<PAGE>
 
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                                   FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996

Commission File Number 1-6271
                              AVEMCO CORPORATION
            (Exact name of Registrant as specified in its charter)

         DELAWARE                                          52-0733935
(State or other jurisdiction                            (I.R.S. Employer
of incorporation or organization)                      Identification Number)

                  411 AVIATION WAY, FREDERICK, MARYLAND 21701
                   (Address of principal executive offices)
                                  (Zip Code)

                                (301) 694-5700
             (Registrant's telephone number, including area code)

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

   COMMON STOCK, $.10 PAR VALUE              NEW YORK STOCK EXCHANGE
        (Title of class)             (Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act:  NONE

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

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

State the aggregate market value of the voting stock held by non-affiliates of
the Registrant.  The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked prices of
such stock, as of a specified date within 60 days prior to the date of filing:
ON MARCH 1, 1997, THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-
AFFILIATES OF THE REGISTRANT WAS $187,298,000.

Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date:  THE NUMBER OF COMMON SHARES
OUTSTANDING AT MARCH 1, 1997, WAS 8,375,712.
<PAGE>
 
                                    PART I

ITEM 1.   BUSINESS
------         

RECENT DEVELOPMENT

On January 17, 1997, AVEMCO Corporation ("AVEMCO"), Registrant, and HCC
Insurance Holdings, Inc., ("HCCH") jointly announced that they had signed a
Letter of Intent to merge AVEMCO with a wholly-owned subsidiary of HCCH in a
stock-for-stock transaction, with AVEMCO becoming a wholly-owned subsidiary of
HCCH.  On February 28, 1997, AVEMCO and HCCH jointly announced that the Boards
of Directors of AVEMCO and HCCH had executed an Agreement and Plan of
Reorganization (the "Agreement").  Pursuant to the terms of the Agreement, each
share of AVEMCO's common stock will be exchanged for one share of HCCH's common
stock.

The proposed transaction is intended to be accounted for as a pooling of
interests and to be a nontaxable exchange to AVEMCO's shareholders.  It is
subject to various conditions, including receipt of required regulatory
approvals and the approval of the transaction by shareholders of both AVEMCO and
HCCH.  A special shareholders' meeting is anticipated to be held in the second
quarter of 1997, and a proxy statement describing the transaction in detail is
expected to be submitted to the shareholders shortly.  There can be no assurance
that the conditions to the proposed merger will be satisfied or that the
shareholders will approve the transaction.

GENERAL

AVEMCO is an insurance holding company organized in 1959, that coordinates the
activities of its subsidiaries and provides them with management, business
planning, investment, human resource, marketing, and financial services.  The
subsidiaries of AVEMCO are engaged in the business of providing specialty
property and casualty insurance products and services, principally involving
aviation.  Non-aviation specialty lines include lenders single interest, short-
term health, and pleasure marine.  Insurance products are distributed on a
direct basis nationally and in Canada (except Quebec), and through agency and
brokerage networks nationwide.  AVEMCO and its subsidiaries operate together as
the AVEMCO Group.  AVEMCO's principal executive offices are located at Frederick
Municipal Airport, 411 Aviation Way, Frederick, Maryland 21701, and its
telephone number is (301) 694-5700.

Since its organization, AVEMCO and its predecessor companies have generally
achieved an underwriting profit (33 out of 36 years).  AVEMCO Insurance Company
is rated "A+" (Superior) by A.M. Best, and its policyholders' surplus position
substantially exceeded the minimum requirements as stipulated by insurance
industry risk-based capital regulations.

AVEMCO's principal insurance subsidiary is AVEMCO Insurance Company ("AIC"), a
direct writer of aviation and pleasure marine business. AIC underwrites various
types of aviation insurance for owners and pilots of general aviation aircraft,
including commercial coverages for fixed base operators. General aviation
encompasses private business aircraft, air taxi services, recreational

                                       2
<PAGE>
 
flying, fixed-based operations and similar activities. It excludes military and
commercial airline operations. Other aviation-related commercial insurance
coverages are written for lending institutions and leasing companies on both
general aviation and commercial aviation equipment. AIC also serves as the
reinsurer for most of the business produced and managed by other members of the
AVEMCO Group. Other insurance company members of the AVEMCO Group include U.S.
Specialty Insurance Company, a wholly-owned subsidiary of AIC, underwriter of
aviation, pleasure marine, and lenders single interest insurance through
independent agents and brokers, whose business is also reinsured by AIC. The
AVEMCO Group also controls National Insurance Underwriters ("NIU"), a reciprocal
insurance exchange through AVEMCO's ownership of Specialty Insurance
Underwriters, Inc. ("SIUI"), the attorney-in-fact for the exchange. NIU is
currently writing a limited amount of aviation and automobile insurance in a few
states. AIC also owned National Assurance Underwriters, Inc. ("NAUI"), an
insurer that was sold in August 1996, but whose business (aviation insurance)
was retained by AIC as part of the sale transaction.

Other insurance producers (non-insurers) in the AVEMCO Group include: (i)
Matterhorn Bank Programs, Inc., a wholly-owned subsidiary of AVEMCO and its
wholly-owned subsidiary, KFA, Inc., which are general agencies that market
blanket lenders single interest coverage for banks and other financial
institutions covering risks of physical loss or damage to the property securing
their installment loans (primarily automobiles) and other insurance products to
financial institutions, through independent agents and brokers.  Matterhorn's
business is primarily written by U.S. Specialty Insurance Company; and (ii)
Brooks-Shettle Company, a wholly-owned subsidiary of AVEMCO, which is an
insurance and reinsurance broker specializing in short-term health and travel
insurance programs on an international basis, as well as marine insurance within
the United States.  The business and operations of Hinchcliff International,
Inc. ("Hinchcliff"), acquired by AVEMCO in January 1996, and International Group
Services, Inc. ("IGS"), acquired by AVEMCO in December 1994, were merged into
Brooks-Shettle Company under which names Brooks-Shettle Company also continues
to do business.  The businss of both Hinchcliff and IGS includes short-term
student health insurance.  Much of Brooks-Shettle Company's business is
reinsured by AIC.

The AVEMCO Group's insurance operations are complemented by its insurance
service group operations, which are largely focused in areas that offer AVEMCO
opportunities to generate additional specialty insurance premiums.  Currently,
the Group's service operations are conducted by the following companies and
concentrated in the following areas:  (i) Loss Management Services, Inc., a
wholly-owned subsidiary of AVEMCO, provides claims management and related
subrogation and salvage services for the Group's insurers, as well as other
insurance companies and financial institutions; (ii) MEDEX Assistance
Corporation, a wholly-owned subsidiary of AVEMCO, provides worldwide,
multilingual emergency assistance services on a 24-hour basis for individuals
who become sick or injured primarily while traveling outside their home
countries; and (iii) The Wheatley Group, Ltd., a wholly-owned subsidiary of
AVEMCO, which provides computer products, software, and related services for
property and casualty insurance companies in the United States.

                                       3
<PAGE>
 
UNDERWRITING RATIOS

The following table sets forth certain information (statutory basis) with
respect to the underwriting results of AVEMCO Insurance Company and Subsidiaries
for each of the last three years.
<TABLE>
<CAPTION>
 
                          1996       1995      1994
                        ---------  --------  --------
<S>                     <C>        <C>       <C>
    Premiums written    $106,965   $99,795   $90,651
                        ========   =======   =======
    Premiums earned     $ 85,115   $80,135   $75,559
                        ========   =======   =======
    Loss ratio              73.1%     69.4%     61.2%
    Expense ratio           23.0%     25.5%     28.6%
                        --------   -------   -------
    Combined ratio          96.1%     94.9%     89.8%
                        ========   =======   =======
</TABLE>

UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

Management's Discussion and Analysis - Loss Reserves on page 10, and Note 4,
Unpaid Losses and Loss Adjustment Expenses, of the Notes to Consolidated
Financial Statements on pages 55 and 56 are incorporated herein.

INVESTMENTS

Management's Discussion and Analysis - Investments on pages 9 and 10, and Note
2, Investments, of the Notes to Consolidated Financial Statements on pages 52
through 54 are incorporated herein.

REINSURANCE

Management's Discussion and Analysis - Reinsurance on pages 10 and 11, and Note
9, Reinsurance, of the Notes to Consolidated Financial Statements on page 61 are
incorporated herein.

REGULATION

AVEMCO Insurance Company and its subsidiary are subject to regulation and
supervision of their operations in each of the jurisdictions where they conduct
business.  Regulations vary from jurisdiction to jurisdiction, but generally,
they provide regulatory authorities with broad supervisory, regulatory and
administrative powers over such matters as licenses, standards of solvency,
premium rates, policy forms, investments, security deposits, methods of
accounting, form and content of financial statements, reserves for unpaid losses
and loss adjustment expenses, reinsurance, minimum capital and surplus
requirements, dividends and other distributions, periodic examinations and
annual and other report filings.  In general, regulations exist for the
protection of policyholders rather than the shareholders.  Congress has been
considering whether it is appropriate to modify or repeal the McCarran-Ferguson
Act, which grants to the states the responsibility for regulating the insurance
industry and provides limited exemption to the "business of insurance" from
federal anti-trust laws. Bills have been introduced in Congress from time to
time, but whether any changes in the current statute will be made, or the effect
of such changes, if any, cannot presently be determined.

                                       4
<PAGE>
 
In 1988, California voters passed an initiative known as Proposition 103.  The
Proposition provides, among other things, that rates for most insurance policies
issued or renewed between November 8, 1988, and November 8, 1989, be rolled back
to the levels of November 8, 1987, and then reduced an additional 20%.  In
addition, rates for most California insurance policies issued or renewed after
November 8, 1989, are subject to prior approval by the California Department of
Insurance (the Department).  The implementation of Proposition 103 by the
Registrant's insurance subsidiaries, as well as other California licensed
insurers, was complicated by numerous legal challenges and uncertainties since
its passage.  AVEMCO's insurance subsidiaries settled their outstanding
Proposition 103 matters with the California Department of Insurance during 1995.
AVEMCO and its affected subsidiaries had previously provided for a potential
rollback impact in prior years.  Refund payments were made in 1996.

COMPETITION

The property/casualty insurance industry is highly competitive and many
insurance companies offer the same specialty lines of business as AVEMCO's
subsidiaries.  Insurance products are distributed on a direct basis to
policyholders and also through the agent/broker community.  In the direct
writing of aviation insurance, historically, there have been few insurers which
act as direct writers.  AVEMCO's principal subsidiary, AIC, is currently the
largest if measured by the number of insurance policies issued.  In the agency
distribution of aviation insurance, market share is highly fragmented, and
AVEMCO competes against numerous managing general agencies, independent
agencies, and pools and syndicates.  In recognition that the aviation insurance
sector has been engaged in an extremely competitive price environment, AVEMCO
has continued to emphasize rate discipline and has been unwilling to write
aviation business at what it considers inadequate rates.  It also attempts to
compete on the basis of policy provisions, quality and timely service, including
accessible personnel, application turnaround, and expeditious claims settlement.
AVEMCO's other specialty insurance lines, including the lenders single interest,
short-term health and pleasure marine lines, are highly competitive as its
subsidiaries compete with many specialty insurers, as well as multi-line
insurance companies, many of which have more experience, larger volumes of
business, and greater financial resources than the resources of AVEMCO and its
subsidiaries.  They compete primarily on the basis of both price and service.

EMPLOYEES

At December 31, 1996, the Registrant employed 482 people.

ITEM 2.   PROPERTIES
------             

AVEMCO's activities are carried out from its 40,000 square foot headquarters,
owned by AVEMCO and located adjacent to the Frederick Municipal Airport in
Frederick, Maryland. AVEMCO also owns and occupies a 48,200 square foot office
building and storage complex in St. Peters, Missouri, a two-story 12,000 square
foot office building in Ithaca, New York, and a one-story building in Fort
Worth, Texas, containing approximately 2,500 square feet. AVEMCO leases
approximately 64,000 square feet of office space at 20 other locations
throughout the United States, Canada, China, and the United Kingdom.

                                       5
<PAGE>
 
ITEM 3.   LEGAL PROCEEDINGS
------                  

None, except routine litigation incidental to the business, in connection with
the insurance subsidiaries' operations.

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

None during the fourth quarter of 1996.

                                    PART II

ITEM 5.   MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 
------    MATTERS


The Registrant's Common Stock is listed on the New York Stock Exchange under
ticker symbol"AVE."  There are approximately 3,500 stockholders.
<TABLE>
<CAPTION>
 
                   High      Low    Dividends
                  -------  -------  ---------
<S>               <C>      <C>      <C>
1996
Fourth Quarter    $16 1/8  $15       $    .12
Third Quarter     $16 1/2  $13 5/8   $    .12
Second Quarter    $16      $11 3/4   $    .12
First Quarter     $16      $14 5/8   $    .12
 
1995
Fourth Quarter    $17 1/2  $15 3/4   $    .12
Third Quarter     $18      $15 5/8   $    .12
Second Quarter    $18 1/4  $16 1/2   $    .11
First Quarter     $17 5/8  $14 5/8   $    .11
</TABLE>

Note 7, Debt on page 59, and Note 10, Stockholders' Equity and Capital
Transactions, of the Notes to Consolidated Financial Statements on pages 61 and
62 are incorporated herein.

As part of the "Agreement," referred to in Part I, Item 1, Business, Recent
Development, AVEMCO agreed not to declare a dividend with a record date prior to
June 1, 1997, without the written consent of HCCH or subsequently if a
shareholders' meeting to consider the merger has been fixed and announced by the
AVEMCO Board of Directors and the Joint Proxy Statement/Prospectus has been
distributed to the shareholders of AVEMCO.

                                       6
<PAGE>
 
<TABLE>
<CAPTION>

ITEM 6.   FIVE-YEAR SUMMARY OF SELECTED FINANCIAL DATA
------
(In thousands, except per share data and ratios)

SUMMARY OF OPERATIONS:                   1996       1995       1994       1993       1992
                                       ---------  ---------  ---------  ---------  ---------
<S>                                    <C>        <C>        <C>        <C>        <C>
Revenues:
Premiums earned                        $ 86,170   $ 80,458   $ 75,518   $ 62,702   $ 57,385
Commissions                               8,819      7,046      6,418      5,909      6,145
Net investment income                     8,223      8,498      8,245      9,004      9,218
Computer products and services            9,913     10,188      9,185     11,129      4,836
Realized gain (loss) on sale of
 investments                              3,244        575       (248)     9,634      2,742
Realized gain on subsidiary sale          3,307         --         --         --         --
Other revenues                            8,214      6,439      5,472      5,523      6,597
                                       --------   --------   --------   --------   --------
Total revenues                          127,890    113,204    104,590    103,901     86,923
                                       --------   --------   --------   --------   --------
EXPENSES:
Losses and loss adjustment
expenses                                 62,866     55,605     46,310     41,502     36,783
Commissions                               7,092      6,513      7,159      5,716      6,966
Other expenses                           41,970     41,984     37,582     37,830     32,387
                                       --------   --------   --------   --------   --------
Total expenses                          111,928    104,102     91,051     85,048     76,136
                                       --------   --------   --------   --------   --------
Earnings before income taxes           $ 15,962   $  9,102   $ 13,539   $ 18,853   $ 10,787
                                       ========   ========   ========   ========   ========
Net earnings/1/                        $ 12,288   $  7,918   $ 10,833   $ 15,572   $  9,603
                                       ========   ========   ========   ========   ========
PER SHARE DATA:
Net earnings/1, 2/                     $   1.45   $    .90   $   1.20   $   1.41   $    .82
                                       --------   --------   --------   --------   --------
Dividends declared                     $    .48   $    .46   $    .44   $    .42   $    .40
                                       --------   --------   --------   --------   --------
Stockholders' equity per share/3,4/    $   7.33   $   7.14   $   6.28   $   5.92   $   7.76
                                       --------   --------   --------   --------   --------
Weighted average number of
of common and common
equivalent shares                         8,478      8,846      9,019     11,041     11,734
                                       --------   --------   --------   --------   --------
Common shares outstanding                 8,264      8,649      8,850      9,109     11,493
                                       --------   --------   --------   --------   --------
OTHER FINANCIAL DATA:
Investments /4/                        $149,238   $149,544   $136,378   $139,384   $151,013
                                       --------   --------   --------   --------   --------
Total assets /4/                       $217,666   $213,802   $201,350   $210,693   $231,621
                                       --------   --------   --------   --------   --------
Debt                                   $ 56,667   $ 54,967   $ 54,600   $ 54,500   $ 39,000
                                       --------   --------   --------   --------   --------
Stockholders' equity /4/               $ 60,572   $ 61,759   $ 55,610   $ 53,930   $ 89,215
                                       --------   --------   --------   --------   --------
Return on equity                           20.1%      13.5%      19.8%      21.8%      11.1%
                                       --------   --------   --------   --------   --------
</TABLE>

/1/1993 includes cumulative effect of the adoption of FASB Statement No. 109,
   "Accounting for Income Taxes."
/2/Based on weighted average number of common and common equivalent shares.
/3/Based on common shares outstanding.
/4/Certain investments since January 1994 are presented on a different basis
   from December 31, 1993, and prior, due to the January 1, 1994, adoption of
   FASB Statement No. 115, "Accounting for Certain Investments in Debt and
   Equity Securities." FASB Statement No. 115 prohibits restatement of prior
   years' financial statements.

                                       7
<PAGE>
 
ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
------    RESULTS OF OPERATIONS

OVERVIEW OF BUSINESS

The Registrant's insurance subsidiaries underwrite aviation and other specialty
line insurance products.  Non-aviation lines include lenders single interest,
short-term health and pleasure marine.  The insurance services businesses
complement the insurance operations.

The specialty insurance lines of business, particularly the aviation and
pleasure marine, are volatile from both a rate and claims perspective.  As a
result, the Registrant's operating results are subject to significant
fluctuations from year to year due to the impact of competition on premium
pricing, the frequency and severity of claims activity, weather-related
catastrophes, and general economic conditions.

The Registrant has and continues to emphasize rate discipline in all lines of
its business.  The aviation insurance sector, the Registrant's primary line of
business, has been engaged in an extremely competitive rate environment for
quite some time.  There continues to be some improvement of competitive rates in
the aviation insurance sector, especially in the areas of higher-valued aircraft
hulls and pilots, who are transitioning to larger or more complex aircraft.

To augment the aviation business, the Registrant continues to develop, both
internally and through acquisition, the growth of its other specialty lines and
its insurance services business.

LIQUIDITY AND CAPITAL RESOURCES

LIQUIDITY--

The Registrant's Consolidated Statements of Cash Flows on page 49 detail the net
cash provided and used by operating, investment, and financing activities.  The
Registrant's primary sources of operating funds are insurance premiums,
commissions, service fees and investment revenues.  Primary uses of operating
funds are for claim payments to insureds, commissions, and other operating
expenses.  Operating activities provided $5.8 million, $11.1 million, and $11.8
million of net cash flow in 1996, 1995, and 1994, respectively.  Since the level
of operating cash flow is principally affected by premium production, paid loss
activity, the sale of investment securities, and reinsurance recoveries
received, operating cash flow could vary significantly from period to period.

Net operating cash flow of $5.8 million for 1996 was below that of 1995.  1996
operating cash flow was affected by the realized gains on the sale of
investments and the realized gain on the sale of a subsidiary, which were
excluded from operating activities and included in cash flow from investment
activities.  In addition, 1996 operating cash flow was further impacted by one-
time refund payments of $2.4 million related to the settlement of California
Proposition 103 matters. The Registrant's insurance subsidiaries had fully
provided for such refund amounts in prior years. Net operating cash

                                       8
<PAGE>
 
flow for 1995 decreased from that of 1994 primarily because of increased paid
claims activity in 1995 and the effect of reinsurance recoverables received in
1994.

Capital expenditures for property and equipment additions were $700,000, $1.9
million, and $700,000, in 1996, 1995, and 1994, respectively.  1996 additions
were mainly computer equipment upgrades.  1995 expenditures consisted primarily
of costs associated with two subsidiary office relocations and assets acquired
through two acquisitions.  1994 additions were primarily comprised of computer
hardware upgrades.  The Registrant does not anticipate a significant level of
property and equipment capital expenditures during 1997.  Other expenditures
include the 1994 $2.0 million acquisition of assets from International Group
Services, Inc., a third party administrator that specializes in short-term
health insurance programs.  All expenditures were financed principally by
internally-generated funds.

At December 31, 1996, the Registrant had $31.6 million in cash and short-term
investments.  Additionally, $3.3 million of its fixed income portfolio is
scheduled to mature in 1997.  A further source of short-term liquidity includes
a credit facility with a bank.  $7.0 million is available under that commitment
to address short-term cash needs.  The Registrant's investment portfolio is
highly liquid, consisting principally of readily marketable securities.  In
developing its investment strategy, the Registrant establishes a level of cash
and highly liquid short- and intermediate-term securities which, combined with
expected cash flow, is believed adequate to meet anticipated payment
obligations.  While short-term liquidity is considered adequate, long-term
liquidity will be primarily dependent upon premium production and paid loss
activity.

INVESTMENTS--

The Registrant's investment portfolio represents 69% of its total assets.  The
Registrant follows investment guidelines which, in addition to providing for an
acceptable after-tax return on its investments, are structured to preserve
capital, maintain sufficient liquidity to meet obligations, and maintain what is
considered an ample margin of capital and surplus to sustain planned writings of
insurance.  At December 31, 1996, 76% of the Registrant's investments were in
fixed income securities, 7% in equities, and 17% in short-term investments.  The
Registrant's only real estate investments are in its operating facilities.
Fixed income securities consist principally of high investment grade securities
with an average maturity of about eight years.  The Registrant does not use
derivative instruments, such as mortgage derivatives, options and structured
notes, to leverage its investment portfolio.

At December 31, 1996, the Registrant's $149.2 million investment portfolio
reflected after-tax appreciation of $2.3 million above its cost basis.

