|The Commerce Group, Inc.                    
|--------------------------------------------
|211 Main Street, Webster, Massacusetts 01570
|                                            
|2003                                        
|Annual                                      
|Report                                      
|and                                         
|Form 10-K                                   

<PAGE>

|TABLE OF CONTENTS                              
|-----------------------------------------------
|                                               
|                                               
|                                               
|Financial Highlights                           
|Letter to Stockholders                         
|Stockholder Equity and Dividend Per Share Chart
|Form 10-K Facing Page                          
|Glossary of Selected Insurance Terms           
|                                               
|Part I                                         
|                                               
|Item 1.                                        
|                                               
|                                               
|                                               
|                                               
|                                               
|                                               
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|                                               
|                                               
|                                               
|                                               
|Item 2.                                        
|Item 3.                                        
|Item 4.                                        
|                                               
|Part II                                        
|                                               
|Item 5.                                        
|Item 6.                                        
|Item 7.                                        
|                                               
|Item 7a.                                       
|Item 8.                                        
|                                               
|Item 9.                                        
|                                               
|Item 9a.                                       
|                                               
|Part III                                       
|                                               
|Item 10.                                       
|Item 11.                                       
|Item 12.                                       
|                                               
|Item 13.                                       
|Item 14.                                       
|                                               
|Part IV                                        
|                                               
|Item 15.                                       
|                                               
|                                               
|                                               
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|                                               
|                                               
|                                               

<PAGE>

|FINANCIAL HIGHLIGHTS                                                
|--------------------------------------------------------------------
|(Dollars in Thousands, Except Per Share Amounts)                    
|                                                                    
|                                                                    
|                                                                    
|                                                                    
|Direct premiums written                                             
|                                                                    
|Net premiums written                                                
|                                                                    
|                                                                    
|Earned premiums                                                     
|Net investment income                                               
|Premium finance and service fees                                    
|Amortization of excess of book value of                             
|subsidiary interest over cost                                       
|Net realized investment gains (losses)                              
|Other income                                                        
|                                                                    
|Total revenues                                                      
|                                                                    
|Earnings before income taxes, minority interest and change in       
|accounting principle                                                
|Income taxes                                                        
|                                                                    
|Earnings before minority interest and change in accounting principle
|Minority interest in net (earnings) loss of subsidiary              
|                                                                    
|Earnings before change in accounting principle                      
|Change in accounting principle, net of taxes                        
|                                                                    
|Net earnings                                                        
|                                                                    
|                                                                    
|Comprehensive income                                                
|Net earnings per common share:                                      
|Basic                                                               
|Diluted                                                             
|                                                                    
|Cash dividends paid per share                                       
|Weighted average number of common shares                            
|outstanding:                                                        
|Basic                                                               
|Diluted                                                             
|Total investments at market value                                   
|and equity value                                                    
|Total assets                                                        
|Total liabilities                                                   
|Minority interest                                                   
|Total stockholders' equity                                          
|Total stockholders' equity per share                                
|Consolidated GAAP ratios (unaudited)(1):                            
|Loss and LAE ratio                                                  
|Underwriting expense ratio                                          
|                                                                    
|Combined ratio                                                      
|                                                                    
|                                                                    
|Net premiums written to policyholders' surplus                      
|                                                                    



|(1) | Consolidated GAAP ratios combine all insurance company results with corporate expenses and use earned premiums to calculate the ratios.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  1

|THE COMMERCE GROUP, INC.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|March 5, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|To Our Stockholders:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In 2003, your Company experienced satisfactory financial results for the 28th consecutive year.  From the very first day the funding of The Commerce Insurance Company was accomplished (April 3, 1972) through December 31, 2003, we have achieved underwriting profit of $343.6 million on total premiums written of $13.0 billion.  This underwriting profit represents 2.6% of total premiums written.                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In December 2003, the 2004 personal automobile insurance rate decision was announced by the Massachusetts Insurance Commissioner.  Despite the industry's request for a 12.4% increase, 2004 state mandated average premium per automobile was increased by 2.5%.  The Massachusetts marketplace remains highly competitive.  Throughout these ongoing competitive times, your Company's share of the Massachusetts personal automobile market has continued to grow, and at year-end, our estimated market share was 27.6%, up from 25.9% in 2002.                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In 2003, direct and net premiums written each surpassed the $1.5 billion mark.  As we reach these record levels of premiums, your Company will continue to pursue the goal of growing in targeted markets beyond the borders of Massachusetts.  In furtherance of this goal, direct premiums written outside of Massachusetts represented 14.4% of our total business in 2003, as compared to 13.4% in 2002.                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In December, your Company completed a very successful $300 million public debt offering.  The proceeds are being used to enhance the capital position of our insurance operating subsidiaries in support of recent premium growth both within and outside of Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Your Company has continued to grow and prosper.  The Commerce Insurance Company continues to be the largest writer of Massachusetts private passenger automobile insurance, the second largest writer of Massachusetts homeowners insurance, as well as the third largest writer of Massachusetts commercial automobile insurance.  The combined insurance companies were also ranked as the 22nd largest personal automobile insurance group in the country by A.M. Best Co., based on the most recently available direct premiums written information.  Additionally, I am very pleased to report that your Company again received a group rating of A+ (Superior) from A.M. Best Co.                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Written premiums, earned premiums, total assets and total stockholders' equity per share, as illustrated in the bar graph on the facing page, are all at new highs.  For those of you who are interested in the details, I draw your attention to the pages in this report labeled "Management's Discussion and Analysis of Financial Condition and Results of Operations."  Behind these numbers are an extremely dedicated group of people:  Our policyholders (represented by over 1,285,000 policies in force); Agents (1,808); Employees (2,018); Officers (43); Commerce Group Directors (17); and, of course, our Stockholders (over 6,800, including our Employee Stock Ownership Plan participants, who now number 2,322).
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Property-liability insurance remains a good business to be in and The Commerce Group, Inc. will continue its efforts to be one of the most profitable long-term players.  Your Company's management continues to believe that owners' interests are its primary constituency.                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Our sincere thanks to those who have helped in this building process, especially our Agents, Employees, Officers and Board of Directors.  This diverse force of committed, ethical and hard working people will continue to build on our past successes and look to the future with excitement and opportunity.  Their individual ingenuity, enthusiasm, dedication and professionalism will continue to serve our stockholders well.                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Your comments or questions regarding this report, or The Commerce Group, Inc. affairs in general, are solicited as always, at any time.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

<PAGE>  2

|The bar graph on page 4 illustrates the Company's annual total stockholders' equity per share value and annual total stockholders' equity per share value including cumulative cash dividends paid per share through each December 31, year-end, over the most recent fifteen-year period. The X-axis lists the years beginning with 1989 through 2003. The Y-axis lists the dollar values starting at $0.00 and increasing in one-dollar increments to $38.00. The graph depicts a total stockholders' equity per share value in 1989 of $2.53, 1990 of $3.36, 1991 of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $10.88, 1995 of $14.96, 1996 of $16.28, 1997 of $18.11, 1998 of $19.72, 1999 of $19.44, 2000 of $23.16, 2001 of $24.43, 2002 of $24.60 and 2003 of $28.45. The graph also depicts the total stockholders' equity per share value adjusted to include cumulative dividends paid per share. The total of these amounts to the per share value in 1989 of $2.53, 1990 of $3.36, 1991 of $4.80, 1992 of $7.42, 1993 of $10.09, 1994 of $11.03, 1995 of $15.34, 1996 of $17.47, 1997 of $20.33, 1998 of $23.01, 1999 of $23.84, 2000 of $28.71, 2001 of $31.17, 2002 of $32.57 and 2003 of $37.69.
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<PAGE>  3

|
|

<PAGE>  4

|UNITED STATES                                                                                                                                                                                                                                                                                                                                                                    
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|SECURITIES AND EXCHANGE COMMISSION                                                                                                                                                                                                                                                                                                                                               
|Washington, D.C. 20549                                                                                                                                                                                                                                                                                                                                                           
|FORM 10-K                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                 
|(Mark One)                                                                                                                                                                                                                                                                                                                                                                       
|[X]                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                 
|For the fiscal year ended December 31, 2003                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                 
|OR                                                                                                                                                                                                                                                                                                                                                                               
|[   ]                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                 
|For the transition period from____ to ___.                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                 
|Commission file number 001-13672                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                 
|The Commerce Group, Inc.                                                                                                                                                                                                                                                                                                                                                         
|(Exact name of registrant as specified in its charter)                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                 
|Massachusetts                                                                                                                                                                                                                                                                                                                                                                    
|(State or other jurisdiction of incorporation or organization)                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                 
|211 Main Street                                                                                                                                                                                                                                                                                                                                                                  
|Webster, Massachusetts                                                                                                                                                                                                                                                                                                                                                           
|(Address of principal executive offices)                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                 
|Registrant's telephone number, including area code: (508) 943-9000                                                                                                                                                                                                                                                                                                               
|Securities registered pursuant to Section 12(b) of the Act:                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                 
|Title of each Class                                                                                                                                                                                                                                                                                                                                                              
|Common stock, $.50 par value per share                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                 
|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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  [X]      No  [   ]
|                                                                                                                                                                                                                                                                                                                                                                                 
|Indicate by check mark 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.  [   ]                                     
|                                                                                                                                                                                                                                                                                                                                                                                 
|Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).                                                                                                                                                                                                                                                                   
|Yes  [X]      No  [   ]                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                 
|The aggregate market value of the voting common equity held by non-affiliates computed by reference to the price at which the common stock was last sold as of June 30, 2003 was $884,980,205.                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                 
|As of February 27, 2004, the number of shares outstanding of the registrant's common stock (exclusive of treasury shares) was 32,427,075.                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                 
|DOCUMENTS INCORPORATED BY REFERENCE                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                 
|Portions of the registrant's definitive Proxy Statement for its annual meeting of stockholders, which the registrant intends to file within 120 days after the end of the registrant's fiscal year ended December 31, 2003, are incorporated by reference into Part III hereof as provided therein.                                                                              

<PAGE>  5

|GLOSSARY OF SELECTED INSURANCE TERMS      
|------------------------------------------
|                                          
|Affinity group marketing program          
|                                          
|Assumed premiums                          
|                                          
|A.M. Best                                 
|                                          
|Casualty insurance                        
|                                          
|Catastrophe, catastrophic loss            
|                                          
|Combined ratio                            
|                                          
|Commissioner                              
|                                          
|Commonwealth Automobile Reinsurers ("CAR")
|                                          
|Direct                                    
|Direct loss ratio                         
|                                          
|                                          
|Direct premiums written                   
|                                          
|Domestic insurer                          
|                                          
|Earned premiums                           

<PAGE>  6

|Excess of loss reinsurance                  | Reinsurance which indemnifies the reinsured against all or a specified portion of losses under reinsured policies in excess of a specific dollar amount or "retention."                                                                                               
|------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                            |                                                                                                                                                                                                                                                                       
|Exclusive representative producer ("ERP")   | A Massachusetts automobile insurance agency which does not have a voluntary agency automobile insurance relationship with an insurer, and which is assigned by CAR to an insurer who is a Servicing Carrier.                                                          
|                                            |                                                                                                                                                                                                                                                                       
|Exposure                                    | An insurable unit defined as an automobile.                                                                                                                                                                                                                           
|                                            |                                                                                                                                                                                                                                                                       
|Frequency                                   | The relative incidence of number of claims in relation to an exposure, or group of exposures.                                                                                                                                                                         
|                                            |                                                                                                                                                                                                                                                                       
|Hard market                                 | An insurance market in which the demand for insurance exceeds the readily available supply and premiums are relatively high.                                                                                                                                          
|                                            |                                                                                                                                                                                                                                                                       
|Incurred but not reported reserves ("IBNR") | Reserves for estimated losses which have been incurred by insureds but not yet reported to the insurer.                                                                                                                                                               
|                                            |                                                                                                                                                                                                                                                                       
|Incurred losses                             | The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid.  Incurred losses include a provision for IBNR and salvage and subrogation.                                                                                     
|                                            |                                                                                                                                                                                                                                                                       
|Inherent diminished value                   | An alleged loss in market value caused by a supposed perception that a car that has been involved in an accident, even when fully repaired, is not worth as much as an otherwise identical car that has not been involved in an accident.                             
|                                            |                                                                                                                                                                                                                                                                       
|Inland marine insurance                     | As used by the Company, insurance that provides protection for specific types of personal property, such as jewelry, coins and fine arts, over the limits covered in a standard homeowners insurance policy.                                                          
|                                            |                                                                                                                                                                                                                                                                       
|Loss adjustment expenses                    | The expenses relating to settling claims, including legal and other fees and the portion of general company expenses allocated to claim settlement costs.                                                                                                             
|                                            |                                                                                                                                                                                                                                                                       
|LAE ratio                                   | The ratio of LAE, net of reinsurance recoveries, to earned premiums.                                                                                                                                                                                                  
|                                            |                                                                                                                                                                                                                                                                       
|Loss and LAE ratio                          | The ratio of incurred losses plus LAE, net of reinsurance recoveries, to earned premiums.                                                                                                                                                                             
|                                            |                                                                                                                                                                                                                                                                       
|Loss reserves                               | Liabilities established by insurers to reflect the estimated cost of claims payments and the related expenses that the insurer will ultimately be required to pay in respect of insurance it has written.  Reserves are established for losses and for LAE.           
|                                            |                                                                                                                                                                                                                                                                       
|Net premiums written                        | Direct premiums written for a given period less premiums ceded to reinsurers during such period plus premiums assumed during such period.                                                                                                                             
|                                            |                                                                                                                                                                                                                                                                       
|Participation ratio                         | A Massachusetts insurer's share of the CAR deficit based upon the insurer's market share of automobile risks not reinsured through CAR, adjusted for utilization of CAR and credits for voluntarily writing less desirable under-priced business and ceded exclusions.
|                                            |                                                                                                                                                                                                                                                                       
|Premium-to-surplus ratio                    | The ratio of net premiums written to policyholders' surplus.                                                                                                                                                                                                          

<PAGE>  7

|Property insurance                     | Insurance that indemnifies a person with an insurable interest in tangible property for loss related to damage to or loss of use of the subject property.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------------------------------------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Pure loss ratio                        | The ratio of net incurred losses, excluding LAE, to premiums earned.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Quota share reinsurance                | Reinsurance in which the reinsured shares a proportion of the original premiums and losses under the reinsured policy.  Also known as pro-rata reinsurance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Rate deviation                         | A specific state approved departure from an otherwise applicable state set rate level provided to safe drivers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Rate discount                          | A specific state approved discount from an otherwise applicable state set rate level provided to members of affinity group marketing programs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Reinsurance                            | The acceptance by one or more insurers, called re-insurers, of all or a portion of the risk underwritten by another insurer who has directly written the coverage. However, the legal rights of the insured generally are not affected by the reinsurance transaction and the insurance company issuing the insurance policy remains liable to the insured for payment of policy benefits.                                                                                                                                                                                                                                                                                                                                                                 
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Safe Driver Insurance Plan ("SDIP")    | A program mandated by Massachusetts state law that encourages safe driving by rewarding drivers who do not cause an accident, or incur a traffic law violation and by charging high risk drivers a greater amount of premiums. Under SDIP, drivers incur surcharge points for traffic violations and at-fault accidents. Drivers also earn credit points for each incident free year. Drivers begin at a starting or neutral SDIP Step 15. Drivers can earn credits down to SDIP Step 9, the lowest step for good drivers, and incur surcharge points up to SDIP Step 35, the highest step for bad drivers. The SDIP is set to be revenue neutral industry-wide, such that credits received by good drivers are offset with surcharges paid by bad drivers.
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Salvage                                | The sale of damaged goods, for which the insured has been indemnified by the insurance company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Servicing Carrier                      | An automobile insurer writing business in Massachusetts which can reinsure risks through CAR while remaining responsible for servicing the related private passenger and/or commercial automobile policies and which must provide a market for ERPs assigned to it by CAR. There are 20 companies servicing private passenger automobile and 28 companies servicing commercial automobile. In total, 35 carriers service either the private passenger or commercial markets.                                                                                                                                                                                                                                                                               
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Severity                               | The relative magnitude of the dollar amount of a claim, or group of claims.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Soft market                            | An insurance market in which the supply of insurance exceeds the current demand and premiums are relatively low.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Statutory accounting practices ("SAP") | Recording transactions and preparing financial statements in accordance with the rules and procedures prescribed or permitted by an insurer's state insurance regulatory authority for the purposes of financial reporting to regulators, which in general reflect a liquidating, rather than going concern, concept of accounting.                                                                                                                                                                                                                                                                                                                                                                                                                        

<PAGE>  8

|Statutory surplus          | The excess of admitted assets over total liabilities (including loss reserves), determined in accordance with SAP.                                                                         
|-------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                           |                                                                                                                                                                                            
|Subrogation                | The substitution of the insurer's right to recover in place of the insured's right to recover from a third party responsible for a loss paid by the insurer.                               
|                           |                                                                                                                                                                                            
|Take-all-comers            | A phrase used to characterize the Massachusetts personal automobile insurance system under which all insurers are required to underwrite and accept virtually all risks submitted to them. 
|                           |                                                                                                                                                                                            
|Underwriting               | The insurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested and determining the applicable premiums.
|                           |                                                                                                                                                                                            
|Underwriting expenses      | The aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations.                   
|                           |                                                                                                                                                                                            
|Underwriting expense ratio | The ratio of underwriting expenses to net premiums written determined in accordance with SAP.                                                                                              
|                           |                                                                                                                                                                                            
|Unearned premiums          | The portion of a premium representing the unexpired amount of the contract term as of a certain date.                                                                                      

<PAGE>  9

|Unless otherwise stated, "we," "our," "us" or "the Company" means The Commerce Group, Inc., and its subsidiaries.  "Commerce" refers to The Commerce Insurance Company, "Commerce West" refers to Commerce West Insurance Company, "American Commerce" refers to American Commerce Insurance Company, "Citation" refers to Citation Insurance Company, and "AHC" refers to ACIC Holding Co., Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|PART I                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(Dollars in thousands, except for ratios and per share data, unless noted otherwise)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|ITEM 1. BUSINESS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|We provide personal and commercial property and casualty insurance in Massachusetts and, to a lesser extent, in other states.  We market our products exclusively through our network of independent agents.  Our core product lines are personal and commercial automobile and homeowners insurance.  We have been the largest writer of personal property and casualty insurance in Massachusetts in terms of direct premiums written since 1990.  At the end of 2003, our estimated share of the Massachusetts personal automobile market was 27.6%, up from 25.9% at the end of 2002.  For each of the past five years for which data is available, we have been the second largest writer of homeowners insurance in Massachusetts.  We are the third largest writer of commercial automobile insurance in Massachusetts, based on the most recently available data.On a consolidated basis, we were ranked the 22nd largest personal automobile insurance group in the country by A.M. Best, in terms of direct premiums written, based on the most recently available information as of December 31, 2003.  In addition to our core product lines, we write commercial multi-peril, inland marine, fire, general liability, and personal and commercial umbrella insurance.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|We were incorporated in 1976.  We write insurance through our principal subsidiary, Commerce, which was incorporated in 1971 and began writing business in Massachusetts in 1972.  We also write insurance through three other subsidiaries - Citation, Commerce West and American Commerce.  Citation was incorporated in Massachusetts on September 24, 1981.  We acquired Commerce West on August 31, 1995 and we acquired American Commerce on January 29, 1999.  Citation writes insurance in Massachusetts.  Commerce West writes insurance in California and Oregon.  American Commerce, a wholly-owned subsidiary of AHC, is located in Columbus, Ohio and writes insurance in 16 states.  AHC's common stock is 95% owned by us and 5% owned by AAA Southern New England.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|In December 2003, we completed a $300 million public debt offering.  The proceeds are being used to enhance the capital position of our insurance operating subsidiaries in support of recent premium growth both within and outside of Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|Also, in 2003, we completed a reorganization of our subsidiary companies (see Exhibit 21.1 of this Form 10-K for our current organizational structure).  The purpose of the reorganization was to allow us a more efficient use of our capital through our operating subsidiaries and to streamline our organizational structure.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|Our primary business strategy is to continue to focus on the personal automobile market in Massachusetts and the other states where we write business.  We maintain approximately 1.3 million in-force policies through our insurance company subsidiaries.  Commerce and Citation service approximately 1,060,000 policies in Massachusetts and Commerce services approximately 7,000 policies in New Hampshire.  American Commerce and Commerce West service over 220,000 policies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

<PAGE>  10

|Our direct premiums written for the years ended December 31, 2003 and 2002 in Massachusetts and all other states follows:
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|                      |               |               | All Other |   |           |  | % of 
|--------------------- | ------------- | ------------- | --------- | - | --------- |  | -----
|2003                  | Massachusetts |               | States    |   | Total     |  | Total
|                      |               |               |           |   |           |  |      
|                      |               |               |           |   |           |  |      
|Personal Automobile   | $             | 1,191,123     |           | $ | 194,409   |  | $    
|Homeowners            |               | 102,951       |           |   | 36,098    |  |      
|Commercial Automobile |               | 89,862        |           |   | 8,067     |  |      
|Other Lines           |               | 35,468        |           |   | 991       |  |      
|                      |               |               |           |   |           |  |      
|Total                 | $             | 1,419,404     |           | $ | 239,565   |  | $    
|                      |               |               |           |   |           |  |      
|Percentage of Total   |               | 85.6%         |           |   | 14.4%     |  |      
|                      |               |               |           |   |           |  |      
|                      |               |               |           |   |           |  |      
|                      |               |               |           |   | All Other |  |      
|2002                  |               | Massachusetts |           |   | States    |  |      
|                      |               |               |           |   |           |  |      
|                      |               |               |           |   |           |  |      
|Personal Automobile   | $             | 1,032,438     |           | $ | 155,045   |  | $    
|Homeowners            |               | 87,634        |           |   | 27,376    |  |      
|Commercial Automobile |               | 74,879        |           |   | 5,151     |  |      
|Other Lines           |               | 23,569        |           |   | 764       |  |      
|                      |               |               |           |   |           |  |      
|Total                 | $             | 1,218,520     |           | $ | 188,336   |  | $    
|                      |               |               |           |   |           |  |      
|Percentage of Total   |               | 86.6%         |           |   | 13.4%     |  |      
|                      |               |               |           |   |           |  |      



|We attribute our success primarily to the following factors:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|We also face certain risks which are inherent to our business.  See "Risks Related to Our Business."                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|We market our products exclusively through independent insurance agencies.  Our relationships with these agencies are critical to our continued success.  We believe that we are the preferred provider for most of our agencies and that, as a result, we have gained access to policyholders with average or above average underwriting profit characteristics.  We focus on selecting and retaining agencies with historical premium growth rates and loss ratios that meet our criteria, and we devote substantial resources to maintaining strong relationships with our existing agencies.  We pay our agencies significant compensation in the form of profit sharing, which is based, in part, on the underwriting profits of each agency's business written with us.  In addition, we occasionally sponsor incentive award trips for agents to encourage profitability and growth.  See "Marketing."
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|Based on agency surveys that we conduct several times a year, we believe that we are attentive to the needs of our agencies and insureds.  We emphasize our commitment to the Massachusetts insurance market by our responsiveness in servicing claims and our internal support for agency operations, including direct billing of insureds, direct claim reporting, agency upload and download systems, on-line inquiry systems for our agents, and by providing competitively priced automobile and property insurance programs and products.                                                                                                                                                                                                                                                                                                                                                              

<PAGE>  11

|Massachusetts Business.We believe that a significant factor in our success is our focus on the personal automobile insurance market in Massachusetts, which accounted for 71.8% of our total direct premiums written for the year ended December 31, 2003.  The terms, conditions, and rates of personal automobile insurance are subject to extensive regulation in Massachusetts.  As a consequence of our focus on the Massachusetts market, we have both an in-depth understanding of this market and the ability to respond effectively to shifts in the state's regulatory and underwriting environments.  Currently, we are required by law to accept virtually all private passenger automobile insurance business submitted to us by our agencies in Massachusetts.  Our ability to underwrite this business profitably, however, depends on our understanding of the risks in the business as well as our management of reinsurance through CAR.                                                                                                                                                                                                                                 
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|We have actively pursued affinity group marketing programs since 1995.  Our affinity group marketing programs provide members of participating groups and associates with a convenient means of purchasing discounted private passenger automobile insurance.  We emphasize writing insurance for larger affinity groups, although we consider accounts with as few as 25 participants.  Affinity groups are eligible for rate discounts, which must be filed annually with the Massachusetts Division of Insurance.  In general, we look for affinity groups with mature, stable membership, favorable driving records and below average turnover ratios.  Participants who leave the sponsoring group during the term of the policy are allowed to maintain the policy until expiration.  At expiration, we will issue through the agency a non-discounted policy at the insured's option.                                                                                                                                                                                                                                                                                               
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|We also offer homeowners insurance in Massachusetts, including a very limited amount of policies in designated coastal areas.  Our average homeowners policy is an all risk, replacement cost insurance policy covering a dwelling and its contents.  Our published limits of liability for property damage to a dwelling in Massachusetts are a minimum coverage of $60 and a maximum coverage of $750.  Some policies over this amount are written on an exception basis.  For personal liability, the minimum coverage is $100 and the maximum coverage is $1.0 million.  The average dwelling coverage amount per policy in Massachusetts written by Commerce and Citation is approximately $195.  Generally, the average amount of contents coverage is 70% of the amount of coverage for the dwelling, with limitations on the amount of coverage per item placed on securities, cash, jewelry, furs, silverware, computer equipment, and firearms.  However, additional coverage for such items can be purchased.  We also offer personal liability umbrella coverage of $1.0 million, $2.0 million, and $3.0 million, which is reinsured through Employers Reinsurance Corporation.
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|We offer a preferred risk homeowners product through Citation, which has an alternative pricing schedule for selected insureds meeting more restrictive underwriting guidelines.  Citation produced approximately 53% of our Massachusetts homeowner business during that period, calculated based on direct premiums written.  Citation also provides a separate rating tier for preferred commercial automobile business.  Citation wrote approximately 14% of the voluntary commercial automobile premium produced by our voluntary agents during 2003.  We expect that these secondary rating tiers will continue to assist us in retaining better commercial automobile and homeowner accounts.  Although we were the third largest writer of commercial automobile insurance in Massachusetts, we were the largest writer of voluntary commercial automobile insurance, as reported by CAR through November 2003.                                                                                                                                                                                                                                                                    
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|We believe our long-term commitment to providing consistent markets for Massachusetts insurance agencies is a significant factor in enabling us to increase and maintain our market share by contracting with agencies that meet our agency criteria.  We believe that Massachusetts insurance agencies are more likely to seek to develop and expand relationships with domestic insurers, that, like us, have a long-term commitment to, and focus on, the Massachusetts personal automobile market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|Agreements for the Transfer of Massachusetts Business from Other Companies in 2002.We entered into an agreement with Berkshire Mutual Insurance Company for the transfer to us, effective January 1, 2002, of the Massachusetts personal automobile business written by Berkshire.  Under terms of the agreement, we offered agency contracts to independent agencies that represented Berkshire for personal automobile insurance in Massachusetts.  This allowed agents of Berkshire the opportunity to offer our automobile insurance policies to their customers whose policies renewed in 2002.  We assumed all of Berkshire's obligations for future policy years beyond 2001 under CAR, including assignment of Berkshire's involuntary agents.  As consideration, we received a cash payment of $7.0 million from Berkshire in early January 2002.                                                                                                                                                                                                                                                                                                                                 
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|We announced the formation of a marketing alliance with Horace Mann Educators Corporation on October 18, 2001.  Under the terms of an agency agreement we have with Horace Mann Service Corporation, a licensed brokerage agency in Massachusetts, Horace Mann provides its personal automobile customers with our policies.  New personal automobile policies sold by Horace Mann have been insured with us, beginning no later than January 1, 2002, at the policyholder's option.  All personal automobile policies written by Horace Mann were converted to our policies upon renewal in 2002.  We did not receive any monetary consideration from this alliance because we did not assume any of Horace Mann's future obligations to CAR.                                                                                                                                                                                                                                                                                                                                                                                                                                             

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|We entered into an agreement on July 15, 2002, with MassWest Insurance Company for the transfer of Massachusetts personal automobile business written by MassWest to us, effective November 1, 2002.  Under the terms of the agreement, we offered agency contracts to independent agencies that represented MassWest for personal automobile insurance in Massachusetts.  This allowed agents of MassWest the opportunity to offer our automobile insurance policies to their customers, who were insured by MassWest, beginning with policies that renewed after that date.  We assumed all of MassWest's obligations for future policy years beyond 2002 under the Massachusetts residual market system, commonly known as CAR, and received consideration of $2.5 million from MassWest.
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|Business in Other States.American Commerce predominantly writes private passenger automobile and homeowners insurance in 16 states exclusively through 28 independent insurance agencies owned and operated by AAA clubs.  Products are similar to those offered by us in Massachusetts, although pricing of products is determined on a state-by-state basis.  All of its business is underwritten at American Commerce's headquarters in Columbus, Ohio.  American Commerce primarily targets preferred insurance risks.                                                                                                                                                                                                                                                                  
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|We realized that the volume of business American Commerce was writing in some states did not justify the time, effort and expense associated with supporting that writing.  American Commerce completed an analysis of states that it believes it can successfully continue to write in, focusing on states where possibilities exist to grow profitably.  Based on this, a number of states have been identified from which American Commerce will cease writing.  Various AAA clubs and the appropriate Divisions of Insurance will be or have been notified of American Commerce's intent to cease writing in those states.  Business in eight states will be shed by American Commerce through this process.                                                                            
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|Commerce West predominantly writes preferred and non-standard private passenger automobile insurance in California and Oregon through 1,096 independent insurance agencies and brokers.  All of Commerce West's business is underwritten at its headquarters in Pleasanton, California.  Although it primarily writes preferred private passenger automobile business, Commerce West also writes non-standard private passenger automobile business and commercial automobile business.                                                                                                                                                                                                                                                                                                     
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|The following table shows the eleven states with the highest direct premiums written by American Commerce, which amount to greater than 95% of its business in 2003, and the two states in which Commerce West writes insurance, for the years ended December 31, 2003, 2002 and 2001:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      



|Company            | State         | 2003 |         | 2002 |   | 2001   
|------------------ | ------------- | ---- | ------- | ---- | - | -------
|                   |               |      |         |      |   |        
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|American Commerce: | Arizona       | $    | 47,740  |      | $ | 30,396 
|                   | Washington    |      | 21,592  |      |   | 16,339 
|                   | Rhode Island  |      | 21,138  |      |   | 17,371 
|                   | Ohio          |      | 20,375  |      |   | 16,923 
|                   | Oklahoma      |      | 18,536  |      |   | 13,010 
|                   | Oregon        |      | 14,861  |      |   | 13,046 
|                   | Kentucky      |      | 9,861   |      |   | 8,289  
|                   | Indiana       |      | 6,268   |      |   | 6,242  
|                   | Tennessee     |      | 4,526   |      |   | 3,376  
|                   | Idaho         |      | 3,326   |      |   | 3,010  
|                   | West Virginia |      | 3,262   |      |   | 2,885  
|                   | Other States  |      | 9,004   |      |   | 8,266  
|                   |               |      |         |      |   |        
|                   | Total         | $    | 180,489 |      | $ | 139,153
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|Commerce West:     | California    | $    | 47,648  |      | $ | 40,861 
|                   | Oregon        |      | 5,518   |      |   | 5,464  
|                   |               |      |         |      |   |        
|                   | Total         | $    | 53,166  |      | $ | 46,325 
|                   |               |      |         |      |   |        

|Commerce writes personal property and casualty insurance in New Hampshire through 34 independent insurance agencies as of December 31, 2003.  Direct premiums written in New Hampshire amounted to $5.9 million, $2.9 million and $0.4 million for the years ended December 31, 2003, 2002 and 2001, respectively.                                                                                                                                                                                                                                                                                                                                                                                                         
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|Ratings.Commerce and Citation currently have a combined A.M. Best's rating of "A+ (Superior)," which is A.M. Best's second highest rating out of fifteen.  Commerce West and American Commerce currently have A.M. Best's ratings of "A (Excellent)," which is A.M. Best's third highest rating.  According to A.M. Best, an insurer with a "Superior" rating has achieved superior overall performance and has shown the strongest ability to meet its policyholder and other contractual obligations when compared to the norms of the property and casualty insurance industry.  An insurer with an "Excellent" rating has demonstrated excellent overall performance when compared to standards developed by A.M. Best.

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|Moody's Investor Services also rates the financial strength of insurance companies, and has assigned an A2 ("Good") rating to Commerce, which is Moody's third highest rating.  Moody's did not rate the other operating insurance subsidiaries.  According to Moody's, an issuer with an A2 ("Good") rating offers good financial security, with elements present which suggest a susceptibility to impairment sometime in the future.  Moody's assigns nine ratings to insurance companies, which currently range from Aaa to C, with a numerical modifier in each generic rating classification to refer to the ranking in the group, with 1 being the highest and 3 being the lowest.  Moody's divides their ratings into "strong" and "weak" companies, with companies in one of the top four rating categories being considered "strong" companies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|Additionally, Standard & Poor's rates the financial strength of insurance companies, and assigns eight ratings, which currently range from AAA to CC, and may further modify that rating with a "+" or a "-" to show relative standing within the category.  S&P has assigned an "A" rating, its third highest rating, to Commerce and Citation.  S&P did not rate our remaining insurance subsidiaries.  According to S&P, an insurer with an "A" rating has strong financial security characteristics, but is somewhat more likely to be affected by adverse business conditions than are insurers with higher ratings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|A.M. Best, Moody's and S&P base their ratings on factors that concern policyholders and not upon factors concerning investor protection.  Such ratings are subject to change and are not recommendations to buy, sell or hold securities.  Any future decrease in the ratings of one of our subsidiaries could adversely affect our competitive position.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|Inter-Affiliate Pooling Agreement.We have implemented an inter-affiliate reinsurance pooling agreement, which we refer to as a "pool" or "pooling agreement," that is effective for the first quarter of 2004, contemporaneously with the reorganization of our insurance subsidiary companies described elsewhere in this Form 10-K.  The pool will consist solely of our four insurance subsidiary companies.  The pool will permit each insurance subsidiary to rely on the capacity of the entire pool, rather than its own capital and surplus, and it will prevent any one insurance subsidiary from suffering any undue losses, as all insurance subsidiaries will share underwriting profits and losses in proportion to their pool participation percentages.  It is intended to produce a more uniform and stable underwriting result than the companies would otherwise experience individually, and, we believe, will permit a more efficient use of our surplus, particularly following the completion of our debt offering to support premium growth.  We also expect that the pool will provide greater diversification for each subsidiary, both geographic and, to a lesser extent, by product mix.  We believe the pool will also permit all insurance subsidiaries to obtain a group rating from each of A.M. Best, Moody's and S&P.
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|The pool participation percentage of each insurance subsidiary will reflect the ratio of that subsidiary's year end policyholders' surplus to our aggregate policyholders' surplus.  For the year beginning January 1, 2004, the percentages are expected to be as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|Through the pooling agreement, Commerce will assume from all the other insurance subsidiaries, net of applicable reinsurance, all of their combined premiums, losses, loss expenses and underwriting expenses.  In addition, Commerce will combine this business with its own direct business, and then cede back to the other insurance subsidiaries their respective percentage of the combined premiums, losses, loss expenses and underwriting expenses of all of our insurance subsidiaries, including Commerce.  Accounts shall be rendered quarterly with inter-company balances settled within the next quarter.  The pool may be terminated in the event of an uncured breach, or by mutual agreement of all of the parties.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
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|Our Products                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|Automobile Insurance Lines.Our principal insurance line is personal automobile insurance.  We offer automobile policyholders the following types of coverage: bodily injury liability coverage, including underinsured and uninsured motorist coverage, personal injury protection coverage, property damage liability coverage and physical damage coverage, including fire, theft and other hazards specified in the policy.  In Massachusetts and New Hampshire, our policies have one-year terms.  Personal automobile insurance policies written by Commerce West and American Commerce usually have policy terms of six months.  Our published maximum liability limits for our Massachusetts business are $500 per person and $1.0 million per accident for bodily injury, and $100 for property damage.  For New Hampshire, our published maximum limits of liability are $500 per person and $1.0 million per accident for bodily injury, and $250 for property damage.  Liability limits of $100 per person injured, $300 per accident and $100 for property damage are the limits most commonly purchased in Massachusetts.  Our maximum published limits of liability for Massachusetts voluntary commercial accounts                                                                                                                      

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|are $1,000 per person and per accident for bodily injury and $500 for property damage, or $1,000 for combined single limit, with $1,000 combined single limit being our most commonly purchased coverage.  Our published maximum liability limits for automobile insurance written by Commerce West in California are $500 per person and per accident for bodily injury, and $100 for property damage; and $250 per person and $500 per accident for bodily injury, and $100 for property damage in Oregon.  For California business, liability limits of $15 per person injured and $30 per accident are most commonly purchased.  For Oregon business, liability limits of $25 per person injured and $50 per accident are most commonly purchased.  Our published maximum liability limits for our business in a majority of the states where American Commerce writes business are $1.0 million per person and per accident for bodily injury, $1.0 million for property damage and $500 for homeowners insurance.  For bodily injury coverage written by American Commerce, liability limits of $100 per person injured and $300 per accident are most commonly purchased.  For American Commerce, property damage liability limits of $50 are most commonly purchased, and for homeowner liability, coverage of $100 is most commonly purchased.                                                                             
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|Massachusetts Automobile Business.  Massachusetts automobile business is the principal component of our Massachusetts property and casualty operations.  In Massachusetts, private passenger automobile insurance is subject to extensive regulation.  Owners of automobiles are generally required to demonstrate certain minimum automobile insurance coverages as a prerequisite to registering any automobile.  With very limited exceptions, private passenger automobile insurers are required by law to issue a policy to any applicant seeking to obtain such coverages.  Based on market share, insurance companies in Massachusetts are also assigned agents known as ERPs.  Marketing and underwriting strategies for companies operating in Massachusetts are limited by maximum premium rates and minimum agency commission levels for personal automobile insurance, both of which are mandated by the Commissioner.  In Massachusetts, accident rates, bodily injury claims, and medical care costs continue to be among the highest in the nation.  According to the Automobile Insurers Bureau of Massachusetts, or AIB, Massachusetts "has higher than average medical costs and liability claims involving attorneys."  According to the NAIC State Average Expenditures Report, Massachusetts personal automobile premium per exposure, based on 2001 premium information, was the fourth highest in the nation.
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|During the three-year period from 2001 through 2003, average mandated Massachusetts personal automobile insurance premium rates decreased an average of 1.9% per year.  The Commissioner approved an average increase of 2.5% in personal automobile premiums for 2004, as compared to an increase of 2.7% in 2003.  Coinciding with the 2004 rate decision, the Commissioner also approved a 0.9% increase in the commission agents receive for selling private passenger automobile insurance in 2004.  The following table shows the state-mandated average rate change, the actual average revenue change per exposure and our average revenue change per exposure as estimated for 2004 and for the three previous years in Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     



|         |  |                     |  | Actual State Average |  |                   
|-------- |  | ------------------- |  | -------------------- |  | ------------------
|         |  |                     |  | Revenue              |  | Commerce Average  
|         |  | State Mandated      |  | Change               |  | Revenue Change Per
|Year     |  | Average Rate Change |  | Per Exposure (2)     |  | Exposure          
|         |  |                     |  |                      |  |                   
|         |  |                     |  |                      |  |                   
|2004 (1) |  | 2.5%                |  | 7.0%                 |  | 5.8%              
|2003     |  | 2.7%                |  | 8.1%                 |  | 7.9%              
|2002     |  | 0.0%                |  | 5.0%                 |  | 5.3%              
|2001     |  | (8.3)%              |  | (3.5)%               |  | (1.9)%            



|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Estimated for actual state and Commerce average revenue change per exposure.
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|(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Based on Massachusetts Division of Insurance filings.                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                             
|The actual state average revenue change per exposure represents the change in the average premium paid by drivers in Massachusetts, as opposed to the state mandated average rate change.  As can be seen above, our average revenue change per exposure corresponds more closely to the actual state average revenue change.  The reason for this is that both take into account newer vehicles, as compared to the state mandated average rate change which does not consider revenue arising from the mandated rate applied to new vehicle purchases.                                                
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|On January 5, 2004, the Massachusetts Attorney General (the "AG") filed an appeal with the Supreme Judicial Court of Massachusetts arguing that the Massachusetts Division of Insurance (the "DOI") "wrongly imposed a 2.5% increase" in average personal automobile premiums for 2004.  According to the AG, "for the second consecutive year, the DOI has, without justification, ruled in favor of an increase in auto insurance rates that will hurt Massachusetts drivers."  We cannot predict whether the AG's appeal will be successful, and if so, whether it will have a material impact on us.

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|Commonwealth Automobile Reinsurers (CAR)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|A significant aspect of our automobile insurance business relates to our interaction with CAR.  CAR is a reinsurance mechanism mandated in Massachusetts, which enables Commerce and the other participating insurers to reinsure any automobile risk that the insurer perceives to be under-priced.  CAR is responsible for the administration of the personal and commercial reinsurance mechanisms in Massachusetts.  Participating insurers, which are responsible for over 99% of total direct premiums written for personal automobile insurance in Massachusetts, are required to offer automobile insurance coverage to all eligible applicants pursuant to "take-all-comers" regulations, but may reinsure under-priced business with CAR.  In addition, participating insurers are obligated to accept ERPs from CAR and to provide an automobile insurance market in Massachusetts for those agencies.  ERP assignments occur by line of business and may apply to personal automobile only, commercial automobile only, or both lines.                                                                                                                                                                                                                                                                                                                                                                                                                                  
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|CAR maintains separate pools for personal and commercial automobile risks.  All companies writing automobile insurance in Massachusetts share in the underwriting results of CAR business for their respective product line or lines, whether or not they are servicing carriers.  Since its inception, CAR has annually generated hundreds of millions of dollars in underwriting losses, primarily in the personal automobile pool.  Accordingly, each automobile insurer attempts to develop and implement underwriting strategies that will minimize its relative share of the CAR deficit while maintaining acceptable loss ratios on risks not reinsured through CAR.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|In general, the CAR reinsurance mechanism operates in the following manner.  Within established periods, a servicing carrier must identify which policies it wishes to retain and which policies it wishes to cede to CAR.  A servicing carrier pays to CAR all of the premiums generated by the policies it has ceded and also pays over to CAR the difference between standard rates and the reduced premium resulting from affinity group marketing discounts or safe driver deviations on policies ceded to CAR.  CAR reimburses servicing carriers for all losses incurred on account of ceded policies, although, as with reinsurance generally, reinsurance of a policy through CAR does not legally discharge the participating insurer from its liability to the policyholder for the full amount of the policy.  Servicing carriers also receive fees for servicing ceded policies based on the expense structure established by CAR, which compensate for underwriting expenses, including commissions, and certain loss adjustment expenses.                                                                                                                                                                                                                                                                                                                                                                                                                            
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|Member companies of CAR have joint and several liabilities for the obligations of CAR.  If one member of CAR fails to pay its assessments, each of the remaining members of CAR will be required to pay its pro rata share of the member who fails to pay its obligations.  At the present time, we are not aware of any CAR member company who has failed to meet its obligations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|An insurer's proportionate share of the CAR deficit is allocated based on a formula called a participation ratio, which can vary significantly between the personal and commercial pools, and between different policy years.  Under current regulations, an insurer's share of the CAR deficit is first based on its market share for retained automobile risks for the particular pool.  An insurer's share is then adjusted by a utilization formula, such that, in general, its participation ratio is adversely affected if its relative use of CAR reinsurance exceeds that of the Massachusetts industry, and its participation ratio is favorably affected if its relative use of CAR reinsurance is less than that of the Massachusetts industry.  The current formula also contains a provision whereby certain high risk or under-priced business, if reinsured through CAR, is excluded in determining an insurer's participation ratio.  Finally, for the personal automobile CAR pool, an insurer's participation ratio may be affected by credits received for not reinsuring through CAR, automobile risks in selected under-priced classes and territories.  An insurer's participation ratio will be favorably affected if its relative use of credits exceeds that of the Massachusetts industry.  Credit values are set annually by CAR, and we cannot forecast whether the yearly changes will be beneficial or detrimental to our personal automobile results.
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|Our private passenger participation ratio used to calculate our share of the deficit for CAR, as compared to our Massachusetts market share, for the years ended December 31, 2003, 2002 and 2001 follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          



|     |  | Commerce Participation Ratio in CAR |  | Commerce Market Share
|---- |  | ----------------------------------- |  | ---------------------
|     |  |                                     |  |                      
|     |  |                                     |  |                      
|2003 |  | 20.2% (1)                           |  | 27.6% (2)            
|2002 |  | 18.2%                               |  | 25.9%                
|2001 |  | 17.3%                               |  | 23.2%                



|(1) | Estimated by CAR as of September 2003.
|--- | --------------------------------------
|(2) | Estimated by CAR as of November 2003. 

