the security, the expectation for each individual securitys
performance, the credit worthiness and related liquidity of the issuer and the issuers business
sector. The evaluation for other-than-temporary impairment requires a significant amount of judgment.
As such, there are a number of risks and uncertainties inherent in the process of monitoring for
potential impairments and determining if a decline is other-than-temporary. These risks and
uncertainties include the risks that: 1. The economic outlook is worse than anticipated and has
a greater adverse impact on a particular issuer than anticipated. 2. Our assessment of a particular issuers ability to meet all
of its contractual obligations changes based on changes in the
facts and circumstances related to the issuer. 3. New information is obtained or facts and circumstances
change that cause a change in our ability or intent to hold a
security to maturity or until it recovers in value. When a security is considered other-than-temporarily impaired, we monitor trends or
circumstances that may impact other material investments in our portfolio. For example, we review
any other securities that are held in the portfolio from the same issuer and also consider any
circumstances that may impact other securities of issuers in the same industry. At December 31,
2004, we had no significant concentration of unrealized losses in any one issuer, industry or
sector. For fixed income and equity securities, we consider the following factors, among others,
to determine if a security is other-than-temporarily impaired:  
    the extent and duration to which market value is less
than cost
    historical operating performance of the security
    issuer news releases, including those disclosing that the issuer
has committed an event of default (missed payment beyond
grace period, bankruptcy filing, loss of principle customer
or supplier, debt downgrade, disposal of segment, etc.)
    near term prospects for improvement of the issuer and/or its
industry to include relevant industry conditions and trends
    industry research and communications with industry specialists
    third party research reports
    credit rating reports
    financial models and expectations
    discussions with issuers management by investment manager
    our ability and intent to hold the investment for a period
of time sufficient to allow for any anticipated recovery
    time to conversion with respect to a mandatory convertible
security For fixed income securities, we also consider the following factors:  
    the recoverability of principle and interest
    the issuers ability to continue to make obligated
payments to security holders
    the current interest rate environment The investment portfolio is comprised of various asset classes which are independently managed
by external professional portfolio managers under the oversight and guidelines established by our
investment committee. We evaluate the performance of the portfolio managers relative to benchmarks
we believe appropriate given the asset class. Investment managers will manage the portfolio under
these guidelines to maximize the return on their investment class. As part of their investment
strategy, the investment managers will buy and sell securities based on changes in the availability
of, and the yield on, alternative investments. Investment managers may also buy and sell
investments to diversify risk, attain a specific characteristic such as duration or credit quality,
rebalance or reposition the portfolio or for a variety of other reasons. It is our intent, and thus the intent of our investment managers, to hold securities that have
an unrealized gain or loss. For the securities with an unrealized loss, which in our judgment we
believe to be temporary, it is our intent to hold the security for a period of time that will allow
the security to recover in value. However, if the investment managers believe returns would be
enhanced by selling the security and reinvesting the proceeds, the managers may do so, in which
case the unrealized gain or loss will be recognized as a realized gain or loss. As part of our
comprehensive quarterly review for other than temporary impairment, the investment managers
identify any securities in which they have the intent to sell in the near term. In the case where
investment managers have indicated their intent to sell a security in the near term and there is an
unrealized loss, we record an other-than-temporary impairment at the balance sheet date, if such
date is prior to the sale of the security. At December 31, 2004, we had no securities with an
unrealized loss for which a decision was made to sell in the near term. For the year ended December 31, 2004, we incurred no losses related to other-than-temporary
impairments. For the years ended December 31, 2003 and 2002, we incurred approximately $1.9 million
and $4.6 million, respectively, in other-than-temporary impairment losses. Impairment charges are
included in the consolidated financial statements in net realized investment gains (losses). Defined Benefit Pension Plans Midland maintains defined benefit pension plans for a limited number of active participants.
The defined benefit pension plans are not open to employees hired after March 31, 2000. The pension
expense is calculated based upon a number of actuarial assumptions, including an expected long-term
rate of 3OTHE MIDLAND COMPANY




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THE MIDLAND COMPANY AND SUBSIDIARIES return and a discount rate. In determining our expected long-term rate of return and our
discount rate, we evaluate input from our actuaries, asset allocations, long-term bond yields and
historical performance of the invested pension assets over a ten-year period. If other assumptions
were used, the amount recorded as pension expense would be different from our current estimate. Intangible Assets (Goodwill) As required by SFAS No. 142, we ceased amortizing goodwill effective January 1, 2002. Based on
the impairment test required by SFAS No. 142 in the quarter ended March 31, 2002, a non-recurring
charge of $1.5 million after-tax was taken against income and is reported as cumulative effect of
change in accounting principle in the income statement. Prior to January 1, 2002, goodwill was
amortized on a straight-line basis over a 10-year period. As of December 31, 2004, our remaining
goodwill balance was $2.1 million and is included in other assets. New Accounting Standards In March 2004, the Financial Accounting Standards Board (FASB) ratified the consensus
reached by the Emerging Issues Task Force in Issue 03-1, The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments (EITF 03-1). EITF 03-1 provides guidance
for determining when an investment is considered impaired, whether impairment is
other-than-temporary, and measurement of an impairment loss. An investment is considered impaired
if the fair value of the investment is less than its carrying value. Generally, an impairment is
considered other-than-temporary unless: (a) the investor has the ability and intent to hold an
investment for a reasonable period of time sufficient for a forecasted recovery of fair value up to
(or beyond) the carrying value of the investment; and (b) evidence indicating that the carrying
value of the investment is recoverable within a reasonable period of time outweighs evidence to the
contrary. If impairment is determined to be other-than-temporary, then an impairment loss should be
recognized equal to the difference between the investments carrying value and its fair value. In September 2004, the FASB deferred the effective date of paragraphs 10 through 20 of EITF
03-1 pending further guidance. Gross unrealized losses on available for sale securities were $1.4
million at December 31, 2004. Any other-than-temporary impairments that may possibly be recognized
upon adoption of paragraphs 10 through 20 will be dependent on market conditions and managements
intent and ability to hold any such potentially impaired securities. In December 2004, the FASB issued SFAS 123 (Revised 2004), Share-Based Payment, and is
required to be applied as of the first interim or annual reporting period that begins after June
15, 2005. The revised statement (SFAS No. 123 (R)) requires compensation cost relating to
share-based payment transactions to be recognized in a company s financial statements under the
fair value method. SFAS No. 123 (R) replaces FASB Statement 123 Accounting for Stock-Based
Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees.
Midland is currently assessing the transition to SFAS 123 (R) and does not expect its impact in 2005
to be significantly greater than the 2004 pro forma amounts. The FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4,
SFAS No. 152, Accounting for Real Estate Time Sharing Transactions, an amendment of FASB
Statements No. 66 and 67, and SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29 during 2004, all of
which are effective for fiscal years beginning after June 15, 2005. The adoption of these
statements will not have a material impact on Midlands consolidated financial position or results
of operations. Impact of Inflation We do not consider the impact of the change in prices due to inflation to be material in
the analysis of our overall operations. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is the risk that we will incur investment losses due to adverse changes in
market rates and prices. Our market risk exposures are substantially related to the Companys
investment portfolio and changes in interest rates and equity prices. Each risk is defined in more
detail as follows. Interest rate risk is the risk that the Company will incur economic losses due to adverse
changes in interest rates. The risk arises from many of the Companys investment activities, as the
Company invests substantial funds in interest-sensitive assets. The Company manages the interest
rate risk inherent in its investment assets relative to the interest rate risk inherent in its
liabilities. One of the measures the Company uses to quantify this exposure is duration. By
definition, duration is a measure of the sensitivity of the fair value of a fixed income portfolio
to changes in interest rates. Based upon the 4.4 year duration of the Companys fixed income
portfolio as of December 31, 2004, management estimates that a 100 basis point increase in interest
rates would decrease the market value of its $770.6 million debt security portfolio by 4.4%, or
$33.9 million. Equity price risk is the risk that the Company will incur economic losses due to adverse
changes in a particular stock or stock index. the Companys equity exposure consists primarily of
declines in the value of its equity security holdings. As of December 31, 2004, the Company had
$200.8 million in equity holdings, including $77.1 million of U.S. Bancorp common stock. A 10%
decrease in the market value of U.S. Bancorps common stock would decrease the fair value of its
equity portfolio by approximately $7.7 million. As of December 31, 2004, the remainder of the
Companys portfolio of equity securities had a beta coefficient (a measure of stock price
volatility) of 1.01. This means that, in general, if the S&P 500 Index decreases by 10%, management
estimates that the fair value of the remaining equity portfolio will decrease by 10.1%. The active management of market risk is integral to the Companys operations. The Company has
investment guidelines that define the overall framework for managing market and other investment
risks, including the accountabilities and controls over these activities. THE MIDLAND COMPANY 31




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##### 



CONSOLIDATED STATEMENTS OF INCOME THE MIDLAND COMPANY AND SUBSIDIARIES Years Ended December 31,(Amounts in thousands, except per share
data)
    
    2004
    
    
    2003
    
    
    2002Revenues:Insurance:Premiums earned
    
    $
    677,584
    
    
    $
    638,038
    
    
    $
    577,668Net investment income
    
    
    37,165
    
    
    
    33,279
    
    
    
    35,899Net realized investment gains (losses)
    
    
    9,933
    
    
    
    4,566
    
    
    
    (6,900
    )Other insurance income
    
    
    13,780
    
    
    
    14,064
    
    
    
    13,756Transportation
    
    
    45,379
    
    
    
    28,240
    
    
    
    23,285Total
    
    
    783,841
    
    
    
    718,187
    
    
    
    643,708Costs and Expenses:Insurance:Losses and loss adjustment expenses
    
    
    348,611
    
    
    
    392,232
    
    
    
    341,015Commissions and other policy acquisition costs
    
    
    201,155
    
    
    
    177,622
    
    
    
    169,477Operating and administrative expenses
    
    
    108,536
    
    
    
    87,714
    
    
    
    80,985Transportation operating expenses
    
    
    43,266
    
    
    
    26,645
    
    
    
    22,641Interest expense
    
    
    5,169
    
    
    
    3,742
    
    
    
    3,849Total
    
    
    706,737
    
    
    
    687,955
    
    
    
    617,967Income Before Federal Income Tax and Cumulative
Effect of Change in Accounting Principle
    
    
    77,104
    
    
    
    30,232
    
    
    
    25,741Provision for Federal Income Tax
    
    
    22,866
    
    
    
    6,956
    
    
    
    5,437Income Before Cumulative Effect of Change in Accounting Principle
    
    
    54,238
    
    
    
    23,276
    
    
    
    20,304Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    
    
    
    
    (1,463
    )Net Income
    
    $
    54,238
    
    
    $
    23,276
    
    
    $
    18,841Basic Earnings (Losses) Per Share of Common Stock:Income Before Cumulative Effect of Change in Accounting Principle
    
    $
    2.91
    
    
    $
    1.34
    
    
    $
    1.17Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    
    
    
    
    (0.08
    )Total
    
    $
    2.91
    
    
    $
    1.34
    
    
    $
    1.09Diluted Earnings (Losses) Per Share of Common Stock:Income Before Cumulative Effect of Change in Accounting Principle
    
    $
    2.83
    
    
    $
    1.30
    
    
    $
    1.14Cumulative Effect of Change in Accounting Principle
    
    
    
    
    
    
    
    
    
    
    (0.08
    )Total
    
    $
    2.83
    
    
    $
    1.30
    
    
    $
    1.06
 See notes to consolidated financial statements. 32THE MIDLAND COMPANY




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##### 



CONSOLIDATED BALANCE SHEETS THE MIDLAND COMPANY AND SUBSIDIARIES December 31,(Amounts in thousands)
    
    2004
    
    
    2003ASSETSMarketable Securities:Fixed income (amortized cost, $745,514 in 2004 and $643,735 in 2003)
    
    $
    770,639
    
    
    $
    671,454Equity (cost, $109,851 in 2004 and $87,998 in 2003)
    
