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10-K/A 1 w15962e10vkza.htm AMENDMENT #1 TO FORM 10-K MERCER INSURANCE GROUP, INC. e10vkza

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K/A

Amendment No. 1


þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		for the fiscal year ended December 31, 2004

or

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

		transition period from to .

Commission file number 000-25425

Mercer Insurance Group, Inc.

(Exact name of registrant as specified in its charter)


Pennsylvania		23-2934601
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

10 North Highway 31

P.O. Box 278

Pennington, NJ 08534

(Address of principal executive offices)

Registrant’s telephone number, including area code:

(609) 737-0426

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

Common Stock (no par value)

Title of Each Class:

Common Stock, no par value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ

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

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. o

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

The aggregate market value of the voting and non-voting common stock held by non-affiliates (computed by reference to the price at which the common stock was last sold) as of the last business day of the Registrant’s most recently completed second fiscal quarter was: $85,152,440.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of March 7, 2005. Common Stock, no par value: 6,560,733.

Documents Incorporated by Reference

Portions of the definitive Proxy Statement for the 2005 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.

EXPLANATORY NOTE

The registrant is filing this Amendment No. 1 to Form 10-K for the year ended December 31, 2004, in response to a request by the SEC to 1) remove narrative disclosure referring to overall or total underwriting profit or loss contained within Item 7, the Management’s Discussion and Analysis of Financial Condition and Results of Operations, 2) to change the disclosure of Contractual Obligations contained within Item 7, the Management’s Discussion and Analysis of Financial Condition and Results of Operations, to disclose projected cash disbursements pertaining to insurance obligations, as projected at December 31, 2004, on a gross basis, and not net of reinsurance, and 3) to expand the disclosure in Item 9A, Controls and Procedures, to include the information required by Item 307 of Regulation S-K regarding Disclosure Controls and Procedures.

Other than the changes referred to above, all other information included in the Mercer Insurance Group, Inc. Form 10-K, as filed on March 16, 2005, remains unchanged. All Items of Part I, Items 5, 6, 7A, 8, and 9 of Part II, and all Items of Part III of that filing have been omitted from this Amendment because they are unchanged. All information contained herein is as of December 31, 2004, and does not reflect any events that have occurred subsequent to that date.

FORM 10-K/A

For the year Ended December 31, 2004

Table of Contents


			Page

PART II				3

	ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		3
	ITEM 9A.	Controls and Procedures.		19

PART IV				21

	ITEM 15.	Exhibits, Financial Statement Schedules.		21
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
CERTIFICATION OF CHIEF FINANCIAL OFFICER
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
CERTIFICATION OF CHIEF FINANCIAL OFFICER


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

The following presents management’s discussion and analysis of our financial condition and results of operations as of the dates and for the periods indicated. You should read this discussion in conjunction with the condensed consolidated financial statements and notes thereto included in this report, and the “Description of Business” contained in Item 1 of this report. This discussion contains forward-looking information that involves risks and uncertainties. Actual results could differ significantly from these forward-looking statements.

OVERVIEW

The Company and its subsidiaries underwrite property and casualty insurance in New Jersey and Pennsylvania. Our consolidated operating insurance company subsidiaries are:


	•	Mercer Insurance Company, a Pennsylvania property and casualty stock insurance company offering insurance coverages to businesses and individuals in New Jersey and Pennsylvania,

	•	Mercer Insurance Company of New Jersey, Inc., a New Jersey property and casualty stock insurance corporation offering insurance coverages to businesses and individuals located in New Jersey; and

	•	Franklin Insurance Company, a property and casualty stock insurance company offering private passenger automobile and homeowners insurances to individuals located in Pennsylvania.

We manage our business and report our operating results in three operating segments: commercial lines insurance, personal lines insurance and the investment function. See Note 9 of the notes to our consolidated financial statements included in this report. However, we do not allocate assets to segments, and assets are reviewed in the aggregate for decision-making purposes. Our commercial lines insurance business consists primarily of multi-peril and general liability and related coverages. Our personal lines insurance business consists primarily of homeowners and private passenger automobile insurance coverages. We market both the commercial and personal insurance lines through independent agents.

Our income is principally derived from insurance premiums received from insureds in the commercial lines (businesses insured) and personal lines (individuals insured) segments, less the costs of underwriting the insurance policies, the costs of settling and paying claims reported on the policies, and from investment income reduced by investment expenses, and from gains or losses on holdings in our investment portfolio. Variability in our income is caused by a variety of circumstances, some within the control of our companies and some not within their control. Premium volume is affected by, among other things, the availability of quality, properly-priced underwriting risks being produced by our agents, the ability to retain on renewal existing good-performing accounts, competition from other insurance companies, regulatory rate approvals, our reputation, and other limitations created by the marketplace or regulators. Our underwriting costs are affected by, among other things, the amount of commission and profit-sharing we pay our agents to produce the underwriting risks we receive premiums for, the cost of issuing insurance policies and maintaining our customer and agent relationships, marketing costs, taxes we pay to the states we operate in on the amount of premium we collect, and other assessments and charges imposed on our companies by the regulators in the states in which we do business. Our claim and claim settlement costs are affected by, among other things, the quality of our underwriting accounts, severe weather in our operating region, the nature of the claim, the regulatory and legal environment in our territories, inflation in underlying medical and property repair costs, and the availability and cost of reinsurance. Our investment income and realized gains and losses are determined by, among other things, market forces, the rates of interest and dividends paid on our portfolio holdings, the credit or investment quality of the issuer and the success of its underlying business, the market perception of the company invested in, and other factors such as ratings by rating agencies and analysts.

CRITICAL ACCOUNTING POLICIES

General

We are required to make estimates and assumptions in certain circumstances that affect amounts reported in our consolidated financial statements and related footnotes. We evaluate these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions, and that reported results of operation will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. We believe the following policies are the most sensitive to estimates and judgments.

Liabilities for Loss and Loss Adjustment Expenses

The liability for losses and loss adjustment expenses represents estimates of the ultimate unpaid cost of all losses incurred, including losses for claims that have not yet been reported to our insurance companies. The amount of loss reserves for reported claims is based primarily upon a case-by-case evaluation of the type of risk involved, knowledge of the circumstances surrounding each claim and the insurance policy provisions relating to the type of loss. The amounts of loss reserves for unreported claims and loss adjustment expenses are determined using historical information by line of insurance as adjusted to current conditions. Inflation is ordinarily implicitly provided for in the reserving function through analysis of costs, trends and reviews of historical reserving results over multiple years.