<PAGE>  16

|Our objective has been, and continues to be, to develop and implement underwriting strategies to obtain the optimum balance between our CAR participation ratio and the loss ratios on automobile risks that we choose to retain.  For each automobile risk, we make a judgment as to whether the projected impact on our profitability from retaining the risk outweighs the incremental cost of reinsuring the risk through CAR.  In general, increased voluntary retention levels result in higher voluntary loss ratios but lower CAR participation costs.  In determining the incremental cost of reinsuring a risk through CAR, we estimate our participation ratio for a given period by modeling the anticipated Massachusetts industry-wide CAR trends.  Once we estimate our participation ratio, we then are able to compare the incremental effect on our share of the CAR deficit of either reinsuring or retaining the particular automobile risks.  Finally, for personal automobile risks, we utilize our internal underwriting database and internally-developed actuarial reporting and decision support systems to develop a projected underwriting loss ratio for each risk.  We then compare the impact of the automobile risk on our participation ratio in order to estimate whether, after taking all CAR and other factors into account, our profitability will be enhanced by reinsuring or retaining such risk.  We believe that, because of our significant share of the Massachusetts personal automobile insurance market, we can utilize statistically credible data for a greater array of underwriting factors than our competitors.  We believe that the use of our underwriting database gives us a competitive advantage in deciding which personal automobile risks to reinsure through CAR.
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|We believe that individual companies in the marketplace make changes to their CAR strategies in an effort to obtain their optimum balance between retained and ceded writings.  In 2003, we ceded to CAR approximately $89.6 million, or 7.5%, of our Massachusetts personal automobile direct premiums written, compared to $75.4 million, or 7.3%, in 2002, and $60.3 million, or 7.0%, in 2001.  For 2003, 2002 and 2001, we reinsured through CAR approximately 5.1%, 4.9% and 4.9%, respectively, of our personal automobile exposures, as compared to industry averages of 7.0%, 7.5% and 7.7%, respectively.  Our strategy has been to maintain above average voluntary retention levels, as well as to voluntarily retain personal automobile business that receives credits, favorably impacting the utilization formula.  These credits result from voluntarily retaining business in under-priced territories and for under-priced classes.  We believe that our strategy has favorably affected our participation ratio, as evidenced by our CAR participation ratio consistently being at least several percentage points below our share of the Massachusetts personal automobile market, as reflected in the above table.  This strategy increases our voluntary loss ratios as under-priced business generally produces higher loss ratios.                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
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|Although commercial automobile insurance is a relatively smaller portion of our total insurance writings, the related commercial automobile risk selection decisions remain an important element in determining our profitability.  In 2003, we ceded to CAR approximately $15.3 million, or 17.0%, of our Massachusetts commercial automobile direct premiums written, as compared to $12.8 million, or 17.0%, in 2002.  The percentage of commercial automobile premiums ceded to CAR by the industry was estimated by us to be 27% in 2003 and 28% in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|CAR personal and commercial automobile business for the years ended December 31, 2003, 2002 and 2001 follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    



|                        | 2003     |  | 2002     |  | 2001     
|----------------------- | -------- |  | -------- |  | ---------
|                        |          |  |          |  |          
|                        | Ceded    |  | Assumed  |  | Ceded    
|                        |          |  |          |  |          
|                        |          |  |          |  |          
|Income Statement:       |          |  |          |  |          
|Written premiums        | $104,898 |  | $112,547 |  | $  88,198
|Earned premiums         | 96,150   |  | 104,297  |  | 80,241   
|Losses and LAE incurred | 114,267  |  | 144,252  |  | 114,578  
|Underwriting expenses   | -        |  | 35,883   |  | -        
|Balance Sheet:          |          |  |          |  |          
|Unearned premiums       | 55,656   |  | 55,624   |  | 52,374   
|Unpaid losses and LAE   | 137,087  |  | 133,175  |  | 112,102  



|For the years ended December 31, 2003, 2002 and 2001, our servicing fees related to policies ceded to CAR were $18.9 million, $18.7 million and $17.2 million, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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|In a letter to the Commissioner dated June 25, 2002, the Massachusetts Attorney General reported that, based on his examination of available information, he "believes that the CAR plan for providing access to insurance in the residual market does not comply with the CAR enabling statute, and must be changed to produce a fair and equitable market."  The Attorney General's letter describes several factors that he believes support his findings and which he believes should be corrected in order to comply with applicable Massachusetts law.  The Attorney General's letter calls on the Commissioner to work with him to address these issues.  It is uncertain when, whether and to what extent the issues raised by the Attorney General will be addressed by the Commissioner.  We cannot predict whether changes to the CAR rules, if any, would have a material impact on us.
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|In response to the Attorney General's letter and a request by the Commissioner for suggestions on reforming CAR, a group of other Massachusetts automobile insurers known as the "Concerned Industry Committee", representing more than                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

<PAGE>  17

|50% of the business written in the state, is in the process of developing a proposal suggesting changes to the residual market system.  It appears that a fundamental component of that group's proposal is to eliminate the current system of pooling of residual market risks and replace it with a system that would randomly assign individual residual market risks.  The group has yet to submit its proposal formally to the appropriate regulatory authorities and we cannot predict whether it will do so.  We also cannot predict whether such changes to the residual market system or CAR rules, if any, will occur or if such changes would have a material impact on us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|Marketing                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|We market our insurance products exclusively through a network of licensed independent agencies.  As of December 31, 2003, we had 650 agencies throughout Massachusetts (of which 203 are ERPs), 34 agencies throughout New Hampshire, 1,096 agencies and brokers in California and Oregon for Commerce West, and 28 agencies in 16 states for American Commerce.  Our voluntary, non-ERP independent agencies may also represent other insurance companies, some of which may compete directly with us.  The ERPs may represent other companies for lines of business other than personal and commercial automobile and, for these other lines, the ERPs may represent companies that compete with us.  The independent insurance agencies are under contract with our subsidiaries and must conduct their business according to the provisions of their contracts.  Contracts for Massachusetts agencies may be terminated by us upon 180 days notice to the agency or at will by the agency.  ERP contracts may be terminated by us if the ERP violates CAR rules and our actions are upheld by the CAR Governing Committee.                                                                                                                                                                                                               
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|Massachusetts Business.We seek to establish long-term relationships with agencies that can generate a sizable volume of business with profitable underwriting characteristics and for which we will be among the top one or two preferred writers of private passenger automobile policies. Of the 650 licensed independent agencies currently in our Massachusetts network, 246 agencies have been licensed with us for less than five years. This is primarily the result of 127 new appointments in 2002, most of whom came from our acquisition of the Massachusetts personal automobile business written by Berkshire Mutual Insurance Company and MassWest Insurance Company. We also have 62 agencies with licenses from six to ten years and 338 licensed agencies that have been writing business with us for over ten years, of which 190 have been associated with us for over 15 years.                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|We also assess whether the mix of a prospective agency's business will expand our presence in one or more of our core product lines. In 2003, the agencies representing us in Massachusetts produced an average of approximately $2.2 million of our direct premiums written per agency, a 13% increase as compared to 2002. During 2003, in Massachusetts, 198 agencies produced between $1.0 million and $2.0 million of direct premiums written, an additional 101 agencies produced between $2.0 million and $3.0 million, an additional 39 agencies produced between $3.0 million and $4.0 million and lastly, an additional 74 agencies produced over $4.0 million. The remaining 238 agencies, primarily ERPs and former Berkshire Mutual agencies, each produced less than $1.0 million of direct premiums written. Our three largest agencies each produced approximately $90.5 million, $22.6 million, and $18.0 million of our Massachusetts direct premiums written, or approximately 6.5%, 1.6% and 1.3% of total Massachusetts direct premiums written, respectively. Our largest insurance agent is a subsidiary of the AAA Southern New England, which also owns a 5% equity interest in AHC and controls a Rhode Island AAA insurance agency which produced an additional 1.2% of our total direct premiums written for 2003.
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|Included in the increase for Massachusetts personal automobile direct premiums written are premiums that were the result of appointments of new agents. During 2003, Commerce had 48 new appointments. Of these new appointments, 16 were voluntary agents resulting in an additional $4.2 million in premiums. The remainder of the new appointments was ERPs. Business obtained from new ERPs amounted to $16.2 million during 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|We carefully monitor an agency's performance. An Agency Evaluation Committee, comprised of representatives of our Marketing, Underwriting, and Premium Accounting departments, uses a host of pre-established criteria (loss ratio, premium volume, business distributions, etc.) to evaluate agencies continuously. Generally, we will counsel an agency on how to improve its underwriting and profitability before we consider terminating the agency. During 2003, we terminated 15 non-ERP agencies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|Our agencies receive commissions on policies written for us and are eligible to receive contingent commissions through a profit sharing arrangement. The Commissioner annually establishes a minimum average direct commission for personal automobile insurance, which in 2003 was 11.0%. Our contingent commissions are tied to the underwriting profit on policies written by an agency. We generally pay a qualifying agency up to 45% of the rolling three-year underwriting profit attributable to the agency's business. The arrangement for profit sharing on Massachusetts policies utilizes a three-year rolling plan, with one-third of each of the current and the two prior years' profit or loss calculations, summed to a single amount. This amount, if positive, is multiplied by the profit sharing rate and paid to the agent. To qualify for profit sharing, an agent generally must have a three-year average loss ratio of 55% or better. CAR credits for voluntary business written in                                                                                                                                                                                                                                                                                                                                 

<PAGE>  18

|under-priced territories and credits for writing youthful operators on a voluntary basis can increase the loss ratio eligibility for profit sharing. Books of business with limited credits must achieve a lower loss ratio, generally around 50%, to qualify. In 2003, our total commissions to our agencies were 13.8% of direct premiums written, of which direct commissions and contingent commissions were 12.5% and 1.3%, respectively, versus total commission expensed of 15.1%, of which 13.6% was direct and 1.5% was contingent in 2002. Total commissions are higher than the personal automobile minimum commission rates primarily due to bonus commissions in 2003 to agencies with better performing private passenger automobile books of business, coupled with higher commissions on non-automobile lines of business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|We also occasionally sponsor incentive award trips to encourage and reward agency profitability and growth. In late 2001, we initiated a sales incentive contest with the qualification period running from January 1, 2002 to April 30, 2003. Qualification criteria included profitability, written premium volume, private passenger and commercial automobile growth, longevity and use of our services, which increase efficiencies between our agencies and us. Expenses in 2003 and 2002 related to the sales incentive contest were $634 and $954, respectively. In addition, we will hold similar sales incentive contests, for which qualifying growth will run between 2003 and 2005, with trips taking place in 2004 and 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|We devote substantial time and resources to the development of our information systems, which we believe have enhanced both our underwriting and our agency support. Through the use of several customized software programs, we have the ability to analyze our internal historical underwriting data and use such information in making, in our belief, more informed underwriting decisions. In particular, we believe that the amount and extent of detailed data accumulated as a result of our significant share of the Massachusetts personal automobile market give us a competitive advantage in determining which personal automobile risks to reinsure through CAR. Our information systems also enable us to provide extensive support to our agencies. This support includes a direct billing system, which covers over 98% of our policyholders, and an on-line inquiry system, which allows agencies to ascertain the status of pending claims and direct bill information via the internet. The system also allows agents on-line access to manuals, reports and forms. We also offer an agency upload for personal automobile and an agency download product for personal automobile and homeowners. We expect to expand these offerings from time to time. In addition, we provide access to a system that allows our agencies to quote premiums for our three core product lines directly to policyholders. During 2003, more than 90% of our agents had access to one or more of these systems.
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|We believe that, because of our compensation arrangements and our emphasis on service, an increasing number of our agencies will rely on us as their principal supplier of insurance products. We believe that we are the preferred provider for most of our agencies. Although we believe, based on annual surveys of our agencies, that our relationships with our independent agencies are excellent, any disruption in these relationships could adversely affect our business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|Affinity Programs in Massachusetts.As previously mentioned, since 1995, we have been a leader in affinity group marketing in Massachusetts by providing discounts to members of the AAA clubs. Based on information provided to us by the AAA clubs operating in Massachusetts, we believe that membership in these clubs represents approximately one-third of the Massachusetts motoring public. We increased our total Massachusetts private passenger automobile written insurance exposures by 6.9%, ending 2003 with approximately 27.6% of the Massachusetts private passenger automobile market, up from 25.9% at the end of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|The AAA Affinity group discount has been established at 5.0% for 2004 and 2003, as compared to 6.0% for 2002 and 2001. In 2001, the AAA Affinity group discount and Step 9 deviation could have produced a combined 7.9% discount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|Other States.Commerce writes personal lines insurance through independent insurance agencies in the state of New Hampshire. Commerce West predominantly writes preferred and non-standard private passenger automobile insurance in California and Oregon through independent insurance agencies and brokers. Commerce West also writes commercial automobile insurance in California. This program was introduced in late 2000. American Commerce predominantly writes preferred private passenger automobile and homeowners insurance in 16 states exclusively through AAA independent insurance agencies, as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|Underwriting                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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|We seek to achieve an underwriting profit, as measured by a statutory combined ratio of less than 100%, in each of our product lines, in both hard markets and soft markets. The strategy is designed to achieve consistent profitability with substantial growth in net premiums written during hard markets and growth that is more modest during soft markets. All of our policies have been written on a "claims incurred basis," meaning that we cover claims based on occurrences that take place during the policy period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

<PAGE>  19

|Agencies are authorized to bind us on risks as limited by our written underwriting rules and practices, which set forth eligibility rules for various policies and coverages, unacceptable risks, and maximum and minimum limits of liability. For non-automobile policies, other than certain umbrella policies, our agencies have the ability to bind us for a limited period, typically 60 days, during which time we review all risks to determine whether we will accept or reject the policy. During this review period, we are obligated to pay any claim that would be covered under the policy. Violation of our underwriting rules and practices is grounds for termination of the agency's contract with us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In Massachusetts, we and each of the other insurers that participate in CAR must write all private passenger automobile risks submitted to us. Massachusetts personal automobile insurance rates are fixed annually by the Commissioner. All companies writing personal automobile policies are required to use such mandated rates, unless they have received prior approval from the Commissioner to offer a lower rate. The actual premium paid by a particular policyholder, however, is adjusted, either up or down, based upon the driving record of the insured operator. Moving violations and accidents for which the insured was at fault within the most recent six year period are used to determine each operator's safe driver surcharge or credit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|We set our voluntary Massachusetts commercial automobile insurance rates competitively, subject to the Commissioner's authority to disapprove such rates. CAR files the rates for commercial automobile risks reinsured through CAR, subject to the authority of the Commissioner to disapprove the rates, except for private passenger type non-fleet business which are filed by insurance companies and approved by the Commissioner.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Our rates for other product lines, including homeowners and commercial lines of general liability and property insurance, are based in part on loss cost data from the Insurance Services Office, or ISO, which is an industry bureau providing policy forms and rate making data, and in part, on our own experience and industry price levels. We are not obligated by statute to accept every homeowners risk submitted to us. Accordingly, risks meeting our underwriting guidelines are accepted, and all other risks are declined or not renewed. We use ISO policy forms and have added special coverage features to meet our product needs. Rates and forms must be filed with and approved by the Commissioner.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|Reinsurance                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In addition to participating in CAR, we reinsure with other insurance companies, on a claims incurred basis, a portion of our potential exposure under the policies we have written. The objective of this reinsurance is to mitigate the adverse financial consequences of a severe loss under individual policies, or catastrophic occurrences where a number of claims can produce an extraordinary aggregate loss. Reinsurance does not legally discharge us from our primary liability to the insured for the full amount of the policies, but it does make the reinsurer liable to us to the extent of the reinsured portion of any loss ultimately suffered. We seek to utilize reinsurers that we consider adequately capitalized and financially able to meet their respective obligations under reinsurance agreements with us. We use a variety of reinsurance mechanisms to protect ourselves against loss. For additional information, please refer to Note G to the audited consolidated financial statements included in this Form 10-K.                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Settlement of Claims                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Claims under insurance policies written by us are investigated and settled primarily by claims adjusters employed by us. At December 31, 2003, Commerce employed a staff of 928 people in its claims department, located in Webster, Massachusetts. In addition to these individuals, Commerce utilized the services of 30 independent appraisal firms and 12 independent property adjusting companies which are strategically located throughout Massachusetts and New Hampshire. Commerce also has a special unit that investigates suspected insurance fraud and abuse. At December 31, 2003, American Commerce employed a staff of 88 people that settled claims at three regional claims offices located around the country, in addition to our Massachusetts location. In addition to these individuals, American Commerce used the services of 39 independent appraisal firms and 38 independent property adjusting companies, which are also located around the country in addition to our Massachusetts location. At December 31, 2003, Commerce West settled claims at its home office, employing a staff of 31 in its claims department. In addition, Commerce West utilized the services of 14 independent appraisal firms located in California and Oregon. If a claim or loss cannot be settled and results in litigation, we retain outside counsel to represent us.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|We believe that, based on surveys of our agency force and insureds, through our claims staff of experienced adjusters, appraisers, managers, and administrative staff, we have higher customer satisfaction than many of our competitors. All claims office staff members work closely with agents, insureds and claimants with a goal of settling claims fairly, rapidly and cost effectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

<PAGE>  20

|Since 1996, Commerce has been expanding a 24-hour claim reporting service in Massachusetts to third-party claimants and insureds of interested agencies. This service allows customers to report their first notice of a loss at any time of the day, 365 days a year. This reporting methodology allows us to improve customer satisfaction by making the initial claim handling much faster and ultimately reducing indemnity payments such as rental and storage.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Certain of our agencies in Massachusetts have settlement authority for claims, other than automobile property losses, that are less than $2,500 (actual amount). The settlement authority of agencies under automobile policies is limited to claims for towing. As of December 31, 2003, there were 292 Massachusetts agents who signed up for this claim payment methodology. This service is available to all agents and their use of the service fluctuates on an ongoing basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|The Massachusetts Unfair Claims Settlement Practices Act, or Chapter 176D, and other similar provisions in states in which we do business, prohibit insurers from engaging in certain claim settlement practices. These practices include:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|An insurer's violation of any of these obligations expressly violates a number of state laws, including the Massachusetts Consumer Protection Act, or Chapter 93A. Any party, including claimants and insureds, whose rights are affected by an insurer's violation of Chapter 176D, is entitled to bring a claim against the insurer under Chapter 93A. Similar provisions exist in other states where we do business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|The damages available under Chapter 93A may not necessarily be related to the harm caused by the insurer's violation of Chapter 176D. Chapter 93A provides in effect that the party that brings a successful Chapter 93A claim will be entitled, at a minimum, to the amount of the judgment on all claims arising out of the same underlying occurrence, plus their legal fees, regardless of the limits of the policy issued by the insurer. Moreover, Chapter 93A permits the court to double or triple the party's damages if the insurer's violation of Chapter 176D was willful or knowing. If the underlying policy risk was ceded to CAR, we may seek reimbursement from CAR for legal expenses on any claim that we successfully defend. This is the only instance in which CAR will make any reimbursement on a Chapter 93A claim.                                                                                                                                                                                                                                                                           
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|Loss and Loss Adjustment Expense Reserves                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|The following table represents the development of reserves, net of reinsurance, for 1993 through 2003. The top line of the table shows the reserves at the balance sheet date for each of the indicated years, representing the estimated amounts of losses and LAE for claims arising in all years that were unpaid at the balance sheet date, including losses that had been incurred but not yet reported to us. The upper portion of the table shows the cumulative amounts paid as of successive years expressed as a percentage with respect to that year's ending reserve liability. The lower portion of the table shows the re-estimated amount as a percentage of the previously recorded reserves based on experience as of the end of each succeeding year, including cumulative payments made since the end of the respective year. The estimate changes as more information becomes known about the payments, frequency and severity of claims for individual years. Favorable loss development exists when the original reserve estimate is greater than the re-estimated reserves at December 31, 2003.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|For additional information, please refer to "Critical Accounting Policies" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|In evaluating the cumulative information in the following table, it should be noted that each year's amount includes the cumulative effects of all changes in amounts for prior periods. This table does not present accident or policy year development data. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future development based on the following table.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

<PAGE>  21

|                                       | 2003                         | 2002   | 2001   | 2000   | 1999   | 1998(1) | 1997    | 1996    | 1995    | 1994    | 1993   
|-------------------------------------- | ---------------------------- | ------ | ------ | ------ | ------ | ------- | ------- | ------- | ------- | ------- | -------
|                                       | (Dollars stated in millions)
|                                       |                              |        |        |        |        |         |         |         |         |         |        
|Reserves for losses and loss           |                              |        |        |        |        |         |         |         |         |         |        
|adjustment expenses                    | $792.3                       | $678.3 | $594.2 | $585.9 | $558.8 | $561.2  | $529.8  | $534.0  | $493.9  | $455.5  | $422.2 
|Paid (cumulative) as a percentage of   |                              |        |        |        |        |         |         |         |         |         |        
|current reserves as of:                |                              |        |        |        |        |         |         |         |         |         |        
|One year later                         |                              | 50.6%  | 51.3%  | 53.0%  | 51.5%  | 48.8%   | 53.0%   | 52.1%   | 49.6%   | 48.9%   | 53.9%  
|Two years later                        |                              |        | 71.7   | 72.9   | 73.3   | 72.2    | 77.1    | 74.7    | 71.9    | 70.1    | 73.5   
|Three years later                      |                              |        |        | 84.4   | 84.3   | 83.6    | 92.0    | 87.4    | 86.1    | 82.8    | 84.1   
|Four years later                       |                              |        |        |        | 90.4   | 89.1    | 98.1    | 96.0    | 92.9    | 91.8    | 90.5   
|Five years later                       |                              |        |        |        |        | 92.1    | 101.1   | 98.9    | 98.1    | 95.1    | 95.3   
|Six years later                        |                              |        |        |        |        |         | 102.4   | 100.1   | 99.1    | 98.3    | 96.5   
|Seven years later                      |                              |        |        |        |        |         |         | 100.7   | 99.8    | 98.6    | 98.5   
|Eight years later                      |                              |        |        |        |        |         |         |         | 100.2   | 99.2    | 98.7   
|Nine years later                       |                              |        |        |        |        |         |         |         |         | 99.5    | 99.1   
|Ten years later                        |                              |        |        |        |        |         |         |         |         |         | 99.2   
|Reserves re-estimated as a             |                              |        |        |        |        |         |         |         |         |         |        
|percentage of initial reserves as of:  |                              |        |        |        |        |         |         |         |         |         |        
|One year later                         |                              | 96.3%  | 97.6%  | 94.0%  | 92.4%  | 92.9%   | 88.4%   | 84.3%   | 82.2%   | 83.6%   | 83.9%  
|Two years later                        |                              |        | 93.9   | 93.7   | 90.3   | 91.9    | 85.6    | 79.3    | 74.1    | 73.2    | 75.9   
|Three years later                      |                              |        |        | 91.8   | 90.3   | 91.3    | 85.1    | 77.4    | 71.5    | 68.9    | 69.4   
|Four years later                       |                              |        |        |        | 89.3   | 91.3    | 84.7    | 77.3    | 69.7    | 67.8    | 67.3   
|Five years later                       |                              |        |        |        |        | 88.8    | 84.4    | 77.1    | 70.4    | 66.3    | 66.4   
|Six years later                        |                              |        |        |        |        |         | 81.0    | 76.8    | 70.1    | 66.9    | 65.7   
|Seven years later                      |                              |        |        |        |        |         |         | 74.5    | 69.9    | 66.8    | 66.2   
|Eight years later                      |                              |        |        |        |        |         |         |         | 68.3    | 66.7    | 66.1   
|Nine years later                       |                              |        |        |        |        |         |         |         |         | 65.1    | 66.1   
|Ten years later                        |                              |        |        |        |        |         |         |         |         |         | 64.6   
|Redundancy expressed as a percent      |                              |        |        |        |        |         |         |         |         |         |        
|of year end reserves                   |                              | 3.7%   | 6.1%   | 8.2%   | 10.7%  | 11.2%   | 19.0%   | 25.5%   | 31.7%   | 34.9%   | 35.4%  
|                                       |                              |        |        |        |        |         |         |         |         |         |        
|Gross liability, end of year           | $957.4                       | $815.6 | $695.2 | $684.8 | $671.0 | $657.0  | $639.7  | $658.0  | $620.9  | $593.0  | $556.4 
|Reinsurance recoverables               | 165.1                        | 137.3  | 101.0  | 98.9   | 112.2  | 95.8    | 109.9   | 124.0   | 127.0   | 137.5   | 134.2  
|                                       |                              |        |        |        |        |         |         |         |         |         |        
|Net liability, end of year             | $792.3                       | $678.3 | $594.2 | $585.9 | $558.8 | $561.2  | $529.8  | $534.0  | $493.9  | $455.5  | $422.2 
|Impact of re-estimation of reserve (2) | -                            | (25.2) | (36.5) | (48.0) | (59.7) | (62.7)  | (100.5) | (136.4) | (156.4) | (159.0) | (149.5)
|                                       |                              |        |        |        |        |         |         |         |         |         |        
|Net estimated liability, latest        | $792.3                       | $653.1 | $557.7 | $537.9 | $499.1 | $498.5  | $429.3  | $397.6  | $337.5  | $296.5  | $272.7 
|                                       |                              |        |        |        |        |         |         |         |         |         |        



|(1) | The 1998 amount includes an adjustment to add $63.1 million in loss and LAE reserves for American Commerce at January 29, 1999. For additional information about losses and LAE, gross and net of reinsurance, see Note E to the audited consolidated financial statements included in this Form 10-K.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | The re-estimation of reserves is made up of gross estimated liabilities and reinsurance recoverable changes that occurred. Because these components have not been tracked individually during the above referenced years, it is not feasible for us to accurately report them individually.           

<PAGE>  22

|Included in our loss reserves, are liabilities for unpaid claims and claim adjustment expenses for environmental related claims such as oil spills, mold and lead paint. We held reserves in the amount of $1.7 million for lead paint related claims at December 31, 2003 and 2002 and $1.6 million at December 31, 2001. We believe that these reserves are adequate. Our reserves for other environmental claims such as oil spills and mold were $5.0 million and $1.2 million, respectively, at December 31, 2003. Reserves have been established to cover these claims for known losses. Because of our limited exposure to these types of claims, we believe they will not have a material impact on our financial position.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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|Operating Ratios                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
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|Loss and Underwriting Expense Ratios.Loss and underwriting expense ratios are used to interpret the underwriting experience of property and casualty insurance companies. Losses and LAE are stated as a percentage of premiums earned because losses may occur over the life of a policy. Underwriting expenses on a statutory basis are stated as a percentage of net premiums written rather than earned premiums because most underwriting expenses are incurred when policies are written and are not spread over the policy period. Underwriting profit margins are reflected by the extent to which the sum of the loss and underwriting expense ratios, which we refer to as the combined ratio, are less than 100%. The combined ratio is considered the best simple index of current underwriting performance of an insurer. Our loss and LAE ratio, underwriting expense ratio and combined ratio, and the industry combined ratio, on a statutory basis, are shown in the following table. Our ratios include lines of insurance other than automobile, as do the industry combined ratios for all writers. Data for the property and casualty industry generally may not be directly comparable to our data. This is because we conduct our business primarily in Massachusetts, where approximately 85.6% of our direct premiums were written for the year ended December 31, 2003, and, secondly, we primarily write personal automotive insurance.



|                                           | Year Ended December 31,
|------------------------------------------ | -----------------------
|                                           |                        
|                                           | 2003                   
|                                           |                        
|                                           |                        
|Company Group Statutory Ratios (unaudited) |                        
|Loss and LAE Ratio                         | 73.4%                  
|Underwriting Expense Ratio                 | 22.9%                  
|                                           |                        
|Combined Ratio                             | 96.3%                  
|                                           |                        
|                                           |                        
|Industry Combined Ratio (all writers) (1)  | 99.0%                  
|                                           |                        



|(1)                                                                                                                                                                                                                                                                                                                                                                                                  | Source: A.M. Best's Review Preview(January 2004), as reported by A.M. Best for all property and casualty insurance companies and adjusted to reflect our relative product mix. The 2003 industry information is estimated by A.M. Best.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                     |                                                                                                                                                                                                                                        
|Premiums to Surplus Ratio.The statutory ratios of the net premiums written to policyholders' surplus for the five years ended December 31, 2003 follow, for our industry and us. While there is no regulatory requirement applicable to us which establishes a permissible net premiums to surplus ratio, guidelines established by the NAIC provide that this ratio should be no greater than 300%.
|                                                                                                                                                                                                                                                                                                                                                                                                    
|The premium to surplus ratios for the five years ended 2003 for our industry and us follow (in millions of dollars):                                                                                                                                                                                                                                                                                



|                              | 2003     |  | 2002      |  | 2001      |  | 2000      |  | 1999  
|----------------------------- | -------- |  | --------- |  | --------- |  | --------- |  | ------
|                              |          |  |           |  |           |  |           |  |       
|                              |          |  |           |  |           |  |           |  |       
|Net premiums written by us    | $1,555.5 |  | $1,313.0  |  | $1,079.0  |  | $1,008.9  |  | $912.0
|Policyholders' surplus of our |          |  |           |  |           |  |           |  |       
|insurance subsidiaries        | $1,075.1 |  | $   662.0 |  | $   715.9 |  | $   661.0 |  | $519.0
|Our ratio                     | 144.7%   |  | 198.3%    |  | 150.7%    |  | 152.6%    |  | 175.7%
|Industry ratio(1)             | 126.2%   |  | 130.2%    |  | 111.6%    |  | 94.1%     |  | 85.4% 



|(1)                                                                                                                                                                                                                                                                                   | Source: A.M. Best's Review Preview(January 2004), for all property and casualty insurance companies. The 2003 industry information is estimated by A.M. Best.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                      |                                                                                                                                                              
|Investments                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                     
|Investment income is an important source of revenue for us, and the return on our investment portfolio has a material effect on our net earnings. Our investment objective continues to focus on maximizing after-tax investment income through investing in high quality securities.
|                                                                                                                                                                                                                                                                                     
|Our investment strategy emphasizes investment yield while maintaining investment quality. The focus of our investment objectives continues to be maximizing after-tax investment income through investing in high quality diversified                                                

<PAGE>  23

|investments structured to maximize after-tax investment income while minimizing risk. A secondary objective is to achieve above average after-tax total return. Our funds are generally invested in securities with maturities intended to provide adequate funds to pay claims and meet other operating needs without the forced sale of investments. During 2003, we sold a significant portion of our securities with unrealized gains in order to implement a change in our investment view. This change in view caused us to reduce the average duration of our investment portfolio during the second and third quarters and also included the sale of a number of securities which had increased in value significantly as overall credit spreads tightened. During the third quarter as interest rates rose, we began to invest in longer-term securities, ultimately resulting in 2003 year end duration being slightly higher, as compared to year end 2002.                                                                                                                                                                                                                                                                                                                            
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|For additional information on our investment income and investment portfolio, please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note B to the audited consolidated financial statements included in this Form 10-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|Regulation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|General.Although the U.S. federal government does not directly regulate the insurance industry, federal initiatives often have an impact on the industry. Congress and certain federal agencies continue to investigate the current condition of the insurance industry, encompassing both life and health and property and casualty insurance, in the United States in order to decide whether some form of federal role in the regulation of insurance companies would be appropriate. Congress conducts hearings relating, in general, to the solvency of insurers and has proposed federal legislation from time to time on this and other subjects.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|The Terrorism Risk Insurance Act of 2002 was signed into law on November 26, 2002. The purpose of this Act is to establish a temporary federal program that provides a system of shared public and private compensation for certain insured losses resulting from acts of terrorism. The Act defines a "certified" act of terrorism as "an act that is certified by the Secretary of the Treasury as resulting in aggregate losses in excess of $5.0 million, is a violent act or dangerous to human life, property or infrastructure, and is committed by an individual(s) acting on behalf of any foreign person or interest as part of an effort to coerce the civilian population of the United States or to influence the policy or affect the conduct of the United States Government by coercion." Due to the types of coverage offered by us and the limited exposure we have outside of Massachusetts, we believe that the financial impact upon us as a result of the Act will be immaterial.                                                                                                                                                                                                                                                                                           
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|At the state level, various forms of automobile insurance reform are continuously debated. New regulations and legislation are often proposed with the goal of reducing the need for premium increases. For further details, see "Massachusetts Personal Automobile Insurance" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in this Form 10-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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|Our primary business is subject to extensive regulation. In Massachusetts, the Commissioner is appointed by the Governor of Massachusetts and has broad authority. The Commissioner fixes maximum policy rates and establishes minimum agent commission levels on personal automobile insurance. In addition, the Commissioner grants and revokes licenses to write insurance, approves policy forms, sets reserve requirements, determines the form and content of statutory financial statements and establishes the type and character of portfolio investments. The Commissioner also approves company submissions regarding affinity group insurance programs and corresponding discounts along with safe driver deviations. Consequently, the policies and regulations set by the Commissioner are an important element of writing insurance in Massachusetts. In states outside of Massachusetts, premium rates generally must be filed with, and approved by the Commissioner of Insurance in that particular state. In general, minimum commissions to agents are not set by the other state commissioners.                                                                                                                                                                              
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|State insurance regulators are responsible for conducting periodic examinations of insurance companies. Massachusetts Division of Insurance regulations provide that insurance companies will be examined every five years or more frequently as deemed prudent by the Commissioner. California Department of Insurance regulations provide that insurance companies will be examined every three years. Ohio Department of Insurance regulations provide that insurance companies will be examined at least every five years. Both Commerce and Citation were last examined for the five-year period ended December 31, 1998. Commerce and Citation have been notified that they will be examined in 2004 for the five-year period ended December 31, 2003. Commerce West was last examined in 2001 by the California Department of Insurance for the three-year period ended December 31, 1999, and is currently being examined for the four years ended December 31, 2003. American Commerce was examined in 1999 by the Ohio Department of Insurance for the five-year period ended December 31, 1997. American Commerce has been notified that it will be examined in 2004 for the five-year period ended December 2002. The previously completed examinations produced no material findings.

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|Automobile Insurance Regulation Overview.Massachusetts has required compulsory automobile insurance coverage since 1925. States outside of Massachusetts generally have varying levels of minimum compulsory insurance. Under current law, all Massachusetts motorists are required to carry certain minimum coverages mandated by the state. The Commissioner fixes and establishes, among other things, the maximum rates insurers may charge for the compulsory personal automobile coverages. With very limited exceptions, each insurer writing automobile insurance in Massachusetts must accept all risks submitted to the insurer for the compulsory coverage, but is permitted to reinsure these risks (including affinity group marketing insurance risks) through CAR.
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|Compulsory Coverage.Compulsory coverage includes no-fault coverage, limited bodily injury coverage, property damage coverage and coverage against uninsured or hit and run motorists. The Massachusetts no-fault statute provides for personal injury protection coverage, which entitles a party to be reimbursed directly by the party's own insurer for certain medical expenses, lost wages and other defined expenses arising from an automobile accident, up to a specific amount, even if another party caused the accident.                                                                                                                                                                                                                                              
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|Rates and Commissions.Massachusetts personal automobile insurance rates are fixed and established annually by the Commissioner. Affinity group marketing insurance programs and safe driver rate deviations must be annually approved by the Commissioner. We set our voluntary Massachusetts commercial automobile insurance rates competitively, subject to the Commissioner's authority to disapprove such rates. CAR files the rate for commercial automobile risks reinsured through CAR, subject to the authority of the Commissioner to disapprove the rates, except for private passenger type non-fleet business which is filed by insurance companies and approved by the Commissioner. For additional information, see "Commonwealth Automobile Reinsurers."          
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|In fixing classifications of risks and establishing personal automobile rates, the Commissioner must consider numerous factors, including driver and automobile characteristics and the claim rate in the state's designated geographical territories. These factors are based upon data that are two or more years old. Premiums charged to a policyholder are adjusted based upon the safe driver rating of the operator. Moving violations and at-fault accidents affect each driver's safe driver rating. In addition, the Extra Risk Rating regulations permit insurers to deny coverage or charge surcharged rates for physical damage coverage to both high risk vehicles and insureds with excessive prior loss or violation activity.                                   
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|The Commissioner sets an average minimum direct agency commission rate for personal automobile insurance. With respect to risks reinsured through CAR, the maximum amount of commissions that CAR will reimburse, as part of their expense allowance structure, is fixed at that prescribed rate.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|Outside of Massachusetts, rates and commissions are set competitively on a company-by-company and state-by-state basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|Mandatory Underwriting.Massachusetts law specifies that all individuals holding a valid driver's license be entitled to purchase the mandatory automobile insurance coverages regardless of their driving experience or accident record. The Massachusetts Legislature has also placed certain restraints on insurers' discretion to refuse to renew automobile insurance policies. Policyholders are generally entitled to renew except in cases of fraud, material misrepresentation, revocation or suspension of an operator's license or nonpayment of premiums. With very limited exceptions, insurers that participate in CAR in Massachusetts must accept every automobile risk submitted to them.                                                                        
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|Under the Massachusetts system of rate regulation, some personal automobile insurance risks are purposefully under-priced by the Commissioner, and therefore, absent state-intervention, insurers would not ordinarily choose to write those risks. The CAR reinsurance program described below is intended to mitigate the burden imposed by the Massachusetts take-all-comers system, by allowing insurers to transfer the exposure for under-priced risks to an industry pool, and by granting participation credits for certain under-priced risks. These credits are allowed by statute.                                                                                                                                                                                    
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|Commonwealth Automobile Reinsurers.CAR is a Massachusetts state-mandated reinsurance mechanism, under which all premiums, expenses and losses on ceded business are pooled and shared by all insurers. It is similar to a joint underwriting association because a number of insurers participate in the program. As of December 31, 2003, 35 insurers participated for the personal and commercial automobile lines, including Commerce.                                                                                                                                                                                                                                                                                                                                        
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|In general, agencies licensed to issue automobile insurance policies are entitled to be assigned to at least one servicing carrier. There are two categories of agencies: (1) those that have voluntary agreements with one or more servicing carriers, and (2) those that do not. The latter are assigned by CAR, generally to a single servicing carrier and are known as ERPs. There can be ERPs for private passenger automobile or commercial automobile or both.                                                                                                                                                                                                                                                                                                           

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|An insurer may terminate its participation in CAR, for example, by surrendering its license to write automobile policies in Massachusetts. Termination does not discharge or otherwise affect liability of an insurer incurred prior to termination. A withdrawing insurer is assessed a share of CAR's projected deficits for future years based on the insurer's prior years' participation in CAR. The assessment paid by the withdrawing insurer is redistributed to the remaining insurers based on their participation ratios.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|An insurer can transfer its obligations for its personal insurance policies to another insurer who formally agrees to assume these obligations. The transferring insurer is thereby relieved of future CAR obligations which otherwise would have arisen as a consequence of the business transferred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|Insurance Holding Company Structure.As an insurance holding company, we are subject to regulation under the insurance holding company statutes of the states in which any of our subsidiary insurance companies is incorporated. Because our subsidiaries are members of an insurance holding company system, they are required to register with their respective Divisions of Insurance and to submit reports describing:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|California and Ohio have insurance holding company laws similar to those in Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|Each member of the insurance holding company system must keep current the information required to be disclosed by reporting all material changes or additions within 15 days of the end of the month in which it learns of such change or addition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|Massachusetts law prohibits a party that is not a domestic insurer from acquiring "control" of a domestic insurer or of a company controlling a domestic insurer without prior approval of the Commissioner. Control is presumed to exist if a party directly or indirectly holds, owns or controls ten percent or more of the voting stock of another party, but may be rebutted by showing that control does not exist. California and Ohio have laws similar to those in Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|In the event of the insolvency, liquidation or other reorganization of any of our insurance subsidiaries, our creditors and stockholders will have no right to proceed against the assets of those subsidiaries, or to cause the liquidation or bankruptcy of any company under federal or state bankruptcy laws. State laws govern such liquidation or rehabilitation proceedings and the Division of Insurance would act as receiver for the particular company. Creditors and policyholders of the insurance subsidiaries would be entitled to payment in full from such assets before a stockholder, such as Commerce Holdings in our case, would be entitled to receive any distribution therefrom.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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|Payment of Dividends.Under Massachusetts law, an insurer may pay cash dividends only from earnings and statutory surplus, and the insurer's remaining surplus must be both reasonable in relation to its outstanding liabilities and adequate to its financial needs. California and Ohio have similar laws. Following the declaration and payment of such dividends, the insurer must file a report with the Commissioner. A Massachusetts insurance company may not pay an extraordinary dividend or distribution unless the insurer gives the Commissioner at least 30 days' prior notice of the declaration and the Commissioner does not disapprove of the plan of payment prior to the date of such payment. An extraordinary dividend or distribution is one whose fair market value, together with that of other dividends or distributions within the preceding twelve-month period, excluding pro rata distributions of any class of the insurer's own securities, exceeds the greater of (1) ten percent of the insurer's surplus as regards to policyholders as of the preceding year end or (2) the net income of such insurer for the preceding year. California and Ohio have similar laws regulating the payment of dividends by insurance companies to those in Massachusetts.
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|The aggregate amount of dividends calculated in accordance with regulations in Massachusetts, California and Ohio that could have been paid in 2003 from all of our insurance subsidiaries without prior regulatory approval was approximately $76.0 million, of which $66.2 million was declared and paid as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|Protection Against Insurer Insolvency.All insurance companies are required to participate in insurance insolvency fund programs in the states in which they write. For further information, please refer to Note Q to the audited consolidated financial statements included in this Form 10-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|National Association of Insurance Commissions Guidelines.The NAIC Insurance Regulatory Information System, or IRIS, was developed by a committee of state insurance regulators and is intended primarily to assist state insurance regulators in executing their statutory mandates to oversee the financial condition of insurance companies operating in their respective states. IRIS identifies eleven industry ratios and specifies "usual values" for each ratio. Departure from the "usual values" on four or more of the ratios can lead to inquiries from individual state insurance commissioners as to certain aspects of an insurer's business. For the year ended December 31, 2003, our consolidated property and casualty operations had no ratios outside the "usual values."                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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|In order to enhance the regulation of insurer insolvency, the NAIC developed a formula and model law to provide for risk-based capital, or RBC, requirements for property and casualty insurance companies. The model law has since been adopted in all states. RBC requirements are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC model for property and casualty insurance companies measures three major areas of risk facing property and casualty insurers:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|Insurers having less statutory surplus than required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC model formula proposes four levels of regulatory action. The extent of regulatory intervention and action increases as the percentage of surplus to RBC falls. The first level, defined by the NAIC as the "Company Action Level," requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. The second level, defined by the NAIC as the "Regulatory Action Level," requires an insurer to submit a plan containing corrective actions and permits the Commissioner to perform an examination or other analysis and issue a corrective order if surplus falls below 150% of the RBC amount. The third level, the "Authorized Control Level," allows the regulator to rehabilitate or liquidate an insurer in addition to the aforementioned actions if surplus falls below 100% of the RBC amount. The fourth and final action level, the "Mandatory Control Level," requires the regulator to rehabilitate or liquidate the insurer if surplus falls below 70% of the RBC amount. As indicated in the following table, the RBC level of each of our insurance subsidiaries at December 31, 2003 significantly exceeds the 200% RBC level requirements.



|                                                        |          |         |          |   | American |  | Commerce
|------------------------------------------------------- | -------- | ------- | -------- | - | -------- |  | --------
|                                                        | Commerce |         | Citation |   | Commerce |  | West    
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|Statutory surplus                                       | $        | 855,377 |          | $ | 107,387  |  | $       
|200% RBC Company Action Level                           |          | 179,771 |          |   | 5,697    |  |         
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|Statutory surplus in excess of RBC Company Action Level | $        | 675,606 |          | $ | 101,690  |  | $       
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|RBC amounts                                             | $        | 89,885  |          | $ | 2,849    |  | $       
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|Percent of surplus to RBC amounts                       |          | 952%    |          |   | 3,769%   |  |         
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|Competition                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|The property and casualty insurance industry is highly cyclical, characterized by periods of increasing premium rates and limited underwriting capacity, followed by periods of intensive price competition and abundant underwriting capacity. This industry also is highly competitive, with a large number of companies, many of which operate in more than one state, offering automobile, homeowners, commercial property and other lines of insurance. Some of our competitors have larger volumes of business and greater financial resources and some sell insurance directly to policyholders rather than through independent agents.
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|Massachusetts.Because our insurance products are marketed exclusively through independent agencies, most of whom represent more than one company, we face competition within each agency. We compete for business within independent agencies by offering a more attractively priced product to the consumer and by paying agents significant compensation in the form of commissions and profit sharing, which are based in part on the underwriting profits or losses of                                                                                                                                                                    

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|the agency business written with us. We also seek to provide a consistent market, prompt servicing of policyholder claims and effective agency support services. We believe, based upon regular surveys of our agencies, our relationships with our independent agencies are excellent. Any disruption in these relationships could adversely affect our business. We also believe that our relationship with the four AAA clubs that sponsor the AAA affinity group marketing program is excellent. We have agreed that we shall be the AAA clubs' exclusive underwriter of Massachusetts personal automobile group programs, and we have a rolling three-year contract with the AAA clubs. This contract automatically renews annually and may be terminated upon a minimum of two years written notice to us.                                                                                                                                                                                                                                                                                                                                                                
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|We believe that the Massachusetts regulatory environment, which fixes maximum personal automobile insurance rates, assigns ERPs to servicing carriers, apportions losses incurred by CAR and establishes minimum agency commissions, has discouraged certain companies with more traditional underwriting and pricing approaches from establishing a presence or expanding their market share in Massachusetts. Any material change in this situation could adversely affect our business. For additional information, see "Massachusetts Personal Automobile Insurance" in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in this Form 10-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|Other States.We compete with various regional and domestic insurers, national agency companies and direct writers. Some of these competitors have financial resources greater than ours. Any of these competitors could undertake actions that could adversely affect our profitability, such as pricing automobile insurance premiums more aggressively or offering greater compensation to independent agencies. Commerce West's principal competitors in California are Mercury General, with a 2002 market share of 8.5% and Progressive, with a 2002 market share of 2.3%. American Commerce's principal competitors for automobile insurance in its largest state, Arizona, are State Farm, with a 2002 market share of 19.0% and Allstate, with a 2002 market share of 9.7%.                                                                                                                                                                                                                                                                                                                                                                                             
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|Both American Commerce and Commerce West file and seek approval for premium rates with the respective divisions of insurance in the states they do business. American Commerce competes for business by utilizing AAA-owned and operated independent agencies that offer competitively priced products and provide quality service. The AAA-owned independent agencies are offered compensation in the form of commission and profit sharing, based primarily on loss ratios, as well as stock options and bonuses based on the year-over-year increase in the volume of agency business written with American Commerce. Commerce West competes for business by using independent insurance agencies and brokers that offer competitively priced products and provide quality service. We offer compensation to agents and brokers in the form of commissions and profit sharing, which are based in part on the underwriting profits and losses of the agency business written with us. We offer competitively priced products and commissions to agents in New Hampshire. Profit sharing, based on loss experience, is also offered as an inducement for exceptional business.
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|Our Employees                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|As of December 31, 2003, we employed 2,060 people. Commerce and Citation employed 1,783 people; American Commerce employed 198 people; and Commerce West employed 79 people. We are not a party to any collective bargaining agreements, and we believe our relationships with our employees are very good.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
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|Information Available on Our Website                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|We make available, free of charge, on our website (http://www.commerceinsurance.com) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We have posted our code of ethics on our website and it is available in print to any stockholder that requests it.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
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|We have published procedures to contact the Board of Directors and non-management directors on our website and will include these procedures in our Proxy Statement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|Our Insurance Agency Subsidiary                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|Clark-Prout is a wholly-owned insurance agency that offers a full line of insurance products, including policies written by us, as well as policies written by other insurance companies. For the years ended December 31, 2003, 2002, and 2001, Clark-Prout's revenues were less than 0.1% of our consolidated revenues, amounting to $651, $622 and $629, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

