UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K/A

Amendment No. 1

(MARK ONE)

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004

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

FOR THE TRANSITION PERIOD FROM __________ TO __________

Commission File Number 000-22761

PMA Capital Corporation

(Exact name of registrant as specified in its charter)

Pennsylvania	23-2217932
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)
380 Sentry Parkway
Blue Bell, Pennsylvania	19422
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code: (215) 665-5046

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

	Name of each exchange on
Title of each class:	which registered:
8.50% Monthly Income Senior	American Stock Exchange
Notes due 2018

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

Class A Common Stock, par value $5.00 per share

(Title of Class)

Rights to Purchase Preferred Stock

(Title of Class)

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 Rule 12b-2 of the Act). YES /X/ NO / /

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES / /  NO /X/

The aggregate market value of the Class A Common Stock held by non-affiliates of the registrant on June 30, 2004, based on the last price at which the Class A Common Stock was sold on such date, was $265,925,034.

There were 31,683,961 shares outstanding of the registrant’s Class A Common stock, $5 par value per share, as of the close of business on February 28, 2005.

Explanatory Note

As disclosed in our Annual Report on Form 10-K filed on March 16, 2005, in November 2004 we exchanged $84.1 million aggregate principal amount of 6.50% Senior Secured Convertible Debentures due 2022 (the “6.50% Convertible Debt”) for an equal amount of our 4.25% Senior Convertible Debentures due 2022 (the “4.25% Convertible Debt”). The 6.50% Convertible Debt is secured by a first lien on a portion of the capital stock of our principal operating subsidiaries, PMA Capital Insurance Company, Pennsylvania Manufacturers Indemnity Company, Pennsylvania Manufacturers’ Association Insurance Company and Manufacturers Alliance Insurance Company. As a result of the security interest granted, we are required to file three years of separate audited GAAP financial statements for these subsidiaries.

This Amendment No.1 to our Annual Report on Form 10-K is being filed for the sole purpose of filing such audited financial statements. For ease of reference, we have also included the audited consolidated financial statements of PMA Capital Corporation (the “Company”) previously filed in our report on Form 10-K. No changes have been made to the Company’s consolidated financial statements.

PART II

Item 8. Financial Statements and Supplemental Data

See Part IV, Item 15 “Exhibits and Financial Statement Schedules” beginning on Page 2.

Item 9A. Controls and Procedures

Disclosure Controls and Procedures

As disclosed in our Annual Report on Form 10-K filed on March 16, 2005, as of the end of the period covered by such report, we, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

However, as disclosed in our Annual Report on Form 10-K, in November 2004 we exchanged $84.1 million aggregate principal amount of 6.50% Convertible Debt for an equal amount of our 4.25% Convertible Debt. The 6.50% Convertible Debt is secured by a first lien on a portion of the capital stock of our principal operating subsidiaries, PMA Capital Insurance Company, Pennsylvania Manufacturers Indemnity Company, Pennsylvania Manufacturers’ Association Insurance Company and Manufacturers Alliance Insurance Company. As a result of the security interest granted, we are required to file three years of separate audited GAAP financial statements for these subsidiaries. This Amendment No.1 to our Annual Report on Form 10-K is being filed for the sole purpose of filing such audited financial statements.

Management’s Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of the Company’s internal control over financial reporting was conducted based upon the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based upon that evaluation, the Company’s management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2004.

Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which is included herein.

1

PART IV

Item 15. Exhibits and Financial Statement Schedules

FINANCIAL STATEMENTS AND SCHEDULES

(a) (1)	Registrant - Index to Consolidated Financial Statements	Page
	Consolidated Balance Sheets at December 31, 2004 and 2003	4
	Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002	5
	Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	6
	Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2004, 2003 and 2002	7
	Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2004, 2003 and 2002	8
	Notes to Consolidated Financial Statements	9
	Reports of Independent Registered Public Accountants	35
(a) (2)	The Financial Statement Schedules are listed in the Index to Financial Statement Schedules on page FS-1. All other schedules specified by Article 7 of Regulation S-X are not required pursuant to the related instructions or are inapplicable and, therefore, have been omitted.
(a) (3)	The Exhibits are listed in the Index to Exhibits on page E-1.
(c)	The financial statement schedules required by Regulation S-X (17 CFR 210) which are excluded from the annual report to shareholders by Rule 14a-3(b), including separate financial statements of affiliates whose securities are pledged as collateral.
(I)	Financial Statements of Pennsylvania Manufacturers’ Association Insurance Company
	Balance Sheets at December 31, 2004 and 2003	38
	Statements of Operations for the years ended December 31, 2004, 2003 and 2002	39
	Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	40
	Statements of Shareholder’s Equity for the years ended December 31, 2004, 2003 and 2002	41
	Statements of Comprehensive Income for the years ended December 31, 2004, 2003 and 2002	42
	Notes to Financial Statements	43
	Reports of Independent Registered Public Accountants	53
(II)	Financial Statements of Manufacturers Alliance Insurance Company
	Balance Sheets at December 31, 2004 and 2003	55
	Statements of Operations for the years ended December 31, 2004, 2003 and 2002	56
	Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	57
	Statements of Shareholder’s Equity for the years ended December 31, 2004, 2003 and 2002	58
	Statements of Comprehensive Income for the years ended December 31, 2004, 2003 and 2002	59
	Notes to Financial Statements	60
	Reports of Independent Registered Public Accountants	68
(III)	Financial Statements of Pennsylvania Manufacturers Indemnity Company
	Balance Sheets at December 31, 2004 and 2003	70
	Statements of Operations for the years ended December 31, 2004, 2003 and 2002	71
	Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	72
	Statements of Shareholder’s Equity for the years ended December 31, 2004, 2003 and 2002	73
	Statements of Comprehensive Income for the years ended December 31, 2004, 2003 and 2002	74
	Notes to Financial Statements	75
	Reports of Independent Registered Public Accountants	83

2

(IV)	Consolidated Financial Statements of PMA Capital Insurance Company
	Consolidated Balance Sheets at December 31, 2004 and 2003	85
	Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002	86
	Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002	87
	Consolidated Statements of Shareholder’s Equity for the years ended December 31, 2004, 2003 and 2002	88
	Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2004, 2003 and 2002	89
	Notes to Consolidated Financial Statements	90
	Reports of Independent Registered Public Accountants	103

3

PMA CAPITAL CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)	2004			2003
Assets:
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
2004 - $1,283,256; 2003 - $1,806,090)	$	1,304,086		$	1,854,555
Short-term investments		123,746			151,332
Short-term investments, loaned securities collateral		-			6,300
Cash		35,537			28,963
Total investments and cash		1,463,369			2,041,150
Accrued investment income		15,517			20,870
Premiums receivable (net of valuation allowance: 2004 - $7,049; 2003 - $7,972)		197,831			364,125
Reinsurance receivables (net of valuation allowance: 2004 - $9,002; 2003 - $6,769)		1,142,552			1,220,320
Deferred income taxes, net		86,501			76,962
Deferred acquisition costs		31,426			83,975
Funds held by reinsureds		142,064			124,695
Other assets		174,725			255,861
Total assets	$	3,253,985		$	4,187,958
Liabilities:
Unpaid losses and loss adjustment expenses	$	2,111,598		$	2,541,318
Unearned premiums		158,489			403,708
Long-term debt		214,467			187,566
Accounts payable, accrued expenses and other liabilities		196,744			314,830
Funds held under reinsurance treaties		121,234			262,105
Dividends to policyholders		5,977			8,479
Payable under securities loan agreements		25			6,285
Total liabilities		2,808,534			3,724,291
Commitments and contingencies (Note 7)
Shareholders' Equity:
Class A Common stock, $5 par value
(2004 - 60,000,000 shares authorized; 34,217,945 shares issued and 31,676,851 outstanding;
2003 - 60,000,000 shares authorized; 34,217,945 shares issued and 31,334,403 outstanding)		171,090			171,090
Additional paid-in capital		109,331			109,331
Retained earnings		213,313			216,115
Accumulated other comprehensive income (loss)		(1,959	)		19,622
Notes receivable from officers		-			(65	)
Treasury stock, at cost (2004 - 2,541,094 shares; 2003 - 2,883,542 shares)		(45,573	)		(52,426	)
Unearned restricted stock compensation		(751	)		-
Total shareholders' equity		445,451			463,667
Total liabilities and shareholders' equity	$	3,253,985		$	4,187,958

See accompanying notes to the consolidated financial statements.

4

PMA CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)	2004		2003			2002
Revenues:
Net premiums written	$	301,610	$	1,192,254		$	1,104,997
Change in net unearned premiums		216,975		5,911			(113,986	)
Net premiums earned		518,585		1,198,165			991,011
Net investment income		56,945		68,923			84,881
Net realized investment gains (losses)		6,493		13,780			(16,085	)
Other revenues		25,941		20,379			15,330
Total revenues		607,964		1,301,247			1,075,137
Losses and Expenses:
Losses and loss adjustment expenses		380,556		998,347			823,658
Acquisition expenses		115,225		256,446			216,984
Operating expenses		84,912		103,672			102,808
Dividends to policyholders		4,999		641			7,587
Interest expense		12,354		9,887			3,257
Loss on debt exchange		5,973		-			-
Total losses and expenses		604,019		1,368,993			1,154,294
Income (loss) before income taxes		3,945		(67,746	)		(79,157	)
Income tax expense (benefit)		2,115		25,823			(31,133	)
Net income (loss)	$	1,830	$	(93,569	)	$	(48,024	)
Income (loss) per share:
Basic	$	0.06	$	(2.99	)	$	(1.53	)
Diluted	$	0.06	$	(2.99	)	$	(1.53	)

See accompanying notes to the consolidated financial statements.