Reserves are closely monitored and are recomputed periodically using the most recent information on reported claims and a variety of statistical techniques. Specifically, on a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves, and paid losses with respect to the current and prior accident years. We use historical paid and incurred losses and accident year data to derive expected ultimate loss and loss adjustment expense ratios by line of business. We then apply these expected loss and loss adjustment expense ratios to in-force business to derive a reserve level for each line of business. This amount, together with reserves required by new reported claims and changes to existing case reserves, is compared to existing reserves to establish the adjustment to reserves that is required. In connection with the determination of the reserves, we also consider other specific factors such as recent weather-related losses, trends in historical paid losses, and legal and judicial trends with respect to theories of liability. Because of the nature of our business, which generally provides coverage for short-term risks, loss development is comparatively rapid and historical paid losses, adjusted for known variables, have been a reliable predictive measure of future losses.

Nevertheless, reserves are estimates because there are uncertainties inherent in the determination of ultimate losses. Court decisions, regulatory changes and economic conditions can affect the ultimate cost of claims that occurred in the past as well as create uncertainties regarding future loss cost trends. Accordingly, the ultimate liability for unpaid losses and loss settlement expenses will likely differ from the amount recorded at December 31, 2004. Changes in estimates or differences between estimates and amounts ultimately paid are reflected in current operations. Loss reserving techniques and assumptions have been consistently applied during the periods presented.

The table below summarizes the effect on net loss reserves and surplus in the event of reasonably likely changes in the variables considered in establishing loss and loss adjustment expense reserves. The range of reasonably likely changes was established based on a review of changes in accident year development by line of

business and applied to loss reserves as a whole. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:


								Adjusted Loss
			Adjusted Loss and					and Loss
Change in Loss			Loss Adjustment		Percentage			Adjustment		Percentage
and Loss			Reserves Net of		Change in			Reserves Net of		Change in
Adjustment			Reinsurance as of		Equity as of			Reinsurance as of		Equity as of
Reserves Net of			December 31,		December 31,			December 31,		December 31,
Reinsurance			2004		2004(1)			2003		2003(1)

(Dollars in thousands)
	(10.0	)%	$	29,669		2.2	%	$	29,003		2.2	%
	(7.5	)%		30,493		1.6	%		29,808		1.6	%
	(5.0	)%		31,317		1.1	%		30,614		1.1	%
	(2.5	)%		32,141		0.5	%		31,419		0.5	%
	Base			32,965		—			32,225		—
	2.5	%		33,789		(0.5	)%		33,031		(0.5	)%
	5.0	%		34,613		(1.1	)%		33,836		(1.1	)%
	7.5	%		35,437		(1.6	)%		34,642		(1.6	)%
	10.0	%		36,262		(2.2	)%		35,448		(2.2	)%


(1)	Net of Tax

The property and casualty industry has incurred substantial aggregate losses from claims related to asbestos-related illnesses, environmental remediation, product and construction defect liability, mold, and other uncertain or environmental exposures. We have not experienced significant losses from these types of claims.

In the discussions that follow, we use the term “loss development,” which refers to the calendar year income statement impact of changes in the provision for loss and loss adjustment expenses incurred in prior accident years.

The table below summarizes loss and loss adjustment reserves by major line of business:


		December 31,

		2004		2003		2002

		(Dollars in thousands)
Commercial lines:
	Commercial multi-peril	$	5,441	$	6,998	$	6,017
	Other liability		9,374		8,708		6,390
	Workers’ compensation		4,627		4,684		4,224
	Commercial automobile		1,456		2,251		1,886
	Fire, allied, inland marine		781		242		119

			21,679		22,883		18,636

Personal lines:
	Homeowners		10,095		9,509		8,896
	Personal automobile		2,283		3,073		2,070
	Fire, allied, inland marine		338		328		477
	Other liability		1,596		1,400		1,201
	Workers’ compensation		37		68		68

			14,349		14,378		12,712

Total		$	36,028	$	37,261	$	31,348

Investments

Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in Stockholders’ Equity as a component of comprehensive income and, accordingly, have no effect on net income. A decline in fair value of an investment below its cost that is deemed other than temporary is charged to earnings as a realized loss. We monitor our investment portfolio and review investments that have experienced a decline in fair value below cost to evaluate whether the decline is other than temporary. These evaluations involve judgment and consider the magnitude and reasons for a decline and the prospects for the fair value to recover in the near term. In the years ended December 31, 2004, 2003 and 2002, we recorded a pre-tax charge to earnings of $15,000, $454,000, and $647,000, respectively. These charges are primarily with respect to equity securities that we determined were other than temporarily impaired. Adverse investment market conditions, poor operating performance, or other adversity encountered by companies whose stock or fixed maturity securities we own could result in impairment charges in the future. The Company’s policy on impairment of value of investments is as follows: if a security has a market value below cost it is considered impaired. For any such security a review of the financial condition and prospects of the company will be performed by the Investment Committee to determine if the decline in market value is other than temporary. If it is determined that the decline in market value is “other than temporary”, the carrying value of the security will be written down to “realizable value” and the amount of the write down accounted for as a realized loss. “Realizable value” is defined for this purpose as the market price of the security. Write-down to a value other than the market price requires objective evidence in support of that value.

In evaluating the potential impairment of fixed income securities, the Investment Committee will evaluate relevant factors, including but not limited to the following: the issuer’s current financial condition and ability to make future scheduled principal and interest payments, relevant rating history, analysis and guidance provided by rating agencies and analysts, the degree to which an issuer is current or in arrears in making principal and interest payments, and changes in price relative to the market.

In evaluating the potential impairment of equity securities, the Investment Committee will evaluate certain factors, including but not limited to the following: the relationship of market price per share versus carrying value per share at the date of acquisition and the date of evaluation, the price-to-earnings ratio at the date of acquisition and the date of evaluation, any rating agency announcements, the issuer’s financial condition and near-term prospects, including any specific events that may influence the issuer’s operations, the independent auditor’s report on the issuer’s financial statements; and any buy/sell/hold recommendations or price projections by outside investment advisors.

We have one significant non-traded equity security, a non-voting common stock in Excess Reinsurance Company, which is carried at $1.1 million. Excess Reinsurance Company paid a special dividend in 2004 to the Group in the amount of $274,000. Its fair value is estimated at the statutory book value as reported to the National Association of Insurance Commissioners (NAIC). Other non-traded securities, which are not material in the aggregate, are carried at cost.

Policy Acquisition Costs

We defer policy acquisition costs, such as commissions, premium taxes and certain other underwriting expenses that vary with and are directly related to the production of business. These costs are amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, loss and loss adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Future changes in estimates, the most significant of which is expected loss and loss adjustment expenses, may require acceleration of the amortization of deferred policy acquisition costs.