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|Our Mortgage Operations                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|Insurance companies are permitted to invest in mortgages. We formed Bay Finance Company, Inc., or Bay Finance, to originate and service residential and commercial mortgages in Massachusetts and, on a limited basis, in Connecticut. For the years ended December 31, 2003, 2002, and 2001, our mortgage operations accounted for less than 0.3% of our consolidated revenues, amounting to $1.2 million, $2.7 million and $3.6 million, respectively.                                                                                                                                                                                                                                                                                                                                                                                                               
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|Our Segments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|We have four reportable segments: (1) property and casualty insurance - Massachusetts; (2) property and casualty insurance - other than Massachusetts; (3) real estate and commercial lending; and (4) corporate and other. Our property and casualty insurance operations are written through Commerce, Citation, Commerce West, and American Commerce and are marketed to affinity groups, individuals, families and businesses through our relationships with professional independent insurance agencies. Our wholly-owned subsidiary, Bay Finance, originates and services residential and commercial mortgages in Massachusetts and Connecticut. The corporate and other segment represents the remainder of our activities, including those of the parent company. For additional segment information, see Note P to our financial statements in this Form 10-K.
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|Risks Related to Our Business                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|Our success is primarily dependent upon how well we manage our business. However, our success could be significantly affected by factors over which we have limited or no control. For example:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | * | Market fluctuations and changes in interest rates have had, and may continue to have, significant and negative effects on our investment portfolio.                                
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | * | We may not be able to alleviate risk through reinsurance arrangements successfully, which could cause us to reduce our premiums written in certain lines or could result in losses.
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | * | We rely on our information technology and telecommunication systems, and the failure of these systems could adversely affect our business.                                         
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|ITEM 2. PROPERTIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|We conduct our Massachusetts operations from approximately 436,000 square feet of space in several buildings that we own in Webster, Massachusetts, which is located approximately 50 miles southwest of Boston. Our principal administrative offices in Webster are recently rehabilitated and newly constructed buildings. Our data processing and operational departments are housed in modern office buildings on a separate 28 acre site. During 2001, we purchased a 130,000 square foot building adjacent to that site. We expended approximately $13 million renovating the building in 2002. Commerce West currently leases approximately 17,000 square feet of office space in Pleasanton, California. Commerce West anticipates it may relocate from its existing leased location within the next one to three years. American Commerce conducts its operations from approximately 40,000 square feet of space in a building it owns located on a two acre site in Columbus, Ohio. American Commerce also leases property at three district claims offices.                                                                                                                                                                                                                                                                                                                                                                                   
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|ITEM 3. LEGAL PROCEEDINGS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|As is common with property and casualty insurance companies, we are a defendant in various legal actions arising from the normal course of our business, including claims based on Massachusetts Chapter 176D and Chapter 93A. See "Settlement of Claims." Similar provisions exist in other states where we do business. We consider these proceedings to be ordinary to operations or without foundation in fact. We believe that these actions will not have a material adverse effect on our consolidated financial position.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|We previously disclosed that a purported class action lawsuit was pending in Massachusetts state court against Commerce. The lawsuit, titled "Elena Given, individually and as a representative of all persons similarly situated v. The Commerce Insurance Company," alleged damages as a result of the alleged inherent diminished value to vehicles that are involved in accidents. In April 2002, the trial judge in that case entered partial summary judgment for the plaintiff on the issue of whether the Massachusetts automobile policy covers her claim, ruling that the plaintiff would be entitled to reimbursement under the policy if the plaintiff were able both to prove that her vehicle suffered "inherent diminished value" in the accident and to quantify the amount of such diminution in value. During the third quarter of 2002, Commerce applied for direct appellate review of this issue by the Supreme Judicial Court of Massachusetts ("SJC"), and this application was granted. On October 7, 2003, the SJC ruled in favor of Commerce, overturning the trial court's decision that the Massachusetts automobile policy provides coverage for inherent diminished value. The plaintiff has dismissed the case. Commerce had not previously established a reserve for any contingent liability related to the Given litigation; therefore, there was no financial impact as a result of the conclusion of this litigation.
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|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|There were no matters submitted to a vote of security holders during the fourth quarter of 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

<PAGE>  30

|PART II                                                                                                                                                                       
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|ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS                                                                                                 
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|Our common stock trades on the NYSE under the symbol "CGI." The high, low and close prices for shares as quoted on Bloomberg.com of our common stock for 2003 and 2002 follow:



|               | 2003   |        | 2002  
|-------------- | ------ | ------ | ------
|               |        |        |       
|               | High   | Low    | Close 
|               |        |        |       
|               |        |        |       
|First Quarter  | $38.38 | $31.70 | $34.20
|Second Quarter | 38.00  | 33.91  | 36.20 
|Third Quarter  | 40.00  | 35.34  | 37.96 
|Fourth Quarter | 41.24  | 37.93  | 39.50 



|As of February 27, 2004, there were 1,031 stockholders of record of our common stock. This number does not include beneficial owners whose stock shares are held in "street name" or held in accounts for participants of our Employee Stock Ownership Plan.                                                                                                                                                                                                                                                                                                                                    
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|Our Board of Directors voted to declare four quarterly dividends to stockholders of record totaling $1.27 per share and $1.23 per share in 2003 and 2002, respectively. On May 16, 2003, the Board voted to increase the quarterly stockholder dividend from $0.31 to $0.32 per share to stockholders of record as of May 30, 2003. Prior to that declaration, we had paid quarterly dividends of $0.31 per share dating back to May 17, 2002 when the Board voted to increase the dividend from $0.30 to $0.31 per share.                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|In November 2001, the Board of Directors authorized a stock buy-back program to purchase shares of our common stock. During the period from January 1, 2003 through December 31, 2003, we purchased 403,572 shares of our own common stock at an average cost of $36.32. At December 31, 2003, we had authority to purchase a total of 574,284 additional shares of our common stock under the current buy-back program. As of December 31, 2003, we held a total of 6,568,964 shares of treasury stock.                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|A portion of our cash flow consists of dividends received from Commerce Holdings, Inc. ("CHI"), which receives dividends from Commerce and Citation. The payment of any cash dividends to holders of common stock by us therefore depends on the receipt of dividend payments from CHI. To the extent Commerce and Citation are restricted from paying dividends, CHI will be limited in its ability to pay dividends to us. The payment of dividends by Commerce and Citation is subject to limitations imposed by Massachusetts law, as discussed in Item 1 of this report under "Regulation."
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|We will provide, upon written request and without charge, a copy of this Form 10-K. Requests must be directed to:                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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<PAGE>  31

|ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA                                                                                                                                                                                                                                                                                                                                                                                                                     
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|The data below should be read in conjunction with the consolidated financial statements, related footnotes, and other financial information included herein. The financial statements for the year ended December 31, 2003 were audited by PricewaterhouseCoopers LLP. The financial statements for the four years ended December 31, 2002 were audited by Ernst & Young LLP. All dollar amounts in the following tables are in thousands, except per share data.



|                                         | 2003 |           | 2002 |   | 2001      |  | 2000 |           | 1999
|---------------------------------------- | ---- | --------- | ---- | - | --------- |  | ---- | --------- | ----
|                                         |      |           |      |   |           |  |      |           |     
|                                         |      |           |      |   |           |  |      |           |     
|Statement of Earnings Data:              |      |           |      |   |           |  |      |           |     
|Net premiums written                     | $    | 1,555,499 |      | $ | 1,313,014 |  | $    | 1,078,967 |     
|Increase in unearned premiums            |      | (109,871) |      |   | (102,974) |  |      | (35,315)  |     
|                                         |      |           |      |   |           |  |      |           |     
|Earned premiums                          |      | 1,445,628 |      |   | 1,210,040 |  |      | 1,043,652 |     
|Net investment income                    |      | 92,183    |      |   | 98,466    |  |      | 99,563    |     
|Premium finance and service fees         |      | 26,908    |      |   | 21,498    |  |      | 17,819    |     
|Amortization of excess of book value     |      |           |      |   |           |  |      |           |     
|of subsidiary interest over cost         |      | -         |      |   | -         |  |      | 3,389     |     
|Net realized investment gains            |      |           |      |   |           |  |      |           |     
|(losses)                                 |      | 76,103    |      |   | (82,385)  |  |      | (10,633)  |     
|Other income                             |      | -         |      |   | 9,500     |  |      | -         |     
|                                         |      |           |      |   |           |  |      |           |     
|Total revenues                           |      | 1,640,822 |      |   | 1,257,119 |  |      | 1,153,790 |     
|                                         |      |           |      |   |           |  |      |           |     
|Losses and loss adjustment expenses      |      | 1,070,147 |      |   | 909,769   |  |      | 781,631   |     
|Policy acquisition costs                 |      | 350,250   |      |   | 295,324   |  |      | 264,377   |     
|Interest expense and amortization        |      |           |      |   |           |  |      |           |     
|of bond fees                             |      | 1,120     |      |   | -         |  |      | -         |     
|                                         |      |           |      |   |           |  |      |           |     
|Total expenses                           |      | 1,421,517 |      |   | 1,205,093 |  |      | 1,046,008 |     
|                                         |      |           |      |   |           |  |      |           |     
|Earnings before income taxes, minority   |      |           |      |   |           |  |      |           |     
|interest and change in accounting        |      |           |      |   |           |  |      |           |     
|principle                                |      | 219,305   |      |   | 52,026    |  |      | 107,782   |     
|Income taxes                             |      | 58,068    |      |   | 17,063    |  |      | 18,392    |     
|                                         |      |           |      |   |           |  |      |           |     
|Earnings before minority interest and    |      |           |      |   |           |  |      |           |     
|change in accounting principle           |      | 161,237   |      |   | 34,963    |  |      | 89,390    |     
|Minority interest in net (earnings) loss |      |           |      |   |           |  |      |           |     
|of subsidiary                            |      | (294)     |      |   | 555       |  |      | 863       |     
|                                         |      |           |      |   |           |  |      |           |     
|Earnings before change in accounting     |      |           |      |   |           |  |      |           |     
|principle                                |      | 160,943   |      |   | 35,518    |  |      | 90,253    |     
|Change in accounting principle,          |      |           |      |   |           |  |      |           |     
|net of taxes                             |      | -         |      |   | 11,237    |  |      | -         |     
|                                         |      |           |      |   |           |  |      |           |     
|Net earnings                             | $    | 160,943   |      | $ | 46,755    |  | $    | 90,253    |     
|                                         |      |           |      |   |           |  |      |           |     
|Comprehensive income                     | $    | 164,762   |      | $ | 59,625    |  | $    | 90,814    |     
|                                         |      |           |      |   |           |  |      |           |     
|Basic earnings per share:                |      |           |      |   |           |  |      |           |     
|Before change in accounting principle    | $    | 5.03      |      | $ | 1.09      |  | $    | 2.69      |     
|Change in accounting principle           |      | -         |      |   | 0.34      |  |      | -         |     
|                                         |      |           |      |   |           |  |      |           |     
|Net earnings                             | $    | 5.03      |      | $ | 1.43      |  | $    | 2.69      |     
|                                         |      |           |      |   |           |  |      |           |     
|Diluted earnings per share:              |      |           |      |   |           |  |      |           |     
|Before change in accounting principle    | $    | 4.99      |      | $ | 1.08      |  | $    | 2.67      |     
|Change in accounting principle           |      | -         |      |   | 0.34      |  |      | -         |     
|                                         |      |           |      |   |           |  |      |           |     
|Net earnings                             | $    | 4.99      |      | $ | 1.42      |  | $    | 2.67      |     
|                                         |      |           |      |   |           |  |      |           |     
|Cash dividends paid per share            | $    | 1.27      |      | $ | 1.23      |  | $    | 1.19      |     
|                                         |      |           |      |   |           |  |      |           |     
|                                         |      |           |      |   |           |  |      |           |     
|                                         |      | 2003      |      |   | 2002      |  |      | 2001      |     
|                                         |      |           |      |   |           |  |      |           |     
|Balance Sheet Data:                      |      |           |      |   |           |  |      |           |     
|Total investments                        | $    | 2,211,099 |      | $ | 1,613,439 |  | $    | 1,530,713 |     
|Premiums receivable                      |      | 361,839   |      |   | 297,610   |  |      | 246,221   |     
|Total assets                             |      | 3,164,231 |      |   | 2,419,073 |  |      | 2,187,143 |     
|Unpaid losses and loss adjustment        |      |           |      |   |           |  |      |           |     
|expenses                                 |      | 957,353   |      |   | 815,626   |  |      | 695,192   |     
|Unearned premiums                        |      | 810,462   |      |   | 687,148   |  |      | 563,456   |     
|Bonds payable                            |      | 297,984   |      |   | -         |  |      | -         |     
|Stockholders' equity                     |      | 912,211   |      |   | 790,052   |  |      | 809,433   |     
|Stockholders' equity per share           |      | 28.45     |      |   | 24.60     |  |      | 24.43     |     

<PAGE>  32

|ITEM 7.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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|Unless otherwise stated, "we," "our" or "us" means The Commerce Group, Inc., "CGI," and its subsidiaries. "Commerce" refers to The Commerce Insurance Company, "Commerce West" refers to Commerce West Insurance Company, "American Commerce" refers to American Commerce Insurance Company, "Citation" refers to Citation Insurance Company, and "AHC" refers to ACIC Holding Co., Inc. In addition, unless otherwise stated, all references to "years ended" are for our fiscal year which ends December 31, and dollar amounts are in thousands, except per share data                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|Overview                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
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|The following discussion and analysis should be read in conjunction with our consolidated financial statements in this Form 10-K.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|We provide personal and commercial property and casualty insurance in Massachusetts and, to a lesser extent, in other states. Casualty insurance is primarily concerned with the losses of the insured due to injuries to other persons and to the property of others, and the legal liability imposed on the insured as a consequence of such losses. Our core product lines are personal automobile, homeowners, and commercial automobile insurance. We market our products exclusively through our network of independent agents, including 650 agents in Massachusetts, 34 agents in New Hampshire, 1,096 agents in California and Oregon, and 28 agents in 16 other states, as of December 31, 2003. Our primary business strategy is to continue to focus on the personal automobile insurance market in Massachusetts and to grow by increasing the proportion of our business in other states in which we currently have a significant presence, primarily as a result of our acquisitions of Commerce West and American Commerce in 1995 and 1999, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
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|Our ability to capitalize on our business strengths and implement our strategies entails particular risks. For example, because we are primarily a personal automobile insurance carrier, adverse developments in this industry could adversely affect us to a greater extent as compared to insurers that are more diversified across multiple business lines. Additionally, the concentration of our business in Massachusetts makes us more susceptible to any adverse development in the prevailing legislative, regulatory, economic, demographic, competitive and other conditions, including weather-related events, and adverse judicial decisions in Massachusetts, and could make it more costly or difficult for us to conduct our business. Regulatory changes to reform the residual market and to enhance competition in Massachusetts are being considered and, if enacted, could adversely affect our market share and profitability. Also, if our affinity relationship with the AAA Clubs of Massachusetts were to be terminated, we would lose a significant avenue for offering our existing affinity group discounts and our sales of personal automobile insurance products in Massachusetts would likely decline, if we are unable to devise and implement effective mitigation measures. As the AAA arrangements have rolling three-year terms, an AAA Club may terminate upon a minimum of two years' written notice. If American Commerce's relationship with one or more large AAA clubs terminates, then American Commerce would lose a substantial portion of its business, which could have a material adverse effect on our business and results of operations. A significant decline in our sales of personal automobile insurance products in Massachusetts would have a material adverse effect on our business and results of operations.
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|Our revenue principally reflects:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                      
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | * | premium finance charges and service fee income that we earn in connection with the billing and deferral of premium payments; and                                                                                                                                                                                                                                        
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | * | realized investment gains (losses).                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                         
|Our expenses principally reflect:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | * | incurred losses and loss adjustment expenses (which we sometimes refer to as LAE), including estimates for losses incurred during the period but not yet reported to us and changes in estimates from prior periods related to direct and assumed business, less the portion of those incurred losses and loss adjustment expenses that are ceded to other insurers; and
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | * | policy acquisition costs, including agent compensation and general and administrative costs, such as salaries and benefits, and advertising that are not deferred for accounting purposes to a future period.                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                         
|Measurement of Results                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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|We evaluate our operations by monitoring key measures of growth and profitability. We measure our growth by examining our direct premiums written as well as increases in exposures and policies. We generally measure our operating results by examining our net income, return on equity, and our loss and LAE, underwriting expense and combined ratios. The following provides further explanation of the key measures that we use to evaluate our results:                                                                                                                                                                                                                                                                                                                                                                                                      
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|Direct Premiums Written.Direct premiums written is the sum of the total policy premiums, net of cancellations, associated with policies underwritten and issued by our insurance subsidiaries. We use direct premiums written, which includes premiums that we cede to CAR and other reinsurers, as a measure of the underlying growth of our insurance business from period to period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|Net Premiums Written.Net premiums written is the sum of direct premiums written for a given period, less premiums ceded to CAR and other reinsurers during such period, plus premiums assumed during such period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
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|Earned Premiums.Earned premiums constitute the portion of net premiums written that is equal to the expired portion of policies and recognized as income for accounting purposes during a given period.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|Investment Income.Investment income relates to earnings on our investment portfolio. We rely on after-tax investment income as a significant source of net earnings since we generally seek to produce a combined ratio (see below) of slightly less than 100%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
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|Loss and LAE Ratio.The loss and LAE ratio is the ratio of losses and loss adjustment expenses incurred to premiums earned, expressed as a percentage, and measures the underwriting profitability of a company's insurance business. This ratio is measured net of our reinsurance recoveries. We use this ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. For our insurance subsidiaries, this ratio is generally calculated using statutory accounting principles which for this purpose are essentially the same as accounting principles generally accepted in the United States of America ("GAAP"). Occasionally we will use the term "pure loss ratio" which refers to the ratio (expressed as a percentage) of incurred losses, excluding LAE, to earned premiums.
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|Underwriting Expense Ratio.The underwriting expense ratio is the ratio of underwriting expenses to net premiums written, expressed as a percentage, determined in accordance with statutory accounting principles. Underwriting expenses are the aggregate of policy acquisition costs, including commissions, and the portion of administrative, general and other expenses attributable to underwriting operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                
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|Combined Ratio.The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio and measures a company's overall underwriting profit. If the combined ratio is at or above 100%, an insurance company cannot be profitable without investment income, and may not be profitable if investment income is insufficient. We use the statutory combined ratio in evaluating our overall underwriting profitability and as a measure for comparison of our profitability relative to the profitability of our competitors.                                                                                                                                                                                                                                                                                                                      
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|Critical Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|The preparation of financial statements in conformity with GAAP requires us 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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|financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We consider the following accounting policies, which are especially dependent upon our judgments and estimates, to be critical to the preparation of our financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
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|Unpaid Losses and Loss Adjustment Expenses.Unpaid losses and LAE, by their nature, are inherently uncertain as to the ultimate outcome of the estimated amounts. The liability for loss and loss adjustment expenses represents our best estimate of the ultimate net cost of all loss and loss adjustment expenses incurred after reinsurance and amounts estimated to be recoverable through salvage and subrogation. The estimate for ultimate net cost of all losses incurred through the balance sheet date includes the adjusted case estimates for losses, incurred but not reported ("IBNR") losses, salvage and subrogation recoverable and a reserve for LAE. In arriving at our best estimate, we begin with the aggregate of individual case reserves and then make adjustments to these amounts on a line of business basis. These adjustments to the aggregate case reserves by line of business are made based on analyses performed by us as further described below. The entire liability for unpaid losses and LAE is also separately reviewed quarterly and annually by our actuarial department. Liability estimates are continually analyzed and updated, and therefore, the ultimate liability may be more or less than the current estimate. The effects of changes in the estimates are included in the results of operations in the period in which the estimates are revised.
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|The claim cycle begins when a claim is reported to us and claims personnel establish a "case reserve" for the estimated amount of our exposure without regard to injury causality, third party liability or potential recoveries. The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding the claim and the policy provisions relating to the loss. This estimate reflects the informed judgment of such personnel based on the experience and knowledge of the claims personnel adjusting the claim. During the loss adjustment period, these case basis estimates are revised as deemed necessary by our claims department personnel based on subsequent developments and periodic reviews of the claim.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|In accordance with industry practice, we also maintain reserves for estimated IBNR, salvage and subrogation recoverable and LAE. These reserves are determined based on historical information and our experience. Adjustments to these reserves are made periodically to take into account changes in the volume of policies written, claims frequency, severity and payment patterns, the mix of business, claims processing and other items that can be expected to affect our liability for losses and LAE over time.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|When reviewing the liability for unpaid losses and LAE, we analyze historical data and estimate the impact of various factors such as:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method, however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves is affected by many factors, as noted above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
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|By using individual estimates of reported claims adjusted for our best estimate by line of business and a review of these results by our actuarial area using generally accepted actuarial reserving techniques, we arrive at our final estimate of our net liability for losses and LAE. After taking into account all relevant factors, we believe that, based on existing information, the provision for losses and LAE at December 31, 2003 is adequate to cover the ultimate net cost of losses and claims incurred as of that date. The ultimate liability, however, may be greater or lower than established reserves. If the ultimate payment is greater than or less than our estimated liability for losses and LAE, we will incur additional expense or income, as appropriate, which may have a material impact on our results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|We calculate our estimate independently from those amounts calculated by our actuaries, and therefore, the final results are most often not the same. We estimate our amounts primarily by reviewing historical loss and LAE data, focusing                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

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|mainly on payment data. We also review and compare the most recent loss frequency, severity, and payment data to historical trends in an attempt to determine if patterns are remaining consistent or not. We attempt to establish our reserve estimate as close as possible to the amount required for the ultimate future payments necessary to settle all losses. Our aggregate actuarial estimate for the loss and LAE reserves, on a consolidated basis and net of reinsurance recoverable, ranges from a low of $694.2 million to a high of $807.9 million, as of December 31, 2003. Our financial statement loss and LAE reserves net of reinsurance, based on our best estimate, was established at $792.3 million for that date.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|Investments.A focus of our judgments and estimates relating to investments involves the potential impairment of investments for other-than-temporary declines in market values. The carrying value of investments in fixed maturities, which include taxable and non-taxable bonds, and investments in common and preferred stocks, are derived from market prices supplied by our investment custodian, or in the few cases where no price is provided by the custodian, we obtain a third party valuation. Fair market value of fixed maturities and equity securities is based on quoted market prices. For other investments, fair value equals quoted market price, if available. Unrealized investment gains and losses on common and preferred stocks and fixed maturities, to the extent that there is no other-than-temporary impairment of value, are credited or charged, net of any tax effect, to a separate component of stockholders' equity, known as "net accumulated other comprehensive income (loss)," until realized.                                                                                                                                                                                                                                                                                                                                                
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|We review all security holdings on a quarterly basis for potential other-than-temporary declines in market value in accordance with GAAP. As part of this process, we consider any significant market declines in the context of the overall market and also in relation to the outlook for the specific issuer of the security. Each quarter, we review all securities whose market values have declined below book price. From a quantitative standpoint, we view all securities that have declined more than 20% below book price and have remained so for two quarters as potentially in need of a write-down. In addition, any other security that we view as impaired for a significant period of time is also a candidate for a write-down, even if the percentage decline is less than 20%. In order to review these holdings, we look at any security that has been in a continuous unrealized loss position (regardless of the amount of the loss) for any period exceeding six months. In this way, we are not only looking at the amount of the unrealized loss, but also at the amount of time the loss has existed. There is a risk that we may assess an other-than-temporary decline in market value as being temporary and, consequently, not charge the impairment to our earnings, which could have a significant impact on our future earnings and financial position.
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|In conjunction with reviewing the amount a security has declined, we also assess the aging of all unrealized losses on a particular security on a quarterly basis. That is, we look at how long a security has been at an unrealized loss position by classifying it within the following categories: under 6 months, 6 to 12 months, 12 to 24 months, 24 to 34 months and greater than 34 months.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|Our net earnings in recent years have been significantly affected by our ownership interests in several closed-end preferred stock mutual funds that we were required to account for using the equity method of accounting. For our investment in any fund in which we own 20% or more of the fund's shares, the equity method of accounting requires us to categorize as a realized investment gain or loss the change in the net asset value of that fund as compared to the end of the immediately preceding fiscal quarter. Our investment in these funds has had a material effect on our realized gains and losses in recent years and may have caused our net earnings to be more volatile than those of similar companies. During 2003, we decreased our ownership below 20% in all but one closed-end preferred stock mutual fund.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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|Massachusetts Personal Automobile Insurance                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
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|Overview.We remain focused on personal automobile insurance and related activities in Massachusetts. We have been the largest writer of personal property and casualty insurance in Massachusetts in terms of market share of direct premiums written since 1990. Our estimated share of the Massachusetts personal automobile market increased to 27.6% during the eleven months ended November 30, 2003, as shown in the table below, significantly exceeding our two nearest competitors, Safety Insurance Group, Inc. and Arbella Insurance Group, who maintained an estimated 10.6% and 9.9% market share, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

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|Growth of Massachusetts Personal Automobile Insured Vehicles
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|Year Ended December 31, 2003 (1)                            
|Year Ended December 31, 2002                                
|Year Ended December 31, 2001                                



|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | Estimated by CAR; market share estimate is as of November 30, 2003.
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|In Massachusetts, private passenger automobile insurance is subject to extensive regulation. Owners of automobiles are generally required to demonstrate certain minimum automobile insurance coverages as a prerequisite to registering any automobile. With very limited exceptions, private passenger automobile insurers are required by law to issue a policy to any applicant seeking to obtain such coverages, commonly known as the "take all comers" law. Based on their market shares, insurers in Massachusetts are also assigned agents, known as ERPs, which have been unable to obtain a voluntary contract with an insurance carrier. Marketing and underwriting strategies for companies operating in Massachusetts are limited by maximum premium rates and minimum agency commission levels for personal automobile insurance, both of which are mandated by the Commissioner. In Massachusetts, accident rates, bodily injury claims, and medical care costs continue to be among the highest in the nation. According to the Automobile Insurers Bureau of Massachusetts, or AIB, Massachusetts "has higher than average medical costs and liability claims involving attorneys." According to the NAIC State Average Expenditure Report, Massachusetts' personal automobile premium per exposure, based on 2001 premium information, was the fourth highest in the nation.
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|Changes in Premium Rates.During the three-year period from 2001 to 2003, average mandated Massachusetts personal automobile insurance premium rates decreased an average of 1.9% per year, primarily due to an 8.3% decrease in 2001. Coinciding with the 2004 rate decision, the Commissioner also approved a 0.9% increase in the commission agents receive for selling private passenger automobile insurance for 2004. The following table shows the state-mandated average rate change, the actual average revenue change per exposure and our average revenue change per exposure as estimated for 2004 and for the three previous years in Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               



|         |  |                        |  | Actual State Average |  | Commerce Average  
|-------- |  | ---------------------- |  | -------------------- |  | ------------------
|         |  | State Mandated Average |  | Revenue Change       |  | Revenue Change Per
|Year     |  | Rate Change (2)        |  | Per Exposure (2)     |  | Exposure          
|         |  |                        |  |                      |  |                   
|         |  |                        |  |                      |  |                   
|2004 (1) |  | 2.5%                   |  | 7.0%                 |  | 5.8%              
|2003     |  | 2.7%                   |  | 8.1%                 |  | 7.9%              
|2002     |  | 0.0%                   |  | 5.0%                 |  | 5.3%              
|2001     |  | (8.3)%                 |  | (3.5)%               |  | (1.9)%            



|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Estimated for actual state and Commerce average revenue change per exposure.
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|(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | Based on Massachusetts Division of Insurance filings.                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                             
|Although mandated average personal automobile premium rates increased 2.7% in 2003, our average revenue per exposure increased 7.9%. We believe that the relative increase for 2003 as compared to the Commissioner's state mandated average rate resulted primarily from several factors:                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | *                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | *                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|The actual state average revenue change per exposure represents the change in the average premium paid by drivers in Massachusetts, as opposed to the state mandated average rate change. As can be seen above, our average revenue change per exposure corresponds more closely to the actual state average revenue change. The reason for this is that both take into account newer vehicles, as compared to the state mandated average rate change, which does not.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|On January 5, 2004, the Massachusetts Attorney General (the "AG") filed an appeal with the Supreme Judicial Court of Massachusetts arguing that the Massachusetts Division of Insurance (the "DOI") "wrongly imposed a 2.5% increase" in average personal automobile premiums for 2004. According to the AG, "for the second consecutive year, the                                                                                                                    

<PAGE>  37

|DOI has, without justification, ruled in favor of an increase in auto insurance rates that will hurt Massachusetts drivers." We cannot predict whether the AG's appeal will be successful, and if so, whether it will have a material impact on us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|CAR.Our performance in our personal and commercial automobile insurance lines in Massachusetts is integrally tied to our participation in CAR, the state-mandated reinsurance mechanism. CAR permits us and most other writers of automobile insurance in Massachusetts to reinsure any automobile risk that the insurer perceives to be under-priced at the premium level permitted by the Commissioner. All companies writing automobile insurance in Massachusetts share in the underwriting results of CAR business for their respective product line or lines. Since CAR's inception, it has annually generated hundreds of millions of dollars of underwriting losses, primarily in the personal pool.                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|We are required to share in CAR's underwriting results. Under current regulations, our share of the CAR personal or commercial deficit is based upon our market share for automobile risks for the particular pool, adjusted by a "utilization" concept, such that, in general, we are disproportionately and adversely affected if our relative use of CAR reinsurance exceeds that of the industry, and favorably affected if our relative use of CAR reinsurance is less than that of the industry.                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|For personal automobile insurance, insurers can reduce their participation ratio by voluntarily writing credit eligible business. Companies are provided credits against their participation ratio for writing those policies that are intentionally underpriced by the Commissioner in the rate setting process. Our strategy has been to maintain above average voluntary retention levels, as well as to voluntarily retain private passenger automobile risks that receive credits. This favorably affects our participation ratio compared to our market share, but also adversely impacts our voluntary loss ratio. We reinsured through CAR approximately 5.1%, 4.9% and 4.9% of our personal automobile exposures for the years ended 2003, 2002 and 2001, respectively, as compared to industry averages of 7.0%, 7.5% and 7.7% for the same periods, respectively. See "Our Business - Commonwealth Automobile Reinsurers."
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Affinity Group Marketing.Since 1995, we have been a leader in affinity group marketing in Massachusetts, through agreements with the four American Automobile Association Clubs operating in Massachusetts, offering discounts on private passenger automobile insurance to the clubs' members who reside in Massachusetts. A 5% discount was approved by the Commissioner for policies effective January 1, 2004. Based on information provided to us by the AAA clubs operating in Massachusetts, we believe that membership in these clubs represents approximately one-third of the Massachusetts motoring public, and has been the primary reason for a 97.9% increase in the number of personal automobile exposures written by us since year-end 1995. The following table presents total direct premiums written attributable to the AAA clubs' group business in Massachusetts for the years ended 2003, 2002 and 2001:     



|                                                |  | For the year Ended,
|----------------------------------------------- |  | -------------------
|                                                |  |                    
|                                                |  | 2003               
|                                                |  |                    
|                                                |  |                    
|Total AAA-Massachusetts direct premiums written |  | $691,700           
|Percentage of total direct premiums written     |  | 41.7%              
|Percentage of Massachusetts direct personal     |  |                    
|automobile premiums                             |  | 58.0%              
|Total AAA-Massachusetts exposures               |  | 649,000            
|Percentage of Massachusetts exposures           |  | 58.1%              



|The decreasing percentages since 2001 is attributed to a higher rate of increase in non-group business as compared to increases in the AAA program. Of the total Massachusetts automobile exposures written through the AAA affinity group program by us, approximately 13.6% were written through insurance agencies owned by the AAA clubs (8.4% of our total Massachusetts automobile exposures). The remaining 86.4% of the AAA group program were written through our network of independent agents (91.6% of our total Massachusetts automobile exposures).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Other States                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Direct premiums written in states other than Massachusetts by American Commerce and Commerce West increased $48.1 million, or 25.9%, to $233.6 million at December 31, 2003 from $185.5 million at December 31, 2002. American Commerce's direct premiums written increased $41.3 million, or 29.7%, primarily due to an increase in personal automobile premiums of $33.2 million, or 29.7%. American Commerce also experienced a 29.7% increase in homeowners premiums written. The increase in personal automobile and homeowners was primarily due to additional rate per policy coupled with a 9.9% increase in business written, offset slightly by a decreased retention in personal automobile in-force policies. Commerce West direct premiums written increased $6.8 million, or 14.8%. The growth for Commerce West is primarily attributable to expansion of commercial and preferred personal automobile programs. Personal automobile direct premiums written by Commerce West increased $3.9 million, or 9.5% primarily from an increase in rates, while commercial automobile direct premiums written increased $2.9 million, or 56.6%, primarily due to a 49.3% increase in the number of policies.

<PAGE>  38

|Year Ended December 31, 2003 Compared to Year Ended December 31, 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Overview                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Our net earnings for the year ended 2003, as compared to 2002, were favorably affected primarily by significant increases in our realized investment gains. We do not expect similar significant increases in our realized investment gains for 2004, nor do we expect our realized gains in 2004 to be similar to those in 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Our after-tax net realized investment gains for the year ended 2003 increased by $121.8 million compared to 2002. The increase was due to after-tax net investment gains for 2003 of $53.4 million compared to after-tax net investment losses of $68.4 million for 2002. The 2003 after-tax net investment gains resulted primarily from:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The 2002 after-tax net investment losses were primarily caused by the decrease in net asset value, or NAV, of our equity investment in closed-end preferred stock mutual funds, the write-down of securities for other-than-temporary impairment of value, and the impact of the valuation allowance on deferred taxes. See "Investment Gains and Losses."                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Partially offsetting the change in after-tax net investment gains (losses) was the effect of two one-time items which increased 2002 income. In 2002, we had $9.5 million of other income and $11.2 million for the after-tax cumulative effect of a change in accounting for negative goodwill. The $9.5 million of prior year other income was related to payments received from other insurance carriers under agreements to assume their Massachusetts personal automobile insurance business written in Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Our losses and loss adjustment expenses increased by $160.4 million, or 17.6%, for the year ended 2003 compared to 2002. The increase resulted primarily from our premium growth partially offset by a decrease in our loss ratio (on a statutory basis) to 73.4% from 75.1% in 2002. The decrease was primarily driven by slightly more favorable experience in the current year personal automobile line of business due to increases in average earned premium revenue per automobile and more favorable loss reserve development compared to 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Our policy acquisition costs increased by $54.9 million, or 18.6% for the year ended 2003 compared to 2002. The increase resulted primarily from our premium growth, partially offset by a decrease in our underwriting ratio (on a statutory basis) to 22.9% for the year ended 2003 compared to 23.6% for 2002. The decrease in our underwriting ratio was primarily due to lower 2003 policy year mandated Massachusetts personal automobile commission rates. See "Policy Acquisition Costs."                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Certain corporate expenses included in our loss adjustment expenses and policy acquisition costs do not impact the statutory loss and LAE ratio or the statutory underwriting ratio because they are not expenses borne by our insurance subsidiaries. These expenses are primarily related to stock options granted to agents of American Commerce and book value awards granted to our officers. During 2003, corporate expenses related to the American Commerce agents' options increased to $9.0 million, as compared to $1.5 million in 2002. This increase was due to an increase in the market value of our common stock, an increase in the number of stock options outstanding, an additional year of vesting of those stock options granted in prior years and changes in estimates made to certain assumptions used in our fair value estimation. The corporate expenses related to the book value awards amounted to $7.1 million in 2003, as compared to $1.0 million in 2002. The value of book value awards is primarily related to the growth in our stockholders' equity. At December 31, 2003, our stockholders' equity per share was $28.45, as compared to $24.60 at December 31, 2002.

<PAGE>  39

|Premiums                                                                                                                                        
|------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                
|The following table and discussion compares direct premiums written, net premiums written and earned premiums for the years ended 2003 and 2002.



|                                       | 2003       |  | 2002        |  | Change    |  | Change
|-------------------------------------- | ---------- |  | ----------- |  | --------- |  | ------
|                                       |            |  |             |  |           |  |       
|                                       |            |  |             |  |           |  |       
|Direct Premiums Written:               |            |  |             |  |           |  |       
|Personal automobile in Massachusetts   | $1,191,123 |  | $1,032,438  |  | $ 158,685 |  | 15.4% 
|Personal automobile in other states    | 194,409    |  | 155,045     |  | 39,364    |  | 25.4% 
|Commercial automobile in Massachusetts | 89,862     |  | 74,879      |  | 14,983    |  | 20.0% 
|Commercial automobile in other states  | 8,067      |  | 5,151       |  | 2,916     |  | 56.6% 
|Homeowners in Massachusetts            | 102,951    |  | 83,610      |  | 19,341    |  | 23.1% 
|Homeowners in other states             | 36,098     |  | 27,376      |  | 8,722     |  | 31.9% 
|Other lines in Massachusetts           | 35,468     |  | 27,593      |  | 7,875     |  | 28.5% 
|Other lines in all other states        | 991        |  | 764         |  | 227       |  | 29.7% 
|                                       |            |  |             |  |           |  |       
|Total Direct Premiums Written          | $1,658,969 |  | $1,406,856  |  | $ 252,113 |  | 17.9% 
|                                       |            |  |             |  |           |  |       
|                                       |            |  |             |  |           |  |       
|Net Premiums Written:                  |            |  |             |  |           |  |       
|Personal automobile in Massachusetts   | $1,101,171 |  | $   958,639 |  | $ 142,532 |  | 14.9% 
|Personal automobile in other states    | 194,353    |  | 152,796     |  | 41,557    |  | 27.2% 
|Commercial automobile in Massachusetts | 74,529     |  | 62,072      |  | 12,457    |  | 20.1% 
|Commercial automobile in other states  | 7,705      |  | 4,968       |  | 2,737     |  | 55.1% 
|Homeowners in Massachusetts            | 38,476     |  | 24,145      |  | 14,331    |  | 59.4% 
|Homeowners in other states             | 13,234     |  | 6,142       |  | 7,092     |  | 115.5%
|Other lines in Massachusetts           | 11,262     |  | 6,693       |  | 4,569     |  | 68.3% 
|Other lines in all other states        | 405        |  | 235         |  | 170       |  | 72.3% 
|Assumed premiums from CAR              | 112,547    |  | 96,269      |  | 16,278    |  | 16.9% 
|Assumed premiums from other than CAR   | 1,817      |  | 1,055       |  | 762       |  | 72.2% 
|                                       |            |  |             |  |           |  |       
|Total Net Premiums Written             | $1,555,499 |  | $1,313,014  |  | $ 242,485 |  | 18.5% 
|                                       |            |  |             |  |           |  |       
|                                       |            |  |             |  |           |  |       
|Earned Premiums:                       |            |  |             |  |           |  |       
|Personal automobile in Massachusetts   | $1,028,854 |  | $   878,739 |  | $ 150,115 |  | 17.1% 
|Personal automobile in other states    | 186,072    |  | 146,381     |  | 39,691    |  | 27.1% 
|Commercial automobile in Massachusetts | 68,537     |  | 55,752      |  | 12,785    |  | 22.9% 
|Commercial automobile in other states  | 6,631      |  | 3,139       |  | 3,492     |  | 111.2%
|Homeowners in Massachusetts            | 30,302     |  | 21,682      |  | 8,620     |  | 39.8% 
|Homeowners in other states             | 10,092     |  | 5,459       |  | 4,633     |  | 84.9% 
|Other lines in Massachusetts           | 8,841      |  | 7,007       |  | 1,834     |  | 26.2% 
|Other lines in all other states        | 331        |  | 206         |  | 125       |  | 60.7% 
|Assumed premiums from CAR              | 104,297    |  | 90,594      |  | 13,703    |  | 15.1% 
|Assumed premiums from other than CAR   | 1,671      |  | 1,081       |  | 590       |  | 54.6% 
|                                       |            |  |             |  |           |  |       
|Total Earned Premiums                  | $1,445,628 |  | $1,210,040  |  | $ 235,588 |  | 19.5% 
|                                       |            |  |             |  |           |  |       
|                                       |            |  |             |  |           |  |       
|Earned premiums in Massachusetts       | $1,136,534 |  | $   963,180 |  | $ 173,354 |  | 18.0% 
|Earned premiums - assumed              | 105,968    |  | 91,675      |  | 14,293    |  | 15.6% 
|Earned premiums in all other states    | 203,126    |  | 155,185     |  | 47,941    |  | 30.9% 
|                                       |            |  |             |  |           |  |       
|Total Earned Premiums                  | $1,445,628 |  | $1,210,040  |  | $ 235,588 |  | 19.5% 
|                                       |            |  |             |  |           |  |       



|The increase in Massachusetts personal automobile direct premiums written during 2003 resulted primarily from a 7.9% increase in average written premium per written exposure coupled with a 6.9% increase in the number of exposures written. We attribute the growth in exposures to increased penetration of our independent agents' books of business as the overall number of exposures in Massachusetts has had less than 1% growth during the period. The increase in other than Massachusetts personal automobile and homeowners business was primarily due to additional rate per policy coupled with an approximate 10% increase in business written, offset slightly by a decreased retention in personal automobile in-force policies.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Our increase in Massachusetts commercial automobile premiums is directly related to our effort to increase writings in this line of business and from increases in the average rate per policy. Our increase in Massachusetts homeowner premiums is primarily related to:                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

<PAGE>  40

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | *           | an 11.4% increase in average premium per policy;                                                                                        
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | *           | increases in policy count due to an increased number of agents;                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | *           | fewer carriers writing homeowner business;                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | *           | our pricing position in the marketplace; and,                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | *           | agents writing more homeowner business to achieve a homeowner discount for their customer when we also insure the customer's automobile.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|The increase in total earned premiums for 2003 was primarily attributable to increases in personal and commercial automobile business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Net Investment Income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Net investment income is affected by the composition of our investment portfolio and yields on those investments. As depicted in the following table, net investment income for the year ended 2003 decreased $6.3 million, or 6.4%, compared to 2002, principally as a result of a decrease in average yields partially offset by an increase in average invested assets at cost. The decrease in yield is primarily due to lower short-term yields coupled with an environment of lower average long-term yields and higher yielding investment securities being called. The decline in average long-term yields is illustrated by a decrease in the yield on 10-year government bonds which declined 59 basis points from an average of 4.57% at December 31, 2002 to an average of 3.98% at December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | Years Ended
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 2003        |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|Investment Return:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |             |                                                                                                                                         
|Average month-end investments (at cost)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | $ 1,742,869 |                                                                                                                                         
|Net investment income before tax                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | 92,183      |                                                                                                                                         
|Net investment income after-tax                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 73,210      |                                                                                                                                         
|Net investment income as a percentage of average net investments (at cost)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 5.3%        |                                                                                                                                         
|Net investment income after-tax as a percentage of average net investments (at cost)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  | 4.2%        |                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |             |                                                                                                                                         
|Premium Finance and Service Fees                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Premium finance and service fees increased $5.4 million, or 25.2%, during the year ended 2003, as a result of increased business and a service fee increase on Massachusetts new and renewal business from $3.00 to $4.00 per installment payment, for policies with effective dates on or after July 1, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Investment Gains and Losses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Net realized investment gains totaled $76.1 million, or $1.66 per diluted share, for the year ended 2003 as compared to net realized investment losses of $82.4 million, or $2.07 per diluted share, for 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|During 2003, we sold a significant portion of our securities with unrealized gains in order to implement a change in our investment view. Our investment strategy emphasizes investment yield while maintaining investment quality. The focus of our investment objectives continues to be maximizing after-tax investment income through investing in high quality diversified investments structured to maximize after-tax investment income while minimizing risk. A secondary objective is to achieve above average after-tax total return. Our funds are generally invested in securities with maturities intended to provide adequate funds to pay claims and meet other operating needs without the forced sale of investments. This change in view caused us to reduce the average duration of our investment portfolio during the second and third quarters, which in turn resulted in the sale of a number of securities that had increased in value significantly as overall credit spreads tightened. This caused overall portfolio turnover (e.g. volume of trades) to increase beyond that of recent years. The portfolio sales occurred in securities that had been purchased during 2003 as well as those purchased in previous years. Thus, while we did sell some higher yielding instruments, the overall after-tax yield of the portfolio did not fall significantly beyond the decline in interest rates as a whole. During the third quarter as interest rates rose, we began to invest in longer-term securities, resulting in a slightly higher duration at year end. Primarily as a result of these sales, we realized net investment gains of $56.3 million in those categories for the year ended 2003, compared to a net realized investment loss of $1.3 million on sales of securities in those categories during 2002.