5

PMA CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)	2004			2003			2002
Cash flows from operating activities:
Net income (loss)	$	1,830		$	(93,569	)	$	(48,024	)
Adjustments to reconcile net income (loss) to net cash flows
provided by (used in) operating activities:
Deferred income tax expense (benefit)		2,115			25,823			(27,527	)
Net realized investment (gains) losses		(6,493	)		(13,780	)		16,085
Depreciation and amortization		19,667			21,229			9,199
Loss on debt exchange		5,973			-			-
Change in:
Premiums receivable and unearned premiums, net		(78,925	)		(2,121	)		34,516
Reinsurance receivables		77,768			74,763			(34,319	)
Unpaid losses and loss adjustment expenses		(429,720	)		91,428			125,451
Funds held by reinsureds		(17,369	)		32,784			(12,240	)
Funds held under reinsurance treaties		(140,871	)		12,435			21,778
Deferred acquisition costs		52,549			5,247			(24,872	)
Accounts payable, accrued expenses and other liabilities		(118,116	)		38,329			25,836
Dividends to policyholders		(2,502	)		(6,519	)		(2,134	)
Accrued investment income		5,353			(2,270	)		521
Other, net		25,474			(34,149	)		(12,103	)
Net cash flows provided by (used in) operating activities		(603,267	)		149,630			72,167
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases		(484,142	)		(1,062,420	)		(964,047	)
Maturities and calls		231,622			319,241			256,625
Sales		779,494			395,287			634,480
Net (purchases) sales of short-term investments		28,664			147,584			(29,942	)
Proceeds from sale of subsidiary, net of cash sold		-			17,676			-
Proceeds from other assets sold		41,147			-			-
Other, net		(1,043	)		(3,358	)		(20,961	)
Net cash flows provided by (used in) investing activities		595,742			(185,990	)		(123,845	)
Cash flows from financing activities:
Dividends paid to shareholders		-			(9,870	)		(12,102	)
Issuance of long-term debt		15,825			100,000			151,250
Debt issue costs		(600	)		(3,662	)		(3,009	)
Repayment of debt		(1,185	)		(65,000	)		(62,500	)
Proceeds from exercise of stock options		-			2			2,866
Purchase of treasury stock		-			-			(1,726	)
Net repayments of notes receivable from officers		59			-			96
Net cash flows provided by financing activities		14,099			21,470			74,875
Net increase (decrease) in cash		6,574			(14,890	)		23,197
Cash - beginning of year		28,963			43,853			20,656
Cash - end of year	$	35,537		$	28,963		$	43,853
Supplementary cash flow information:
Income tax paid (refunded)	$	(2,592	)	$	2,600		$	(10,649	)
Interest paid	$	11,607		$	8,366		$	2,091

See accompanying notes to the consolidated financial statements.

6

PMA CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands)	2004			2003			2002
Class A Common Stock	$	171,090		$	171,090		$	171,090
Additional paid-in capital - Class A Common stock		109,331			109,331			109,331
Retained earnings:
Balance at beginning of year		216,115			319,014			382,165
Net income (loss)		1,830			(93,569	)		(48,024	)
Class A Common stock dividends declared		-			(9,870	)		(13,142	)
Reissuance of treasury shares under employee benefit plans		(4,632	)		540			(1,985	)
Balance at end of year		213,313			216,115			319,014
Accumulated other comprehensive income (loss):
Balance at beginning of year		19,622			34,552			5,375
Other comprehensive income (loss), net of tax expense (benefit):
2004 - ($11,620); 2003 - ($8,039); 2002 - $15,710		(21,581	)		(14,930	)		29,177
Balance at end of year		(1,959	)		19,622			34,552
Notes receivable from officers:
Balance at beginning of year		(65	)		(62	)		(158	)
Repayment (interest accrued) of notes receivable from officers		65			(3	)		96
Balance at end of year		-			(65	)		(62	)
Treasury stock - Class A Common:
Balance at beginning of year		(52,426	)		(52,535	)		(55,797	)
Purchase of treasury shares		-			-			(1,726	)
Reissuance of treasury shares under employee benefit plans		6,853			109			4,988
Balance at end of year		(45,573	)		(52,426	)		(52,535	)
Unearned restricted stock compensation:
Balance at beginning of year		-			-			-
Issuance of restricted stock, net of cancellations		(2,185	)		-			-
Amortization of unearned restricted stock compensation		1,434			-			-
Balance at end of year		(751	)		-			-
Total shareholders' equity:
Balance at beginning of year		463,667			581,390			612,006
Net income (loss)		1,830			(93,569	)		(48,024	)
Class A Common stock dividends declared		-			(9,870	)		(13,142	)
Purchase of treasury shares		-			-			(1,726	)
Reissuance of treasury shares under employee benefit plans		2,221			649			3,003
Other comprehensive income (loss)		(21,581	)		(14,930	)		29,177
Repayment (interest accrued) of notes receivable from officers		65			(3	)		96
Issuance of restricted stock, net of cancellations		(2,185	)		-			-
Amortization of unearned restricted stock compensation		1,434			-			-
Balance at end of year	$	445,451		$	463,667		$	581,390

See accompanying notes to the consolidated financial statements.

7

PMA CAPITAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)	2004			2003			2002
Net income (loss)	$	1,830		$	(93,569	)	$	(48,024	)
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities
Holding gains (losses) arising during the period		(13,540	)		7,077			17,355
Less: reclassification adjustment for (gains) losses included in net
income (loss), net of tax expense (benefit): 2004 - $2,273;
2003 - $4,823; 2002 - ($5,630)		(4,220	)		(8,957	)		10,455
Total unrealized gains (losses) on securites		(17,760	)		(1,880	)		27,810
Pension plan liability adjustment, net of tax benefit
2004 - $434; 2003 - $8,406		(806	)		(15,609	)		-
Foreign currency translation gains (losses), net of tax expense (benefit):
2004 - ($1,623); 2003 - $1,378; 2002 - $736		(3,015	)		2,559			1,367
Other comprehensive income (loss), net of tax		(21,581	)		(14,930	)		29,177
Comprehensive loss	$	(19,751	)	$	(108,499	)	$	(18,847	)

See accompanying notes to the consolidated financial statements.

8

Notes to Consolidated Financial Statements

Note 1. Business Description

The accompanying consolidated financial statements include the accounts of PMA Capital Corporation and its subsidiaries (collectively referred to as “PMA Capital” or the “Company”). PMA Capital Corporation is an insurance holding company that owns and operates specialty risk management businesses:

The PMA Insurance Group— The PMA Insurance Group writes workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance, primarily in the eastern part of the United States. Approximately 87% of The PMA Insurance Group’s business for 2004 was produced through independent agents and brokers.

Run-off Operations— Run-off Operations consists of the results of the Company’s former reinsurance and excess and surplus lines businesses. The Company’s former reinsurance operations offered excess of loss and pro rata property and casualty reinsurance protection mainly through reinsurance brokers. In November 2003, the Company decided to withdraw from the reinsurance business. In May 2002, the Company withdrew from its former excess and surplus lines business.

Note 2. Summary of Significant Accounting Policies

A. Basis of Presentation — The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany accounts and transactions have been eliminated in consolidation. The preparation of consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. In addition, certain prior year amounts have been restated to conform to the current year classification. The balance sheet information presented in these financial statements and notes thereto is as of December 31 for each respective year. The statement of operations information is for the year ended December 31 for each respective year.

B. Investments — All fixed maturities are classified as available-for-sale and, accordingly, are carried at fair value. Changes in fair value of fixed maturities, net of income tax effects, are reflected in accumulated other comprehensive income (loss). All short-term, highly liquid investments, which have original maturities of one year or less from acquisition date, are treated as short-term investments and are carried at amortized cost, which approximates fair value.

Realized gains and losses, determined by the first-in, first-out method, are reflected in income in the period in which the sale transaction occurs. For all securities that are in an unrealized loss position for an extended period of time and for all securities whose fair value is significantly below amortized cost, the Company performs an evaluation of the specific events attributable to the market decline of the security. The Company considers the length of time and extent to which the security’s market value has been below cost as well as the general market conditions, industry characteristics and the fundamental operating results of the issuer to determine if the decline is other than temporary. The Company also considers as part of the evaluation its intent and ability to hold the security until its market value has recovered to a level at least equal to the amortized cost. When the Company determines that a security’s unrealized loss is other than temporary, a realized loss is recognized in the period in which the decline in value is determined to be other than temporary. The write-downs are measured based on public market prices and the Company’s expectation of the future realizable value for the security at the time the Company determines the decline in value was other than temporary.

The Company participates in a securities lending program through which securities are lent from the Company’s portfolio for short periods of time to qualifying third parties via a lending agent. Borrowers of these securities must provide collateral equal to a minimum of 102% of the market value including accrued interest of the lent securities. Acceptable collateral may be in the form of either cash or securities. Cash received as collateral is invested in short-term investments, and is recorded as such on the Balance Sheet, along with a corresponding liability included in payable under securities loan agreements. All securities received as collateral are of similar quality to those securities lent by the Company. The Company is not permitted by contract to sell or repledge the securities received as collateral. Additionally, the Company limits securities lending to 40% of statutory admitted assets of its insurance subsidiaries, with a 2% limit on statutory admitted assets to any individual borrower. The Company either receives a fee from the borrower or retains a portion of the income earned on the collateral. Under the terms of the securities lending program, the Company is indemnified against borrower default, with the lending

9

agent responsible to the Company for any deficiency between the cost of replacing a security that was not returned and the amount of collateral held by the Company.