Reinsurance

Amounts recoverable from property and casualty reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts.

Ceded unearned premiums and reinsurance balances recoverable on paid and unpaid loss and loss adjustment expenses are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve us of our legal liability to our policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid loss and loss adjustment expenses affect the estimates for the ceded portion of these liabilities.

We continually monitor the financial condition of our reinsurers.

Income Taxes

We use the asset and liability method of accounting for income taxes. Deferred income taxes arise from the recognition of temporary differences between financial statement carrying amounts and the tax bases of our assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. The effect of a change in tax rates is recognized in the period of the enactment date.

RESULTS OF OPERATIONS

Our results of operations are influenced by factors affecting the property and casualty insurance industry in general. The operating results of the United States property and casualty insurance industry are subject to significant variations due to competition, weather, catastrophic events, regulation, general economic conditions, judicial trends, fluctuations in interest rates and other changes in the investment environment.

Revenue and income by segment is as follows for the years ended December 31, 2004, 2003 and 2002


				December 31,

				2004			2003			2002

				(In thousands)
Revenues:
	Net premiums earned:
		Commercial lines		$	32,370		$	25,964		$	20,088
		Personal lines			23,414			21,900			20,366

			Total net premiums earned		55,784			47,864			40,454

	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			386			329

			Total Revenues		59,467			50,660			42,624

Income before income taxes:
	Underwriting income (loss):
		Commercial lines			5,581			3,109			2,892
		Personal lines			(4,908	)		(4,951	)		(1,432	)

			Total underwriting income (loss)		673			(1,842	)		1,460
	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			320			234

			Income before income taxes and minority interest in income of subsidiary	$	4,356		$	888		$	3,535

Our growth in premiums and underwriting results have been, and continue to be, influenced by market conditions. Pricing in the property and casualty insurance industry historically has been cyclical. During a soft market cycle, price competition is prevalent and makes it difficult to write and retain properly priced personal and commercial lines business. Our policy is to maintain our disciplined underwriting and pricing standards during soft markets, even at the expense of premium growth. After a sustained soft market cycle, the insurance industry entered into a hard market cycle in approximately early 2000, which continued into 2004. Beginning in 2004, the industry has seen increasing competition and a softening of rates in many markets, many of which we compete in, and particularly in property exposures. If market rates continue to soften, it may have a negative impact on our ability to grow, and on our underwriting margins. The cyclicality of the market, and its potential impact on our results, is difficult to predict with any significant reliability.

On June 1, 2001, we acquired 49% (the controlling interest, when taken into account with other considerations) of the outstanding shares of common stock of Franklin Holding and thereafter consolidated the financial condition and results of operations of Franklin Holding with Mercer Insurance Company. For the period between June 1, 2001 and December 15, 2003, we allocated a portion of Franklin Holding’s net income to the minority interest in Franklin Holding. This resulted in allocations of income to minority interest of $131,000 and $138,000 for the years ended December 31, 2003 and 2002, respectively. The minority interest in Franklin Holding was acquired by the Company immediately after the Conversion, through an exchange of shares in which the owners of the minority interest received 502,525 shares of the Company in exchange for all minority shares in Franklin Holding. Since Franklin Holding Company, Inc. became wholly owned within the group in December, 2003, no further income will be allocated to the minority interest for it.

YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

The components of income for 2004 and 2003, and the change and percentage change from year to year, are shown in the charts below. The accompanying narrative refers to the statistical information displayed in the chart immediately above the narrative.


2004 vs. 2003 Income		2004			2003			Change			% Change

Commercial lines underwriting income		$	5,581		$	3,109		$	2,472			79.5	%
Personal lines underwriting loss			(4,908	)		(4,951	)		43			0.9	%
	Total underwriting income (loss)		673			(1,842	)		2,515			N/M
Net investment income			2,841			1,707			1,134			66.4	%
Realized investment gains (losses)			484			703			(219	)		(31.1	)%
Other revenue, net of stock conversion expenses			358			320			38			(7.3	)%
	Income before income taxes and minority interest in income of subsidiary		4,356			888			3,468			N/M
Income taxes			1,092			174			918			N/M
	Income before minority interest in income of subsidiary		3,264			714			2,550			N/M
Minority interest in income of subsidiary			—			(131	)		131			N/M
	Net income	$	3,264		$	583		$	2,681			N/M
Loss/ LAE ratio (GAAP)			50.4	%		57.9	%		(7.5	)%
Underwriting expense ratio (GAAP)			48.4	%		45.9	%		2.5	%
	Combined ratio (GAAP)		98.8	%		103.8	%		(5.0	)%
Loss/ LAE ratio (Statutory)			50.5	%		57.9	%		(7.4	)%
Underwriting expense ratio (Statutory)			44.9	%		44.3	%		0.6	%
	Combined ratio (Statutory)		95.4	%		102.2	%		(6.8	)%

(N/ M means “not meaningful”)

Charts and discussion relating to each of our segments (commercial lines underwriting, personal lines underwriting, and the investments segment) follow below.

We had a strong performance in our commercial lines underwriting results, and a modest improvement in our personal lines underwriting results in 2004. Our GAAP combined ratio improved to 98.8% in 2004 from 103.8%, and our statutory combined ratio improved in 2004 to 95.4% from 102.2%. Our net investment income increased 66.4% to $2.8 million, primarily as a result of the increased investment portfolio resulting from the receipt of $53 million in Conversion proceeds on December 16, 2003. Realized investment gains, primarily from the sale of equity securities in both 2004 and 2003, added to the Company’s income as the equities portfolio value continued to grow in 2004. Our other income, primarily service charges recorded on insurance premiums paid over the term of the policy instead of when the policy is issued, declined modestly in 2004. In 2004 there was no minority interest in the income of our subsidiary, as there was in 2003, because all of the minority interest was acquired immediately after the Conversion in the acquisition of the remaining 51% of Franklin Holding Company. Also impacting the Company’s income in 2004 was the cost of being a public company, which adversely impacted both net income and the GAAP underwriting expense ratio, and, to a lesser extent, the statutory underwriting expense ratio.

Net loss and loss adjustment expenses incurred increased in 2004 overall by only $405,000, or 1.5%, to $28.1 million, reflecting lower claims frequency in 2004 over 2003, despite growth in exposures in 2004 as our net premium earned grew by 16.5%. The lower loss and loss adjustment expense ratio in 2004 resulted from more normal weather patterns than were experienced in our operating territory in 2003, which included hail, tornados, and windstorms, all of which resulted in a higher than usual frequency of claims throughout most of 2003.