The Registrant has classified its investments as available for sale.  While the
Registrant has the ability to hold its investments until maturity, these
securities may be sold prior to maturity in response to changing market and
economic conditions or to maximize after-tax returns.

                                       9
<PAGE>
 
The Registrant had $3.2 million of realized investment gains in 1996 compared to
a nominal realized investment gain of $575,000 in 1995. Decisions to sell
securities are governed by considerations such as surplus exposure, tax
consequences and investment opportunities. As a result, realized investment
gains or losses can vary significantly from period to period. The majority of
the 1996 realized investment gains arose from the Registrant's decision to
liquidate its common equity portfolio. Additional information regarding the
Registrant's investment portfolio is detailed on pages 52 through 54, and page
66.

LOSS RESERVES--

Historical experience, judgmental factors, adherence to a strategy of targeting
rate adequacy, continual monitoring of reserve levels, and paying claims in a
prompt fashion have all contributed to a favorable development of loss reserves
during the past several years.  A historical perspective of the Registrant's
loss reserve developments is included in Note 4 to the consolidated financial
statements on pages 55 and 56, and is incorporated herein.

The development of unpaid loss and loss adjustment expense refers to the
difference between original estimates for unpaid losses and loss adjustment
expenses and the re-evaluation of those estimates in subsequent years as loss
payments are made and open claims adjusted to reflect current information.
Redundant or favorable development occurs when original estimates are higher
than subsequently paid or adjusted.

During 1996, the Registrant experienced overall favorable development of $3.3
million on gross unpaid losses and loss adjustment expenses.  The 1996 favorable
development compares with favorable development of $2.5 million and $3.2 million
in 1995 and 1994, respectively.

The Registrant experienced overall favorable development of $1.1 million on net
unpaid loss and loss adjustment expenses after deducting reinsurance
protections.  This compares with favorable development of $1.1 million for 1995
and $2.9 million for 1994.  The gross loss reserve development and net loss
reserve development can vary significantly, as the level of reinsurance carried
on any one risk is dependent upon several factors.

The Registrant's insurance specialty businesses are mostly short-tail in nature,
meaning that claims are paid or settled in a relatively short time frame from
the time reported.  Nonetheless, the nature of the Registrant's principal
insurance specialty line, aviation, consists of low frequency, high severity
claims, which can result in significant changes in the development of unpaid
losses and loss adjustment expenses from period to period.  The timing of
salvage and subrogation recoveries could likewise affect the loss reserve
development.

The Registrant did not experience any significant environmental claim activity
during 1996, 1995 or 1994, and currently anticipates that activity in the future
should not have a material adverse effect on the overall consolidated financial
position of the Registrant.

                                       10
<PAGE>
 
REINSURANCE--

The Registrant's specialty lines of business, particularly aviation and pleasure
marine, are volatile from both a rate and a claims perspective, leading to
potentially wide swings in underwriting results.  Accordingly, the Registrant is
a party to several reinsurance arrangements.  These reinsurance arrangements are
utilized to assist in limiting maximum loss, provide greater diversification of
risk, reduce exposures on larger risks, and provide a level of protection from
catastrophic events.  The Registrant routinely reviews and adjusts its
reinsurance strategy, taking into account the anticipated future direction of
its business, underwriting considerations such as rate and risk levels,
conditions in the reinsurance marketplace and the cost-benefit relationship
expected to be derived from such reinsurance arrangements.  Most of the aviation
business is covered under a quota share/surplus share reinsurance arrangement.
Facultative reinsurance placements are also used, primarily on policies with
limits larger than are covered by treaty reinsurance.  The Registrant's
retention on its aviation business varies according to policy limits.  The
largest net aggregate amount retained in any one risk is $1.6 million.  The
Registrant currently retains all of the pleasure marine business that it writes,
subject to catastrophic reinsurance protections.  Under its catastrophe
reinsurance, which also covers the aviation business line, the Registrant
absorbs the first $2.5 million  in losses, with catastrophe reinsurance
protection to $10.5 million.  The lenders single interest and short-term health
business participate in proportional treaty reinsurance.  For 1996, the
Registrant retained 86% of its premium production and ceded 14% to reinsurers
under its various reinsurance arrangements. Approximately 63% of the net amounts
recoverable from reinsurers at December 31, 1996, are attributable to
reinsurance arrangements with three reinsurers.  No significant amounts
recoverable from reinsurers have been written off as uncollectible in the past
three years.  Additional information regarding reinsurance is detailed in Note 9
to the consolidated financial statements on page 61 and is incorporated herein
by reference.

CAPITAL RESOURCES--

The annual dividends for 1996 and 1995 were $.48 per share and $.46 per share,
respectively, marking the twenty-first and twentieth years in which the
Registrant has paid an increased dividend.

The Registrant's common stock repurchase program reflects continued efforts to
effectively manage its capital base and enhance shareholder value.  Its capital
needs vary from period to period recognizing the volatility in the underwriting
of its specialty insurance products.  The aviation insurance industry continues
in the longest competitive cycle in its history.  The Registrant acquired
520,000 of its common shares during 1996.  Since inception of its stock
repurchase program in the 1987 fourth quarter through the end of 1996, the
Registrant has repurchased 6,727,380 shares of its stock at prices ranging from
$9.75 to $22.00 per share.

The Registrant utilized a combination of its revolving credit facility, a
portion of the proceeds from the sale of investments, and funds generated by its
subsidiaries operating activities to finance its capital management program.
Funds provided by the Registrant's principal subsidiary, AVEMCO Insurance
Company, were paid through dividends. Regulatory restrictions on such dividends
are detailed in Note 10 of the Registrant's consolidated financial statements.

                                       11
<PAGE>
 
The Registrant's ability to support substantial future growth is reflected in
its insurance subsidiary's ratio of net premiums written to statutory
policyholders' surplus, a measure used by insurance regulators and analysts to
evaluate liquidity and capital resources.  The insurance subsidiary's ratio is
currently 1.19 to 1; a general maximum regulatory guideline is 3 to 1.  The
ratio of unpaid losses and expenses to surplus was .46 to 1.  1996 marked the
22nd consecutive year and the 33rd in 36 years in business where an underwriting
profit was achieved.  The Registrant currently is adequately capitalized to
support future planned activities.  The insurance subsidiary continues its "A+"
(Superior) rating from A.M. Best.  In addition, the insurance subsidiary's
December 31, 1996, policyholders' surplus position substantially exceeded the
minimum requirements as stipulated by insurance industry risk-based capital
regulations.

SUBSEQUENT EVENT

On January 17, 1997, AVEMCO and HCC Insurance Holdings, Inc., ("HCCH") jointly
announced that they had signed a Letter of Intent to merge AVEMCO with a wholly-
owned subsidiary of HCCH in a stock-for-stock transaction, with AVEMCO becoming
a wholly-owned subsidiary of HCCH.  On February 28, 1997, AVEMCO and HCCH
jointly announced that the Boards of Directors of AVEMCO and HCCH had executed
an Agreement and Plan of Reorganization (the "Agreement").  Pursuant to the
terms of the Agreement, each share of AVEMCO's common stock will be exchanged
for one share of HCCH's common stock.

The proposed transaction is intended to be accounted for as a pooling of
interests and to be a nontaxable exchange to AVEMCO's shareholders.  It is
subject to various conditions, including receipt of required regulatory
approvals and the approval of the transaction by shareholders of both AVEMCO and
HCCH.  A special shareholders' meeting is anticipated to be held in the second
quarter of 1997, and a proxy statement describing the transaction in detail is
expected to be submitted to the shareholders shortly.  There can be no assurance
that the conditions to the proposed merger will be satisfied or that the
shareholders will approve the transaction.

RESULTS OF OPERATIONS - 1996 COMPARED TO 1995
1996 marks the sixth consecutive year that the Registrant has grown its gross
premiums writing base.  Gross premiums written for 1996 increased over 1995 as
follows:
<TABLE>
<CAPTION>
                                    (000's)
Line of Business                1996      1995
----------------------------  --------  ---------
<S>                           <C>       <C>
    Aviation                  $ 69,474  $ 69,076
    Non-aviation                37,491    31,072
                              --------  --------
    Gross Premiums Written    $106,965  $100,148
                              ========  ========
</TABLE>

Gross premiums written for the aviation line were $69.5 million in 1996 compared
to $69.1 million in 1995. Included in 1995 gross premiums written, however, were
$4 million of non-recurring premiums associated with the January 1995
acquisition of the aviation business from Aviation Underwriting Specialists.
Excluding those non-recurring premiums, gross aviation premiums written
increased 7% over 1995 due to a combination of rate improvement and unit growth.

                                       12
<PAGE>
 
Gross premiums written on the non-aviation insurance lines increased 21% over
1995 to $37.5 million. Particularly noteworthy was the lenders single interest
production.  This particular insurance product, managed by Matterhorn Bank
Programs, Inc., a consolidated subsidiary, protects a lender's retail
installment portfolio primarily against risk of physical loss of or damage to
property securing its installment loans should the borrower fail to maintain the
required insurance.  Strong new business growth pushed 1996 lenders single
interest gross premiums written 38% to $22.9 million as compared to $16.6
million in 1995.

Gross premiums written for short-term health insurance programs were $10.2
million in 1996 compared to $10.9 million in 1995.  The decline was principally
impacted by the Registrant's decision to discontinue as a reinsurer of a trip-
travel program that represented $6.3 million of gross premiums written in 1995,
when it was unable to negotiate satisfactory renewal terms.  That decline was
largely offset with increased participation in short-term health programs
managed and underwritten by the Registrant's International Group Services
division of Brooks-Shettle Company, a consolidated subsidiary, and participation
late in 1996 on short-term programs managed and underwritten by its Hinchcliff
International division.

Pleasure marine gross premiums written increased to $4.4 million in 1996 versus
$3.5 million in 1995 through improved new business production by the
Registrant's independent agency insurer, U.S. Specialty Insurance Company.  The
Registrant is continuing to develop this product gradually by stressing
conservative underwriting guidelines.  In addition, the Registrant continues to
retain 100% of the pleasure marine risks it writes, with the exception of
reinsurance coverage for catastrophic marine losses.

Net premiums written for all lines of business reflect the business retained by
the Registrant after its reinsurance arrangements are considered.  Net premiums
written  increased over 1995 primarily because of the growth in the lenders
single interest business.  1996 earned premium revenues of $86.2 million
increased over 1995's $80.5 million, consistent with the increase in net
premiums written.

Commission revenues, consisting primarily of commissions received on reinsurance
ceded and commissions produced by agency operations, net of amounts paid to
their agents, increased to $8.8 million in 1996 as compared to $7.0 million in
1995.  The increase is mainly attributed to commissions generated by the
Hinchcliff International division of Brooks-Shettle Company.

Net investment income in 1996 was $8.2 million compared to $8.5 million in 1995.
The slight decrease is principally attributed to a lower average invested asset
base during 1996.  The Registrant  sold its common equity securities in 1996.

Computer product and service revenues generated by The Wheatley Group, Ltd., a
consolidated subsidiary, was $9.9 million in 1996, slightly behind 1995's $10.2
million.  Hardware equipment sales declined by $800,000, while Wheatley's core
software revenues increased by $500,000.  Hardware sales can vary significantly
from period to period.

                                       13
<PAGE>
 
Realized gains on the sale of investments were $3.2 million in 1996 as compared
to $600,000 in 1995.  The majority of the 1996 gains arose from the Registrant's
decision to sell its common equities.

The Registrant sold a subsidiary, National Assurance Underwriters, Inc., during
1996, while retaining all that subsidiary's insurance business.  The sale
generated a realized gain of $3.3 million.

Other revenues increased to $8.2 million in 1996 as compared to $6.4 million in
1995.  $1.0 million of the increase is directly attributed to MEDEX Assistance
Corporation, a consolidated subsidiary that improved its revenue performance by
30% over 1995.

From a claims perspective, the net loss ratio for 1996 was 73.0% compared to
69.1% in 1995.
<TABLE>
<CAPTION>
 
                      Net Loss Ratios
Line of Business            1996          1995
--------------------- ----------------  --------
<S>                   <C>               <C>
    Aviation                     76.1%     68.7%
    Non-aviation                 67.9%     70.0%
    All Lines                    73.0%     69.1%
</TABLE> 
Net incurred losses and loss adjustment expenses were as follows:
<TABLE> 
<CAPTION> 
                               (000's)
    Line of Business       1996      1995
----------------------   -------   -------
<S>                      <C>       <C> 
    Aviation             $40,387   $36,575
    Non-aviation          22,479    19,030
                         -------   -------
    Net Incurred Losses  $62,866   $55,605
                         =======   =======
</TABLE>

Net aviation incurred losses in 1996 increased over 1995, principally due to
increased physical damage claims activity on higher-valued aircraft.  In
addition, earlier in 1996 there was a higher than usual increase in reported
small claims activity.  Non-aviation losses in 1996 were $22.4 million compared
to $19.0 million in 1995 as an increase in lenders single interest insurance
claims commensurate with their new business growth was partially offset by
improved loss performance by the short-term health programs.

Incurred losses in 1996 were also affected by Hurricane Fran which struck the
eastern portion of the United States in September.  This storm resulted in an
after-tax earnings reduction of $548,000 or $.07 per share.  There were no
significant weather-related losses in 1995.

Commission expense, representing costs incurred to generate insurance business
through the assumed reinsurance and independent agency markets increased to $7.1
million in 1996 as compared to $6.5 million in 1995.  This increase is
consistent with the upward trend in reinsurance assumed production.

                                       14
<PAGE>
 
Lower variable interest rates combined with a lower level of bank borrowings
during 1996 decreased interest expense to $3.8 million in 1996 from $4.2 million
in 1995.

Selling, general, and administrative costs increased a modest 2.5% in 1996 as
the Registrant incurred additional operating costs from the recently acquired
Hinchcliff International, Inc. subsidiary while supporting increased revenue
activities in its other business units without a significant increase in
operating costs.

Income tax expense increased in 1996 to $3.7 million as compared to $1.2 million
in 1995, mainly as the result of the increased realized investment gains and the
realized gain on the sale of National Assurance Underwriters, Inc.  Both of
these items were fully taxable.

In October 1995, the Financial Accounting Standards Board issued Statement No.
123, "Accounting for Stock-based Compensation."  This Statement establishes an
alternative fair value-based method of accounting for all employee stock
compensation plans in addition to the intrinsic value-based method.  The
Registrant has elected to continue to use the intrinsic value method as
permitted by the Statement.  The Registrant has made the necessary disclosures
as required by the Statement in its Notes to Consolidated Statements.

RESULTS OF OPERATIONS - 1995 COMPARED TO 1994

Gross premiums written for 1995 increased over 1994 as follows:
<TABLE>
<CAPTION>
 
                                   (000's)
Line of Business                1995     1994
----------------------------  --------  -------
<S>                           <C>       <C>
    Aviation                  $ 69,076  $56,812
    Non-aviation                31,072   33,840
                              --------  -------
    Gross Premiums Written    $100,148  $90,652
                              ========  =======
    Net Premiums Written      $ 85,540  $73,450
                              ========  =======
</TABLE>

Gross premiums written for aviation during 1995 increased by 22% over 1994.
That increase resulted principally from the purchase of the aviation business of
Aviation Underwriting Specialists (AUS) during the 1995 first quarter. In
addition, there was new business growth. While the rate situation in the
aviation insurance sector remained competitive, there was some improvement.
Market rates continued to rise during 1995, with more significant increases in
the areas of high-valued aircraft hulls and with pilots who are transitioning to
larger or more complex aircraft.

Gross premiums written on non-aviation lines were $31.1 million compared to
$33.8 million in 1994.  The drop in premium was principally attributable to the
short-term health business, where there was a reduced level of participation in
one profitable short-term health program, along with the discontinuance of
another program that was not meeting the Registrant's underwriting objectives.
These actions had the effect of reducing earned premium revenues when compared
to 1994.  The

                                       15
<PAGE>
 
Registrant plans to continue to build its participation in certain short-term
health programs managed by International Group Services (IGS), which it acquired
in December of 1994. The Registrant also expects to begin participating late in
1996 on short-term health programs managed by Hinchcliff International
(Hinchcliff), a subsidiary acquired in January 1996. IGS and Hinchcliff are
third-party administrators and producers of short-term health insurance
programs, primarily covering foreign students who temporarily reside in the
United States while attending colleges and universities.

Lenders single interest gross premium writings were $16.6 million for 1995
compared to $16.3 million written in 1994.  This business principally covers
automobile loans and is thereby closely linked to automobile sales, which had a
downturn in 1995.  Additionally, Matterhorn emphasizes rate discipline and will
not write business at what it believes to be an inadequate rate.

Pleasure marine gross premiums written for 1995 were $3.5 million, similar to
that of 1994.  The Registrant continues to emphasize movement away from coastal
exposures, given the frequency of weather-related events over the last several
years.  The Registrant continues to retain 100% of the pleasure marine business
it writes with the exception of reinsurance for catastrophic marine losses.

Net premiums written for all lines of business reflect the business retained by
the Registrant after its reinsurance arrangements are considered.  Net premiums
written increased over 1994 because of the growth in the aviation business.
Earned premium revenues of $80.5 million increased over 1994's $75.5 million,
consistent with the increase in net premium written.

Commission revenues increased to $7.0 million in 1995 as compared to $6.4
million in 1994, primarily as a result of the IGS acquisition.

Net investment income of $8.5 million was slightly above 1994's $8.2 million,
principally due to an increase in average invested assets.

Computer product and service revenues generated by The Wheatley Group, Ltd., a
consolidated subsidiary, amounted to $10.2 million compared to $9.2 million for
1994.  The revenue increase is principally attributable to an increase in
hardware equipment sales.

Realized investment gains and or losses for 1995 and 1994 were nominal.

From a claims standpoint, the net loss ratio for 1995 was 69.1% compared to
61.3% for 1994.
<TABLE>
<CAPTION>
 
                     Net Loss Ratios
Line of Business     1995        1994
-----------------  --------    -------- 
<S>                <C>         <C>
    Aviation         68.7%        62.8%
    Non-aviation     70.0%        59.2%
    All Lines        69.1%        61.3%
</TABLE> 

                                       16
<PAGE>
 
Net incurred losses and loss adjustment expenses were as follows;
<TABLE> 
<CAPTION> 
 
                                 (000's)
    Line of Business         1995      1994
------------------------   -------   -------
<S>                        <C>       <C> 
    Aviation               $36,575   $27,460
    Non-aviation            19,030    18,850
                           -------   -------
    Net Incurred Losses    $55,605   $46,310
                           =======   =======
</TABLE>

Net incurred losses on aviation claims increased compared to 1994.  Claim
activity on the growing book of higher-valued aircraft was one principal reason
for the increase.  The Registrant experienced a difficult third quarter from a
claims perspective.  Historically, that quarter can be volatile since it is the
peak season for aircraft and watercraft use.  The Registrant incurred several
large hull claims during that period.  The Registrant did not experience an
increase in claims frequency or severity on the liability side.  Another reason
for the increase in net incurred losses was due to the additional claim activity
on the aviation book of business acquired from AUS during the first quarter of
1995.

There were no significant weather-related losses during 1995 or 1994.
Additionally, the Registrant did not incur significant losses associated with
the "Blizzard of 1996," which occurred shortly after the end of the year.

Commission expense declined to $6.5 million in 1995 compared to $7.2 million in
1994.  This decrease is principally attributable to the decline in premiums
related to the short-term health plans.

Higher variable interest rates and a slightly higher level of bank borrowings
increased interest expense to $4.2 million in 1995 from $3.7 million in 1994.

Selling, general, and administrative expenses for 1995 increased over the prior
year, primarily due to the acquisition of the AUS book of aviation business, the
acquisition of the IGS business and additional costs incurred with the software
business.

Income tax expense decreased to $1.2 million in 1995 from $2.7 million in 1994
as pre-tax earnings were predominantly comprised of non-taxable investment
income in relation to income from fully taxable sources, such as underwriting
and realized investment gains.

The Registrant's principal subsidiary, AVEMCO Insurance Company, settled its
outstanding Proposition 103 matters with the California Department of Insurance
during 1995.  The Registrant had previously provided for a potential rollback
impact in prior years such that the effect on 1995 net earnings of the ultimate
settlement was not material.

In summary, increased claims activity in the aviation business and a reduced
level of participation in two short-term health programs were the principal
factors for the reduced level of earnings when compared to 1994.

                                       17
<PAGE>
 
RESULTS OF OPERATIONS - 1994 COMPARED TO 1993

Gross premiums written for 1994 increased over 1993 as follows:
<TABLE>
<CAPTION>
 
                                   (000's)
Line of Business               1994      1993
----------------------------  -------  --------
<S>                           <C>      <C>
    Aviation                  $56,812  $58,239
    Non-aviation               33,840   24,016
                              -------  -------
    Gross Premiums Written    $90,652  $82,255
                              =======  =======
    Net Premiums Written      $73,450  $62,456
                              =======  =======
</TABLE>

Gross premiums written for aviation during 1994 were 2% under the prior year.
During 1994, the Registrant strengthened underwriting criteria on certain
classes of aviation business to increase its underwriting profitability.
Additionally, the Registrant continued to emphasize rate discipline, recognizing
that the aviation insurance sector had been engaged in an extremely competitive
rate environment for quite some time.  The Registrant has been unwilling to
write aviation business at what it considers inadequate rates.

Lenders single interest gross premium writings were $16.3 million for 1994,
reflecting a 22% increase over that of 1993.  Matterhorn's business principally
covers automobile loans and is thereby closely linked to automobile sales, which
continued to show upward trends in 1994.  Additional growth in Matterhorn's
business came from the previous acquisition by Matterhorn of KFA, Inc., in
Oklahoma.