C. Premiums — Premiums, including estimates of additional premiums resulting from audits of insureds’ records, and premiums from ceding companies which are typically reported on a delayed basis, are earned principally on a pro rata basis over the terms of the policies. For reinsurance premiums assumed, management must estimate the subject premiums associated with the treaties in order to determine the level of written and earned premiums for a reporting period. Such estimates are based on information from brokers and ceding companies, which can be subject to change as new information becomes available. Any changes occurring or reported to the Company after the policy term are recorded as earned premiums in the period in which the adjustment is made. See Note 4 for additional information. With respect to policies that provide for premium adjustments, such as experience-rated or exposure-based adjustments, such premium adjustments may be made subsequent to the end of the policy’s coverage period and will be recorded as earned premiums in the period in which the adjustment is made. Premiums applicable to the unexpired terms of policies in force are reported as unearned premiums. The estimated premiums receivable on retrospectively rated policies are reported as a component of premiums receivable.

D. Unpaid Losses and Loss Adjustment Expenses — Unpaid losses and loss adjustment expenses (“LAE”), which are stated net of estimated salvage and subrogation, are estimates of losses and LAE on known claims and estimates of losses and LAE incurred but not reported (“IBNR”). IBNR reserves are calculated utilizing various actuarial methods. Unpaid losses on certain workers’ compensation claims are discounted to present value using the Company’s payment experience and mortality and interest assumptions in accordance with statutory accounting practices prescribed by the Pennsylvania Insurance Department. The Company also discounts unpaid losses and LAE for certain other claims at rates permitted by domiciliary regulators or if the timing and amount of such claims are fixed and determinable. The methods of making such estimates and establishing the resulting reserves are continually reviewed and updated and any adjustments resulting there from are reflected in earnings in the period identified. See Note 4 for additional information.

E. Reinsurance — In the ordinary course of business, PMA Capital’s reinsurance and insurance subsidiaries assume and cede premiums with other insurance companies and are members of various insurance pools and associations. The Company’s insurance and reinsurance subsidiaries cede business in order to limit the maximum net loss and limit the accumulation of many smaller losses from a catastrophic event. The insurance and reinsurance subsidiaries remain primarily liable to their clients in the event their reinsurers are unable to meet their financial obligations. Reinsurance receivables include claims paid by the Company and estimates of unpaid losses and LAE that are subject to reimbursement under reinsurance and retrocessional contracts. The method for determining the reinsurance receivable for unpaid losses and LAE involves reviewing actuarial estimates of unpaid losses and LAE to determine the Company’s ability to cede unpaid losses and LAE under its existing reinsurance contracts. This method is continually reviewed and updated and any adjustments resulting there from are reflected in earnings in the period identified. Under certain of the Company’s reinsurance and retrocessional contracts, additional premium and interest may be required if predetermined loss and LAE thresholds are exceeded.

Certain of the Company’s reinsurance contracts are retroactive in nature. Any benefit derived from retroactive reinsurance contracts is deferred and amortized into income over the payout pattern of the underlying claim liabilities unless the contracts call for immediate recovery by the Company from reinsurers as ceded losses are incurred.

Certain of the Company’s assumed and ceded reinsurance contracts are funds held arrangements. In a funds held arrangement, the ceding company retains the premiums instead of paying them to the reinsurer and losses are offset against these funds in an experience account. Because the reinsurer is not in receipt of the funds, the reinsurer will generally earn interest on the experience fund balance at a predetermined credited rate of interest. The Company generally earns an interest rate of between 6% and 8% on its assumed funds held arrangements and generally pays interest at a rate of between 6% and 7% on its ceded funds held arrangements. The interest earned or credited on funds held arrangements is included in net investment income in the Statement of Operations. In addition, interest on funds held arrangements will continue to be earned or credited until the experience account is fully depleted, which can extend many years beyond the expiration of the coverage period.

F. Deferred Acquisition Costs — Costs that directly relate to and vary with the acquisition of new and renewal business are deferred and amortized over the period during which the related premiums are earned. Such direct costs include commissions or brokerage and premium taxes, as well as other policy issuance costs and underwriting expenses. The Company determines whether acquisition costs are recoverable considering future losses and LAE, maintenance costs and

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anticipated investment income. To the extent that acquisition costs are not recoverable, the deficiency is charged to income in the period identified.

G. Derivatives — The derivative component of the Company’s 6.50% Senior Secured Convertible Debt due 2022 (“6.50% Convertible Debt”) is bifurcated and recorded at fair value in long-term debt on the Balance Sheet. Changes in fair value are recorded in net realized investment gains (losses). See Note 6 for additional information.

H. Dividends to Policyholders — The PMA Insurance Group sells certain workers’ compensation insurance policies with dividend payment features. These policyholders share in the underwriting results of their respective policies in the form of dividends declared at the discretion of the Board of Directors of The PMA Insurance Group’s operating companies. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the individual policies.

I. Income Taxes — The Company records deferred tax assets and liabilities to the extent of the tax effect of differences between the financial statement carrying values and tax bases of assets and liabilities. A valuation allowance is recorded for deferred tax assets where it appears more likely than not that the Company will not be able to recover the deferred tax asset. See Note 12 for additional information.

J. Stock-Based Compensation — The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s Class A Common stock at grant date or other measurement date over the amount an employee must pay to acquire the Class A Common stock. The following table illustrates the effect on net income (loss) if the fair value based method had been applied:

(in thousands, except per share)	2004			2003			2002
Net income (loss)	$	1,830		$	(93,569	)	$	(48,024	)
Stock-based compensation expense already
included in reported net income (loss), net of tax		820			156			140
Total stock-based compensation expense
determined under fair value based method,
net of tax		(2,112	)		(1,302	)		(1,480	)
Pro forma net income (loss)	$	538		$	(94,715	)	$	(49,364	)
Net income (loss) per share:
Basic - as reported	$	0.06		$	(2.99	)	$	(1.53	)
Basic - pro forma	$	0.02		$	(3.02	)	$	(1.58	)
Diluted - as reported	$	0.06		$	(2.99	)	$	(1.53	)
Diluted - pro forma	$	0.02		$	(3.02	)	$	(1.58	)

K. Other Revenues — Other revenues include service revenues related to unbundled claims, risk management and related services provided by The PMA Insurance Group, which are earned over the term of the related contracts in proportion to the actual services rendered, and other miscellaneous revenues. During 2004, other revenues included a $6.6 million gain on the sale of a partnership interest.

L. Recent Accounting Pronouncements — In December 2003, the Financial Accounting Standards Board (“FASB”) revised Statement of Financial Accounting Standards (“SFAS”) No. 132, “Employers’ Disclosures About Pensions and Other Postretirement Benefits,” to require additional disclosures regarding defined benefit pension plans and other defined benefit postretirement plans. The Company has applied the disclosure provisions of SFAS No. 132, as revised, to its Consolidated Financial Statements.

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In December 2004, the Company adopted Emerging Issues Task Force (“EITF”) Consensus 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings Per Share,” which requires the inclusion of the dilutive effect of contingently convertible debt instruments in the computation of diluted income (loss) per share regardless of whether the contingency triggering convertibility has been met. The Company’s earnings per share calculation for the first and second quarters of 2003 did not include the effects of potential conversion because the conditions for convertibility had not yet occurred. Adoption of EITF 04-8 resulted in a reduction in the Company’s first and second quarter 2003 diluted income per share by three and four cents, respectively, but has no effect for full year 2003, because the effect of conversion would have been anti-dilutive. Beginning in the third quarter of 2003, the conversion requirements were met on the Company’s convertible debt. See unaudited “Quarterly Financial Information” for additional information.

In March 2004, the EITF reached a consensus regarding EITF 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.”  The consensus provides guidance for evaluating whether an investment is other-than-temporarily impaired.  The disclosure provisions of EITF 03-1 were effective for year-end 2003, with the recognition and measurement provisions scheduled to be effective for the third quarter of 2004. However, in September 2004, the FASB issued Staff Position EITF 03-1-1, which delays the effective date of the application of the recognition and measurement provisions of EITF 03-1. The delay of the recognition and measurement provisions is expected to be superseded concurrently with the issuance of a FASB Staff Position which will provide additional implementation guidance. The Company will assess whether this guidance will have a material impact on its financial condition or results of operations once the new guidance is released.

In December 2004, the FASB revised SFAS No. 123, “Share-Based Payment” to require the recognition of expenses relating to share-based payment transactions, including employee stock option grants, based on the fair value of the equity instruments issued. The Company is required to adopt the revised SFAS No. 123 in the third quarter of 2005. Effective with the third quarter of 2005, the Company will recognize an expense over the required service period for any stock options granted, modified, cancelled, or repurchased after that date and for the portion of grants for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards. In December 2002, the Company adopted the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based

Compensation - Transition and Disclosure,” which required prominent disclosures in financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. See Note 2-J for the effect on net income (loss) if the fair value based method had been applied.

Note 3. Investments

The Company’s investment portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, the Company does not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 10% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers.