Loss development of prior year net loss and loss adjustment expense reserves was a favorable $0.9 million in 2004 and was generally attributable to accident years 2002 and 2003 for commercial multi-peril, commercial auto and other liability. Loss reserves for these and all other lines of business have been established based on company trends and our consideration of industry trends, and recent settlement of reported cases has been favorable. This favorable development is a reflection of the disciplined underwriting employed by the Company in its risk selection process.


2004 vs. 2003 Revenue		2004		2003		Change			% Change

Direct premiums written		$	65,790	$	61,152	$	4,638			7.6	%
Net premiums written			59,504		52,802		6,702			12.7	%
Net premiums earned			55,784		47,864		7,920			16.5	%
Net investment income			2,841		1,707		1,134			66.4	%
Realized investment gains			484		703		(219	)		(31.2	)%
Other Revenue			358		386		(28	)		(7.3	)%
	Total Revenue	$	59,467	$	50,660	$	8,807			17.4	%

Total revenues for 2004, were $59.5 million, which was 17.4% greater than 2003 revenues. This increase was due primarily to a $7.9 million increase in net premiums earned in 2004, and an increase in net investment income of $1.1 million.

Direct premiums written increased 7.6% to $65.8 million in 2004, reflecting the return of the market to a more competitive pricing posture and the Company’s reluctance to take on underwriting risks which are priced inappropriately. Net premiums written increased 12.7% in 2004, a higher growth rate over that of the direct premiums written reflecting the increased retention under the Company’s reinsurance program in 2004. Net premiums earned increased by 16.5% to $55.8 million in 2004.

Growth in Net Investment Income is discussed below.


2004 vs. 2003 Investment Income and Realized Gains		2004			2003		Change			% Change

Fixed Income securities		$	3,284		$	2,120	$	1,164			54.9	%
Dividends			673			466		207			44.4	%
Cash, cash equivalents & other			398			205		193			94.1	%
	Gross investment income		4,355			2,791		1,564			56.0	%
Investment expenses			1,514			1,084		430			39.7	%
	Net investment income	$	2,841		$	1,707	$	1,134			66.4	%
Realized gains (losses) on fixed income		$	(97	)	$	186	$	(283	)		N/M
Realized gains on equities			590			517		73			N/M
Realized losses — other			(9	)		—		(9	)		N/M
	Net realized gains	$	484		$	703	$	(219	)		(31.2	)%

(N/ M means “not meaningful”)

Net investment income increased $1.1 million, or 66.4% in 2004, due principally to the increased portfolio holdings resulting from the receipt of approximately $53 million of proceeds upon the completion of the Conversion. In addition, the Company received a special dividend of $274,000 in 2004 on its investment in Excess Reinsurance Company, compared to no dividend in 2003.

Effective January 1, 2004, the Company engaged a new management firm for its fixed income securities portfolio. One of its assignments was to invest the proceeds of the Conversion, which, given a difficult interest rate environment and fixed income securities market, was not largely completed until the second quarter of 2004. Consequently, a significant portion of the Conversion proceeds earned a cash-equivalent yield during this period. In addition, investment expenses increased in 2004 by approximately $210,000 for the cost of such

management, compared to the prior commission-based fixed income securities management which existed while the Company was a mutual insurance company prior to the Conversion.

In implementing the investment policy guidelines and directions of the Investment Committee of the Board of Directors, the fixed income securities managers have changed the composition of the fixed income securities portfolio to be more heavily weighted in tax-exempt securities, industrial and miscellaneous fixed income securities, and mortgage-backed securities, and less heavily weighted towards U.S government and government agencies fixed income securities. The portfolio remains invested 100% in investment grade fixed income securities, with, as of December 31, 2004, an average rating of AAA, an average duration of 3.7 years (excluding mortgage-backed securities), and average tax equivalent yield of 4.17%. Our average portfolio duration exceeds that of our insurance liabilities, however the portfolio maturities are laddered to ensure adequate liquidity.

Net realized gains decreased 31.2% to $484,000 in 2004. In 2004, net realized investment gains of $484,000 included gains on securities sales of $1,037,000, offset by other than temporary writedowns of $15,000 and losses on securities sales of $538,000. The losses from securities sales were comprised of $242,000 from the sale of bonds and $296,000 from the sale of equities. The following table summarizes the period of time that equity securities sold at a loss during 2004 had been in a continuous unrealized loss position:


	Fair
	Value on		Realized
Period of Time in an Unrealized Loss Position	Sale Date		Loss

	(In thousands)
0-6 months	$	1,025	$	292
7-12 months		276		4
More than 12 months		—		—

Total	$	1,301	$	296

The equity securities sold at a loss had been expected to appreciate in value but after reevaluation were sold so that sale proceeds could be reinvested. Securities were sold due to a desire to reduce exposure to certain issuers and industries or in light of changing economic conditions.

The following table summarizes the length of time equity securities with unrealized losses at December 31, 2004 have been in an unrealized loss position:


					Length of Unrealized Loss

	Fair		Unrealized		Less than		6 to 12		Over 12
December 31, 2004	Value		Losses		6 Months		Months		Months

	(In thousands)
Equity securities unrealized loss	$	498	$	13	$	13	$	0	$	0

Results of our Commercial Lines segment were as follows:


2004 vs. 2003 Commercial Lines (CL)		2004			2003			Change			% Change

CL Direct premiums written		$	40,883		$	35,803		$	5,080			14.2	%
CL Net premiums written		$	36,492		$	30,315		$	6,177			20.4	%
CL Net premiums earned		$	32,370		$	25,964		$	6,406			24.7	%
CL Loss/ LAE expense ratio (GAAP)			31.9	%		39.1	%		(7.2	)%
CL Expense ratio (GAAP)			50.9	%		49.0	%		1.9	%
	CL Combined ratio (GAAP)		82.8	%		88.1	%		(5.3	)%

Consistent with our goal of increasing commercial business, we increased commercial lines direct premiums written by $5.1 million, or 14.2% in 2004. With our increased reinsurance retentions in 2004, our commercial lines net premiums written increased by 20.4%, or $6.2 million. Direct commercial multi-peril premiums written, the largest component of our commercial lines segment, increased 19.7% to $22.2 million in 2004, compared to $18.6 million for 2003, and commercial multi-peril net premiums earned increased by

30.4% to $16.5 million in 2004, compared to $12.7 million for 2003. Our largest increase in policy count was within our Religious Institutions sector, where our increasing market presence is helping us add new premium, and in our Special Contractors sector. We expect this trend of increasing commercial writings to continue by targeting selected types of risks with selected producers.