Gross premiums written for short-term health programs were $13.9 million in 1994
versus $5.8 million for 1993.  The Registrant's experience in this market began
a number of years ago with the development of the TravMed(R) product for United
States citizens traveling abroad.  In 1991 a similar product was developed for
foreign students studying aviation curriculums in the United States.  As an
outgrowth of that activity, Brooks-Shettle Company, a consolidated subsidiary,
with long-standing involvement in short-term health coverages, established an
underwriting and reinsurance program for foreign nationals attending a broader
range of studies in American colleges and universities.  The Registrant
participated as an assuming reinsurer in that business during 1994. Toward the
end of 1994, the Registrant acquired certain assets of International Group
Services, Inc. This third party administrator had approximately $12.3 million in
short-term student health premiums under administration. The Registrant plans to
increase its insurance participation in this line of business through the
acquisition.

Pleasure marine gross premiums written for 1994 were $3.6 million compared to
$4.4 million in 1993.  That decline was expected because of the rate increases
and the continued movement away from coastal exposures.  Prior to 1994,
underwriting results were adversely impacted by catastrophes that included
Hurricanes Bob and Andrew and a few other coastal storms.

                                       18
<PAGE>
 
Net premiums written increased over 1993 because of continued growth in the
lenders single interest and short-term health lines and increased retention on
the pleasure marine line.  Earned premium revenues of $75.5 million increased
over 1993's $62.7 million, consistent with the increase in net premiums written.

Commission revenues, net of amounts paid to agents, increased over 1993
primarily because of the substantial growth in the lenders single interest and
short-term health businesses.

Net investment income of $8.2 million was under 1993's $9.0 million, principally
due to a decline in average invested assets.  During the 1993 second half, $15
million of equity securities were sold; the proceeds from those sales were used
to repurchase a block of the Registrant's common stock.

Computer products and services revenues generated by The Wheatley Group, Ltd., a
consolidated subsidiary, amounted to $9.2 million contrasted to $11.1 million
for 1993.  The revenue decline is principally attributable to a decrease in
hardware equipment sales.  Software revenues and services increased from $6.1
million in 1993 to $7.8 million in 1994.  Wheatley contributed $1.7 million and
$1.4 million to pre-tax operating earnings for 1994 and 1993, respectively.

Realized losses on the sale of investments were $248,000 in 1994; realized gains
on the sale of investments were $9.6 million in 1993.  The majority of the 1993
gains arose from the sale of equity securities.

From a claims standpoint, the net loss ratio for 1994 was 61.3% compared to
66.2% for 1993.
<TABLE>
<CAPTION>
 
                      Net Loss Ratios
Line of Business     1994         1993
------------------- --------  --------
<S>                 <C>       <C>
    Aviation          62.8%     71.1%
    Non-aviation      59.2%     56.1%
    All Lines         61.3%     66.2%
 
</TABLE>

Net incurred losses and loss adjustment expenses were as follows:
<TABLE> 
<CAPTION> 
 
                                (000's)
Line of Business             1994      1993
---------------------       -------   -------
<S>                         <C>       <C> 
    Aviation                $27,460   $30,055
    Non-aviation             18,850    11,447
                            -------   -------
    Net Incurred Loss       $46,310   $41,502
                            =======   =======
</TABLE>

Net incurred losses on aviation claims declined compared to 1993.  During 1994,
the Registrant strengthened underwriting criteria on certain classes of aviation
business to increase underwriting profitability.  Additionally, the Registrant
did not incur any significant weather-related losses.  Weather-related losses
for 1993, after reinsurance recoveries, amounted to $1.2 million and were
principally related to the "Blizzard of 1993" and the "Midwest Flooding."  Net
incurred losses on the 

                                       19
<PAGE>
 
non-aviation lines of business were $18.9 million versus $11.4 million for 1993,
principally due to increased claims on the lenders single interest and short-
term health lines of business. Those increases are consistent with the premium
growth in those businesses during the course of 1994.

Commission expense increased to $7.2 million in 1994, as compared to $5.7
million in 1993.  This increase is primarily attributable to the increase in
assumed reinsurance business, particularly the short-term health programs.

Higher variable interest rates, coupled with a larger average outstanding debt
balance on the Registrant's credit facility, increased interest expense to $3.7
million in 1994 from $2.3 million in 1993.  Selling, general, and administrative
expenses increased a modest 3% reflecting the Registrant's continuing efforts to
attain efficient operating cost structures throughout its various business
units.  The Registrant also incurred approximately $600,000 in non-recurring
advisory expenses related to a share repurchase transaction with GEICO in 1993.

Income tax expense decreased in 1994 to $2.7 million from $4.2 million in 1993,
principally as a result of the decline in realized investment gains from 1993's
level.  Those 1993 gains were taxed at the full 34% tax rate.

Composition of net earnings was as follows:
<TABLE>
<CAPTION>
 
                                               (000's)
                                            1994     1993
                                          --------  -------
<S>                                       <C>       <C>
    Operations                            $10,997   $ 8,270
    Realized investment gains (losses)       (164)    6,359
    FASB tax implementation                    --       943
                                          -------   -------
    Net earnings                          $10,833   $15,572
                                          =======   =======
</TABLE>

ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
------                                            

The consolidated financial statements and notes to the consolidated financial
statements of the Registrant and subsidiaries on pages 45 through 64, and the
Independent Auditors' Report on page 65 are incorporated herein.

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

None

                                       20
<PAGE>
 
                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-------                                                   

DIRECTORS OF REGISTRANT

The following table lists certain information with respect to the Registrant's
directors:

<TABLE>
<CAPTION> 

                               Other Positions and Offices with the Registrant,
                               Principal Occupation, Business Experience During
Name, Age, and Year            Past Five Years and Other Directorships in Public    Term
First Served as a Director     Companies                                           Expires
-------------------------------------------------------------------------------------------- 
<S>                            <C>                                                 <C>
H. Lowell Davis (a)(c)(d)      Vice Chairman and Director, Potomac Electric         1997
Age:  64                       Power Company.  Former Chief Financial Officer
Director since 1985            of that company.

Paul J. Hanna (a)(c)           Until retirement in 1986, Vice Chairman and          1997
Age: 81                        Director, GEICO Corporation.
Director since 1980

Steven A. Markel (b)(d)        Vice Chairman, Markel Corporation; Director:         1997
Age:  48                       Fairfax Financial Holdings, Ltd. (Canada);
Director since 1994            Director: Morden & Helwig Group, Inc. (Canada);
                               Director: S&K Famous Brands, Inc.

Michael Collins (a)(b)(d)      President, Michael Collins Associates                1998
Age:  66                       (consulting firm); Trustee: National Geographic 
Director since 1986            Society; Former Astronaut; Vice President, 
                               Washington Operations of LTV Aerospace and Defense
                               Company (1980-85).

John F. Shettle, Jr. (c)       President and Chief Executive Officer of the         1998
Age:  42                       Registrant; Chairman, Eastern Aviation & Marine
Director since 1993            Underwriters, Inc., a subsidiary of the Registrant;
                               Board member and officer of various other
                               subsidiaries of the Registrant.
</TABLE>

                                       21
<PAGE>
 
<TABLE>
<CAPTION>
                               Other Positions and Offices with the Registrant,  
                               Principal Occupation, Business Experience During  
Name, Age, and Year            Past Five Years and Other Directorships in Public    Term 
First Served as a Director     Companies                                           Expires 
-------------------------------------------------------------------------------------------- 
<S>                            <C>                                                 <C>
Rachel B. Trinder (b)(d)       Attorney; partner with law firm of Zuckert, Scoutt   1998
Age:  42                       & Rasenberger LLP since 1985; associate from
Director since 1996            1978-1985.

William P. Condon (a)(c)       Chairman of the Board of Directors of the            1999
Age:  59                       Registrant; Chairman of the Boards of various
Director since 1973            subsidiaries of the Registrant; Chief Executive
                               Officer of the Registrant until March 1, 1997.

Arnold H. Johnson (a)(c)       Until retirement in 1982, Chairman of the Board      1999
Age:  79                       of Directors and Chief Executive Officer of the
Director since 1965            Registrant  and Chairman of the Boards of its
                               subsidiaries.

Thomas J. Schwab (b)(c)        Attorney; partner with law firm of Wald,             1999
Age:  69                       Harkrader and Ross until 1984; Secretary of the
Director since 1987            Registrant until April 1987.
</TABLE>

   (a) Member of the Executive Committee
   (b) Member of the Audit Committee
   (c) Member of the Investment Committee
   (d) Member of the Compensation and Stock Option Committee

The Board of Directors of the Registrant met six times during 1996.  In
addition, the Registrant has the following standing committees of the Board:

 .  EXECUTIVE COMMITTEE. The Executive Committee has the authority to act during
   intervals between meetings of the Board of Directors and to exercise all
   powers of the Board except those reserved to the Board by statute, the
   Certificate of Incorporation or Bylaws. It also functions to advise the Board
   on all matters pertaining to Board nominations and membership. The Executive
   Committee will not consider nominations for Board membership from
   shareholders. The Committee met two times during 1996.

                                       22
<PAGE>
 
 .  AUDIT COMMITTEE. The Audit Committee, composed entirely of outside directors,
   serves as a liaison between the Board and the Registrant's auditors, to
   discuss with the auditors before their examination its scope and approach,
   and to discuss with them after their examination the results of the audit.
   The Committee met three times in 1996.

 .  INVESTMENT COMMITTEE. The Investment Committee serves to review the
   investment policy and investment guidelines of the Registrant, and makes
   recommendations to the Board of Directors. The Committee met four times
   during 1996.

 .  COMPENSATION AND STOCK OPTION COMMITTEE. The Compensation and Stock Option
   Committee is responsible for recommendations to the Board in decisions
   affecting compensation to employees, including salaries of officers and
   allocation of awards under the Executive Performance Compensation Plan, and
   is responsible for the awarding of stock options under the Registrant's stock
   option plans. The Committee met two times in 1996.

All directors attended at least 75 percent of the meetings of the Board and
Committees of which they were members.

The Registrant's current arrangement for compensation of directors is that those
directors who are not employees of the Registrant, or a subsidiary, receive an
annual retainer of $18,000.  For each Board and Executive Committee meeting
attended, non-employee members receive $1,200 ($1,400 for the Chairman of the
Executive Committee).  For all other Committee meetings attended, members
receive $900 ($1,000 if Chairman of the Committee).  The Registrant also
reimburses directors for travel expenses incurred in attending meetings.

The Registrant has a plan whereby non-employee directors may defer their annual
retainer fees until age 70-1/2 or until their service with the Board terminates.
The Registrant also has a consulting plan for directors, pursuant to which
directors retiring from the Board after age 65 and after at least ten years of
service on the Board may continue to receive between 50% and 100% of the annual
retainer (but not the per meeting fees) they would receive as active directors,
the percentage depending on years of active service as a director.  The fee at
the 50% level would be payable for a minimum of 10 years of active service on
the Board, 75% for a minimum of 15 years of active service, and 100% fee for a
minimum of 20 years of active service.

Arnold H. Johnson also serves as consultant to the Registrant under the terms of
a consulting agreement which provides for payments of an annual consulting fee
of $37,000.  All payments under the agreement are deferred for five years from
the time earned, and such deferrals accrue interest at the rate of 8% per annum.
The agreement may be terminated prior to its May 1, 1997, expiration by either
party for cause, upon 90 days' notice.

                                       23
<PAGE>
 
EXECUTIVE OFFICERS OF THE REGISTRANT

Set forth below is information regarding executive officers of the Registrant.
Each officer holds such office until the next annual election of officers, which
is held at the first meeting of the Board of Directors after the annual meeting
of shareholders, and until his/her successor is elected.

In conjunction with the signing of the "Agreement," referred to in Part I, Item
1, Business, Recent Development, William P. Condon, Chairman of the Board and
Chief Executive Officer of AVEMCO, stepped down as Chief Executive Officer of
AVEMCO effective March 1, 1997.  He will continue as Chairman of the Board of
AVEMCO until the merger is consummated.  Effective March 1, 1997, John F.
Shettle, Jr., President of AVEMCO, assumed the additional duties of Chief
Executive Officer of AVEMCO.

William P. Condon, 59, has been Chairman of the Board of the Registrant since
1982, and until March 1, 1997, was also Chief Executive Officer.  He was
President and Chief Operating Officer of the Registrant from 1973 until May
1994.  He also is, or has served as, Chairman of the Board, a director and/or an
officer of various subsidiaries of the Registrant, having been employed by the
Registrant, or one or more of its subsidiaries, since 1961.

John F. Shettle, Jr., 42, has been President and Chief Operating Officer of the
Registrant, since 1994, and has been a director of the Registrant since July
1993.  As of March 1, 1997, he has also been Chief Executive Officer.  He was
Executive Vice President of the Registrant from 1991 until May 1994.  He was
Senior Vice President-Business Development and Planning of the Registrant from
1988 through May 1991.  He was President of Eastern Aviation and Marine
Underwriters, Inc., a wholly-owned subsidiary of the Registrant, from the
Registrant's acquisition of that subsidiary in 1983 to 1987.  He also is, or has
served as, a director and/or an officer of various subsidiaries of the
Registrant.

John R. Yuska, 52, has been Senior Vice President and Chief Financial Officer of
the Registrant since 1988.  He was Vice President-Finance of the Registrant from
1986 through 1987, and Treasurer of the Registrant from 1978 through 1985.  He
also is, or has served as, a director and/or an officer of various subsidiaries
of the Registrant, having been employed by the Registrant since 1978.

Thomas H. Chero, 46, has been Senior Vice President-Legal of the Registrant
since 1988 and Corporate Secretary of the Registrant since 1987.  He was Vice
President-Legal of the Registrant from 1986 through 1987.  He also is, or has
served as, a director and/or an officer of various subsidiaries of the
Registrant, having been employed by the Registrant, or one or more of its
subsidiaries, since 1976.

Thomas L. Hudson, 48, has been Vice President-Business Development of the
Registrant since 1994.  He was elected President of MEDEX Assistance
Corporation, a wholly-owned subsidiary of the Registrant, in 1995.  Mr. Hudson
was previously a Partner with the law firm of Venable, Baejter and Howard,
having been employed there from 1977 until 1994, when he left to join the
Registrant.

                                       24
<PAGE>
 
John E. Sweeney, 46, has been Vice President-Marketing since 1993.  He was
Assistant Vice President-Sales from 1987 through 1992, and has been employed by
the Registrant, or one or more of its subsidiaries, since 1974.

Jon R. Harden, 41, has been Vice President-Sales since 1993.  He was Assistant
Vice President-Sales from February 1989 through 1992, and has been employed by
the Registrant, or one or more of its subsidiaries, since 1981.

Thomas E. Lentz, 38, has been Treasurer of the Registrant since 1988.  He also
is an officer of various subsidiaries of the Registrant, having been employed by
the Registrant, or one or more of its subsidiaries, since 1985.

COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT

Section 16 of the Securities Exchange Act of 1934, as amended, requires the
Registrant's officers, directors and persons who own greater than 10% of a
registered class of the Registrant's equity securities to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and New York Stock Exchange.  Based on a review of the Forms 3, 4, and 5 it has
received, and/or on written representations from certain reporting persons that
no Form 5 was required for them, the Registrant believes that all Section 16
filing requirements applicable to its officers, directors and 10% beneficial
owners were complied with by such persons with the following exceptions which
were reported on Form 5 by each individual for the year ended 1996:

 .  Arnold H. Johnson, director, gifted 2,300 shares of AVEMCO common stock in
   one transaction on February 14, 1994.

 .  John Sweeney, Vice President-Marketing, sold 300 shares of AVEMCO common
   stock in one transaction on September 1, 1996.

ITEM 11.  EXECUTIVE COMPENSATION
-------                             

The following table sets forth the annual and long-term compensation for the
Registrant's Chief Executive Officer and the four highest-paid executive
officers, as well as all other compensation paid or awarded to each such
individual for the Registrant's last three fiscal years.

                                       25
<PAGE>
 
<TABLE>
<CAPTION> 
                                   SUMMARY COMPENSATION TABLE
                                                                      Long-Term
                                                                     Compensation
                                                                     ------------
                                                                        Awards
                                                                        ------
 Name and                                   Annual Compensation       Securities     All Other
 Principal                               ------------------------     Underlying    Compensation
 Position                       Year     Salary($)  Bonus($)/(1)/   Options/SARs(#)  ($)/(2)/
-------------------------------------------------------------------------------------------------
<S>                             <C>      <C>           <C>          <C>               <C> 
William P. Condon               1996     400,000          192,000               0      7,071
Chairman of the Board           1995     390,000           92,000               0      6,382
Age: 59                         1994     390,000          155,000           7,500     10,237
 
John F. Shettle, Jr.            1996     165,000           89,000               0      6,027
President and Chief             1995     157,000           43,000               0      5,338
Executive Officer               1994     145,500           76,000           5,000      9,193
Age:  42
 
John R. Yuska                   1996     134,000           68,000               0      6,585
Senior Vice President and       1995     128,000           30,000               0      5,896
Chief Financial Officer         1994     123,000           61,000           3,000      9,409
Age:  52
 
Thomas H. Chero                 1996     105,000           67,000               0      2,544
Senior Vice President -         1995     100,000           31,000               0        522
Legal and Corporate             1994      95,000           58,000           3,000      9,193
Secretary
Age:  46
 
Thomas L. Hudson                1996     115,000           26,000           8,000      5,423
Vice President -                1995     113,000           13,000           1,000      2,435
Business Development            1994      55,423           12,000           1,000          0
Age:  48
-------------------------------------------------------------------------------------------------
</TABLE> 
/(1)/"Bonus" consists of Performance Compensation awarded for 1996 performance,
     but which was paid in early 1997. Similar timing also applies for the
     previous two years shown.

/(2)/"All Other Compensation" consists of the employer contribution to the
     defined contribution Profit Sharing Plan and Group Term Life Plan for
     Messrs. Condon, Shettle, Jr., Yuska, Chero, and Hudson respectively, as
     follows: (i) Profit Sharing: $5,721, $5,721, $5,721, $2,022, and $4,901;
     (ii) Term Life: $1,350, $306, $864, $522, and $522.

Note:  All of the executive officers listed have been with the Registrant, or a
subsidiary of the Registrant, for more than five years except Mr. Hudson, who
was a partner with the law firm of Venable, Baetjer and Howard, having been
employed there from 1977 until 1994, when he left to join the Registrant.  Mr.
Hudson also serves as President of the Registrant's subsidiary, MEDEX Assistance
Corporation.

                                       26
<PAGE>
 
OPTION/SAR GRANTS

The following table sets forth certain information concerning options/SARs
granted during 1996 to the named executives:

                     OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
 
                             Individual Grants
----------------------------------------------------------------------           Potential Realizable
                             % of Total                                            Value of Assumed
                             Number of        Options/SARs                       Annual Rates of Stock
                             Securities         Granted     Exercise               Price Appreciation
                             Underlying       to Employees   or Base               for Option Term/(1)/
                            Options/SARs       in Fiscal      Price    Expiration  -------------------
Name                        Granted/(2)/          Year       ($/Sh)       Date      5%($)       10%($)
--------------------------------------------------------------------------------------------------------
<S>                     <C>                   <C>           <C>        <C>         <C>          <C> 
 
William P. Condon                  0               --             --           --          --        --
                                                                 
John F. Shettle, Jr.               0               --             --           --          --        --
                                                                 
John R. Yuska                      0               --             --           --          --        --
                                                                 
Thomas H. Chero                    0               --             --           --          --        --
                                                                 
Thomas L. Hudson               8,000             17.5          15.25   12/12/2006      76,725   194,437
--------------------------------------------------------------------------------------------------------
</TABLE>
     
/(1)/Potential realizable value is the net gain realizable based on an
     assumption that the price of the Common Stock appreciates at the annual
     compounded rate shown from the date of grant until the end of the ten-year
     option term. These numbers are calculated based upon the requirements
     promulgated by the Securities and Exchange Commission and do not reflect
     the Registrant's estimate of future stock price growth.

/(2)/Options granted were under the Registrant's Nonstatutory Stock Option Plan
     and vest at the rate of 25% each year, commencing on the one-year
     anniversary of the date of grant.

                                       27
<PAGE>
 
OPTION/SAR EXERCISES AND VALUES

The following table summarizes options/SARs exercised during 1996 and presents
the value of unexercised options/SARs held by the named executives at fiscal
year end:

            AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
                       FISCAL YEAR-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
 
                                                             Number of         Value of Unexercised
                                                       Securities Underlying     In-the-Money/(1)/
                                                     Unexercised Options/SARs     Options/SARs
                          Shares          Value       at Fiscal Year-End (#)   at Fiscal Year-End ($)
                        Acquired on     Realized        Exercisable(E)/          Exercisable(E)/
         Name           Exercise (#)      ($)           Unexercisable(U)         Unexercisable(U)
------------------------------------------------------------------------------------------------------
<S>                     <C>             <C>          <C>                        <C>            
William P. Condon             -0-           -0-           97,000     E              231,977  E
                                                          13,750     U                7,500  U

John F. Shettle, Jr.          -0-           -0-           58,000     E               85,298  E
                                                           4,000     U                5,000  U

John R. Yuska               11,700        81,409          68,600     E              125,505  E
                                                           2,500     U                3,000  U

Thomas H. Chero               -0-           -0-           44,450     E               14,408  E
                                                           2,500     U                3,000  U

Thomas L. Hudson              -0-           -0-              750     E                1,000  E
                                                           9,250     U                4,000  U
------------------------------------------------------------------------------------------------------
</TABLE>
/(1)/In-the-money option value is the fair market share value at fiscal 1996
     year-end ($15.625 per share) less the option exercise price times the
     number of shares.

PROFIT SHARING PLAN

The Registrant has a qualified defined contribution Profit Sharing Plan, which
became effective October 1, 1969, and in which substantially all employees of
the Registrant and its subsidiaries who have completed a qualifying year of
service may participate.  The Registrant and its subsidiaries contribute each
year 5% of "consolidated net profits before taxes," as defined in the Plan, (but
not in excess of 15% of the compensation paid to participating employees during
the year), to a trust fund.  The Registrant's contribution each year is
allocated to active participants on a pro rata basis based upon W-2 compensation
for the year (excluding compensation from stock option exercises), subject to
individual compensation limits imposed by the federal government ($150,000 for
1996).  The entire amount in the Profit Sharing Plan to the employee's credit is
distributable to the employee upon retirement or to the employee's designee upon
death.  Upon withdrawal as a participant prior to retirement, the employee
receives amounts contributed by the employee, if any, adjusted for investment
results on such amounts, plus 20% of the remaining amount to the employee's
credit for each year of employment after the third year of employment, not to
exceed 100% of such amount at the end of the seventh year of employment.  The
total Registrant's contribution to the Profit Sharing

                                       28
<PAGE>
 
Plan for the year ended December 31, 1996, was $491,000. The Registrant's
contribution with respect to the five named executive officers is shown in the
Summary Compensation Table.