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The amortized cost and fair value of the Company’s investment portfolio are as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(dollar amounts in thousands)	Cost		Gains		Losses		Value
December 31, 2004
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	312,954	$	4,671	$	3,431	$	314,194
States, political subdivisions and foreign government securities		19,026		832		90		19,768
Corporate debt securities		450,396		20,031		2,163		468,264
Mortgage-backed and other asset-backed securities		500,880		7,562		6,582		501,860
Total fixed maturities available for sale		1,283,256		33,096		12,266		1,304,086
Short-term investments		123,746		-		-		123,746
Total investments	$	1,407,002	$	33,096	$	12,266	$	1,427,832
December 31, 2003
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	340,483	$	11,975	$	1,253	$	351,205
States, political subdivisions and foreign government securities		20,200		718		95		20,823
Corporate debt securities		764,710		32,833		2,360		795,183
Mortgage-backed and other asset-backed securities		680,697		15,008		8,361		687,344
Total fixed maturities available for sale		1,806,090		60,534		12,069		1,854,555
Short-term investments		157,632		-		-		157,632
Total investments	$	1,963,722	$	60,534	$	12,069	$	2,012,187

As of December 31, 2004, gross unrealized losses on the Company’s investment asset portfolio were $12.3 million. For securities that were in an unrealized loss position at December 31, 2004, the length of time that such securities have been in an unrealized loss position, as measured by their month-end fair values, is as follows:

										Percentage
	Number of		Fair		Amortized		Unrealized			Fair Value to
(dollar amounts in millions)	Securities		Value		Cost		Loss			Amortized Cost
Less than 6 months		152	$	138.2	$	139.1	$	(0.9	)		99	%
6 to 9 months		71		108.5		110.0		(1.5	)		99	%
9 to 12 months		7		8.2		8.4		(0.2	)		98	%
More than 12 months		34		44.0		49.4		(5.4	)		89	%
Subtotal		264		298.9		306.9		(8.0	)		97	%
U.S. Treasury and Agency securities		107		277.3		281.6		(4.3	)		98	%
Total		371	$	576.2	$	588.5	$	(12.3	)		98	%

The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are as follows:

	Amortized		Fair
(dollar amounts in thousands)	Cost		Value
2005	$	93,874	$	93,727
2006-2009		308,918		307,778
2010-2014		215,822		221,056
2015 and thereafter		163,762		179,665
Mortgage-backed and other asset-backed securities		500,880		501,860
	$	1,283,256	$	1,304,086

Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.

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Net investment income consists of the following:

(dollars amounts in thousands)	2004			2003			2002
Fixed maturities	$	69,540		$	81,090		$	84,957
Short-term investments		1,707			2,684			5,073
Other		749			627			913
Total investment income		71,996			84,401			90,943
Investment expenses		(6,348	)		(5,070	)		(3,173	)
Interest on funds held, net		(8,703	)		(10,408	)		(2,889	)
Net investment income	$	56,945		$	68,923		$	84,881

Net realized investment gains (losses) consist of the following:

(dollar amounts in thousands)	2004			2003			2002
Realized gains	$	20,083		$	18,726		$	18,659
Realized losses		(4,847	)		(4,946	)		(34,744	)
Foreign exchange loss		(4,897	)		-			-
Change in fair value of derivative		(3,846	)		-			-
Total net realized investment gains (losses)	$	6,493		$	13,780		$	(16,085	)

Included in realized losses for 2004, 2003 and 2002 were impairment losses of $334,000, $2.6 million and $23.8 million, respectively. The impairment losses for 2004 were related to an asset-backed security and a security issued by an airline company. The impairment losses for 2003 primarily related to securities issued by airline companies and an asset-backed security. The impairment losses for 2002 primarily related to corporate bonds issued by telecommunications and energy companies, including $14.2 million for WorldCom. The write-downs were measured based on public market prices and the Company’s expectation of the future realizable value for the security at the time when the Company determined the decline in value was other than temporary.

The realized loss on the change in fair value of derivative related to the increase in the fair value of the derivative component of the 6.50% Convertible Debt from the date of issuance/exchange to December 31, 2004. See Note 6 for additional information.

At December 31, 2003, the Company had $6.3 million of collateral related to securities on loan, substantially all of which was cash received and subsequently reinvested in short-term investments.

On December 31, 2004, the Company had securities with a total amortized cost of $47.9 million and fair value of $48.5 million on deposit with various governmental authorities, as required by law. In addition, the Company had securities with a total amortized cost of $27.8 million and fair value of $28.2 million held in trust for the benefit of certain ceding companies on reinsurance balances assumed by the Run-off Operations. Securities with a total amortized cost and fair value of $7.0 million were held in trust to support the Company’s participation in the underwriting capacity of a Lloyd’s of London syndicate. There were also securities with a total amortized cost and fair value of $4.0 million pledged as collateral for letters of credit issued on behalf of the Company. The securities held in trust, on deposit or pledged as collateral are included in fixed maturities and short-term investments on the Balance Sheet.

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Note 4. Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and LAE is summarized as follows:

(dollar amounts in thousands)	2004			2003			2002
Balance at January 1	$	2,541,318		$	2,449,890		$	2,324,439
Less: reinsurance recoverable on unpaid losses and LAE		1,195,048			1,265,584			1,181,322
Net balance at January 1		1,346,270			1,184,306			1,143,117
Losses and LAE incurred, net:
Current year, net of discount		406,828			768,114			655,395
Prior years		(40,363	)		218,774			159,748
Accretion of prior years' discount		14,091			11,459			8,515
Total losses and LAE incurred, net		380,556			998,347			823,658
Losses and LAE paid, net:
Current year		(122,256	)		(185,850	)		(138,127	)
Prior years		(605,755	)		(650,533	)		(594,342	)
Total losses and LAE paid, net		(728,011	)		(836,383	)		(732,469	)
Reserves transferred		-			-			(50,000	)
Net balance at December 31		998,815			1,346,270			1,184,306
Reinsurance recoverable on unpaid losses and LAE		1,112,783			1,195,048			1,265,584
Balance at December 31	$	2,111,598		$	2,541,318		$	2,449,890

Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. Due to the “long-tail” nature of a significant portion of the Company’s business, in many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. The Company defines long-tail business as those lines of business in which a majority of coverage involves average loss payment lags of several years beyond the expiration of the policy. The Company’s major long-tail lines include its workers’ compensation and casualty reinsurance business. In addition, because reinsurers rely on their ceding companies to provide them with information regarding incurred losses, reported claims for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development and uncertainty. As part of the process for determining the Company’s unpaid losses and LAE, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments, changes in social attitudes and economic conditions.

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The following table summarizes the effect on the Company’s underwriting assets and liabilities of the commutation and novation of certain reinsurance and retrocessional contracts by the Run-off Operations segment occurring in 2004. The commutations and novations did not have a material effect on the Company’s results of operations for 2004.

(dollar amounts in thousands)	2004
Assets:
Reinsurance receivables	$	(63,662	)
Funds held by reinsureds		(31,330	)
Other assets		(70,537	)
Liabilities:
Unpaid losses and loss adjustment expenses	$	(202,667	)
Unearned premiums		(26,596	)
Other liabilities		(70,228	)
Funds held under reinsurance treaties		(82,095	)

The components of the Company’s (favorable) unfavorable development of reserves for losses and LAE for prior accident years, excluding accretion of discount, are as follows:

(dollar amounts in thousands)	2004			2003		2002
The PMA Insurance Group	$	(2,070	)	$	49,685	$	1,082
Run-off Operations		(38,293	)		169,089		158,666
Total net (favorable) unfavorable development	$	(40,363	)	$	218,774	$	159,748

During 2004, the favorable prior year loss development at the Run-off Operations related primarily to reinsurance contracts that were novated or commuted. This favorable prior year loss development was substantially offset by net premiums earned and acquisition expenses.

The PMA Insurance Group recorded favorable prior year loss development of $2.1 million in 2004, primarily reflecting better than expected loss experience from rent-a-captive workers’ compensation business. Dividends to policyholders offset this favorable development. Rent-a-captives are used by customers as an alternative method to manage their loss exposure without establishing and capitalizing their own captive insurance company.

During 2003, The PMA Insurance Group recorded unfavorable prior year loss development of $49.7 million. As part of the year end closing process, in the fourth quarter of 2003, the Company’s actuaries completed a comprehensive year-end actuarial analysis of loss reserves. Based on the actuarial work performed, the Company’s actuaries noticed higher than expected claims severity in workers' compensation business written for accident years 2001 and 2002, primarily from loss-sensitive and participating workers' compensation business. As a result, The PMA Insurance Group increased loss reserves for prior years by $50 million. An independent actuarial firm also conducted a comprehensive review of The PMA Insurance Group’s loss reserves as of December 31, 2003 and concluded that such carried loss reserves were reasonable as of December 31, 2003. Under The PMA Insurance Group's loss-sensitive rating plans, the amount of the insured's premiums is adjusted after the policy period expires based, to a large extent, upon the insured's actual losses incurred during the policy period. Under policies that are subject to dividend plans, the ultimate amount of the dividend that the insured may receive is also based, to a large extent, upon loss experience during the policy period. Accordingly, offsetting the effects of this unfavorable prior year loss development were premium adjustments of $35 million under loss-sensitive plans and reduced policyholder dividends of $8 million, resulting in a net fourth quarter pre-tax charge of $7 million.

During 2003, the Run-off Operations increased its net loss reserves for prior accident years for reinsurance business by $169.1 million, including $150 million during the third quarter. The third quarter 2003 reserve charge related to higher than expected underwriting losses, primarily from casualty business written in accident years 1997 through 2000. Approximately

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75% of the charge was related to general liability business written from 1997 to 2000 with substantially all of the remainder of the charge from the commercial automobile line written during those same years. During the third quarter, the Company’s actuaries conducted their periodic comprehensive reserve review. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of reinsurance business written. The information derived during this review indicated that a large portion of the change in expected loss development was due to increasing loss trends emerging in calendar year 2003 for prior accident years. This increase in 2003 loss trends caused management to determine that the reserve levels, primarily for accident years 1997 to 2000, needed to be increased by $150 million. An independent actuarial firm also conducted a comprehensive review of the Company’s Traditional-Treaty, Specialty-Treaty and Facultative reinsurance loss reserves, and concluded that those carried loss reserves were reasonable at September 30, 2003.