<PAGE>  41

|Of the remaining $76.1 million total of net realized gains, we recognized net gains of $37.7 million for the year ended 2003 attributable to the change in the net asset value of seven closed-end preferred stock mutual funds in which we owned 20% or more through the period our ownership remained greater than 20%. During the third and fourth quarters of 2003, we dropped below the 20% ownership level and did not have the ability to exercise significant influence over operating and financial policies for six funds. Therefore, as of December 31, 2003, the investments were reported at fair market value and the unrealized gains or losses from the point our ownership fell below 20% to year end were reported as comprehensive income. See "Critical Accounting Policies -Investments." For the year ended 2003, the net realized investment gains attributable to these fund investments were $37.7 million, as compared to net realized investment losses of $45.1 million for that category of investments for 2002. Market conditions during 2003 caused a significant increase in the net asset value of those funds and, as a direct consequence, an increase in the net realized investment gains that we recognized for those investments for the year ended 2003.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Our gains on investment securities were partially offset by write-downs for other-than-temporary declines in the market value of certain fixed maturities, preferred stocks and common stocks totaling $17.6 million and $32.1 million for the years ended 2003 and 2002, respectively. The other-than-temporary write-downs for the 2003 period consisted of $2.4 million for one municipal bond, $7.1 million for three corporate bonds, $7.3 million for three preferred stocks and $0.8 million for five common stocks. The other than temporary write-downs for 2002 consisted of $0.8 million for one municipal bond, $16.1 million for three corporate bonds, $9.1 million for eight preferred stocks and $6.1 million for two common stocks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

<PAGE>  42

|We use the aging table below in our analysis of our exposure to potential other-than-temporary impairment. Gross unrealized losses on our fixed maturity and equity securities at December 31, 2003 by duration of unrealized loss and by credit quality (for fixed maturity securities) follow (dollars in thousands):
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                         |       |          | 0 - 6  |   | 6 - 12  |  | 12 - 24 |         | Over 24
|---------------------------------------- | ----- | -------- | ------ | - | ------- |  | ------- | ------- | -------
|                                         | Total |          | Months |   | Months  |  | Months  |         | Months 
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Total equity and fixed maturity          |       |          |        |   |         |  |         |         |        
|securities:                              |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 135      |        |   | 52      |  |         | 59      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 677,761  |        | $ | 307,839 |  | $       | 313,455 |        
|Total amortized cost                     |       | 692,761  |        |   | 311,379 |  |         | 322,933 |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (15,000) |        | $ | (3,540) |  | $       | (9,478) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 2.2%     |        |   | 1.1%    |  |         | 3.0%    |        
|                                         |       |          |        |   |         |  |         |         |        
|Equity securities:                       |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 31       |        |   | 11      |  |         | 16      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 95,922   |        | $ | 37,250  |  | $       | 48,468  |        
|Total cost                               |       | 99,332   |        |   | 38,179  |  |         | 50,720  |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (3,410)  |        | $ | (929)   |  | $       | (2,252) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 3.6%     |        |   | 2.5%    |  |         | 4.6%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fixed maturity securities:         |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 104      |        |   | 41      |  |         | 43      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 581,839  |        | $ | 270,589 |  | $       | 264,987 |        
|Total amortized cost                     |       | 593,429  |        |   | 273,200 |  |         | 272,213 |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (11,590) |        | $ | (2,611) |  | $       | (7,226) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 2.0%     |        |   | 1.0%    |  |         | 2.7%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Investment grade fixed maturity          |       |          |        |   |         |  |         |         |        
|securities:                              |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 97       |        |   | 35      |  |         | 43      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 562,754  |        | $ | 254,934 |  | $       | 264,987 |        
|Total amortized cost                     |       | 574,109  |        |   | 257,315 |  |         | 272,213 |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (11,355) |        | $ | (2,381) |  | $       | (7,226) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 2.0%     |        |   | 0.9%    |  |         | 2.7%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Below investment grade fixed maturity    |       |          |        |   |         |  |         |         |        
|securities:                              |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 7        |        |   | 6       |  |         | -       |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 19,085   |        | $ | 15,655  |  | $       | -       |        
|Total amortized cost                     |       | 19,320   |        |   | 15,885  |  |         | -       |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (235)    |        | $ | (230)   |  | $       | -       |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 1.2%     |        |   | 1.5%    |  |         | -%      |        
|                                         |       |          |        |   |         |  |         |         |        



|None of our securities at December 31, 2003 has been in an unrealized loss position for more than 34 months. For our unrealized loss positions held between 24 and 34 months, 27%, or $12.7 million (cost), were rated AAA and were generally below amortized cost primarily due to interest rate moves. In addition, 56%, or $26.7 million, were invested in municipal bonds, all of which were rated investment grade. We do not believe any of these bonds warrant an other-than-temporary write-down as their fair values were below cost primarily due to general market conditions and not due to specific credit concerns of the obligor. The remaining 17%, or $8.2 million, consists of utility company preferred stocks rated BA2/BB+. The operating company of this utility is rated investment grade. We believe these unrealized losses are temporary in nature, that the obligor will continue to meet its obligations and we intend to hold these securities to their maturity. We will continue to monitor these holdings closely.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|For our unrealized loss positions held between 12 and 24 months, 45%, or $4.8 million (cost), were rated AAA and generally had market values that were below amortized cost due to the effect of interest rate moves. In addition, 23%, or $2.5 million, were investment grade rated municipal bonds and preferred stocks which we feel will continue to meet their obligations. The remaining 32%, or $3.4 million, is attributable to a B rated municipal housing issuer from which we expect                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

<PAGE>  43

|to receive full payment upon the sale of assets underlying the securities. The closing of this transaction is expected in the first quarter of 2004.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|For our unrealized loss positions held between 6 and 12 months, approximately 74%, or $238.7 million (cost), were rated AAA and generally had market values below amortized cost due to interest rate moves. In addition, 25%, or $79.6 million, were invested in investment grade corporate and municipal bonds and preferred stocks. We view the declines in these securities as temporary, as the declines were principally due to market conditions and not due to the specific credit concerns of the obligor. Lastly, about 1.5%, or $4.5 million, were invested in utility preferred stocks that were rated below investment grade, though the respective operating companies carry investment grade ratings. We believe these unrealized losses are temporary in nature, that the obligor will continue to meet its obligations and we intend to hold these securities to their maturity. We will continue to monitor these holdings closely.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Unrealized losses from our below investment grade fixed maturity securities by credit quality at December 31, 2003 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|                                                              |       |      |    |   |      |  | CC or
|------------------------------------------------------------- | ----- | ---- | -- | - | ---- |  | -----
|                                                              | Total |      | BB |   | B    |  | Lower
|                                                              |       |      |    |   |      |  |      
|                                                              |       |      |    |   |      |  |      
|State and political subdivision                               | $     | 6    |    | $ | -    |  | $    
|Corporate                                                     |       | 229  |    |   | 157  |  |      
|                                                              |       |      |    |   |      |  |      
|Total                                                         | $     | 235  |    | $ | 157  |  | $    
|                                                              |       |      |    |   |      |  |      
|                                                              |       |      |    |   |      |  |      
|Percentage of total fixed maturity security unrealized losses |       | 2.1% |    |   | 1.4% |  |      
|                                                              |       |      |    |   |      |  |      



|Losses and Loss Adjustment Expenses                                                                                                                                                                                                                                                                                                                                                  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                     
|Our loss and LAE ratio (on a statutory basis) decreased to 73.4% for the year ended 2003 compared to 75.1% for 2002. The decrease was primarily driven by slightly more favorable experience in the current year personal automobile line of business due to increases in average earned premium revenue per automobile and more favorable loss reserve development compared to 2002.
|                                                                                                                                                                                                                                                                                                                                                                                     
|A reconciliation of beginning and ending reserves for losses and loss adjustment expenses for the years ended 2003 and 2002, net of reinsurance deductions from all reinsurers including CAR, follows:                                                                                                                                                                               



|                                                                                        | 2003 |           | 2002
|--------------------------------------------------------------------------------------- | ---- | --------- | ----
|                                                                                        |      |           |     
|                                                                                        |      |           |     
|Incurred losses and LAE:                                                                |      |           |     
|Provision for insured events of the current year                                        | $    | 1,095,371 |     
|Decrease in provision for insured events of prior years                                 |      | (25,224)  |     
|                                                                                        |      |           |     
|Total incurred losses and LAE                                                           |      | 1,070,147 |     
|                                                                                        |      |           |     
|Payments:                                                                               |      |           |     
|Losses and LAE attributable to insured events of the current year                       |      | 625,803   |     
|Losses and LAE attributable to insured events of prior years                            |      | 330,349   |     
|                                                                                        |      |           |     
|Total payments                                                                          |      | 956,152   |     
|                                                                                        |      |           |     
|Increase in loss and LAE reserves during the year                                       |      | 113,995   |     
|Loss and LAE reserves prior to the effect of ceded reinsurance recoverable, beginning   |      |           |     
|of year                                                                                 |      | 678,348   |     
|                                                                                        |      |           |     
|Loss and LAE reserves prior to the effect of ceded reinsurance recoverable, end of year |      | 792,343   |     
|Ceded reinsurance recoverable                                                           |      | 165,010   |     
|                                                                                        |      |           |     
|Loss and LAE reserves, end of year                                                      | $    | 957,353   |     
|                                                                                        |      |           |     



|As a result of changes in estimates of insured events in prior years, the provision for loss and loss adjustment expenses decreased $25,224 for the year ended 2003 and $14,437 for the year ended 2002. The favorable development is due primarily to lower than anticipated losses related to the personal automobile liability line of business, offset by worse development in automobile physical damage and commercial automobile liability. Conditions and trends that have affected development in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based upon these developments. The amounts we will ultimately incur from loss and loss adjustment expenses could differ materially in the near term from the amounts recorded.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  44

|Approximately $35,000 in personal automobile liability redundancies developed for the year ended 2003, with two thirds of this amount coming from the 2002 and 2001 accident years. The remaining redundancy in this area came about evenly from the four accident years prior to this. The primary reason for the redundancies in this area is that claim severity came in better than we anticipated. The approximate $4,700 worse development in automobile physical damage occurred in the 2002 accident year offset by redundancies in the 2001 accident year. The 2002 impact was mainly from higher IBNR claims as a result of a severe winter storm during the last week of 2002, coupled with higher severity on physical damage claims. The 2001 redundancies primarily resulted from higher than anticipated subrogation. We also experienced deficiencies of $2,300 and $1,500 for accident years 2001 and 2002, respectively, in 2003 in our commercial automobile liability area. These deficiencies were primarily related to higher severity as compared to claims incurred in prior years. Various redundancies and deficiencies for the other lines of business and accident years combined for the remaining approximately $1,300 net deficiency.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|The redundancies for year end 2002 primarily related to the 2001 personal automobile liability area, as claim severity mainly came in better than anticipated and was offset by worse development for the previous accident years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Total unpaid losses and LAE by line of business at December 31, 2003 and 2002 follow (in millions):                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 



|                             | 2003 |       | 2002
|---------------------------- | ---- | ----- | ----
|                             |      |       |     
|                             |      |       |     
|Private passenger automobile | $    | 575.3 |     
|Commercial automobile        |      | 47.0  |     
|CAR                          |      | 240.3 |     
|Homeowners                   |      | 58.4  |     
|Other                        |      | 36.4  |     
|                             |      |       |     
|Total                        | $    | 957.4 |     
|                             |      |       |     



|Ceded unpaid losses and LAE recoverable by line of business at December 31, 2003 and 2002 follow (in millions):
|---------------------------------------------------------------------------------------------------------------



|                             | 2003 |       | 2002
|---------------------------- | ---- | ----- | ----
|                             |      |       |     
|                             |      |       |     
|Private passenger automobile | $    | -     |     
|Commercial automobile        |      | -     |     
|CAR                          |      | 107.1 |     
|Homeowners                   |      | 34.4  |     
|Other                        |      | 23.6  |     
|                             |      |       |     
|Total                        | $    | 165.1 |     
|                             |      |       |     



|Unpaid losses and LAE reserves prior to the effect of ceded reinsurance recoverable, by line of business, at December 31, 2003 and 2002, and the actuarial low and high range estimates at December 31, 2003 follow (in millions):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                             |      |       |      |   | 2003 Actuarial Estimate
|---------------------------- | ---- | ----- | ---- | - | -----------------------
|                             |      |       |      |   |                        
|                             | 2003 |       | 2002 |   | Low                    
|                             |      |       |      |   |                        
|                             |      |       |      |   |                        
|Private passenger automobile | $    | 575.3 |      | $ | 500.1                  
|Commercial automobile        |      | 47.0  |      |   | 35.8                   
|CAR                          |      | 133.2 |      |   | 115.5                  
|Homeowners                   |      | 24.0  |      |   | 18.1                   
|Other                        |      | 12.8  |      |   | 8.8                    
|                             |      |       |      |   |                        
|Total                        | $    | 792.3 |      | $ | 678.3                  
|                             |      |       |      |   |                        



|Policy Acquisition Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|As a percentage of net premiums written, statutory underwriting expenses for our insurance subsidiaries improved to 22.9% for the year ended 2003 as compared to 23.6% for 2002. The improvement was primarily due to lower 2003 policy year mandated Massachusetts personal automobile commission rates partially offset by a charge for an assessment from the Massachusetts Insurers Insolvency Fund ("MIIF") of $8.1 million in 2003, compared to a 2002 MIIF charge of $4.5 million.

<PAGE>  45

|Combined Ratio                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|For the year ended 2003, our statutory combined ratio was 96.3%, compared with 98.7% for 2002. The decrease in the combined ratio was primarily the result of the factors that resulted in the lower loss and underwriting ratios previously mentioned.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Our overall effective tax rate for the year ended 2003 was 26.5% as compared to 32.8% for 2002. In both years, our effective rate was lower than the statutory rate of 35.0% primarily due to tax-exempt interest and the corporate dividends received deduction. Our income tax rate for the year ended 2002 was adversely impacted by a tax valuation allowance of $3.9 million related to a deferred tax asset previously established for realized investment losses. Our income tax rate for 2003 was benefited by the reversal of the tax valuation allowance from 2002.                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Change in Accounting Principle                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Due to the effect of a change in accounting principle related to goodwill, we recorded income in the first quarter of 2002, net of taxes, of $11.2 million, or $0.34 per share (diluted). This amount represented the remaining unamortized negative goodwill related to closed-end preferred stock mutual funds and the remaining excess of book value of subsidiary interest over cost relating to the 1999 acquisition of American Commerce. Negative goodwill and the excess of book value of subsidiary interest over cost were created in these acquisitions because the underlying value of the assets purchased exceeded the purchase price. The subsequent recognition of income that occurred as these items were eliminated was not a taxable event but instead became part of the basis of the acquired asset.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Year Ended December 31, 2002 compared to Year Ended December 31, 2001                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Overview                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Our net earnings for the year ended 2002 were adversely affected primarily by a significant increase in our net realized investment losses and, to a lesser extent, by an increase in our losses and loss adjustment expenses, which together more than offset an increase in our earned premiums.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Our after-tax net realized investment losses increased by $62.6 million for the year ended 2002 compared to the year ended 2001. The increased losses resulted primarily from:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Our losses and loss adjustment expenses increased by $128.1 million, or 16.4%, in 2002 compared to 2001. The increase resulted primarily from our premium growth and an increase in our loss ratio (on a statutory basis) to 75.1% for 2002 compared to 74.5% for 2001. See "Losses and Loss Adjustment Expenses."                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Our earned premiums increased by $166.4 million, or 15.9%, in 2002 compared to 2001, primarily resulting from:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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<PAGE>  46

|Premiums                                                                                                                                        
|------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                
|The following table and discussion compares direct premiums written, net premiums written and earned premiums for the years ended 2002 and 2001:



|                                       | 2002        |  | 2001        |  | Change    |  | Change
|-------------------------------------- | ----------- |  | ----------- |  | --------- |  | ------
|                                       |             |  |             |  |           |  |       
|Direct Premiums Written                |             |  |             |  |           |  |       
|Personal automobile in Massachusetts   | $1,032,438  |  | $   859,922 |  | $ 172,516 |  | 20.1% 
|Personal automobile in other states    | 155,045     |  | 122,320     |  | 32,725    |  | 26.8% 
|Commercial automobile in Massachusetts | 74,879      |  | 58,088      |  | 16,791    |  | 28.9% 
|Commercial automobile in other states  | 5,151       |  | 1,514       |  | 3,637     |  | 240.2%
|Homeowners in Massachusetts            | 83,610      |  | 69,716      |  | 13,894    |  | 19.9% 
|Homeowners in other states             | 27,376      |  | 18,710      |  | 8,666     |  | 46.3% 
|Other lines in Massachusetts           | 27,593      |  | 21,423      |  | 6,170     |  | 28.8% 
|Other lines in all other states        | 764         |  | 714         |  | 50        |  | 7.0%  
|                                       |             |  |             |  |           |  |       
|Total Direct Premiums Written          | $1,406,856  |  | $1,152,407  |  | $ 254,449 |  | 22.1% 
|                                       |             |  |             |  |           |  |       
|                                       |             |  |             |  |           |  |       
|Net Premiums Written:                  |             |  |             |  |           |  |       
|Personal automobile in Massachusetts   | $   958,639 |  | $   797,534 |  | $ 161,105 |  | 20.2% 
|Personal automobile in other states    | 152,796     |  | 122,256     |  | 30,540    |  | 25.0% 
|Commercial automobile in Massachusetts | 62,072      |  | 48,991      |  | 13,081    |  | 26.7% 
|Commercial automobile in other states  | 4,968       |  | 1,477       |  | 3,491     |  | 236.4%
|Homeowners in Massachusetts            | 24,145      |  | 19,481      |  | 4,664     |  | 23.9% 
|Homeowners in other states             | 6,142       |  | 4,576       |  | 1,566     |  | 34.2% 
|Other lines in Massachusetts           | 6,693       |  | 4,661       |  | 2,032     |  | 43.6% 
|Other lines in all other states        | 235         |  | 172         |  | 63        |  | 36.6% 
|Assumed premiums from CAR              | 96,269      |  | 79,360      |  | 16,909    |  | 21.3% 
|Assumed premiums from other than CAR   | 1,055       |  | 459         |  | 596       |  | 129.8%
|                                       |             |  |             |  |           |  |       
|Total Net Premiums Written             | $1,313,014  |  | $1,078,967  |  | $ 234,047 |  | 21.7% 
|                                       |             |  |             |  |           |  |       
|                                       |             |  |             |  |           |  |       
|Earned Premiums:                       |             |  |             |  |           |  |       
|Personal automobile in Massachusetts   | $   878,739 |  | $   776,552 |  | $ 102,187 |  | 13.2% 
|Personal automobile in other states    | 146,381     |  | 116,479     |  | 29,902    |  | 25.7% 
|Commercial automobile in Massachusetts | 55,752      |  | 43,008      |  | 12,744    |  | 29.6% 
|Commercial automobile in other states  | 3,139       |  | 711         |  | 2,428     |  | 341.5%
|Homeowners in Massachusetts            | 21,682      |  | 18,286      |  | 3,396     |  | 18.6% 
|Homeowners in other states             | 5,459       |  | 3,731       |  | 1,728     |  | 46.3% 
|Other lines in Massachusetts           | 7,007       |  | 4,123       |  | 2,884     |  | 69.9% 
|Other lines in all other states        | 206         |  | 158         |  | 48        |  | 30.4% 
|Assumed premiums from CAR              | 90,594      |  | 80,176      |  | 10,418    |  | 13.0% 
|Assumed premiums from other than CAR   | 1,081       |  | 428         |  | 653       |  | 152.6%
|                                       |             |  |             |  |           |  |       
|Total Earned Premiums                  | $1,210,040  |  | $1,043,652  |  | $ 166,388 |  | 15.9% 
|                                       |             |  |             |  |           |  |       
|                                       |             |  |             |  |           |  |       
|Earned premiums in Massachusetts       | $   963,180 |  | $   841,969 |  | $ 121,211 |  | 14.4% 
|Earned premiums - assumed              | 91,675      |  | 80,604      |  | 11,071    |  | 13.7% 
|Earned premiums in all other states    | 155,185     |  | 121,079     |  | 34,106    |  | 28.2% 
|                                       |             |  |             |  |           |  |       
|Total Earned Premiums                  | $1,210,040  |  | $1,043,652  |  | $ 166,388 |  | 15.9% 
|                                       |             |  |             |  |           |  |       

<PAGE>  47

|The increase in Massachusetts personal automobile direct premiums written resulted primarily from increases of 13.8% and 14.0% in the number of Massachusetts personal automobile exposures for liability and physical damage coverage, respectively, and from increases in rates for the coverage types noted below. The components of these changes for 2002 and 2001 follow:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                           |  | 2002            |  | 2001           
|-------------------------- |  | --------------- |  | ---------------
|Coverage Type              |  | Rate Change (1) |  | Rate Change (1)
|                           |  |                 |  |                
|                           |  |                 |  |                
|Liability:                 |  |                 |  |                
|Bodily injury              |  | 6.0%            |  | (2.1)%         
|Personal injury protection |  | 18.7%           |  | (12.9)%        
|Property damage to others  |  | 3.9%            |  | 1.0%           
|Physical Damage:           |  |                 |  |                
|Collision                  |  | 4.8%            |  | (0.1)%         
|Comprehensive              |  | 0.1%            |  | (7.6)%         
|Total (2)                  |  | 5.3%            |  | (1.9)%         



|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | Represents change in our average rate per exposure from our prior year average rate for Massachusetts private passenger automobile premiums.                                                                   
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | The total rate change depicted is the result of the weighted average of premiums written for all coverages divided by liability exposures only, because all exposures are required to carry liability coverage.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                                                                                                                                                
|The above percentage changes were primarily the result of rate modifications in the individual coverage components in the 2002 state mandated rates, changes in our safe driver rate deviations, and changes in the distribution of our business by class and territory. The combination of these factors resulted in a 5.3% increase in the average personal automobile premium per exposure in 2002. Despite no change from the previous year for the 2002 state mandated average rates, our increase in the average personal automobile premium per exposure was primarily due to the above-noted changes. Also having an impact, was the fact that the announced rate decision did not include the effect of future purchases of new automobiles in the year to which the rate decision applied. In addition, our mix of personal automobile business differs from that of the industry. In 2002, we did not offer our customers safe driver deviations.                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Included in the premium increase for Massachusetts personal automobile direct premiums written are premiums that were the result of appointments of new agents. During 2002, we had 127 new appointments, of which 89 were from voluntary agents resulting in an additional $50.5 million in premiums. These new appointments were primarily the result of our agreements to acquire the Massachusetts personal automobile business from Berkshire Mutual Insurance Company and MassWest Insurance Company. See Item 1, "Agreements for the Transfer of Massachusetts Business from Other Companies in 2002." The remainder of the new appointments resulted from ERPs. Business obtained from new ERPs amounted to $17.0 million during 2002.                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The AAA affinity group discount for 2002 was established at 6.0%, which was unchanged from 2001. In 2001, for drivers who qualified, our AAA affinity group discount and safe driver deviations could be combined for up to a 7.9% reduction from state-mandated rates. In 2002, we did not offer a safe driver discount.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Although direct premiums written for personal automobile insurance in states other than Massachusetts increased 26.8% in 2002, an overall depressed rate environment and adverse development of prior year reserves resulted in diminished underwriting profits. Personal automobile direct premiums written by American Commerce increased $26.6 million, or 31.3%, to $111.8 million in 2002 as compared to $85.1 million in 2001, due primarily to book rollovers of business from existing agents, partially offset by decreases in states where we are not actively pursuing writings. Personal automobile direct premiums written from Commerce West increased $3.9 million, or 10.5%, to $41.1 million in 2002 as compared to $37.2 million in 2001. Both companies primarily target preferred insurance risks and write predominantly personal automobile insurance. Commerce West's recent growth is attributable to preferred personal automobile business. Personal automobile policies for both companies are written primarily for a policy term of six months.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The increase in direct premiums written for Massachusetts commercial automobile insurance in 2002 was due primarily to an increase of approximately 14.0% in the number of policies written, combined with a 13.0% increase in the average commercial automobile premium per policy. The increase in premium per policy was attributable to demand for insurance exceeding supply in the commercial automobile market, as well as our own increase of volume of larger commercial automobile accounts. In 2002, we experienced an increase of approximately $1.9 million from policies with premiums in excess of $50. In addition, base rates for other voluntary commercial automobile policies have increased moderately, and a reduction in Individual Risk Premium Modification, or IRPM, credits has occurred, favorably affecting                                                                                                                                                                                                                                    

<PAGE>  48

|average premiums per policy. In addition, we experienced approximately a 3.0% increase in rates for policies written through CAR. The increased business was attributable to our initiative to expand writings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|The increase in direct premiums written for Massachusetts homeowners insurance in 2002 was due primarily to a 10.8% increase in the number of Massachusetts policies written coupled with a 7.3% increase in the average Massachusetts premium per policy. Our increase in Massachusetts homeowner premiums is primarily related to several factors:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Homeowners insurance written by American Commerce in other states increased 46.3% to $27.4 million in 2002 due primarily to book rollovers of business from existing agents and the impact caused by contraction of authority to write homeowner business by competitors. Homeowner policies in all states are written primarily for a policy term of one year.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|The increase in total net premiums written was primarily due to the growth in direct premiums written as described above offset by an increase in premiums ceded to CAR and the quota share agreement. Net premiums written for homeowners insurance in all other states increased $1.6 million, with net premiums written of $6.1 million in 2002 as compared to $4.6 million in 2001.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|The increase in total earned premiums during 2002 was primarily due to increases in written premiums as described above and 2001 written premiums being earned in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Net Investment Income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|As depicted in the accompanying table, net investment income before taxes for 2002 decreased $1.1 million, or 1.1%, as compared to 2001, principally as a result of a decreased in yield partially offset by an increase in average invested assets at cost. The decrease in yield was primarily due to lower short-term yields, coupled with an environment of lower long-term yields and higher yielding investment securities being called. During 2002, we purchased approximately $142 million of Fannie Mae ("FNMA") securities. We believe these securities will have a duration of less than three years. This will allow us to achieve higher yields until longer term investments are acquired. Net investment income as a percentage of total average investments was 6.3% in 2002 compared to 6.6% in 2001. Net investment income, after-tax, as a percentage of total average investments, was 5.0% in 2002 and 5.3% in 2001.
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Investment Return:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Average month-end investments (at cost)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Net investment income before tax                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Net investment income after-tax                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Net investment income as a percentage of average net investments (at cost)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Net investment income after-tax as a percentage of average net investments (at cost)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Premium Finance and Service Fees                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Premium finance and service fees increased $3.7 million, or 20.6%, during 2002, as a result of increased business and a service fee increase on Massachusetts new and renewal business from $3.00 to $4.00 per installment payment, for policies with effective dates on or after July 1, 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Investment Gains and Losses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Net realized investment losses totaled $82.4 million during 2002 as compared to $10.6 million in 2001. Net realized investment losses during 2002 were primarily centered in two areas: closed-end preferred stock mutual funds and other-than-temporary impairments. Declines in the market values of utility stocks held by various closed-end preferred stock mutual funds totaling $44.6 million were the primary reasons for these losses. We reflect these declines through realized losses                                                                                                                                                                                                                                                                                                                                                                                                                                         

<PAGE>  49

|because our significant level of ownership requires the use of the equity method of accounting for these funds. See "Critical Accounting Policies - Investments" above for more information on our use of the equity method of accounting for these funds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|The realized losses for 2002 also resulted from write-downs for other-than-temporary declines in the market value of certain fixed maturities, preferred and common stocks totaling $32.1 million. Our management focuses on the potential impairment of investments for other-than-temporary declines in market value. During 2002, an impairment in an investment was deemed to be other-than-temporary when a security's market value had diminished by more than 25% of cost for two consecutive calendar quarters. If the contractual terms of the security were being complied with, management performed a cash flow valuation to determine the potential impairment of the security. If the security was deemed impaired, we adjusted the security's cost to market value by recording a realized loss based on publicly available information or, in the absence of such information, to a value based on cash flow modeling. See "Critical Accounting Policies - Investments" above for more information about our current policy for determining whether an other-than-temporary decline in investment securities has occurred.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|During 2002, $3.7 million in realized investment losses were also incurred related to our investments in venture capital funds. These investments primarily provide seed capital for start-up companies with emerging high technology initiatives in the financial services industry. These investments are made in limited partnerships and our exposure to loss is limited to our actual investment. Investments in these venture capital funds are accounted for on an equity basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Losses and Loss Adjustment Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|Our loss and LAE ratio (on a statutory basis) increased to 75.1% in 2002 as compared to 74.5% in 2001. The primary reasons for this increase were higher private passenger automobile losses from CAR as a result of increased participation in CAR and higher CAR loss ratios, coupled with an increase in the frequency of personal automobile bodily injury claims compared to last year. Another factor in the increase resulted from business written outside of Massachusetts for which the loss ratio increased to 86.4% during 2002 as compared to 84.6% for 2001. These factors were somewhat offset by a lower physical damage claim frequency and a lower loss ratio in the Massachusetts commercial automobile line.                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|The following table reconciles beginning and ending reserves for losses and loss adjustment expense, net of reinsurance deductions from all reinsurers including CAR, as shown in our consolidated financial statements for the years indicated.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          



|                                                                                          | 2002     |  | 2001    
|----------------------------------------------------------------------------------------- | -------- |  | --------
|                                                                                          |          |  |         
|                                                                                          |          |  |         
|Unpaid losses and loss adjustment expense reserves, beginning of year, prior to effect of |          |  |         
|ceded reinsurance recoverable                                                             | $594,156 |  | $585,867
|                                                                                          |          |  |         
|Incurred losses and loss adjustment expenses:                                             |          |  |         
|Provision for insured events of the current year                                          | 924,206  |  | 816,951 
|Decrease in provision for insured events of prior years                                   | (14,437) |  | (35,320)
|                                                                                          |          |  |         
|Total incurred losses and loss adjustment expenses                                        | 909,769  |  | 781,631 
|                                                                                          |          |  |         
|Payments:                                                                                 |          |  |         
|Losses and loss adjustment expenses attributable to insured events of the current year    | 539,555  |  | 487,918 
|Losses and loss adjustment expenses attributable to insured events of prior years         | 286,022  |  | 285,424 
|                                                                                          |          |  |         
|Total payments                                                                            | 825,577  |  | 773,342 
|                                                                                          |          |  |         
|Unpaid losses and loss adjustment expense reserves prior to effect of ceded               |          |  |         
|reinsurance recoverable                                                                   | 678,348  |  | 594,156 
|Ceded reinsurance recoverable                                                             | 137,278  |  | 101,036 
|                                                                                          |          |  |         
|Unpaid losses and loss adjustment expense reserves at the end of year per financial       |          |  |         
|statements                                                                                | $815,626 |  | $695,192
|                                                                                          |          |  |         



|The decrease in provision for insured events of prior years represents redundancies for reserves established for prior years. This decrease in provision was principally the result of re-estimation of unpaid losses and loss adjustment expenses principally on the personal automobile, commercial automobile and homeowners lines of business.                                                                                                                               
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Policy Acquisition Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|As a percentage of net premiums written, our statutory underwriting expenses decreased to 23.6% in 2002 as compared to 24.2% in 2001. The improvement was primarily due to a lower mandated Massachusetts personal automobile commission rate in 2002 as compared to 2001, and to lower general underwriting expenses. Another factor in the decrease resulted from business written outside of Massachusetts where the underwriting expense ratio decreased to 29.7% for 2002 as

<PAGE>  50

|compared to 32.6% for 2001. These factors were partially offset by higher contingent commission expenses and higher insolvency assessments. The 2002 underwriting ratio includes a $4.5 million charge, as compared to a $3.1 million charge in 2001, representing our allocation from the MIIF.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Combined Ratio                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Our statutory combined ratio was 98.7% for both 2002 and 2001. This resulted in an underwriting profit of 1.3% for both 2002 and 2001. This was the result of the factors mentioned above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Our effective tax rate was 32.8% and 17.1% for the years ended December 31, 2002 and 2001, respectively. In 2002, the effective tax rate was affected by the write-off of deferred tax assets of $14.8 million. This amount was comprised of $10.9 million from the write-off of a deferred tax asset associated with realized losses on our closed-end preferred stock mutual funds that were ineligible for a tax benefit and $3.9 million of valuation allowance associated with our inability to claim a portion of our realized losses against prior years' realized gains. In 2001, the effective rate was lower than the statutory rate of 35% primarily due to tax-exempt interest income and the corporate dividends received deduction.                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Minority Interest in Net Loss of Subsidiary                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Effective January 1, 2002, the ownership interests in ACIC Holding Co., Inc. were recapitalized. Prior to the recapitalization at December 31, 2001, we maintained an 80% common stock interest and AAA Southern New England, or AAA SNE, maintained a 20% common stock interest in ACIC Holding. Additionally, all ACIC Holding preferred stock was owned by us. The recapitalization resulted in the redemption of our ACIC Holding preferred stock in exchange for 3,000 additional shares of ACIC Holding common stock. This resulted in an increase in our ACIC Holding common stock interest to 95% with AAA SNE maintaining a 5% ACIC Holding common stock interest, with no preferred stock outstanding.                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Net Earnings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Our net earnings decreased $43.5 million, or 48.2%, to $46.8 million during 2002 as compared to $90.3 million in 2001, resulting primarily from an increase in our net realized investment losses of $71.8 million and an increase in our losses and loss adjustment expenses of $128.1 million, which together more than offset an increase of $166.4 million in our earned premiums, all as previously described in this section. Net earnings for 2002 included income, net of taxes, of $11.2 million due to the effect of a change in accounting principle related to SFAS No. 142.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Change in Accounting Principle                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|See item as previously stated in this report in our comparison of 2003 to 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|2001 Restatement for Employee Stock Option Variable Accounting Treatment Made in 2002                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|In 2002, we restated 2001 for the effect of a change in accounting for employee stock options. For employee stock options which we issued from 1999 through 2001, we used fixed accounting treatment through September 30, 2002. At that time, we concluded that variable accounting treatment was more appropriate than fixed accounting treatment. Therefore, we applied variable accounting treatment in 2002, as well as retroactively to 2001 and prior years. Accordingly, in 2002, we restated results for 2001 and the first three quarters of 2002. The impact of the restatement for the year ended 2001 resulted in a decrease in net earnings of $2.8 million, or $0.08 per diluted share. As allowed by Statement of Financial Accounting Standards ("SFAS") No. 148, we have elected to continue to apply variable accounting for our stock options granted in 1999 and 2000. We continue to comply with Accounting Principles Board ("APB") Opinion No. 25 and related interpretations in applying fixed accounting for the employee stock options granted in 2001.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Liquidity and Capital Resources                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The primary sources of our liquidity are funds generated from insurance premiums, net investment income, premium finance and service fees and the maturing and sale of investments. The primary uses of our liquidity are payment of policy claims, operating costs and payment of dividends to our stockholders.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Our operating activities provided cash of $260.1 million in the year ended 2003 as compared to $231.4 million during 2002, representing an increase of $28.7 million, or 12.4%. Premiums collected less loss and policy acquisition cost payments were $53.8 million higher for the year ended 2003 compared to 2002. The primary reason for this increase is that                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

<PAGE>  51

|the increase in premiums collected outpaced the increase in losses and LAE paid and the policy acquisition costs paid. This occurs when we have significant increases in business, as claims paid tend to lag behind premiums collected. Net investment income received continued to decline, and was approximately $10 million less than prior year, due primarily to decreased investment yields and higher yielding securities being called.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|For the years ended 2003 and 2002, net cash flows from investing activities used cash of $504.0 million and $127.2 million, respectively. The majority of the difference was a $1.6 billion increase in purchases of fixed securities and equity securities, partially offset by an increase in the proceeds from the sales and maturities of fixed maturities, equities and closed-end preferred stock mutual funds totaling $1.2 billion. This resulted from our decision to sell a significant portion of our securities with unrealized gains in order to implement a change in our investment view. This change in view caused us to reduce the average duration of our investment portfolio during the second and third quarters, which in turn resulted in the sale of a number of securities that had increased in value significantly as overall credit spreads tightened. This caused overall portfolio turnover (e.g. volume of trades) to increase beyond that of recent years. The portfolio sales occurred in securities that had been purchased during 2003 as well as those purchased in previous years. Thus, while we did sell some higher yielding instruments, the overall after-tax yield of the portfolio did not fall significantly beyond the decline in interest rates as a whole. During the third quarter as interest rates rose, we began to invest in longer-term securities, resulting in a slightly higher duration at year end. Investing activities were funded by the accumulation of cash and cash provided by operating activities.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|The decrease in the carrying value of the closed-end preferred stock mutual funds in 2003 was primarily the result of sales and the reclassification of six preferred stock mutual funds in which we no longer have a greater than 20% ownership position. We no longer use the equity method of accounting for these six funds, but instead mark them to market.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Cash flows provided by financing activities totaled $253.1 million during the year ended 2003 compared to $79.0 million used during 2002. The increase in cash in 2003, relative to 2002, was primarily from the net proceeds of our bond offering of $295.7 million, and from a $34.2 million reduction in treasury stock purchases. We issued $300 million face value of senior unsecured notes which mature December 9, 2013. We will pay 5.95% interest on these notes semi-annually on June 9 and December 9. We are using the proceeds for general corporate purposes, including enhancement of the capital position of our operating subsidiaries in support of recent premium growth, as well as to continue our diversification efforts outside of Massachusetts. We and our subsidiaries will be able to issue or incur additional indebtedness that is senior to the notes in the future, provided the secured portion of such debt does not exceed 15% of our consolidated tangible net worth.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Cash used in financing activities totaled $79.0 million during the year ended 2002 compared to $63.2 million during 2001. During 2002, cash flows used in financing activities consisted of $40.3 million in dividends paid to stockholders and $48.8 million used to purchase 1.3 million shares of treasury stock, partially offset by $10.1 million from the issuance of common stock pursuant to our stock option plan. During 2001, cash flows used in financing activities consisted of $40.0 million in dividends paid to stockholders and $23.3 million used to purchase approximately 623,000 shares of treasury stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|We purchased a 130,000 square foot building in 2001 and renovated it during 2002. Expenditures in 2003, 2002 and 2001 were $2.0 million, $13.1 million and $4.9 million, respectively. The project was complete as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|We rely upon dividends from our operating subsidiaries for our cash requirements, including payments of interest and principal on the notes. Under Massachusetts law, if our subsidiaries wish to make any dividend or other distribution to us, they may, within certain limitations, pay such dividends and then file a report with the Commissioner. The aggregate amount of dividends calculated in accordance with regulations of Massachusetts, California and Ohio that could have been paid in 2003 from all of our insurance subsidiaries without prior regulatory approval was approximately $76.0 million, of which $66.2 million was declared and paid as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Investments. Our funds are generally invested in securities with maturities intended to provide adequate funds to pay claims without the forced sale of investments. The carrying value (at market and equity) of total investments, including cash and cash equivalents at December 31, 2003 was $2.2 billion. These funds provide sufficient liquidity for the payment of claims and other short-term cash needs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

<PAGE>  52

|Our fixed maturity and equity security portfolio at fair and equity values at December 31, 2003 and 2002 follows:
|-----------------------------------------------------------------------------------------------------------------



|                                                 | 2003       |  | 2002      
|------------------------------------------------ | ---------- |  | ----------
|                                                 |            |  |           
|                                                 |            |  |           
|Investment grade fixed maturity securities       | $1,427,669 |  | $  662,604
|Below investment grade fixed maturity securities | 70,062     |  | 21,207    
|                                                 |            |  |           
|Total fixed maturity securities                  | 1,497,731  |  | 683,811   
|Equity securities (1)                            | 458,518    |  | 675,491   
|                                                 |            |  |           
|Total fixed maturity and equity securities       | $1,956,249 |  | $1,359,302
|                                                 |            |  |           



|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Represents preferred and common stocks and preferred stock mutual funds.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                         
|Our fixed income portfolio's weighted average duration (which includes all fixed maturities and preferred stocks) as of December 31, 2003, was 5.6 years. At December 31, 2002, our fixed income portfolio had a weighted average duration of 4.5 years versus 5.7 years at December 31, 2001. The "duration" of a security is the time-weighted present value of the security's expected cash flows and is used to measure a security's price sensitivity to changes in interest rates. The 2003 weighted average duration is short compared to the average stated maturity of 22.9 years because of our holdings in GNMA, FNMA and municipal housing bonds in the fixed maturity portfolio. The duration reflects industry prepayment assumptions. The municipal housing bonds are similar in nature to GNMAs in that they pay down principal during the life of the bond. For these types of bonds, investors are compensated primarily for reinvestment risk rather than credit quality risk. During periods of significant interest rate volatility, the underlying mortgages may prepay more quickly or more slowly than anticipated. If the repayment of principal occurs earlier than anticipated during periods of declining interest rates, investment income may decline due to the reinvestment of these funds at the lower current market rates. The analytic systems we used to calculate the above duration data utilize optional call dates, sinking fund requirements and assume a non-static prepayment pattern in deriving these averages.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Our fixed maturity security portfolio by investment type and credit quality as of December 31, 2003 follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 



|                                              | Investment Grade |  | Below Investment Grade
|--------------------------------------------- | ---------------- |  | ----------------------
|                                              |                  |  |                       
|                                              | Fair Value       |  | Cost                  
|                                              |                  |  |                       
|                                              |                  |  |                       
|U.S. government and agency                    | $   294,167      |  | $   297,750           
|State and political subdivision               | 702,349          |  | 689,787               
|Corporate                                     | 251,115          |  | 241,875               
|Mortgage-backed                               | 180,038          |  | 181,116               
|                                              |                  |  |                       
|Total fixed maturity securities               | $1,427,669       |  | $1,410,528            
|                                              |                  |  |                       
|                                              |                  |  |                       
|Percentage of total fixed maturity securities | 95.3%            |  | 95.4%                 
|                                              |                  |  |                       



|Our credit quality classifications are based on Standard & Poor's ("S&P") rating agency designations. S&P's BB rating category is the highest quality tier within the below investment grade universe. Approximately 92% of the below investment grade fixed maturity securities are rated within the top two S&P tiers of the below investment grade categories.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                 
|Our below investment grade fixed maturity securities at fair value by credit quality at December 31, 2003 follow:                                                                                                                                                                                                                                                



|                                              |           |  |              |  |           |  | CC or  
|--------------------------------------------- | --------- |  | ------------ |  | --------- |  | -------
|                                              | Total     |  | BB           |  | B         |  | Lower  
|                                              |           |  |              |  |           |  |        
|                                              |           |  |              |  |           |  |        
|State and political subdivision               | $   6,607 |  | $          - |  | $   3,430 |  | $ 3,177
|Corporate                                     | 63,455    |  | 43,405       |  | 17,597    |  | 2,453  
|                                              |           |  |              |  |           |  |        
|Total fixed maturity securities at fair value | $ 70,062  |  | $ 43,405     |  | $ 21,027  |  | $ 5,630
|                                              |           |  |              |  |           |  |        
|Total fixed maturity securities at cost       | $ 68,209  |  | $ 42,592     |  | $ 20,253  |  | $ 5,364
|                                              |           |  |              |  |           |  |        
|Percentage of total fixed maturity securities | 4.7%      |  | 2.9%         |  | 1.4%      |  | 0.4%   
|                                              |           |  |              |  |           |  |        