PENSION PLAN

The Registrant has a noncontributory defined benefit Pension Plan covering
substantially all employees of the Registrant and its subsidiaries who have
attained age 21 and have completed one year of qualifying service.  The Pension
Plan, funded through an insurance company, provides for a retirement benefit at
age 65, which is integrated with Social Security, based upon the employee's
highest five consecutive years average W-2 compensation at the rate of .6% of
such five-year average up to "covered compensation" as defined in the Plan plus
1.1% of such five-year average compensation in excess of "covered compensation",
all multiplied by years of credited service.  W-2 compensation used to calculate
an employee's final average compensation was capped by federal law at $150,000
for Plan year 1996, but is indexed for inflation for subsequent plan years.
Compensation attributable to the exercise of stock options is not includable for
benefit determinations.  Vesting for Plan benefits is 100% after five years of
service with 0% for less than five years of service.

                              PENSION PLAN TABLE
                              ------------------
                               YEARS OF SERVICE
<TABLE>
<CAPTION>
 
--------------------------------------------------------------------------------
        Remuneration        15        20        25        30        35
       --------------  -------   -------   -------   -------   -------
       <S>             <C>       <C>       <C>       <C>       <C> 
       $ 125,000       $18,557   $24,742   $30,928   $37,113   $43,299
         150,000        22,682    30,242    37,803    45,363    52,924
       * 175,000        22,682    30,242    38,803    45,363    52,924
       * 200,000        22,682    30,242    38,803    45,363    52,924
       * 225,000        22,682    30,242    38,803    45,363    52,924
       * 250,000        22,682    30,242    38,803    45,363    52,924
       * 300,000        22,682    30,242    38,803    45,363    52,924
       * 400,000        22,682    30,242    38,803    45,363    52,924
       * 450,000        22,682    30,242    38,803    45,363    52,924
       * 500,000        22,682    30,242    38,803    45,363    52,924
--------------------------------------------------------------------------------
</TABLE>

* The 1996 compensation is limited to $150,000 for the benefit determinations.
  The Registrant does not have a nonqualified or other pension plan that would
  apply in excess of the remuneration shown.
--------------------------------------------------------------------------------

The pension table shows maximum annual benefits which would be payable for a
person retiring in 1996 at age 65 calculated in accordance with the current Plan
provisions on a straight life annuity basis, with average earnings shown as
"Remuneration".

A retiree's Social Security benefit is integrated into the Plan's step-rate
formula and there is no additional reduction to the amount shown in the table as
a result of Social Security payments.  The 

                                       29
<PAGE>
 
Plan's "covered compensation" level for 1996 utilized in the table was $27,580
for a person retiring at age 65.

For 1996, the Registrant's pension contribution was approximately 1.9% of
covered annual payroll of Plan participants covered by the Plan.  The amount
expended by the Registrant for financial reporting purposes for the Pension Plan
is excluded from the Summary Compensation Table because the contribution with
respect to a specified person cannot be readily separated or individually
calculated by the actuary of the Plan.

The compensation of Messrs. Condon, Shettle, Jr., Yuska, Chero, and Hudson
covered by the Pension Plan in 1996 was $493,350, $208,306, $164,864, $136,522,
and $128,522 respectively; however, no compensation in excess of $150,000 is
considered in calculating benefits for 1996 for any of these individuals.  These
amounts are based upon W-2 compensation for 1996 as provided for by the Plan,
whereas the Summary Compensation Table includes the executive officers'
performance compensation paid early in 1997 for fiscal 1996 work performed,
which award will not be included in the Plan computation until 1997.  As of
December 31, 1996, Messrs. Condon, Shettle, Jr., Yuska, Chero, and Hudson had
credited service under the Plan of 35, 13, 19, 20, and 2 years, respectively.

Effective December 31, 1996, the Board approved a curtailment to the Pension
Plan.  The Registrant currently intends to continue to allow benefits to accrue
under the Plan through December 31, 1998, utilizing some of the Plan's excess
assets, and then terminate the Plan, allowing participant balances to be rolled
over into a 401(k) plan.  The Registrant currently intends to convert its Profit
Sharing Plan into a 401(k) plan.  The Registrant has reserved its right to
alter, amend, and/or terminate any of its defined benefits and defined
contribution plans at any time as it may see fit, however.

PERFORMANCE COMPENSATION PLAN

Under the Performance Compensation Plan for officers of the Registrant and of
its subsidiaries (including executive officers, but excluding the CEO), between
7% and 9% of the Registrant's annual net earnings (as defined in the Plan), in
excess of a minimum earnings deductible amount (determined by formula in the
Plan), is set aside in a pool each year.  No performance compensation may be
awarded under the Plan for any year during which a dividend is not paid to the
shareholders, and no performance compensation is available for award until after
the minimum earnings deductible amount is achieved.  Net earnings as defined in
the Plan include the Registrant's consolidated profit after tax, but before the
allocation of performance compensation under any of the Registrant's performance
compensation plans (officer, employee, and CEO plans).  The minimum earnings
deductible amount is calculated as the product of the weighted average number of
the Registrant's common stock and common stock equivalents for the Plan year
times the larger of:  (i) one-third the average of the Registrant's consolidated
earnings per share as reported to the shareholders for the immediately preceding
three Plan years, or, (ii) the per share amount calculated in (i), for any Plan
year after 1973, prior to the current Plan year, if greater than the current
Plan year's per share amount.  For 1996, 47 officers participated in and
received awards under the Plan.

                                       30
<PAGE>
 
STOCK OPTION PLANS

The Registrant's Nonstatutory Stock Option (NSO) Plan, adopted in 1990,
authorizes the grant from time to time of NSOs on the Registrant's Common Stock
to eligible employees, up to a total of 375,000 shares.  8,000 NSOs were granted
to one named executive officer for 1996 performance out of a total of 45,600
NSOs awarded during the year.  As of March 1, 1997, NSOs representing 356,400
shares of Common Stock were outstanding.  The Plan is administered by the
Compensation and Stock Option Committee of the Registrant's Board of Directors,
which Committee determines which employees are to be granted NSOs and the number
of shares covered by the award.  Any employee of the Registrant or a subsidiary
who owns less than 10% of the Registrant's outstanding Common Stock may be
granted an NSO.

The exercise price of shares covered by NSOs must be 100% of the fair market
value of such shares on  the date  of grant.  The NSO exercise period is
determined by the Committee, but may not exceed ten years from the date of
grant.  NSOs are not exercisable during the first year after grant, and the Plan
states that NSOs may provide that only a portion of the shares covered by an NSO
may be exercisable during each year after the first year after grant.  Option
vesting is normally over a four-year period (25% per year), but the Committee
may reduce or extend the period from between one and ten years.  There are
exceptions to the rules on exercise pertaining to such matters as
reorganization, mergers, and changes of control of the Registrant.

The Registrant had an Incentive Stock Option (ISO) Plan which expired in
December 1992 with respect to new grants.  ISOs representing 387,300 shares of
Common Stock were outstanding as of March 1, 1997.

Neither the NSO nor the ISO Plan provides for the issuance of SARs, nor does the
Registrant have a separate SAR Plan.  Any reference to "Options/SARs" herein is
to options granted under the stock option plans.

EMPLOYMENT CONTRACTS

1.  EXECUTIVE OFFICERS (OTHER THAN THE CHIEF EXECUTIVE OFFICER). Executive
    officers are under written contract with the Registrant for their employment
    services. Such contracts provide for a fixed salary subject to annual review
    for potential increase. In addition, such contracts provide that such
    officers are eligible to participate in the Performance Compensation Plan
    and Stock Option Plans described elsewhere herein. No award is guaranteed
    under any such plan and such plans may be modified or terminated by the
    Board of Directors at any time. While the employment agreements generally
    cover terms from one to three years, each of them is terminable by either
    the officer or the Registrant upon 30 to 90 days' written notice, with or
    without cause. After the effective date of termination by either party, no
    additional compensation is payable regardless of the term. On December 31,
    1996, the employment agreements of Messrs. Chero, Shettle, Jr., and Yuska
    expired and the parties are under no written employment agreements with the
    Registrant as of the date hereof.

    In order to be eligible to participate in the Performance Compensation Plan
    and Stock Option Plans, executive officers must agree not to compete with
    the Registrant for two years after 

                                       31
<PAGE>
 
    employment is terminated. This noncompete applies if employment is
    terminated by the executive officer for any reason, or by the Registrant for
    cause. The agreements also provide that in the event of a change of control
    of the Registrant, being the acquisition of 40% or more of the Registrant's
    voting stock by another entity and its affiliates, not approved by two-
    thirds of the directors who are not affiliated with the party attempting to
    change control ("disinterested directors"), the two-year noncompete does not
    apply. In the event of such a change in control of the Registrant, stock
    option awards also become fully vested and exercisable as provided for in
    the Plans.

2.  CHIEF EXECUTIVE OFFICER. Mr. Condon is employed under written contract with
    the Registrant which was entered into in 1993 and expires on December 31,
    1997. It provides for a fixed base annual salary subject to annual review
    for potential increase and/or the addition of other compensation as may be
    deemed appropriate by the Board of Directors. Mr. Condon's salary for 1996
    was $400,000. In addition, such contract provides for an annual performance
    compensation of 2% of net earnings above a minimum earnings deductible
    amount calculated as set forth in the agreement. Net earnings and the
    minimum earnings deductible amount are calculated for the purposes of the
    agreement in the same manner as described in the Performance Compensation
    Plan for officers. The contract provides that Mr. Condon's total
    compensation from salary and performance compensation for any calendar year
    is limited to one million dollars, but it also provides that the Board, in
    its sole discretion, may award some or all of the additional performance
    compensation that would cause total compensation to exceed one million
    dollars, whether tax deductible or not. Mr. Condon also participates in the
    Registrant's stock option plans.

    The employment agreement provides for termination by Mr. Condon upon 180
    days' notice, with or without cause, or by the Registrant upon breach by Mr.
    Condon of his obligations under the agreement or for cause. In addition, the
    Registrant may terminate his services at any time if it agrees to pay him
    the base salary and annual performance compensation he would otherwise have
    been entitled to receive had the contract not been terminated. In this
    event, the noncompetition provision described below would apply during the
    remainder of the term.

    The agreement contains a two-year noncompetition provision which the Board
    of Directors may elect to invoke subsequent to the expiration of the
    Agreement provided it gives at least 12 months' prior notice and agrees to
    continue to pay Mr. Condon one-half of his base salary during that two-year
    period. The Board may also invoke this provision if Mr. Condon elects to
    terminate prior to expiration.

    The contract also has a provision that, in the event of a change of control
    of the Registrant of more than 30% of the Registrant's outstanding voting
    stock that is not approved by two-thirds of the disinterested directors (as
    described above), Mr. Condon may elect to terminate the contract upon 30
    days' written notice, in which event the two-year noncompete would not apply
    and Mr. Condon would receive such salary and performance compensation as he
    would otherwise be entitled to receive for the remaining term. In the event
    of a change in control of the Registrant of 40% or more of the Registrant's
    voting stock by another entity and its affiliates that is not approved by
    two-thirds of the disinterested directors, stock option awards also become
    fully

                                       32
<PAGE>
 
    vested and exercisable as provided for in the Plans. The Registrant elected
    in 1996 to invoke Mr. Condon's noncompete for a two-year period commencing
    December 31, 1997, the date his employment agreement expires.

    On March 1, 1997, Mr. Condon stepped down as Chief Executive Officer, but
    remains as the Chairman of the Board. Mr. John F. Shettle, Jr., President,
    assumed the additional office of Chief Executive Officer. AVEMCO on such
    date also agreed to transfer to Mr. Condon certain programs currently in the
    concept stage, which do not involve any of AVEMCO's current business
    activities, and related items, subject to the agreement not to compete and a
    first right of refusal with respect to insurance products related to such
    programs.

3.  CHIEF EXECUTIVE OFFICER AND EXECUTIVE OFFICERS. All employees of the
    Registrant, including executive officers, whether under written employment
    contract or not, are eligible to participate in the Registrant's group life,
    health, disability, and retirement programs, including the AVEMCO
    Corporation Pension Plan (defined benefit plan) and the AVEMCO Corporation
    Profit Sharing Plan (defined contribution plan) according to the terms of
    those plans. Both retirement plans are described elsewhere herein.

COMPENSATION COMMITTEE INTERLOCKS AND/OR INSIDER PARTICIPATION.  None

REPORT OF THE COMPENSATION AND STOCK OPTION COMMITTEE

1.  EXECUTIVE OFFICERS (OTHER THAN CHIEF EXECUTIVE OFFICER "CEO"). The cash
    compensation of executive officers consists of annual salary and performance
    compensation, pursuant to a contract (described elsewhere herein) which each
    executive officer has with the Registrant.

    SALARIES. The salaries of executive officers are based upon the officer's
    current position(s) in the Registrant and the officer's responsibilities.
    Prior experience in the executive's field, as well as with the Registrant,
    is also taken into consideration. The Committee, in establishing salary
    recommendations, also looks at prevailing salaries of executive officers of
    other companies, particularly insurance companies, having comparable
    positions, but in making those comparisons it takes into consideration the
    fact that the Registrant's compensation policy since adoption of the
    Performance Compensation Plan (initially adopted as the Executive Bonus Plan
    in 1974) has been that performance compensation should constitute a
    significant portion of total cash compensation of the Registrant's executive
    officers. Accordingly, salaries are generally set at levels that are
    substantially less than what total compensation, including performance
    compensation, is expected to be.

    With respect to annual salary adjustments including those made for 1996, the
    Committee gives substantial consideration to the recommendations of the CEO
    and considers each executive officer's salary in relationship to certain
    factors, including the officer's prior year's salary, prior years' salary
    increases, changes in the cost of living, changes in responsibilities, and
    how such officer was rated by the CEO and by other officers in an annual
    superior and peer review evaluation process that has been utilized by the
    Registrant for many years. The Committee does not use any specific corporate
    performance measures or weighting, and determination is therefore largely
    subjective in nature.

                                       33
<PAGE>
 
    PERFORMANCE COMPENSATION. The Committee's initial role in setting
    performance compensation, which constitutes a significant portion of total
    cash compensation, is to recommend to the Board of Directors the percentage
    of from 7% to 9% of net earnings as defined in the Plan in excess of the
    Plan's formula earnings deductible (which earnings deductible was $3,561,000
    for 1996) to be used to create the performance compensation pool. For 1996,
    the percentage recommended by the Committee to the Board, and accepted by
    the Board, was 9%, which resulted in a performance compensation pool from
    1996 earnings of $843,000 for the 47 officer participants. This compares to
    $413,000 for 46 participants in 1995, at which time the percentage was also
    9%.
    
    In determining the percentage of net earnings comprising the pool each year,
    the Committee, pursuant to the terms of the Plan, considers certain factors
    including net earnings, return on equity, the Registrant's Common Stock
    dividend and its market price over time, the number of participants in the
    Plan (the Plan covers generally all officers of the Registrant, excluding
    the CEO, and its subsidiaries and not just executive officers), the total
    compensation of participants, both base and performance, compensation for
    comparable employees in other firms, particularly insurance-related firms,
    market and economic conditions, cycles of the Registrant's business, and
    employee morale. In determining individual awards and, in particular, awards
    to the executive officers from such pool, the Committee considers a proposal
    given to it by the CEO for allocating the pool, and also considers each
    executive's duties and responsibilities, total compensation, evaluations by
    both the CEO and by the executive officer's superiors and peers,
    contributions to the financial success of the Registrant, and years of
    service. While the Committee looks at the factors set forth, its
    determination is largely subjective in nature.
     
    STOCK OPTIONS. The Committee administers the Registrant's stock option
    plans. Its policy has been to utilize the benefits it believes accrue to the
    Registrant and its stockholders by the grant of stock options to executive
    officers and others. All stock options require that the underlying Common
    Stock be purchased at 100% of its market value on the grant date of the
    options, and no exercise price of an outstanding option has ever been
    lowered. The Committee determines the number of options to be granted each
    year, taking into consideration the amount of stock available under the
    stock option plans, as well as the general performance criteria described
    elsewhere with respect to performance compensation. The CEO's
    recommendations as to the allocation of stock options among executive
    officers, which takes into consideration an evaluation of each executive's
    contribution to the Registrant's overall performance, as well as the
    evaluation given to the executive under the annual superior and peer review
    process referred to above, are normally accepted by the Committee. As with
    performance compensation, while the Committee looks at these factors, its
    determination is largely subjective in nature, except that a numerical
    superior and peer evaluation score cutoff is used by the Committee, below
    which no stock option awards are made. For 1996, awards were principally
    targeted toward participants who received fewer awards in the past,
    particularly in light of the relatively low level of options remaining in
    the Plan for award. Accordingly, only one named executive officer was
    awarded stock options for 1996.

2.  CHIEF EXECUTIVE OFFICER.  The cash compensation of the Chief Executive 
    Officer consists of an annual salary and an annual performance compensation
    of 2% of defined net earnings in excess
                                       34
<PAGE>
 
    of a minimum earnings level, pursuant to a contract (previously described)
    which Mr. Condon has with the Registrant.

    SALARY. In recommending Mr. Condon's salary increase, if any, to the Board,
    the Committee considers his past salary, past salary increases, salaries of
    CEOs of comparable insurance companies, the cost of living, and the
    Registrant's net earnings. As it does in setting the percentage under the
    Performance Compensation Plan for executives, the Committee considers the
    performance of the Registrant, in absolute terms and relative to its
    competitors, how it considers the CEO has dealt with competitive factors
    compared with other CEOs in the industry, and how shareholders have fared.
    It also considers the CEO's performance in planning for ways of enhancing
    the future earnings and value of the Registrant. The Committee does not use
    any specific corporate performance measures or weighting, but return on
    equity is given significant consideration. Determination is thus largely
    subjective in nature.

    For 1996, based upon these factors, the Committee chose not to increase Mr.
    Condon's salary above its 1995 level.

    PERFORMANCE COMPENSATION. Pursuant to the terms of the Registrant's contract
    with Mr. Condon, described under "Employment Contracts", Mr. Condon's
    performance compensation is determined strictly by formula based upon
    earnings, except when total compensation from salary and performance
    compensation would exceed one million dollars. Since it did not for 1996,
    the Committee made no additional decisions regarding Mr. Condon's
    performance compensation.

    STOCK OPTIONS. The Committee determines the stock options to be awarded to
    Mr. Condon. It considers the same factors that are utilized in its review
    for salary increase. While the Committee looks at these factors, its
    determination is largely subjective in nature. For 1996, the Committee chose
    to principally target awards to participants who received fewer options in
    the past, particularly in light of the relatively low level of options
    remaining in the Plan for award. Accordingly, no award was made to Mr.
    Condon for 1996.
    
    3.GENERAL CONSIDERATIONS. Salary recommendations for each year are made
    prior to the beginning of the year, while performance compensation and stock
    options awards are determined at the end of the year and are based on the
    financial and other results for that year. Accordingly, changes in salaries
    do not necessarily coincide with changes in performance compensation or
    stock option awards.
    
    The Committee's approach to executive compensation as described above has
    been in effect for many years. The Committee believes that this approach,
    which blends the objective determinations, such as formulas and peer and
    superior evaluations, with the subjective determinations described above,
    provides a flexibility that is in the best interests of the Registrant and
    its shareholders.

                         The Compensation and Stock Option Committee


                         H. Lowell Davis, Chairman
                         Michael Collins
                         Steven A. Markel
                         Rachel B. Trinder

                                       35
<PAGE>
 
               COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN*
                  AMONG AVEMCO CORPORATION, THE S&P 500 INDEX
                 AND THE S&P PROPERTY-CASUALTY INSURANCE INDEX
<TABLE>
<CAPTION>
 
                            CUMULATIVE TOTAL RETURN
                                   (dollars)
--------------------------------------------------------------------------
          Company/Index       12/91     12/92   12/93  12/94  12/95  12/96
----------------------------  -----     -----   -----  -----  -----  -----
<S>                           <C>    <C>        <C>    <C>    <C>    <C> 
AVEMCO Corporation..........    100        95      78     66     70     71
S&P 500.....................    100       108     118    120    165    203
S&P Property-Casualty Ins...    100       112     115    121    163    199
</TABLE>

* $100 invested on 12/31/91 in stock or Index, including reinvestment of
  dividends.
  Fiscal year ending December 31.

                                       36
<PAGE>
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-------                                                                 

PRINCIPAL SHAREHOLDERS

The following table sets forth information based upon the records of the
Registrant and filings with the Securities and Exchange Commission with respect
to each beneficial owner of more than 5% of the Registrant's outstanding voting
stock as of March 1, 1997.
<TABLE>
<CAPTION>
 
                          Name and Address of           Amount and Nature of     Percent
 Title of Class            Beneficial Owner             Beneficial Ownership    of Class
----------------  -----------------------------------  -----------------------  ---------
<S>               <C>                                  <C>                      <C>
Common Stock      Vanguard/PRIMECAP Fund, Inc.               650,000 shares(1)       7.8%
                  P.O. Box 2600
                  Valley Forge, PA 19482
 
Common Stock      Markel Corporation and Subsidiaries        855,500 shares(2)      10.2%
                  4551 Cox Road
                  Glen Allen, VA 23060
 
Common Stock      David L. Babson & Co., Inc.                580,650 shares(3)       6.9%
                  One Memorial Drive
                  Cambridge, MA  02142
</TABLE>

            

/(1)/ Vanguard/PRIMECAP Fund, Inc. reported that it has sole voting power and
      shared dispositive power over 650,000 shares of Common Stock of the
      Registrant.