In the commercial lines segment for 2004, we had an underwriting gain of $5.6 million, a GAAP combined ratio of 82.8%, a GAAP loss and loss adjustment expense ratio of 31.9% and a GAAP underwriting expense ratio of 50.9%, compared to an underwriting gain of $3.1 million, a GAAP combined ratio of 88.1%, a GAAP loss and loss adjustment expense ratio of 39.1% and an underwriting expense ratio of 49.0% for 2003.

Results of our Personal Lines segment were as follows:


2004 vs. 2003 Personal Lines (PL)		2004			2003			Change			% Change

PL Direct premiums written		$	24,906		$	25,349		$	(443	)		(1.7	)%
PL Net premiums written		$	23,011		$	22,487		$	524			2.3	%
PL Net premiums earned		$	23,414		$	21,900		$	1,514			6.9	%
PL Loss/ LAE expense ratio (GAAP)			76.1	%		80.3	%		(4.2	)%
PL Expense ratio (GAAP)			44.9	%		42.3	%		2.6	%
	PL Combined ratio (GAAP)		121.0	%		122.6	%		(1.6	)%

In the personal lines segment for 2004, we had an underwriting loss of $4.9 million, a GAAP combined ratio of 121.0%, a GAAP loss and loss adjustment expense ratio of 76.1% and a GAAP underwriting expense ratio of 44.9%, compared to an underwriting loss of $5.0 million, a GAAP combined ratio of 122.6%, a GAAP loss and loss adjustment expense ratio of 80.3% and a GAAP underwriting expense ratio of 42.3% for 2003.

The personal lines losses in 2004 were slightly better than in 2003, with the losses in both years heavier than usual and attributable to harsh weather conditions. After a number of winters with relatively mild weather conditions in our operating region, our first quarter of 2004, and our first and fourth quarters of 2003 suffered from unusually cold weather conditions. These conditions lead to a high frequency of losses from frozen pipes, structural collapses, and more frequent automobile losses and accidents. The homeowners loss and loss expense ratio was 82.8% in 2004 and 74.3% for 2003, and the personal automobile loss and loss expense ratio was 77.0% for 2004 and 94.5% for 2003.

Net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 7.4% to $13.5 million for 2004, compared to $12.6 million for 2003. The growth rate for homeowners insurance reflects the reclassification of certain homeowners risks from our preferred program to our standard program, resulting in a higher premium, as part of a general review of the homeowners program which was completed in late 2003. Premiums are higher for the standard program compared to the preferred program. The Company is preparing to seek a rate increase for the homeowners line in New Jersey, based on an MSO form, which, if approved, will result in an increase in premiums written for this line.

Personal automobile direct written premiums, written exclusively in Pennsylvania, decreased 2.9% to $7.7 million in 2004, compared to $7.9 million for 2003. Net earned premiums for personal automobile increased by 4.4% to $7.2 million for 2004, from $6.9 million for 2003. The slight decrease in personal automobile direct premiums is attributable to a change in our underwriting guidelines, with a planned decrease in less attractive lower-tier business being replaced by more attractive higher-tier business in 2004, a trend we

expect to continue with the result of overall growth in this line. Despite the increases in personal lines premiums, we will continue to focus principally on our commercial lines growth.


2004 vs. 2003 Expenses and Expense Ratio		2004			2003		Change			% Change

Amortization of DAC		$	15,075		$	13,413	$	1,662			12.4	%
	As a % of net premiums earned		27.0	%		28.0		(1.0	)%
Other underwriting expenses			11,898			8,560		3,338			39.0	%
Stock conversion expenses			—			66		(66	)		N/M
	Total expenses excluding losses/ LAE	$	26,973		$	22,039	$	4,934			22.4	%
Underwriting expense ratio			48.4	%		45.9		2.5	%

(N/ M means “not meaningful”)

Underwriting expenses increased by $4.9 million, or 22.4%, to $27.0 million for 2004, from 2003. This increase was principally attributable to an increase in other underwriting expenses, growth in commissions resulting from higher premium volume, and increased charges relating to corporate expenses and compensation expenses, including bonuses and agents profit-sharing, which were at higher levels than in 2003. In 2004, the Company had pre-tax costs associated with Sarbanes — Oxley compliance of $832,000, for which there were no costs in 2003, pre-tax costs of $383,000 associated with grants of restricted stock, for which there were no costs in 2003, and pre-tax costs of $874,000 associated with the allocation of shares to employee participants by the ESOP for 2004, for which the 2003 pre-tax cost was $568,000.

We are currently in the process of converting our information system. When completed, we expect some costs to moderate as implementation costs and costs associated with operating dual systems end. These reduced costs will be offset by some higher staffing costs, but we also should be positioned to expand premium volume in the near term without material incremental expense because of increased processing capacity.

In the third quarter of 2004, we began renewing most of our New Jersey policies in our Mercer Insurance Company of New Jersey, Inc. subsidiary, thus reducing the Company’s liability for retaliatory premium taxes, which should produce, on an annual basis, approximately $800,000 in relief from such taxes.


2004 vs. 2003 Income Taxes		2004			2003			Change			% Change

Income before income taxes and minority interest in income of subsidiary		$	4,356		$	888		$	3,468			N/M
Income taxes			1,092			174			918			N/M
	Income before minority interest in income of subsidiary	$	3,264		$	714		$	2,550			N/M
	Effective tax rate		25.1	%		19.6	%		5.5	%

(N/ M means “not meaningful”)

Federal income tax expense was $1.1 million for 2004, an effective rate of 25.1%, compared to $174,000, an effective rate of 19.6%, in 2003. The increase in the effective tax rate in 2004 is primarily attributable to the fact that tax-exempt investment income and dividend income (which reduce the effective tax rate) represented a smaller percentage of net income in 2004 than in 2003.

YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002

For the year ended December 31, 2003, the Company had net income of $583,000 compared to $2.2 million for the same period in 2002. Although the underwriting gain from our commercial lines segment for 2003 increased 7.5% from the prior year to $3.1 million, our personal lines segment incurred an underwriting loss of $5.0 million in 2003, an increased loss of $3.5 million over the prior comparable period. In our investment segment, net investment income decreased in 2003 by $354,000, when compared to 2002, and realized gains for 2003 were $703,000, as compared to a net realized loss of $220,000 for 2002.

Total revenues for 2003, were $50.7 million, which was 19.0% greater than 2002 revenues of $42.6 million. This increase was due primarily to a $7.4 million increase in net premiums earned in 2003, an increase in realized gains of $923,000, and a decrease in net revenues from investments of $354,000 as compared to 2002.