<PAGE>  53

|Contractual Obligations and Commercial Commitments                                                
|--------------------------------------------------------------------------------------------------
|                                                                                                  
|Our contractual obligations and commercial commitments as of December 31, 2003 by maturity follow:



|                              |          |  | Payments Due by Fiscal Period
|----------------------------- | -------- |  | -----------------------------
|                              |          |  |                              
|Contractual Obligations       | Total    |  | 2004                         
|                              |          |  |                              
|                              |          |  |                              
|Bond indebtedness principal   | $300,000 |  | $          -                 
|Bond indebtedness interest    | 178,500  |  | 17,850                       
|                              |          |  |                              
|Total contractual obligations | $478,500 |  | $ 17,850                     
|                              |          |  |                              
|                              |          |  |                              
|                              |          |  | Commitment Expiration        
|                              |          |  |                              
|Commercial Commitments        | Total    |  | 2004                         
|                              |          |  |                              
|                              |          |  |                              
|Venture capital partnerships  | $ 20,639 |  | $          -                 
|                              |          |  |                              



|We have commitments in two venture capital fund investments. These investments are made in limited partnerships and our exposure to loss is limited to our actual investment. One limited partnership investment required a commitment by us to invest up to $50.0 million into the partnership. As of December 31, 2003, we have invested $30.3 million into the partnership. The partnership was formed to operate as an investment fund principally for the purpose of making investments primarily in equity, equity-related and other securities issued in expansion financing, start-ups, buy-outs and recapitalization transactions relating to companies in the areas of insurance, financial services, e-commerce, healthcare, and related businesses, including, without limitation, service and technology enterprises supporting such businesses.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The other limited partnership interest required a commitment by us to invest up to $3.5 million into the partnership. As of December 31, 2003, we have invested $2.6 million into the partnership. The partnership was formed to operate as an investment fund principally for the purpose of making investments in equity and equity related securities of companies operating in the area of insurance distribution and distribution related activities.                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Our liabilities increased 38.3% at December 31, 2003 from December 31, 2002. The liability for losses and loss adjustment expenses represented 22.8% of the total liability increase, primarily as a result of increased business. The unearned premiums increase represented 19.8% of the total liability increase due primarily to increases in our business. The bond payable represented 47.9% of the total liability increase.                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Liabilities for unpaid losses and loss adjustment expenses at December 31, 2003 and 2002 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             



|                                                         |  | 2003      |  | 2002     
|-------------------------------------------------------- |  | --------- |  | ---------
|                                                         |  |           |  |          
|                                                         |  |           |  |          
|Net voluntary unpaid loss and LAE reserves               |  | $ 760,156 |  | $ 650,892
|Voluntary salvage and subrogation recoverable            |  | (100,988) |  | (88,108) 
|Assumed unpaid loss and LAE reserves from CAR            |  | 155,874   |  | 138,355  
|Assumed salvage and subrogation recoverable from CAR     |  | (22,699)  |  | (22,790) 
|                                                         |  |           |  |          
|Total voluntary and assumed unpaid loss and LAE reserves |  | 792,343   |  | 678,349  
|Adjustment for ceded unpaid loss and LAE reserves        |  | 174,010   |  | 146,277  
|Adjustment for ceded salvage and subrogation recoverable |  | (9,000)   |  | (9,000)  
|                                                         |  |           |  |          
|Total unpaid loss and LAE reserves                       |  | $ 957,353 |  | $ 815,626
|                                                         |  |           |  |          



|We have negotiated a 65% quota-share agreement for one year with modified terms. The new program became effective July 1, 2003. In the event of a catastrophe, recovery is limited to 65% of the loss with a maximum recovery estimated at $233 million, equating to a total loss to us of $359 million. Several limitations were added to the new contract regarding losses related to nuclear, chemical, and biological terrorist events. Our maximum loss recovery in case of these types of events is estimated at $26 million. Our estimated total loss, before reinsurance, on our other than automobile business for 100 and 250-year hurricanes is approximately $200 million and $322 million, respectively. We derived our estimates through the services of Employers Reinsurance Corporation on our December 31, 2002 other-than-automobile exposures, which utilized the RMS (Risk Management Solutions) risk assessment system, and are based on increases in policies written in 2003 that are subject to the quota share treaty. We believe that most property and casualty insurance companies establish their catastrophe reinsurance programs between the 100-year and 250-year storm estimates.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  54

|Industry and regulatory guidelines suggest that the ratio of a property and casualty insurer's annual net premiums written to statutory policyholders' surplus should not exceed 3.00 to 1.00. The following table presents, on a consolidated basis, our net premiums written to statutory surplus ratio:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                                |  | For the Year Ended
|----------------------------------------------- |  | ------------------
|                                                |  |                   
|                                                |  | 2003              
|                                                |  |                   
|                                                |  |                   
|Net premiums written to statutory surplus ratio |  | 1.45:1            



|In connection with the acquisition of American Commerce in January 1999, we granted stock options to agents that had been placing business with American Commerce before the acquisition. As of December 31, 2003, 1,872,380 of these options are outstanding. Each option may be exercised on or after January 29, 2004. The options will expire on January 29, 2009. Each option has two components: the right to exercise and a put option. The right to exercise permits the agents to purchase a certain amount of our common stock at an exercise price of $36.32 per share. The put option allows the agent to require us to purchase the option from the agent at a price of $3.68 per share. The agents would have an incentive to exercise their put options if the price of our common stock was below $40.00 on the exercise date. All of these options, except for 55,070 options, are vested in the put option. Our accrued liability for the exercise of these options was $14.2 million at December 31, 2003. Our total liability under the put options would be $6.7 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Market Risk: Interest Rate Sensitivity and Equity Price Risk                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Our investment strategy emphasizes investment yield while maintaining investment quality. The focus of our investment objectives continues to be maximizing after-tax investment income through investing in high quality diversified investments structured to maximize after-tax investment income while minimizing risk. A secondary objective is to achieve above average after-tax total return. Our funds are generally invested in securities with maturities intended to provide adequate funds to pay claims and meet other operating needs without the forced sale of investments. During 2003, we sold a significant portion of our securities with unrealized gains in order to implement a change in our investment view. This change in view caused us to reduce the average duration of our investment portfolio during the second and third quarters and included the sale of a number of securities which had increased in value significantly as overall credit spreads tightened. This caused overall portfolio turnover (e.g. volume of trades) to increase beyond that of recent years. The portfolio sales occurred in securities that had been purchased during 2003 as well as those purchased in previous years. Thus, while we did sell some higher yielding instruments, the overall after tax yield of the portfolio did not fall significantly beyond the decline in interest rates as a whole. During the third quarter as interest rates rose, we began to invest in longer-term securities, resulting in a slightly higher duration at year end 2003.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|In conducting investing activities, we are subject to, and assume, market risk. Market risk is the risk of an adverse financial impact from changes in interest rates and market prices. The level of risk assumed by us is a function of our overall objectives, liquidity needs and market volatility.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|We manage our market risk by focusing on higher quality equity and fixed income investments, by periodically monitoring the credit strength of companies in which investments are made, by limiting exposure in any one investment and by monitoring the quality of the investment portfolio by taking into account credit ratings assigned by recognized rating organizations. Our portfolio includes six securities in default, three corporate bonds, two preferred stocks and one municipal bond with a total carrying value of $4.0 million at December 31, 2003. Of our bonds and preferred stocks, 93% were rated in either of the two highest quality categories provided by the NAIC as of December 31, 2003, as compared to 96.5% at December 31, 2002. This decrease primarily resulted from an increase in the market value of securities that are not rated in either of the two highest categories. Although we have significant holdings of various closed-end preferred stock mutual funds, these funds are comprised primarily of preferred and common stocks traded on national stock exchanges, thus limiting exposure to any one investment.                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Interest Rate Sensitivity.As part of our investing activities, we assume positions in fixed maturity, equity, short-term and cash equivalents markets. Therefore, we are exposed to the impacts of interest rate changes in the market value of investments. At December 31, 2003, our exposure to interest rate changes and equity price risk has been estimated using sensitivity analysis. The interest rate impact is defined as the effect of a hypothetical interest rate change of plus-or-minus 200 basis points on the market value of fixed maturities and preferred stocks.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Changes in interest rates would result in unrealized gains or losses in the market value of the fixed maturity and preferred stock portfolio due to differences between current market rates and the stated rates for these investments. The following table summarizes our interest rate risk, based on the results of the sensitivity analysis at December 31, 2003. The table also reflects the changes in market value and stockholders' equity that would be attributable to realized investment gains (losses) that we would recognize under the equity method of accounting with respect to the change in the net asset value of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

<PAGE>  55

|any mutual fund in which we own 20% or more of the shares outstanding. See "Critical Accounting Policies - Investments."
|------------------------------------------------------------------------------------------------------------------------



|                                      |  | Estimated Market |  |               |  |                         
|------------------------------------- |  | ---------------- |  | ------------- |  | ------------------------
|                                      |  | Value of Fixed   |  | Estimated     |  |                         
|                                      |  | Income and       |  | Increase      |  | Hypothetical Percentage 
|                                      |  | Preferred Stock  |  | (Decrease) in |  | Increase (Decrease) in  
|Hypothetical Change in Interest Rates |  | Investments      |  | Market Value  |  | Stockholders' Equity (1)
|                                      |  |                  |  |               |  |                         
|                                      |  |                  |  |               |  |                         
|200 basis point increase              |  | $1,592,898       |  | $ (203,554)   |  | (14.5%)                 
|No change                             |  | 1,796,452        |  | -             |  | -                       
|200 basis point decrease              |  | 1,987,976        |  | 191,524       |  | 13.6%                   



|(1)                                                                                                                                                                                                                                                                 | Net of income taxes at an assumed rate of 35%.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------
|                                                                                                                                                                                                                                                                    |                                               
|Equity Price Risk.The equity price risk is defined as a hypothetical change of plus-or-minus 10% in the market value of common stocks. The following table summarizes our equity price risk, based on the results of the sensitivity analysis at December 31, 2003:



|                                    |  |                       |  | Estimated     |  |                         
|----------------------------------- |  | --------------------- |  | ------------- |  | ------------------------
|                                    |  | Estimated Market      |  | Increase      |  | Hypothetical Percentage 
|                                    |  | Value of Common       |  | (Decrease) in |  | Increase (Decrease) in  
|Hypothetical Change in Market Price |  | Equity Investments(1) |  | Market Value  |  | Stockholders' Equity (2)
|                                    |  |                       |  |               |  |                         
|                                    |  |                       |  |               |  |                         
|20% price increase                  |  | $191,756              |  | $31,959       |  | 2.3%                    
|10% price increase                  |  | 175,777               |  | 15,980        |  | 1.1%                    
|No change                           |  | 159,797               |  | -             |  | -                       
|10% price decrease                  |  | 143,817               |  | (15,980)      |  | (1.1)%                  
|20% price decrease                  |  | 127,838               |  | (31,959)      |  | (2.3)%                  



|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | Includes both common stocks and a closed-end preferred stock mutual fund valued at equity.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------
|(2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | Net of income taxes at an assumed rate of 35%.                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                                                                                           
|The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected results. These hypothetical estimates are based upon numerous assumptions such as the nature and timing of interest rate levels including the yield curve shape, prepayments on loans and securities, reinvestment and replacement of asset and liability cash flows and other assumptions. While assumptions are developed based upon current economic conditions, we cannot provide any assurance as to the predictive nature of these assumptions. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to prepayment and refinancing levels likely deviating from those assumed and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that management might take in responding to or anticipating changes in interest rates.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Segment Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|We have four reportable segments:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | *                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | *                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | *                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | *                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |                                                                                           
|Our property and casualty insurance operations are written through Commerce, Citation, American Commerce, and Commerce West and are marketed to affinity groups, individuals, families and businesses through our relationships with professional independent insurance agencies. Our property and casualty insurance - Massachusetts segment also includes the operations of Clark-Prout Insurance Agency, our wholly-owned subsidiary. Our wholly-owned subsidiary, Bay Finance Company, Inc., originates and services residential and commercial mortgages in Massachusetts and Connecticut. The corporate and other segment represents the remainder of our activities, including those of Commerce Group.                                                                                                                                                                                                                                                                    

<PAGE>  56

|We evaluate performance and allocate resources based primarily on the property and casualty insurance segments, which represent over 99% of our total revenue for the past three years. The accounting policies of the reportable segments are the same as those used in the notes to the financial statements.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                               
|Selected information by segment for the years ended 2003, 2002 and 2001 follows:                                                                                                                                                                                                                               



|                                   |             |  | Earnings (Losses)    |  |             
|---------------------------------- | ----------- |  | -------------------- |  | ------------
|                                   |             |  | Before Income        |  |             
|                                   |             |  | Taxes and Change in  |  | Identifiable
|                                   | Revenue     |  | Accounting Principle |  | Assets      
|                                   |             |  |                      |  |             
|                                   |             |  |                      |  |             
|2003:                              |             |  |                      |  |             
|Property and casualty insurance    |             |  |                      |  |             
|Massachusetts                      | $ 1,413,074 |  | $ 224,092            |  | $ 2,784,091 
|Other than Massachusetts           | 226,978     |  | 16,182               |  | 333,044     
|Real estate and commercial lending | 1,233       |  | 1,233                |  | 16,924      
|Corporate and other                | (463)       |  | (22,496)             |  | 30,172      
|                                   |             |  |                      |  |             
|Consolidated                       | $ 1,640,822 |  | $ 219,011            |  | $ 3,164,231 
|                                   |             |  |                      |  |             
|                                   |             |  |                      |  |             
|2002:                              |             |  |                      |  |             
|Property and casualty insurance    |             |  |                      |  |             
|Massachusetts                      | $ 1,092,396 |  | $   72,903           |  | $ 2,106,317 
|Other than Massachusetts           | 161,962     |  | (16,479)             |  | 273,012     
|Real estate and commercial lending | 2,737       |  | 2,737                |  | 27,554      
|Corporate and other                | 24          |  | (6,580)              |  | 12,190      
|                                   |             |  |                      |  |             
|Consolidated                       | $ 1,257,119 |  | $   52,581           |  | $ 2,419,073 
|                                   |             |  |                      |  |             
|                                   |             |  |                      |  |             
|2001:                              |             |  |                      |  |             
|Property and casualty insurance    |             |  |                      |  |             
|Massachusetts                      | $ 1,011,318 |  | $ 118,657            |  | $ 1,886,514 
|Other than Massachusetts           | 135,483     |  | (5,867)              |  | 249,316     
|Real estate and commercial lending | 3,592       |  | 3,592                |  | 40,483      
|Corporate and other                | 3,397       |  | (7,737)              |  | 10,830      
|                                   |             |  |                      |  |             
|Consolidated                       | $1,153,790  |  | $ 108,645            |  | $ 2,187,143 
|                                   |             |  |                      |  |             



|Effects of Inflation and Recession                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|We generally are unable to recover the costs of inflation in our personal automobile insurance line since the premiums charged for personal automobile insurance in Massachusetts, our principal business segment, are subject to state regulation. Additionally, the premium rates that we charge for personal automobile insurance in Massachusetts are adjusted by the Commissioner only at annual intervals. Such annual adjustments in premium rates may lag behind related cost increases. Economic recessions can have an impact upon us, primarily through the policyholder's election to decrease non-compulsory coverages afforded by the policy and decreased driving, each of which tends to decrease claims.      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|To the extent inflation and economic recession influence yields on investments, we are also affected. As each of these environments affect current market rates of return, previously committed investments may rise or decline in value depending on the type and maturity of investment.                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Inflation and recession must also be considered by us in the creation and review of loss and LAE reserves since portions of these reserves are expected to be paid over extended periods of time. The anticipated effect of economic conditions is implicitly considered when estimating liabilities for losses and LAE. The importance of continually adjusting reserves is even more pronounced in periods of changing economic circumstances.                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Forward-Looking Statements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|This annual report and Form 10-K may contain statements that are not historical fact and constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act. Statements about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as "anticipates," "estimates," "plans," "projects," "continuing," "ongoing," "expects," "may," "should," "management believes," "we believe," "we intend," and similar words or phrases. These statements may address, among

<PAGE>  57

|other things, our strategy for growth, business development, regulatory approvals, market position, expenditures, financial results and reserves. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. All forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this annual report and Form 10-K and in our recently filed registration statement on Form S-3, our Forms 10-Q, and other documents filed with the SEC. Among the key factors that could cause actual results to differ materially from forward-looking statements:                                                                                                                                                                                                           
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|You should not place undue reliance on any forward-looking statement. The risk factors referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statement made by us or on our behalf. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|For the information required by this Item, please refer to "Part II, Item 7, Market Risk: Interest Rate Sensitivity and Equity Price Risk" section (MD&A).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

<PAGE>  58

|ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|REPORT OF MANAGEMENT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Our management is responsible for the consolidated financial statements and all other information presented in this Annual Report on Form 10-K. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America determined by management to be appropriate in the circumstances and include amounts based on management's informed estimates and judgments. Financial information presented elsewhere in this Annual Report on Form 10-K is consistent with the financial statements. The appropriateness of data underlying such financial information is monitored through internal accounting controls, an internal audit department, independent auditors and the Board of Directors through its audit committee.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|We maintain a system of internal accounting controls designed to provide reasonable assurance to management and the Board of Directors that assets are safeguarded and that transactions are executed in accordance with management's authorization and recorded properly. The system of internal accounting controls is supported by the selection and training of qualified personnel combined with the appropriate division of responsibilities.                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Management recognizes its responsibility for fostering a strong ethical climate so that our affairs are conducted according to the highest standards of personal and corporate conduct. The Board of Directors has adopted a formal Code of Ethics and Corporate Compliance Program governing employees and directors. Management encourages open communication within the company and requires the confidential treatment of proprietary information and compliance with all domestic laws, including those relating to financial disclosure.                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The 2003 consolidated financial statements were audited by our independent auditors, PricewaterhouseCoopers LLP, in accordance with auditing standards generally accepted in the United States of America. Management has made available to PricewaterhouseCoopers LLP all of our financial records and related data, including reports prepared by the Internal Audit Department as well as the minutes of stockholders' and directors' meetings. Furthermore, management believes that all representations made to PricewaterhouseCoopers LLP were valid and appropriate.                                                                                                                                                                                                                  

<PAGE>  59

|Report of Independent Auditors                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
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|To the Board of Directors and Stockholders                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|of The Commerce Group, Inc.:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
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|In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of The Commerce Group, Inc. and Subsidiaries at December 31, 2003 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15(a) (2) present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. The financial statements and financial statement schedules of the Company as of December 31, 2002 and 2001 and for each of the two years in the period ended December 31, 2002 were audited by other auditors whose report dated January 31, 2003, expressed an unqualified opinion on those financial statements and included an explanatory paragraph that described the restatement of the 2001 consolidated financial statements due to a change in accounting for stock options discussed in Note A to the financial statements and the adoption in 2002 of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.
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|/s/ PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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|Boston, Massachusetts                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|January 29, 2004                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

<PAGE>  60

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                              
|---------------------------------------------------------------------------------------
|CONSOLIDATED BALANCE SHEET                                                             
|December 31,                                                                           
|(Thousands of Dollars)                                                                 
|                                                                                       
|ASSETS                                                                                 
|                                                                                       
|                                                                                       
|                                                                                       
|Investments (NOTES A2, A3, and B):                                                     
|Fixed maturities, at market (amortized cost: $1,478,737 and $666,910)                  
|Preferred stocks, at market (cost: $283,423 and $301,141)                              
|Common stocks, at market (cost: $95,412 and $81,602)                                   
|Preferred stock mutual funds, at equity (cost: $50,795 and $294,192)                   
|Mortgage loans on real estate and collateral notes receivable (less allowance for      
|possible loan losses of $379 and $418)                                                 
|Cash and cash equivalents                                                              
|Other investments, at market (cost: $38,826 and $35,015 )                              
|                                                                                       
|Total investments                                                                      
|Accrued investment income                                                              
|Premiums receivable (less allowance for doubtful receivables of $2,254 and $1,661)     
|Deferred policy acquisition costs (NOTES A4 and C)                                     
|Property and equipment, net of accumulated depreciation (NOTES A5 and D)               
|Residual market receivable (NOTE G)                                                    
|Due from reinsurers (NOTE G)                                                           
|Current income taxes (NOTES A9 and H)                                                  
|Deferred income taxes (NOTES A9 and H)                                                 
|Receivable for investments sold                                                        
|Non-compete agreement, net of accumulated amortization (NOTE A6)                       
|Other assets                                                                           
|                                                                                       
|Total assets                                                                           
|                                                                                       
|                                                                                       
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                   
|Liabilities:                                                                           
|Unpaid losses and loss adjustment expenses (NOTES A7, E and G)                         
|Unearned premiums (NOTE A8)                                                            
|Bonds payable ($300,000 face less $2,016 discount)(NOTE F)                             
|Current income taxes (NOTES A9 and H)                                                  
|Deferred income (NOTES A10 and G)                                                      
|Contingent commissions accrued (NOTE A11)                                              
|Other liabilities and accrued expenses                                                 
|                                                                                       
|Total liabilities                                                                      
|                                                                                       
|Minority interest (NOTE A14)                                                           
|                                                                                       
|Stockholders' Equity (NOTES B, M, N and O):                                            
|Preferred stock, authorized 5,000,000 shares at $1.00 par value                        
|Common stock, authorized 100,000,000 shares at $0.50 par value; 38,629,664 and         
|38,281,627 shares issued                                                               
|Paid-in capital                                                                        
|Net accumulated other comprehensive income, net of income taxes of $15,664             
|and $13,603                                                                            
|Retained earnings                                                                      
|                                                                                       
|Total stockholders' equity before treasury stock                                       
|Treasury stock, 6,568,964 and 6,165,392 shares, at cost (NOTE A15)                     
|                                                                                       
|Total stockholders' equity                                                             
|                                                                                       
|Total liabilities, minority interest and stockholders' equity                          
|                                                                                       
|                                                                                       
|The accompanying notes are an integral part of these consolidated financial statements.

<PAGE>  61

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                              
|---------------------------------------------------------------------------------------
|CONSOLIDATED STATEMENT OF EARNINGS                                                     
|For the years ended December 31,                                                       
|(Thousands of Dollars, Except Per Share Data)                                          
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Revenues:                                                                              
|Earned premiums (NOTES A8 and G)                                                       
|Net investment income (NOTE B)                                                         
|Premium finance and service fees                                                       
|Amortization of excess of book value of subsidiary interest over                       
|cost (NOTE A12)                                                                        
|Net realized investment gains (losses)(NOTE B)                                         
|Other income                                                                           
|                                                                                       
|Total revenues                                                                         
|                                                                                       
|Expenses:                                                                              
|Losses and loss adjustment expenses (NOTES A7, E and G)                                
|Policy acquisition costs (NOTES A4 and C)                                              
|Interest expense & amortization of bond fees (NOTE F)                                  
|                                                                                       
|Total expenses                                                                         
|                                                                                       
|Earnings before income taxes, minority interest and change in                          
|accounting principle                                                                   
|Income taxes (NOTES A9 and H)                                                          
|                                                                                       
|Earnings before minority interest and change in accounting principle                   
|Minority interest in net (earnings) loss of subsidiary (NOTE A14)                      
|                                                                                       
|Earnings before change in accounting principle                                         
|Change in accounting principle, net of taxes (NOTE A12)                                
|                                                                                       
|NET EARNINGS                                                                           
|                                                                                       
|                                                                                       
|Net earnings per basic common share (NOTE A16):                                        
|Before change in accounting principle                                                  
|Change in accounting principle                                                         
|                                                                                       
|Net earnings                                                                           
|                                                                                       
|Net earnings per diluted common share (NOTE A16):                                      
|Before change in accounting principle                                                  
|Change in accounting principle                                                         
|                                                                                       
|Net earnings                                                                           
|                                                                                       
|                                                                                       
|Pro forma net earnings and earnings per share assuming earlier                         
|application of change in accounting principle:                                         
|Net earnings, as reported                                                              
|Change in accounting principle                                                         
|                                                                                       
|Pro forma net earnings                                                                 
|                                                                                       
|Pro forma basic earnings per share                                                     
|                                                                                       
|Pro forma diluted earnings per share                                                   
|                                                                                       
|                                                                                       
|CASH DIVIDENDS PAID PER SHARE                                                          
|                                                                                       
|WEIGHTED AVERAGE NUMBER OF COMMON                                                      
|SHARES OUTSTANDING:                                                                    
|BASIC                                                                                  
|                                                                                       
|DILUTED                                                                                
|                                                                                       
|                                                                                       
|The accompanying notes are an integral part of these consolidated financial statements.

<PAGE>  62

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES     
|----------------------------------------------
|CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
|For the years ended December 31,              
|(Thousands of Dollars)                        
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|                                              
|Balance, January 1, 2001                      
|                                              
|Net earnings                                  
|                                              
|Other comprehensive income:                   
|Unrealized holding losses arising             
|during the year, net of tax                   
|benefit of $(633)                             
|Reclassification adjustment, net              
|of taxes of $936                              
|                                              
|Other comprehensive income                    
|                                              
|Comprehensive income                          
|Stockholder dividends                         
|Treasury stock purchased                      
|                                              
|Balance, December 31, 2001                    
|                                              
|Net earnings                                  
|                                              
|Other comprehensive income:                   
|Unrealized holding gains arising              
|during the year, net of taxes of              
|$6,495                                        
|Reclassification adjustment, net              
|of taxes of $434                              
|                                              
|Other comprehensive income                    
|                                              
|Comprehensive income                          
|Stockholder dividends                         
|Capital stock issued (1)                      
|Treasury stock purchased                      
|                                              
|Balance, December 31, 2002                    
|                                              
|Net earnings                                  
|                                              
|Other comprehensive income:                   
|Unrealized holding gains arising              
|during the year, net of taxes of              
|$5,441                                        
|Reclassification adjustment, net              
|of tax benefit of $(3,380)                    
|                                              
|Other comprehensive income                    
|                                              
|Comprehensive income                          
|Stockholder dividends                         
|Capital stock issued (2)                      
|Treasury stock purchased                      
|                                              
|Balance, December 31, 2003                    
|                                              



|(1)                                                                                     | Due to the exercise of 281,627 employee stock options.
|--------------------------------------------------------------------------------------- | ------------------------------------------------------
|(2)                                                                                     | Due to the exercise of 348,037 employee stock options.
|                                                                                        |                                                       
|The accompanying notes are an integral part of these consolidated financial statements.

<PAGE>  63

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                              
|---------------------------------------------------------------------------------------
|CONSOLIDATED STATEMENT OF CASH FLOWS                                                   
|For the years ended December 31,                                                       
|(Thousands of Dollars)                                                                 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Cash flows from operating activities:                                                  
|Premiums collected                                                                     
|Net investment income received                                                         
|Premium finance and service fees received                                              
|Losses and loss adjustment expenses paid                                               
|Policy acquisition costs paid                                                          
|Federal income tax payments                                                            
|Other receipts                                                                         
|                                                                                       
|Net cash provided by operating activities                                              
|                                                                                       
|Cash flows from investing activities:                                                  
|Proceeds from maturity of fixed maturities                                             
|Proceeds from sale of fixed maturities                                                 
|Proceeds from sale of equity securities                                                
|Proceeds from sale of preferred stock mutual funds                                     
|Proceeds from sale of other investments                                                
|Purchase of fixed maturities                                                           
|Purchase of equity securities                                                          
|Purchase of preferred stock mutual funds                                               
|Purchase of other investments                                                          
|Payments received on mortgage loans and collateral notes                               
|receivable                                                                             
|Mortgage loans and collateral notes originated                                         
|Purchase of property and equipment                                                     
|Other proceeds from investing activities                                               
|                                                                                       
|Net cash (used in) provided by investing activities                                    
|                                                                                       
|Cash flows from financing activities:                                                  
|Dividends paid to stockholders                                                         
|Purchase of treasury stock                                                             
|Capital stock issued                                                                   
|Proceeds from bond issuance                                                            
|Bond issue costs                                                                       
|                                                                                       
|Net cash provided by (used in) financing activities                                    
|                                                                                       
|Increase in cash and cash equivalents                                                  
|Cash and cash equivalents at beginning of year                                         
|                                                                                       
|Cash and cash equivalents at end of year                                               
|                                                                                       
|                                                                                       
|The accompanying notes are an integral part of these consolidated financial statements.

<PAGE>  64

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                              
|---------------------------------------------------------------------------------------
|CONSOLIDATED STATEMENT OF CASH FLOWS                                                   
|Reconciliation of Net Earnings to Net Cash Provided by Operating Activities            
|For the years ended December 31,                                                       
|(Thousands of Dollars)                                                                 
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Cash flows from operating activities:                                                  
|Net earnings                                                                           
|Adjustments to reconcile net earnings to net cash                                      
|provided by operating activities:                                                      
|Premiums receivable                                                                    
|Deferred policy acquisition costs                                                      
|Residual market receivable                                                             
|Due from reinsurers                                                                    
|Losses and loss adjustment expenses                                                    
|Unearned premiums                                                                      
|Current income taxes                                                                   
|Deferred income taxes                                                                  
|Deferred income                                                                        
|Contingent commissions                                                                 
|Other assets, liabilities and accrued expenses                                         
|Net realized investment (gains) losses                                                 
|Other - net                                                                            
|                                                                                       
|Net cash provided by operating activities                                              
|                                                                                       
|                                                                                       
|The accompanying notes are an integral part of these consolidated financial statements.

<PAGE>  65

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|NOTE A - Summary of Significant Accounting Policies                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|1.    Basis of Presentation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The Commerce Group, Inc. (the "Company") provides personal and commercial property and casualty insurance in Massachusetts and, to a lesser extent, in other states. In addition, the Company originates and services residential and commercial mortgages in Massachusetts and Connecticut. The Company's primary business is Massachusetts property and casualty insurance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP").                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The consolidated financial statements include The Commerce Group, Inc. and its wholly-owned subsidiaries, Bay Finance Company, Inc., Clark-Prout Insurance Agency, Inc. and Commerce Holdings, Inc. ("CHI"). The Commerce Insurance Company ("Commerce"), Commerce West Insurance Company ("Commerce West") and Citation Insurance Company ("Citation") are wholly-owned subsidiaries of CHI. American Commerce Insurance Company ("American Commerce") is a wholly-owned subsidiary of ACIC Holding Co., Inc. ("AHC"). AHC is owned jointly with AAA Southern New England ("AAA SNE") with Commerce maintaining a 95% common stock interest and AAA SNE maintaining a 5% common stock interest (see NOTE A14).                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|All inter-company transactions and balances have been eliminated in consolidation. Certain prior year account balances have been reclassified to conform to the 2003 presentation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The insurance subsidiaries, Commerce, Citation, Commerce West and American Commerce, prepare statutory financial statements in accordance with accounting practices prescribed or permitted by the National Association of Insurance Commissioners ("NAIC") and the Division of Insurance of The Commonwealth of Massachusetts, the State of California, and the State of Ohio.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The preparation of financial statements in conformity with GAAP 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|2.    Investments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|All investment transactions have credit exposure to the extent that a counter party may default on an obligation to the Company. Credit risk is a consequence of carrying investment positions. To manage credit risk, the Company focuses on higher quality fixed-income securities and preferred stocks, reviews the credit strength of all companies in which it invests, limits its exposure in any one investment category and monitors the portfolio quality, taking into account credit ratings assigned by recognized statistical rating organizations.                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|A focus of management's judgments and estimates relating to investments involves the potential impairment of investments for other-than-temporary declines in market values. Carrying values of investments in fixed maturities, which include taxable and non-taxable bonds, and investments in common and preferred stocks are derived from market prices supplied by the Company's investment custodian, or in the few cases where no price is provided by the custodian, we obtain a third party valuation. For other investments, fair value equals quoted market price, if available. Unrealized investment gains and losses on common and preferred stocks and fixed maturities, to the extent that there is no other-than-temporary impairment of value, are credited or charged, net of any tax effect, to a separate component of stockholders' equity, known as "net accumulated other comprehensive income (loss)," until realized.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|The Companyreviews all security holdings on a quarterly basis for potential other-than-temporary declines in market value in accordance with GAAP. As part of this process, the Company considers any significant market declines in the context of the overall market and in relation to the outlook for the specific issuer of the security. Each quarter, the Company reviews all securities whose market values have declined below book price. From a quantitative standpoint, the Company views all securities that have declined more than 20% below book price and have remained so for two quarters as                                                                                                                                                                                                                                                                                                                                

<PAGE>  66

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|NOTE A - Summary of Significant Accounting Policies  (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|potentially in need of a write-down. In addition, any other security that is viewed as impaired for a significant period is also a candidate for a write-down, even if the percentage decline is less than 20%. In order to review these holdings, the Company looks at any security that has been in a continuous unrealized loss position (regardless of the amount of the loss) for any period exceeding six months. In this way, the Company not only looks at the amount of the unrealized loss, but also at the amount of time the loss has existed. There is a risk that the Company may assess an other-than-temporary decline in market value as being temporary and, consequently, not charge the impairment to our earnings, which could have a significant impact on its future earnings and financial position.                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|In addition to reviewing the amount a security has declined, management also assesses the aging of all unrealized losses. That is, management looks at how long a security has been at an unrealized loss position by classifying it within the following categories: under 6 months, 6 to 12 months, 12 to 24 months, 24 to 34 months and greater than 34 months.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|If the security is deemed impaired, the Company adjusts the securities cost to market value through realized loss based on publicly available prices or, in the absence of such information, on a price supplied by a broker. Accumulated other comprehensive losses of less than 20% of costs that relate to interest rate changes and not to declines in a security's rating, financial situation or sector issues are not considered impaired due to the Company's ability and intent to hold these securities to maturity. During 2003, the Company wrote down $17,616 in bonds and preferred and common stocks with impairment as determined by management to be other-than-temporary. When investment securities are sold, the realized gain or loss is determined based upon specific identification. Fair market value of fixed maturities and common and preferred stocks are based on quoted market prices. For other securities held as investments, fair market value equals quoted market price, if available. If a quoted market price is not available, a price is obtained from a broker. The Company has not invested more than 5% of fixed maturities in any one state or political subdivision.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The Company accounts for venture capital fund investments in which it owns more than a 5% interest on the equity method. The operating results of these venture capital fund investments have been reflected in realized gains and losses.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The Company records its equity in the changes in net assets of closed-end preferred stock mutual funds, in which it owns 20% or greater, as a component of realized gains and losses. These investments are valued at original cost plus the cumulative undistributed equity in earnings and losses of the funds.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The Company originates and holds mortgage loans on real estate on properties located in Massachusetts and Connecticut. Mortgage loans are collateralized by the related real estate. Agency loans are generally collateralized by the assets of the agency. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. The Company performs in-depth credit evaluations on all new mortgage customers. The company has not incurred any bad debt expense on mortgage loans during the three years ended 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Mortgage loans on real estate and collateral notes receivable are stated at the amount of unpaid principal, less an allowance for possible loan losses. The adequacy of the allowance for possible loan losses is evaluated on a regular basis by management. Loan losses are charged against the allowance when management believes the collectibility of the principal is unlikely and recoveries are credited to the allowance when received.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Interest on mortgage loans is included in income as earned based upon rates applied to principal amounts outstanding. Accrual of interest on mortgage loans is discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal, or when a loan becomes contractually past due more than ninety days. When a loan is placed on non-accrual status, all unpaid interest previously accrued is reversed against current period earnings.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|All of the Company's investments in fixed maturity and equity securities at December 31, 2003 and 2002 were classified as available-for-sale. Realized gains and losses on available-for-sale securities for the years ended December 31, 2003, 2002 and 2001 were determined by using the specific identification method. Fair value is based on quoted market price, when available. When quoted market prices are not available, fair value is estimated with the use of independent pricing sources.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

<PAGE>  67

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|NOTE A - Summary of Significant Accounting Policies  (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|3.    Cash and Cash Equivalents                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Cash equivalents include short-term, liquid investments that are readily convertible to known amounts of cash and so near their maturity that they present insignificant risk of changes in value because of changes in interest rates.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|The cash and cash equivalent balances at December 31, 2003 and 2002 include $39.5 million and $36.4 million, respectively, which represents outstanding checks for which there was no right of offset. These amounts are also included in other liabilities and accrued expenses for the respective years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|4.    Deferred Policy Acquisition Costs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Policy acquisition costs are calculated by line of business as a percentage of unearned premiums by multiplying the sum of current commission rates plus current premium tax rates plus an estimate of the percentage of other underwriting expenses incurred at policy issuance. These costs are deferred and amortized over the period in which the related premiums are earned, the amount being reduced by any potential premium deficiency. If any potential premium deficiency exists, it represents future estimated losses, loss adjustment expenses and amortization of deferred acquisition costs in excess of the related unearned premiums. There was no premium deficiency in 2003, 2002 and 2001. In determining whether a premium deficiency exists, the Company considers anticipated investment income.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|5.    Property and Equipment                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Property and equipment are stated at cost and are depreciated on the straight-line method over the estimated useful lives of the assets using the following rates and lives:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        



|                                            | Percent Per |  | Useful Life
|------------------------------------------- | ----------- |  | -----------
|                                            | Annum       |  | (years)    
|                                            |             |  |            
|                                            |             |  |            
|Buildings                                   | 2.5         |  | 40         
|Building improvements (prior to 1992)       | 2.5         |  | 40         
|Building improvements (1992 and subsequent) | 5.0         |  | 20         
|Equipment and office furniture              | 10.0        |  | 10         
|EDP equipment and copiers                   | 20.0        |  | 5          
|Automobiles                                 | 33.3        |  | 3          



|Maintenance and repairs are charged to operations; betterments are capitalized. The cost of property sold or otherwise disposed and the accumulated depreciation thereon is eliminated from the related property and accumulated depreciation accounts and any resulting gain or loss is credited or charged to income. The Company capitalizes fixed assets. A fixed asset is classified as property and equipment having an economic life of more than one year and having physical substance with a unit dollar value of $1.0 or greater.                                                                                                                                                 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|6.    Non-Compete Agreement                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The non-compete agreement in the amount of $1,779 represents the unamortized portion of the purchase price associated with the acquisition of American Commerce allocated to the arrangement whereby the American Automobile Association, Inc. ("AAA National") agreed not to compete with American Commerce prior to February 2009. The cost of $3,500 is being amortized on a straight-line basis over the term of the arrangement. The amount of accumulated amortization at December 31, 2003 and 2002 was $1,721 and $1,371, respectively. The Company has amortized this agreement for $350 each year since the acquisition. This will continue until the agreement is fully amortized.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|7.    Unpaid Losses and Loss Adjustment Expenses                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Loss and loss adjustment expense ("LAE") reserves by their nature are inherently uncertain as to the ultimate outcome of the estimated amounts. The liability for unpaid losses and LAE represents the accumulation of individual case estimates for reported losses, adjustments to this amount on a line of business basis and estimates for incurred but not reported ("IBNR") losses and LAE net of, salvage and subrogation recoverable. The liability for losses and LAE is intended to cover the ultimate net cost of all losses and LAE incurred through the balance sheet date. Liability estimates are                                                                             



<PAGE>  68



|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|NOTE A - Summary of Significant Accounting Policies (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|continually reviewed and updated, and therefore, the ultimate liability may be more or less than the current estimate. The effects of changes in the estimates are included in the results of operations in the period in which the estimates are revised.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|8.    Premiums                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Approximately 84% of our direct premiums written for the year ended December 31, 2003 were generated from personal automobile insurance policies. Approximately 86% of our direct premiums written for the year ended December 31, 2003 were generated in Massachusetts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Insurance premiums are recognized as income ratably over the terms of the policies. Unearned premiums are determined by prorating written premiums on a daily basis over the terms of the policies. A significant portion of the Company's Massachusetts premiums written is derived through the American Automobile Association Clubs of Massachusetts ("AAA Clubs") affinity group marketing program. Of the Company's total direct premiums written, the portion attributable to the AAA affinity group marketing program in Massachusetts was $691,694 or 41.7% in 2003, $619,020 or 44.0% in 2002 and $545,496 or 47.3% in 2001. Of these amounts, 13.6% were written through insurance agencies owned by the AAA Clubs and 86.4% were written through the Company's network of independent agents in 2003.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|9.    Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|As a member of a consolidated group for tax purposes, the Company and its subsidiaries (said parties constituting an "Affiliated Group" as defined in and for purposes of the Internal Revenue Code) are jointly and severally liable for federal income taxes of the Affiliated Group. The Company and its subsidiaries have entered into an agreement establishing an allocation of tax liability and for compensation of the respective members of the Affiliated Group for use of their tax losses and credits.                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|The method of allocation calls for current taxes to be allocated among all affiliated companies based on a written tax-sharing agreement. Under this agreement, allocation is made primarily on a separate return basis with current payment for losses and other tax items utilized in the consolidated return. However, to the extent that a payer member of the group has future net operating losses, which it cannot absorb in the year incurred, other members within the group will refund payments to the payer.                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|The Company uses an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, the Company generally considers all expected future events other than changes in the tax law or rates, unless enacted. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|10.  Deferred Income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Income consisting of expense reimbursements, which include servicing carrier fees from Commonwealth Automobile Reinsurers ("CAR"), a state-mandated reinsurance mechanism, on policies written for CAR, are deferred and amortized over the term of the related insurance policies (see NOTE G).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|11.  Contingent Commissions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|In addition to state mandated minimum and other commissions on policies written, the Company pays certain of its agencies compensation in the form of profit sharing. This is based, in part, on the underwriting profits of an individual agent's business written with the Company. The arrangement for Massachusetts business utilizes a three-year rolling plan, with one third of the agent's profit or loss for each of the current and the two prior years' calculations summed to a single amount. This amount, if positive, is multiplied by the profit sharing commission rate and paid to the agent. Outside of Massachusetts, Commerce, Commerce West and American Commerce each have contingent commission plans tailored to their specific markets.                                               

<PAGE>  69

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|NOTE A - Summary of Significant Accounting Policies (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|12.  Change in Accounting Principle                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Due to the effect of a change in accounting principle related to Statement of Financial Accounting Standards ("SFAS") No.142, the Company recorded income in the first quarter of 2002, net of taxes, of $11,237 or $0.34 per share (diluted). This amount represented the remaining unamortized negative goodwill related to preferred stock mutual funds and the remaining excess of book value of subsidiary interest over cost relating to the 1999 acquisition of American Commerce. Negative goodwill and the excess of book value of subsidiary interest over cost occurred in these acquisitions because the underlying value of the assets purchased exceeded the purchase price. The subsequent recognition of income that occurred as these items were eliminated was not a taxable event but instead became part of the basis of the acquired asset.                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|13.  Stock-based Compensation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|In 2002, the Company restated 2001 for the effect of a change in accounting for employee stock options. For employee stock options issued from 1999 through 2001, the Company used fixed accounting treatment through September 30, 2002. At that time, the Company concluded that variable accounting treatment was more appropriate than fixed accounting treatment. Therefore, variable accounting treatment was applied in 2002, as well as retroactively to 2001 and prior years. Accordingly, in 2002, the Company restated results for 2001 and the first three quarters of 2002. The impact of the restatement for the year ended 2001 resulted in a decrease in net earnings of $2.8 million, or $0.08 per diluted share. As allowed by SFAS No. 148, the Company has elected to continue to apply variable accounting for stock options granted in 1999 and 2000. The Company uses fixed accounting treatment under Accounting Principles Board ("APB") Opinion No. 25 and related interpretations for the employee stock options granted in 2001.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Pro forma net earnings and earnings per share as if the Company had applied the fair value method of accounting for its stock-based compensation plans accounted for under the intrinsic value method for the years ended December 31 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               



|                                                                 | 2003         |  | 2002         |  | 2001        
|---------------------------------------------------------------- | ------------ |  | ------------ |  | ------------
|                                                                 |              |  |              |  |             
|                                                                 |              |  |              |  |             
|Net earnings, as reported                                        | $ 160,943    |  | $ 46,755     |  | $ 90,253    
|Deduct: Stock-based employee compensation expense determined     |              |  |              |  |             
|under fair value method for awards granted in 2001, net of taxes | 1,807        |  | 1,807        |  | 1,355       
|                                                                 |              |  |              |  |             
|Pro forma net earnings under fair value accounting               | $ 159,136    |  | $ 44,948     |  | $ 88,898    
|                                                                 |              |  |              |  |             
|Basic earnings per share:                                        |              |  |              |  |             
|As reported                                                      | $       5.03 |  | $       1.43 |  | $       2.69
|                                                                 |              |  |              |  |             
|Pro forma                                                        | $       4.97 |  | $       1.37 |  | $       2.65
|                                                                 |              |  |              |  |             
|Diluted earnings per share:                                      |              |  |              |  |             
|As reported                                                      | $       4.99 |  | $       1.42 |  | $       2.67
|                                                                 |              |  |              |  |             
|Pro forma                                                        | $       4.93 |  | $       1.36 |  | $       2.63
|                                                                 |              |  |              |  |             



|The fair value of employee options granted in 2001 was estimated on the date of grant, using the Black-Scholes option-pricing model. No options were granted in 2003 and 2002. The weighted average fair value and related assumptions of the 2001 options were:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Weighted average fair value   | $ 7.04
|----------------------------- | ------
|Dividend yield                | 3.76% 
|Expected volatility           | 27.6% 
|Risk-free interest rate       | 4.48% 
|Expected option life in years | 7     



|14.  Minority Interest in Net (Earnings) Loss of Subsidiary                                                                                                                                                                                                                                                                                                                                                                                                            
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Effective January 1, 2002, the ownership interests in AHC were recapitalized. Prior to the recapitalization at December 31, 2001, the Company maintained an 80% common stock interest and AAA SNE maintained a 20% common stock interest in AHC. Additionally, all AHC preferred stock was owned by the Company. The recapitalization resulted in redemption of all the AHC preferred stock by the Company in exchange for 3,000 additional shares of AHC common stock.