/(2)/ Markel Corporation reported that it has sole voting power and sole
      dispositive power over 855,500 shares of Common Stock of the Registrant
      through its ownership and control of various subsidiaries of Markel which
      hold the stock directly.

/(3)/ David L. Babson & Co., Inc. reported that it is an investment advisor with
      sole dispositive power over 580,650 shares of Common Stock of the
      Registrant with sole voting power over 385,350 of those shares and shared
      voting power over the remaining 195,300 shares.

                                       37
<PAGE>
 
MANAGEMENT OWNERSHIP

The following is a table showing the shares of the Registrant's Common Stock
beneficially owned as of March 1, 1997, by each director and nominee, each of
the executive officers named below, and directors and officers of the Registrant
as a group.
<TABLE>
<CAPTION>
                                                 Name of                   Amount           Percent
            Title of Class                  Beneficial Owner               Owned            of Class
---------------------------------------  -----------------------  ------------------------  --------
<S>                                      <C>                      <C>                       <C>
Common Stock                             Michael Collins            9,000 shares                  *
Common Stock                             William P. Condon        235,804 shares/(1)(4)/         2.7
Common Stock                             H. Lowell Davis            9,507 shares                  *
Common Stock                             Paul J. Hanna             25,950 shares/(5)/             *
Common Stock                             Arnold H. Johnson         81,950 shares                  *
Common Stock                             Steven A. Markel           5,000 shares/(3)/             *
Common Stock                             Thomas J. Schwab           8,751 shares/(2)/             *
Common Stock                             John F. Shettle, Jr.     174,641 shares /(1)(4)/        2.0
Common Stock                             Rachel B. Trinder            200 shares                  *
Common Stock                             Thomas H. Chero           46,900 shares/(1)/             *
Common Stock                             Thomas L. Hudson           1,086 shares/(1)/             *
Common Stock                             John R. Yuska             98,451 shares/(1)(4)/         1.1

All Directors and Officers as a Group                             744,737 shares(6)              8.7
(15 in number)                                                    =======                        ===
</TABLE>

* less than 1%

/(1)/ Includes shares of Common Stock which as of March 1, 1997, were subject to
      outstanding stock options exercisable within 60 days, held by the named
      executive officers as follows: Condon 67,000, Shettle, Jr. 43,000, Yuska
      53,600, Chero 44,450, and Hudson 750.

/(2)/ Includes 814 shares owned by Mr. Schwab's wife.

/(3)/ Mr. Markel's shares do not include 855,500 shares owned by Markel
      Corporation and subsidiaries, of which Mr. Markel is Vice Chairman. Mr.
      Markel disclaims beneficial ownership of these shares.

/(4)/ Includes shares of Common Stock held by the AVEMCO Corporation Profit
      Sharing Trust that each of the following individuals who serve as Trustee
      are deemed to own indirectly by virtue of being a beneficiary of the
      Trust, calculated on the basis of his proportional beneficial interest in
      the Trust, as follows: Condon 39,061, Shettle, Jr. 6,216, Yuska 13,151.
      The Trust holds 297,500 shares in the aggregate, over which the three
      Trustees share voting and dispositive power.

/(5)/ Includes 450 shares owned by the Hanna Foundation Trust.

/(6)/ Includes 255,250 shares of Common Stock which as of March 1, 1997, were
      subject to outstanding stock options exercisable within 60 days.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------                                               

None.

                                       38
<PAGE>
 
                                    PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
-------                                                                 
<TABLE>
<CAPTION>


(A) (1) INDEX TO FINANCIAL STATEMENTS                                   PAGE

<S>                                                                     <C> 
December 31, 1996 and 1995:
     Consolidated Balance Sheets.....................................    45
 
For the Years Ended December 31, 1996, 1995 and 1994:
 
     Consolidated Statements of Income...............................    47
     Consolidated Statements of Stockholders' Equity.................    48
     Consolidated Statements of Cash Flows...........................    49
     Notes to Consolidated Financial Statements......................    50
 
Independent Auditors' Report.........................................    65

(A) (2) INDEX TO FINANCIAL STATEMENT SCHEDULES
 
AVEMCO Corporation and Subsidiaries:
 
     Schedule I - Summary of Investments - Other than
       Investments in Related Parties................................    66
 
     Schedule II - Condensed Financial Information of Registrant.....    67
 
     Schedule V - Valuation and Qualifying Accounts..................    71
 
AVEMCO Insurance Company and Subsidiaries:
 
     Schedule IV - Reinsurance.......................................    72
 
     Schedule VI - Supplemental Information Concerning
       Property-Casualty Insurance Operations........................    73
</TABLE>

All other schedules are omitted as the required information is inapplicable or
is presented in the Consolidated Financial Statements or related notes.

                                       39
<PAGE>
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 
-------   (CONT.)
<TABLE> 
<CAPTION> 
(A) (3) EXHIBITS

Number                 Description                              Reference
------                 -----------                              ---------
<S> <C>                                                 <C> 
 .   Plan of acquisition, reorganization,
    ------------------------------------
    arrangement, liquidation or succession............  Exhibit 1 to Form 8-K filed 
    --------------------------------------              March 6, 1997, incorporated herein 
                                                        by reference

 .   Articles of Incorporation and Bylaws
    ------------------------------------
    3.1 Articles of Incorporation, as amended.........  Exhibit 3.1 to AVEMCO
                                                        Corporation's Annual Report on
                                                        Form 10-K for the year ended
                                                        December 31, 1989, and
                                                        incorporated herein by reference.

    3.2 Bylaws, as amended...........................   Exhibit 3.2 to AVEMCO Corporation's 
                                                        Annual Report on Form 10-K for the 
                                                        year ended December 31, 1989, and 
                                                        incorporated herein by reference.

 .   Instruments Defining the Rights of Security                                          
    -------------------------------------------
    Holders, Including Indentures 
    ----------------------------- 
    4.1 Specimen certificate representing
        the common stock, $.10 par value.............   Exhibit 4.1 to AVEMCO
                                                        Corporation's Annual Report on
                                                        Form 10-K for the year ended
                                                        December 31, 1989, and
                                                        incorporated herein by reference.

 .   Voting Trust Agreement............................            N/A
    ----------------------
 
 .   Material Contracts
    ------------------
    10.1 Incentive stock option plan, as amended......  Exhibit 28.A. to Form S-8
                                                        Registration Statement, File
                                                        No. 33-22520, and incorporated
                                                        herein by reference.
</TABLE>

                                       40
<PAGE>
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
-------   (CONT.)
<TABLE> 
<CAPTION> 
Number                 Description                              Reference
------                 -----------                              ---------
<S> <C>                                                 <C> 
    10.2 Non-statutory stock option plan.............   Exhibit 10.2 to AVEMCO
                                                        Corporation's Annual Report on 
                                                        Form 10-K for the year ended 
                                                        December 31, 1990, and 
                                                        incorporated herein by reference.

    10.3 Management contracts:

         . Five most highly compensated executive officers:

           a. Chairman and Chief Executive Officer...   Exhibit 10.3.a to AVEMCO
                                                        Corporation's Annual Report on 
                                                        Form 10-K for the year ended 
                                                        December 31, 1993, and 
                                                        incorporated herein by reference.

           b. President and Chief Operating Officer..   Exhibit 10.3.b to AVEMCO
                                                        Corporation's Annual Report on 
                                                        Form 10-K for the year ended 
                                                        December 31, 1994, and 
                                                        incorporated herein by reference.

           c. Senior Vice President and
              Chief Financial Officer................                 Page 75

           d. Senior Vice President - Legal..........                 Page 89

           e. Vice President - Business Development .   Exhibit 10.3.e to AVEMCO
                                                        Corporation's Annual Report on
                                                        Form 10-K for the year ended
                                                        December 31, 1995, and
                                                        incorporated herein by reference.

        .   Directors:

           f. Consulting agreement...................   Exhibit 10.3.f to AVEMCO 
                                                        Corporation's Annual Report on
                                                        Form 10-K for the year ended 
                                                        December 31, 1992, and
                                                        incorporated herein by reference.
</TABLE> 

                                       41
<PAGE>
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 
-------   (CONT.)
<TABLE> 
<CAPTION> 
Number                 Description                              Reference
------                 -----------                              ---------
<S> <C>                                                 <C> 
           g. Deferred compensation
              agreement..............................   Exhibit 10.2.g to AVEMCO 
                                                        Corporation's Annual Report on
                                                        Form 10-K for the year ended 
                                                        December 31, 1989, and 
                                                        incorporated herein by reference.
 
    10.4 Executive Performance Compensation Plan......  Exhibit 10.4 to AVEMCO
                                                        Corporation's Annual Report on
                                                        Form 10-K for the year ended
                                                        December 31, 1992, and 
                                                        incorporated herein by reference.
        . Statement Regarding Computation of Per
          --------------------------------------
          Share Earnings
          --------------

          11.1 Computation/Statement.................             Page 103

        . Statement Regarding Computation of Ratios                   N/A
          -----------------------------------------                      

        . Annual Report to Security Holders, Form
          ---------------------------------------
          10-Q or Quarterly Reports to Shareholders                   N/A
          -----------------------------------------                    

        . Letter Regarding Change in Accounting
          -------------------------------------
          Principles.................................                 N/A
          ----------

        . Previously Unfiled Documents................                N/A
          ----------------------------

        . Subsidiaries of the Registrant
          ------------------------------
          21.1 Organizational chart...................            Page 104

        . Published Report Regarding Matters
          ----------------------------------
          Submitted to Vote to Security Holders                       N/A
          -------------------------------------                    

        . Consent of Experts and Counsel
          ------------------------------
          23.1 Accountants' Consent                               Page 105

        . Power of Attorney                                           N/A
          -----------------                      
</TABLE> 

                                       42
<PAGE>
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K 
-------   (CONT.)
<TABLE> 
<CAPTION> 
Number                 Description                              Reference
------                 -----------                              ---------
<S> <C>                                                 <C> 

        . Information from Reports Furnished to
          -------------------------------------
          State Regulatory Authorities                                N/A
          ----------------------------                                   

        . Additional Exhibits
          -------------------
          None

    (B) Reports on Form 8-K
        -------------------
        Letter of Intent..............................  AVEMCO Corporation Report on 
                                                        Form 8-K filed January 22, 1997.

        Agreement and Plan of Reorganization..........  AVEMCO Corporation Report on 
                                                        Form 8-K filed March 6, 1997, and 
                                                        Exhibit 1 thereto.

    (C) See 14 (a)

    (D) See 14 (a)
</TABLE> 

                                       43
<PAGE>
 
                                  SIGNATURES

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

 
AVEMCO Corporation
 
By: /s/ William P. Condon                /s/ John F. Shettle, Jr.
   ----------------------------------   -------------------------------
   William P. Condon                    John F. Shettle, Jr.
   Director and Chairman of the Board   Director, President, and Chief
   Date: March 25, 1997                 Executive Officer
        -----------------------------   Date: March 25, 1997
                                             --------------------------

   /s/ John R. Yuska
   ----------------------------------
   John R. Yuska
   Senior Vice President and
   Chief Financial Officer
   Date: March 25, 1997
         ----------------------------

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
 
<S>                             <C>                               <C> 
/s/ Michael Collins             /s/ Paul J. Hanna                 /s/ Thomas J. Schwab
--------------------------      ------------------------------    -----------------------------
Michael Collins                 Paul J. Hanna                     Thomas J. Schwab
Director                        Director                          Director
Date: March 25, 1997            Date: March 25, 1997              Date: March 25, 1997
      --------------------            ------------------------          -----------------------

/s/ William P. Condon           /s/ Arnold H. Johnson             /s/ John F. Shettle, Jr.
--------------------------      ------------------------------    -----------------------------
William P. Condon               Arnold H. Johnson                 John F. Shettle, Jr.
Director and Chairman           Director                          Director, President, and
of the Board                    Date: March 25, 1997              Chief Executive Officer
Date: March 25, 1997                  ------------------------    Date: March 25, 1997
      --------------------                                              ----------------------- 
 
/s/ H. Lowell Davis             /s/ Steven A. Markel              /s/ Rachel B. Trinder
--------------------------      ------------------------------    -----------------------------
H. Lowell Davis                 Steven A. Markel                  Rachel B. Trinder
Director                        Director                          Director
Date: March 25, 1997            Date: March 25, 1997              Date: March 25, 1997
      --------------------            ------------------------          -----------------------
</TABLE> 

                                       44
<PAGE>
 
AVEMCO CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 1996 and 1995
<TABLE> 
<CAPTION> 
 
Assets                                                                          1996                 1995
--------------------------------------------------------------          ------------         ------------
<S>                                                                    <C>                  <C>  
Investments (note 2):                                                                  
Fixed maturities,                                                                      
  at fair value (amortized cost $109,177,000;                                          
  $107,068,000 in 1995).......................................          $112,828,000         $112,136,000
Equity securities, at fair value (cost $10,953,000;                                    
  $20,199,000 in 1995)........................................            10,817,000           22,524,000
Short-term investments, at cost which approximates                                     
   fair value.................................................            25,593,000           14,884,000
                                                                        ------------         ------------
    Total investments.........................................           149,238,000          149,544,000
                                                                                       
Cash..........................................................             5,959,000            3,466,000
                                                                                       
Receivables:                                                                           
Premiums......................................................            21,267,000           16,406,000
Reinsurance recoverable (note 9)..............................             9,503,000           14,292,000
Other, net....................................................             8,341,000            8,231,000
                                                                        ------------         ------------
    Total receivables.........................................            39,111,000           38,929,000
                                                                                       
Deferred policy acquisition costs.............................             6,071,000            5,511,000
                                                                                       
Prepaid reinsurance premiums (note 9).........................             5,913,000            5,178,000
                                                                                       
Property and equipment, at cost, less accumulated                                      
depreciation (note 3).........................................             7,886,000            8,051,000
                                                                                       
Other assets, net.............................................             3,488,000            3,123,000
                                                                        ------------         ------------
    Total assets..............................................          $217,666,000         $213,802,000
                                                                        ============         ============
</TABLE> 
 
See accompanying notes to consolidated financial statements.

                                       45
<PAGE>
 
<TABLE> 
<CAPTION> 

Liabilities and Stockholders' Equity                                         1996               1995
--------------------------------------------------------------       ------------       ------------
<S>                                                                 <C>                <C>  
Liabilities:                                                                       
Unpaid losses and loss adjustment expenses (note 4)...........       $ 43,227,000       $ 42,305,000
Unearned premiums.............................................         37,201,000         32,363,000
Accounts payable, accrued expenses, and other liabilities.....         17,797,000         16,009,000
Ceded reinsurance premiums payable............................          1,549,000          5,047,000
Deferred income tax liabilities (note 6)......................            653,000          1,352,000
Debt (note 7).................................................         56,667,000         54,967,000
                                                                     ------------       ------------
    Total liabilities.........................................        157,094,000        152,043,000
                                                                     ------------       ------------
                                                                                   
Stockholders' Equity (notes 2, 5, 7, and 10):                                      
Preferred stock, par value, $10.00 per share;                                      
  500,000 shares authorized; none issued......................                 --                 --
Common stock, par value, $.10 per share;                                           
  20,000,000 shares authorized; 11,565,811 issued;                                 
  11,551,161 in 1995..........................................          1,157,000          1,155,000
Additional paid-in capital....................................         19,140,000         18,293,000
Net unrealized appreciation on investments....................          2,320,000          4,879,000
Foreign currency translation adjustments......................           (218,000)          (182,000)
Retained earnings.............................................         94,843,000         88,184,000
                                                                     ------------       ------------
                                                                      117,242,000        112,329,000
                                                                                   
Less treasury stock, 3,301,741 shares in 1996 and                                  
  2,901,741 in 1995, at cost..................................        (56,670,000)       (50,570,000)
                                                                     ------------       ------------
                                                                                   
    Total stockholders' equity                                         60,572,000         61,759,000
                                                                     ------------       ------------
                                                                                   
Contingent liabilities (note 9)                                                    
                                                                                   
    Total liabilities and stockholders' equity                       $217,666,000       $213,802,000
                                                                     ============       ============
</TABLE>

                                       46
<PAGE>
 
<TABLE>
<CAPTION>
AVEMCO CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

Years Ended December 31,                            1996          1995           1994
----------------------------------------------  ------------  -------------  -------------
<S>                                             <C>           <C>            <C>
Revenues:
Premiums earned (note 9)......................  $ 86,170,000  $ 80,458,000   $ 75,518,000
Commissions...................................     8,819,000     7,046,000      6,418,000
Net investment income (note 2)................     8,223,000     8,498,000      8,245,000
Computer products and services................     9,913,000    10,188,000      9,185,000
Realized gain (loss) on sale of investments
   (note 2)...................................     3,244,000       575,000       (248,000)
Realized gain on subsidiary sale (note 11)....     3,307,000            --             --
Other revenues................................     8,214,000     6,439,000      5,472,000
                                                ------------  ------------   ------------
   Total revenues.............................   127,890,000   113,204,000    104,590,000
                                                ------------  ------------   ------------
Expenses:
Losses and loss adjustment expenses
   (notes 4 and 9)............................    62,866,000    55,605,000     46,310,000
Commissions (note 11).........................     7,092,000     6,513,000      7,159,000
Interest (note 7).............................     3,827,000     4,224,000      3,725,000
Cost of computer hardware sold................     1,442,000     1,961,000      1,032,000
Selling, general and administrative expenses..    36,701,000    35,799,000     32,825,000
                                                ------------  ------------   ------------
   Total expenses.............................   111,928,000   104,102,000     91,051,000
                                                ------------  ------------   ------------
Earnings before income taxes..................    15,962,000     9,102,000     13,539,000
Income taxes (note 6):
Current provision.............................     3,054,000     1,287,000      2,679,000
Deferred provision (benefit)..................       620,000      (103,000)        27,000
                                                ------------  ------------   ------------
   Total income taxes.........................     3,674,000     1,184,000      2,706,000
                                                ------------  ------------   ------------
   Net earnings...............................  $ 12,288,000  $  7,918,000   $ 10,833,000
                                                ============  ============   ============
Earnings per common and common
equivalent share (note 10):
   Net earnings...............................         $1.45          $.90          $1.20
                                                ============  ============   ============
Weighted average number of common
 and common equivalent shares.................     8,478,393     8,845,857      9,019,322
                                                ============  ============   ============
 
</TABLE>

See accompanying notes to consolidated financial statements.

                                       47
<PAGE>
 
AVEMCO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
THREE YEARS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
 
                                                                         
                                                                                          
                                                                     NET                     
                                   COMMON STOCK                  UNREALIZED       FOREIGN
                             ---------------------- ADDITIONAL   APPRECIATION/    CURRENCY                               TOTAL
                               SHARES        PAR      PAID-IN   (DEPRECIATION)  TRANSLATION   RETAINED    TREASURY    STOCKHOLDERS'
                               ISSUED       VALUE     CAPITAL   ON INVESTMENTS  ADJUSTMENTS   EARNINGS      STOCK         EQUITY
                             ----------  ---------- ----------- --------------  -----------  ------------ ----------- --------------

<S>                          <C>         <C>        <C>         <C>             <C>           <C>         <C>         <C>
Year ended December 31,
 1994
Balance at beginning of
 year......................  11,534,861  $1,153,000 $18,136,000  $   284,000     $(169,000)   $77,381,000 $(42,855,000) $53,930,000
Net earnings...............          --          --          --           --            --     10,833,000           --   10,833,000
Dividends declared ($.44
 per share)................          --          --          --           --            --     (3,929,000)          --   (3,929,000)

Cumulative net unrealized
 appreciation on
  fixed maturities at
   January 1, 1994.........          --          --          --    4,922,000            --             --           --    4,922,000
Change in net unrealized
 appreciation
  (depreciation) on
   investments.............          --          --          --   (6,048,000)           --             --           --   (6,048,000)

Exercise of common stock
 options...................       8,500       1,000      70,000           --            --             --           --       71,000
Repurchase of common stock.          --          --          --           --            --             --   (4,133,000)  (4,133,000)

Foreign currency
 translation adjustments...          --          --          --           --       (36,000)            --           --      (36,000)

                             ----------   ---------   ---------   ----------   -----------    -----------   ----------  -----------
Balance at end of year.....  11,543,361   1,154,000  18,206,000     (842,000)     (205,000)    84,285,000  (46,988,000)  55,610,000
                             ----------   ---------   ---------   ----------   -----------    -----------   ----------  -----------
Year ended December 31,
 1995
Net earnings...............          --          --          --           --            --      7,918,000           --    7,918,000
Dividends declared ($.46
 per share)................          --          --          --           --            --     (4,019,000)          --   (4,019,000)

Change in net unrealized
 appreciation on
  investments..............          --          --          --    5,721,000            --             --           --    5,721,000
Exercise of common stock
 options...................       7,800       1,000      87,000           --            --             --           --       88,000
Repurchase of common stock.          --         --           --           --            --             --   (3,582,000)  (3,582,000)

Foreign currency
 translation adjustments...          --         --           --           --        23,000             --           --       23,000
                             ----------   ---------   ---------   ----------   -----------    -----------   ----------  -----------
Balance at end of year.....  11,551,161   1,155,000  18,293,000    4,879,000      (182,000)    88,184,000  (50,570,000)  61,759,000
                             ----------   ---------   ---------   ----------   -----------    -----------   ----------  -----------
Year ended December 31,
 1996
Net earnings...............          --          --          --           --            --     12,288,000           --   12,288,000
Dividends declared ($.48
 per share)................          --          --          --           --            --     (4,022,000)          --   (4,022,000)

Change in net unrealized
 appreciation on
  investments........                --          --          --   (2,559,000)           --             --           --   (2,559,000)

Issuance of common stock...     120,000      12,000     913,000           --            --             --           --      925,000
Exercise of common stock
 options...................      14,650       2,000     124,000           --            --             --           --      126,000
Repurchase of common stock.          --          --          --           --            --             --   (7,909,000)  (7,909,000)

Retirement of treasury
 stock.....................    (120,000)    (12,000)   (190,000)          --            --     (1,607,000)   1,809,000           --
Foreign currency
 translation adjustments...          --          --          --           --       (36,000)            --           --      (36,000)

                             ----------   ---------   ---------   ----------   -----------    -----------   ----------  -----------
Balance at end of year.....  11,565,811  $1,157,000 $19,140,000  $ 2,320,000     $(218,000)   $94,843,000 $(56,670,000) $60,572,000
                             ==========  ========== ===========  ===========   ===========    =========== ============  ===========
 
</TABLE>
 
See accompanying notes to consolidated financial statements.