Direct premiums written increased 20.2% to $61.2 million in 2003 when compared to 2002, and consisted of $35.8 million of commercial lines premiums, a 30.2% increase, and $25.3 million of personal lines premiums, an 8.5% increase. Net premiums earned increased by 18.3% to $47.9 million for 2003 as compared to $40.5 million for the prior year. Commercial lines net premiums earned increased 29.3% to $26.0 million in 2003, and personal lines net premiums earned increased 7.5% to $21.9 million in 2003. The overall increases in direct premiums written and net premiums earned are generally attributable to firmer pricing and continued strong growth in our commercial lines business.

Consistent with our goal of increasing commercial business, we increased direct commercial multi-peril premiums written, the largest component of our commercial lines segment, by 37.8% to $18.6 million in 2003, compared to $13.5 million for 2002, and increased commercial multi-peril net premiums earned by 31.6% to $12.7 million in 2003, compared to $9.6 million for 2002.

For the same comparative periods, net premiums earned for our homeowners insurance, the largest component of our personal lines segment, increased 5.7% to $12.6 million for 2003, compared to $11.9 million for 2002, while the increase in homeowners direct premiums written increased 7.3% to $14.7 million in 2003 from $13.7 million in 2002. The growth rate for homeowners insurance reflects the reclassification of certain homeowners risks from our preferred program to our standard program, resulting in a higher premium, as part of a general review of the homeowners program which is substantially complete. Premiums are higher for the standard program compared to the preferred program.

Personal automobile direct written premiums, written exclusively in Pennsylvania, increased 14.8% to $7.9 million in 2003, compared to $6.9 million for 2002. Net earned premiums for personal automobile increased by 15.9% to $6.9 million for 2003, from $5.9 million for 2002. Despite the increases in personal lines premiums, we will continue to focus principally on our commercial lines growth.

Net investment income decreased $354,000, or 17.2%, to $1.7 million in 2003, due to declining interest rates and an increase in investment expenses. Net realized gains increased to $703,000 in 2003, from a realized loss of $220,000 in 2002. In 2003, realized investment gains of $703,000 were comprised of gains on securities sales of $1,396,000, offset by other than temporary writedowns of $454,000 and losses on securities sales of $239,000. Of the equities included in the $454,000 of other than temporary writedowns, equities representing $358,000 of that total were sold in 2003 at a gain of $49,000. The losses from securities sales were comprised of $35,000 from the sale of bonds and $204,000 from the sale of equities. The following table summarizes the period of time that equity securities sold at a loss during 2003 had been in a continuous unrealized loss position:


	Fair
	Value on		Realized
Period of Time in an Unrealized Loss Position	Sale Date		Loss

	(In thousands)
0-6 months	$	100	$	6
7-12 months		245		114
More than 12 months		735		84

Total	$	1,080	$	204

The following table summarizes the length of time equity securities with unrealized losses at December 31, 2003 were in an unrealized loss position:


						Length of Unrealized Loss

		Fair		Unrealized		Less than		6 to 12		Over 12
		Value		Losses		6 Months		Months		Months

		(In thousands)
Equity securities
	More than 80% of cost	$	1,677	$	78	$	74	$	4	$	0
	Less than 80% of cost		0		0		0		0		0

Total		$	1,677	$	78	$	74	$	4	$	0

For 2003, we had a combined ratio of 103.8%, a loss and loss adjustment expense ratio of 57.9% and an underwriting expense ratio of 45.9%, compared to a combined ratio of 96.4%, a loss and loss adjustment expense ratio of 49.6% and an underwriting expense ratio of 46.8% for 2002.

In the commercial lines segment for 2003, we had an underwriting gain of $3.1 million, a combined ratio of 88.1%, a loss and loss adjustment expense ratio of 39.1% and an underwriting expense ratio of 49.0%, compared to an underwriting gain of $2.9 million, a combined ratio of 85.6%, a loss and loss adjustment expense ratio of 36.3% and an underwriting expense ratio of 49.3% for 2002.

In the personal lines segment for 2003, we had an underwriting loss of $5.0 million, a combined ratio of 122.6%, a loss and loss adjustment expense ratio of 80.3% and an underwriting expense ratio of 42.3%, compared to an underwriting loss of $1.4 million, a combined ratio of 107.0%, a loss and loss adjustment expense ratio of 62.8% and an underwriting expense ratio of 44.2% for 2002.

Net loss and loss adjustment expenses incurred increased overall by $7.6 million, or 38.2%, to $27.7 million for 2003 from 2002. The increase in loss and loss adjustment expenses reflects the increase in commercial and personal lines volume and an increase in the frequency of personal lines losses. The increase in personal lines losses is attributable to harsher weather conditions for 2003 compared to 2002. After a number of winters with relatively mild weather conditions in our operating region, our first and fourth quarters suffered from unusually cold weather conditions. In addition, there was considerably more snow during the first quarter of 2003 compared to the same period in 2002. These conditions lead to losses from frozen pipes, structural collapses, more frequent automobile losses and slip-and-fall accidents. We also had unusual weather events in the second and third quarters, including hail, tornados, and windstorms, all of which resulted in a higher than usual frequency of claims. The increase in these losses is evidenced by the increase in the homeowners loss and loss expense ratio to 74.3% for 2003, compared to 68.1% for 2002, and an increase in the personal automobile loss and loss expense ratio to 94.5% for 2003, compared to 67.8% for 2002. Loss development of prior year net loss and loss adjustment expense reserves was a favorable $0.6 million and was generally attributable to accident years 1998 through 2002 for commercial multi-peril and commercial workers’ compensation. Loss reserves for the commercial multi-peril and workers’ compensation lines have been established based on company trends and our consideration of industry trends. Recent settlement of reported cases has been favorable. In addition, we originally had expected a development of losses that was more in line with the industry, but this has not occurred. These factors have resulted in the favorable development indicated and are a reflection of the disciplined underwriting employed by the Company. Favorable development was also present in other lines of business and resulted from the normal claims review process, and not from changes in key assumptions or reserving philosophy.

Underwriting expenses increased by $3.0 million, or 16.1%, to $22.0 million for 2003, from 2002. This increase was principally attributable to an increase in expenses due to higher amortization of deferred policy acquisition costs resulting from higher premium volume, and the charge of $568,000 (pre-tax) associated with the allocation of shares to employee participants by the ESOP for 2003. We are currently in the process of converting our information system. When completed, we expect some costs to moderate as conversion costs and costs associated with operating dual systems end. These reduced costs will be offset by some higher

staffing costs, but we also should be positioned to expand premium volume without material incremental expense because of increased processing capacity.