The Company’s analysis was enhanced by an extensive review of specific accounts, comprising about 40% of the carried reserves of the reinsurance business for accident years 1997 to 2000. The Company’s actuaries visited a number of former ceding company clients, which collectively comprised about 25% of the reinsurance business total gross loss and LAE reserves from accident years 1997 to 2000, to discuss reserving and reporting experience with these ceding companies. The Company’s actuaries separately evaluated an additional number of other ceding companies, representing approximately 15% of the reinsurance business total gross loss and LAE reserves from accident years 1997 to 2000, to understand and examine data trends.

During 2002, the Run-off Operations recorded net unfavorable prior year loss development of $159 million ($107 million for reinsurance and $52 million for excess and surplus lines). During 2002, company actuaries conducted reserve reviews to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business. Management’s selection of the ultimate losses resulting from their reviews indicated that net loss reserves for the excess and surplus lines business for prior accident years, mainly 1999 and 2000, needed to be increased by $52 million. This unfavorable prior year development reflects the impact of higher than expected claim severity and, to a lesser extent, frequency, that emerged in 2002 on casualty lines of business, primarily professional liability policies for the nursing homes class of business; general liability, including policies covering contractors’ liability for construction defects; and commercial automobile, mainly for accident years 1999 and 2000.

During 2002, the Run-off Operations also recorded unfavorable prior year development of $107 million for the reinsurance business. During the fourth quarter, the Company’s actuaries observed a higher than expected increase in the frequency and, to a lesser extent, severity of reported claims by ceding companies. Management’s selection of the ultimate losses indicated that net loss and LAE reserves for prior accident years needed to be increased by $64 million in the fourth quarter of 2002, primarily for excess of loss and pro rata general liability occurrence contracts and, to a lesser extent, excess of loss general liability claims-made contracts, from accident years 1998, 1999 and 2000.

The remaining $43 million of unfavorable prior year development on reinsurance business in 2002 primarily reflects the recording of losses and LAE on additional earned premiums recorded during 2002 as a result of a change in the Company’s estimate of ultimate premiums written from prior years. Because premiums from ceding companies are typically reported on a delayed basis, the Company monitors and updates as appropriate the estimated ultimate premiums written. The Company’s periodic reviews of estimated ultimate premiums written, which compared actual reported premiums and originally estimated premiums based on ceding company estimates, indicated that premiums written in recent years, primarily in the Traditional- and Specialty-Treaty units for 2001 and 2000, were higher than originally estimated. As a result, the Company recorded additional net premiums earned during 2002, including $39.9 million in the second quarter, which were completely offset by losses and LAE and acquisition expenses.

Reserves transferred in 2002 reflect the assumption of losses by an unaffiliated third party. Cash and short-term investments of $50 million were transferred to support the payment of the transferred reserves.

Unpaid losses for the Company’s workers’ compensation claims, net of reinsurance, at December 31, 2004 and 2003 were $448.7 million and $433.8 million, net of discount of $48.2 million and $54.6 million, respectively. The discount rate used was approximately 5% at December 31, 2004 and 2003.

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The Company’s loss reserves were stated net of salvage and subrogation of $30.8 million and $33.2 million at December 31, 2004 and 2003, respectively.

During 2004, the Company’s actuaries conducted their periodic reserve reviews of The PMA Insurance Group and the Run-off Operations. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business. The information derived during these reviews indicated that general liability and professional liability lines written by the Run-off Operations continued to exhibit volatility. While the conclusion of the reviews indicated that no adjustments to reserves were necessary and that the Company’s carried reserves were reasonable, continued volatility could require adjustments in future periods.

On December 6, 2004, the New York jury in the trial regarding the insurance coverage for the World Trade Center rendered a verdict that the September 11, 2001 attack on the World Trade Center constituted two occurrences under the policies issued by certain insurers. The Company considers the jury's verdict to be contrary to the terms of the insurance coverage in force and to the intent of the parties involved. Because the litigation is ongoing and the appraisal and valuation process is pending, the ultimate resolution of this issue cannot be determined at this time. The Company estimates that it could be required to incur a charge of up to $5 million pre-tax at the Run-off Operations if it is ultimately determined that the September 11, 2001 attack on the World Trade Center constituted two occurrences under the policies issued by certain of its ceding companies and if as a result of this determination, additional losses are incurred by its ceding companies.

Management believes that its unpaid losses and LAE are fairly stated at December 31, 2004. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates, assumptions and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2004, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

At December 31, 2004, 2003 and 2002, gross reserves for asbestos-related losses were $27.9 million, $37.8 million and $42.1 million, respectively ($14.0 million, $17.8 million and $25.8 million, net of reinsurance, respectively). Of the net asbestos reserves, approximately $10.3 million, $14.9 million and $22.9 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively.

At December 31, 2004, 2003 and 2002, gross reserves for environmental-related losses were $16.1 million, $14.2 million and $18.2 million, respectively ($6.4 million, $8.8 million and $14.3 million, net of reinsurance, respectively). Of the net environmental reserves, approximately $3.0 million, $3.7 million, and $7.9 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, the Company’s ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company’s financial condition, results of operations and liquidity.

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Note 5. Reinsurance

The components of net premiums written and earned, and losses and LAE incurred are as follows:

(dollar amounts in thousands)	2004			2003			2002
Written premiums:
Direct	$	386,260		$	652,795		$	604,984
Assumed		(33,998	)		776,848			781,562
Ceded		(50,652	)		(237,389	)		(281,549	)
Net	$	301,610		$	1,192,254		$	1,104,997
Earned premiums:
Direct	$	461,365		$	638,716		$	599,827
Assumed		136,131			788,025			691,740
Ceded		(78,911	)		(228,576	)		(300,556	)
Net	$	518,585		$	1,198,165		$	991,011
Losses and LAE:
Direct	$	372,059		$	484,889		$	503,867
Assumed		108,308			756,570			543,025
Ceded		(99,811	)		(243,112	)		(223,234	)
Net	$	380,556		$	998,347		$	823,658

In 2004, the Company purchased reinsurance covering potential adverse loss development of the loss and LAE reserves of the Run-off Operations. Under the agreement, the Company ceded $100 million in carried loss and LAE reserves and paid $146.5 million in cash. During 2004, the Company incurred $6.0 million in ceded premiums for this agreement. In addition, the contract requires additional premiums of $2.5 million if it is not commuted by December 2007.At December 31, 2004, the Run-off Operations have $105 million of available coverage under this agreement for future adverse loss development.

Any future cession of losses may require the Company to cede additional premiums of up to $35 million on a pro rata basis, at the following contractually determined levels:

Losses ceded	Additional premiums
$0 - $20 million	No additional premiums
$20 - $50 million	Up to $20 million
$50 - $80 million	Up to $15 million
$80 - $105 million	No additional premiums

The additional premiums have been prepaid and are included in other assets on the Balance Sheet. Because the coverage is retroactive, the Company will not record the benefit of this reinsurance in its Statement of Operations until it receives the related recoveries.

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At December 31, 2004, the Company had reinsurance receivables due from the following unaffiliated reinsurers in excess of 5% of shareholders’ equity:

	Reinsurance
(dollar amounts in thousands)	Receivables		Collateral
The London Reinsurance Group and Affiliates(1)	$	288,777	$	274,717
Swiss Reinsurance America Corporation		140,824		27,087
PXRE Reinsurance Company		128,542		72,509
St. Paul and Affiliates(2)		102,910		79,709
Houston Casualty Company		75,701		-
Imagine Insurance Company Limited		34,212		34,212
Partner Reinsurance Co		30,474		-
Hannover Ruckversicherungs AG		30,065		-

(1)	Includes Trabaja Reinsurance Company ($264.1 million) and London Life & General Reinsurance Company ($24.7 million).
(2)	Includes United States Fidelity & Guaranty Insurance Company ($68.6 million), Mountain Ridge Insurance Company ($24.6 million) and other affiliated entities ($9.7 million).

The Company performs credit reviews of its reinsurers focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Reinsurers failing to meet the Company’s standards are excluded from the Company’s reinsurance programs. In addition, the Company requires collateral, typically assets in trust, letters of credit or funds withheld, to support balances due from certain reinsurers, generally those not authorized to transact business in the applicable jurisdictions. At December 31, 2004 and 2003, the Company’s reinsurance receivables of $1,142.6 million and $1,220.3 million were supported by $507.2 million and $644.1 million of collateral. Of the uncollateralized reinsurance receivables as of December 31, 2004, approximately 94% were from reinsurers rated “A-” or better by A.M. Best.

The PMA Insurance Group has recorded reinsurance receivables of $13.9 million at December 31, 2004, related to certain umbrella policies covering years prior to 1977. The reinsurer has disputed the extent of coverage under these policies. The ultimate resolution of this dispute cannot be determined at this time. An unfavorable resolution of the dispute could have a material adverse effect on the Company’s financial condition and results of operations.

The Company’s largest reinsurer is Trabaja Reinsurance Company (“Trabaja”). Reinsurance receivables from Trabaja were $264.1 million at December 31, 2004, of which 95% were collateralized.