    
    200,799
    
    
    
    174,868Total
    
    
    971,438
    
    
    
    846,322Cash
    
    
    6,858
    
    
    
    2,386Accounts Receivable Net
    
    
    113,979
    
    
    
    94,008Reinsurance Recoverables and Prepaid Reinsurance Premiums
    
    
    87,726
    
    
    
    70,990Property, Plant and Equipment Net
    
    
    68,312
    
    
    
    69,328Deferred Insurance Policy Acquisition Costs
    
    
    90,423
    
    
    
    87,873Other Assets
    
    
    25,948
    
    
    
    21,309Total Assets
    
    $
    1,364,684
    
    
    $
    1,192,216LIABILITIES AND SHAREHOLDERS EQUITYUnearned Insurance Premiums
    
    $
    390,447
    
    
    $
    383,869Insurance Loss Reserves
    
    
    232,915
    
    
    
    204,833Insurance Commissions Payable
    
    
    45,374
    
    
    
    30,522Funds Held Under Reinsurance Agreements and Reinsurance Payables
    
    
    11,465
    
    
    
    6,978Long-Term Debt
    
    
    58,729
    
    
    
    62,217Notes Payable
    
    
    33,177
    
    
    
    33,625Deferred Federal Income Tax
    
    
    47,604
    
    
    
    47,429Other Payables and Accruals
    
    
    88,697
    
    
    
    66,685Junior Subordinated Debentures
    
    
    24,000
    
    
    
    Total Liabilities
    
    
    932,408
    
    
    
    836,158Commitments and Contingencies
    
    
    
    
    
    
    Shareholders Equity:Common stock (issued and outstanding: 18,807 shares at December 31 , 2004
and 17,643 shares at December 31 , 2003 after deducting treasury stock
of 4,199 shares and 4,213 shares, respectively)
    
    
    959
    
    
    
    911Additional paid-in capital
    
    
    51,184
    
    
    
    23,406Retained earnings
    
    
    350,141
    
    
    
    299,752Accumulated other comprehensive income
    
    
    73,027
    
    
    
    73,455Treasury stock (at cost)
    
    
    (43,035
    )
    
    
    (41 ,442
    )Unvested restricted stock awards
    
    
    
    
    
    
    (24
    )Total Shareholders Equity
    
    
    432,276
    
    
    
    356,058Total Liabilities and Shareholders Equity
    
    $
    1,364,684
    
    
    $
    1,192,216
 See notes to consolidated financial statements. THE MIDLAND COMPANY 33




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##### 



CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY THE MIDLAND COMPANY AND SUBSIDIARIES (Amounts in thousands)
    
    Years Ended December 31, 2004, 2003 and 2002Accumulated
    
    
    
    
    
    
    UnvestedAdditional
    
    
    
    
    
    
    Other
    
    
    
    
    
    
    Restricted
    
    
    
    
    
    
    Compre-Common
    
    
    Paid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    Treasury
    
    
    Stock
    
    
    
    
    
    
    hensiveStock
    
    
    Capital
    
    
    Earnings
    
    
    Income
    
    
    Stock
    
    
    Awards
    
    
    Total
    
    
    IncomeBalance, December 31, 2001
    
    $
    911
    
    
    $
    20,386
    
    
    $
    264,057
    
    
    $
    45,875
    
    
    $
    (38,698
    )
    
    $
    (655
    )
    
    $
    291,876Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    18,841
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,841
    
    
    $
    18,841Increase in unrealized gain on
marketable securities, net of
related income tax effect of $2,117
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,379
    
    
    
    
    
    
    
    
    
    
    
    3,379
    
    
    
    3,379Other, net of federal income tax of $906
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,681
    )
    
    
    
    
    
    
    
    
    
    
    (1,681
    )
    
    
    (1,681
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    20,539Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,893
    )
    
    
    
    
    
    
    (3,893
    )Issuance of treasury stock
for options exercised and
other employee benefit plans
    
    
    
    
    
    
    627
    
    
    
    
    
    
    
    
    
    
    
    1,049
    
    
    
    
    
    
    
    1,676Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (3,072
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,072
    )Federal income tax benefit related to the
exercise or granting of stock awards
    
    
    
    
    
    
    1,570
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,570Amortization and cancellation of
unvested restricted stock awards
    
    
    
    
    
    
    (67
    )
    
    
    
    
    
    
    
    
    
    
    (63
    )
    
    
    342
    
    
    
    212Balance, December 31, 2002
    
    
    911
    
    
    
    22,516
    
    
    
    279,826
    
    
    
    47,573
    
    
    
    (41,605
    )
    
    
    (313
    )
    
    
    308,908Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    23,276
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,276
    
    
    $
    23,276Increase in unrealized gain on
marketable securities, net of
related income tax effect of $13,601
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,237
    
    
    
    
    
    
    
    
    
    
    
    25,237
    
    
    
    25,237Other, net of federal income
tax of $347
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    645
    
    
    
    
    
    
    
    
    
    
    
    645
    
    
    
    645Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    49,158Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,133
    )
    
    
    
    
    
    
    (1,133
    )Issuance of treasury stock
for options exercised and
other employee benefit plans
    
    
    
    
    
    
    714
    
    
    
    
    
    
    
    
    
    
    
    1,301
    
    
    
    
    
    
    
    2,015Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (3,350
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,350
    )Federal income tax benefit related to the
exercise or granting of stock awards
    
    
    
    
    
    
    182
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    182Amortization and cancellation of
unvested restricted stock awards
    
    
    
    
    
    
    (6
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    289
    
    
    
    278Balance, December 31, 2003
    
    
    911
    
    
    
    23,406
    
    
    
    299,752
    
    
    
    73,455
    
    
    
    (41,442
    )
    
    
    (24
    )
    
    
    356,058Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    54,238
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    54,238
    
    
    $
    54,238Increase in unrealized gain on
marketable securities, net of
related income tax effect of $518
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    966
    
    
    
    
    
    
    
    
    
    
    
    966
    
    
    
    966Other, net of federal income
tax of $750
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,394
    )
    
    
    
    
    
    
    
    
    
    
    (1,394
    )
    
    
    (1,394
    )Total comprehensive income
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    53,810Common stock issuance
    
    
    48
    
    
    
    25,022
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,070Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,918
    )
    
    
    
    
    
    
    (2,918
    )Issuance of treasury stock
for options exercised and
other employee benefit plans
    
    
    
    
    
    
    1,642
    
    
    
    
    
    
    
    
    
    
    
    1,325
    
    
    
    
    
    
    
    2,967Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (3,849
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,849
    )Federal income tax benefit related to the
exercise or granting of stock awards
    
    
    
    
    
    
    1,114
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,114Amortization and cancellation of
unvested restricted stock awards
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    24
    
    
    
    24Balance, December 31, 2004
    
    $
    959
    
    
    $
    51,184
    
    
    $
    350,141
    
    
    $
    73,027
    
    
    $
    (43,035
    )
    
    $
    
    
    
    $
    432,276
 See notes to consolidated financial statements. 34THE MIDLAND COMPANY




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##### 



CONSOLIDATED STATEMENTS OF CASH FLOWS THE MIDLAND COMPANY AND SUBSIDIARIES Year Ended December 31,(Amounts in thousands)
    
    2004
    
    
    2003
    
    
    2002Cash Flows from Operating Activities:Net income
    
    $
    54,238
    
    
    $
    23,276
    
    
    $
    18,841Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    10,867
    
    
    
    9,742
    
    
    
    8,307Net realized losses (gains) from sale of investments
    
    
    (9,169
    )
    
    
    (3,767
    )
    
    
    6,680Cumulative effect of change in accounting for goodwill
    
    
    
    
    
    
    
    
    
    
    2,250Increase in insurance loss reserves
    
    
    28,082
    
    
    
    40,116
    
    
    
    16,043Increase (decrease) in other accounts payable and accruals
    
    
    20,532
    
    
    
    5,784
    
    
    
    (5,586
    )Decrease (increase) in net accounts receivable
    
    
    (19,971
    )
    
    
    8,087
    
    
    
    (7,717
    )Decrease (increase) in reinsurance recoverables
and prepaid reinsurance premiums
    
    
    (16,736
    )
    
    
    5,636
    
    
    
    (6,831
    )Increase (decrease) in insurance commissions payable
    
    
    14,852
    
    
    
    (132
    )
    
    
    3,767Increase (decrease) in unearned insurance premiums
    
    
    6,578
    
    
    
    (22,442
    )
    
    
    2,456Increase (decrease) in funds held under reinsurance
agreements and reinsurance payables
    
    
    4,487
    
    
    
    4,001
    
    
    
    (3,320
    )Increase in other assets
    
    
    (4,315
    )
    
    
    (2,788
    )
    
    
    (805
    )Decrease (increase) in deferred insurance policy acquisition costs
    
    
    (2,550
    )
    
    
    8,523
    
    
    
    4,389Provision (benefit) for deferred federal income tax
    
    
    407
    
    
    
    (2,162
    )
    
    
    2,828Other  net
    
    
    1,604
    
    
    
    3,075
    
    
    
    1,236Net cash provided by operating activities
    
    
    88,906
    
    
    
    76,949
    
    
    
    42,538Cash Flows from Investing Activities:Purchase of marketable securities
    
    
    (617,105
    )
    
    
    (509,516
    )
    
    
    (305,731
    )Sale of marketable securities
    
    
    407,729
    
    
    
    333,637
    
    
    
    243,363Maturity of marketable securities
    
    
    76,946
    
    
    
    86,626
    
    
    
    58,772Decrease (increase) in cash equivalent marketable securities
    
    
    15,992
    
    
    
    22,089
    
    
    
    (34,774
    )Acquisition of property, plant and equipment
    
    
    (11,699
    )
    
    
    (15,019
    )
    
    
    (10,667
    )Proceeds from sale of property, plant and equipment
    
    
    2,243
    
    
    
    517
    
    
    
    159Net cash used in investing activities
    
    
    (125,894
    )
    
    
    (81,666
    )
    
    
    (48,878
    )Cash Flows from Financing Activities:Proceeds from common stock issuance
    
    
    25,070
    
    
    
    
    
    
    
    Issuance of junior subordinated debentures
    
    
    24,000
    
    
    
    
    
    
    
    Dividends paid
    
    
    (3,723
    )
    
    
    (3,281
    )
    
    
    (3,014
    )Issuance of treasury stock
    
    
    2,967
    
    
    
    2,015
    
    
    
    1,676Increase (decrease) in other notes payable
    
    
    (448
    )
    
    
    (9,613
    )
    
    
    7,716Issuance of long-term debt
    
    
    
    
    
    
    14,797
    
    
    
    Repayment of long-term debt
    
    
    (3,488
    )
    
    
    (1,657
    )
    
    
    (1,456
    )Purchase of treasury stock
    
    
    (2,918
    )
    
    
    (1,133
    )
    
    
    (3,893
    )Net cash provided by financing activities
    
    
    41,460
    
    
    
    1,128
    
    
    
    1,029Net Increase (Decrease) in Cash
    
    
    4,472
    
    
    
    (3,589
    )
    
    
    (5,311
    )Cash at
Beginning of Year
    
    
    2,386
    
    
    
    5,975
    
    
    
    11,286Cash at End of Year
    
    $
    6,858
    
    
    $
    2,386
    
    
    $
    5,975Interest Paid
    
    $
    4,470
    
    
    $
    3,528
    
    
    $
    3,852Income Taxes Paid
    
    $
    22,869
    
    
    $
    1,946
    
    
    $
    6,700
 In 2003, an obligation of $2,649 was incurred when the Company capitalized a lease
related to a certain piece of transportation equipment upon adoption of FASB Interpretation
No. 46. See notes to consolidated financial statements. THE MIDLAND COMPANY 35