                                       48
<PAGE>
 
<TABLE>
<CAPTION>
AVEMCO CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years Ended December 31,                                     1996           1995           1994
-------------------------------------------------------  -------------  -------------  -------------
<S>                                                      <C>            <C>            <C>
OPERATING ACTIVITIES:
Net earnings                                             $ 12,288,000   $  7,918,000   $ 10,833,000
Adjustments to reconcile net earnings to cash
flows from operating activities:
 Depreciation and amortization                              1,679,000      1,604,000      1,348,000
 Deferred tax expense (benefit)                               620,000       (103,000)        27,000
 Realized (gain) loss on sale of investments               (3,244,000)      (575,000)       248,000
 Realized (gain) loss on sale of property
   and equipment                                             (128,000)        14,000         (4,000)
 Realized gain on sale of subsidiary                       (3,307,000)            --             --
 Change in:
  Receivables                                                 (22,000)    (1,994,000)     5,329,000
  Deferred policy acquisition costs                          (560,000)      (589,000)        70,000
  Prepaid reinsurance premiums                               (735,000)       254,000      1,626,000
  Unpaid losses and loss adjustment expenses                  922,000      1,103,000     (4,577,000)
  Unearned premiums                                         4,838,000      5,362,000     (3,737,000)
  Ceded reinsurance premiums payable                       (3,498,000)      (484,000)    (1,617,000)
  Accounts payable, accrued expenses and other             (3,071,000)    (1,448,000)     2,249,000
                                                         ------------   ------------   ------------
  Net cash flows provided from operating
    activities                                              5,782,000     11,062,000     11,795,000
                                                         ------------   ------------   ------------
INVESTMENT ACTIVITIES:
Proceeds from sale of fixed maturities                     20,934,000     23,318,000     22,747,000
Proceeds from redemption of fixed maturities                9,288,000     13,227,000     13,036,000
Proceeds from sale of equity securities                    22,991,000     14,692,000      7,711,000
Purchase of fixed maturities                              (38,372,000)   (45,225,000)   (26,673,000)
Purchase of equity securities                             (10,729,000)    (5,181,000)   (14,270,000)
Net purchase of short-term investments                    (10,709,000)    (4,614,000)    (1,494,000)
Proceeds from sale of subsidiary                           13,957,000             --             --
Proceeds from sale of property and equipment                  185,000          9,000         11,000
Purchase of property, equipment, and long-term assets        (728,000)    (1,867,000)    (2,699,000)
                                                         ------------   ------------   ------------
   Net cash flows provided from (used by)
     investment activities                                  6,817,000     (5,641,000)    (1,631,000)
                                                         ------------   ------------   ------------
FINANCING ACTIVITIES:
Proceeds from borrowings                                   44,000,000     11,700,000     12,700,000
Principal payments on debt                                (42,300,000)   (11,333,000)   (12,600,000)
Proceeds from exercise of common stock options                125,000         88,000         71,000
Dividends to stockholders                                  (4,022,000)    (4,019,000)    (3,929,000)
Repurchase of common stock                                 (7,909,000)    (3,582,000)    (4,133,000)
                                                         ------------   ------------   ------------
   Net cash flows used by financing activities            (10,106,000)    (7,146,000)    (7,891,000)
                                                         ------------   ------------   ------------
Net increase (decrease) in cash                             2,493,000     (1,725,000)     2,273,000
Cash, beginning of year                                     3,466,000      5,191,000      2,918,000
                                                         ------------   ------------   ------------
Cash, end of year                                        $  5,959,000   $  3,466,000   $  5,191,000
                                                         ============   ============   ============
</TABLE>

See accompanying notes to consolidated financial statements.

                                       49
<PAGE>
 
AVEMCO CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements
December 31, 1996, 1995 and 1994

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(A)  BASIS OF PRESENTATION
     The consolidated financial statements include the accounts of AVEMCO
     Corporation and all of its subsidiaries ("the company"). All material
     intercompany accounts and transactions have been eliminated in
     consolidation.

     The company's insurance subsidiaries underwrite aviation and other
     specialty insurance products. Non-aviation lines include lenders single
     interest, short-term health and pleasure marine. The insurance service
     businesses complement the insurance operations and are concentrated in
     claims management, specialty insurance administration, reinsurance
     brokerage, worldwide emergency assistance, and software systems for the
     property/casualty insurance industry.
     
     The preparation of the consolidated financial statements in conformity with
     generally accepted accounting principles requires management to make
     estimates and assumptions that affect the reported amounts of assets and
     liabilities and disclosure of contingent assets and liabilities at the date
     of the financial statements and the reported amounts of revenues and
     expenses during the reporting period. Actual results could differ from
     those estimates.

(B)  INSURANCE PREMIUMS AND COMMISSIONS
     Premiums on insurance policies written are recognized, net of ceded
     premiums, principally on a monthly pro rata basis over the terms of
     individual policies. Commissions on reinsurance are included in the
     computation of deferred policy acquisition costs and thereby are partially
     deferred (see note 1(e)).
     
(C)  COMPUTER PRODUCTS AND SERVICES
     Revenue from custom software products is recognized using the percentage of
     completion method of accounting. Other software contracts are recognized
     when delivery has occurred, other remaining vendor obligations are no
     longer significant, and collectibility is probable. Computer hardware is
     recognized when delivery has occurred. Maintenance support is recognized
     pro rata over the term of the maintenance agreement.

(D)  UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
     The liability for insurance losses is determined by aggregating the
     estimated liability on both individually reported and incurred but not
     reported claims. The liability for adjustment expenses on losses incurred
     but not settled is determined on the basis of historical experience of
     adjustment expenses in relation to losses incurred. Estimated amounts of
     salvage recoverable on paid and unpaid losses are recorded as a reduction
     of unpaid losses. Claims are continually monitored and management believes
     that the liability for losses and loss adjustment expenses at December 31,
     1996 and 1995, is adequate to cover the ultimate liability. However, such
     estimates may be more or less than the amount ultimately paid when the
     claims are settled (see note 4).

                                       50
<PAGE>
 
(E)  DEFERRED POLICY ACQUISITION COSTS
     Policy acquisition costs (such as premium taxes, commissions paid on
     reinsurance assumed, and a portion of other underwriting expenses) incurred
     in the writing of insurance business are deferred and amortized over the
     terms of the insurance policies. Anticipated losses and loss expenses,
     based on historical and current experience, are considered in determining
     the recoverability of deferred acquisition costs.
     
(F)  INVESTMENTS
     Investments in fixed maturities (bonds and redeemable preferred stock) are
     considered as available for sale and are carried at fair value, as
     determined by quoted market prices. The company has the ability to hold all
     fixed maturity investments until their maturity. However, securities may be
     sold to take advantage of market and economic conditions or as part of the
     company's investment strategy. Equity securities (common stock and non-
     redeemable preferred stock) are classified as available for sale and are
     carried at fair value, as determined by quoted market prices. Gain or loss
     on securities transactions are recognized as realized, or when other than
     temporary declines occur, and are determined by the identified certificate
     method. Unrealized appreciation or depreciation of equity securities and
     fixed maturity investments, net of deferred tax effect, if any, are
     excluded from net earnings and credited or charged directly to
     stockholders' equity (see note 2).

(G)  DEPRECIATION AND AMORTIZATION
     Property and equipment are depreciated by straight-line and accelerated
     methods over their useful lives, which range from three years for certain
     equipment to 45 years for certain buildings. Intangible costs of
     acquisitions, included in other assets, are amortized on a straight-line
     basis over their useful lives ranging from three to 15 years.

(H)  INCOME TAXES
     Deferred tax assets and liabilities are recognized for the future tax
     consequences attributable to differences between the financial statement
     carrying amounts of existing assets and liabilities and their respective
     tax bases. Deferred tax assets and liabilities are measured using enacted
     tax rates expected to apply to taxable income in the years in which those
     temporary differences are expected to be recovered or settled. The effect
     on deferred tax assets and liabilities of a change in tax rates is
     recognized in income in the period that includes the enactment date.

(I)  EARNINGS PER SHARE
     Earnings per share are based on the weighted average number of common and
     common equivalent shares outstanding during the year. Outstanding common
     stock options, when dilutive, are considered to be common stock equivalents
     for the purpose of this calculation. The weighted average number of common
     and common equivalent shares has been impacted by the company's continuing
     common stock repurchase program implemented in 1987.

                                       51
<PAGE>
 
(2)  INVESTMENTS

The following summarizes the amortized cost, unrealized gains and losses, and
fair value of investments in fixed income securities at December 31, 1996, 1995,
and 1994.  Bonds consist primarily of debt securities issued by states and
political subdivisions.
<TABLE>
<CAPTION>
 
                                Unrealized
-------------------------------------------------------------------------------
                         Amortized
                           Cost               Gains       Losses     Fair Value
                    --------------------  ------------  ----------   ----------
<S>                 <C>                   <C>           <C>          <C> 
December 31, 1996:
Bonds                      $101,117,000    $3,910,000  $  309,000  $104,718,000
Redeemable
 preferred stocks             8,060,000        81,000      31,000     8,110,000
                           ------------    ----------  ----------  ------------
Total                      $109,177,000    $3,991,000  $  340,000  $112,828,000
                           ============    ==========  ==========  ============
 
December 31, 1995:
Bonds                      $102,376,000    $5,219,000  $  276,000  $107,319,000
Redeemable
 preferred stocks             4,692,000       145,000      20,000     4,817,000
                           ------------    ----------  ----------  ------------
Total                      $107,068,000    $5,364,000  $  296,000  $112,136,000
                           ============    ==========  ==========  ============
 
December 31, 1994:
Bonds                      $ 96,114,000    $2,830,000  $2,794,000  $ 96,150,000
Redeemable
 preferred stocks             8,487,000        10,000     158,000     8,339,000
                           ------------    ----------  ----------  ------------
Total                      $104,601,000    $2,840,000  $2,952,000  $104,489,000
                           ============    ==========  ==========  ============
</TABLE>

The amortized cost and estimated fair value of fixed income securities at
December 31, 1996, by contractual maturity, are shown below.  Expected
maturities will differ from contractual maturities because borrowers may have
the right to call or prepay obligations with or without call or prepayment
penalties.
<TABLE>
<CAPTION>
 
                           December 31, 1996
                      --------------------------
                        Amortized       Fair
      Maturity            Cost         Value
--------------------  ------------  ------------
<S>                   <C>           <C>
Less than one year    $  3,344,000  $  3,356,000
1 to 3 years             6,215,000     6,366,000
3 to 5 years            12,519,000    12,881,000
5 to 10 years           45,986,000    47,661,000
Over 10 years           41,113,000    42,564,000
                      ------------  ------------
   Total              $109,177,000  $112,828,000
                      ============  ============
</TABLE>

                                       52
<PAGE>
 
  The company has $7,268,000 of fixed income securities at December 31, 1996,
pledged with regulators and treasurers of various states and the Canadian
national government for protection of its policyholders and creditors as
required by various state and Canadian national government insurance
regulations.

The following summarizes the cost, unrealized gains and losses, and fair value
of investments in equity securities at December 31, 1996, 1995, and 1994:
<TABLE>
<CAPTION>
 
                                         Unrealized
                      ------------------------------------------------
                         Cost        Gains       Losses    Fair Value
                      -----------  ----------  ----------  -----------
<S>                   <C>          <C>         <C>         <C>
December 31, 1996:
Common stocks         $        --  $       --  $       --  $        --
Preferred stocks       10,953,000     122,000     258,000   10,817,000
                      -----------  ----------  ----------  -----------
    Total             $10,953,000  $  122,000  $  258,000  $10,817,000
                      ===========  ==========  ==========  ===========
 
December 31, 1995:
Common stocks         $ 6,158,000  $2,609,000  $   14,000  $ 8,753,000
Preferred stocks       14,041,000     243,000     513,000   13,771,000
                      -----------  ----------  ----------  -----------
    Total             $20,199,000  $2,852,000  $  527,000  $22,524,000
                      ===========  ==========  ==========  ===========
 
December 31, 1994:
Common stocks         $ 6,871,000  $  371,000  $  180,000  $ 7,062,000
Preferred stocks       15,912,000       6,000   1,361,000   14,557,000
                      -----------  ----------  ----------  -----------
    Total             $22,783,000  $  377,000  $1,541,000  $21,619,000
                      ===========  ==========  ==========  ===========
</TABLE>

Below are the changes, as reflected in stockholders' equity, in net unrealized
appreciation (depreciation) in fair value, net of applicable income taxes, of
investments in fixed maturities and equity securities for the years ended
December 31, 1996, 1995, and 1994:
<TABLE>
<CAPTION>
 
                                          1996         1995          1994
                                      ------------  -----------  ------------
<S>                                   <C>           <C>          <C>
  Fixed maturities                    $  (936,000)  $3,419,000   $(4,995,000)
  Equity securities                    (1,623,000)   2,302,000    (1,053,000)
                                      -----------   ----------   -----------
  Net change for year                  (2,559,000)   5,721,000    (6,048,000)
  Cumulative net unrealized         
   appreciation on fixed matu-      
   rities at January 1, 1994                   --           --     4,922,000
  Net unrealized appreciation,      
   beginning of year                    4,879,000     (842,000)      284,000
                                      -----------   ----------   -----------
  Net unrealized appreciation
   (depreciation), end of year        $ 2,320,000   $4,879,000   $  (842,000)
                                      ===========   ==========   ===========
</TABLE> 

                                       53
<PAGE>
 
Net investment income consists of the following for the years ended December 31,
1996, 1995, and 1994:
<TABLE> 
<CAPTION> 
 
                                 1996         1995          1994
                              -----------   ----------   -----------
<S>                           <C>          <C>           <C> 
Fixed maturities              $ 6,616,000   $6,496,000   $ 7,125,000
Equity securities                 984,000    1,225,000       998,000
Short-term investments          1,083,000    1,177,000       522,000
                              -----------   ----------   -----------

Gross investment income         8,683,000    8,898,000     8,645,000
Investment expenses              (460,000)    (400,000)     (400,000)
                              -----------   ----------   -----------
 
Net investment income         $ 8,223,000   $8,498,000   $ 8,245,000
                              ===========   ==========   ===========
</TABLE>

Realized gains (losses), before taxes, on the sale of investment securities are
as follows for the years ended December 31, 1996, 1995, and 1994:
<TABLE>
<CAPTION>
 
                                  1996       1995       1994
                               ----------  --------  ----------
<S>                            <C>         <C>       <C>
 
Fixed maturities               $  230,000  $382,000  $(147,000)
Equity securities               3,014,000   193,000   (101,000)
                               ----------  --------  ---------
Net realized gains (losses)    $3,244,000  $575,000  $(248,000)
                               ==========  ========  =========
</TABLE>

Proceeds from the sale and redemption of fixed income securities during 1996,
1995, and 1994, were $30,222,000, $36,545,000, and $35,783,000, respectively.
Gross gains of $523,000, $492,000, and $452,000 in 1996, 1995, and 1994,
respectively, and gross losses of $293,000, $110,000, and $599,000, in 1996,
1995, and 1994, respectively, were realized from these transactions.

(3)  PROPERTY AND EQUIPMENT

Property and equipment at December 31, 1996  and 1995, consist of the following:
<TABLE>
<CAPTION>
 
                                          1996          1995
                                      ------------  ------------
<S>                                   <C>           <C>
 
Buildings and improvements            $ 6,583,000   $ 6,128,000
Furniture, fixtures, and equipment      9,841,000     9,819,000
                                      -----------   -----------
                                       16,424,000    15,947,000
Less accumulated depreciation          (8,538,000)   (7,896,000)
                                      -----------   -----------
 
Property and equipment, net           $ 7,886,000   $ 8,051,000
                                      ===========   ===========
</TABLE>

For the years ended December 31, 1996, 1995, and 1994, depreciation expense was
$1,284,000, $1,221,000, and $1,091,000, respectively.

                                       54
<PAGE>
 
(4)  UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES 

The following table presents the net liability for unpaid losses and loss
adjustment expenses as originally estimated at December 31, 1987 through 1996,
the cumulative amounts paid with respect to the liability for each subsequent
year, the re-estimated liability at each subsequent year-end, the resulting
development of original liability estimates for 1987 through 1995, and
supplemental gross unpaid losses and loss adjustment expense information.
<TABLE>
<CAPTION>
                                1987         1988         1989         1990         1991    
                             -----------  -----------  -----------  -----------  -----------
<S>                          <C>          <C>          <C>          <C>          <C>        
Net unpaid losses and loss                                                                  
 adjustment expenses         $41,170,000  $37,846,000  $38,955,000  $33,146,000  $24,957,000
Cumulative paid losses and                                                                  
 loss adjustment expenses:                                                                  
   One year later             20,932,000   17,689,000   17,145,000   16,350,000   14,137,000
   Two years later            26,950,000   25,364,000   26,118,000   22,766,000   17,524,000
   Three years later          29,483,000   30,043,000   30,015,000   24,516,000   21,791,000
   Four years later           31,463,000   32,107,000   30,671,000   27,415,000   23,063,000
   Five years later           32,538,000   31,822,000   33,300,000   27,969,000   23,952,000
   Six years later            31,844,000   33,580,000   33,803,000   28,373,000             
   Seven years later          33,485,000   33,862,000   34,128,000                          
   Eight years later          33,739,000   33,940,000                                       
   Nine years later           33,801,000                                                    

Net unpaid losses and loss                                                                  
 adjustment expenses                                                                        
 re-estimated as of:                                                                        
   One year later             37,447,000   36,147,000   36,145,000   27,373,000   23,624,000
   Two years later            36,000,000   35,483,000   32,946,000   27,728,000   24,066,000
   Three years later          34,884,000   34,013,000   33,464,000   27,904,000   23,886,000
   Four years later           33,817,000   34,531,000   33,458,000   28,277,000   24,061,000
   Five years later           34,365,000   34,106,000   33,958,000   28,384,000   24,443,000
   Six years later            33,985,000   34,178,000   34,092,000   28,669,000             
   Seven years later          34,069,000   34,050,000   34,401,000                          
   Eight years later          33,927,000   34,179,000                                       
   Nine years later           34,039,000                                                    
Net cumulative redundancy                                                                   
 (deficiency)                $ 7,131,000  $ 3,667,000  $ 4,554,000  $ 4,477,000  $   514,000
                             ===========  ===========  ===========  ===========  ===========
</TABLE> 
<TABLE> 
<CAPTION> 

                                                    1992         1993         1994          1995         1996    
                                                 -----------  -----------  -----------  ------------  -----------
<S>                                              <C>          <C>          <C>          <C>           <C>        
Net unpaid losses and loss                                                                                       
 adjustment expenses                             $26,663,000  $29,958,000  $31,137,000  $32,933,000   $35,349,000
Cumulative paid losses and                                                                                       
 loss adjustment expenses:                                                                                       
   One year later                                 12,263,000   16,897,000   20,786,000   22,216,000              
   Two years later                                19,262,000   22,805,000   27,052,000                           
   Three years later                              21,298,000   25,676,000                                        
   Four years later                               22,557,000                                                     
   Five years later                                                                                              
   Six years later                                                                                               
   Seven years later                                                                                             
   Eight years later                                                                                             
   Nine years later                                                                                              

Net unpaid losses and loss                                                                                       
 adjustment expenses                                                                                             
 re-estimated as of:                                                                                             
   One year later                                 24,299,000   27,011,000   29,989,000   31,799,000              
   Two years later                                22,903,000   27,535,000   31,520,000                           
   Three years later                              22,949,000   28,614,000                                        
   Four years later                               23,284,000                                                     
   Five years later                                                                                              
   Six years later                                                                                               
   Seven years later                                                                                             
   Eight years later                                                                                             
   Nine years later                                                                                              
Net cumulative redundancy (deficiency)          $  3,379,000 $  1,344,000  $  (383,000) $ 1,134,000
                                                ============ ============  ============ ===========
</TABLE>
<TABLE> 
<CAPTION> 
                                                                                            
                                                          1994          1995         1996
                                                       -----------  -----------  ----------- 
<S>                                                    <C>          <C>          <C> 
Gross unpaid losses and loss adjustment                                                     
 expenses..........................................    $41,202,000  $42,305,000  $43,227,000
Reinsurance recoverable on unpaid losses 
and loss adjustment expenses.......................     10,065,000    9,372,000    7,878,000
                                                       -----------  -----------  ----------- 
Net unpaid losses and loss adjustment                                                       
 expenses..........................................    $31,137,000  $32,933,000  $35,349,000
                                                       ===========  ===========  ===========
Re-estimated gross unpaid losses and loss adjustment                                        
 expenses..........................................    $39,067,000  $38,997,000
Re-estimated reinsurance recoverable on unpaid 
losses and loss adjustment expenses................      7,547,000    7,198,000
                                                       -----------  ----------- 
Re-estimated net unpaid losses and loss adjustment                                          
 expenses..........................................    $31,520,000  $31,799,000
                                                       ===========  ===========
Gross cumulative redundancy........................    $ 2,135,000  $ 3,308,000             
                                                       ===========  ===========                          
</TABLE> 

The development of unpaid losses and loss adjustment expenses refers to the
difference between original estimates for unpaid losses and loss adjustment
expenses and the re-evaluation of these estimates in subsequent years as loss
payments are made and open claims adjusted to reflect current information.
Redundant or favorable development occurs when original estimates are higher
than subsequently indicated, whereas deficient development occurs when original
estimates are lower than subsequently indicated.