Trabaja, formerly PMA Insurance Cayman, Ltd. (“PMA Cayman”), is a wholly owned subsidiary of London Life and Casualty Reinsurance Corporation (“London Reinsurance Group”). The Company sold PMA Cayman to London Reinsurance Group for $1.8 million, and transferred approximately $230 million of cash and invested assets as well as loss reserves to the buyer in 1998. Under the terms of the sale of PMA Cayman to London Reinsurance Group in 1998, the Company has agreed to indemnify London Reinsurance Group, up to a maximum of $15 million if the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves of PMA Cayman were established. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, then the Company will participate in such favorable loss reserve development.

In January 2002, the Company supplemented its in-force reinsurance programs for The PMA Insurance Group and its former reinsurance business with retroactive reinsurance contracts with Trabaja that provide coverage for adverse loss development on certain lines of business for accident years prior to 2002. These contracts provide coverage of up to $125 million in losses in return for $55 million of funding, which included $50 million of assets and $5 million in ceded premiums. Under the terms of the contracts, losses and LAE of the Run-off Operations ceded to Trabaja for accident years 1996 through 2001 are recoverable as they are incurred by the Company. In 2002, the Run-off Operations recognized a benefit of $25 million for losses ceded to these reinsurance contracts. Any future cession of losses under these contracts may require the Company to cede additional premiums ranging from 40% to 50% of ceded losses depending on the level of such losses.

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Note 6. Debt

The Company’s outstanding debt is as follows:

(dollar amounts in thousands)	2004		2003
Long-term debt:
6.50% Convertible Debt	$	99,140	$	-
Derivative component of 6.50% Convertible Debt		13,086		-
4.25% Convertible Debt		925		86,250
Trust preferred debt		43,816		43,816
8.50% Senior Notes		57,500		57,500
Total long-term debt	$	214,467	$	187,566

In November 2004, the Company exchanged $84.1 million aggregate principal amount of 6.50% Convertible Debt for $84.1 million aggregate principal amount of its outstanding 4.25% Senior Convertible Debt due 2022 (“4.25% Convertible Debt” and together with the 6.50% Convertible Debt, the “Convertible Debt” ). The Company did not receive any proceeds as a result of the exchange offer. The Company recorded a loss on the debt exchange of $6.0 million, which resulted from the initial recording of the 6.50% Convertible Debt at fair value and the write-off of unamortized issuance costs associated with the 4.25% Convertible Debt. In November 2004, the Company received net proceeds of $15.2 million from the issuance of $15 million aggregate principal amount of 6.50% Convertible Debt in a private placement to a limited number of qualified institutional buyers. The Convertible Debt may be converted at any time, at the holder's option, at a current price of $16.368 per share.

On June 30, 2009, holders of the 6.50% Convertible Debt will have the right to require the Company to repurchase for cash any amounts outstanding for 114% of the principal amount of the debt plus accrued and unpaid interest, if any, to the settlement date. In 2006, in the event PMA Capital Corporation receives any extraordinary dividends from its subsidiaries, the Company will be required to use 50% of those dividends to redeem up to $35 million principal amount of the 6.50% Convertible Debt at 110% of the original principal amount. Holders may elect to receive any premium over the principal amount (“Put Premium”) in either cash or Class A common stock, with the number of shares determined based on a value of $8.00 per share.

The 6.50% Convertible Debt is secured equally and ratably with the Company's $57.5 million 8.50% Monthly Income Senior Notes due 2018 (the “8.50% Senior Notes”) by a first lien on 20% of the capital stock of the Company's principal operating subsidiaries. The Company has agreed to make an additional pledge of the remainder of the capital stock of these subsidiaries if the A.M. Best financial strength rating of the Pooled Companies is not A- or higher on December 31, 2005 or is reduced below B++ prior to December 31, 2005. The 6.50% Convertible Debt is convertible at the rate of 61.0948 shares per $1000 principal amount, equivalent to a conversion price of $16.368 per share of Class A common stock.

The Put Premium and conversion features of the 6.50% Convertible Debt constitute a derivative which requires bifurcation. Any change in the fair value of the derivative component of the 6.50% Convertible Debt is recognized in net realized investment gains (losses). The Company had a net realized loss of $3.8 million in 2004 for the increase in the fair value of the derivative component of the 6.50% Convertible Debt from the date of issuance to December 31, 2004.

In 2003, the Company issued $43.8 million of 30-year floating rate subordinated debentures to three wholly owned statutory trust subsidiaries. The Company used all of the $41.2 million of net proceeds to pay down a portion of its then outstanding bank credit facility and for general corporate purposes. The trust preferred debt matures in 2033 and is redeemable, in whole or in part, in 2008 at the stated liquidation amount plus accrued and unpaid interest. The interest rates on the trust preferred debt equal the three-month London InterBank Offered Rate ("LIBOR") plus 4.10%, 4.20% and 4.05% and is payable on a quarterly basis. At December 31, 2004, the weighted average interest rate on the trust preferred securities was 6.51%.

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The Company has the right to defer interest payments on the Trust Preferred securities for up to twenty consecutive quarters but, if so deferred, it may not declare or pay cash dividends or distributions on its Class A common stock. The Company has guaranteed the obligations of these statutory trust subsidiaries with respect to distributions and payments on the trust preferred securities issued by these subsidiaries.

In 2003, the Company issued $57.5 million of 8.50% Senior Notes due June 15, 2018, from which it realized net proceeds of $55.1 million. The Company used the proceeds from the offering to repay the remaining balance outstanding under its prior bank credit facility, to increase the statutory capital and surplus of its insurance subsidiaries, and for general corporate purposes. The Company has the right to call these securities beginning in June 2008.

In October 2002, the Company issued $86.25 million of 4.25% Convertible Debt from which the Company received net proceeds of $83.7 million. The Company used the proceeds from this offering primarily to increase the capital of its insurance and reinsurance subsidiaries. As discussed above, the Company exchanged $84.1 million of this debt in November 2004. The Company also retired $1.2 million of this debt in December 2004 through open market purchases. As of December 31, 2004, $925,000 remained outstanding. This debt is convertible at a conversion price of $16.368 per share, subject to adjustment upon certain events. Further, holders of this debt, at their option, may require the Company to repurchase all or a portion of the debt on September 30, 2006, 2008, 2010, 2012 and 2017, or subject to specified exceptions, upon a change in control. The Company may choose to pay the repurchase price in cash or shares of Class A common stock. The Convertible Debt is redeemable in cash, in whole or in part, at the Company’s option at any time on or after September 30, 2006.

The indenture governing the 6.50% Convertible Debt contains restrictive covenants with respect to limitations on the Company’s ability to incur indebtedness, enter into transactions with affiliates or engage in a merger or sale of all or substantially all of the Company’s assets.

Note 7. Commitments and Contingencies

The Company leases certain office space and office equipment such as computers under noncancelable operating leases. Future minimum net operating lease obligations as of December 31, 2004 are as follows:

(dollar amounts in thousands)	Office space (1)		Office equipment		Total operating leases
2005	$	3,724	$	3,017	$	6,741
2006		3,469		2,171		5,640
2007		3,518		963		4,481
2008		2,992		169		3,161
2009		2,443		13		2,456
2010 and thereafter		4,921		-		4,921
	$	21,067	$	6,333	$	27,400

(1) Net of sublease rentals of $1.5 million in 2005 and 2006, $1.6 million in 2007, 2008 and 2009 and $7.8 million thereafter.

Total rent expense incurred under operating leases was $3.9 million, $4.0 million and $4.1 million for 2004, 2003 and 2002, respectively.

In the event a property and casualty insurer operating in a jurisdiction where the Company’s insurance subsidiaries also operate becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. As of December 31, 2004 and 2003, the Company had recorded liabilities of $6.6 million and $7.5 million for these assessments, which are included in accounts payable, accrued expenses and other liabilities on the Balance Sheet.

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Prior to December 2004, the Company had an interest in a real estate partnership for which it had provided a guaranty of $7.0 million related to loans on properties of the partnership. In December 2004, the Company sold the partnership and as such, this guaranty terminated at the time of the sale.

Until December 31, 2003, the Company had an executive loan program, through which a financial institution provided personal demand loans to the Company’s officers. The Company had provided collateral and agreed to purchase any loan in default. In November 2003, the financial institution sold the Company’s collateral partially securing the loans of two former officers of the Company in satisfaction of their loans in the aggregate amount of $2.0 million. The Company received $1.7 million in repayment for the loans of one former officer in 2004, and in consideration of the Company forgiving $166,000 of indebtedness, the former officer executed an agreement, which, among other things, includes a release of the Company and its officers, employees and affiliates from any and all claims as of the date of that agreement. The loan of the other former officer in the outstanding principal amount of $185,000 is fully secured and is due on April 30, 2005. The Company is accruing interest on this loan, which is included in other assets on the Balance Sheet, at a rate of 4.5% as of December 31, 2004.

Under the terms of the sale of PMA Cayman in 1998, the Company has agreed to indemnify the buyer, up to a maximum of $15.0 million if the actual claim payments in the aggregate exceed the estimated payments upon which the loss reserves of the former subsidiary were established. If the actual claim payments in the aggregate are less than the estimated payments upon which the loss reserves have been established, the Company will participate in such favorable loss reserve development.

At December 31, 2004, The PMA Insurance Group is guarantor of $2.2 million principal amount on certain premium finance loans made by unaffiliated premium finance companies to insureds.

See Note 4 for information regarding losses related to the September 11, 2001 attack on the World Trade Center and Note 5 for information regarding disputed reinsurance receivables.

The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded receivables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.