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE MIDLAND COMPANY AND SUBSIDIARIESYears Ended December 31, 2004, 2003 and 2002 1. GENERAL INFORMATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Midland Company (the Company or Midland) operates in two industries  insurance and
transportation with the most significant business activities being in insurance. Midlands
insurance operations are conducted through its wholly-owned subsidiary, American Modern Insurance
Group, Inc. (American Modern). M/G Transport Services, Inc. and MGT Services, Inc. (collectively
M/G Transport) operates a fleet of dry cargo barges for the movement of dry bulk commodities such
as petroleum coke, ores, barite, sugar and other cargos primarily on the lower Mississippi River
and its tributaries. The accounting policies of the Company and its subsidiaries conform to accounting principles
generally accepted in the United States of America. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of America requires
management to make numerous estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. The accompanying consolidated financial statements
include estimates for items such as insurance loss reserves, income taxes, various other liability
accounts and deferred insurance policy acquisition costs. Actual results could differ from those
estimates. Policies that affect the more significant elements of the consolidated financial
statements are summarized below. Principles of ConsolidationThe consolidated financial statements include the accounts of the
Company and all subsidiary companies. Material intercompany balances and transactions have been
eliminated. Share information has been adjusted for a 2 for 1 stock split effective July 17, 2002.
Certain prior year amounts have been reclassified to conform to current year presentation. Marketable Securities Marketable securities are categorized as fixed income securities (cash
equivalents, debt instruments and preferred stocks having scheduled redemption provisions) and
equity securities (common, convertible and preferred stocks which do not have redemption
provisions). The Company classifies all fixed income and equity securities as available-for-sale
and carries such investments at market value. Unrealized gains or losses on investments, net of
related income taxes, are included in shareholders equity as an item of accumulated other
comprehensive income. Realized gains and losses on sales of investments are recognized in income on
a specific identification basis. Derivatives are valued separately and the change in market value
of the derivatives is included in Net Realized Investment Gains (Losses) on the Consolidated
Statements of Income. Available-for-sale securities are reviewed quarterly for possible other-than-temporary
impairment. The review includes an analysis of the facts and circumstances of each individual
investment such as the length of time the fair value has been below cost, the expectation for that
securitys performance, the credit worthiness of the issuer and the Companys intent to sell or its
ability to hold the security to maturity. A decline in value that is considered to be
other-than-temporary is recorded as a loss within Net Realized Investment Gains (Losses) in the
Consolidated Statements of Income. Properly and Depreciation Property, plant and equipment are recorded at cost. The Company
periodically measures fixed assets for impairment. Depreciation and
amortization are generally calculated over the estimated useful lives of the respective properties (buildings and
equipment - 15 to 35 years, furniture and equipment - 3 to
7 years, and barges - 20 years). The Company has implemented several modules and is continuing the process of developing an
information technology system for its insurance operations. The system is known as modernLINK® and
its development began in 2000 and will continue over the next several years. Certain costs that are
directly related with this system are capitalized. As components of the system are implemented and
placed into service, depreciation commences using the straight-line method of depreciation over a
four-year period. Federal Income Tax Deferred federal income taxes are recognized to reflect the net tax
effects of temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for federal income tax purposes. The Company
continually reviews deferred tax assets to determine the necessity of a valuation allowance. The Company files a consolidated federal income tax return which includes all subsidiaries. Insurance Income Premiums for physical damage and other property and casualty related
coverages, net of premiums ceded to reinsurers, are recognized as income on a pro-rata basis over
the lives of the policies. Credit accident and health and credit life premiums are recognized as
income over the lives of the policies in proportion to the amount of insurance protection provided.
The Company does not consider anticipated investment income in determining premium deficiencies (if
any) on short-term contracts. Policy acquisition costs, primarily pre-paid commission expenses and
premium taxes, are capitalized and expensed over the terms of the related policies on the same
basis as the related premiums are earned. Selling and administrative expenses that are not
primarily related to premiums written are expensed as incurred. Insurance Loss Reserves Unpaid insurance losses and loss adjustment expenses include an
amount determined from reports on individual cases and an amount, based on past experience and
other assumptions, for losses incurred but not reported. Such liabilities are necessarily based on
estimates and, while management believes that the amounts are fairly stated, the ultimate liability
may be in excess of or less than the amounts provided. The methods of making such estimates and for
establishing the resulting liabilities are continually reviewed and any adjustments resulting
therefrom are included in earnings currently. Insurance loss reserves also include an amount for
claim drafts issued but not yet paid. Allowance for Losses Provisions for losses on receivables are made in amounts deemed
necessary to maintain adequate reserves to cover probable future losses. Reinsurance In order to limit its exposure to certain levels of risks, the Company cedes
varying portions of its written premiums to other insurance companies. As such, the Company limits
its loss exposure to that portion of the insurable risk it retains. In addition, the Company pays a
percentage of earned premiums to reinsurers in return for coverage against catastrophic losses.
However, if a reinsurer fails to honor its obligations, American Modern could suffer additional
losses as the reinsurance contracts do not relieve American Modern of its obligations to
policyholders. 36THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIES American Modern and its independent reinsurance brokers regularly conduct market
security evaluations of both its current and prospective reinsurers. Such evaluations include a
complete review of each reinsurers financial condition along with an assessment of credit risk
concentrations arising from similar geographic regions, activities or economic characteristics of
the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. The
specific evaluation procedures include, but are not limited to, reviewing the periodic financial
statements and ratings assigned to each reinsurer from rating agencies such as S&P, Moodys and
A.M. Best. During 2004, more than 85% of the Companys catastrophe reinsurers had an A.M. Best or
S&P rating of A or higher. In addition, American Modern may, in some cases, require reinsurers to establish trust funds
and maintain letters of credit to further minimize possible exposures. All reinsurance amounts owed
to American Modern are current and management believes that no allowance for uncollectible accounts
related to this recoverable is necessary. Management also believes there is no significant
concentration of credit risk arising from any single reinsurer. The Company also assumes a limited amount of business on certain reinsurance contracts.
Related premiums and loss reserves are recorded based on records supplied by the ceding companies. Transportation
Revenues  Revenues for river transportation activities are recognized when
earned. If freight services are in process at the end of a reporting period, an allocation of
revenue between reporting periods is made based on relative transit time in each reporting period
with expenses recognized as incurred. Statements of Cash Flows For purposes of the statements of cash flows, the Company defines
cash as cash held in operating accounts at financial institutions. The amounts reported in the
statements of cash flows for the purchase, sale or maturity of marketable securities do not include
cash equivalents. Fair
Value of Financial Instruments  The carrying values of cash, receivables, short-term
notes payable, trade accounts payable and any financial instruments included in other assets and
accrued liabilities approximate their fair values principally because of the short-term maturities
of these instruments. Generally, the fair value of investments, including derivatives, is
considered to be the market value which is based on quoted market prices. The fair value of
long-term debt is estimated using interest rates that are currently available to the Company for
issuance of debt with similar terms and maturities. Derivative
InstrumentsThe Company accounts for its derivatives under Statement of Financial
Accounting Standard (SFAS) 133, Accounting for Derivative Instruments and Hedging Activities,
as amended. The standard requires recognition of all derivatives as either assets or liabilities in
the balance sheet and requires measurement of those instruments at fair value through adjustments
to either accumulated other comprehensive income or current earnings or both, as appropriate.
During 2002, the Company entered into a series of interest rate swaps to convert $30 million of
floating rate debt to a fixed rate. The interest rate swaps were designated as a cash flow hedge
and were deemed to be 100% effective. Thus, the changes in the fair value of the swap agreements
are recorded as a separate component of shareholders equity and have no impact on the Consolidated
Statements of Income. At December 31, 2004, 2003 and 2002, $0.3 million, $0.9 million and $1.3 million, respectively, in deferred losses, net of tax, related
to this hedge were recorded in accumulated other comprehensive income. The fair value of the
Companys interest rate swaps at December 31, 2004 and 2003 of $0.5 million and $1.4 million,
respectively, is included in Other Payables and Accruals. For the year ended December 31, 2004,
there were no cash flow hedges that were discontinued related to forecasted transactions deemed not
probable of occurring. Stock Option and Award Plans  Midland has various plans which provide for granting options
and common stock to certain employees and independent directors of the Company and its
subsidiaries. The Company accounts for compensation expense related to such transactions using the
intrinsic value based method under the provisions of Accounting Principles Board (APB) Opinion
No. 25 and its related interpretations. Midlands equity compensation plans are described more
fully in Note 14. The fair values of the 2004, 2003 and 2002 option grants were estimated on the date of the
grant using the Black Scholes option-pricing model with the following (weighted average)
assumptions: 2004
    
    
    2003
    
    
    2002Fair value of options granted
    
    $
    8.77
    
    
    $
    6.07
    
    
    $
    7.48Dividend yield
    
    
    1.0
    %
    
    
    1.1
    %
    
    
    1.2
    %Expected volatility
    
    
    31.6
    %
    
    
    31.5
    %
    
    
    29.1
    %Risk free interest rate
    
    
    3.6
    %
    
    
    3.6
    %
    
    
    4.9
    %Expected life (in years)
    
    
    7
    
    
    
    7
    
    
    
    7
 Midland
accounts for stock options using the intrinsic valuemethod, therefore no
compensation cost has been recognized for the stock option plans. Had the Company accounted for all
stock based employee compensation under the fair value method (SFAS 123), the Companys 2004, 2003
and 2002 net income and earnings per share would have been reduced to the pro forma amounts
indicated below (amounts in 000s, except per share data): 2004
    
    
    2003
    
    
    2002Net Income as Reported
    
    $
    54,238
    
    
    $
    23,276
    
    
    $
    18,841Deduct: Total stock-based
employee compensation determined
under fair value
based method for all awards,
net of related tax effects
    
    
    1,053
    
    
    
    892
    
    
    
    700Proforma Net Income
    
    $
    53,185
    
    
    $
    22,384
    
    
    $
    18,141Average shares outstandingBasic
    
    
    18,618
    
    
    
    17,417
    
    
    
    17,323Diluted
    
    
    19,190
    
    
    
    17,937
    
    
    
    17,789Earnings per shareBasic  as reported
    
    $
    2.91
    
    
    $
    1.34
    
    
    $
    1.09Basic proforma
    
    
    2.86
    
    
    
    1.29
    
    
    
    1.05Diluted  as reported
    
    $
    2.83
    
    
    $
    1.30
    
    
    $
    1.06Diluted  proforma
    
    
    2.77
    
    
    
    1.25
    
    
    
    1.02
 Compensation expense in the pro-forma disclosure is not indicative of future amounts as
options vest over several years and additional grants are generally made each year. THE MIDLAND COMPANY 37




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES New Accounting Standards In March 2004, the Financial Accounting Standards Board
(FASB) ratified the consensus reached by the Emerging Issues Task Force in Issue 03 -1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF
03-1). EITF 03-1 provides guidance for determining when an investment is considered impaired,
whether impairment is other-than-temporary, and measurement of an impairment loss. Generally, an
impairment is considered other-than-temporary unless: (a) the investor has the ability and intent
to hold an investment for a reasonable period of time sufficient for a forecasted recovery of fair
value up to (or beyond) the carrying value of the investment; and (b) evidence indicating that the
carrying value of the investment is recoverable within a reasonable period of time outweighs
evidence to the contrary. If impairment is determined to be other-than-temporary, then an
impairment loss should be recognized equal to the difference between the investments carrying
value and its fair value. In September 2004, the FASB deferred the effective date of paragraphs 10 through 20 of EITF
03-1 pending further guidance. Gross unrealized losses on available for sale securities were $1.4
million at December 31, 2004. Any other-than-temporary impairments that may possibly be recognized
upon adoption of paragraphs 10 through 20 will be dependent on market conditions and managements
intent and ability to hold any such potentially impaired securities. In December 2004, the FASB issued SFAS 123 (Revised 2004), Share-Based Payment, and is
required to be applied as of the first interim or annual reporting period that begins after June
15, 2005. The revised statement (SFAS No. 123(R)) requires compensation cost relating to
share-based payment transactions to be recognized in a companys financial statements under the
fair value method. SFAS No. 123(R) replaces FASB Statement 123 Accounting for Stock-Based
Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees.
Midland is currently assessing the transition to SFAS 123(R) and does not expect its impact in 2005
to be significantly greater than the 2004 pro forma amounts. The FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, SFAS
No. 152, Accounting for Real Estate Time Sharing Transactions, an amendment of FASB Statements No.
66 and 67, and SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29
during 2004, all of which are effective for fiscal years beginning after June 15, 2005. The
adoption of these statements will not have a material impact on Midlands consolidated financial
position or results of operations. ReclassificationsCertain prior period amounts have been reclassified to conform to the
current years classification. 2. MARKETABLE SECURITIES Thousands of DollarsCost orAmortized
    