<PAGE>  70

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE A - Summary of Significant Accounting Policies (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|This resulted in the Company increasing its AHC common stock interest to 95% with AAA SNE maintaining a 5% AHC common stock interest, with no preferred stock outstanding. The recapitalization also resulted in the creation of $4.5 million in minority interest for AAA SNE. The $(294) and $555 represent AAA SNE's 5% share of the equity in (earnings) loss of AHC for 2003 and 2002, respectively. The $863 represents AAA SNE's 20% share of the equity in loss of AHC for 2001.                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|15.  Treasury Stock                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|In November 2001, the Board of Directors of the Company authorized the repurchase of an additional 2,000,000 shares of common stock of the Company. During the period from January 1, 2003 through December 31, 2003, the Company purchased 403,572 shares of its own common stock at an average cost of $36.32. At December 31, 2003, the Company had authority to purchase a total of 574,284 additional shares of its common stock under the current buy-back program. As of December 31, 2003, the Company held a total of 6,568,964 shares of treasury stock.                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|16.  Net Earnings Per Common Share (EPS)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Basic EPS is computed based on the weighted average number of common shares outstanding. Diluted EPS is computed based on the weighted average number of common shares outstanding adjusted by the number of additional common shares that would have been outstanding had the potentially dilutive common shares been issued and reduced by the number of common shares the Company could have repurchased from the proceeds of the potentially dilutive shares. The Company's only dilutive instruments are stock options outstanding. Basic and diluted EPS are calculated as follows for the years ended 2003, 2002 and 2001:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Net earnings for basic and diluted EPS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Common share information:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Average shares outstanding for basic EPS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Dilutive effect of stock options                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Average shares outstanding for dilutive EPS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Basic EPS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Dilutive EPS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|The computation of diluted EPS did not include stock options that were anti-dilutive, as their exercise price was greater than the average market price of the Company's common stock during the year. The number of such options was 1,850,000, 750,000 and 2,147,380 for the years ended December 31, 2003, 2002 and 2001, respectively.                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE B - Investments and Investment Income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|1.    Fixed Maturity Securities                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Fair market value and amortized cost of our fixed maturity securities at December 31 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     



|                                | 2003           |  | 2002          
|------------------------------- | -------------- |  | --------------
|                                |                |  |               
|                                | Fair Market    |  | Amortized     
|                                | Value          |  | Cost          
|                                |                |  |               
|                                |                |  |               
|U.S. government and agency      | $          250 |  | $          242
|State and political subdivision | 708,957        |  | 696,198       
|Corporate                       | 314,570        |  | 303,674       
|Mortgage-backed                 | 473,954        |  | 478,623       
|                                |                |  |               
|Total fixed maturity securities | $1,497,731     |  | $1,478,737    
|                                |                |  |               

<PAGE>  71

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                
|-------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                               
|(Thousands of Dollars, Except for Per Share Data)                                                                        
|                                                                                                                         
|NOTE B - Investments and Investment Income (continued)                                                                   
|                                                                                                                         
|The amortized cost and approximate fair market value of fixed maturities, by contractual maturity, at December 31 follow:



|                                       | 2003          |  | 2002         
|-------------------------------------- | ------------- |  | -------------
|                                       |               |  |              
|                                       | Fair Market   |  | Amortized    
|                                       | Value         |  | Cost         
|                                       |               |  |              
|                                       |               |  |              
|Due in one year or less                | $       2,776 |  | $       2,773
|Due after one year through five years  | 99,328        |  | 98,641       
|Due after five years through ten years | 50,092        |  | 48,828       
|Due after ten years                    | 871,581       |  | 849,872      
|                                       |               |  |              
|                                       | 1,023,777     |  | 1,000,114    
|GNMA & FNMA mortgage-backed bonds      | 473,954       |  | 478,623      
|                                       |               |  |              
|Total fixed maturities                 | $1,497,731    |  | $1,478,737   
|                                       |               |  |              



|Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. The carrying value of fixed maturities on deposit for state regulating authorities is $7,304.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                          
|2.    Closed-end Preferred Stock Mutual Funds                                                                                                                                                                             
|                                                                                                                                                                                                                          
|The Company's holdings in closed-end preferred stock mutual funds at December 31, 2003 and 2002 accounted for under the equity method follow:                                                                             



|                |  | December 31, 2003
|--------------- |  | -----------------
|                |  |                  
|                |  | Fund             
|                |  | Shares           
|Fund Symbol (1) |  | Held             
|                |  |                  
|                |  |                  
|PDT             |  | 4,695,000        
|                |  |                  

<PAGE>  72

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES             
|------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS            
|(Thousands of Dollars, Except for Per Share Data)     
|                                                      
|NOTE B - Investments and Investment Income (continued)



|                |  | December 31, 2002
|--------------- |  | -----------------
|                |  |                  
|                |  | Fund             
|                |  | Shares           
|Fund Symbol (1) |  | Held             
|                |  |                  
|                |  |                  
|PGD(2)          |  | 2,571,100        
|PPF(2)          |  | 2,373,800        
|PDF(2)          |  | 4,696,100        
|PDT             |  | 5,506,500        
|DIV(2)          |  | 3,635,600        
|PFD(2)          |  | 2,799,500        
|PFO(2)          |  | 3,756,043        
|                |  |                  
|Total           |  |                  
|                |  |                  



|(1)                                                                                  | John Hancock Patriot Global Dividend Fund ("PGD"), John Hancock Patriot Preferred Dividend Fund ("PPF"), John Hancock Patriot Premium Dividend I Fund ("PDF"), John Hancock Patriot Premium Dividend II Fund ("PDT"), John Hancock Patriot Select Dividend Fund ("DIV"), Preferred Income Fund ("PFD"), Preferred Income Opportunity Fund ("PFO").                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2)                                                                                  | During 2003, the Company's ownership interest in these funds dropped below an ownership percentage of 20%, and the Company did not have the ability to exercise significant influence over operating and financial policies. Therefore, the Company no longer accounts for its investment in those funds using the equity method of accounting. These funds are now reported at fair market value, the unrealized gains and losses are reported as comprehensive income, and they are classified under the common stock category. During 2003, a reclassification was made from preferred stock mutual funds to common stocks for each fund for the amount of the NAV at the time ownership fell below 20%. Gains or losses related to changes in NAV recorded on these funds prior to their reclassification were recorded as realized gains or losses.
|                                                                                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|3.    Mortgage Loans on Real Estate and Collateral Notes Receivable                 
|                                                                                    
|Mortgage loans on real estate and collateral notes receivable at December 31 follow:



|                                                              | 2003     |  | 2002   
|------------------------------------------------------------- | -------- |  | -------
|                                                              |          |  |        
|                                                              |          |  |        
|Residential (1st Mortgages)                                   | $  8,310 |  | $17,834
|Residential (2nd Mortgages)                                   | 110      |  | 57     
|Commercial (1st Mortgages)                                    | 5,807    |  | 6,421  
|Commercial (2nd Mortgages)                                    | 10       |  | 13     
|                                                              |          |  |        
|                                                              | 14,237   |  | 24,325 
|Collateral notes receivable                                   | 2,537    |  | 2,847  
|                                                              |          |  |        
|                                                              | 16,774   |  | 27,172 
|Allowance for possible loan losses                            | (379)    |  | (418)  
|                                                              |          |  |        
|Mortgage loans on real estate and collateral notes receivable | $16,395  |  | $26,754
|                                                              |          |  |        



|Fair value of the Company's mortgage loans on real estate and collateral notes receivable is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit and for the same remaining maturities. The future cash flows associated with certain non-performing loans are estimated based on expected payments from borrowers either through work out arrangements or the disposition of collateral. The estimated fair value of mortgage loans on real estate and collateral notes receivable at December 31, 2003 and 2002, prior to the allowance for possible loan losses, was $17,579 and $28,012, respectively.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  73

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE B - Investments and Investment Income (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|At December 31, 2003 and 2002, mortgage loans on non-accrual status totaled $455 and $388, respectively. Allowances of $40 and $53 were established in 2003 and 2002, respectively, for these loans. The reduction in interest income associated with non-accrual loans was $36, $44 and $99 for the years ended December 31, 2003, 2002 and 2001, respectively.                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|The Company originates and services residential and commercial mortgages in Massachusetts and Connecticut. The Company's exposure is generally 80% or less of the appraised value of any collateralized real property at the time of the loan origination. The ability and willingness of residential and commercial borrowers to honor their repayment commitments is generally dependent upon the level of overall economic activity and real estate values. During the years ended December 31, 2003, 2002 and 2001 the Company did not acquire any property through foreclosure of mortgages.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|A summary of the changes in the allowance for possible loan losses for the years ended December 31 follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      



|                                               | 2003 |  | 2002  |  | 2001 
|---------------------------------------------- | ---- |  | ----- |  | -----
|                                               |      |  |       |  |      
|                                               |      |  |       |  |      
|Balance, beginning of year                     | $418 |  | $660  |  | $858 
|Decrease in provision for possible loan losses | (39) |  | (242) |  | (198)
|                                               |      |  |       |  |      
|Balance, end of year                           | $379 |  | $418  |  | $660 
|                                               |      |  |       |  |      



|Mortgage principal and collateral notes receivable balances at December 31 follow:
|----------------------------------------------------------------------------------



|                                                            | 2003 |        | 2002
|----------------------------------------------------------- | ---- | ------ | ----
|                                                            |      |        |     
|                                                            |      |        |     
|Fixed rate mortgages and collateral notes maturing:         |      |        |     
|One year or less                                            | $    | 45     |     
|More than one year to five years                            |      | 1,608  |     
|More than five years to ten years                           |      | 886    |     
|Over ten years                                              |      | 7,306  |     
|                                                            |      |        |     
|Total fixed mortgages                                       | $    | 9,845  |     
|                                                            |      |        |     
|Adjustable rate mortgages and collateral notes maturing:    |      |        |     
|One year or less                                            | $    | -      |     
|More than one year to five years                            |      | 157    |     
|More than five years to ten years                           |      | 1,779  |     
|Over ten years                                              |      | 4,993  |     
|                                                            |      |        |     
|Total adjustable mortgages                                  | $    | 6,929  |     
|                                                            |      |        |     
|Total mortgages                                             | $    | 16,774 |     
|                                                            |      |        |     
|Past due over 90 days                                       | $    | 455    |     
|                                                            |      |        |     
|Mortgages in foreclosure, included in past due over 90 days | $    | -      |     
|                                                            |      |        |     

<PAGE>  74

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                      
|-------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                     
|(Thousands of Dollars, Except for Per Share Data)                              
|                                                                               
|NOTE B - Investments and Investment Income (continued)                         
|                                                                               
|4.    Net Investment Income                                                    
|                                                                               
|The components of net investment income for the years ended December 31 follow:



|                                          | 2003    |  | 2002      |  | 2001     
|----------------------------------------- | ------- |  | --------- |  | ---------
|                                          |         |  |           |  |          
|                                          |         |  |           |  |          
|Interest on fixed maturities              | $49,909 |  | $  44,741 |  | $  45,542
|Dividends on common and preferred stocks  | 23,393  |  | 25,683    |  | 23,768   
|Dividends on preferred stock mutual funds | 18,199  |  | 24,069    |  | 23,165   
|Interest on cash and cash equivalents     | 1,563   |  | 3,415     |  | 5,729    
|Interest on mortgage loans                | 1,767   |  | 2,945     |  | 4,026    
|Other                                     | 640     |  | 166       |  | 308      
|                                          |         |  |           |  |          
|Total investment income                   | 95,471  |  | 101,019   |  | 102,538  
|Investment expenses                       | 3,288   |  | 2,553     |  | 2,975    
|                                          |         |  |           |  |          
|Net investment income                     | $92,183 |  | $  98,466 |  | $  99,563
|                                          |         |  |           |  |          



|5.    Net Realized Investment Gains (Losses)                                  
|------------------------------------------------------------------------------
|                                                                              
|Net realized investment gains (losses) for the years ended December 31 follow:



|                                                                           | 2003       |  | 2002      |  | 2001      
|-------------------------------------------------------------------------- | ---------- |  | --------- |  | ----------
|                                                                           |            |  |           |  |           
|                                                                           |            |  |           |  |           
|Impairment losses:                                                         |            |  |           |  |           
|Fixed maturity securities                                                  | $  (9,566) |  | $(16,919) |  | $  (1,180)
|Equity securities                                                          | (8,050)    |  | (15,195)  |  | (1,485)   
|                                                                           |            |  |           |  |           
|Total impairment losses                                                    | (17,616)   |  | (32,114)  |  | (2,665)   
|                                                                           |            |  |           |  |           
|Transaction gains (losses):                                                |            |  |           |  |           
|Fixed maturity securities gains                                            | 28,701     |  | 978       |  | 966       
|Fixed maturity securities losses                                           | (5,901)    |  | (2,584)   |  | (2,602)   
|Equity securities gains                                                    | 49,485     |  | 1,663     |  | 731       
|Equity securities losses                                                   | (15,960)   |  | (1,318)   |  | (2,335)   
|Venture capital fund gains                                                 | 428        |  | 53        |  | 586       
|Venture capital fund losses                                                | (396)      |  | (3,705)   |  | (9,656)   
|Other investments gains                                                    | 76         |  | 254       |  | 219       
|Other investments losses                                                   | (409)      |  | (500)     |  | (459)     
|                                                                           |            |  |           |  |           
|Net transaction gains (losses)                                             | 56,024     |  | (5,159)   |  | (12,550)  
|                                                                           |            |  |           |  |           
|Equity in earnings (losses) of closed-end preferred stock mutual funds (1) | 37,695     |  | (45,112)  |  | 4,582     
|                                                                           |            |  |           |  |           
|Net realized investment gains (losses) included in net earnings            | $76,103    |  | $(82,385) |  | $(10,633) 
|                                                                           |            |  |           |  |           



|(1) | Includes $3,215 in 2001 relating to the amortization of negative goodwill, at the time of purchase of these securities.
|--- | -----------------------------------------------------------------------------------------------------------------------

<PAGE>  75

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                             
|------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                            
|(Thousands of Dollars, Except for Per Share Data)                                                     
|                                                                                                      
|NOTE B - Investments and Investment Income (continued)                                                
|                                                                                                      
|Proceeds from investment sales, calls, maturities and paydowns for the years ended December 31 follow:



|                                                    | 2003        |  | 2002        |  | 2001       
|--------------------------------------------------- | ----------- |  | ----------- |  | -----------
|                                                    |             |  |             |  |            
|                                                    |             |  |             |  |            
|Sales:                                              |             |  |             |  |            
|Closed-end preferred stock mutual funds             | $   172,378 |  | $     6,362 |  | $     2,945
|Equity securities                                   | 345,535     |  | -           |  | 2,402      
|Fixed maturity securities                           | 488,750     |  | -           |  | 19,081     
|                                                    |             |  |             |  |            
|Total sales                                         | 1,006,663   |  | 6,362       |  | 24,428     
|                                                    |             |  |             |  |            
|Calls, maturities and paydowns:                     |             |  |             |  |            
|Fixed maturity securities                           | 291,460     |  | 177,550     |  | 96,410     
|Equity securities                                   | 62,817      |  | 21,739      |  | 48,366     
|                                                    |             |  |             |  |            
|Total calls, maturities and paydowns                | 354,277     |  | 199,289     |  | 144,776    
|                                                    |             |  |             |  |            
|Other:                                              |             |  |             |  |            
|Venture capital fund investments                    | 3,436       |  | 1,902       |  | 5,735      
|Other investments                                   | 13,471      |  | 15,521      |  | 14,506     
|                                                    |             |  |             |  |            
|Proceeds from sales, calls, maturities and paydowns | $1,377,847  |  | $ 223,074   |  | $ 189,445  
|                                                    |             |  |             |  |            



|6.    Unrealized Investment Gains (Losses)                                                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                   
|Gross and net unrealized investment gains and losses, excluding minority interest, from fixed maturity and equity securities at December 31 follow:



|                                                      | 2003        |  | 2002       
|----------------------------------------------------- | ----------- |  | -----------
|                                                      |             |  |            
|                                                      | Gains       |  | Losses     
|                                                      |             |  |            
|                                                      |             |  |            
|Fixed maturity securities:                            |             |  |            
|U.S. government and agency                            | $         8 |  | $         -
|State and political subdivision                       | 16,188      |  | (3,429)    
|Corporate                                             | 12,682      |  | (1,786)    
|Mortgage-backed                                       | 1,706       |  | (6,375)    
|                                                      |             |  |            
|Fixed maturity securities unrealized gains and losses | $30,584     |  | $(11,590)  
|                                                      |             |  |            
|Equity securities unrealized gains and losses         | $29,292     |  | $  (3,410) 
|                                                      |             |  |            
|Net unrealized gains                                  | $44,876     |  |            
|                                                      |             |  |            

<PAGE>  76

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                            
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                           
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                    
|                                                                                                                                                                                     
|NOTE B - Investments and Investment Income (continued)                                                                                                                               
|                                                                                                                                                                                     
|Gross unrealized losses on our fixed maturity and equity securities at December 31, 2003 by duration of unrealized loss and by credit quality (for fixed maturity securities) follow:



|                                         |       |          | 0 - 6  |   | 6 - 12  |  | 12 - 24 |         | Over 24
|---------------------------------------- | ----- | -------- | ------ | - | ------- |  | ------- | ------- | -------
|                                         | Total |          | Months |   | Months  |  | Months  |         | Months 
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Total equity and fixed maturity          |       |          |        |   |         |  |         |         |        
|securities:                              |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 135      |        |   | 52      |  |         | 59      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 677,761  |        | $ | 307,839 |  | $       | 313,455 |        
|Total amortized cost                     |       | 692,761  |        |   | 311,379 |  |         | 322,933 |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (15,000) |        | $ | (3,540) |  | $       | (9,478) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 2.2%     |        |   | 1.1%    |  |         | 3.0%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Equity securities:                       |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 31       |        |   | 11      |  |         | 16      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 95,922   |        | $ | 37,250  |  | $       | 48,468  |        
|Total amortized cost                     |       | 99,332   |        |   | 38,179  |  |         | 50,720  |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (3,410)  |        | $ | (929)   |  | $       | (2,252) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 3.6%     |        |   | 2.5%    |  |         | 4.6%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fixed maturity securities:         |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 104      |        |   | 41      |  |         | 43      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 581,839  |        | $ | 270,589 |  | $       | 264,987 |        
|Total amortized cost                     |       | 593,429  |        |   | 273,200 |  |         | 272,213 |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (11,590) |        | $ | (2,611) |  | $       | (7,226) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 2.0%     |        |   | 1.0%    |  |         | 2.7%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Investment grade fixed maturity          |       |          |        |   |         |  |         |         |        
|securities:                              |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 97       |        |   | 35      |  |         | 43      |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 562,754  |        | $ | 254,934 |  | $       | 264,987 |        
|Total amortized cost                     |       | 574,109  |        |   | 257,315 |  |         | 272,213 |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (11,355) |        | $ | (2,381) |  | $       | (7,226) |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 2.0%     |        |   | 0.9%    |  |         | 2.7%    |        
|                                         |       |          |        |   |         |  |         |         |        
|                                         |       |          |        |   |         |  |         |         |        
|Below investment grade fixed maturity    |       |          |        |   |         |  |         |         |        
|securities:                              |       |          |        |   |         |  |         |         |        
|Number of positions                      |       | 7        |        |   | 6       |  |         | -       |        
|                                         |       |          |        |   |         |  |         |         |        
|Total fair value                         | $     | 19,085   |        | $ | 15,655  |  | $       | -       |        
|Total amortized                          |       | 19,320   |        |   | 15,885  |  |         | -       |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss                          | $     | (235)    |        | $ | (230)   |  | $       | -       |        
|                                         |       |          |        |   |         |  |         |         |        
|Unrealized loss percentage to fair value |       | 1.2%     |        |   | 1.5%    |  |         | -%      |        
|                                         |       |          |        |   |         |  |         |         |        



|None of the securities at December 31, 2003 has been in an unrealized loss position for more than 34 months. For our unrealized loss positions held between 24 and 34 months, 27%, or $12.7 million (cost), were rated AAA and were generally below amortized cost primarily due to interest rate moves. In addition, 56%, or $26.7 million, were invested in municipal bonds, all of which were rated investment grade. The Company does not believe any of these bonds warrant an other-than-temporary write-down as their fair values were below cost primarily due to general market conditions and not due to specific credit concerns of the obligor. The remaining 17%, or $8.2 million, consists of utility company preferred stocks rated BA2/BB+. The operating company of this utility is rated investment grade. The Company believes these unrealized
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  77

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|NOTE B - Investments and Investment Income (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|losses are temporary in nature, that the obligor will continue to meet its obligations and the Company intends to hold these securities to their maturity. Management will continue to monitor these holdings closely.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|For the unrealized loss positions held between 12 and 24 months, 45%, or $4.8 million (cost), were rated AAA and generally had market values that were below amortized cost due to the effect of interest rate moves. In addition, 23%, or $2.5 million, were investment grade rated municipal bonds and preferred stocks which the Company believes will continue to meet their obligations. The remaining 32%, or $3.4 million, is attributable to a B rated municipal housing issuer from which the Company expects to receive full payment upon the sale of assets underlying the securities. The closing of this transaction is expected in the first quarter of 2004.                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|For the unrealized loss positions held between 6 and 12 months, approximately 74%, or $238.7 million (cost), were rated AAA and generally had market values below amortized cost due to interest rate moves. In addition, 25%, or $79.6 million, were invested in investment grade corporate and municipal bonds and preferred stocks. The Company views the declines in these securities as temporary, as the declines were principally due to market conditions and not due to the specific concerns of the obligor. Lastly, about 1.5%, or $4.5 million, were invested in utility preferred stocks that were rated below investment grade, though the respective operating companies carry investment grade ratings. The Company believes these unrealized losses are temporary in nature, that the obligor will continue to meet its obligations and the Company intends to hold these securities to their maturity. Management will continue to monitor these holdings closely.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Unrealized losses from below investment grade fixed maturity securities by credit quality at December 31, 2003 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              



|                                                              |        |  |        |  |      |  | CC or
|------------------------------------------------------------- | ------ |  | ------ |  | ---- |  | -----
|                                                              | Total  |  | BB     |  | B    |  | Lower
|                                                              |        |  |        |  |      |  |      
|                                                              |        |  |        |  |      |  |      
|State and political subdivision                               | $    6 |  | $    - |  | $  5 |  | $   1
|Corporate                                                     | 229    |  | 157    |  | 72   |  | 0    
|                                                              |        |  |        |  |      |  |      
|Total                                                         | $235   |  | $157   |  | $77  |  | $   1
|                                                              |        |  |        |  |      |  |      
|                                                              |        |  |        |  |      |  |      
|Percentage of total fixed maturity security unrealized losses | 2.0%   |  | 1.4%   |  | 0.7% |  | 0.01%
|                                                              |        |  |        |  |      |  |      



|7.    Other Comprehensive Income (Loss)                                                                       
|--------------------------------------------------------------------------------------------------------------
|                                                                                                              
|Other comprehensive income (loss), less applicable income tax expense, for the years ended December 31 follow:



|                                   | 2003     |  | 2002     |  | 2001     
|---------------------------------- | -------- |  | -------- |  | ---------
|                                   |          |  |          |  |          
|                                   |          |  |          |  |          
|Other comprehensive income (loss): |          |  |          |  |          
|Fixed maturities                   | $  2,093 |  | $  9,194 |  | $  3,653 
|Preferred stocks                   | 11,854   |  | 12,397   |  | 7,259    
|Common stocks                      | (8,104)  |  | (1,538)  |  | (8,369)  
|Other                              | -        |  | -        |  | (1,327)  
|Impact of minority interest        | 37       |  | (254)    |  | (352)    
|                                   |          |  |          |  |          
|Total                              | 5,880    |  | 19,799   |  | 864      
|                                   |          |  |          |  |          
|Tax expense                        | (2,048)  |  | (6,840)  |  | (272)    
|Tax impact of minority interest    | (13)     |  | (89)     |  | (31)     
|                                   |          |  |          |  |          
|Total tax expense                  | (2,061)  |  | (6,929)  |  | (303)    
|                                   |          |  |          |  |          
|Total other comprehensive income   | $  3,819 |  | $12,870  |  | $     561
|                                   |          |  |          |  |          

<PAGE>  78

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                          
|---------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                         
|(Thousands of Dollars, Except for Per Share Data)                                                  
|                                                                                                   
|NOTE B - Investments and Investment Income (continued)                                             
|                                                                                                   
|Net accumulated other comprehensive income (loss) on stocks and fixed maturity investments follows:



|                                           | 2003     |  | 2002     |  | 2001    
|------------------------------------------ | -------- |  | -------- |  | --------
|                                           |          |  |          |  |         
|                                           |          |  |          |  |         
|Accumulated other comprehensive income     | $ 59,876 |  | $ 54,699 |  | $ 45,873
|Accumulated other comprehensive losses     | (15,000) |  | (15,666) |  | (26,893)
|Impact of minority interest                | (129)    |  | (166)    |  | 88      
|                                           |          |  |          |  |         
|Net accumulated other comprehensive income | 44,747   |  | 38,867   |  | 19,068  
|                                           |          |  |          |  |         
|Tax expense                                | (15,709) |  | (13,661) |  | (6,643) 
|Tax impact of minority interest            | 45       |  | 58       |  | (31)    
|                                           |          |  |          |  |         
|Total tax expense and minority interest    | (15,664) |  | (13,603) |  | (6,674) 
|                                           |          |  |          |  |         
|Total                                      | $ 29,083 |  | $ 25,264 |  | $ 12,394
|                                           |          |  |          |  |         



|NOTE C - Deferred Policy Acquisition Costs                       
|-----------------------------------------------------------------
|                                                                 
|Policy acquisition costs incurred and amortized to income follow:



|                                | 2003      |  | 2002      |  | 2001     
|------------------------------- | --------- |  | --------- |  | ---------
|                                |           |  |           |  |          
|                                |           |  |           |  |          
|Balance, January 1              | $ 138,241 |  | $ 116,557 |  | $ 111,305
|Costs deferred during the year  | 365,614   |  | 317,008   |  | 269,629  
|Amortization charged to expense | (350,250) |  | (295,324) |  | (264,377)
|                                |           |  |           |  |          
|Balance, December 31            | $ 153,605 |  | $ 138,241 |  | $ 116,557
|                                |           |  |           |  |          



|NOTE D - Property and Equipment                                    
|-------------------------------------------------------------------
|                                                                   
|Property and equipment owned by the Company at December 31 follows:



|                               | 2003     |  | 2002    
|------------------------------ | -------- |  | --------
|                               |          |  |         
|                               |          |  |         
|Buildings                      | $ 55,399 |  | $ 53,012
|Equipment and office furniture | 44,747   |  | 42,217  
|Building improvements          | 829      |  | 798     
|                               |          |  |         
|                               | 100,975  |  | 96,027  
|Less accumulated depreciation  | (51,937) |  | (48,477)
|                               |          |  |         
|                               | 49,038   |  | 47,550  
|Land                           | 3,959    |  | 3,959   
|                               |          |  |         
|                               | $ 52,997 |  | $ 51,509
|                               |          |  |         



|Depreciation expense was $5,893, $5,417 and $4,280 for the years ended December 31, 2003, 2002 and 2001, respectively. Depreciation expense is allocated evenly between loss adjustment expenses and policy acquisition costs.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  79

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                   
|------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                  
|(Thousands of Dollars, Except for Per Share Data)           
|                                                            
|NOTE E - Unpaid Losses and Loss Adjustment Expenses (LAE)   
|                                                            
|Liabilities for unpaid losses and LAE at December 31 follow:



|                                                         | 2003      |  | 2002     
|-------------------------------------------------------- | --------- |  | ---------
|                                                         |           |  |          
|                                                         |           |  |          
|Net voluntary unpaid loss and LAE reserves               | $ 760,156 |  | $ 650,892
|Voluntary salvage and subrogation recoverable            | (100,988) |  | (88,108) 
|Assumed unpaid loss and LAE reserves from CAR            | 155,874   |  | 138,355  
|Assumed salvage and subrogation recoverable from CAR     | (22,699)  |  | (22,790) 
|                                                         |           |  |          
|Total voluntary and assumed unpaid loss and LAE reserves | 792,343   |  | 678,349  
|Adjustment for ceded unpaid loss and LAE reserves        | 174,010   |  | 146,277  
|Adjustment for ceded salvage and subrogation recoverable | (9,000)   |  | (9,000)  
|                                                         |           |  |          
|Total unpaid loss and LAE reserves                       | $ 957,353 |  | $ 815,626
|                                                         |           |  |          



|Unpaid Losses and LAE, by their nature, are inherently uncertain as to the ultimate outcome of the estimated amounts. The liability for unpaid losses and LAE represents management's best estimate of the ultimate net cost of all losses and LAE incurred through the balance sheet date. The estimate for ultimate net cost of all losses incurred through the balance sheet date includes the adjusted case estimates for losses, incurred but not reported losses, salvage and subrogation recoverable and a reserve for LAE. In arriving at its best estimate, management begins with the aggregate of individual case reserves and then makes adjustments to these amounts on a line of business basis. These adjustments to the aggregate case reserves by line of business are made based on analysis performed by management as further described below. The entire liability for unpaid losses and LAE is also independently reviewed quarterly and annually by the Company's Actuarial Department. Liability estimates are continually analyzed and updated, and therefore, the ultimate liability may be more or less than the current estimate. The effects of changes in the estimates are included in the results of operations in the period in which the estimates are revised.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses, insurers establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported losses and LAE. Quarterly, the Company reviews these reserves internally. Regulations of the Division of Insurance require the Company to obtain a certification annually from either a qualified actuary or an approved loss reserve specialist that its loss and LAE reserves are reasonable.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|When a claim is reported to the Company, claims personnel establish a "case reserve" for the estimated amount of the ultimate exposure to the Company. The amount of the reserve is primarily based upon an evaluation of the type of claim involved, the circumstances surrounding the claim and the policy provisions relating to the loss. This estimate reflects the informed judgment of such personnel based on general insurance reserving practices and on the experience and knowledge of the claims personnel adjusting the claim. During the loss adjustment period, these estimates are revised as deemed necessary by the Company's claims department personnel based on subsequent developments and periodic reviews of the cases.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|In accordance with industry practice, the Company also maintains reserves for estimated IBNR and LAE net of salvage and subrogation recoverable. These reserves are determined based on historical information and the experience of the Company. Adjustments to these reserves are made periodically to take into account changes in the volume of business written, claims frequency and severity, the mix of business, claims processing and other items that can be expected to affect the Company's liability for losses and LAE over time.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|When reviewing the liability for unpaid losses and LAE, the Company analyzes historical data and estimates the impact of various factors, including:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

<PAGE>  80

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|NOTE E - Unpaid Losses and Loss Adjustment Expenses (LAE) (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method, however, for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual development of reserves is affected by many factors.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|By using both individual estimates of reported claims and generally accepted actuarial reserving techniques, the Company estimates the ultimate net liability for losses and LAE. After taking into account all relevant factors, management believes that, based on existing information, the provision for losses and LAE at December 31, 2003 is adequate to cover the ultimate net cost of losses and claims incurred as of that date. The ultimate liability, however, may be greater or lower than established reserves. If the ultimate exposure is greater than (or less than) management's estimated liability for losses and LAE the Company will incur additional expense (income) which may have a material impact on the Company's consolidated financial position. The Company does not discount to present value that portion of its loss reserves expected to be paid in future periods.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Included in the loss reserve methodologies described above, are liabilities for unpaid claims and claim adjustment expenses for environmental related claims such as oil spills, mold and lead paint. Reserves have been established to cover these claims for known losses. Because of the Company's limited exposure to these types of claims, management believes they will not have a material impact on the consolidated financial position of the Company in the future. Loss reserves on environmental related claims amounted to $7,906 and $5,773 at December 31, 2003 and 2002, respectively.                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|The change in reserves for unpaid losses and loss adjustment expense, net of reinsurance deductions from all reinsurers, including CAR, for the years ended December 31 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         



|                                                                  | 2003        |  | 2002      |  | 2001     
|----------------------------------------------------------------- | ----------- |  | --------- |  | ---------
|                                                                  |             |  |           |  |          
|                                                                  |             |  |           |  |          
|Incurred losses and LAE:                                          |             |  |           |  |          
|Provision for insured events of the current year                  | $1,095,371  |  | $ 924,206 |  | $ 816,951
|Decrease in provision for insured events of prior years           | (25,224)    |  | (14,437)  |  | (35,320) 
|                                                                  |             |  |           |  |          
|Total incurred losses and LAE                                     | 1,070,147   |  | 909,769   |  | 781,631  
|                                                                  |             |  |           |  |          
|Payments:                                                         |             |  |           |  |          
|Losses and LAE attributable to insured events of the current year | 625,803     |  | 539,555   |  | 487,918  
|Losses and LAE attributable to insured events of prior years      | 330,349     |  | 286,022   |  | 285,424  
|                                                                  |             |  |           |  |          
|Total payments                                                    | 956,152     |  | 825,577   |  | 773,342  
|                                                                  |             |  |           |  |          
|Change in loss and LAE reserves during the year                   | 113,995     |  | 84,192    |  | 8,289    
|Loss and LAE reserves prior to the effect of ceded reinsurance    |             |  |           |  |          
|recoverable, beginning of year                                    | 678,348     |  | 594,156   |  | 585,867  
|                                                                  |             |  |           |  |          
|Loss and LAE reserves prior to the effect of ceded reinsurance    |             |  |           |  |          
|recoverable, end of year                                          | 792,343     |  | 678,348   |  | 594,156  
|Ceded reinsurance recoverable                                     | 165,010     |  | 137,278   |  | 101,036  
|                                                                  |             |  |           |  |          
|Loss and LAE reserves, end of year                                | $   957,353 |  | $ 815,626 |  | $ 695,192
|                                                                  |             |  |           |  |          



|As a result of changes in estimates of insured events in prior years, the provision for loss and loss adjustment expenses decreased $25,224 for the year ended 2003 and $14,437 for the year ended 2002. The favorable development is due primarily to lower than anticipated losses related to the personal automobile liability line of business, offset by worse development in automobile physical damage and commercial automobile liability. Conditions and trends that have affected development in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based upon these developments. The amounts we will ultimately incur from loss and loss adjustment expenses could differ materially in the near term from the amounts recorded.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  81

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE E - Unpaid losses and Loss Adjustment Expenses (LAE) (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Approximately $35,000 in personal automobile liability redundancies developed for the year ended 2003, with two thirds of this amount coming from the 2002 and 2001 accident years. The remaining redundancy in this area came about evenly from the four accident years prior to this. The primary reason for the redundancies in this area is that claim severity came in better than the Company anticipated. The approximate $4,700 worse development in automobile physical damage occurred in the 2002 accident year offset by redundancies in the 2001 accident year. The 2002 impact was mainly from higher IBNR claims as a result of a severe winter storm during the last week of 2002, coupled with higher severity on physical damage claims. The 2001 redundancies primarily resulted from higher than anticipated subrogation. The Company also experienced deficiencies of $2,300 and $1,500 for accident years 2001 and 2002, respectively, in 2003 in the commercial automobile liability area. These deficiencies were primarily related to higher severity as compared to claims incurred in prior years. Various redundancies and deficiencies for the other lines of business and accident years combined for the remaining approximately $1,300 net deficiency.                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|The reserves for loss and loss adjustment expenses represent management's best estimate of the ultimate net cost of all loss and loss adjustment expenses incurred after reinsurance and for amounts estimated to be recoverable through salvage and subrogation. The Company's aggregate actuarial estimate for the loss and LAE reserves, on a consolidated basis and net of reinsurance recoverable, ranges from a low of $694.2 million to a high of $807.9 million, as of December 31, 2003. The Company's financial statement loss and LAE reserves net of reinsurance, based on management's best estimate, was established at $792.3 million for that date. Management calculates its estimate independently from those amounts as calculated by the Company's actuaries and, therefore, the final results are most often not the same. Management estimates its amounts primarily by reviewing historical loss and LAE data, focusing mainly on payment data. It also reviews and compares most recent loss frequency, severity and payment data to historical trends in an attempt to determine if patterns are remaining consistent or not. Management attempts to establish its reserve estimate as close to the amount required for the ultimate future payments necessary to settle all losses. The accuracy of this estimate is reflected by the line noted in the above table entitled "decrease in provision for insured events of prior years."
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|The Company's loss and LAE reserves reflect its share of the aggregate CAR loss and LAE reserves of the Company and the 34 other writers of automobile insurance in Massachusetts that participate in CAR ("Servicing Carriers").                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|The Company is a defendant in various legal actions arising from the normal course of its business. These proceedings are considered to be ordinary to operations or without foundation in fact. Management is of the opinion that these actions will not have a materially adverse effect on the consolidated financial statements of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE F - Bonds Payable                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|On December 9, 2003, the Company issued $300 million face value of senior unsecured and unsubordinated debt ("the Senior Notes") which matures December 9, 2013. The Senior Notes were issued at 99.3% to yield 6.04%, and bear a coupon interest rate of 5.95%, payable semi-annually on June 9 and December 9 beginning 2004. Proceeds from the issuance were $298.0 million. Costs related to the issuance of the Senior Notes have been deferred and recorded in other assets on the balance sheet. The deferred costs and the original issue discount will be amortized into interest expense over the life of the Senior Notes. The fair market value of the Senior Notes at December 31, 2003 was $302.3 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE G - Reinsurance Activity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|The Company reinsures with other insurance companies on a claims incurred basis a portion of our potential exposure under the policies we have written. The objective of this reinsurance is to mitigate the adverse financial consequences of a severe loss under individual policies, or catastrophic occurrences where a number of claims can produce an extraordinary aggregate loss. Reinsurance does not legally discharge the Company from its primary liability to the insured for the full amount of the policies, but it does make the reinsurer liable to the Company to the extent of the reinsured portion of any loss ultimately suffered. The Company seeks to utilize reinsurers that it considers adequately capitalized and financially able to meet their respective obligations under reinsurance agreements with it. The Company uses a variety of reinsurance mechanisms to protect itself against loss.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|Quota Share Reinsurance.The Company entered into a new one-year 65% quota share reinsurance program to cover all non-automobile property and liability business, except umbrella policies, effective July 1, 2003. Prior to July 1,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

<PAGE>  82

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
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|NOTE G - Reinsurance Activity (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|2003, the Company maintained a 75% quota share reinsurance program, which was incepted on July 1, 1998 and established for a five year period. Quota share reinsurance refers to a form of pro rata reinsurance arrangement pursuant to which the reinsurer participates in a specified percentage of the premiums and losses on every risk that comes within the scope of the reinsurance agreement. The current program is split among American Re-Insurance Corporation, rated "A+(Superior)" by A.M. Best (its second highest rating), Employers Reinsurance Corporation, rated "A (Excellent)" by A.M. Best (its third highest rating), Swiss Reinsurance America Corporation, rated "A+ (Superior)" by A.M. Best, and Transatlantic Insurance Company, rated "A++ (Superior)" by A.M. Best (its top rating). The maximum per occurrence dollar recovery is equal to 225% of the annual net premiums ceded to the quota share arrangement in the contract year. The maximum aggregate per year dollar recovery under the quota share contract is equal to 325% of the annual net premium ceded to the quota share arrangement in the contract year. A sliding scale commission, based on loss ratio, is utilized under this program. Several limitations were added to the new quota share program regarding losses related to nuclear, chemical and biological terrorist events. The Company's maximum loss recovery in case of these types of events is estimated at $26 million. This program provides the Company with sufficient protection for catastrophe coverage to enable it to forego pure catastrophe reinsurance coverage.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The table below provides information depicting the approximate recovery under the quota share contract at various loss scenarios, if a single catastrophe were to strike through June 30, 2004:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             



|Total Loss |  | Reinsurance Recovery |  | Net Loss Retained by Commerce
|---------- |  | -------------------- |  | -----------------------------
|           |  |                      |  |                              
|           |  |                      |  |                              
|$  50,000  |  | $  32,500            |  | $  17,500                    
|100,000    |  | 65,000               |  | 35,000                       
|150,000    |  | 97,500               |  | 52,500                       
|200,000    |  | 130,000              |  | 70,000                       
|250,000    |  | 162,500              |  | 87,500                       
|300,000    |  | 195,000              |  | 105,000                      



|Under the above scenario and based on the twelve month projected premiums to be ceded under the program, we have no reinsurance recoveries for a single event catastrophe in excess of a total loss of approximately $359 million. The level of reinsurance protection increases (decreases) when the Company cedes more (less) premium to the reinsurers.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|It is customary for property and casualty companies to evaluate their exposure to a weather-related catastrophe by estimating the losses that would be incurred if a storm equivalent to the most destructive storm that has occurred during a given period were to occur during a current fiscal year or reinsurance policy period. If the estimate focuses on hurricanes during the past 100 years, for example, the most destructive hurricane during that period is referred to as a "100-year hurricane." Our estimated total loss, before reinsurance, on our other-than-automobile business for 100 and 250-year hurricanes is approximately $200 million and $322 million, respectively. Our estimates were derived through the services of Employers Reinsurance Corporation on our December 31, 2002 other-than-automobile exposures, which utilized the RMS (Risk Management Solutions) risk assessment system, and are based on increases in policies written in 2003 that are subject to the quota share treaty. We believe that most property and casualty insurance companies establish their catastrophe reinsurance programs between the 100-year and 250-year storm estimates.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Written premiums ceded in 2003, 2002 and 2001 under the current and prior quota share programs combined were $107.3 million, $98.0 million and $78.6 million, respectively. The 9.5% increase in written premiums ceded in 2003 versus 2002 in this program was primarily the result of a $19.3 million, or 23.1% increase in Massachusetts homeowner direct written premium, coupled with an $8.7 million, or 31.9%, increase in direct homeowner writings in states other than Massachusetts, as previously mentioned. The impact of these increases was offset by the reduction on the quota share participation rate from 75 % to 65 % on July 1, 2003. Ceding commission income is calculated on a ceded earned premium basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Casualty Reinsurance.Casualty reinsurance, excluding umbrella policies, is written on an excess of loss basis for any one event or occurrence with a maximum recovery of $8.0 million over a net retention of $2.0 million. This coverage is placed with Swiss Reinsurance America Corporation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

<PAGE>  83

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|NOTE G - Reinsurance Activity (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Personal and commercial liability umbrella policies are reinsured on a 95% quota share basis in regard to limits up to $1.0 million and 100% quota share basis for limits in excess of $1.0 million but not exceeding $5.0 million for policies with underlying automobile coverage of $250/$500 or more. We also have personal liability umbrella reinsurance coverage for policies with underlying automobile coverage of $100/$300 on a 65% quota share basis for limits up to $1.0 million and 100% quota share basis for limits in excess of $1.0 million but not exceeding $3.0 million. The personal liability coverage was placed with American Re-Insurance through year end 2002. Effective January 1, 2003, we entered into a 95% personal umbrella quota share agreement with Employers Reinsurance Corporation, rated "A (Excellent)" by A.M. Best (its third highest rating). Through July 15, 2002, our commercial liability umbrella policies were placed with American Re-Insurance Company. Subsequent to July 15, 2002, we entered into a 95% commercial umbrella quota share agreement with Employers Reinsurance Corporation.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Earned premiums and losses and loss adjustment expenses are stated in the accompanying consolidated financial statements after deductions for ceded reinsurance. Those deductions for reinsurance, other than CAR, follow for the years ended December 31:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  



|                                           | 2003      |  | 2002      |  | 2001    
|------------------------------------------ | --------- |  | --------- |  | --------
|                                           |           |  |           |  |         
|                                           |           |  |           |  |         
|Income Statement                           |           |  |           |  |         
|Written premiums ceded                     | $ 111,119 |  | $ 101,913 |  | $ 81,827
|Earned premiums ceded                      | 108,249   |  | 90,075    |  | 77,226  
|Losses and loss adjustment expenses ceded  | 68,139    |  | 47,658    |  | 40,514  
|Balance Sheet                              |           |  |           |  |         
|Unpaid losses and loss adjustment expenses | 58,074    |  | 43,380    |  | 32,101  
|Unearned premiums                          | 59,712    |  | 55,023    |  | 42,258  



|The Company, as primary insurer, would be required to pay losses in their entirety in the event that the reinsurers were unable to discharge their obligations under the reinsurance agreements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Effective July 1, 2002, Commerce entered into a retrocessional reinsurance agreement with one of its quota share reinsurers who maintained a one-third participation in Commerce's 75% quota share treaty. For a premium paid to Commerce, Commerce indemnified the reinsurer if the reinsurer incurred a loss for a single event or occurrence over a certain threshold. Losses assumed by the reinsurer must first exceed $15,000 before a reimbursement would have been made, by Commerce, to the reinsurer. Commerce's exposure to the reinsurer under this agreement was for a maximum of $35,000. The threshold translated into a $60,000 total loss event or occurrence to Commerce, $15,000 of which represented the reinsurers 25% portion of the quota share treaty, before the reinsurer would have received any benefit. This contract terminated on June 30, 2003 with no losses incurred by Commerce.                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Commonwealth Automobile Reinsurers ("CAR")                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|CAR, a state-mandated reinsurance mechanism, enables the Company and the other Servicing Carriers to reinsure any automobile risk that the insurer perceives to be under-priced at the premium level permitted by the Commissioner. Servicing Carriers, who are responsible for over 99.0% of total direct premiums written for personal automobile insurance in Massachusetts, are required to offer automobile insurance coverage to all eligible applicants pursuant to "take-all-comers" regulations, but may reinsure business with CAR.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Since its inception, CAR has annually generated multi-million dollar underwriting losses, primarily in the personal automobile pool. The Company is required to share in the underwriting results of CAR business for its respective product lines. Under current regulations, the Company's share of the CAR personal or commercial deficit is based upon its market share for automobile risks for the particular pool, adjusted by a "utilization" concept, such that, in general, the Company is disproportionately and adversely affected if its relative use of CAR reinsurance exceeds that of the industry, and favorably affected if its relative use of CAR reinsurance is less than that of the industry. For personal automobile writers, companies can reduce their participation ratio by writing credit eligible business voluntarily. Companies are provided credits against their participation ratio for writing those classes and territories of business that are purposefully under-priced in the Massachusetts rate setting process. The Company's strategy has been to maintain above average voluntary retention levels, as well as to retain private passenger automobile business voluntarily that receives credits. This favorably affects the

<PAGE>  84

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                    
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                   
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                             
|NOTE G - Reinsurance Activity (continued)                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                             
|Company's participation ratio compared to its market share, but adversely impacts its voluntary loss ratio. During 2003, 2002 and 2001, the Company's net participation in the CAR personal automobile pool approximated 20.2%, 18.2% and 17.3%, respectively, as reported by CAR, compared to the Company's estimated market share in those years of 27.6%, 25.9% and 23.2%.
|                                                                                                                                                                                                                                                                                                                                                                             
|Reinsurance activity with CAR for fiscal years 2003, 2002 and 2001 follows:                                                                                                                                                                                                                                                                                                  



|                        | 2003     |  | 2002     |  | 2001     
|----------------------- | -------- |  | -------- |  | ---------
|                        |          |  |          |  |          
|                        | Ceded    |  | Assumed  |  | Ceded    
|                        |          |  |          |  |          
|                        |          |  |          |  |          
|Income Statement:       |          |  |          |  |          
|Written premiums        | $104,898 |  | $112,547 |  | $  88,198
|Earned premiums         | 96,150   |  | 104,297  |  | 80,241   
|Losses and LAE incurred | 114,267  |  | 144,252  |  | 114,578  
|Underwriting expenses   | -        |  | 35,883   |  | -        
|                        |          |  |          |  |          
|Balance Sheet:          |          |  |          |  |          
|Unearned premiums       | 55,656   |  | 55,624   |  | 52,374   
|Unpaid losses and LAE   | 137,087  |  | 133,175  |  | 112,102  



|The Company pays to CAR all of the premiums generated by the policies it has ceded and CAR reimburses the Company for all losses incurred on account of ceded policies. In addition, the Company receives a fee for servicing ceded policies based on the expense structure established by CAR. For the years ended December 31, 2003, 2002 and 2001, these servicing fees amounted to $18,938, $18,668 and $17,161, respectively.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The Company presents assets and liabilities gross of reinsurance. The Residual Market Receivable represents the gross amount of reinsurance recoverable from CAR including unpaid losses, unearned premiums, paid losses recoverable and unpaid ceded and assumed premiums.                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The current CAR utilization-based participation ratio has been in place for the personal automobile market since 1994. During 2003, 2002 and 2001, the Company's amount of personal automobile exposures it reinsured through CAR approximated 5.1%, 4.9%, and 4.9%, respectively, as compared to industry averages of 7.0%, 7.5% and 7.7%, respectively.                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|Member companies of CAR have joint and several liabilities for the obligations of CAR. If one member of CAR fails to pay its assessments, the remaining members of CAR will be required to pay the pro-rata share of the member who fails to pay their obligations. At the present time, the Company is not aware of any CAR member company who has failed to meet their obligations.                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The Company's two largest reinsurance components, quota share and CAR, settle on a quarterly basis. Quota share settles 45 days after the end of each quarter and CAR settles 90 days after the end of each quarter. There were no balances in dispute for the years ended 2003 and 2002 for both components.                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|NOTE H - Income Taxes                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The Company and its subsidiaries file a consolidated federal income tax return.                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The federal income tax expense (benefit) for the years ended December 31 follows:                                                                                                                                                                                                                                                                                                                                                 



|         | 2003     |  | 2002     |  | 2001    
|-------- | -------- |  | -------- |  | --------
|         |          |  |          |  |         
|         |          |  |          |  |         
|Current  | $ 63,852 |  | $ 32,956 |  | $ 28,571
|Deferred | (5,784)  |  | (15,893) |  | (10,179)
|         |          |  |          |  |         
|         | $ 58,068 |  | $ 17,063 |  | $ 18,392
|         |          |  |          |  |         