                                       55
<PAGE>
 
(4)  UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES (CONTINUED)

The following table sets forth a reconciliation of beginning and ending net
unpaid losses and loss adjustment expenses and additional supplemental gross
unpaid loss and loss adjustment expense information.  Net unpaid losses and loss
adjustment expenses reflect unpaid losses and loss adjustment expenses after
reinsurance arrangements have been considered.
<TABLE>
<CAPTION>
                                                   Years Ended December 31,
                                           --------------------------------------
                                              1996          1995          1994
                                           -----------   ------------  ----------
<S>                                        <C>           <C>           <C>
Net unpaid losses and loss adjustment
 expenses, beginning of year............. $32,933,000   $31,137,000   $29,958,000
                                          -----------   -----------   -----------
Losses and loss adjustment expenses:      
 Provision for insured events of          
   the current year......................  64,000,000    56,753,000    49,257,000
 Decrease in provision for insured        
   events of prior years.................  (1,134,000)   (1,148,000)   (2,947,000)
                                          -----------   -----------   -----------
    Total losses and loss adjustment      
      expenses...........................  62,866,000    55,605,000    46,310,000
                                          -----------   -----------   -----------
Payments:................................ 
 Losses and loss adjustment expenses      
   attributable to insured events of      
   the current year......................  38,234,000    33,023,000    28,234,000
 Losses and loss adjustment expenses      
   attributable to insured events of      
   prior years...........................  22,216,000    20,786,000    16,897,000
                                          -----------   -----------   -----------
    Total payments.......................  60,450,000    53,809,000    45,131,000
                                          -----------   -----------   -----------
Net unpaid losses and loss adjustment     
 expenses, end of year...................  35,349,000    32,933,000    31,137,000
Reinsurance recoverable on unpaid         
 losses and loss adjustment expenses,     
 end of year.............................   7,878,000     9,372,000    10,065,000
                                          -----------   -----------   -----------
Gross unpaid losses and loss adjustment   
 expenses, end of year................... $43,227,000   $42,305,000   $41,202,000
                                          ===========   ===========   ===========
</TABLE>

(5)  STOCK OPTIONS

The stockholders approved a 375,000 share non-statutory stock option plan in
1991 and a 1,350,000 share incentive stock option plan in 1982.  Both plans are
administered by the Compensation and Stock Option Committee of the Board of
Directors.

Under the non-statutory stock option plan, options may be granted to employees
to purchase shares of the company's common stock. Options are granted at the
fair market value on the date of the grant and, generally, expire ten years from
the date of grant. Generally, options cannot be exercised earlier

                                       56
<PAGE>
 
than one year after the date on which granted and become exercisable at a rate
of 25% per year provided, however, that an option may be exercised in full in
the event of, among other things, a change in control of the company.

The incentive stock option plan expired December 1992 and no additional grants
can be made under this plan.  Major provisions are similar to the non-statutory
stock option plan, except that upon the exercise of an option, an incentive
stock option participant agrees not to voluntarily terminate emloyment without
the consent of the company for a period of at least two years from the date of
such exercise.  The actual options that any participant may annually receive or
exercise, including any that may be accelerated due to a change in control, are
limited, however, to the maximum amount allowable under the Internal Revenue
Code.

The following table summarizes stock option activity under these plans for the
years ended December 31, 1996, 1995, and 1994:
<TABLE>
<CAPTION>
                                    1996                              1995                         1994
                       -------------------------------  ------------------------------  ------------------------------  
                                           Weighted-                        Weighted-                       Weighted-
                                            Average                          Average                         Average
                                           Exercise                         Exercise                        Exercise
                          Shares            Price            Shares           Price         Shares            Price
                       -------------  ----------------  ---------------  -------------  ---------------  --------------- 
<S>                    <C>            <C>               <C>              <C>            <C>              <C>
Outstanding at      
  beginning of year      899,300           $  17.19         910,025        $  17.18         877,925         $ 17.33
Granted                   45,600              15.25           9,000         16.4375          51,000           13.625
Exercised                (14,650)              8.54          (7,800)          11.15          (8,500)           8.42
Cancelled                (61,850)             20.02         (11,925)          20.10         (10,400)          19.51
                     ------------                           -------                         -------
Outstanding at      
   year-end              868,400           $  17.03         899,300        $  17.19         910,025         $ 17.18
                     ============                           =======                         =======
Exercisable at      
  year-end               769,650           $  17.03         747,200        $  16.67         629,725         $ 16.07
                     ============                           =======                         =======
</TABLE> 
 
The fair value of options granted during 1996, 1995, and 1994 were $4.69, $4.91,
and $5.39, respectively.
 
Outstanding options at December 31, 1996, consist of the following:
<TABLE> 
<CAPTION> 
 
                                   Options Outstanding                     Options Exercisable
                    -----------------------------------------------   -----------------------------
Range of                Number      Weighted-Avg.                         Number
Exercise             Outstanding     Remaining        Weighted-Avg     Exercisable   Weighted-Avg.
 Prices              at 12/31/96   Contractual Life  Exercise Price    at 12/31/96  Exercise Price
---------------------------------------------------------------------------------------------------
<S>                  <C>            <C>              <C>               <C>          <C> 
$10.00-13.99            234,075         1.94          $  11.95         215,075          $ 11.80
 14.00-17.99            407,575         3.84             16.12         355,675            16.22
 18.00-21.99             52,600         6.92             18.50          39,250            18.50
$22.00-26.00            174,150         5.25             25.55         159,650            25.53
                       --------                                        -------
                        868,400         3.80          $  17.03         769,650         $  17.03
                       ========                                        =======
</TABLE>

                                       57
<PAGE>
 
The intrinsic value method was applied in accounting for stock option activity.
Accordingly, no compensation cost is recognized in the consolidated statements
of income.  Had compensation cost been determined consistent with the fair value
method, the proforma net earnings and earnings per share impact, if any, would
have been immaterial.

(6)  INCOME TAXES

The following is a reconciliation of the expected federal income tax rate with
the company's effective tax rate on earnings:
<TABLE>
<CAPTION>
                                                  1996          1995         1994
                                               -----------  ------------  -----------
<S>                                            <C>          <C>           <C>
   Expected tax rate                                 35.0%         35.0%        35.0%
   Effect on tax rate resulting from:       
     Tax exempt income on securities                (11.3)        (18.8)       (13.7)
     Allowable dividend exclusion                    (2.0)         (3.7)        (2.3)
     Other                                            1.3            .5          1.0
                                               ----------   -----------   ----------
   Effective tax rate                                23.0%         13.0%        20.0%
                                               ==========   ===========   ==========
</TABLE> 
Deferred income tax assets and liabilities are comprised of the following at
December 31:
<TABLE> 
<CAPTION> 
 
                                                          1996          1995         1994
                                                    ----------   -----------   ----------
<S>                                                 <C>          <C>           <C> 
Deferred income tax assets:                    
 Discounted unpaid loss and loss adjustment    
    expenses                                        $  841,000   $ 1,120,000   $1,059,000
 Unearned premiums reduction                         2,151,000     1,849,000    1,501,000
 California Proposition 103 deferral                   105,000       132,000    1,016,000
 Alternative minimum tax credit carryforwards          653,000       927,000      121,000
 Unrealized depreciation on investments                     --            --      434,000
 Other                                                 172,000       262,000      254,000
                                                    ----------   -----------   ----------
   Gross deferred income tax assets                  3,922,000     4,290,000    4,385,000
                                                    ----------   -----------   ----------
Deferred income tax liabilities:               
 Deferred policy acquisition costs                   2,064,000     1,874,000    1,674,000
 Property and equipment                                856,000       859,000      860,000
 Investments                                           459,000       395,000      359,000
 Unrealized appreciation on investments              1,196,000     2,514,000           --
                                                    ----------   -----------   ----------
   Gross deferred income tax liabilities             4,575,000     5,642,000    2,893,000
                                                    ----------   -----------   ----------
   Net deferred income tax assets (liabilities)     $ (653,000)  $(1,352,000)  $1,492,000
                                                    ==========   ===========   ==========
</TABLE>

A valuation allowance as of December 31, 1996 and 1995, has not been recognized
as it appears more likely than not that the combination of carryback potential
and estimated future taxable income should be sufficient to allow for the
realization of the deferred income tax assets.

State income taxes, which are included in the current income tax provisions,
were $780,000, $405,000, and $395,000 in 1996, 1995, and 1994, respectively.
Federal and state income taxes paid in 1996, 1995, and 1994 were $2,686,000,
$944,000, and $2,801,000, respectively.

                                       58
<PAGE>
 
(7)  DEBT

The company has an unsecured revolving credit facility with a bank that allows
it to borrow up to $60,000,000 through April 30, 1997.  Interest is payable at
the lower of the bank's floating prime rate or the daily London Interbank
Offered Rate for three month U.S. dollar deposits (LIBOR) plus 1.45%.  The
interest rate at December 31, 1996, was 7.08%.  The company also has the option,
at any time, to convert any portion of the outstanding principal balance of the
loan into term notes, which may be amortized over any period not to extend
beyond December 31, 2000.  Interest would be based on the revolving credit
facility's fluctuating rate.  However, the company may, at its option, convert
the fluctuating rate to a negotiated fixed rate by executing an interest rate
swap agreement.  The revised credit agreement provides for a commitment fee of
one half of 1% per annum of the average daily unused credit. $53,000,000 was
drawn under this credit facility at December 31, 1996.

The revised credit facility requires the company to maintain a consolidated net
worth, as defined, of $48,895,000.  Dividends to stockholders in any one year
may not exceed 53% of the prior year's net earnings.  Other significant
covenants in the credit facility provide for certain limitations on the
company's liability to net worth ratio, cash flow to current portion of long
term debt, the acquisition, disposition and pledging of assets, incurring of
indebtedness, and require its insurance subsidiary to maintain a certain
statutory policyholders' surplus and net premium written to policyholders'
surplus ratio.

The company also has a $10,000,000 unsecured five-year term loan with a bank.
The loan will be repaid in 60 monthly principal installments of $166,667, plus
interest.  Interest is payable on a fluctuating basis equal to LIBOR plus 1.65%.
The company may, however, at its option, convert the fluctuating rate to a
negotiated fixed rate by executing an interest rate swap agreement.  The
interest rate at December 31, 1996, was 7.28%.  At December 31, 1996, the
outstanding principal amount of the loan was $3,667,000.  Principal payments for
the next two years ending December 31, 1998, are $2,167,000 in 1997, and
$1,500,000 in 1998.

Interest paid on all debt in 1996, 1995, and 1994, was $3,918,000, $4,031,000,
and $3,915,000, respectively.

(8)  EMPLOYEE BENEFITS

The company has a non-contributory defined benefit retirement plan covering
substantially all employees who meet specified age and service requirements.
Benefits are based on years of service, final average compensation and are
integrated with the provisions of the Federal Insurance Compensation Act (Social
Security), as provided for in the plan. Pension plan assets are primarily
invested in immediate participation guaranteed contracts and pooled separate
investment accounts of a life insurance company. The company's funding policy is
to contribute amounts that meet minimum funding requirements, but which do not
exceed the maximum funding limits as currently determined under applicable tax
regulations.

Total pension expense (credit) amounted to $(590,000), $512,000, and $430,000 in
1996, 1995, and 1994, respectively.  A curtailment gain of $1,044,000 was
recognized in 1996 as a result of the

                                       59
<PAGE>
 
company's decision to eliminate certain future service time credits. The
following summarizes the plan's status at December 31:

Actuarial present value of pension benefit obligations:
<TABLE>
<CAPTION>
 
                                              1996          1995          1994
                                          ------------  ------------  ------------
<S>                                       <C>           <C>           <C>
Vested benefit obligation                 $(4,352,000)  $(4,383,000)  $(3,930,000)
Non-vested benefit obligation                (277,000)     (191,000)      (93,000)
                                          -----------   -----------   -----------
Accumulated benefit obligation             (4,629,000)   (4,574,000)   (4,023,000)
Effect of projected future            
 compensation increases                      (458,000)   (2,013,000)   (1,414,000)
                                          -----------   -----------   -----------
Projected benefit obligation               (5,087,000)   (6,587,000)   (5,437,000)
Fair value of plan assets                   6,995,000     5,613,000     4,296,000
Unrecognized net prior obligation              53,000       209,000       236,000
Unrecognized prior service cost                27,000       497,000       557,000
Unrecognized net (gain) loss               (1,423,000)      147,000       248,000
                                          -----------   -----------   -----------
Prepaid (accrued) pension cost            $   565,000   $  (121,000)  $  (100,000)
                                          ===========   ===========   ===========
</TABLE> 
Net periodic pension expense (credit) for the years ended December 31,
 
<TABLE> 
<CAPTION> 
                                                  1996           1995          1994
                                                -----------   -----------   -----------
<S>                                             <C>           <C>           <C> 
Service cost                                    $   459,000   $   378,000   $   328,000
Interest cost                                       481,000       422,000       376,000
Actual return on plan assets                       (534,000)     (376,000)     (362,000)
Amortization of prior service cost                   21,000        61,000        61,000
Amortization of net prior obligation                 27,000        27,000        27,000
Gain from curtailment                            (1,044,000)           --            --
                                                -----------   -----------   -----------
Net periodic pension expense (credit)           $  (590,000)  $   512,000   $   430,000
                                                ===========   ===========   ===========
Rate assumptions:
                                                  1996           1995          1994
                                                -----------   -----------   -----------
Average discount rate                               8.0%         7.25%          7.5%
Expected long-term rate of return                   8.5%          8.5%          8.5%
Compensation increase rate                          5.0%          5.0%          5.0%
</TABLE>

The company also has a trusteed defined contribution profit sharing plan
covering substantially all employees who meet specified service requirements.
Under the plan, the company contributes 5% of defined net earnings before income
taxes.  The company's contribution is limited, however, to the maximum amount
allowable as a tax deduction under the Internal Revenue Code.  For the years
ended December 31, 1996, 1995, and 1994, the company's contribution to the plan
was $491,000, $420,000, and $709,000 respectively.

                                       60
<PAGE>
 
(9)  REINSURANCE

In the normal course of business, AVEMCO Insurance Company and subsidiaries, the
company's principal insurance subsidiary, assumes and cedes reinsurance as a
party to quota share, surplus share, excess of loss, facultative, and
catastrophe reinsurance agreements.  These reinsurance arrangements are utilized
to limit maximum loss, provide greater diversification of risk and to minimize
exposures on larger risks.  Accounts in the accompanying consolidated statements
of income are reflected net of the reinsurance ceded.

A summary of reinsurance activity follows:
<TABLE>
<CAPTION>
 
                                                        Years Ended December 31,
                                           -------------------------------------------
                                               1996            1995           1994
                                           -------------  -------------  -------------
<S>                                        <C>            <C>            <C>
 
Direct premiums written                     $ 94,487,000   $ 79,602,000   $ 74,850,000
Assumed premiums written                      12,478,000     20,546,000     15,802,000
Ceded premiums written                       (14,719,000)   (14,608,000)   (17,202,000)
                                            ------------   ------------   ------------
 
Net premiums written                        $ 92,246,000   $ 85,540,000   $ 73,450,000
                                            ============   ============   ============
 
Direct earned premiums                      $ 90,093,000   $ 76,218,000   $ 77,521,000
Assumed earned premiums                       12,070,000     18,580,000     16,806,000
Ceded earned premiums                        (15,993,000)   (14,340,000)   (18,809,000)
                                            ------------   ------------   ------------
 
Net earned premiums                         $ 86,170,000   $ 80,458,000   $ 75,518,000
                                            ============   ============   ============
 
Losses and loss adjustment expenses         $ 72,607,000   $ 64,418,000   $ 57,668,000
Reinsurance recoveries                        (9,741,000)    (8,813,000)   (11,358,000)
                                            ------------   ------------   ------------
 
Net losses and loss adjustment expenses     $ 62,866,000   $ 55,605,000   $ 46,310,000
                                            ============   ============   ============
</TABLE>

The ceding or transfer of business to reinsurers does not discharge the primary
liability of AVEMCO Insurance Company; therefore, the insurance subsidiary is
contingently liable for the estimated amounts recoverable from reinsurers should
reinsurers be unable to meet their obligations.  AVEMCO Insurance Company held
$9,285,000 and $8,498,000 of irrevocable letters of credit and other funds from
reinsurers at December 31, 1996 and 1995, respectively.

(10)  STOCKHOLDERS' EQUITY AND CAPITAL TRANSACTIONS

The company's stock repurchase program, initially approved by the Board of
Directors in October 1987 and subsequently revised to reflect current
conditions, allows the company to buy back shares of AVEMCO Corporation common
stock from time to time on the open market at prevailing prices and through
private block transactions as may become available.  At December 31, 1996, the
company had repurchased 6,727,380 common shares under the stock repurchase
program at prices ranging from $9.75 to $22.00.  As a result of the company's
stock repurchase program, there were  8,264,070 shares of its common stock
outstanding on December 31, 1996.

                                       61
<PAGE>
 
AVEMCO Insurance Company is restricted on paying dividends, loans, or advances
by minimum statutory surplus requirements.  In addition, state regulatory
restrictions were revised, effective July 1993, to limit the amount of
distribution that may be paid without prior approval by regulatory authorities.
At December 31, 1996, the maximum dividend payout which could be made during
1997 without prior approval is $7,667,000.  During 1996 and 1995, the company
received annual dividends of $7,400,000 and $7,200,000, respectively, from the
principal subsidiary.  These dividends have been eliminated in the accompanying
consolidated financial statements.

Policyholders' surplus (stockholder's equity as determined in accordance with
statutory accounting practices) of AVEMCO Insurance Company and subsidiaries, at
December 31, 1996 and 1995, was $76,669,000 and $73,808,000, respectively.

(11) SUMMARY SUPPLEMENTAL FINANCIAL DATA WITH RESPECT TO INSURANCE SUBSIDIARY

Following are the consolidated financial summaries of the AVEMCO Insurance
Company and subsidiaries, which is the principal subsidiary of AVEMCO
Corporation.
                   AVEMCO Insurance Company and Subsidiaries
                      Consolidated Summaries of Operations
<TABLE>
<CAPTION>
                                               Years Ended December 31,
                                        ---------------------------------------
                                           1996          1995          1994
                                        ------------  -----------  ------------
<S>                                     <C>           <C>          <C>
Revenues:
 Premiums earned                        $ 86,170,000  $80,458,000  $75,518,000
 Net investment income                     6,638,000    6,988,000    6,952,000
 Commissions on reinsurance ceded          3,969,000    3,586,000    4,624,000
 Realized investment gains (losses)        2,218,000      390,000     (301,000)
 Realized gain on subsidiary sale          3,307,000           --           --
 Other revenues                              145,000      152,000       65,000
                                        ------------  -----------  -----------
Total revenues                           102,447,000   91,574,000   86,858,000
                                        ------------  -----------  -----------
 
Expenses:
 Losses and loss adjustment expenses      62,866,000   55,605,000   46,310,000
 Commissions                               9,599,000    8,495,000    9,142,000
 Other expenses                           15,179,000   15,882,000   16,480,000
                                        ------------  -----------  -----------
Total expenses                            87,644,000   79,982,000   71,932,000
                                        ------------  -----------  -----------
Earnings before income taxes              14,803,000   11,592,000   14,926,000
Income taxes                               3,705,000    2,426,000    3,251,000
                                        ------------  -----------  ----------- 
Net earnings                            $ 11,098,000  $ 9,166,000  $11,675,000
                                        ============  ===========  ===========
</TABLE>

                                       62
<PAGE>
 
                   AVEMCO Insurance Company and Subsidiaries
                      Consolidated Summary Balance Sheets
<TABLE>
<CAPTION>
                                                            December 31,
                                              ----------------------------------------
                                                  1996          1995          1994
                                              ------------  ------------  ------------
<S>                                           <C>           <C>           <C>
Assets:
 Investments                                  $125,555,000  $125,399,000  $114,104,000
 Cash                                              895,000        86,000       460,000
 Premiums and other receivables                 28,723,000    23,113,000    17,488,000
 Reinsurance recoverable                         9,503,000    14,292,000    16,903,000
 Deferred policy acquisition costs               6,071,000     5,511,000     4,922,000
 Prepaid reinsurance premiums                    5,913,000     5,178,000     4,924,000
 Other assets                                      183,000       137,000     2,217,000
                                              ------------  ------------  ------------
Total assets                                  $176,843,000  $173,716,000  $161,018,000
                                              ============  ============  ============
 
Liabilities and Stockholder's Equity:
 Unpaid losses and expenses                   $ 43,227,000  $ 42,305,000  $ 41,202,000
 Unearned premiums                              37,201,000    32,363,000    27,001,000
 Ceded reinsurance payable                       1,549,000     5,045,000     5,503,000
 Other liabilities                               4,208,000     4,977,000     4,855,000
                                              ------------  ------------  ------------
Total liabilities                               86,185,000    84,690,000    78,561,000
Total stockholder's equity                      90,658,000    89,026,000    82,457,000
                                              ------------  ------------  ------------
 
Total liabilities and stockholder's equity    $176,843,000  $173,716,000  $161,018,000
                                              ============  ============  ============
</TABLE>

Policy acquisition costs amortized for the years ended December 31, 1996, 1995,
and 1994, were $16,421,000, $14,722,000, and $15,488,000, respectively, which
includes $2,782,000, $1,982,000, and $1,983,000 of commission expense paid to
affiliates which were eliminated in consolidation.

Net earnings as determined in accordance with statutory accounting practices for
AVEMCO Insurance Company and subsidiaries were $10,439,000, $8,098,000, and
$11,751,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
Net earnings as determined in accordance with statutory accounting practices
differ from net earnings as prepared in accordance with generally accepted
accounting principles primarily because of deferred policy acquisition costs.

AVEMCO Insurance Company sold its National Assurance Underwriters, Inc.,
subsidiary during 1996 while retaining all that subsidiary's insurance business.
The sale generated a $3.3 million realized gain.