We also expect underwriting expenses to moderate in future periods because we intend to significantly reduce the amount of business written in Mercer Insurance Company, the New Jersey business of which became subject to New Jersey’s retaliatory premium tax when it redomesticated to Pennsylvania in 1997. We plan to do this by renewing, to the extent possible, Mercer Insurance Company premium volume in Mercer Insurance Company of New Jersey, Inc., our New Jersey domestic insurer that is not subject to this retaliatory tax. We had not previously renewed policies in our New Jersey subsidiary because only policyholders of Mercer Insurance Company, domiciled in Pennsylvania, had subscription and voting rights. Therefore, renewing policies in the New Jersey subsidiary before completion of the Conversion would have denied subscription rights to Mercer Insurance Company’s policyholders and disenfranchised them. The cost of the additional premium tax was $738,000 for 2003 and $607,000 for 2002.

Federal income tax expense was $174,000 for 2003, an effective rate of 19.6%, compared to $1,155,000, an effective rate of 32.7%, in 2002. The decrease in the effective tax rate in 2003 is attributable to tax-exempt investment income being a larger percentage of net income than in the prior year.

LIQUIDITY AND CAPITAL RESOURCES

Our insurance companies generate sufficient funds from their operations and maintain a high degree of liquidity in their investment portfolios. The primary source of funds to meet the demands of claim settlements and operating expenses are premium collections, investment earnings and maturing investments. Mercer Insurance Company in 2004 completed an expansion of its facilities in Pennington, New Jersey, at a cost of $2.9 million. These improvements are fully paid for and will not require any further use of operating cash flow.

We are also in the process of building an information system platform that will allow our producers to conduct their business through the Internet or through the method they have historically used. As of December 31, 2004, we have spent $3.1 million on the development of this platform, which includes license fees for software used in the platform. It is anticipated to be completed in mid 2006, at an additional cost of $1.0 million. Mercer Insurance Company possesses sufficient resources for these future expenditures without incurring any debt.

Our insurance companies maintain investment and reinsurance programs that are intended to provide sufficient funds to meet their obligations without forced sales of investments. They maintain a portion of their investment portfolio in relatively short-term and highly liquid assets to ensure the availability of funds.

The principal source of liquidity for Mercer Insurance Group will continue to be the net proceeds it retained from the Conversion stock offering, and dividend payments (when allowed by regulators) and other fees received from Mercer Insurance Company. For a period of three years after the Conversion, Mercer Insurance Company may not declare or pay any dividend to Mercer Insurance Group without the approval of the Pennsylvania Insurance Department. After this three-year period, Mercer Insurance Company will be restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to its holding company. Under Pennsylvania law, there is a maximum amount that may be paid by Mercer Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. This limit is the greater of 10% of Mercer Insurance Company’s statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Mercer Insurance Company for the period covered by such annual statement.

If the dividend restrictions imposed on Mercer Insurance Company related to the Conversion were not in effect, then as of December 31, 2004, the amounts available for payment of dividends from Mercer Insurance Company in 2005, without the prior approval of the Pennsylvania Insurance Department would have been approximately $6.2 million.

Prior to its payment of any dividends, Mercer Insurance Company of New Jersey, Inc. is required to provide notice of the intended dividends to the New Jersey Department of Banking and Insurance. New Jersey

law sets the maximum amount of dividends that may be paid, which amount cannot exceed the greater of 10% of Mercer Insurance Company of New Jersey, Inc.’s statutory surplus as reported on the most recent annual statement filed with New Jersey, or the net income, not including realized capital gains, for the period covered by the annual statement. The New Jersey Department has the power to limit or prohibit dividend payments if certain conditions exist. These restrictions or any subsequently imposed restrictions may affect our future liquidity. As of December 31, 2004, the amount available for payment of dividends by Mercer Insurance Company of New Jersey, Inc. to Mercer Insurance Company in 2005 without the prior approval of New Jersey Department of Banking and Insurance is approximately $1.6 million.

As a Pennsylvania domiciled insurance company, dividends payable by Franklin Insurance Company are subject to the same formula limitation described above for Mercer Insurance Company. As of December 31, 2004, the amount available for payment of dividends from Franklin Insurance Company in 2005, without the prior approval of the Pennsylvania Insurance Department, is approximately $0.6 million.

Total assets increased 2.6%, or $4.6 million to $180.4 million, at December 31, 2004 from December 31, 2003. Increased premium volume drove increases in premium receivables of $2.1 million, or 23%, and deferred policy acquisition costs of $627,000, or 8%. Reinsurance receivables decreased $2.5 million, or 60%, due to higher retentions under the Company’s reinsurance agreements. Investments increased $1.8 million, or 1%, to $125.1 million, and cash balances increased $939,000, or 6%. Other assets decreased $1.6 million, or 59%, to $1.1 million, principally due to a Federal Income Tax refund received in 2004.

Total liabilities increased 3%, or $2.5 million, in 2004, to $80.0 million. Increased premium volume is primarily responsible for the increase in unearned premium reserves of $3.7 million, or 12%. Loss and loss expense reserves decreased $1.2 million, or 3%, as a result of the payment of a large number of case reserves related to claims accrued but unpaid at the end of 2003, and which related to the unusually high claims frequency experienced by the Company in late 2003.

Total stockholders’ equity increased by $2 million, or 2%, due principally to 2004 earnings, offset in part by purchases of treasury stock in the amount of $3.1 million. Unrealized gains on the investment portfolio increased $708,000 (after tax), due principally to growth in the value of the Company’s equities portfolio.

In connection with the Conversion, the ESOP was established, and purchased 626,111 shares from the Company in return for a note bearing interest at 4% on the principal amount of $6,261,110. Mercer Insurance Company will make annual contributions to the ESOP sufficient to repay that loan to the Company. It is anticipated that the loan will be repaid in 10 equal annual installments, and that, in proportion to annual principal and interest payments, approximately 10% of the original ESOP shares will be allocated annually to employee participants of the ESOP. An expense charge will be booked ratably during each year for the shares committed to be allocated to participants that year, determined with reference to the fair market value of the Company’s stock at the time the commitment to allocate the shares is accrued and recognized. The issuance of the shares to the ESOP was fully recognized in the Additional Paid-in Capital account at Conversion, with a contra account entitled Unearned ESOP Shares established in the Stockholders’ Equity section of the balance sheet for the unallocated shares at an amount equal to their original per-share purchase price.