<PAGE>  85

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|NOTE H - Income Taxes (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Realization of a deferred tax asset is dependent on generating sufficient taxable income in future years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. SFAS No. 109 requires a valuation allowance to be recorded when it is more likely than not that some or all of the deferred tax assets will not be realized. At December 31, 2002, the Company's valuation allowance of $3,936 represented the tax effect related to realized investment losses that may not have been recoverable due to the uncertainties as to the amount of realized investment gains that may have been available in the future. The Company had sufficient capital gains in 2003 to reverse the 2002 year end valuation allowance in 2003.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|Deferred tax liabilities (assets) at December 31 follow:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



|                                                 | 2003       |  | 2002      
|------------------------------------------------ | ---------- |  | ----------
|                                                 |            |  |           
|                                                 |            |  |           
|Unearned premiums                                | $ (48,846) |  | $ (41,113)
|Discounting of loss reserves                     | (22,248)   |  | (24,147)  
|Equity in losses of preferred stock mutual funds | -          |  | (7,847)   
|Employee stock option expense                    | (7,797)    |  | (5,514)   
|Investment write-downs                           | (13,159)   |  | (10,297)  
|Deferred income                                  | (10,797)   |  | (8,916)   
|Book value awards expense                        | (3,850)    |  | (221)     
|Directors' retirement compensation expense       | (1,006)    |  | (918)     
|Other                                            | (3,322)    |  | (3,375)   
|                                                 |            |  |           
|                                                 | (111,025)  |  | (102,348) 
|Valuation allowance                              | -          |  | 3,936     
|                                                 |            |  |           
|Deferred tax assets                              | (111,025)  |  | (98,412)  
|                                                 |            |  |           
|Deferred policy acquisition costs                | 53,763     |  | 48,384    
|Salvage and subrogation recoverable              | 2,429      |  | 2,466     
|Tax depreciation in excess of book depreciation  | 1,724      |  | 2,051     
|Equity in preferred stock mutual funds           | 3,377      |  | -         
|Net accumulated comprehensive income             | 15,664     |  | 13,603    
|Other                                            | 828        |  | 1,180     
|                                                 |            |  |           
|Deferred tax liabilities                         | 77,785     |  | 67,684    
|                                                 |            |  |           
|Net deferred tax asset                           | $ (33,240) |  | $ (30,728)
|                                                 |            |  |           



|Federal income tax on income is less than the amount computed by applying the statutory rate of 35% for the years ended 2003, 2002 and 2001 for the following reasons:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                   | 2003    |  | 2002  |  | 2001   
|---------------------------------- | ------- |  | ----- |  | -------
|                                   |         |  |       |  |        
|                                   |         |  |       |  |        
|Tax at statutory rate              | $76,757 |  | 35.0% |  | $18,220
|Tax exempt interest                | (4,933) |  | (2.2) |  | (5,556)
|Dividends paid to ESOP             |         |  |       |  |        
|participants                       | (1,211) |  | (0.6) |  | (844)  
|Dividends received deduction       | (7,942) |  | (3.6) |  | (9,100)
|Valuation allowance                | (3,936) |  | (1.8) |  | 3,936  
|Realized losses ineligible for tax |         |  |       |  |        
|deduction                          | -       |  | -     |  | 10,874 
|Amortization of excess of book     |         |  |       |  |        
|value of subsidiary interest       |         |  |       |  |        
|over cost                          | -       |  | -     |  | -      
|Amortization of preferred stock    |         |  |       |  |        
|mutual fund negative goodwill      | -       |  | -     |  | -      
|Other                              | (667)   |  | (0.3) |  | (467)  
|                                   |         |  |       |  |        
|Tax at effective rate              | $58,068 |  | 26.5% |  | $17,063
|                                   |         |  |       |  |        

<PAGE>  86

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|NOTE I - Related-Party Transactions                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The Company has made loans to insurance agencies with which Commerce transacts business on a regular basis. At December 31, 2003, ten loans with an aggregate outstanding principal balance of $2,537 were collateralized by the assets of the agencies and one loan with an outstanding balance of $281 was collateralized by real estate as the primary collateral and the assets of the agency as secondary collateral. There were no loans to insurance agencies collateralized solely by real estate. At December 31, 2002, elevenloans with an aggregate outstanding balance of $2,847 were collateralized by the assets of the agencies and one loan with an outstanding balance of $298 was collateralized by real estate as the primary collateral and the assets of the agency as secondary collateral.                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The immediate family of Raymond J. Lauring, a Director of the Company, owns more than a 10% equity interest in Lauring Construction Company. Mr. Lauring has no ownership interest in Lauring Construction Company. During 2003 and 2002, Lauring Construction Company provided construction and construction management services in connection with a contract for the estimated $13 million renovation of a 130,000 square foot building purchased by the Company. Terms of the contract provided for a fixed fee of $650 for supervision of management of the project. Total payments on the supervision and management services portion of the contract in 2003 and 2002 were $375 and $275, respectively. Payments to Lauring Construction Company in 2003 and 2002 for actual materials used and construction work performed on this project were $335 and $2,308, respectively, and payments for other work unrelated to the project were $45 in 2003 and $33 in 2002.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|NOTE J - Employee Stock Ownership Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The Company offers an Employee Stock Ownership Plan ("ESOP") for the benefit of substantially all employees, including those of the Company's subsidiaries. The ESOP is noncontributory on the part of participants and contributions are made at the discretion of the Board of Directors. The Company is under no obligation to make contributions or maintain the ESOP for any length of time, and may completely discontinue or terminate the ESOP at any time without liability. Contributions by the Company and subsidiaries to the ESOP for the years ended December 31, 2003, 2002 and 2001 were $8,850, $8,070 and $7,502, respectively. The increase in the contribution in 2003 over 2002 and in 2002 over 2001 was primarily due to an increase in employees. The ESOP held 2,851,748 and 2,921,033 shares of the Company's common stock at December 31, 2003 and 2002, respectively.                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|ESOP participants who are current employees of the Company or its subsidiaries and who are 100% vested in their ESOP accounts can annually elect to transfer out of the ESOP up to 100% of their allocated Company stock in the form of an eligible rollover distribution into another eligible retirement plan, such as a qualified individual retirement arrangement. Approximately 2,096,000 shares owned by participants in the ESOP at December 31, 2003 are allocated to the ESOP accounts of these individuals. ESOP accounts vest at a rate of 20% per service year beginning with a participant's third year of service.                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|ESOP participants who are former employees of the Company may generally elect to withdraw from the ESOP the total amount of shares allocated to their accounts at any time. Approximately 561,000 shares held by the ESOP at December 31, 2003 are allocated to the ESOP accounts of these individuals.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|The remaining approximately 194,000 shares held by the ESOP at December 31, 2003 are allocated to the ESOP accounts of participants who have not yet reached 100% vesting in their account balances. Disposition of these unvested shares is restricted under the ESOP. The Company pays for administration of the ESOP.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|In 2003, the Company's 401(k) Plan was merged into the ESOP. The ESOP is administered by Fidelity Investments. The 401(k) component of the ESOP enables eligible employees to contribute up to 60% of eligible compensation on a pre-tax basis up to the annual maximum limits under federal tax law. The Company incurs no expenses in the form of matching contributions but does pay for administration of the plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|NOTE K - American Commerce Post-Retirement Benefits                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|Effective May 1, 2002, the Directors of American Commerce voted to terminate that portion of the American Commerce noncontributory post-retirement benefit plan (the "post-retirement plan") applicable to future retirees. The post-retirement plan provides benefits for retirees that include medical, dental and life insurance coverages. Retirees at May 1, 2002 and employees who retired prior to that date remained eligible for post-retirement benefits. Dental coverage ceases at                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

<PAGE>  87

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|NOTE K - American Commerce Post-Retirement Benefits (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|age 65 and life insurance coverage decreases based upon the age of the participant until the attainment of age 70 and thereafter. Participants' spouses are also covered under the post-retirement plan. The cost of post-retirement medical, dental and life insurance benefits was accrued over the active service periods of employees to the date they attained full eligibility for such benefits. It is the policy of American Commerce to pay for post-retirement benefits as incurred.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the "Act") was signed into law. The Act introduces a prescription drug benefit under Medicare ("Medicare Part D") as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In accordance with FASB Staff Position FAS 106-1, the Company elected to defer accounting for the effects of the Act until specific, authoritative guidance on the accounting for the federal subsidy is issued. Therefore, any measures of the accumulated benefit obligation and net periodic benefit cost of the post-retirement plan in the consolidated financial statements and accompanying notes do not reflect the effects of the Act. The authoritative guidance, when issued, could require the Company to change previously reported information, however, the Company does not expect this to have a significant effect on its financial condition or results of operation, because this applies to only six participants.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|The post-retirement benefit plan's funded status reconciled with amounts reported in the consolidated balance sheet and the assumptions used in determining the actuarial present value of the benefit obligation at year end follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    



|                                    | 2003        |  | 2002       
|----------------------------------- | ----------- |  | -----------
|                                    |             |  |            
|                                    |             |  |            
|Plan assets at fair value           | $         - |  | $         -
|                                    |             |  |            
|Accumulated benefit obligation:     |             |  |            
|Retirees                            | 1,569       |  | 1,492      
|Active participants, fully eligible | -           |  | -          
|Active participants, not eligible   | -           |  | -          
|                                    |             |  |            
|Projected benefit obligation        | 1,569       |  | 1,492      
|                                    |             |  |            
|Unfunded status of plan             | (1,569)     |  | (1,492)    
|Unrecognized net loss               | 20          |  | -          
|                                    |             |  |            
|Accrued benefit cost                | $ (1,549)   |  | $ (1,492)  
|                                    |             |  |            
|Assumptions:                        |             |  |            
|Weighted average discount rate      | 6.0%        |  | 7.0%       
|                                    |             |  |            



|The measurement dates used to determine post-retirement benefit measurements that make up at least the majority of benefit obligations are December 31, 2003 and 2002, respectively.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                    
|Net periodic cost of the post-retirement plan for the periods ended December 31, 2003, 2002 and 2001 follows:                                                                       



|                                                       | 2003   |  | 2002      |  | 2001 
|------------------------------------------------------ | ------ |  | --------- |  | -----
|                                                       |        |  |           |  |      
|                                                       |        |  |           |  |      
|Service cost-benefits earned                           | $    - |  | $      63 |  | $ 250
|Interest cost on projected benefit obligation          | 88     |  | 131       |  | 248  
|Amortization of unrecognized net transition obligation | -      |  | 1,087     |  | 99   
|Amortization of unrecognized prior service cost        | -      |  | (17)      |  | (3)  
|Amortization of unrecognized gain                      | -      |  | (3,310)   |  | (25) 
|                                                       |        |  |           |  |      
|Net periodic cost (benefit)                            | $  88  |  | $(2,046)  |  | $ 569
|                                                       |        |  |           |  |      



|The assumed health care cost trend rate for 2003 was 7.5% and 6.75% for medical and dental, respectively. These rates grade down until the final trend rates of 6.0% and 5.0% for medical and dental, respectively, are reached in 2010. A one percentage point increase in the assumed health and dental cost trend rates increases the sum of the service and interest costs components of the 2003, 2002 and 2001 periodic post-retirement benefit cost by 11.3%, 16.9% and 16.3% respectively, and the accumulated post-retirement benefit obligation as of December 31, 2003, 2002 and 2001 by 10.5%, 10.9% and 16.6%, respectively.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  88

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|NOTE L - Directors' Retirement Compensation Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|During 2000, the Company's Directors approved a Directors' Retirement Compensation Plan (the "Retirement Plan"). The Retirement Plan becomes effective for each Company Director upon terminating service on the Company's Board of Directors (the "Board") providing that such termination was not made under conditions adverse to the Company's interest. Effective with the annual meeting wherein the Director is not reappointed to the Board, and provided benefits are not paid until such time as the Director has attained the age of 65, the Company will pay an annual retirement benefit equal to 50% of the average annual total compensation of the Director for the immediately preceding three full years ("the three year average compensation"). The annual retirement benefit of 50% of the three year average compensation vests at the rate of 4.0% for each year of Board service up to a maximum of 100% vesting through termination of service. Payments continue for a maximum of ten years over the remaining life of the terminated Director, or his or her then spouse, if the Director pre-deceases the spouse. No payments are to be made after the death of the Director and spouse. Expenses related to the Retirement Plan in 2003, 2002 and 2001 amounted to $286, $117 and $178, respectively. The Company paid $36, $36 and $19 under the Retirement Plan in 2003, 2002 and 2001, respectively. The liability for the Retirement Plan, as calculated based on discounted cash flows, was $2,875 and $2,624 at December 31, 2003 and 2002, respectively.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|NOTE M - Stockholders' Equity                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The amount of consolidated retained earnings at December 31, 2003 represented by undistributed earnings of 50% or less owned investments that are accounted for using the equity method follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            



|                                                  |          |  |          |  | Undistributed
|------------------------------------------------- | -------- |  | -------- |  | -------------
|                                                  | Carrying |  |          |  | Earnings     
|                                                  | Value    |  | Cost     |  | (Loss)       
|                                                  |          |  |          |  |              
|                                                  |          |  |          |  |              
|Preferred stock mutual funds                      | $ 54,274 |  | $ 50,795 |  | $   3,479    
|Other investments in venture capital partnerships | 22,914   |  | 38,826   |  | (15,912)     
|                                                  |          |  |          |  |              
|                                                  | $ 77,188 |  | $ 89,621 |  | (12,433)     
|                                                  |          |  |          |  |              
|Income tax benefit                                |          |  |          |  | (4,352)      
|                                                  |          |  |          |  |              
|Undistributed equity method earnings included in  |          |  |          |  |              
|consolidated retained earnings                    |          |  |          |  | $  (8,081)   
|                                                  |          |  |          |  |              



|Book Value Awards, Stock Appreciation Rights and Stock Option Programs                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|During 2002, the Company's stockholders approved the Incentive Compensation Plan which provides for the award of incentive stock options, non-qualified stock options, book value awards, stock appreciation rights ("SAR"), restricted stock and performance stock units. Up to 5,000,000 shares of common stock (subject to increase for anti-dilution adjustments) may be issued under the Incentive Compensation Plan, including shares that may be issued pursuant to awards of restricted stock or upon the exercise of common stock equivalent awards such as stock options and stock appreciation rights payable in the form of common stock (not in the form of cash). At the discretion of the compensation committee all directors, officers and other senior management employees of the Company or any of its subsidiaries are eligible to participate in this Incentive Compensation Plan.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Book value awards issued relating to the Incentive Compensation Plan totaled 1,408,675, 1,268,784 and 474,541 in 2003, 2002 and 2001, respectively. Expenses relating to book value awards were $11,203, $1,700 and $1,577 in 2003, 2002 and 2001, respectively. The outstanding book value awards entitle the holders to cash payments based upon the extent to which, if at all, the per share book value exceeds certain thresholds set at the time the award was granted.                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Employee stock options ("options") granted during 2001, 2000 and 1999 relating to the Incentive Compensation Plan totaled 1,184,343, 644,520 and 700,179, respectively, including the issuance of options previously terminated. No options were granted in 2003 and 2002. The outstanding options entitle the recipient to purchase the Company's common stock based upon the extent to which, if at all, the per share market value of the common stock exceeds certain thresholds set at the time the option was granted. Unexercised options terminate not later than eight years after the date of grant.                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|Liabilities for the book value awards and employee stock option programs were $17,512 and $10,926 at December 31, 2003 and 2002, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

<PAGE>  89

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                       
|----------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                      
|(Thousands of Dollars, Except for Per Share Data)                                                               
|                                                                                                                
|NOTE M - Stockholders' Equity (continued)                                                                       
|                                                                                                                
|Incentive Compensation Plan activity, related to employee stock options, for the three years ended 2003 follows:
|                                                                                                                



|                                         |           |  | Weighted Average Exercise
|---------------------------------------- | --------- |  | -------------------------
|                                         | Shares    |  | Price                    
|                                         |           |  |                          
|                                         |           |  |                          
|Options outstanding at January 1, 2001   | 1,338,811 |  | $32.35                   
|Granted April 6, 2001                    | 1,184,343 |  | 30.80                    
|Terminated                               | (80,818)  |  | 34.74                    
|                                         |           |  |                          
|Options outstanding at December 31, 2001 | 2,442,336 |  | 31.52                    
|Exercised                                | (281,627) |  | 32.81                    
|                                         |           |  |                          
|Options outstanding at December 31, 2002 | 2,160,709 |  | 31.35                    
|Exercised                                | (348,037) |  | 31.79                    
|                                         |           |  |                          
|Options outstanding at December 31, 2003 | 1,812,672 |  | 31.27                    
|                                         |           |  |                          
|Options exercisable at December 31, 2002 | 347,873   |  | 32.81                    
|                                         |           |  |                          
|Options exercisable at December 31, 2003 | 628,329   |  | 32.15                    
|                                         |           |  |                          



|At December 31, 2003, 2,557,664 shares of common stock may be awarded in the future under the Incentive Compensation Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|The Company follows variable accounting treatment of employee stock options granted in 1999 and 2000 in accordance with APB Opinion 25 and related interpretations. Expenses in 2003 and 2002 related to options granted in 1999 and 2000 were $2,570 and $3,306, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|Additionally, the Company granted 1,100,000, 475,000 and 275,000 options to certain agents ("ACIC agents' options") of American Commerce (the "American Commerce Agents' Plan") in 2003, 2002 and 2001, respectively. The right of the recipient to exercise these ACIC agents' options is contingent upon the average volume of other-than-Massachusetts private passenger automobile and homeowners direct written premiums placed and maintained with American Commerce for a five year period specified in the ACIC agents' option agreement. If qualified, the recipient may purchase the Company's common stock at the exercise price for a period of five years beginning five years after the date of the grant ("the confirmation date"). Unexercised ACIC agents' options terminate not later than ten years after the date of the grant ("the expiration date"). In conjunction with meeting specified premium growth levels over the term of the ACIC agents' options, the Company provided "put rights" to the holders of the ACIC agents' options granted in 1999. These put rights permit the agents' option holders to require the Company to purchase the ACIC agents' options at the difference between $40.00 less the exercise price, at any time from and after the confirmation date through and including the expiration date. Options cannot be exercised using cash. Options can only be exercised using a net share purchase such that the dollar value that the option is in the money is divided by the fair market value of the stock at the date of exercise to arrive at the number of shares received by the option holder. Expenses related to these options, determined in accordance with the fair value accounting provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", amounted to $9,030 in 2003, $1,543 in 2002 and $2,862 in 2001. The American Commerce Agent's Plan has not been, and is not required to be, approved by the Company's stockholders.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

<PAGE>  90

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                          
|-----------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                         
|(Thousands of Dollars, Except for Per Share Data)                                  
|                                                                                   
|NOTE M - Stockholders' Equity (continued)                                          
|                                                                                   
|The American Commerce Agents' Plan activity for the three years ended 2003 follows:



|                                                 |           |  | Weighted
|------------------------------------------------ | --------- |  | --------
|                                                 |           |  | Average 
|                                                 |           |  | Exercise
|                                                 | Shares    |  | Price   
|                                                 |           |  |         
|                                                 |           |  |         
|Agents' options outstanding at January 1, 2001   | 1,947,380 |  | $ 36.23 
|Granted                                          | 275,000   |  | 42.85   
|                                                 |           |  |         
|Agents' options outstanding at December 31, 2001 | 2,222,380 |  | 37.05   
|Granted                                          | 475,000   |  | 49.50   
|                                                 |           |  |         
|Agents' options outstanding at December 31, 2002 | 2,697,380 |  | 39.24   
|Granted                                          | 1,100,000 |  | 46.27   
|                                                 |           |  |         
|Agents' options outstanding at December 31, 2003 | 3,797,380 |  | 41.28   
|                                                 |           |  |         



|None of the outstanding ACIC agents' options was exercisable at December 31, 2003, 2002 and 2001.                                                                                                               
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                
|The fair value of each of the ACIC agents' options granted under the American Commerce Agents' Plan was estimated using the Black-Scholes option-pricing model, with the following weighted average assumptions:



|                              | 2003   |  | 2002   |  | 2001  
|----------------------------- | ------ |  | ------ |  | ------
|                              |        |  |        |  |       
|                              |        |  |        |  |       
|Dividend yield                | 3.20%  |  | 3.53%  |  | 3.16% 
|Expected volatility           | 22.40% |  | 29.50% |  | 28.30%
|Risk-free interest rate       | 3.04%  |  | 2.71%  |  | 4.04% 
|Expected option life in years | 5-9.5  |  | 7      |  | 7     



|The exercise prices for ACIC agents' options granted in 2003, 2002, 2001, 2000 and 1999 are $46.27, $49.50, $42.85, $34.04 and $36.32, respectively. The estimated weighted average fair value per share of the ACIC agents' options under the American Commerce Agents' Plan was $6.82, $5.03 and $5.63 at December 31, 2003, 2002 and 2001, respectively. The ACIC agents' option liability at December 31, 2003 and 2002 was $16.7 million and $7.6 million, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE N - Net Capital Requirements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The insurance companies included in the consolidated financial statements are subject to the financial capacity guidelines established by their respective state Divisions of Insurance. Every Massachusetts insurance company seeking to make any dividend or other distribution to its stockholders may, within certain limitations, pay such dividend and then file a report with the Commissioner. Dividends in excess of these limitations are called extraordinary dividends. An extraordinary dividend is any dividend or other property, whose fair value together with other dividends or distributions made within the preceding twelve months, exceeds the greater of ten percent of the insurer's surplus as regards policyholders as of the end of the preceding year, or the net income of a non-life insurance company for the preceding year. No pro-rata distribution of any class of the insurer's own securities is to be included. No Massachusetts insurance company shall pay an extraordinary dividend or other extraordinary distribution until thirty days after the Commissioner has received notice of the intended distribution and has not objected. No extraordinary dividends were paid in 2003, 2002 and 2001. California and Ohio have similar regulations. No extraordinary dividend was paid by American Commerce in 2003, 2002 and 2001 and no dividends were paid by Commerce West since its acquisition.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The aggregate amount of dividends calculated in accordance with regulations in Massachusetts, California and Ohio that could have been paid in 2003 from all of the Company's insurance subsidiaries without prior regulatory approval was approximately $76.0 million, of which $66.2 million was declared and paid as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

<PAGE>  91

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE N - Net Capital Requirements (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The Board of Directors of the Company voted to declare four quarterly dividends to stockholders of record totaling $1.27 per share and $1.23 per share in 2003 and 2002, respectively. On May 16, 2003, the Board voted to increase the quarterly stockholder dividend from $0.31 to $0.32 per share to stockholders of record as of June 4, 2003. Prior to that declaration, the Company paid quarterly dividends of $0.31 per share dating back to May 19, 2002 when the Board voted to increase the dividend from $0.30 to $0.31 per share.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|NOTE O - Statutory Balances                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|The Company presents statutory financial information because it believes that these measures are useful to interested parties. Statutory measures allow readers to more easily compare our insurance operations with those of other companies, especially those whose GAAP financial statements reflect businesses more diversified than the Company's business. Statutory accounting principles vary in some respects from GAAP. Principal variations include the accounting for:                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

<PAGE>  92

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                       
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                      
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                               
|                                                                                                                                                                                                                
|NOTE O - Statutory Balances (continued)                                                                                                                                                                         
|                                                                                                                                                                                                                
|Following is a GAAP to Statutory reconciliation for both earnings and policyholders surplus for the combined operations of our insurance subsidiaries - Commerce, Citation, Commerce West and American Commerce:



|                                       | 2003     |  | 2002       |  | 2001    
|-------------------------------------- | -------- |  | ---------- |  | --------
|                                       |          |  |            |  |         
|                                       | Earnings |  | Equity     |  | Earnings
|                                       |          |  |            |  |         
|                                       |          |  |            |  |         
|GAAP                                   | $174,456 |  | $1,183,715 |  | $49,433 
|                                       |          |  |            |  |         
|Deferred income taxes (benefits)       | 7,586    |  | 53,788     |  | (15,793)
|Deferred acquisition costs             | (15,366) |  | (153,605)  |  | (21,684)
|Bonds-book versus market               | -        |  | (19,531)   |  | -       
|Preferred stock-market versus book     | -        |  | (11,189)   |  | -       
|Deferred income                        | (498)    |  | 7,684      |  | 1,380   
|Deferred service fee income (expenses) | (1,717)  |  | 105        |  | (943)   
|Deferred reinsurance commissions       | 3,147    |  | 21,908     |  | 3,924   
|Statutory reserve over                 |          |  |            |  |         
|statement reserves                     | -        |  | (94)       |  | -       
|Goodwill in subsidiary                 | (348)    |  | -          |  | 166     
|Pension and post-retirement benefit    | (11)     |  | -          |  | (2,015) 
|Yield to worst amortization            | (1,150)  |  | (4,616)    |  | 274     
|Non-admitted assets                    | -        |  | (3,370)    |  | -       
|Sale of affiliates to subsidiary       | 1,584    |  | -          |  | -       
|Adjustment for non-insurance           |          |  |            |  |         
|company subsidiary                     | -        |  | -          |  | (97)    
|Equity in earnings (losses) of         |          |  |            |  |         
|preferred stock mutual funds           |          |  |            |  |         
|reflected in GAAP earnings             | (33,223) |  | -          |  | 44,363  
|Equity in earnings (losses) of         |          |  |            |  |         
|venture capital funds reflected        |          |  |            |  |         
|in GAAP earnings                       | 1,964    |  | -          |  | 4,399   
|Equity in earnings (losses) of         |          |  |            |  |         
|LIQ Special Trust reflected in         |          |  |            |  |         
|GAAP earnings                          | -        |  | -          |  | 2,484   
|Change in accounting principle         | -        |  | -          |  | (11,237)
|Restatement for option                 |          |  |            |  |         
|accounting                             | -        |  | -          |  | -       
|Other                                  | 14       |  | 279        |  | 466     
|                                       |          |  |            |  |         
|Total adjustments                      | (38,018) |  | (108,641)  |  | 5,687   
|                                       |          |  |            |  |         
|Statutory                              | $136,438 |  | $1,075,074 |  | $55,120 
|                                       |          |  |            |  |         



|NOTE P - Segment Information                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|The Company has four reportable segments: (1) property and casualty insurance - Massachusetts; (2) property and casualty insurance - other than Massachusetts; (3) real estate and commercial lending; and, (4) corporate and other. The Company's property and casualty insurance operations are written through Commerce, Citation, Commerce West, and American Commerce and are marketed to affinity groups, individuals, families and businesses through the Company's relationships with professional independent insurance agencies. The Company's real estate and commercial lending operations are a result of insurance companies having the authority to invest in mortgages. The Company's wholly-owned subsidiary, Bay Finance Company, Inc., originates and services residential and commercial mortgages in Massachusetts and Connecticut. The corporate and other segment represents the remainder of the Company's activities, including those of the parent company.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|The Company evaluates performance and allocates resources based primarily on the property and casualty insurance segments, which represents over 99% of the Company's total revenue for the past three years. The accounting policies of the reportable segments are the same as those described in NOTE A - Summary of Significant Accounting Policies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

<PAGE>  93

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                    
|-------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                   
|(Thousands of Dollars, Except for Per Share Data)            
|                                                             
|NOTE P - Segment Information (continued)                     
|                                                             
|Selected segment information for 2003, 2002 and 2001 follows:



|                                   |             |  | Earnings (Losses) |  |             
|---------------------------------- | ----------- |  | ----------------- |  | ------------
|                                   |             |  | Before Income     |  |             
|                                   |             |  | Taxes and Change  |  |             
|                                   |             |  | in Accounting     |  | Identifiable
|                                   | Revenue     |  | Principle         |  | Assets      
|                                   |             |  |                   |  |             
|                                   |             |  |                   |  |             
|2003:                              |             |  |                   |  |             
|Property and casualty insurance    |             |  |                   |  |             
|Massachusetts                      | $ 1,413,074 |  | $ 224,092         |  | $ 2,784,091 
|Other than Massachusetts           | 226,978     |  | 16,182            |  | 333,044     
|Real estate and commercial lending | 1,233       |  | 1,233             |  | 16,924      
|Corporate and other                | (463)       |  | (22,496)          |  | 30,172      
|                                   |             |  |                   |  |             
|Consolidated                       | $ 1,640,822 |  | $ 219,011         |  | $ 3,164,231 
|                                   |             |  |                   |  |             
|                                   |             |  |                   |  |             
|2002:                              |             |  |                   |  |             
|Property and casualty insurance    |             |  |                   |  |             
|Massachusetts                      | $ 1,092,396 |  | $   72,903        |  | $ 2,106,317 
|Other than Massachusetts           | 161,962     |  | (16,479)          |  | 273,012     
|Real estate and commercial lending | 2,737       |  | 2,737             |  | 27,554      
|Corporate and other                | 24          |  | (6,580)           |  | 12,190      
|                                   |             |  |                   |  |             
|Consolidated                       | $ 1,257,119 |  | $   52,581        |  | $ 2,419,073 
|                                   |             |  |                   |  |             
|                                   |             |  |                   |  |             
|2001:                              |             |  |                   |  |             
|Property and casualty insurance    |             |  |                   |  |             
|Massachusetts                      | $ 1,011,318 |  | $ 118,657         |  | $ 1,886,514 
|Other than Massachusetts           | 135,483     |  | (5,867)           |  | 249,316     
|Real estate and commercial lending | 3,592       |  | 3,592             |  | 40,483      
|Corporate and other                | 3,397       |  | (7,737)           |  | 10,830      
|                                   |             |  |                   |  |             
|Consolidated                       | $ 1,153,790 |  | $ 108,645         |  | $ 2,187,143 
|                                   |             |  |                   |  |             



|NOTE Q - Insolvency Fund Assessments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Protection Against Insurer Insolvency - Massachusetts                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|All of the insurers writing the types of insurance covered by the Massachusetts Insurers Insolvency Fund ("MIIF") are MIIF members. MIIF is obligated to pay any unpaid claim, up to $300, against an insolvent insurer if the claims existed prior to the declaration of insolvency or arose within 60 days thereafter. MIIF assesses members the amounts it deems necessary to pay both its obligations and the expenses of handling covered claims. Subject to certain limitations, assessments are made in the proportion that each member's net written premiums for the preceding calendar year for all property and casualty lines of business bore to the corresponding net written premiums for all members for the same period. The statute that established MIIF also provides for the recoupment by insurers of amounts paid to MIIF. Historically, the Commissioner has allowed insurers to recoup the amounts they paid MIIF through rate adjustments.                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|From MIIF's inception on August 2, 1972 through December 31, 2003, the MIIF has approved assessments totaling $286,016, of which the share for Commerce and Citation was approximately $28,288. It is anticipated that there will be additional assessments from time to time relating to various insolvencies. By statute, no insurer may be assessed in any year an amount greater than two percent of that insurer's direct written premiums for the calendar year preceding the assessment. Although the timing and amounts of any such assessments are not known, based on existing knowledge, management is of the opinion that such assessments will not have a material effect on the consolidated financial position of the Company. MIIF assessed Commerce and Citation $8,106, $4,496 and $3,111 for the years ended December 31, 2003, 2002 and 2001, respectively. The assessment for 2003 was the result of 20 insolvencies. It was primarily the result of the insolvencies of Reliance Insurance Company and Legion Insurance Company for $2,570 each, and the insolvency of Midland Insurance Company for $2,185. The assessment for 2002 was primarily the result of six insolvencies. It was primarily the result of the

<PAGE>  94

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(Thousands of Dollars, Except for Per Share Data)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|NOTE Q - Insolvency Fund Assessments (continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Credit General Insurance Company Insolvency, $1,154, Trust Insurance Company Insolvency, $1,074 and New England Fidelity Insurance Company Insolvency, $1,033. These amounts were offset by refunds for prior year assessments on numerous insurer insolvencies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Protection Against Insurer Insolvency - Other States                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Commerce West, domiciled in California, is covered by the California Insurance Guarantee Association. American Commerce, domiciled in Ohio, is covered by the Ohio Guarantee Association and, as previously mentioned, Commerce and Citation are covered by MIIF. All companies are also covered by similar associations in the states where they do business. These associations operate similarly to the MIIF described earlier. Payments made by American Commerce, Commerce West and Commerce to the associations that they are covered under were $190 in 2003 and $107 in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|NOTE R - Commitments                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|In 2000, Commerce entered into a Limited Partnership Agreement with Conning Partners VI, L.P., a Delaware Limited Partnership. This partnership agreement required a commitment by the Company to invest up to $50,000 into the partnership. In 2003, 2002 and 2001, the Company invested $5,250, $9,965 and $6,341, respectively, into the partnership. As of December 31, 2003, the Company has invested $30,306 into the partnership, leaving a balance for funds available for commitment to the partnership of $19,694. The partnership was formed to operate as an investment fund principally for the purpose of making investments primarily in equity, equity-related and other securities issued in expansion financing, start-ups, buy-outs and recapitalization transactions relating to companies in the areas of insurance, financial services, e-commerce, healthcare, and related businesses, including, without limitation, service and technology enterprises supporting such businesses, in order to realize long-term capital returns, all as determined and managed by the General Partner for the benefit of the Partners.                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|Also in 2000, Commerce entered into a Limited Partnership Agreement with Distribution Partners Investment Capital, L.P. a Delaware Limited Partnership. This partnership agreement required a commitment by the Company to invest up to $3,500 into the partnership. In 2002 and 2001, the Company invested $298 and $1,733, respectively, into the partnership. The Company did not invest in the partnership in 2003. As of December 31, 2003, the Company has invested $2,555 into the partnership leaving a balance of $945 for funds still committed. The partnership was formed to operate as an investment fund principally for the purpose of making investments primarily in equity and equity-related securities of companies operating in the area of insurance distribution and distribution related activities, all as determined and managed by the General Partner for the benefit of the Partners. See Note F for the Company's indebtedness commitment.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|NOTE S - Legal Proceedings                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|As is common with property and casualty insurance companies, the Company is a defendant in various legal actions arising from the normal course of its business, including claims based on the Massachusetts Unfair Claims Settlement Practices Act, or Chapter 176D and the Massachusetts Consumer Protection Act, or Chapter 93A. Similar provisions exist in other states where the Company does business. These proceedings are considered ordinary to operations or without foundation in fact. Management is of the opinion that these actions will not have a material adverse effect on the consolidated financial position of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|The Company previously disclosed that a purported class action lawsuit was pending in Massachusetts state court against Commerce. The lawsuit, titled "Elena Given, individually and as a representative of all persons similarly situated v. The Commerce Insurance Company," alleged damages as a result of the alleged inherent diminished value to vehicles that are involved in accidents. In April 2002, the trial judge in that case entered partial summary judgment for the plaintiff on the issue of whether the Massachusetts automobile policy covers her claim, ruling that the plaintiff would be entitled to reimbursement under the policy if the plaintiff were able both to prove that her vehicle suffered "inherent diminished value" in the accident and to quantify the amount of such diminution in value. During the third quarter of 2002, Commerce applied for direct appellate review of this issue by the Supreme Judicial Court of Massachusetts ("SJC"), and this application was granted. On October 7, 2003, the SJC ruled in favor of Commerce, overturning the trial court's decision that the Massachusetts automobile policy provides coverage for inherent diminished value. The plaintiff has dismissed this case. Commerce had not previously established a reserve for any contingent liability related to the Given litigation; therefore, there was no financial impact as a result of the conclusion of this litigation.

<PAGE>  95

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                         
|----------------------------------------------------------------------------------
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                        
|(Thousands of Dollars, Except for Per Share Data)                                 
|                                                                                  
|NOTE T - Quarterly Results of Operations (Unaudited)                              
|                                                                                  
|An unaudited summary of the Company's 2003 and 2002 quarterly performance follows:



|                                                      | First     |  | Second    |  | Third     |  | Fourth   
|----------------------------------------------------- | --------- |  | --------- |  | --------- |  | ---------
|                                                      | Quarter   |  | Quarter   |  | Quarter   |  | Quarter  
|                                                      |           |  |           |  |           |  |          
|                                                      |           |  |           |  |           |  |          
|2003                                                  |           |  |           |  |           |  |          
|Total revenues                                        | $ 361,177 |  | $ 446,156 |  | $ 405,620 |  | $ 427,869
|Net earnings                                          | 12,920    |  | 71,473    |  | 22,864    |  | 53,686   
|Comprehensive income                                  | 16,425    |  | 75,057    |  | 10,842    |  | 62,438   
|Net earnings per common share:                        |           |  |           |  |           |  |          
|Basic                                                 | 0.40      |  | 2.24      |  | 0.72      |  | 1.67     
|Diluted                                               | 0.40      |  | 2.22      |  | 0.71      |  | 1.65     
|Cash dividends paid per share                         | 0.31      |  | 0.32      |  | 0.32      |  | 0.32     
|                                                      |           |  |           |  |           |  |          
|                                                      | First     |  | Second    |  | Third     |  | Fourth   
|                                                      | Quarter   |  | Quarter   |  | Quarter   |  | Quarter  
|                                                      |           |  |           |  |           |  |          
|                                                      |           |  |           |  |           |  |          
|2002                                                  |           |  |           |  |           |  |          
|Total revenues                                        | $ 312,153 |  | $ 294,788 |  | $ 327,770 |  | $ 322,408
|Earnings (loss) before change in accounting principle | 22,733    |  | (1,300)   |  | 12,628    |  | 1,457    
|Net earnings (loss)                                   | 33,970    |  | (1,300)   |  | 12,628    |  | 1,457    
|Comprehensive income (loss)                           | 38,094    |  | 8,242     |  | (2,425)   |  | 15,714   
|Net earnings (loss) per common share                  |           |  |           |  |           |  |          
|Basic                                                 | 1.03      |  | (0.04)    |  | 0.39      |  | 0.05     
|Diluted                                               | 1.02      |  | (0.04)    |  | 0.38      |  | 0.06     
|Earnings (loss) per common share before change in     |           |  |           |  |           |  |          
|accounting principle:                                 |           |  |           |  |           |  |          
|Basic                                                 | 0.69      |  | (0.04)    |  | 0.39      |  | 0.05     
|Diluted                                               | 0.68      |  | (0.04)    |  | 0.38      |  | 0.06     
|Cash dividends paid per share                         | 0.30      |  | 0.31      |  | 0.31      |  | 0.31     

<PAGE>  96

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|MANAGEMENT'S DISCUSSION OF THE SUPPLEMENTAL INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|ON INSURANCE OPERATIONS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|(Thousands of dollars)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|The following tables depict the progress of the insurance operations of the Company over the past fifteen years. For these years of operation, net premiums written amounted to $11.0 billion. During this period, the aggregate statutory financial ratios were 70.8% for losses and loss expenses and 25.5% for underwriting expenses resulting in an aggregate combined ratio of 96.3 %. Total net investment income amounted to $1.0 billion or 9.4% of net premiums written. Net realized gains were $92.0 million. Stockholders' equity was $67.2 million at the beginning of 1989 and $1.2 billion, at the end of 2003, resulting in an average annual increase in excess of 22.5%, excluding dividends. This figure, including dividends paid, would have been 22.7%. The progress of the insurance operations during the most recent five year period, compared to the two previous five year periods, can best be illustrated by the following comparison:



|                                              | 1999 - 2003 |  | 1994 - 98  |  | 1989 - 93 
|--------------------------------------------- | ----------- |  | ---------- |  | ----------
|                                              |             |  |            |  |           
|                                              |             |  |            |  |           
|Direct premiums written                       | $6,238,030  |  | $3,549,019 |  | $2,324,133
|Net premiums written                          | 5,868,384   |  | 3,390,737  |  | 1,743,511 
|Net investment income                         | 481,619     |  | 379,053    |  | 172,448   
|Net realized gains (losses)                   | (3,770)     |  | 62,121     |  | 33,629    
|Stockholders' equity at end of period         | 1,183,715   |  | 654,819    |  | 351,631   
|Statutory Financial Ratios:                   |             |  |            |  |           
|Losses and loss expenses to premiums earned   | 73.5%       |  | 68.5%      |  | 66.2%     
|Underwriting expenses to net premiums written | 24.2        |  | 26.9       |  | 27.3      
|                                              |             |  |            |  |           
|Combined ratio                                | 97.7%       |  | 95.4%      |  | 93.5%     
|                                              |             |  |            |  |           
|Increase in Stockholders' Equity              | 71.2%       |  | 68.7%      |  | 197.1%    
|                                              |             |  |            |  |           



|The insurance operations of the Company include the operating results of Commerce, Citation, Commerce West, American Commerce and Clark-Prout. Results of Commerce West are included since its acquisition by the Company on August 31, 1995. Results of American Commerce are included since its acquisition by the Company on January 29, 1999.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  97

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                              
|-----------------------------------------------------------------------
|COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES AND RECONCILIATION TO
|CONSOLIDATED FINANCIAL STATEMENTS                                      
|December 31,                                                           
|(Thousands of Dollars)                                                 
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|ASSETS                                                                 
|Cash and short-term investments                                        
|Bonds, at market (at amortized                                         
|cost prior to 1993)                                                    
|Preferred stocks, at market (at                                        
|amortized cost prior to 1993)                                          
|Common stocks, at market                                               
|Preferred stock mutual funds (at equity)                               
|Mortgage loans on real estate                                          
|Other investments                                                      
|Premium balances receivable                                            
|Investment income receivable                                           
|Residual market receivable                                             
|Reinsurance receivable                                                 
|Deferred acquisition costs                                             
|Current income taxes                                                   
|Deferred income taxes                                                  
|Non-compete agreement                                                  
|Real estate, furniture and equipment                                   
|Receivable for investments sold                                        
|                                                                       
|Total insurance company assets                                         
|Total non-insurance company assets                                     
|                                                                       
|Total combined assets                                                  
|                                                                       
|                                                                       
|LIABILITIES AND STOCKHOLDERS' EQUITY                                   
|Unpaid losses and loss expenses                                        
|Unearned premiums                                                      
|Excess of book value of subsidiary                                     
|interest over cost                                                     
|Notes payable                                                          
|Deferred income                                                        
|Accounts payable, accrued and other                                    
|liabilities                                                            
|Current income taxes                                                   
|Deferred income taxes                                                  
|Payable for securities purchased                                       
|Outstanding checks payable                                             
|                                                                       
|Total insurance company liabilities                                    
|Total non-insurance company liabilities                                
|                                                                       
|Total combined liabilities                                             
|                                                                       
|Minority interest (1)                                                  
|                                                                       
|Capital stock                                                          
|Paid-in capital                                                        
|Retained earnings:                                                     
|Balance, January 1                                                     
|Net earnings                                                           
|Sale of subsidiaries                                                   
|Other comprehensive income (loss)                                      
|Dividends paid                                                         
|                                                                       
|Balance, December 31                                                   
|                                                                       
|Total insurance company equity                                         
|Total non-insurance company equity                                     
|                                                                       
|Total combined stockholders' equity                                    
|                                                                       
|Total combined liabilities                                             
|and stockholders' equity                                               
|                                                                       



|(1) | Due to the internal reorganization in 2003, minority interest is no longer part of our insurance operation. Minority interest is included in 2003 for comparative purposes and to reconcile to our consolidated balance sheet.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  98

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                              
|-----------------------------------------------------------------------
|COMBINED BALANCE SHEETS OF INSURANCE SUBSIDIARIES AND RECONCILIATION TO
|CONSOLIDATED FINANCIAL STATEMENTS                                      
|December 31,                                                           
|(Thousands of Dollars)                                                 
|                                                                       
|                                                                       
|                                                                       
|                                                                       
|ASSETS                                                                 
|Cash and short-term investments                                        
|Bonds, at market (at amortized                                         
|cost prior to 1993)                                                    
|Preferred stocks, at market (at                                        
|amortized cost prior to 1993)                                          
|Common stocks, at market                                               
|Preferred stock mutual funds (at equity)                               
|Mortgage loans on real estate                                          
|Other investments                                                      
|Premium balances receivable                                            
|Investment income receivable                                           
|Residual market receivable                                             
|Reinsurance receivable                                                 
|Deferred acquisition costs                                             
|Current income taxes                                                   
|Deferred income taxes                                                  
|Non-compete agreement                                                  
|Real estate, furniture and equipment                                   
|Receivable for investments sold                                        
|                                                                       
|Total insurance company assets                                         
|Total non-insurance company assets                                     
|                                                                       
|Total combined assets                                                  
|                                                                       
|                                                                       
|LIABILITIES AND STOCKHOLDERS' EQUITY                                   
|Unpaid losses and loss expenses                                        
|Unearned premiums                                                      
|Excess of book value of subsidiary
 interest over cost                 
|Notes payable                                                          
|Deferred income                                                        
|Accounts payable, accrued and other
 liabilities                       
|Current income taxes                                                   
|Deferred income taxes                                                  
|Payable for securities purchased                                       
|Outstanding checks payable                                             
|                                                                       
|Total insurance company liabilities                                    
|Total non-insurance company liabilities                                
|                                                                       
|Total combined liabilities                                             
|                                                                       
|Minority interest (1)                                                  
|                                                                       
|Capital stock                                                          
|Paid-in capital                                                        
|Retained earnings:                                                     
|Balance, January 1                                                     
|Net earnings                                                           
|Sale of subsidiaries                                                   
|Other comprehensive income (loss)                                      
|Dividends paid                                                         
|                                                                       
|Balance, December 31                                                   
|                                                                       
|Total insurance company equity                                         
|Total non-insurance company equity                                     
|                                                                       
|Total combined stockholders' equity                                    
|                                                                       
|Total combined liabilities
     and stockholders' equity               
|                                                                       

<PAGE>  99

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                    
|-----------------------------------------------------------------------------
|COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS AND RECONCILIATION TO
|CONSOLIDATED FINANCIAL STATEMENTS                                            
|Years Ended December 31,                                                     
|(Thousands of Dollars)                                                       
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Underwriting:                                                                
|Direct premiums written                                                      
|Assumed premiums                                                             
|Ceded premiums                                                               
|                                                                             
|Net premiums written                                                         
|Increase (decrease) in unearned                                              
|premiums                                                                     
|                                                                             
|Earned premiums                                                              
|                                                                             
|                                                                             
|Expenses:                                                                    
|Losses and loss expenses                                                     
|Underwriting expenses                                                        
|(Increase) decrease in deferred                                              
|acquisition costs                                                            
|                                                                             
|Total expenses                                                               
|                                                                             
|Underwriting income                                                          
|Net investment income                                                        
|Premium finance fees                                                         
|Amortization of excess of book value                                         
|of subsidiary interest over cost                                             
|Net realized investment gains (losses)                                       
|                                                                             
|Earnings before federal income                                               
|taxes, withdrawing companies'                                                
|settlements and minority interest                                            
|Other income:                                                                
|Other income                                                                 
|Withdrawing companies' settlements                                           
|                                                                             
|Earnings before Federal income                                               
|taxes and minority interest                                                  
|Federal income taxes                                                         
|                                                                             
|Earnings before cumulative effect of                                         
|change in accounting principle and                                           
|minority interest                                                            
|Changes in accounting principle                                              
|Minority interest in net (earnings)                                          
|losses of subsidiary(1)                                                      
|                                                                             
|Net earnings for insurance companies                                         
|Net earnings (losses) for non-insurance                                      
|companies                                                                    
|                                                                             
|NET COMBINED EARNINGS                                                        
|                                                                             
|                                                                             
|Statutory Financial Ratios (Unaudited)                                       
|Losses and loss expenses to                                                  
|premiums earned                                                              
|Underwriting expenses to net                                                 
|premiums written                                                             
|                                                                             
|Combined ratio                                                               
|                                                                             
|Underwriting profit                                                          
|                                                                             



|(1) | Due to the internal reorganization in 2003, minority interest is not included in our insurance operations. Minority interest of $(294) in 2003 is included in net earnings for non-insurance companies.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  100