    
    Gross Unrealized
    
    
    
    Fair2004
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    
    ValueDebt Securities:Governments
    
    $
    102,121
    
    
    $
    2,335
    
    
    $
    145
    
    
    $
    104,311Mortgage Backed
    
    
    181,083
    
    
    
    2,540
    
    
    
    449
    
    
    
    183,174Municipals
    
    
    231,450
    
    
    
    9,073
    
    
    
    261
    
    
    
    240,262Corporates
    
    
    181,344
    
    
    
    12,206
    
    
    
    174
    
    
    
    193,376Cash Equivalents
    
    
    35,242
    
    
    
    
    
    
    
    
    
    
    
    35,242Other  Notes
Receivable
    
    
    5,800
    
    
    
    
    
    
    
    
    
    
    
    5,800Accrued Interest
    
    
    8,474
    
    
    
    
    
    
    
    
    
    
    
    8,474Total
    
    
    745,514
    
    
    
    26,154
    
    
    
    1,029
    
    
    
    770,639Equity Securities
    
    
    106,453
    
    
    
    91,343
    
    
    
    395
    
    
    
    197,401Derivatives
    
    
    2,451
    
    
    
    
    
    
    
    
    
    
    
    2,451Accrued Dividends
    
    
    947
    
    
    
    
    
    
    
    
    
    
    
    947Total
    
    
    109,851
    
    
    
    91,343
    
    
    
    395
    
    
    
    200,799Total Marketable
Securities
    
    $
    855,365
    
    
    $
    117,497
    
    
    $
    1,424
    
    
    $
    971,438
 Thousands of DollarsCost orAmortized
    
    
    Gross Unrealized
    
    
    
    Fair2003
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    
    ValueDebt Securities:Governments
    
    $
    63,112
    
    
    $
    2,066
    
    
    $
    104
    
    
    $
    65,074Mortgage Backed
    
    
    171,996
    
    
    
    3,715
    
    
    
    327
    
    
    
    175,384Municipals
    
    
    177,973
    
    
    
    10,845
    
    
    
    230
    
    
    
    188,588Corporates
    
    
    166,119
    
    
    
    12,086
    
    
    
    332
    
    
    
    177,873Cash Equivalents
    
    
    51,234
    
    
    
    
    
    
    
    
    
    
    
    51,234OtherNotes
Receivable
    
    
    6,209
    
    
    
    
    
    
    
    
    
    
    
    6,209Accrued Interest
    
    
    7,092
    
    
    
    
    
    
    
    
    
    
    
    7,092Total
    
    
    643,735
    
    
    
    28,712
    
    
    
    993
    
    
    
    671,454Equity
Securities
    
    
    85,543
    
    
    
    87,798
    
    
    
    928
    
    
    
    172,413Derivatives
    
    
    1,687
    
    
    
    
    
    
    
    
    
    
    
    1,687Accrued Dividends
    
    
    768
    
    
    
    
    
    
    
    
    
    
    
    768Total
    
    
    87,998
    
    
    
    87,798
    
    
    
    928
    
    
    
    174,868Total Marketable
Securities
    
    $
    731,733
    
    
    $
    116,510
    
    
    $
    1,921
    
    
    $
    846,322
 At December 31, 2004 and 2003, the fair value of the Companys investment in the common
stock of US Bancorp, which exceeded 10% of the Companys shareholders equity, was $77.1 million
and $73.3 million, respectively. Also, at December 31, 2004 and 2003, the market value of the
Companys investment portfolio includes approximately $48.6 million and $49.2 million,
respectively, of convertible securities, some of which contain derivatives features. 38THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIES The following is investment information
summarized by investment category (amounts in
000s): 2004
    
    
    2003
    
    
    2002Investment Income:Interest on Fixed
Income Securities
    
    $
    32,523
    
    
    $
    28,714
    
    
    $
    31,274Dividends on
Equity Securities
    
    
    6,547
    
    
    
    6,095
    
    
    
    6,080Investment Expense
    
    
    (1,905
    )
    
    
    (1,530
    )
    
    
    (1,455
    )Net Investment Income
    
    $
    37,165
    
    
    $
    33,279
    
    
    $
    35,899Net Realized Investment Gains (Losses):Fixed Income:Gross Realized Gains
    
    $
    5,121
    
    
    $
    8,172
    
    
    $
    6,333Gross Realized Losses:Other-than-temporary
impairments
    
    
    
    
    
    
    
    
    
    
    (2,725
    )All other
    
    
    (2,109
    )
    
    
    (2,487
    )
    
    
    (4,934
    )Total gross
realized losses
    
    
    (2,109
    )
    
    
    (2,487
    )
    
    
    (7,659
    )Equity Securities:Gross Realized Gains
    
    
    10,962
    
    
    
    3,996
    
    
    
    3,414Gross Realized Losses:Other-than-temporary
impairments
    
    
    
    
    
    
    (1,898
    )
    
    
    (1,914
    )All other
    
    
    (4,041
    )
    
    
    (3,217
    )
    
    
    (7,074
    )Total gross
realized losses
    
    
    (4,041
    )
    
    
    (5,115
    )
    
    
    (8,988
    )Net Realized Investment
Gains (Losses)
    
    $
    9,933
    
    
    $
    4,566
    
    
    $
    (6,900
    )Change in Unrealized
Investment Gains (Losses):Fixed Income
    
    $
    (2,594
    )
    
    $
    (433
    )
    
    $
    15,556Equity Securities
    
    
    4,078
    
    
    
    39,271
    
    
    
    (10,060
    )Change in UnrealizedInvestment Gains (Losses)
    
    $
    1,484
    
    
    $
    38,838
    
    
    $
    5,496
 Included in Net Realized Investment Gains (Losses)
for 2004, 2003 and 2002 is the change in the fair value
of derivative features of (amounts in 000s) $764, $799
and $(220) respectively. The cost or amortized cost and approximate fair
value of debt securities held at December 31, 2004,
summarized by contractual maturities, are shown below.
Actual maturities may differ from contractual
maturities when there exists a right to call or prepay
obligations with or without call or prepayment
penalties (amounts in 000s). Cost orAmortized
    
    
    FairCost
    
    
    ValueOne year or less
    
    $
    39,802
    
    
    $
    40,038After one year through five years
    
    
    201,634
    
    
    
    207,913After five years through ten years
    
    
    221,614
    
    
    
    233,053After 10 years
    
    
    282,464
    
    
    
    289,635Total
    
    $
    745,514
    
    
    $
    770,639
 The Companys fixed income portfolio primarily
consists of high quality investment grade securities
and has an AA Standard & Poors average quality
rating at December 31, 2004. The Company performs
quarterly comprehensive reviews of individual fixed
income and equity portfolio holdings that have a market
value less than their respective carrying value. The
Company, with the assistance of its external
professional money managers, applies both quantitative
and qualitative criteria in its evaluation of possible
other-than-temporary impairment, including facts
specific to each individual investment, including, but
not limited to, the length of time the fair value has
been below carrying value, the extent of the decline,
the Companys intent to hold or sell the security, the
expectation for each securitys performance as well as
prospects for recovery, the credit worthiness and
related liquidity of the issuer and the issuers
business sector. The following table shows the Companys
investments gross unrealized losses and fair value,
aggregated by investment category and length of time
that individual securities have been in a continuous
unrealized loss position, at December 31, 2004 and 2003
(amounts in 000s). 2004
    
    Less Than 12 MonthsFair
    
    
    Unrealized
    
    
    NumberValue
    
    
    Losses
    
    
    SecuritiesGovernments
    
    $
    29,708
    
    
    $
    145
    
    
    
    24Mortgage backed
    
    
    57,896
    
    
    
    331
    
    
    
    44Municipals
    
    
    33,139
    
    
    
    232
    
    
    
    33Corporates
    
    
    20,193
    
    
    
    174
    
    
    
    30Total Debt Securities
    
    
    140,936
    
    
    
    882
    
    
    
    131Equity Securities
    
    
    12,531
    
    
    
    395
    
    
    
    33Total
    
    $
    153,467
    
    
    $
    1,277
    
    
    
    164
 12 Months or MoreFair
    
    
    Unrealized
    
    
    NumberValue
    
    
    Losses
    
    
    SecuritiesGovernments
    
    $
    
    
    
    $
    
    
    
    
    Mortgage backed
    
    
    2,645
    
    
    
    118
    
    
    
    7Municipals
    
    
    1,004
    
    
    
    29
    
    
    
    2Corporates
    
    
    
    
    
    
    
    
    
    
    Total Debt Securities
    
    
    3,649
    
    
    
    147
    
    
    
    9Equity Securities
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    3,649
    
    
    $
    147
    
    
    
    9
 TotalFair
    
    
    Unrealized
    
    
    NumberValue
    
    
    Losses
    
    
    SecuritiesGovernments
    
    $
    29,708
    
    
    $
    145
    
    
    
    24Mortgage backed
    
    
    60,541
    
    
    
    449
    
    
    
    51Municipals
    
    
    34,143
    
    
    
    261
    
    
    
    35Corporates
    
    
    20,193
    
    
    
    174
    
    
    
    30Total Debt Securities
    
    
    144,585
    
    
    
    1,029
    
    
    
    140Equity Securities
    
    
    12,531
    
    
    
    395
    
    
    
    33Total
    
    $
    157,116
    
    
    $
    1,424
    
    
    
    173
 THE MIDLAND COMPANY 39




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES 2003
    
    Less Than 12 MonthsFair
    
    
    Unrealized
    
    
    NumberValue
    
    
    Losses
    
    
    SecuritiesGovernments
    
    $
    6,953
    
    
    $
    105
    
    
    
    10Mortgage backed
    
    
    27,820
    
    
    
    322
    
    
    
    28Municipals
    
    
    10,171
    
    
    
    230
    
    
    
    10Corporates
    
    
    11,494
    
    
    
    219
    
    
    
    23Total Debt Securities
    
    
    56,438
    
    
    
    876
    
    
    
    71Equity Securities
    
    
    4,163
    
    
    
    206
    
    
    
    16Total
    
    $
    60,601
    
    
    $
    1,082
    
    
    
    87
 12 Months or MoreFair
    
    
    Unrealized
    
    
    NumberValue
    
    
    Losses
    
    
    SecuritiesGovernments
    
    $
    
    
    
    $
    
    
    
    
    Mortgage backed
    
    
    
    
    
    
    
    
    
    
    Municipals
    
    
    
    
    
    
    
    
    
    
    Corporates
    
    
    1,159
    
    
    
    117
    
    
    
    3Total Debt Securities
    
    
    1,159
    
    
    
    117
    
    
    
    3Equity Securities
    
    
    5,670
    
    
    
    722
    
    
    
    17Total
    
    $
    6,829
    
    
    $
    839
    
    
    
    20
 TotalFair
    
    
    Unrealized
    
    
    NumberValue
    
    
    Losses
    
    
    SecuritiesGovernments
    
    $
    6,953
    
    
    $
    105
    
    
    
    10Mortgage backed
    
    
    27,820
    
    
    
    322
    
    
    
    28Municipals
    
    
    10,171
    
    
    
    230
    
    
    
    10Corporates
    
    
    12,653
    
    
    
    336
    
    
    
    26Total Debt Securities
    
    
    57,597
    
    
    
    993
    
    
    
    74Equity Securities
    
    
    9,833
    
    
    
    928
    
    
    
    33Total
    
    $
    67,430
    
    
    $
    1,921
    
    
    
    107
 3. ACCOUNTS RECEIVABLENET Accounts receivable at December 31, 2004 and
2003 are generally due within one year and consist of the
following (amounts in 000s): 2004
    
    
    2003Insurance
    
    $
    98,393
    
    
    $
    85,259Transportation
    
    
    8,544
    
    
    
    4,104Other
    
    
    7,868
    
    
    
    5,471Total
    
    
    114,805
    
    
    
    94,834Less Allowance for Losses
    
    
    826
    
    
    
    826Accounts ReceivableNet
    
    $
    113,979
    
    
    $
    94,008
 4. PROPERTY, PLANT AND EQUIPMENTNET At December 31, 2004 and 2003, property, plant
and equipment stated at original cost consist of the
following (amounts in 000s): 2004
    
    
    2003Land
    
    $
    1,491
    
    
    $
    1,341Buildings, Improvements,
Fixtures, etc.
    