The Company and certain of its directors and key executive officers are defendants in several purported class actions that were filed in 2003 in the United States District Court for the Eastern District of Pennsylvania by alleged purchasers of the Company’s Class A Common Stock, 4.25% Convertible Debt and 8.50% Senior Notes. On June 28, 2004, the District Court issued an order consolidating the cases under the caption In Re PMA Capital Corporation Securities Litigation (civil action no. 03-6121) and appointing Sheet Metal Workers Local 9 Pension Trust, Alaska Laborers Employers Retirement Fund and Communications Workers of America for Employees’ Pension and Death Benefits as lead plaintiff. On September 20, 2004, the plaintiffs filed an amended and consolidated complaint on behalf of an alleged class of purchasers of the Company’s securities between May 5, 1999 and February 11, 2004. The complaint alleges, among other things, that the defendants violated Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder by making materially false and misleading public statements and material omissions during the class period regarding the Company’s underwriting performance, loss reserves and related internal controls. The complaint alleges, among other things, that the defendants violated Sections 11, 12(a) (2) and 15 of the Securities Act by making materially false and misleading statements in registration statements and prospectuses about the Company’s financial results, underwriting performance, loss reserves and related internal controls. The complaint seeks unspecified compensatory damages, the right to rescind the purchases of securities in the public offerings, interest, and plaintiffs’ reasonable costs and expenses, including attorneys’ fees and expert fees. The Company intends to vigorously defend against the claims asserted in this consolidated action. The lawsuit is in its earliest stages; therefore, it is not possible at this time to reasonably estimate the impact on the Company. However, the lawsuit may have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

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Note 8. Shareholders’ Equity

Changes in Class A Common stock shares were as follows:

	2004			2003			2002
Treasury stock - Class A Common stock:
Balance at beginning of year		2,883,542			2,889,023			3,050,939
Purchase of treasury shares		-			-			90,185
Reissuance of treasury shares under employee benefit plans		(342,448	)		(5,481	)		(252,101	)
Balance at end of year		2,541,094			2,883,542			2,889,023

In 2004, the Company issued 262,600 shares of restricted Class A common stock to employees under the Company’s 2002 Equity Incentive Plan and 79,326 shares of restricted Class A common stock to its Directors under the 2004 Directors Plan. The restricted stock vests (restrictions lapse) between one and three years. The Company also issued 16,422 shares of Class A Common stock to Directors in 2004 in lieu of a portion of their retainer under the 2004 Directors Plan.

During the vesting period, restricted shares issued are nontransferable and subject to forfeiture, but the shares are entitled to all of the other rights of the outstanding shares. Restricted shares are forfeited if employees terminate employment, or Directors resign from the Board, prior to the lapse of restrictions except upon death or permanent disability. The Company determines the cost of restricted stock awarded, which is recognized as compensation expense over the vesting period, based on the market value of the stock at the time of the award. The Company recorded expenses of $1.3 million during 2004 for restricted stock awards and $112,000 for Class A Common stock issued to Directors in lieu of their retainer. During 2004, 15,900 restricted shares were forfeited.

In 2003, shareholders approved an increase in the authorized shares of the Company’s Class A Common stock, which has a $5 par value, from 40 million shares to 60 million shares.

The Company repurchased 90,185 shares of its Class A Common stock at a cost of $1.7 million in 2002. No shares were repurchased in 2004 or 2003. The Company’s remaining share repurchase authorization at December 31, 2004 is $15.4 million. Decisions regarding share repurchases are subject to prevailing market conditions and an evaluation of the costs and benefits associated with alternative uses of capital.

The Company declared dividends on its Class A Common stock of $0.315 and $0.42 per share in 2003 and 2002, respectively. In November 2003, the Company’s Board of Directors suspended dividends on the Company’s Class A Common stock.

The Company has 2,000,000 shares of undesignated Preferred stock, $0.01 par value per share authorized. There are no shares of Preferred stock issued or outstanding.

In 2000, the Company’s Board of Directors adopted a shareholder rights plan that will expire on May 22, 2010. The rights automatically attached to each share of Class A Common stock. Generally, the rights become exercisable after the acquisition of 15% or more of the Company’s Class A Common stock and permit rights-holders to purchase the Company’s Class A Common stock or that of an acquirer at a substantial discount. The Company may redeem the rights for $0.001 per right at any time prior to an acquisition.

The Company’s domestic insurance subsidiaries’ ability to pay dividends to PMA Capital Corporation is limited by the insurance laws and regulations of the Commonwealth of Pennsylvania. Prior to June 2004, all of PMA Capital’s domestic insurance entities were owned by PMA Capital Insurance Company (“PMACIC”). Only PMACIC, a Pennsylvania domiciled company, could pay dividends directly to PMA Capital Corporation.

In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies, previously subsidiaries of PMACIC, to become direct, wholly owned subsidiaries of PMA Capital Corporation. However, in its Order approving the transfer of the Pooled Companies from PMACIC to PMA Capital Corporation, the Pennsylvania Insurance Department prohibited PMACIC, the Company’s reinsurance subsidiary which is currently in run-off, from any declaration or payment of dividends, return of capital or any other types of distributions in 2004 and 2005 to PMA Capital Corporation.

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In 2006, PMACIC may declare and pay ordinary dividends or returns of capital without the prior approval of the Pennsylvania Insurance Department if, immediately after giving effect to the dividend or returns of capital, PMACIC’s risk-based capital equals or exceeds 225% of Authorized Control Level Capital as defined by the National Association of Insurance Commissioners (“NAIC”). In 2007 and beyond, PMACIC may make dividend payments, as long as such dividends are not considered “extraordinary” under Pennsylvania insurance law.

The Pooled Companies, which are not subject to the Pennsylvania Insurance Department’s Order, paid dividends of $12.1 million to PMA Capital Corporation in 2004. As of December 31, 2004, The Pooled Companies can pay up to $23.5 million in dividends in 2005 without the prior approval of the Pennsylvania Insurance Department.

Dividends received from subsidiaries were $24.0 million and $28.0 million in 2003 and 2002, respectively.

Note 9. Stock Options

The Company currently has stock option plans in place for stock options granted to officers and other key employees for the purchase of the Company’s Class A Common stock, under which 4,800,314 Class A Common shares were reserved for issuance at December 31, 2004. The stock options were granted under terms and conditions determined by the Compensation Committee of the Board of Directors. Stock options granted have a maximum term of ten years, generally vest over periods ranging between one and four years, and are typically granted with an exercise price at least equal to the fair market value of the Class A Common stock on the date the options are granted. Information regarding these option plans is as follows:

	2004					2003					2002
				Weighted					Weighted					Weighted
				Average					Average					Average
	Shares			Price		Shares			Price		Shares			Price
Options outstanding, beginning of year		2,871,619		$	16.07		3,096,494		$	16.93		3,387,154		$	16.45
Options granted		1,350,200			6.34		511,960			9.21		440,500			19.50
Options exercised		-			-		(50,141	)		11.50		(302,465	)		12.66
Options forfeited or expired		(1,464,614	)		14.61		(686,694	)		15.17		(428,695	)		18.78
Options outstanding, end of year(1)		2,757,205		$	12.09		2,871,619		$	16.07		3,096,494		$	16.93
Options exercisable, end of year		1,523,047		$	15.74		1,861,489		$	16.85		2,059,729		$	15.74
Option price range at end of year	$5.78 to $21.50					$9.14 to $21.50					$11.50 to $21.50
Option price range for exercised shares	-					$11.50					$10.00 to $17.00
Options available for grant at end of year	2,043,109					2,057,054					305,158

(1) Included in the options outstanding at December 31, 2002 are 260,000 options (“Target Price Options”), with an exercise price of $17.00. Because the stock did not reach the necessary price, the Target Price Options expired as unvested options in 2003.

All options granted in 2004 and 2003 were granted with an exercise price that equaled or exceeded the market value of the Class A Common stock on the grant date (“out-of-the-money”). The weighted average fair value of options granted in 2004 and 2003 was $3.43 per share and $4.91 per share, respectively. Of the total options granted in 2002, 225,000 were granted with an exercise price that was lower than the market value of the Class A Common stock on the grant date, and such options had a weighted average exercise price of $19.50 per share and a weighted average fair value of $14.61 per share. The remaining 215,500 options were granted out-of-the-money, and such options had an exercise price of $19.50 per share and a weighted average fair value of $7.66 per share.

The Company accounts for stock option compensation using the intrinsic value method. Included in the Company’s net income (loss) were pre-tax stock option compensation costs of ($172,000), $239,000 and $215,000 for 2004, 2003 and 2002, respectively. Stock option compensation increased pre-tax income in 2004 due to the impact of the cancellation of unvested stock options.

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The fair value of options at date of grant was estimated using an option-pricing model with the following weighted average assumptions:

	2004			2003			2002
Expected life (years)		5			10			10
Risk-free interest rate		3.1	%		3.4	%		5.1	%
Expected volatility		60.5	%		44.3	%		16.8	%
Expected dividend yield		0.0	%		4.6	%		2.0	%

Stock options outstanding and options exercisable at December 31, 2004 were as follows:

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
	Number		Remaining		Average		Number		Average
	of Shares		Life		Exercise Price		of Shares		Exercise Price
$5.78 to $8.00		1,291,100		9.28	$	6.37		304,800	$	7.02
$8.01 to $12.00		149,850		8.41	$	9.14		-	$	-
$12.01 to $16.00		315,800		0.43	$	15.33		315,800	$	15.33
$16.01 to $20.00		803,891		4.01	$	18.27		705,883	$	18.10
$20.01 to $21.50		196,564		5.05	$	21.43		196,564	$	21.43

See Note 2-J and 2-L for additional information.