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                    
|-----------------------------------------------------------------------------
|COMBINED STATEMENTS OF EARNINGS OF INSURANCE OPERATIONS AND RECONCILIATION TO
|CONSOLIDATED FINANCIAL STATEMENTS                                            
|Years Ended December 31,                                                     
|(Thousands of Dollars)                                                       
|                                                                             
|                                                                             
|                                                                             
|                                                                             
|Underwriting:                                                                
|Direct premiums written                                                      
|Assumed premiums                                                             
|Ceded premiums                                                               
|                                                                             
|Net premiums written                                                         
|Increase (decrease) in unearned                                              
|premiums                                                                     
|                                                                             
|Earned premiums                                                              
|                                                                             
|                                                                             
|Expenses:                                                                    
|Losses and loss expenses                                                     
|Underwriting expenses                                                        
|(Increase) decrease in deferred                                              
|acquisition costs                                                            
|                                                                             
|Total expenses                                                               
|                                                                             
|Underwriting income                                                          
|Net investment income                                                        
|Premium finance fees                                                         
|Amortization of excess of book value of                                      
|subsidiary interest over cost                                                
|Net realized investment gains (losses)                                       
|                                                                             
|Earnings before federal income                                               
|taxes,withdrawing companies'                                                 
|settlements and minority interest                                            
|Other income:                                                                
|Other income                                                                 
|Withdrawing companies' settlements                                           
|                                                                             
|Earnings before Federal income                                               
|taxes and minority interest                                                  
|Federal income taxes                                                         
|                                                                             
|Earnings before cumulative effect of                                         
|change in accounting principle and                                           
|minority interest                                                            
|Changes in accounting principle                                              
|Minority interest in net (earnings)                                          
|losses of subsidiary(1)                                                      
|                                                                             
|Net earnings for insurance companies                                         
|Net earnings (losses) for non-insurance                                      
|companies                                                                    
|                                                                             
|NET COMBINED EARNINGS                                                        
|                                                                             
|                                                                             
|Statutory Financial Ratios (Unaudited)                                       
|Losses and loss expenses to                                                  
|premiums earned                                                              
|Underwriting expenses to net                                                 
|premiums written                                                             
|                                                                             
|Combined ratio                                                               
|                                                                             
|Underwriting profit                                                          
|                                                                             

<PAGE>  101

|ITEM 9.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND                                  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | FINANCIAL DISCLOSURE                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|Pursuant to a vote adopted on May 16, 2003, the Board of Directors of The Commerce Group, Inc. (the "Registrant") authorized the Audit Committee of the Board of Directors (the "Audit Committee") to appoint, compensate, retain or terminate, and oversee the work of the Registrant's Independent Auditor engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attest services for the Registrant.                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (a)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | The Audit Committee terminated the responsibilities of Ernst & Young LLP effective June 17, 2003.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (b)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (c)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (d)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (e)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|ITEM 9a.  CONTROLS AND PROCEDURES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (a)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | (b)                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |                                                                                                  
|There has been no change in our internal control over financial reporting that has occurred during our last fiscal quarter that has materially affected, or is reasonably likely to affect materially, our internal control over financial reporting.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     



<PAGE>  102



|PART III                                                                                                                                                                                                                                                                                                                                                                                              
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                      
|ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                      
|The information called for by this Item and not provided herein will be contained in the Company's Proxy Statement, which the Company intends to file within 120 days after the end of the Company's fiscal year ended December 31, 2003, and such information is incorporated herein by reference.
The Company has adopted a Code of Ethics and posted it on its website.
Our executive officers are:



|Name                     |  |    | Age |                                                                                  |  | Primary Position with Company | 
|------------------------ |  | -- | --- | -------------------------------------------------------------------------------- |  | ----------------------------- | 
|                         |  |    |     |                                                                                  |  |                               | 
|                         |  |   
|Arthur J. Remillard, Jr. |  | 73 |     | President, Chief Executive Officer, Chairman of the Board and Director          
|                         |  |    |     |                                                                                 
|Gerald Fels              |  | 61 |     | Executive Vice President, Chief Financial Officer and Director                  
|                         |  |    |     |                                                                                 
|Regan P. Remillard       |  | 40 |     | Senior Vice President and Director                                              
|                         |  |    |     |                                                                                 
|Arthur J. Remillard, III |  | 48 |     | Senior Vice President--Policyholder Benefits, Assistant Clerk and Director      
|                         |  |    |     |                                                                                 
|David H. Cochrane        |  | 50 |     | Senior Vice President--Underwriting of Commerce and Citation                    
|                         |  |    |     |                                                                                 
|Peter J. Dignan          |  | 52 |     | Senior Vice President--Marketing and Premium Accounting of Commerce and Citation
|                         |  |    |     |                                                                                 
|James A. Ermilio         |  | 41 |     | Senior Vice President and General Counsel                                       
|                         |  |    |     |                                                                                 
|Joseph J. Staffieri      |  | 57 |     | Senior Vice President--Human Resources                                          
|                         |  |    |     |                                                                                 
|Henry R. Whittier, Jr.   |  | 62 |     | Senior Vice President--Management Information Systems of Commerce and Citation  
|                         |  |    |     |                                                                                 
|Randall V. Becker        |  | 43 |     | Treasurer and Chief Accounting Officer and Director                             



|Arthur J. Remillard, Jr. has been the President, Chief Executive Officer and Chairman of the Board of the Company since 1976. Mr. Remillard has been Chief Executive Officer and Chairman of the Board of Commerce Insurance since 1972 and President of Commerce Insurance from 1972 to November 2001. Additionally, Mr. Remillard is the Chairman of the Governing Committee, Chairman of the Actuarial Committee, Vice Chairman of the Governing Committee Review Panel, Chairman of the Budget Committee and Vice Chairman of the Personnel Committee of CAR. Mr. Remillard is also Chairman of the Governing Committee and a member of the Budget Committee, Executive Committee and Nominating Committee of the AIB.                                                                                                               
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|Gerald Fels, a Certified Public Accountant, was appointed President and Chief Operating Officer of Commerce Insurance in November 2001, and Executive Vice President of Commerce Group in November 1989. From 1981 to November 1989, Mr. Fels was Senior Vice President of Commerce Group. Mr. Fels was the Treasurer of Commerce Group from 1976 to 1994 and of Commerce Insurance from 1975 to 1994. Mr. Fels has also been Chief Financial Officer of Commerce Group since 1976 and of Commerce Insurance since 1975. Mr. Fels became the Chief Executive Officer and President of American Commerce and Commerce West effective November 18, 2003. Additionally, Mr. Fels is Vice Chair and a director of American Nuclear Insurers and an Advisory Committee Member of several investment funds managed by Conning Capital Partners.



<PAGE>  103



|Regan P. Remillard has been a Senior Vice President of Commerce Group since 1995. Mr. Remillard was appointed President of American Commerce in 2001, President of ACIC Holding in 1998 and Vice Chairman of the Board and Chief Executive Officer of American Commerce in 1999. Mr. Remillard was President of Commerce West from 1996 to 2003. From 1995 to February 2000, Mr. Remillard was General Counsel of Commerce Group. From 1994 to 1995, Mr. Remillard was a practicing attorney at Hutchins, Wheeler & Dittmar, a Massachusetts law firm specializing in corporate law and litigation and from 1989 to 1993, Mr. Remillard was Government Affairs Monitor of Commerce Group. Mr. Remillard is a member of the Massachusetts Bar. Mr. Remillard resigned from his positions with American Commerce, Commerce West and ACIC Holding effective November 18, 2003.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Arthur J. Remillard, III was appointed Senior Vice President of Policyholder Benefits in 1988 and has been Assistant Clerk of Commerce Group since 1982. From 1981 to 1988, Mr. Remillard, III had been Vice President-Mortgage Operations. In addition, Mr. Remillard, III was elected Vice Chairman of the Board of Governors of the Insurance Fraud Bureau of the AIB in 2002 and he has served on that Board since 1991. Mr. Remillard, III has also served on the CAR Claims Advisory Committee since 1990 and the AIB Claims Committee since 1991.                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|David H. Cochrane has been the Senior Vice President of Underwriting for Commerce Insurance and Citation since 1988. For approximately four years prior to that, Mr. Cochrane was the Vice President of Financial Services of CAR. Mr. Cochrane has also served on the CAR Market Review Committee since 1988.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Peter J. Dignan was appointed the Senior Vice President of Marketing and Premium Accounting for Commerce Insurance and Citation in 1997. From 1989 to 1997, Mr. Dignan was Vice President of Premium Accounting for Commerce Insurance and Citation. From 1987 to 1989, Mr. Dignan was Assistant Vice President of Premium Accounting for Commerce and Citation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|James A. Ermilio was appointed as Senior Vice President for Commerce Group in May 2001. Mr. Ermilio was also appointed General Counsel of Commerce Group in February 2000 and was a Vice President of Commerce Group from November 1998 to May 2001. Mr. Ermilio is also General Counsel and Secretary of American Commerce and Secretary of ACIC Holding and Commerce West. Mr. Ermilio had been the Associate General Counsel of Commerce Group since September 1998. Mr. Ermilio was Counsel for Glaxo Wellcome, Inc. (currently known as GlaxoSmithKline, Inc.) from 1993 to September 1998. Prior to 1993, Mr. Ermilio was an Associate with the law firm currently known as Bingham McCutchen. Mr. Ermilio is a member of the Massachusetts and District of Columbia Bars.                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Joseph J. Staffieri was appointed the Senior Vice President of Human Resources for Commerce Group in November 2002. From May 2001 to November 2002, Mr. Staffieri was Vice President of Human Resources of Commerce Insurance. Prior to May of 1997 through April of 2001, Mr. Staffieri was the Vice President of Human Resources for Ames Department Stores.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Henry R. Whittier, Jr. was appointed the Senior Vice President of Management Information Systems for Commerce Insurance and Citation in November 2002. From 1995 to November 2002, Mr. Whittier was Vice President of Management Information Systems for Commerce Insurance and Citation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|Randall V. Becker, a Certified Public Accountant, has been Treasurer and Chief Accounting Officer of Commerce Group since 1994. From 1990 to 1994, Mr. Becker was Assistant Treasurer and Comptroller of Commerce Group. From 1986 to 1990, Mr. Becker was the Director of Internal Audit for Commerce Group.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|The only family relationships among the executive officers are that Arthur J. Remillard, III and Regan P. Remillard are the sons of Arthur J. Remillard, Jr.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|ITEM 11. EXECUTIVE COMPENSATION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|The information called for by this Item will be contained in the Company's Proxy Statement, which the Company intends to file within 120 days after the end of the Company's fiscal year ended December 31, 2003 and such information is incorporated herein by reference.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 



<PAGE>  104



|ITEM 12.                                                                                                                                                                                                                                                                   | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS       
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                          
|The information called for by this Item will be contained in the Company's Proxy Statement, which the Company intends to file within 120 days after the end of the Company's fiscal year ended December 31, 2003 and such information is incorporated herein by reference.
|                                                                                                                                                                                                                                                                          
|ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                          
|The information called for by this Item will be contained in the Company's Proxy Statement, which the Company intends to file within 120 days after the end of the Company's fiscal year ended December 31, 2003 and such information is incorporated herein by reference.
|                                                                                                                                                                                                                                                                          
|ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                          
|The information called for by this Item will be contained in the Company's Proxy Statement, which the Company intends to file within 120 days after the end of the Company's fiscal year ended December 31, 2003 and such information is incorporated herein by reference.
|                                                                                                                                                                                                                                                                          
|PART IV                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                          
|ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K                                                                                                                                                                                                  
|                                                                                                                                                                                                                                                                          
|A.                                                                                                                                                                                                                                                                         | (1)
(2)
(3)                                                                                          
|                                                                                                                                                                                                                                                                          
|B.                                                                                                                                                                                                                                                                         | The following reports on Form 8-K were filed or furnished during the quarter ended December 31, 2003:
|                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                           | *                                                                                                    
|                                                                                                                                                                                                                                                                           |                                                                                                      
|                                                                                                                                                                                                                                                                           | *                                                                                                    
|                                                                                                                                                                                                                                                                           |                                                                                                      
|                                                                                                                                                                                                                                                                           | *                                                                                                    
|                                                                                                                                                                                                                                                                           |                                                                                                      
|                                                                                                                                                                                                                                                                           | *                                                                                                    



<PAGE>  105



|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.
|                                                                                                                                                                                                                
|Dated: March 5, 2004                                                                                                                                                                                            
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons, dated March 5, 2004, on behalf of the registrant and in the capacities indicated.    
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|                                                                                                                                                                                                                
|/s/ ARTHUR J. REMILLARD, JR                                                                                                                                                                                     
|                                                                                                                                                                                                                
|(Arthur J. Remillard, Jr.)                                                                                                                                                                                      
|                                                                                                                                                                                                                
|/s/ GERALD FELS                                                                                                                                                                                                 
|                                                                                                                                                                                                                
|(Gerald Fels)                                                                                                                                                                                                   
|                                                                                                                                                                                                                
|/s/ ARTHUR J. REMILLARD, III                                                                                                                                                                                    
|                                                                                                                                                                                                                
|(Arthur J. Remillard, III)                                                                                                                                                                                      
|                                                                                                                                                                                                                
|/s/ REGAN P. REMILLARD                                                                                                                                                                                          
|                                                                                                                                                                                                                
|(Regan P. Remillard)                                                                                                                                                                                            
|                                                                                                                                                                                                                
|/s/ JOHN W. SPILLANE                                                                                                                                                                                            
|                                                                                                                                                                                                                
|(John W. Spillane)                                                                                                                                                                                              
|                                                                                                                                                                                                                
|/s/ RANDALL V. BECKER                                                                                                                                                                                           
|                                                                                                                                                                                                                
|(Randall V. Becker)                                                                                                                                                                                             
|                                                                                                                                                                                                                
|/s/ JOSEPH A. BORSKI, JR.                                                                                                                                                                                       
|                                                                                                                                                                                                                
|(Joseph A. Borski, Jr.)                                                                                                                                                                                         
|                                                                                                                                                                                                                
|/s/ ERIC G. BUTLER                                                                                                                                                                                              
|                                                                                                                                                                                                                
|(Eric G. Butler)                                                                                                                                                                                                
|                                                                                                                                                                                                                
|/s/ HENRY J. CAMOSSE                                                                                                                                                                                            
|                                                                                                                                                                                                                
|(Henry J. Camosse)                                                                                                                                                                                              
|                                                                                                                                                                                                                
|/s/ DAVID R. GRENON                                                                                                                                                                                             
|                                                                                                                                                                                                                
|(David R. Grenon)                                                                                                                                                                                               
|                                                                                                                                                                                                                
|/s/ ROBERT W. HARRIS                                                                                                                                                                                            
|                                                                                                                                                                                                                
|(Robert W. Harris)                                                                                                                                                                                              



<PAGE>  106



|                       | Signature |          |  | Title | 
|---------------------- | --------- | -------- |  | ----- | 
|                       |           |          |  |       | 
|                       |           |          |  |       | 
|                       |           |         
|/s/ ROBERT S. HOWLAND  |           | Director
|                       |           |         
|(Robert S. Howland)    |           |         
|                       |           |         
|/s/ JOHN J. KUNKEL     |           | Director
|                       |           |         
|(John J. Kunkel)       |           |         
|                       |           |         
|/s/ RAYMOND J. LAURING |           | Director
|                       |           |         
|(Raymond J. Lauring)   |           |         
|                       |           |         
|/s/ NORMAND R. MAROIS  |           | Director
|                       |           |         
|(Normand R. Marois)    |           |         
|                       |           |         
|/s/ SURYAKANT M. PATEL |           | Director
|                       |           |         
|(Suryakant M. Patel)   |           |         
|                       |           |         
|/s/ GURBACHAN SINGH    |           | Director
|                       |           |         
|(Gurbachan Singh)      |           |         



<PAGE>  107

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                 
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                          
|INDEX TO FINANCIAL STATEMENT SCHEDULES*                                                                                                                                   
|                                                                                                                                                                          
|                                                                                                                                                                          
|                                                                                                                                                                          
|Schedules                                                                                                                                                                 
|                                                                                                                                                                          
|II                                                                                                                                                                        
|                                                                                                                                                                          
|                                                                                                                                                                          
|III                                                                                                                                                                       
|                                                                                                                                                                          
|                                                                                                                                                                          
|IV                                                                                                                                                                        
|                                                                                                                                                                          
|V                                                                                                                                                                         
|                                                                                                                                                                          
|                                                                                                                                                                          
|X                                                                                                                                                                         
|                                                                                                                                                                          
|                                                                                                                                                                          
|* Financial statement schedules other than those listed are omitted because they are not required, not applicable or the required information has been included elsewhere.

<PAGE>  108

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                           
|------------------------------------------------------------------------------------
|SCHEDULE II                                                                         
|CONDENSED FINANCIAL INFORMATION                                                     
|THE COMMERCE GROUP, INC.                                                            
|(Parent Company Only)                                                               
|BALANCE SHEETS                                                                      
|December 31,                                                                        
|(Thousands of Dollars)                                                              
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|ASSETS                                                                              
|Investments:                                                                        
|Investment in Commerce Holdings, Inc                                                
|Investment in Bay Finance Company, Inc                                              
|Investment in the Clark-Prout Insurance Agency, Inc                                 
|                                                                                    
|Total investments                                                                   
|                                                                                    
|Cash and cash equivalents                                                           
|Property and equipment, net of accumulated depreciation                             
|Current income taxes                                                                
|Deferred income taxes                                                               
|Receivable from affiliates                                                          
|Other assets                                                                        
|                                                                                    
|Total assets                                                                        
|                                                                                    
|                                                                                    
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                
|Liabilities:                                                                        
|Accounts payable and accrued expenses                                               
|Bonds payable ($300,000 face less $2,016 discount)                                  
|Other liabilities                                                                   
|                                                                                    
|Total liabilities                                                                   
|                                                                                    
|                                                                                    
|Stockholders' equity:                                                               
|Capital stock:                                                                      
|Common stock                                                                        
|Paid-in capital                                                                     
|Net accumulated other comprehensive income net of income taxes of $15,664           
|in 2003, $13,603 in 2002 and $6,674 in 2001                                         
|Retained earnings                                                                   
|                                                                                    
|                                                                                    
|Treasury stock, 6,568,964, 6,165,392, and 4,869,548 shares in 2003,                 
|2002 and 2001, at cost                                                              
|                                                                                    
|Total stockholders' equity                                                          
|                                                                                    
|Total liabilities and stockholders' equity                                          
|                                                                                    
|                                                                                    
|The accompanying notes are an integral part of these condensed financial statements.

<PAGE>  109

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                           
|------------------------------------------------------------------------------------
|SCHEDULE II                                                                         
|(continued)                                                                         
|CONDENSED FINANCIAL INFORMATION                                                     
|THE COMMERCE GROUP, INC.                                                            
|(Parent Company Only)                                                               
|STATEMENTS OF EARNINGS                                                              
|Years ended December 31,                                                            
|(Thousands of Dollars)                                                              
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Revenues:                                                                           
|Dividends received from subsidiaries                                                
|Rent income                                                                         
|Investment income                                                                   
|                                                                                    
|Total revenues                                                                      
|                                                                                    
|                                                                                    
|Expenses:                                                                           
|Depreciation                                                                        
|Interest expense & amortization of bond fees                                        
|Administrative expenses                                                             
|                                                                                    
|Total expenses                                                                      
|                                                                                    
|                                                                                    
|Earnings before income tax benefits and equity in net earnings of                   
|subsidiaries over amounts distributed                                               
|Income tax benefits                                                                 
|                                                                                    
|                                                                                    
|Earnings before equity in net earnings of subsidiaries over amounts                 
|distributed                                                                         
|                                                                                    
|Equity in net earnings of subsidiaries over (under) amounts distributed             
|                                                                                    
|Net earnings                                                                        
|                                                                                    
|                                                                                    
|The accompanying notes are an integral part of these condensed financial statements.

<PAGE>  110

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                           
|------------------------------------------------------------------------------------
|SCHEDULE II                                                                         
|(continued)                                                                         
|CONDENSED FINANCIAL INFORMATION                                                     
|THE COMMERCE GROUP, INC.                                                            
|(Parent Company Only)                                                               
|STATEMENTS OF CASH FLOWS                                                            
|Years ended December 31,                                                            
|(Thousands of Dollars)                                                              
|                                                                                    
|                                                                                    
|                                                                                    
|                                                                                    
|Cash flows from operating activities:                                               
|Net earnings                                                                        
|Adjustments to reconcile net earnings to net cash                                   
|provided by operating activities:                                                   
|Dividends received from consolidated subsidiaries                                   
|Equity in earnings of consolidated subsidiaries                                     
|Depreciation and amortization                                                       
|Other assets, other liabilities and accrued expenses                                
|Balances with affiliates                                                            
|Income tax benefits                                                                 
|Other-net                                                                           
|                                                                                    
|Net cash (used in) provided by operating activities                                 
|                                                                                    
|                                                                                    
|Cash flows from investing activities:                                               
|Purchase of property and equipment for company use                                  
|Proceeds from sale of property and equipment                                        
|                                                                                    
|Net cash used in investing activities                                               
|                                                                                    
|                                                                                    
|Cash flows from financing activities:                                               
|Dividends paid to stockholders                                                      
|Purchase of treasury stock                                                          
|Proceeds from bond issuance                                                         
|Bond issue costs                                                                    
|Capital stock issued                                                                
|                                                                                    
|Net cash provided by (used in) financing activities                                 
|                                                                                    
|                                                                                    
|Increase in cash and cash equivalents                                               
|Cash and cash equivalents at beginning of year                                      
|                                                                                    
|Cash and cash equivalents at end of year                                            
|                                                                                    
|                                                                                    
|The accompanying notes are an integral part of these condensed financial statements.

<PAGE>  111

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|SCHEDULE II                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(continued)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|CONDENSED FINANCIAL INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|THE COMMERCE GROUP, INC.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|(Parent Company Only)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|NOTES TO CONDENSED FINANCIAL STATEMENTS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|(Thousands of Dollars)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The accompanying condensed financial statements should be read in conjunction with the Consolidated Financial Statements and the accompanying notes thereto in the Annual Report.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|These condensed financial statements are presented on a "parent company only" basis. The equity of each of the Company's subsidiaries is reflected on each "investment in" line of the balance sheet. The combined net earnings of the Company's subsidiaries is reflected gross of dividends received by the Company from those subsidiaries on the "equity in net earnings of subsidiaries over (under) amounts distributed" lines in the statements of earnings. Since the condensed financial statements are presented on a "parent company only" basis, intercompany balances that are eliminated in the consolidated financial statements are reflected in those financial statements.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|NOTE A--Dividends                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The amounts of cash dividends paid to The Commerce Group, Inc. (parent only) were as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|Consolidated insurance subsidiaries                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|See NOTE N to the Consolidated Financial Statements in the Annual Report for a description of dividend restrictions applicable to the Company's subsidiaries.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|NOTE B--Federal Income Tax Allocation                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|As a member of a consolidated group for tax purposes, the Company and its subsidiaries (said parties constituting an "Affiliated Group" as defined in and for purposes of the Internal Revenue Code) are jointly and severally liable for federal income taxes of the Affiliated Group.  The Company and its subsidiaries have entered into an agreement establishing an allocation of tax liability and for compensation of the respective members of the Affiliated Group for use of their tax losses and credits.                                                                                                                                                                        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|The method of allocation calls for current taxes to be allocated among all affiliated companies based on a written tax-sharing agreement. Under this agreement, allocation is made primarily on a separate return basis with current payment for losses and other tax items utilized in the consolidated return. However, to the extent that a payer member of the group has future net operating losses, which it cannot absorb in the year incurred, other members within the group will refund payments to the payer.                                                                                                                                                                    

<PAGE>  112

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES                                                                                          
|-----------------------------------------------------------------------------------------------------------------------------------
|SCHEDULE II                                                                                                                        
|(continued)                                                                                                                        
|CONDENSED FINANCIAL INFORMATION                                                                                                    
|THE COMMERCE GROUP, INC.                                                                                                           
|(Parent Company Only)                                                                                                              
|NOTES TO CONDENSED FINANCIAL STATEMENTS                                                                                            
|(Thousands of Dollars)                                                                                                             
|                                                                                                                                   
|NOTE C--Consolidated Financial Statements                                                                                          
|                                                                                                                                   
|In preparing the consolidated financial statements of the Company and its subsidiaries, the following amounts have been eliminated:
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|Balance Sheet                                                                                                                      
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|Investment in subsidiaries                                                                                                         
|Receivable from affiliates                                                                                                         
|                                                                                                                                   
|                                                                                                                                   
|                                                                                                                                   
|Statement of Earnings                                                                                                              
|                                                                                                                                   
|                                                                                                                                   
|Dividends from subsidiaries                                                                                                        
|Rent income                                                                                                                        
|                                                                                                                                   
|NOTE D--Reclassification of Prior Year Balances                                                                                    
|                                                                                                                                   
|Certain prior year balances have been reclassified to conform to the 2003 presentation.                                            

<PAGE>  113

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES   
|--------------------------------------------
|SCHEDULE III                                
|SUPPLEMENTARY INSURANCE INFORMATION         
|Years Ended December 31, 2003, 2002 and 2001
|(Thousands of Dollars)                      
|                                            
|                                            
|                                            
|                                            
|                                            
|                                            
|Segment                                     
|                                            
|2003:                                       
|Massachusetts property and casualty         
|insurance                                   
|Other states property and casualty          
|insurance                                   
|Real estate and commercial lending          
|Corporate and other                         
|                                            
|Total                                       
|                                            
|                                            
|2002:                                       
|Massachusetts property and casualty         
|insurance                                   
|Other states property and casualty          
|insurance                                   
|Real estate and commercial lending          
|Corporate and other                         
|                                            
|Total                                       
|                                            
|                                            
|2001:                                       
|Massachusetts property and casualty         
|insurance                                   
|Other states property and casualty          
|insurance                                   
|Real estate and commercial lending          
|Corporate and other                         
|                                            
|Total                                       
|                                            



|(1) | The allocation of net investment income is based upon the specific identification of activity within the various segments.
|--- | --------------------------------------------------------------------------------------------------------------------------

<PAGE>  114

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES   
|--------------------------------------------
|SCHEDULE IV                                 
|REINSURANCE                                 
|Years Ended December 31, 2003, 2002 and 2001
|(Thousands of Dollars)                      
|                                            
|                                            
|                                            
|                                            
|Insurance Premiums Earned                   
|                                            
|                                            
|2003:                                       
|Property and casualty                       
|insurance                                   
|                                            
|                                            
|2002:                                       
|Property and casualty                       
|insurance                                   
|                                            
|                                            
|2001:                                       
|Property and casualty                       
|insurance                                   
|                                            

<PAGE>  115

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES   
|--------------------------------------------
|SCHEDULE V                                  
|VALUATION AND QUALIFYING ACCOUNTS           
|Years Ended December 31, 2003, 2002 and 2001
|(Thousands of Dollars)                      
|                                            
|                                            
|                                            
|                                            
|                                            
|                                            
|                                            
|                                            
|2003:                                       
|Allowance for losses on mortgage loans and  
|collateral notes receivable                 
|                                            
|                                            
|Allowance for doubtful premium receivables  
|                                            
|                                            
|Deferred tax asset valuation allowance      
|                                            
|                                            
|2002:                                       
|Allowance for losses on mortgage loans and  
|collateral notes receivable                 
|                                            
|                                            
|Allowance for doubtful premium receivables  
|                                            
|                                            
|Deferred tax asset valuation allowance      
|                                            
|                                            
|2001:                                       
|Allowance for losses on mortgage loans and  
|collateral notes receivable                 
|                                            
|                                            
|Allowance for doubtful premium receivables  
|                                            



|(1) | Deductions represent net write-offs of amounts determined to be uncollectible.
|--- | ------------------------------------------------------------------------------

<PAGE>  116

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES   
|--------------------------------------------
|SCHEDULE X                                  
|SUPPLEMENTAL INFORMATION CONCERNING         
|PROPERTY-CASUALTY INSURANCE OPERATIONS      
|Years Ended December 31, 2003, 2002 and 2001
|(Thousands of Dollars)                      
|                                            
|                                            
|                                            
|                                            
|                                            
|Affiliation With Registrant                 
|                                            
|                                            
|2003:                                       
|Consolidated property-casualty entities     
|                                            
|                                            
|2002:                                       
|Consolidated property-casualty entities     
|                                            
|                                            
|2001:                                       
|Consolidated property-casualty entities     
|                                            

<PAGE>  117

|THE COMMERCE GROUP, INC. AND SUBSIDIARIES
|-----------------------------------------
|INDEX TO EXHIBITS (A)                    
|                                         
|Exhibit                                  
|Number                                   
|                                         
|                                         
|3.1                                      
|                                         
|3.2                                      
|                                         
|4                                        
|                                         
|4.2                                      
|                                         
|4.3                                      
|                                         
|10.1*                                    
|                                         
|10.2*                                    
|                                         
|10.3*                                    
|                                         
|10.4*                                    
|                                         
|10.5*                                    
|                                         
|10.6*                                    
|                                         
|10.7                                     
|                                         
|10.8*                                    
|                                         
|10.9                                     
|                                         
|10.10                                    
|                                         
|10.11                                    
|                                         
|10.12                                    
|                                         
|10.13                                    
|                                         
|10.14                                    
|                                         
|10.31                                    
|                                         
|16.1                                     
|                                         
|21.1                                     
|                                         
|23                                       
|                                         
|31                                       
|                                         
|32                                       

_______________

|(A) | Exhibits other than those listed are omitted because they are not required or are not applicable. Copies of exhibits are available without charge by writing to the Assistant to the President at 211 Main Street, Webster, MA 01570.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

<PAGE>  118

|(B) |  | Incorporated herein by reference to the Registrant's Registration Statement on Form S-18 (No. 33-12533-B).                         
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------
|    |  |                                                                                                                                    
|(C) |  | Incorporated herein by reference to the Registrant's Form 10-Q for the period ended September 30, 1997.                            
|    |  |                                                                                                                                    
|(D) |  | Incorporated herein by reference to the Registrant's Form 10-K for the year ended December 31, 1999.                               
|    |  |                                                                                                                                    
|(E) |  | Incorporated herein by reference to the Registrant's Form 10-Q for the period ended June 30, 2002.                                 
|    |  |                                                                                                                                    
|(F) |  | Incorporated herein by reference to the Registrant's Form 10-Q for the period ended September 30, 2002.                            
|    |  |                                                                                                                                    
|(G) |  | Incorporated herein by reference to the Registrant's Form 10-K for the year ended December 31, 2002.                               
|    |  |                                                                                                                                    
|(H) |  | Incorporated herein by reference to the Registrant's Form 10-Q for the period ended March 31, 2003.                                
|    |  |                                                                                                                                    
|(I) |  | Incorporated herein by reference to the Registrant's Form S-3/A (File No. 333-109255), filed on November 3, 2003.                  
|    |  |                                                                                                                                    
|(J) |  | Incorporated herein by reference to the Registrant's Form 10-K/A for the year ended December 31, 2002, filed on September 29, 2003.
|    |  |                                                                                                                                    
|(K) |  | Incorporated herein by reference to the Registrant's Form 10-K/A for the year ended December 31, 2002, filed on November 25, 2003. 
|    |  |                                                                                                                                    
|*   |  | Denotes management contract or compensation plan or arrangement.                                                                   

<PAGE>  119

|THE COMMERCE GROUP, INC.
|------------------------
|                        
|DIRECTORS               
|                        
|Randall V. Becker       
|                        
|Joseph A. Borski, Jr.   
|                        
|Eric G. Butler          
|                        
|                        
|Henry J. Camosse        
|                        
|Gerald Fels             
|                        
|David R. Grenon         
|                        
|Robert W. Harris        
|                        
|Robert S. Howland       
|                        
|John J. Kunkel          
|                        
|Raymond J. Lauring      
|                        
|Normand R. Marois       
|                        
|Suryakant M. Patel      
|                        
|Arthur J. Remillard, Jr.
|                        
|Arthur J. Remillard, III
|                        
|Regan P. Remillard      
|                        
|Gurbachan Singh         
|                        
|John W. Spillane        

<PAGE>  120

|                         | DIRECTORS OF                                                                                                                                                                                                                                               
|------------------------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                         | COMMERCE HOLDINGS, INC.                                                                                                                                                                                                                                    
|                         | The Commerce Insurance Company                                                                                                                                                                                                                             
|                         | Commerce West Insurance Company                                                                                                                                                                                                                            
|                         | Citation Insurance Company                                                                                                                                                                                                                                 
|                         |                                                                                                                                                                                                                                                            
|Arthur J. Remillard, Jr. | Chairman of the Board, Chief Executive Officer and President of Commerce Holdings; Chairman of the Board and Chief Executive Officer of Commerce and Citation; Chairman of the Board of Commerce West                                                      
|                         |                                                                                                                                                                                                                                                            
|Gerald Fels              | President, Chief Operating Officer and Chief Financial Officer of Commerce and Citation; Treasurer, Commerce Holdings, Inc.; President of ACIC Holding; President, Chief Executive Officer, Chief Operating Officer and Investment Officer of Commerce West
|                         |                                                                                                                                                                                                                                                            
|Arthur J. Remillard, III | Senior Vice President of Commerce and Citation in charge of Policyholders Benefits; Clerk of Commerce Holdings; Secretary of Commerce and Citation                                                                                                         
|                         |                                                                                                                                                                                                                                                            
|Regan P. Remillard       | Senior Vice President of Commerce and Citation                                                                                                                                                                                                             
|                         |                                                                                                                                                                                                                                                            
|James A. Ermilio         | Senior Vice President and General Counsel of Commerce Holdings, Commerce and Citation; Secretary of Commerce West                                                                                                                                          
|                         |                                                                                                                                                                                                                                                            
|David R. Grenon (1)      | Retired founding CEO and President of The Protector Group Insurance Agency, Inc.; President E-C Realty Corporation and E-C Realty LLC; Chair of Massachusetts Biomedical Initiatives                                                                       
|                         |                                                                                                                                                                                                                                                            
|John M. Nelson (1)       | Chairman of Commonwealth National Bank                                                                                                                                                                                                                     
|                         |                                                                                                                                                                                                                                                            
|Suryakant M. Patel (1)   | Retired physician who specialized in internal medicine                                                                                                                                                                                                     
|                         |                                                                                                                                                                                                                                                            
|William G. Pike (1)      | Retired, Senior Executive Vice President and Chief Financial Officer of Granite State Bankshares, Inc. and Granite Bank                                                                                                                                    
|                         |                                                                                                                                                                                                                                                            
|H. Thomas Rowles (1)     | Chairman of the Board of ACIC Holding and American Commerce; Director of AAA Southern New England                                                                                                                                                          
|                         |                                                                                                                                                                                                                                                            
|Mark A. Shaw (1)         | Treasurer of ACIC Holding; President, Chief Executive Officer and Director of AAA Southern New England; Director of AAA, Inc.; Director of AAA Traffic Safety Foundation                                                                                   



|(1) | Commerce Holdings, Inc., The Commerce Insurance Company and Citation Insurance Company only.
|--- | --------------------------------------------------------------------------------------------

<PAGE>  121

|                        | DIRECTORS OF                                                                                                                          
|----------------------- | --------------------------------------------------------------------------------------------------------------------------------------
|                        | ACIC Holding Co., Inc.(1)                                                                                                             
|                        | American Commerce Insurance Company                                                                                                   
|                        |                                                                                                                                       
|H. Thomas Rowles        | Chairman of the Board of ACIC Holding and American Commerce; Director of AAA Southern New England                                     
|                        |                                                                                                                                       
|Regan P. Remillard      | Vice Chairman of the Board of American Commerce                                                                                       
|                        |                                                                                                                                       
|Mark A. Shaw            | Treasurer of ACIC Holding; President, Chief Executive Officer and Director of AAA Southern New England; Director of AAA-National, Inc.
|                        |                                                                                                                                       
|Gerald Fels             | President of ACIC Holding; President, Chief Executive Officer, Chief Operating Officer and Investment Officer of American Commerce    
|                        |                                                                                                                                       
|Patrick W. Doherty (2)  | President and Chief Executive Officer of AAA Oklahoma                                                                                 
|                        |                                                                                                                                       
|Terry R. Farias (2)     | President and Chief Executive Officer of AAA Hoosier Motor Club                                                                       
|                        |                                                                                                                                       
|Richard S. Hamilton (2) | President and Chief Executive Officer of AAA of East Central                                                                          
|                        |                                                                                                                                       
|Charles B. Liekweg (2)  | President and Chief Executive Officer of AAA Washington                                                                               
|                        |                                                                                                                                       
|D. James McDowell (2)   | President and Chief Executive Officer of AAA Arizona                                                                                  
|                        |                                                                                                                                       
|Peter C. Ohlheiser (2)  | President of Ohio Motorists Association                                                                                               
|                        |                                                                                                                                       
|John D. Porter (2)      | President and Chief Executive Officer of AAA Oregon/Idaho                                                                             
|                        |                                                                                                                                       
|Otto T. Wright (2)      | President and Chief Executive Officer of East Tennessee Automobile Club, Inc.                                                         



|(1) | Incorporated in November 1998. 95% owned by Commerce Holdings, Inc. and 5% owned by AAA Southern New England.
|--- | -------------------------------------------------------------------------------------------------------------
|(2) | American Commerce Insurance Company only.                                                                    

<PAGE>  122

|                         | DIRECTORS OF                                        
|------------------------ | ----------------------------------------------------
|                         | BAY FINANCE COMPANY, INC.                           
|                         |                                                     
|Arthur J. Remillard, Jr. | President and Chief Executive Officer               
|                         |                                                     
|Gerald Fels              | Executive Vice President and Chief Financial Officer
|                         |                                                     
|John W. Spillane         | Clerk                                               
|                         |                                                     
|Arthur J. Remillard, III | Senior Vice President and Assistant Clerk           
|                         |                                                     
|Regan P. Remillard       | Senior Vice President                               
|                         |                                                     
|                         | DIRECTORS OF                                        
|                         | CLARK-PROUT INSURANCE AGENCY, INC.                  
|                         |                                                     
|Arthur J. Remillard, Jr. | President and Chief Executive Officer               
|                         |                                                     
|Gerald Fels              | Executive Vice President and Chief Financial Officer
|                         |                                                     
|John W. Spillane         | Clerk                                               
|                         |                                                     
|Arthur J. Remillard, III | Senior Vice President and Assistant Clerk           
|                         |                                                     
|Elizabeth M. Edwards     | Vice President                                      

<PAGE>  123

|                                                               | THE COMMERCE GROUP, INC.           
|-------------------------------------------------------------- | -----------------------------------
|                                                               | Commerce Holdings, Inc.            
|                                                               | The Commerce Insurance Company     
|                                                               | Commerce West Insurance Company    
|                                                               | ACIC Holding Co., Inc. (1)         
|                                                               | American Commerce Insurance Company
|                                                               | Citation Insurance Company         
|                                                               | Bay Finance Company, Inc.          
|                                                               | Clark-Prout Insurance Agency, Inc. 
|                                                               |                                    
|OFFICERS OF THE COMMERCE GROUP, INC.                          
|                                                               |                                    
|President, Chief Executive Officer and Chairman of the Board   | Arthur J. Remillard, Jr.           
|Executive Vice President and Chief Financial Officer           | Gerald Fels                        
|Senior Vice President and Assistant Clerk                      | Arthur J. Remillard, III           
|Senior Vice President                                          | Regan P. Remillard                 
|Senior Vice President and General Counsel                      | James A. Ermilio                   
|Senior Vice President                                          | Joseph J. Staffieri                
|Clerk                                                          | John W. Spillane                   
|Treasurer and Chief Accounting Officer                         | Randall V. Becker                  
|Vice President and Corporate Compliance Officer                | Robert E. McKenna                  
|Assistant Vice President and Assistant General Counsel         | Thomas D. Jungeberg                
|Assistant Vice President and Senior Counsel                    | Louise M. McCarthy                 
|Assistant Treasurer                                            | Thomas A. Gaylord                  
|                                                               |                                    
|Officers of Massachusetts SUBSIDIARIES (2)                    
|                                                               |                                    
|Chief Executive Officer and Chairman of the Board              | Arthur J. Remillard, Jr.           
|President, Chief Operating Officer and Chief Financial Officer | Gerald Fels                        
|Senior Vice President and Secretary                            | Arthur J. Remillard, III           
|Senior Vice President and General Counsel                      | James A. Ermilio                   
|Senior Vice Presidents                                         | David H. Cochrane                  
|                                                               | Peter J. Dignan                    
|                                                               | Regan P. Remillard                 
|                                                               | Joseph J. Staffieri                
|                                                               | Henry R. Whittier, Jr.             
|Vice President and Chief Investment Officer                    | John W. Hawie                      
|Vice Presidents                                                | Raymond J. Desantis                
|                                                               | Elizabeth M. Edwards               
|                                                               | Karen A. Lussier                   
|                                                               | Donald G. MacLean                  
|                                                               | Robert E. McKenna                  
|                                                               | Michael J. Richards                
|                                                               | Angelos Spetseris                  
|                                                               |                                    
|Assistant Vice President and Assistant General Counsel         | Thomas D. Jungeberg                
|Assistant Vice President and Senior Counsel                    |                                    
|Assistant Vice Presidents                                      | David P. Antocci                   
|                                                               | Robert M. Blackmer                 
|                                                               | Thomas Boyer II                    
|                                                               | Stephen R. Clark                   
|                                                               | Warren S. Ehrlich                  
|                                                               | Richard W. Goodus                  
|                                                               | James E. Gow                       
|                                                               |                                    
|Treasurer and Chief Accounting Officer                         | Randall V. Becker                  
|Assistant Treasurer                                            | Thomas A. Gaylord                  



|(1) | Incorporated in November 1998, the common stock of which is 95% owned by Commerce Holdings, Inc. and 5% owned by AAA Southern New England.                                                                                                                                                                                  
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | Massachusetts subsidiaries include Commerce Holdings, Inc., The Commerce Insurance Company, Citation Insurance Company, Bay Finance Company, Inc. and Clark-Prout Insurance Agency. Officers often hold positions with several operating subsidiaries. The titles listed represent their primary office as of March 1, 2004.

<PAGE>  124

|Officers of ACIC Holding Co., Inc.                                     
|-----------------------------------------------------------------------
|                                                                       
|Chairman of the Board                                                  
|President                                                              
|Treasurer                                                              
|Secretary                                                              
|                                                                       
|Officers of American Commerce Insurance Company                        
|                                                                       
|Chairman of the Board                                                  
|Vice Chairman of the Board                                             
|President, Chief Executive and Operating Officer and Investment Officer
|General Counsel and Secretary                                          
|Vice President and Chief Investment Officer                            
|Vice President                                                         
|Vice President                                                         
|Vice President                                                         
|Assistant General Counsel and Assistant Secretary                      
|Senior Counsel and Assistant Secretary                                 
|Chief Financial Officer and Treasurer                                  
|Assistant Treasurer                                                    
|                                                                       
|Officers of Commerce West Insurance Company                            
|                                                                       
|Chairman of the Board                                                  
|President, Chief Executive and Operating Officer and Investment Officer
|Secretary                                                              
|Chief Financial Officer and Treasurer                                  
|Vice President and Chief Investment Officer                            
|Vice President                                                         
|Vice President                                                         

<PAGE>  125

|Stockholder Information                                                                                                                                     
|------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                            
|Annual Meeting                                                                                                                                              
|                                                                                                                                                            
|The Annual Meeting of stockholders will be held at 9:00 a.m. on Friday, May 21, 2004 at the Company's Policy Services Building, 16 Sutton Road, Webster, MA.
|                                                                                                                                                            
|Transfer Agent                                                                                                                                              
|                                                                                                                                                            
|The Commerce Group, Inc.                                                                                                                                    
|c/o Equiserve Trust Company, N.A.                                                                                                                           
|P.O. Box 219045                                                                                                                                             
|Kansas City, MO 64121-9045                                                                                                                                  
|(877) 282-1168                                                                                                                                              
|http://www.equiserve.com                                                                                                                                    
|                                                                                                                                                            
|Executive Offices                                                                                                                                           
|                                                                                                                                                            
|211 Main Street                                                                                                                                             
|Webster, MA 01570                                                                                                                                           
|(508) 943-9000                                                                                                                                              
|                                                                                                                                                            
|Company Websites                                                                                                                                            
|                                                                                                                                                            
|The Commerce Insurance Company                                                                                                                              
|American Commerce Insurance Company                                                                                                                         
|Commerce West Insurance Company                                                                                                                             
|Bay Finance Company, Inc.                                                                                                                                   
|Clark-Prout Insurance Agency, Inc.                                                                                                                          
|                                                                                                                                                            
|Trading of Common Stock                                                                                                                                     
|                                                                                                                                                            
|The Company's Common Stock trades on the NYSE under the symbol "CGI".                                                                                       
|                                                                                                                                                            
|Independent Auditors                                                                                                                                        
|                                                                                                                                                            
|PricewaterhouseCoopers LLP                                                                                                                                  
|125 High Street                                                                                                                                             
|Boston, MA 02110                                                                                                                                            
|http://www.us.pwc.com                                                                                                                                       

<PAGE>  126