    
    65,341
    
    
    
    66,487Transportation Equipment
    
    
    41,074
    
    
    
    45,625Software Development
    
    
    18,677
    
    
    
    12,909Total
    
    
    126,583
    
    
    
    126,362Less Accumulated Depreciation
and Amortization
    
    
    58,271
    
    
    
    57,034Property, Plant and
EquipmentNet
    
    $
    68,312
    
    
    $
    69,328
 Total rent expense related to the rental of
equipment included in the accompanying Consolidated
Statements of Income is (amounts in 000s) $3,756 in
2004, $4,889 in 2003 and $5,839 in 2002. Future rentals
under non-cancelable operating leases are approximately
(amounts in 000s): $1,232  2005; $871  2006; $854 
2007; $602  2008; $566 in 2009 and $3,016 
thereafter. The Company acquired 30 new and 27 used
barges in 2003 at a total cost of $9.4 million and
acquired 37 used barges in 2004 at a cost of $2.1
million. The Company also has a commitment of $9.9
million for certain transportation equipment in 2005. Depreciation expense recorded in 2004, 2003 and
2002 was (amounts in 000s): $10,043, $8,956 and
$8,093, respectively. As of December 31, 2004 and 2003, the
unamortized balance of modernLINKs software
development costs was $9.9 million and $8.8
million, respectively. 5. DEFERRED INSURANCE POLICY ACQUISITION COSTS Acquisition costs incurred and capitalized
during 2004, 2003 and 2002 amounted to $203.7
million, $169.1 million and $165.1 million,
respectively. Amortization of deferred acquisition
costs was $201.2 million, $177.6 million and $169.5
million for 2004, 2003 and 2002, respectively. 6. GOODWILL On January 1, 2002 Midland adopted SFAS No.
142, Goodwill and Other Intangible Assets. SFAS No.
142 changed the accounting for goodwill from an
amortization method to the impairment approach. Upon
the adoption of the statement, Midland ceased
amortizing goodwill, including goodwill recorded from
past business combinations. As a result of the initial
impairment test, Midland recorded an impairment charge
of $(1.5) million, net of tax of $787,000, or $(0.08)
per share (diluted), in its Other Insurance segment in
the first quarter of 2002. This charge is reported
separately in the income statement as a Cumulative
Effect of Change in Accounting Principle. The fair
value of that reporting unit was estimated using the
expected present value of future cash flows. There were
no additional impairment charges incurred in 2002, 2003
or 2004 as a result of the Companys impairment review.
As of December 31, 2004, the remaining goodwill
balance, all of which is attributable to the Other
Insurance segment, was $2.1 million and is included in
Other Assets. 40THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIES 7. NOTES PAYABLE The Company had conventional lines of credit
with commercial banks of $79 million and $75 million
with $29 million and $30 million in use under these
agreements at December 31, 2004 and 2003,
respectively. Borrowings under these lines of credit
constitute senior debt. Total commercial paper debt
outstanding at December 31, 2004 and 2003 was $4.2
million and $3.6 million, respectively. The aforementioned notes payable, together with

outstanding commercial paper, had weighted average
interest rates of 2.80% and 1.47% at December 31, 2004
and 2003, respectively. 8. LONG-TERM DEBT Long-term debt at December 31, 2004 and
2003 is summarized as follows (amounts in
000s): 2004
    
    
    2003Equipment Obligations, Due Through9.19%
    
    June 20, 2007
    
    
    
    
    
    $
    1,9144.89%
    
    August 13, 2008
    
    $
    6,744
    
    
    
    7,3505.12%
    
    December 11, 2008
    
    
    1,197
    
    
    
    1,300Mortgage Notes, Due Through6.83%
    
    December 20, 2005
    
    
    14,788
    
    
    
    15,653Unsecured Notes Under a
$72 million Credit Facility*5.57%
    
    December 1, 2008
    
    
    30,000
    
    
    
    30,0003.40%
    
    December 1, 2008
    
    
    6,000
    
    
    
    6,000Total Obligations
    
    
    
    
    58,729
    
    
    
    62,217Current Maturities
    
    
    
    
    15,532
    
    
    
    1,574Non Current Portion
    
    
    
    $
    43,197
    
    
    $
    60,643
   *
    
    In 2002, an interest rate swap agreement was entered into with a consortium of three
banks. This agreement fixed the interest rate of this credit facility at 5.57% for the
term of the agreement. The fair value of this agreement as of December 31, 2004 and 2003
was $(0.4) and $(1.4) million, respectively, and is included in Other Payables and
accruals. Equipment and real estate obligations are
collateralized by transportation equipment and real
estate with a net book value of $31.5 million at
December 31, 2004. The aggregate amount of repayment
requirements on long-term debt for the five years
subsequent to 2004 are (amounts in 000s): 2005 
$15,532; 2006  $782; 2007  $821; 2008  $41,594
and 2009  $0. At December 31, 2004 and 2003, the carrying value
of the Companys long-term debt, excluding the fair
value of the interest rate swap agreement disclosed
separately above, approximated its fair value. 9. JUNIOR SUBORDINATED DEBENTURES Wholly-owned subsidiary trusts of Midland have
issued preferred trust securities and, in turn,
purchased a like amount of subordinated debt which
provides interest and principal payments to fund the
trusts obligations. The preferred trust securities are
mandatorily redeemable upon maturity or redemption of
the subordinated debt and are an obligation of Midland.
The interest rate related to these securities is based
on the 90 day LIBOR rate plus 3.5%, not to exceed 12.5%
through the optional redemption dates in April and May
2009, respectively. The interest rate was 5.8% at
December 31, 2004. The junior subordinated debentures
outstanding at December 31, 2004 are due in 2034. They
consist of $12 million issued in April 2004 and $12
million issued in May 2004 that are redeemable at the
Companys option any time after April and May 2009,
respectively. 10. FEDERAL INCOME TAX The provision for federal income tax is summarized as follows (amounts in 000s): 2004
    
    
    2003
    
    
    2002Current provision
    
    $
    22,459
    
    
    $
    9,118
    
    
    $
    2,609Deferred provision (benefit)
    
    
    407
    
    
    
    (2,162
    )
    
    
    2,828Total
    
    $
    22,866
    
    
    $
    6,956
    
    
    $
    5,437
 The federal income tax provision for the years
ended December 31, 2004, 2003 and 2002 is different
from amounts derived by applying the statutory tax
rates to income before federal income tax as follows
(amounts in 000s): 2004
    
    
    2003
    
    
    2002Federal income tax at
statutory rate
    
    $
    26,986
    
    
    $
    10,581
    
    
    $
    9,009Tax effect of:Tax exempt interest
and excludable
dividend income
    
    
    (4,401
    )
    
    
    (3,762
    )
    
    
    (3,925
    )Othernet
    
    
    281
    
    
    
    137
    
    
    
    353Provision for
federal income tax
    
    $
    22,866
    
    
    $
    6,956
    
    
    $
    5,437
 THE MIDLAND COMPANY 41




---



##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES Significant components of the Companys
net deferred federal income tax liability are
summarized as follows (amounts in 000s): 2004
    
    
    2003Deferred tax liabilities:Deferred insurance policy
acquisition costs
    
    $
    28,850
    
    
    $
    27,592Unrealized gain on
marketable securities
    
    
    40,615
    
    
    
    40,097Accelerated depreciation
    
    
    9,315
    
    
    
    9,591Other
    
    
    4,294
    
    
    
    3,605Subtotal
    
    
    83,074
    
    
    
    80,885Deferred tax assets:Unearned insurance premiums
    
    
    23,997
    
    
    
    23,028Pension expense
    
    
    919
    
    
    
    636Insurance loss reserves
    
    
    5,048
    
    
    
    4,377Other
    
    
    5,506
    
    
    
    5,415Subtotal
    
    
    35,470
    
    
    
    33,456Deferred federal income tax
    
    $
    47,604
    
    
    $
    47,429
 For 2004, 2003 and 2002,
$1,114, $182 and $1,570, respectively, of income tax benefits applicable to deductible
compensation related to stock options exercised and restricted stock issued
were credited to shareholders equity. 11. REINSURANCE Premium income in the accompanying
consolidated statements of income include
approximately (amount in 000s) $54,088, $56,184 and
$82,978 of earned premiums on assumed business and is
net of approximately $69,444, $62,677, and $53,087 of
earned premiums on ceded business for 2004, 2003, and
2002, respectively. Written premiums consist of the
following (amount in 000s): 2004
    
    
    2003
    
    
    2002Direct
    
    $
    680,061
    
    
    $
    630,859
    
    
    $
    565,556Assumed
    
    
    74,420
    
    
    
    49,233
    
    
    
    69,465Ceded
    
    
    (69,576
    )
    
    
    (51,445
    )
    
    
    (61,683
    )Net
    
    $
    684,905
    
    
    $
    628,647
    
    
    $
    573,338
 The net earned premium for the property and
casualty group for 2004, 2003 and 2002 was $661,579,
$623,971 and $565,676, respectively. The amounts of recoveries pertaining to property
and casualty reinsurance contracts that were deducted
from losses incurred during 2004, 2003 and 2002 were
(amounts in 000s): $38,295, $23,151 and $10,317,
respectively. 12. INSURANCE LOSS RESERVES Activity in the liability for unpaid insurance
losses and loss adjustment expenses (excluding claim
checks issued but not yet paid) for the property and
casualty companies is summarized as follows (amounts in
000s): 2004
    
    
    2003
    
    
    2002Balance at January 1
    
    $
    169,931
    
    
    $
    131,703
    
    
    $
    122,167Less reinsurance
recoverables
    
    
    20,453
    
    
    
    16,119
    
    
    
    19,309Net balance
at January 1
    
    
    149,478
    
    
    
    115,584
    
    
    
    102,858Incurred related to:Current year
    
    
    359,504
    
    
    
    374,580
    
    
    
    343,600Prior years
    
    
    (17,551
    )
    
    
    12,031
    
    
    
    (8,371
    )Total incurred
    
    
    341,953
    
    
    
    386,611
    
    
    
    335,229Paid related to:Current year
    
    
    257,061
    
    
    
    281,731
    
    
    
    268,343Prior years
    
    
    68,068
    
    
    
    70,986
    
    
    
    54,160Total paid
    
    
    325,129
    
    
    
    352,717
    
    
    
    322,503Net balance at
December 31
    
    
    166,302
    
    
    
    149,478
    
    
    
    115,584Plus reinsurance
recoverables
    
    
    31,364
    
    
    
    20,453
    
    
    