AVEMCO Insurance Company and U.S. Specialty Insurance Company settled their
outstanding Proposition 103 matters with the California Department of Insurance
during 1995.  The company had previously provided for a potential rollback
impact in prior years.  Refund payments were made in 1996.

                                       63
<PAGE>
 
(12) SUBSEQUENT EVENT

On January 17, 1997, AVEMCO and HCC Insurance Holdings, Inc., ("HCCH") jointly
announced that they had signed a Letter of Intent to merge AVEMCO with a wholly-
owned subsidiary of HCCH in a stock-for-stock transaction, with AVEMCO becoming
a wholly-owned subsidiary of HCCH.  On February 28, 1997, AVEMCO and HCCH
jointly announced that the Boards of Directors of AVEMCO and HCCH had executed
an Agreement and Plan of Reorganization (the "Agreement").  Pursuant to the
terms of the Agreement, each share of AVEMCO's common stock will be exchanged
for one share of HCCH's common stock.

The proposed transaction is intended to be accounted for as a pooling of
interests and to be a nontaxable exchange to AVEMCO's shareholders.  It is
subject to various conditions, including receipt of required regulatory
approvals and the approval of the transaction by shareholders of both AVEMCO and
HCCH.  A special shareholders' meeting is anticipated to be held in the second
quarter of 1997, and a proxy statement describing the transaction in detail is
expected to be submitted to the shareholders shortly.  There can be no assurance
that the conditions to the proposed merger will be satisfied or that the
shareholders will approve the transaction.

(13) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

The quarterly results for the three years ended December 31, 1996, are set forth
in the following tables:
<TABLE>
<CAPTION>
                                       Earnings (loss)             Earnings
                                           Before         Net        Per
                          Revenues      Income Taxes    Earnings    Share
                       ---------------  -------------  -----------  -----
<S>                    <C>              <C>            <C>          <C>
1996 by Quarter
---------------
First                    $ 28,378,000    $ 3,409,000   $ 2,687,000  $ .31
Second                     33,146,000      6,420,000     4,702,000    .55
Third                      34,391,000      3,059,000     2,419,000    .29
Fourth                     31,975,000      3,074,000     2,480,000    .30
                         ------------    -----------   -----------  -----
             Annual      $127,890,000    $15,962,000   $12,288,000  $1.45
                         ============    ===========   ===========  =====
 
1995 by Quarter
---------------
First                    $ 26,004,000    $ 3,461,000   $ 2,814,000  $ .32
Second                     29,859,000      3,442,000     2,669,000    .30
Third                      29,085,000       (652,000)       74,000    .01
Fourth                     28,256,000      2,851,000     2,361,000    .27
                         ------------    -----------   -----------  -----
             Annual      $113,204,000    $ 9,102,000   $ 7,918,000  $ .90
                         ============    ===========   ===========  =====
 
1994 by Quarter
---------------
First                    $ 22,004,000    $ 2,898,000   $ 2,399,000  $ .26
Second                     29,710,000      5,014,000     3,570,000    .39
Third                      27,369,000      2,603,000     2,287,000    .26
Fourth                     25,507,000      3,024,000     2,577,000    .29
                         ------------    -----------   -----------  -----
             Annual      $104,590,000    $13,539,000   $10,833,000  $1.20
                         ============    ===========   ===========  =====
</TABLE>

                                       64
<PAGE>
 
                         INDEPENDENT AUDITORS' REPORT


The Board of Directors and Stockholders
AVEMCO Corporation:


We have audited the consolidated financial statements of AVEMCO Corporation and
subsidiaries as listed in the accompanying index.  In connection with our audits
of the consolidated financial statements, we also have audited the financial
statement schedules as listed in the accompanying index. These consolidated
financial statements and financial statement schedules are the responsibility of
the Company's management.  Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedules based on our
audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AVEMCO Corporation
and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1996, in conformity with generally accepted accounting
principles.  Also in our opinion, the related financial statement schedules,
when considered in relation to the basic consolidated financial statements taken
as a whole, present fairly, in all material respects, the information set forth
therein.

The Company changed its method of accounting for fixed maturity investments in
1994 to adopt the provisions of the Financial Accounting Standards Board's
Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for
Certain Investments in Debt and Equity Securities."



                              /s/KPMG Peat Marwick LLP

Washington, D.C.
January 31, 1997 (February 28, 1997, as to Note 12)

                                       65
<PAGE>

<TABLE> 
<CAPTION>  
                      AVEMCO Corporation and Subsidiaries                                       Schedule I
       Summary of Investments-Other Than Investments in Related Parties
                               December 31, 1996


--------------------------------------------------------------------------------------------------------------
             Column A                                             Column B        Column C        Column D
--------------------------------------------------------------------------------------------------------------
                                                                                               Amount at which
                                                                                     Fair      shown in the
        Type of Investment                                          Cost            Value      balance sheet
--------------------------------------------------------------------------------------------------------------
<S>                                                             <C>            <C>             <C>  
Fixed maturities:
        Bonds:
          Federal government and government     
           agencies and authorities                             $  8,570,000   $  8,769,000    $  8,769,000
          States, municipalities and political subdivisions       92,441,000   $ 95,843,000    $ 95,843,000
          Foreign governments                                             --             --              --
          Public utilities                                                --             --              --
          Convertibles and bonds with warrants attached                   --             --              --
          All other corporate bonds                                  106,000        106,000         106,000
        Certificates of deposit                                           --             --              --
        Redeemable preferred stocks                                8,060,000      8,110,000       8,110,000
                                                                ------------    -----------     -----------
                Total fixed maturities                           109,177,000    112,828,000     112,828,000

Equity Securities:
        Common Stocks:
          Public utilities                                                --             --              --
          Banks, trust, and insurance companies                           --             --              --
          Industrial, miscellaneous, and all other                        --             --              --
        Nonredeemable preferred stocks                            10,953,000     10,817,000      10,817,000
                                                                ------------    -----------     -----------
                Total equity securities                           10,953,000     10,817,000      10,817,000

Mortgage loans on real estate                                             --    XXXXXXXXXXX              --
Real estate, at cost                                                      --    XXXXXXXXXXX              --
Policy loans                                                              --    XXXXXXXXXXX              --
Other long-term investments                                               --    XXXXXXXXXXX              --
Short-term investments, at cost which approximates fairs value    25,593,000    XXXXXXXXXXX      25,593,000
                                                                ------------    -----------     -----------
                Total investments                               $145,723,000                   $149,238,000
                                                                ------------                   ------------
</TABLE> 
Fixed maturities and equity securities are carried at fair value.

                                      66
<PAGE>
 
<TABLE> 
<CAPTION> 


                              AVEMCO Corporation                                                    SCHEDULE II
                              (Parent Company)                                                              1/4
                 Condensed Financial Information of Registrant
                            Condensed Balance Sheets
                           December 31, 1996 and 1995
 
ASSETS                                                                                  1996           1995
                                                                                    -------------  -------------
<S>                                                                                 <C>            <C>
Fixed maturities,
   at fair value (amortized cost $19,585,000, $18,877,000 in 1995)................  $ 20,320,000   $ 19,816,000
Equity securities, at fair value (cost $1,273,000, $2,446,000 in 1995)............     1,313,000      3,089,000
Short-term investments, at cost, which approximates fair value....................     1,043,000        546,000
Cash (overdraft)..................................................................       (32,000)       181,000
Property and equipment, at cost, less accumulated depreciation of
   $5,026,000  in 1996 and $4,776,000 in 1995.....................................     3,593,000      4,032,000
Investment in subsidiaries........................................................   103,430,000    105,480,000
Other assets, net.................................................................     1,347,000        725,000
                                                                                    ------------   ------------
      TOTAL ASSETS................................................................  $131,014,000   $133,869,000
                                                                                    ============   ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accrued expenses and other liabilities............................................  $  5,505,000   $  5,095,000
Amounts due to subsidiaries.......................................................     8,270,000     12,048,000
Debt..............................................................................    56,667,000     54,967,000
                                                                                    ------------   ------------
      TOTAL LIABILITIES...........................................................    70,442,000     72,110,000
                                                                                    ------------   ------------
STOCKHOLDERS' EQUITY:
Preferred stock, par value, $10.00 per share - 500,000 shares authorized;
   none issued....................................................................            --             --
Common Stock, par value, $.10 per share - 20,000,000 shares authorized;
   11,565,811 issued; 11,551,161 in 1995..........................................     1,157,000      1,155,000
Additional paid-in capital........................................................    19,140,000     18,293,000
Net unrealized appreciation on investments........................................     2,320,000      4,879,000
Foreign currency translation adjustments..........................................      (218,000)      (182,000)
Retained earnings.................................................................    94,843,000     88,184,000
                                                                                    ------------   ------------
                                                                                     117,242,000    112,329,000
Less treasury stock, 3,301,741 shares in 1996; 2,901,741 shares in 1995, at cost..    56,670,000    (50,570,000)
                                                                                    ------------   ------------
TOTAL STOCKHOLDERS' EQUITY........................................................    60,572,000     61,759,000
                                                                                    ------------   ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................................  $131,014,000   $133,869,000
                                                                                    ============   ============
See accompanying note to condensed financial statements
</TABLE>

                                       67
<PAGE>
 
<TABLE> 
<CAPTION> 
                              AVEMCO Corporation                                                        SCHEDULE II
                              (Parent Company)                                                                  2/4
                 Condensed Financial Information of Registrant
                         Condensed Statements of Income
                            Years ended December 31,
 
 
REVENUES                                                                         1996          1995          1994
                                                                             ------------  ------------  ------------
<S>                                                                          <C>           <C>           <C>
  Net investment income....................................................  $ 1,395,000   $ 1,412,000   $ 1,372,000
  Realized gain on sale of investments.....................................    1,027,000       186,000        52,000
  Management fees from subsidiaries........................................      800,000       600,000     1,000,000
  Other charges to subsidiaries............................................      563,000       542,000       555,000
  Other income (loss)......................................................      173,000       (11,000)        4,000
                                                                             -----------   -----------   -----------
      TOTAL REVENUES.......................................................    3,958,000     2,729,000     2,983,000
                                                                             -----------   -----------   -----------
EXPENSES
  General and administrative...............................................    3,003,000     2,796,000     2,945,000
  Depreciation and amortization............................................      593,000       551,000       558,000
  Interest.................................................................    3,859,000     4,507,000     3,827,000
                                                                             -----------   -----------   -----------
      TOTAL EXPENSES.......................................................    7,455,000     7,854,000     7,330,000
                                                                             -----------   -----------   -----------
Loss before income tax benefit and equity in net earnings of subsidiaries..   (3,497,000)   (5,125,000)   (4,347,000)
Income tax benefit.........................................................    1,674,000     1,977,000     1,574,000
                                                                             -----------   -----------   -----------
Loss before equity in net earnings of subsidiaries.........................   (1,823,000)   (3,148,000)   (2,773,000)
Equity in net earnings of subsidiaries.....................................   14,111,000    11,066,000    13,606,000
                                                                             -----------   -----------   -----------
      NET EARNINGS.........................................................  $12,288,000   $ 7,918,000   $10,833,000
                                                                             ===========   ===========   ===========
See accompanying note to condensed financial statements
</TABLE>

                                       68
<PAGE>
 
<TABLE> 
<CAPTION> 
                             AVEMCO Corporation                                                         SCHEDULE II
                              (Parent Company)                                                                  3/4
                 Condensed Financial Information of Registrant
                       Condensed Statements of Cash Flows
                            Years ended December 31,
 
 
OPERATING ACTIVITIES                                                      1996           1995           1994
                                                                      -------------  -------------  -------------
<S>                                                                   <C>            <C>            <C>
Net earnings........................................................  $ 12,288,000   $  7,918,000   $ 10,833,000
Adjustments to reconcile net earnings to cash flows provided
  from (used by) operating activities:
  Equity in net earnings of subsidiaries............................   (14,111,000)   (11,066,000)   (13,606,000)
  Dividends received from subsidiary companies......................    15,025,000      7,575,000      7,200,000
  Other.............................................................    (4,253,000)     3,307,000      6,056,000
                                                                      ------------   ------------   ------------
      Net cash flows provided from operating activities.............     8,949,000      7,734,000     10,483,000
                                                                      ------------   ------------   ------------
INVESTMENT ACTIVITIES
  Sale or maturity of investments...................................    10,268,000      6,997,000      3,372,000
  Purchase of investments...........................................    (9,251,000)    (6,994,000)    (3,988,000)
  Net purchase of property, equipment, and long-term assets.........       (73,000)      (471,000)    (2,028,000)
                                                                      ------------   ------------   ------------
      Net cash flows provided from (used by) investment activities..       944,000       (468,000)    (2,644,000)
                                                                      ------------   ------------   ------------
FINANCING ACTIVITIES
  Proceeds from borrowings..........................................    44,000,000     11,700,000     12,700,000
  Principal payments on debt........................................   (42,300,000)   (11,333,000)   (12,600,000)
  Proceeds from issuance of common stock............................       125,000         88,000         71,000
  Dividends to stockholders.........................................    (4,022,000)    (4,019,000)    (3,929,000)
  Repurchase of common stock........................................    (7,909,000)    (3,582,000)    (4,133,000)
                                                                      ------------   ------------   ------------
      Net cash flows used by financing activities...................   (10,106,000)    (7,146,000)    (7,891,000)
                                                                      ------------   ------------   ------------
Net increase (decrease) in cash.....................................      (213,000)       120,000        (52,000)
Cash, beginning of year.............................................       181,000         61,000        113,000
                                                                      ------------   ------------   ------------
Cash (overdraft), end of year.......................................  $    (32,000)  $    181,000   $     61,000
                                                                      ============   ============   ============
See accompanying note to condensed financial statements
</TABLE>

                                       69
<PAGE>
 
                             AVEMCO Corporation                      SCHEDULE II
                             (Parent Company)                                4/4
                 Condensed Financial Information of Registrant
                    Note to Condensed Financial Statements
                               December 31, 1996



The condensed financial statements of AVEMCO Corporation (parent company) should
be read in conjunction with the consolidated financial statements and
accompanying notes thereto of AVEMCO Corporation and subsidiaries on pages 45
through 64.

                                       70
<PAGE>
 
                                                                      Schedule V

                      AVEMCO Corporation and Subsidiaries
                       VALUATION AND QUALIFYING ACCOUNTS
                 Years Ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
 
------------------------------------------------------------------------------------------------------------
         Column A                      Column B             Column C            Column D           Column E
------------------------------------------------------------------------------------------------------------
                                                            Additions
                                                            --------
                                                     Charged       Charged/
                                      Balance at     to costs      credited                      Balance at
                                      beginning       and          to other                        close
         Description                  of period     expenses       accounts      Deductions      of period
------------------------------------------------------------------------------------------------------------ 
<S>                                   <C>           <C>            <C>           <C>             <C>
AVEMCO Corporation and Subsidiaries
 
DECEMBER 31, 1996:

  Net unrealized appreciation
     on investments                   $4,879,000    $        -0-   $         -0- $    (2,559,000) $2,320,000
                                      ==========    ============   ============= ===============  ==========
 
DECEMBER 31, 1995:
  Net unrealized appreciation
     (depreciation) on investments    $ (842,000)   $        -0-   $5,721,000/2/ $           -0-  $4,879,000
                                      ==========    ============   ============= ===============  ==========
 
DECEMBER 31, 1994:
  Net unrealized appreciation
     (depreciation) on investments    $  284,000    $        -0-   $4,922,000/1/ $(6,048,000)/2/  $ (842,000)
                                      ==========    ============   ============= ===============  ==========
</TABLE>
/1/ Cumulative net unrealized appreciation on fixed maturities at January 1, 
    1994

/2/  Increase (Decrease) of Stockholders' Equity

                                       71
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                                                                         Schedule IV
                                             AVEMCO Insurance Company and Subsidiaries
                                         (a Wholly-owned Subsidiary of AVEMCO Corporation)
                                                            REINSURANCE
                                           Years Ended December 31, 1996, 1995 and 1994

--------------------------------------------------------------------------------------------------------------
        Column A                     Column B       Column C        Column D       Column E         Column F
                                                                                                   Percentage
                                                    Ceded to         Assumed         Net           of amount
                                     Gross           other          from other      amount           assumed
                                     amount        companies        companies       earned           to net
--------------------------------------------------------------------------------------------------------------
<S>                                <C>             <C>             <C>             <C>             <C> 
1996:
Life insurance in force            $        --     $        --     $        --     $        --     $        --
                                    ==========      ==========      ==========      ==========      ==========
Premiums:
Life insurance                     $        --     $        --     $       --      $       --              --
Accident and health insurance          715,000          41,000       8,855,000       9,529,000              93%
Property and liability insurance    89,378,000      15,952,000       3,215,000      76,641,000               4%
Title insurance                             --              --              --              --              --
                                    ----------      ----------      ----------      ----------      ----------
        Total premiums             $90,093,000     $15,993,000     $12,070,000     $86,170,000              14%
                                    ==========      ==========      ==========      ==========      ==========
1995:
Life insurance in force            $        --     $        --     $        --     $        --              --
                                    ==========      ==========      ==========      ==========      ==========
Premiums:
Life insurance                     $        --     $        --     $        --     $        --              --
Accident and Health insurance          471,000         103,000       8,684,000       9,052,000              96%
Property and liability insurance    75,747,000      14,237,000       9,896,000      71,406,000              14%
Title insurance                             --              --              --              --              --
                                    ----------      ----------      ----------      ----------      ----------
        Total premiums             $76,218,000     $14,340,000     $18,580,000      80,458,000              23%
                                    ==========      ==========      ==========      ==========      ==========
1994:
Life insurance in force            $        --     $        --     $        --     $        --              --
                                    ==========      ==========      ==========      ==========      ==========
Premiums:
Life insurance                     $        --     $        --     $        --     $        --              --
Accident and Health insurance           24,000       1,408,000      15,089,000      13,705,000             110%
Property and liability insurance    77,497,000      17,401,000       1,717,000      61,813,000               3%
Title insurance                             --              --              --              --              --
                                    ----------      ----------      ----------      ----------      ----------
        Total premiums             $77,521,000     $18,809,000     $16,806,000     $75,518,000              22%
                                    ==========      ==========      ==========      ==========      ==========
</TABLE> 
Note: Summary financial data with respect to the insurance subsidiary is 
presented in Note 11 to the consolidated financial statements of AVEMCO 
Corporation and Subsidiaries.

                                      72

<PAGE>
                                                                     Schedule VI
<TABLE> 
<CAPTION> 
                   AVEMCO Insurance Company and Subsidiaries                                                    
               (a Wholly-owned Subsidiary of AVEMCO Corporation)
   SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
                  Years ended December 31, 1996, 1995 and 1994
 
------------------------------------------------------------------------------------------
     Column A                  Column B    Column C   Column D     Column E     Column F      
------------------------------------------------------------------------------------------
                                           Unpaid     Discount
                              Deferred   losses and    if any
                               Policy       Loss      Deducted                             
                             Acquisition Adjustment     in       Unearned      Earned     
        Segment                 Cost      Expenses    Column C   Premiums     Premiums   
-----------------------------------------------------------------------------------------
<S>                          <C>         <C>          <C>       <C>          <C>         
1996
Property and liability
 insurance                   $6,071,000  $43,227,000      $-0-  $37,201,000  $86,170,000   
                             ==========  ===========  ========  ===========  ===========   
                                                                                          
1995                                                                                      
Property and liability                                                                    
 insurance                   $5,511,000  $42,305,000      $-0-  $32,363,000  $80,458,000   
                             ==========  ===========  ========  ===========  ===========   
                                                                                          
1994                                                                                      
Property and liability                                                                    
 insurance                   $4,922,000  $41,202,000      $-0-  $27,001,000  $75,518,000   
                             ==========  ===========  ========  ===========  ===========   
 
</TABLE>

<TABLE>
<CAPTION>
 
----------------------------------------------------------------------------------------------------------
                              Column G            Column H            Column I     Column J     Column K 
----------------------------------------------------------------------------------------------------------
                                                                    Amortization      Net
                                                                        of            Paid
                                                Losses and           Deferred        Losses
                               Net            Loss Adjustment        Policy         and Loss      Net
                            Investment       Expense Incurred       Acquisition    Adustment    Premiums
        Segment              Income             Related to             Costs        Expenses    Written
----------------------------------------------------------------------------------------------------------
                                           (1)            (2)
                                         Current         Prior
                                          Year           Year
                                         -------        ------
<S>                          <C>         <C>           <C>          <C>           <C>          <C>           
1996
Property and liability
 insurance                    $6,638,000 $64,000,000   $(1,134,000)  $16,421,000  $60,450,000  $92,246,000
                              ========== ===========   ===========   ===========  ===========  ===========
                                      
1995                                  
Property and liability                
 insurance                    $6,988,000 $56,753,000   $(1,148,000)  $14,722,000  $53,809,000  $85,540,000
                              ========== ===========   ===========   ===========  ===========  ===========
                                      
1994                                  
Property and liability                
 insurance                    $6,952,000 $49,257,000   $(2,947,000)  $15,488,000  $45,131,000  $73,450,000
                              ========== ===========   ===========   ===========  ===========  ===========
 
</TABLE>


Note:Column I, Amortization of Deferred Policy Acquisition Costs, includes 
$2,782,000, $1,982,000, and $1,983,000 of commission expense paid to affiliates 
for the years ended December 31, 1996, 1995, and 1994, respectively, which were 
eliminated in consolidation.

                                       73
<PAGE>
 
                                 EXHIBIT INDEX
<TABLE>
<CAPTION>
 
 
Exhibit
Number                               Description                       Page
--------------  -----------------------------------------------------  ----
<S>             <C>                                                    <C>
 
     10.3       Management Contracts:

                c. Senior Vice President and Chief Financial Officer.    75

                d. Senior Vice President - Legal.....................    89
 
     11.1       Statement Regarding Computation of per Share Earnings   103
 
     21.1       Organizational Chart.................................   104
 
     23.1       Independent Auditors' Consent........................   105
 
</TABLE>

                                       74