Mercer Insurance Group adopted a stock-based incentive plan at its 2004 annual meeting of shareholders. Pursuant to that plan, Mercer Insurance Group may issue a total of 876,555 shares, equal to 14% of the shares of common stock that were issued in the Conversion. Of this amount, an amount equal to 4% of the shares of common stock issued in the Conversion, or 250,000 shares, may be used to make restricted stock awards under the stock-based incentive plan. The number of shares available for issuance under the plan will increase automatically each year by 1% of the number of shares outstanding at the end of the preceding year. The Company may purchase shares of its common stock in the open market and contribute those shares to the stock-based incentive plan for use in making restricted stock awards under that plan. The fair market value of any common stock used for restricted stock awards will initially represent unearned compensation. As Mercer Insurance Group accrues compensation expense to reflect the vesting of such shares, unearned compensation will be reduced accordingly. This compensation expense will be deductible for federal income tax purposes upon vesting. As described in the following paragraph, the Company undertook to repurchase shares as a partial offset to the stock incentive plan issuances. During 2004, the Company made grants of 215,000 shares

of restricted stock, grants of 173,000 Incentive Stock Options, and grants of 364,700 non-qualified stock options.

On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares are to be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. As of September 30, 2004, 250,000 shares had been repurchased under this authorization for a total consideration of $3.0 million, or $11.90 per share. On October 20, 2004, the Company’s Board of Directors authorized the repurchase of an additional 250,000 shares of its common stock, under the same terms and conditions. As of March 7, 2005, all 250,000 shares authorized under the second authorization have been purchased, including 243,500 shares purchased in 2005 for $3.2 million. The total cost of repurchases under this authorization was $3.3 million, or $13.16 per share. In the aggregate, 500,000 shares have been purchased under both authorizations, for a total cost of $6.3 million, or $12.53 per share, a price accretive to the Company’s book value. The purchases were funded with available cash or short-term investments maintained in the holding company.

IMPACT OF INFLATION

Inflation increases consumers’ needs for property and casualty insurance coverage. Inflation also increases claims incurred by property and casualty insurers as property repairs, replacements and medical expenses increase. These cost increases reduce profit margins to the extent that rate increases are not implemented on an adequate and timely basis. We establish property and casualty insurance premiums levels before the amount of losses and loss expenses, or the extent to which inflation may affect these expenses, are known. Therefore, our insurance companies attempt to anticipate the potential impact of inflation when establishing rates. Because inflation has remained relatively low in recent years, financial results have not been significantly affected by inflation.

Inflation also often results in increases in the general level of interest rates, and, consequently, generally results in increased levels of investment income derived from our investments portfolio.

OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS

The Company was not a party to any unconsolidated arrangement or financial instrument with special purpose entities or other vehicles at December 31, 2004 which would give rise to previously undisclosed market, credit or financing risk.

The Company and its subsidiaries have no significant contractual obligations at December 31, 2004, other than its insurance obligations under its policies of insurance. Projected cash disbursements pertaining to these insurance obligations, as projected at December 31, 2004, are as follows:


	Jan. 1, 2005		Jan. 1, 2006		Jan. 1, 2008		After
	to Dec. 31,		to Dec. 31,		to Dec. 31,		Dec. 31,
	2005		2007		2009		2009		Total

	(Dollars in thousands)
Property and Casualty Insurance Gross Reserves	$	14,006	$	13,523	$	4,936	$	3,563	$	36,028

Total Contractual Obligations	$	14,006	$	13,523	$	4,936	$	3,563	$	36,028


ITEM 9A.	*CONTROLS AND PROCEDURES.*

Evaluation of Disclosure Controls and Procedures

Mercer Insurance Group, Inc’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2004, and based on that evaluation they have concluded that these controls and procedures are effective as of that date.

Management’s Annual Report on Internal Control Over Financial Reporting

There have been no material changes in the Company’s internal control over financial reporting during the fourth quarter of 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

The management of Mercer Insurance Group, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting for the company. With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework and criteria established in Internal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2004.

Mercer Insurance Group, Inc.’s independent auditor, KPMG LLP, a registered public accounting firm, has issued an audit report on our management’s assessment of our internal control over financial reporting. This audit report appears below.


		Mercer Insurance Group, Inc.

March 16, 2005		By: /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer

March 16, 2005		By: /s/ David B. Merclean David B. Merclean Senior Vice President of Finance and Chief Financial Officer

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

We have audited management’s assessment, included in the accompanying management’s report on internal control over financial reporting, that Mercer Insurance Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Mercer Insurance Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Mercer Insurance Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Mercer Insurance Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 16, 2005, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

PART IV


ITEM 15.	*EXHIBITS, FINANCIAL STATEMENT SCHEDULES.*

(3) Exhibits:

The exhibits required by Item 601 of Regulation SK are listed in the Exhibit Index. Documents not accompanying this report are incorporated by reference as indicated on the Exhibit Index.

EXHIBIT INDEX


Number			Title

	2	.1	Plan of Conversion from Mutual to Stock Organization of Mercer Mutual Insurance Company, dated as of December 13, 2002 and amended and restated on March 19, 2003, April 15, 2003 and June 18, 2003 (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

	3	.1	Articles of Incorporation of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

	3	.2	Bylaws of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)

	4	.1	Form of certificate evidencing shares of common stock of Mercer Insurance Group, Inc. (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)

	8	.1	Private Letter Ruling, dated May 8, 2003, from the Internal Revenue Service to Mercer Mutual Insurance Company (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)

	10	.1	Mercer Insurance Group, Inc. Employee Stock Ownership Plan (incorporated by reference herein to the Company’s Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)

	10	.2	Employment Agreement, dated as of October 31, 2004, among BICUS Services Corporation, Mercer Insurance Company and David Merclean (incorporated by reference herein to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed on March 16, 2005)

	10	.3	Mercer Mutual Insurance Company Executive Nonqualified ‘Excess‘ Plan dated June 1, 2002 (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)

	10	.4	Mercer Mutual Insurance Company Benefit Agreement dated December 11, 1989, as amended (incorporated by reference herein to the Company’s Pre-effective Amendment no. 3 on Form S-1, SEC File No. 333-104897.)

	10	.5	Mercer Insurance Group, Inc. 2004 Stock Incentive Plan dated June 16, 2004, (incorporated by reference herein to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed on March 16, 2005)

	14	.1	Code of Ethics (incorporated by reference herein to the Company’s Annual Report on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.)

	31	.1	Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	31	.2	Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	32	.1	Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

	32	.2	Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 and Rule 12b-15 thereunder, the Registrant has duly caused this Amendment No. 1 to its Annual Report on Form 10-K for the year ended December 31, 2004 to be signed on its behalf by the undersigned, thereunto duly authorized.


	Mercer Insurance Group, Inc.


January 11, 2006		By: /s/ Andrew R. Speaker Andrew R. Speaker President and Chief Executive Officer and a Director


January 11, 2006		By: /s/ David B. Merclean David B. Merclean Senior Vice President of Finance and Chief Financial Officer