    16,119Balance at December 31
    
    $
    197,666
    
    
    $
    169,931
    
    
    $
    131,703
 The $17.6 million of favorable loss development
in 2004 was due primarily to claims settling in 2004
for less than the case basis reserve amounts recorded
at the end of 2003. The manufactured housing and
discontinued commercial liability products accounted
for approximately 50% of this favorable development
with the remainder spread out over various insurance
products. During 2003, the Company incurred losses of
$12.0 million related to prior years. The $12.0
million of adverse development pertaining to years
prior to 2003 is attributable to claims that had been
incurred in prior years but reported for the first
time in 2003. These claims were concentrated in our
previously exited commercial liability product. During
2002, the Company experienced favorable development of
$8.4 million related to its loss reserves recorded at
the end of 2001. This favorable development was due to
various insurance products and related to both case
basis reserve development and claims incurred prior to
2002 but reported for the first time in 2002. 42THE MIDLAND COMPANY




---



##### 



THE MIDLAND COMPANY AND SUBSIDIARIES 2004
    
    
    2003
    
    
    2002Property and Casualty
Gross Loss Reserves
    
    $
    197,664
    
    
    $
    169,931
    
    
    $
    131,703Life and Other
Gross Loss Reserves
    
    
    13,434
    
    
    
    12,147
    
    
    
    11,214Outstanding Checks
and Drafts
    
    
    21,817
    
    
    
    22,755
    
    
    
    21,800Consolidated Gross
Loss Reserves
    
    $
    232,915
    
    
    $
    204,833
    
    
    $
    164,717
 Loss reserves, net of reinsurance, for Life and
Other totaled $6.9 million, $6.8 million and $6.3
million at December 31, 2004, 2003 and 2002
respectively. 13. BENEFIT PLANS The Company has a qualified defined benefit
pension plan which provides for the payment of annual
benefits to participants upon retirement. Such benefits
are based on years of service and the participants
highest compensation during five consecutive years of
employment. The Companys funding policy is to
contribute annually an amount sufficient to satisfy
ERISA funding requirements. Contributions are intended
to provide not only for benefits attributed to service
to date but also for benefits expected to be earned in
the future. During 2000, the participants of the
qualified pension plan were given a one-time election
to opt out of the qualified pension plan and enroll in
a qualified self-directed defined contribution
retirement plan. All employees hired subsequent to that
election are automatically enrolled in the qualified
self-directed defined contribution retirement plan. The
Company contributed $1.9 million, $2.0 million and $1.8
million to the qualified self-directed retirement plan
for the years 2004, 2003 and 2002, respectively. The Company has a qualified 401(k) savings plan, a
funded non-qualified savings plan and a funded
non-qualified self-directed retirement plan. The
Company contributed (amounts in 000s) $1,118, $960 and
$908 to the qualified 401(k) savings plan and $228,
$211 and $182 to the non-qualified savings plan for the
years 2004, 2003 and 2002, respectively. The Company also has an unfunded non-qualified
defined benefit pension plan. The Company uses a measurement date of December 31
for its pension plans. The following tables include amounts related
to both the qualified and non-qualified defined
benefit pension plans (amounts in 000s except for
percentages): 2004
    
    
    2003Change in benefit obligation:Benefit obligation at beginning of year
    
    $
    23,716
    
    
    $
    21,638Service cost
    
    
    804
    
    
    
    757Interest cost
    
    
    1,500
    
    
    
    1,455Actuarial loss
    
    
    2,610
    
    
    
    696Benefits paid
    
    
    (940
    )
    
    
    (830
    )Benefit obligation at end of year
(accumulated benefit obligation of
$23,099 and $19,031,respectively)
    
    $
    27,690
    
    
    $
    23,716Change in plan assets:Fair value of plan assets
at beginning of year
    
    $
    18,715
    
    
    $
    16,504Actual return on plan assets
    
    
    1,011
    
    
    
    2,455Employer contributions
    
    
    7
    
    
    
    586Benefits paid
    
    
    (940
    )
    
    
    (830
    )Fair value of plan assets at end of year
    
    $
    18,793
    
    
    $
    18,715Funded status:Funded status at end of year
    
    $
    (8,897
    )
    
    $
    (5,001
    )Unrecognized net actuarial loss
    
    
    7,898
    
    
    
    4,756Unrecognized prior service cost
    
    
    333
    
    
    
    364Unrecognized net transition
obligation (asset)
    
    
    
    
    
    
    (72
    )Prepaid (accrued) benefit cost
    
    $
    (666
    )
    
    $
    47Amounts recognized in the
Consolidated Balance Sheets
consist of:Prepaid benefit cost
    
    $
    
    
    
    $
    495Accrued benefit cost
    
    
    (666
    )
    
    
    (448
    )Additional minimum liability
    
    
    (3,640
    )
    
    
    (168
    )Intangible asset
    
    
    333
    
    
    
    7Accumulated other
comprehensive income
    
    
    3,307
    
    
    
    161Net amount recognized at end of year
    
    $
    (666
    )
    
    $
    47
 2004
    
    
    2003
    
    
    2002Components of net
periodic benefit cost:Service cost
    
    $
    804
    
    
    $
    757
    
    
    $
    714Interest cost
    
    
    1,500
    
    
    
    1,455
    
    
    
    1,395Expected return on assets
    
    
    (1,629
    )
    
    
    (1,575
    )
    
    
    (1,503
    )Amortization of:Transition asset
    
    
    (72
    )
    
    
    (96
    )
    
    
    (96
    )Prior service cost
    
    
    31
    
    
    
    31
    
    
    
    31Actuarial loss
    
    
    86
    
    
    
    53
    
    
    
    30Net periodic benefit cost
    
    $
    720
    
    
    $
    625
    
    
    $
    571
 THE MIDLAND COMPANY 43




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES The assumptions used relative to the plans are evaluated annually and updated as necessary.
The discount rate assumption is based on the Moodys AA rate. The expected long-term rate of return
assumption was based on actuarial recommendations, economic conditions and the historical
performance of the plans investment portfolio over the past ten years. 2004

    
    2003

    
    2002Assumptions:Weighted average assumptions:For disclosure:Discount rate
    
    
    5.75
    %
    
    
    6.00
    %
    
    
    6.75
    %Rate of compensation
increase
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    4.25
    %For measuring net periodic
pension benefit cost:Discount rate
    
    
    6.00
    %
    
    
    6.75
    %
    
    
    7.25
    %Rate of compensation
increase
    
    
    4.00
    %
    
    
    4.25
    %
    
    
    4.25
    %Expected return
on plan assets
    
    
    8.00
    %
    
    
    8.00
    %
    
    
    9.40
    %
 Plan assets consist primarily of equity and fixed income securities managed by
non-affiliated professional investment managers. No plan assets are invested in either real estate
or the Companys stock. The following table reflects the asset allocations at fair value related to
plan assets in 2004 and 2003: Weighted averageasset allocation2004
    
    2003Total equity securities
    
    
    62
    %
    
    
    62
    %Total fixed income securities
    
    
    36
    %
    
    
    37
    %Cash and cash equivalents
    
    
    2
    %
    
    
    1
    %Total
    
    
    100
    %
    
    
    100
    %
 The primary objective for the investment of plan assets is the preservation of capital
with an emphasis on long-term growth without undue exposure to risk. Targeted allocations are 50%
to 80% for equities and 20% to 50% for fixed income securities. The Companys qualified defined benefit pension plan had projected benefit obligations,
accumulated benefit obligations and fair value of plan assets amounting to (in 000s) $26,022,
$21,734 and $18,794 in 2004 and $22,356, $18,415 and $18,715 in 2003, respectively. The Companys
non-qualified defined benefit plan had projected benefit obligations, accumulated benefit obligations and fair
value of plan assets amounting to (in 000s) $1,699, $1,365 and $0 in 2004 and $1,361, $616 and $0
in 2003, respectively. The Company plans to make its required cash contribution of $0.6 million for the 2004 plan
year by September 2005. The Companys expected pension benefit payments, which reflect expected
future service, for the next ten years are as follows (amounts in 000s): 2005  $1,050; 2006 -
$1,048; 2007  $1,254; 2008  $1,311; 2009  $1,354; 2010 through 2014  $8,580. At December 31, 2004 and 2003, the Companys additional minimum pension liabilities were $3.6
million and $0.2 million, respectively. Related to these actuarily determined minimum pension
liabilities, comprehensive income was reduced by $1.4 million and $0.1 million, net of deferred
federal income taxes, at December 31, 2004 and 2003, respectively. 14. STOCK OPTIONS AND AWARD PLANS Midlands equity compensation plans include plans for restricted stock, performance
shares and non-qualified stock options. The Company implemented a restricted stock award program during 1993. Under this program,
restricted grants of the Companys common stock will vest after a five-year incentive period,
conditioned upon the recipients employment throughout the period. During the vesting period,
shares issued are nontransferable, but the shares are entitled to all of the other rights of
outstanding shares. In 2002, 325,000 shares were distributed under this program relating to the
1997 grant. In 2004, 202,000 shares were distributed relating to the 1999 grant. At December 31,
2004, no restricted stock awards are outstanding. In 2000, the Company established a performance stock award program. Under this program, shares
vest after a three-year performance measurement period and will only be awarded if pre-established
performance levels have been achieved. Shares are awarded at no cost and the recipient must have
been employed throughout the entire three-year performance period. In 2004, 26,000 shares were
issued under this program, 34,000 shares have been earned and are scheduled for distribution in
2005, and a maximum of 92,000 and 78,000 shares could potentially be issued in 2006 and 2007,
respectively, related to this program. The expected fair value of these awards is charged to
compensation expense over the performance period. 44THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIES Under the Companys stock option plans, all of the outstanding stock options at December
31, 2004 were non-qualified options and had an exercise price of not less than 100% of the fair
market value of the common stock on the date of grant. Of these stock options, 753,000 were
exercisable at December 31, 2004, and 199,000, 155,000, 112,000 and 52,000 options become
exercisable in 2005, 2006, 2007 and 2008, respectively. A summary of stock option transactions follows: 2004
    
    
    2003
    
    
    2002Wtd.
    
    
    
    
    
    
    Wtd.
    
    
    
    
    
    
    Wtd.Avg.
    
    
    
    
    
    
    Avg.
    
    
    
    
    
    
    Avg.(000s)Shares
    
    
    OptionPrice
    
    
    (000s)Shares
    
    
    OptionPrice
    
    
    (000s)Shares
    
    
    OptionPriceOutstanding,
beginning
of year
    
    
    1,091
    
    
    $
    15.73
    
    
    
    877
    
    
    $
    14.85
    
    
    
    747
    
    
    $
    12.83Exercised
    
    
    (43
    )
    
    
    14.64
    
    
    
    (60
    )
    
    
    10.26
    
    
    
    (52
    )
    
    
    10.24Forfeited
    
    
    (17
    )
    
    
    17.72
    
    
    
    (17
    )
    
    
    15.31
    
    
    
    (46
    )
    
    
    16.65Granted
    
    
    241
    
    
    
    24.40
    
    
    
    291
    
    
    
    17.23
    
    
    
    228
    
    
    
    20.78Outstanding,
end of year
    
    
    1,272
    
    
    $
    17.38
    
    
    
    1,091
    
    
    $
    15.73
    
    
    
    877
    
    
    $
    14.85Exercisable,
end of year
    
    
    753
    
    
    $
    15.12
    
    
    
    552
    
    
    $
    14.16
    
    
    
    417
    
    
    $
    12.76
 Information regarding such outstanding options at December 31, 2004 follows: OutstandingRemaining
    
    OptionsLife
    
    (000's)
    
    
    PriceLess than one year
    
    
    18
    
    
    $
    8.46Two years
    
    
    18
    
    
    
    6.32Four years
    
    
    48
    
    
    
    13.05Five years
    
    
    261
    
    
    
    11.38Six years
    
    
    212
    
    
    
    16.60Seven years
    
    
    199
    
    
    
    20.78Eight years
    
    
    278
    
    
    
    17.23Nine years
    
    
    238
    
    
    
    24.40Total outstanding
    
    
    1,272Weighted average price
    
    
    
    
    
    $
    17.38
 At December 31, 2004, options exercisable have exercise prices between $6.32 and
$24.40 and an average contractual life of approximately 5.8 years. At December 31, 2004, 1,684,000 common shares are authorized for future option award or stock
grants. 15. EARNINGS PER SHARE The following table is a reconciliation of the number of shares used to compute Basic
and Diluted earnings per share. Share information has been adjusted for a 2 for 1 stock split
effective July 17, 2002. No adjustments are necessary to the income used in the Basic or Diluted
calculations for the years ended December 31, 2004, 2003 or 2002. Shares in 000's2004
    
    
    2003
    
    
    2002Shares used in basic
EPS calculation (average
shares outstanding)
    
    
    18,618
    
    
    
    17,417
    
    
    
    17,323Effect of dilutive
stock options
    
    
    455
    
    
    
    266
    
    
    
    252Effect of dilutive
restricted stock grants
    
    
    
    
    
    
    162
    
    
    
    147Effect of dilutive
performance stock awards
    
    
    117
    
    
    
    92
    
    
    
    67Shares used in diluted
EPS calculation
    
    
    19,190
    
    
    
    17,937
    
    
    
    17,789
 16. CONTINGENCIES Various litigation and claims against the Company and its subsidiaries are in process
and pending. Based upon a review of open matters with legal counsel, Management believes that the
outcome of such matters will not have a material effect upon the Companys consolidated financial
position, results of operations or cash flows. The Company also has credit exposure with customers,
generally in the form of premiums receivable. Management monitors these exposures on a regular
basis. However, as collectibility of such receivables is dependent upon the financial stability of
the customers, the Company cannot assure collections in full. Where appropriate, the Company has
provided a reserve for such exposures. 17. SHAREHOLDERS EQUITY The Company has 40,000,000 shares of common stock authorized for issuance without par
value (stated value of $.042 a share). The Company also has 1,000,000 shares of preferred stock
authorized, without par value, none of which have been issued. On February 5, 2004, the Company sold 1,150,000 shares of its common stock pursuant to an
approved universal shelf registration statement previously filed with the Securities and Exchange
Commission on October 21, 2003. The net proceeds derived from the sale of $25.1 million were used
to increase the capital and paid-in surplus of the Companys insurance subsidiaries to fund future
growth and for other general corporate purposes. THE MIDLAND COMPANY 45




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##### 



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) THE MIDLAND COMPANY AND SUBSIDIARIES In January 2001, the Companys Board of Directors authorized the repurchase of up to
1,000,000 shares of the Companys common stock and 414,000 of these shares had been repurchased as
of December 31, 2004. The change in accumulated other comprehensive income is due to changes related to the
unrealized gains and losses on investments, the fair value of interest rate swaps and additional
minimum pension liability as follows (amounts in 000s): 2004
    
    
    2003
    
    
    2002Unrealized holding
gains (losses) on securities
arising during the period
    
    $
    7,421
    
    
    $
    28,205
    
    
    $
    (1,404
    )Reclassification adjustment:Impact of net
realized loss (gain)
    
    
    (9,933
    )
    
    
    (4,566
    )
    
    
    6,900Income taxes on above
    
    
    3,478
    
    
    
    1,598
    
    
    
    (2,117
    )Change in unrealized gains
(losses) on securities, net
    
    
    966
    
    
    
    25,237
    
    
    
    3,379Fair value of interest rate swaps
    
    
    1,002
    
    
    
    511
    
    
    
    (1,945
    )Income taxes on above
    
    
    (351
    )
    
    
    (179
    )
    
    
    681Change in interest
rate swaps, net
    
    
    651
    
    
    
    332
    
    
    
    (1,264
    )Additional Pension Liability
    
    
    (3,146
    )
    
    
    481
    
    
    
    (642
    )Income Taxes
    
    
    1,101
    
    
    
    (168
    )
    
    
    225Change in additional
pension liability, net
    
    
    (2,045
    )
    
    
    313
    
    
    
    (417
    )Net increase (decrease)
in accumulated other
comprehensive income
    
    $
    (428
    )
    
    $
    25,882
    
    
    $
    1,698
 The insurance subsidiaries are subject to state regulations which limit by reference to
statutory net income and policyholders surplus the dividends that can be paid to their parent
company without prior regulatory approval. Dividend restrictions vary between the companies as
determined by the laws of the domiciliary states. Under these restrictions, the maximum dividends
that may be paid by the insurance subsidiaries in 2005 without regulatory approval total
approximately (amounts in 000s): $51,231; such subsidiaries paid cash dividends of $2,600 in 2004,
$5,000 in 2003 and $8,900 in 2002. Net income as reported by the Companys insurance subsidiaries, determined in accordance with
statutory accounting practices, which differ in certain respects from accounting principles
generally accepted in the United States of America, for the Companys insurance subsidiaries was
(amounts in 000s): $57,677, $34,518 and $20,809 for 2004, 2003 and 2002, respectively. Statutory
surplus as reported by the Companys insurance subsidiaries, was (amounts in 000s): $355,518 and
$289,915 at December 31, 2004 and 2003, respectively. 18. RELATED PARTY TRANSACTIONS The Company has a commercial paper program under which qualified purchasers may invest
in the short-term unsecured notes of Midland. Many of the investors in this program are executive
officers and directors of the Company. Total commercial paper debt outstanding at December 31, 2004
and 2003 was $4.2 million and $3.6 million, respectively, of which $3.5 million and $3.0 million at
those respective dates represented notes held either directly or indirectly by the executive
officers and directors of the Company. The effective annual yield paid to all participants in this
program was 2.3% as of December 31, 2004, a rate that is considered to be competitive with the
market rate for similar instruments. 19. INDUSTRY SEGMENTS The Company operates in several industries and Company management reviews operating
results by several different classifications (e.g., product line, legal entity, distribution
channel). Reportable segments are determined based upon revenues and/or operating profits and are
based on significant product groups, which include personal lines property, personal lines
casualty, financial services, all other insurance and transportation. The personal lines property segment includes primarily manufactured housing and site-built
dwelling insurance products. Approximately 44% of American Moderns property and casualty and
credit life gross written premium relates to physical damage insurance and related coverages on
manufactured homes, generally written for a term of 12 months with many coverages similar to
homeowners insurance policies. The personal lines casualty segment includes specialty insurance
products such as motorcycle, watercraft, recreational vehicle, collector car and snowmobile. The
financial services segment includes specialty insurance products such as mortgage fire, collateral
protection and debt cancellation, which are sold to financial institutions or their customers. The
all other insurance segment includes products such as credit life, long-haul truck physical damage,
commercial, excess and surplus lines and also includes the results of our fee producing
subsidiaries. The Company writes insurance throughout the United States with larger concentrations in the
southern and southeastern states. Transportation includes barge chartering and freight brokerage
operations primarily on the lower Mississippi River and its tributaries. 46THE MIDLAND COMPANY




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##### 



THE MIDLAND COMPANY AND SUBSIDIARIES Listed below is financial information required to be reported for each industry
segment. Certain amounts are allocated and certain amounts are not allocated (e.g., assets and
investment gains) to each segment for management review. Operating segment information based upon
how it is reviewed by the Company is as follows for the years ended December 31, 2004, 2003 and
2002 (amounts in 000s): Insurance GroupPersonal
    
    
    Personal
    
    
    
    
    
    
    
    
    
    
    Unallocated
    
    
    
    
    
    
    CorporateLines
    
    
    Lines
    
    
    Financial
    
    
    All Other
    
    
    Insurance
    
    
    
    
    
    
    and All
    
    
    IntersegmentProperty
    
    
    Casualty
    
    
    Services
    
    
    Insurance
    
    
    Amounts
    
    
    Transportation
    
    
    Other
    
    
    Elimination
    
    
    Total2004RevenuesExternal customers
    
    $
    406,544
    
    
    $
    121,432
    
    
    $
    86,803
    
    
    $
    76,405
    
    
    
    
    
    
    $
    45,379
    
    
    $
    180
    
    
    
    
    
    
    $
    736,743Net investment income
    
    
    19,120
    
    
    
    6,107
    
    
    
    3,615
    
    
    
    6,902
    
    
    $
    172
    
    
    
    
    
    
    
    1,546
    
    
    $
    (297
    )
    
    
    37,165Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,623
    
    
    
    
    
    
    
    43
    
    
    
    (9,733
    )
    
    
    9,933Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,038
    
    
    
    856
    
    
    
    2,730
    
    
    
    (455
    )
    
    
    5,169Depreciation and amortization
    
    
    4,238
    
    
    
    1,836
    
    
    
    275
    
    
    
    570
    
    
    
    
    
    
    
    2,296
    
    
    
    1,652
    
    
    
    
    
    
    
    10,867Income before taxes
    
    
    47,418
    
    
    
    4,987
    
    
    
    6,991
    
    
    
    12,396
    
    
    
    17,816
    
    
    
    1,689
    
    
    
    (4,460
    )
    
    
    (9,733
    )
    
    
    77,104Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,662
    
    
    
    599
    
    
    
    (1,989
    )
    
    
    (3,406
    )
    
    
    22,866Acquisition of fixed assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,392
    
    
    
    2,160
    
    
    
    147
    
    
    
    
    
    
    
    11,699Identifiable assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,248,521
    
    
    
    38,869
    
    
    
    113,716
    
    
    
    (36,422
    )
    
    
    1,364,6842003RevenuesExternal customers
    
    $
    413,300
    
    
    $
    119,794
    
    
    $
    54,742
    
    
    $
    64,292
    
    
    
    
    
    
    $
    28,240
    
    
    $
    (26
    )
    
    
    
    
    
    $
    680,342Net investment income
    
    
    18,330
    
    
    
    5,230
    
    
    
    2,527
    
    
    
    6,914
    
    
    $
    185
    
    
    
    2
    
    
    
    307
    
    
    $
    (216
    )
    
    
    33,279Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,566
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,566Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,124
    
    
    
    423
    
    
    
    1,952
    
    
    
    (757
    )
    
    
    3,742Depreciation and amortization
    
    
    3,807
    
    
    
    1,791
    
    
    
    191
    
    
    
    599
    
    
    
    
    
    
    
    2,224
    
    
    
    1,130
    
    
    
    
    
    
    
    9,742Income (loss) before taxes
    
    
    34,849
    
    
    
    (11,452
    )
    
    
    6,797
    
    
    
    (3,501
    )
    
    
    5,190
    
    
    
    1,270
    
    
    
    (2,921
    )
    
    
    
    
    
    
    30,232Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,835
    
    
    
    455
    
    
    
    (1,334
    )
    
    
    
    
    
    
    6,956Acquisition of fixed assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,355
    
    
    
    9,644
    
    
    
    20
    
    
    
    
    
    
    
    15,019Identifiable assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,119,252
    
    
    
    30,990
    
    
    
    66,069
    
    
    
    (24,095
    )
    
    
    1,192,2162002RevenuesExternal customers
    
    $
    392,515
    
    
    $
    93,502
    
    
    $
    40,648
    
    
    $
    64,695
    
    
    
    
    
    
    $
    23,285
    
    
    $
    64
    
    
    
    
    
    
    $
    614,709Net investment income
    
    
    21,535
    
    
    
    4,494
    
    
    
    1,703
    
    
    
    7,528
    
    
    $
    485
    
    
    
    25
    
    
    
    444
    
    
    $
    (315
    )
    
    
    35,899Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,900
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,900
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,124
    
    
    
    215
    
    
    
    2,479
    
    
    
    (969
    )
    
    
    3,849Depreciation and amortization
    
    
    3,540
    
    
    
    1,301
    
    
    
    191
    
    
    
    523
    
    
    
    
    
    
    
    1,627
    
    
    
    1,125
    
    
    
    
    
    
    
    8,307Income (loss) before taxes
    
    
    17,912
    
    
    
    1,012
    
    
    
    3,198
    
    
    
    12,538
    
    
    
    (7,541
    )
    
    
    464
    
    
    
    (1,842
    )
    
    
    
    
    
    
    25,741Income tax expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,939
    
    
    
    168
    
    
    
    (670
    )
    
    
    
    
    
    
    5,437Change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,463
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,463
    )Acquisition of fixed assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,598
    
    
    
    
    
    
    
    69
    
    
    
    
    
    
    
    10,667Identifiable assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,032,034
    
    
    
    22,469
    
    
    
    63,425
    
    
    
    (16,792
    )
    
    
    1,101,136
 The amounts shown for personal lines property, personal lines casualty, financial
services, all other insurance and unallocated insurance comprise the consolidated amounts for
Midlands insurance operations subsidiary, American Modern Insurance Group, Inc. Intersegment
revenues were not significant for 2004, 2003 or 2002. During 2004 the Midland parent company
purchased 492,634 shares of U.S. Bancorp common stock from American Modern Insurance Group, Inc.
The effects of this transaction were eliminated from consolidated net realized investment gains,
income before taxes and income tax expense. Revenues reported above, by definition, exclude investment income and realized gains. For
income before taxes reported above, insurance investment income is allocated to the insurance
segments while realized gains and losses are included in Unallocated Insurance Amounts. The Company
allocates insurance investment income to the segments based primarily on written premium volume.
The Company does not allocate realized gains or losses to the segments as the Company evaluates the
performance of the segments exclusive of the impact of realized gains or losses due to potential
timing issues. Certain other amounts are also not allocated to segments by the Company. No single customer contributed in excess of 10% of consolidated revenues in 2004 or 2003. In
2002, revenues from one customer, GreenTree, which exceeded 10% of consolidated revenues, amounted
to $78.6 million. Certain prior year amounts have been reclassified to conform with current year presentation. THE MIDLAND COMPANY 47




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##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (DELOITTE LOGO) To the Shareholders and Board of Directors of The Midland Company: We have audited the accompanying consolidated balance sheets of The Midland Company and
subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated
statements of income, changes in shareholders equity, and cash flows for each of the three years
in the period ended December 31, 2004. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial statements
based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (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, such consolidated financial statements present fairly, in all material
respects, the financial position of The Midland Company and subsidiaries at December 31, 2004 and
2003, and the results of their operations and their cash flows for each of the three years in the
period ended December 31, 2004, in conformity with accounting principles generally accepted in the
United States of America. As discussed in Note 6, the Company adopted Statement of Financial Standards No. 142,
Goodwill and Other Intangible Assets, effective January 1, 2002. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal Control 
Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated March 1, 2005 expressed an unqualified opinion on managements assessment of
the effectiveness of the Companys internal control over financial reporting and an unqualified
opinion on the effectiveness of the Companys internal control over financial reporting. (DELOITTE LLP LOGO)
Cincinnati, Ohio
March 1, 2005 MANAGEMENTS ASSESSMENT AS TO THE EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING The Management of The Midland Company is responsible for establishing and maintaining adequate
internal control, designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. The Companys internal control over financial reporting
includes those policies and procedures that: (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of
the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or disposition of the
Companys assets that could have a material effect on the financial statements. All internal control systems, no matter how well designed, have inherent limitations,
including the possibility of human error and the circumvention of overriding controls. Accordingly,
even effective internal control can provide only reasonable assurance with respect to financial
statement preparation. Further, because of changes in conditions, the effectiveness of internal
control may vary over time. The Companys Management assessed the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004 as required by Section 404 of the Sarbanes Oxley Act of
2002. Managements assessment is based on the criteria established in the Internal Control 
Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) and was designed to provide reasonable assurance that the Company maintained effective
internal control over financial reporting as of December 31, 2004. Based on our assessment, we
believe that the Company maintained effective internal control over financial reporting as of
December 31, 2004. The Companys independent registered public accounting firm has issued an attestation report
on our internal control over financial reporting as of December 31, 2004 and the Companys
management assessment of the internal control over financial reporting. This report appears on page
49. -s- JOHN W. HAYDEN
    
    -s- JOHN I. VON LEHMANJohn W. Hayden
    
    John I. Von LehmanPresident and
    
    Executive Vice President,Chief Executive Officer
    
    Chief Financial Officer and Secretary
 48THE MIDLAND COMPANY




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM THE MIDLAND COMPANY AND SUBSIDIARIES (DELOITTE LOGO) To the Shareholders and Board of Directors of The Midland Company: We have audited managements assessment, included in the accompanying Managements Assessment
as to the Effectiveness of Internal Control over Financial Reporting, that The Midland Company and
subsidiaries (the Company) maintained effective internal control over financial reporting as of
December 31, 2004, based on criteria established in Internal Control  Integrated Frameworkissued
by the Committee of Sponsoring Organizations of the Treadway Commission. The Companys management
is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting. Our responsibility is
to express an opinion on managements assessment and an opinion on the effectiveness of the
Companys internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions. A companys internal control over financial reporting is a process designed by, or under the
supervision of, the companys principal executive and principal financial officers, or persons
performing similar functions, and effected by the companys board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A companys internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material misstatements
due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that the Company maintained effective internal control
over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based
on the criteria established in Internal Control  Integrated Frameworkissued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 31,
2004, based on the criteria established in Internal Control  Integrated Frameworkissued by the
Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated financial statements as of and for the year ended
December 31, 2004 of the Company and our report dated March 1, 2005 (which includes an explanatory
paragraph related to the adoption on January 1, 2002 of Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets) expressed an unqualified opinion on those
financial statements. -s- Deloitte & Touche LLP
Cincinnati, Ohio
March 1, 2005 THE MIDLAND COMPANY 49




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##### 



QUARTERLY DATA (UNAUDITED) THE MIDLAND COMPANY AND SUBSIDIARIES 2004
    
    
    2003(Amounts in thousands,
    
    First
    
    
    Second
    
    
    Third
    
    
    Fourth
    
    
    First
    
    
    Second
    
    
    Third
    
    
    Fourthexcept per share data)
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    QuarterRevenues
    
    $
    190,621
    
    
    $
    195,583
    
    
    $
    192,881
    
    
    $
    204,756
    
    
    $
    169,288
    
    
    $
    178,642
    
    
    $
    184,222
    
    
    $
    186,035Net income (loss)
    
    $
    16,848
    
    
    $
    11,324
    
    
    $
    2,424
    
    
    $
    23,642
    
    
    $
    10,049
    
    
    $
    (1,017
    )
    
    $
    4,289
    
    
    $
    9,955Basic earnings (loss)
per common
share(a)
    
    $
    .93
    
    
    $
    .60
    
    
    $
    .13
    
    
    $
    1.25
    
    
    $
    .58
    
    
    $
    (.06
    )
    
    $
    .25
    
    
    $
    .57Diluted earnings (loss)
per common share(a)
    
    $
    .90
    
    
    $
    .58
    
    
    $
    .12
    
    
    $
    1.22
    
    
    $
    .56
    
    
    $
    (.06
    )
    
    $
    .23
    
    
    $
    .56Dividends per common share
    
    $
    .05125
    
    
    $
    .05125
    
    
    $
    .05125
    
    
    $
    .05125
    
    
    $
    .0475
    
    
    $
    .0475
    
    
    $
    .0475
    
    
    $
    .0475Price range of
common stock (Nasdaq):High
    
    $
    25.45
    
    
    $
    29.70
    
    
    $
    29.92
    
    
    $
    32.96
    
    
    $
    20.30
    
    
    $
    23.70
    
    
    $
    24.30
    
    
    $
    23.62Low
    
    $
    22.35
    
    
    $
    24.77
    
    
    $
    25.50
    
    
    $
    26.50
    
    
    $
    16.20
    
    
    $
    17.17
    
    
    $
    20.57
    
    
    $
    20.30
   (a)
    The sum of quarterly earnings per common share may not equal the year end earnings per
common share due to rounding. OTHER INFORMATION TRANSFER AGENT AND REGISTRAR
    
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMNational City Bank
    
    Deloitte & Touche LLPShareholder Services
    
    250 East Fifth StreetP.O. Box 92301
    
    Cincinnati, Ohio 45202Cleveland, Ohio 44193-09001-800-622-6757shareholder.inquiries@nationalcity.comorhttp://www.nationalcitystocktransfer.com
 SHAREHOLDERS MEETING The next meeting of the shareholders will be held at 10:00 a.m. on Thursday, April
28, 2005 at the Companys offices, 7000 Midland Boulevard, Amelia, Ohio 45102. MARKET FOR REGISTRANTS COMMON STOCK The Midland Company Common Stock is traded on the NASDAQ National Market System. The symbol is
MLAN. DIVIDEND REINVESTMENT PLAN The Plan provides for the acquisition of additional shares of the Company without brokerage
fees through automatic dividend reinvestment. Enrollment forms and information about the Plan are
available from National City Bank (1-800-622-6757). FORM 10-K A copy of the Companys 2004 Annual Report to the Securities and Exchange Commission on Form
10-K may be obtained free of charge by writing to the Company  Attention: Chief Financial Officer
or from the Companys website www.midlandcompany.com. FINANCIAL INFORMATION For financial information
visit us on the internet at www.nasdaq.com
or www.midlandcompany.com 5OTHE MIDLAND COMPANY




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OFFICERS AND DIRECTORS THE MIDLAND COMPANY AND SUBSIDIARIES BOARD OF DIRECTORS
    
    OFFICERSJames E. Bushman(a) (b) (c)
    
    J. P. Hayden IIIPresident and Chief Executive Officer
    
    Chairman and Chief Operating OfficerCast-Fab Technologies, Inc.John W. HaydenJames H. Carey(a) (b) (d)
    
    President and Chief Executive OfficerCorporate Director/AdvisorMichael J. Conaton(c)
    
    John I. Von LehmanFormerly President and Vice Chairman of the Company
    
    Executive Vice President,Chief Financial Officer and SecretaryJerry A. GrundhoferPresident and Chief Executive Officer
    
    Paul T. BrizzolaraUS Bancorp
    
    Executive Vice President,Chief Legal Officer andJ. P. Hayden, Jr.(c)
    
    Assistant SecretaryChairman of the Executive Committee of the Board,Formerly Chairman and Chief Executive Officer
    
    Paul F. Gelterof the Company
    
    Executive Vice PresidentJ. P. Hayden III(c)
    
    Elisabeth E. BaldockChairman and Chief Operating Officer
    
    Vice President-Human Resources/Learning and DevelopmentJohn W. Hayden(c)President and Chief Executive OfficerW. Todd GrayRobert W. Hayden*
    
    TreasurerFormerly Vice President of the CompanyMichael L. FlowersVice President and Assistant SecretaryWilliam T. HaydenPartner-Katz, Teller, Brant & HildWilliam J. Keating , Jr.(b) (d)
    
    Mark E. BurkePartner-Keating, Muething & Klekamp
    
    Director of TaxationJohn R. LaBar
    
    James E. KroegerFormerly Vice President and Secretary of the Company
    
    Director of Internal AuditRichard M. Norman(a)
    
    Ronald L. GramkeVice President for Finance and Business Services,
    
    Assistant TreasurerTreasurer of Miami University, OhioEdward J. HeskampDavid B. OMaley
    
    Assistant TreasurerChairman, President and Chief Executive OfficerOhio National Financial Services
    
    Matthew J. McConnellAssistant TreasurerJohn M. OMara(b) (c) (d)Corporate Director/Financial Consultant
    
    Mary Ann C. PettitAssistant SecretaryGlenn E. Schembechler(a)Professor Emeritus University of MichiganFrancis Marie Thrailkill, OSU Ed.D.(d)President-College of Mount St. JosephJohn I. Von LehmanExecutive Vice President,Chief Financial Officer and Secretary
  (a)
    Member of Audit Committee(b)
    Member of Compensation Committee(c)
    Member of Executive Committee(d)
    Member of Governance and Nominating Committee*
    Robert W. Hayden resigned from Midlands Board effective
January 31, 2005. Mr Hayden had served on
Midlands Board since 1968.




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(THE MIDLAND COMPANY LOGO) The Midland Company
7000 Midland Boulevard
P.O. Box 1256 Cincinnati, Ohio 45201-1256
Phone (513) 943-7100www.midlandcompany. com