Note 10. Earnings Per Share

Shares used as the denominator of the basic and diluted earnings per share were computed as follows:

	2004		2003		2002
Denominator:
Basic shares		31,344,858		31,330,183		31,284,848
Dilutive effect of:
Restricted stock		243,977		-		-
Stock options		136,994		-		-
Convertible Debt		3,232		-		-
Total diluted shares		31,729,061		31,330,183		31,284,848

The effect of 1.5 million, 2.9 million and 3.1 million stock options were excluded from the computation of diluted earnings per share for 2004, 2003 and 2002, respectively, because they would have been anti-dilutive.

Diluted shares for 2004, 2003 and 2002 do not assume the conversion of the Company’s Convertible Debt into 6.1 million, 5.3 million and 5.3 million shares of Class A Common stock, respectively, because it would have been anti-dilutive. The dilutive effect of the Convertible Debt for 2004 represents the impact of the Put Premium feature on the 6.50% Convertible Debt. See Note 6 for additional information.

Note 11. Fair Value of Financial Instruments

As of December 31, 2004, the carrying amounts for the Company’s financial instruments approximated their estimated fair value. As of December 31, 2003, the carrying amounts for the Company’s financial instruments approximated their estimated fair value, other than the 4.25% Convertible Debt, which had a fair value of approximately $65 million, compared to a carrying value of $86.3 million, and the 8.50% Senior Notes, which had a fair value of approximately $50 million,

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compared to a carrying value of $57.5 million. The Company measures the fair value of fixed maturities, the Convertible Debt and the Senior Notes based upon quoted market prices or by obtaining quotes from dealers. For other financial instruments, the carrying values approximate their fair values. Certain financial instruments, specifically amounts relating to insurance and reinsurance contracts, are excluded from this disclosure.

Note 12. Income Taxes

The components of the Federal income tax expense (benefit) are:

(dollar amounts in thousands)	2004		2003		2002
Current	$	-	$	-	$	(3,606	)
Deferred		2,115		25,823		(27,527	)
Income tax expense (benefit)	$	2,115	$	25,823	$	(31,133	)

A reconciliation between the total income tax expense (benefit) and the amounts computed at the statutory federal income tax rate of 35% is as follows:

(dollar amounts in thousands)	2004			2003			2002
Federal income tax at the statutory rate	$	1,381		$	(23,711	)	$	(27,705	)
Change in valuation allowance		8,000			49,000			-
Reversal of income tax accruals		(8,120	)		-			(3,000	)
Other		854			534			(428	)
Income tax expense (benefit)	$	2,115		$	25,823		$	(31,133	)

The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows:

(dollar amounts in thousands)	2004			2003
Net operating loss and tax credit carryforwards	$	86,891		$	76,854
Discounting of unpaid losses and LAE		41,337			61,619
Unearned premiums		10,949			26,136
Postretirement benefit obligation		9,856			7,712
Allowance for uncollectible accounts		6,666			6,277
Depreciation		3,540			3,264
Other		11,626			9,549
Gross deferred tax assets		170,865			191,411
Valuation allowance		(57,000	)		(49,000	)
Deferred tax assets, net of valuation allowance		113,865			142,411
Deferred acquisition costs		(10,999	)		(29,391	)
Unrealized appreciation of investments		(7,335	)		(16,994	)
Losses of foreign reinsurance affiliates		-			(8,120	)
Capitalized software		(4,204	)		(4,161	)
Foreign exchange translation adjustment		(449	)		(1,973	)
Other		(4,377	)		(4,810	)
Gross deferred tax liabilities		(27,364	)		(65,449	)
Net deferred tax assets	$	86,501		$	76,962

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At December 31, 2004, the Company had a net operating loss ("NOL") carryforward of $221.9 million, which will expire in years 2018 through 2024, and an $8.5 million alternative minimum tax ("AMT") credit carryforward, which does not expire. The NOL carryforward, which produces a gross deferred tax asset of $77.6 million, will be applied to reduce taxable income of the Company.

In 2003, the Company recorded a valuation allowance in the amount of $49 million. In the fourth quarter of 2004, the Company reassessed the valuation allowance previously established against its net deferred tax assets and determined that it needed to be increased by $8 million, considering a number of factors, including the recent losses and revised projections of future earnings at the Run-off Operations. Accordingly, management has estimated at December 31, 2004 that the insurance operations will generate sufficient future taxable income to utilize the net deferred tax asset, net of the $57.0 million valuation allowance, over a period of time not exceeding the expiration of the operating loss carryforwards. The valuation allowance of $57.0 million reserves against $46.3 million of gross deferred tax assets related to the NOL carryforward and all of the projected deferred tax asset related to the AMT credit carryforward because it is more likely than not that this portion of the benefit will not be realized. The Company will continue to periodically assess the realizability of its net deferred tax asset.

The Company's Federal income tax returns are subject to audit by the Internal Revenue Service ("IRS"). No tax years are currently under audit by the IRS. In the fourth quarter of 2004, the Company reversed $8.1 million of certain tax contingency reserves recorded in prior years, due primarily to closed examination years.

In 2002, the Company received refunds from the IRS of $10.6 million, resulting primarily from an AMT net operating loss which was generated in 2001 and carried back to 1998 and 1999.

Note 13. Employee Retirement, Postretirement and Postemployment Benefits

A. Pension and Other Postretirement Benefits:

Pension Benefits —The Company sponsors a qualified non-contributory defined benefit pension plan (the “Qualified Pension Plan”) covering substantially all employees. After meeting certain requirements under the Qualified Pension Plan, an employee acquires a vested right to future benefits. The benefits payable under the plan are generally determined on the basis of an employee’s length of employment and salary during employment. The Company’s policy is to fund pension costs in accordance with the Employee Retirement Income Security Act of 1974.

The Company also maintains non-qualified unfunded supplemental defined benefit pension plans (the “Non-qualified Pension Plans”) for the benefit of certain key employees. The projected benefit obligation and accumulated benefit obligation for the Non-qualified Pension Plans were $7.6 million and $7.3 million, respectively, as of December 31, 2004.

Other Postretirement Benefits —In addition to providing pension benefits, the Company provides certain health care benefits for retired employees and their spouses. Substantially all of the Company’s employees may become eligible for those benefits if they meet the requirements for early retirement under the Qualified Pension Plan and have a minimum of 10 years employment with the Company. For employees who retired on or subsequent to January 1, 1993, the Company will pay a fixed portion of medical insurance premiums, including Medicare Part B. Retirees will absorb future increases in medical premiums.

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The following tables set forth the amounts recognized in the Company’s financial statements with respect to Pension Benefits and Other Postretirement Benefits:

	Pension Benefits						Other Postretirement Benefits
(dollar amounts in thousands)	2004			2003			2004			2003
Change in benefit obligation:
Benefit obligation at beginning of year	$	77,470		$	66,924		$	9,777		$	8,808
Service cost		3,520			3,202			420			364
Interest cost		4,937			4,629			597			596
Actuarial (gain) loss		2,252			4,927			(41	)		652
Benefits paid		(2,427	)		(2,212	)		(756	)		(643	)
Benefit obligation at end of year	$	85,752		$	77,470		$	9,997		$	9,777
Change in plan assets:
Fair value of plan assets at beginning of year	$	62,401		$	57,118		$	-		$	-
Actual return on plan assets		5,066			7,495			-			-
Benefits paid		(2,427	)		(2,212	)		-			-
Fair value of plan assets at end of year	$	65,040		$	62,401		$	-		$	-
Benefit obligation greater than the fair value of plan assets	$	(20,712	)	$	(15,069	)	$	(9,997	)	$	(9,777	)
Unrecognized actuarial (gain) loss		31,016			29,982			(3,063	)		(3,162	)
Unrecognized prior service (cost) benefit		482			487			(484	)		(603	)
Unrecognized net transition obligation		342			338			-			-
Net amount recognized at end of year	$	11,128		$	15,738		$	(13,544	)	$	(13,542	)
Amounts recognized in the balance sheet consist of:
Prepaid benefit cost	$	17,139		$	21,075		$	-		$	-
Accrued benefit cost		(6,011	)		(5,337	)		(13,544	)		(13,542	)
Additional minimum liability		(26,499	)		(25,288	)		-			-
Intangible asset		1,244			1,273			-			-
Accumulated other comprehensive income, pre-tax		25,255			24,015			-			-
Net amount recognized at end of year	$	11,128		$	15,738		$	(13,544	)	$	(13,542	)

	Pension Benefits									Other Postretirement Benefits
(dollar amounts in thousands)	2004			2003			2002			2004			2003			2002
Components of net periodic benefit cost:
Service cost	$	3,520		$	3,202		$	2,396		$	419		$	364		$	316
Interest cost		4,937			4,629			4,278			597			596			589
Expected return on plan assets		(5,198	)		(5,032	)		(4,333	)		-			-			-
Amortization of transition obligation		(4	)		(5	)		(4	)		-			-			-
Amortization of prior service cost		5			5			5			(119	)		(119	)		(119	)
Recognized actuarial (gain) loss		1,642			1,643			662			(140	)		(91	)		(218	)
Net periodic pension cost	$	4,902		$	4,442		$	3,004		$	757		$	750		$	568
Weighted average assumptions:
Discount rate		6.00	%		6.25	%		6.75	%		6.00	%		6.25	%		6.75	%
Expected return on plan assets		8.50	%		9.00	%		9.00	%		-			-			-
Rate of compensation increase		3.75	%		4.00	%		4.50	%		-			-			-

The Company uses a January 1 measurement date for its Plans. For the measurement of Other Postretirement Benefits, a 10% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2004. The rate was assumed to decrease gradually to 5% by 2009 and remain at that level thereafter. A one percentage point change in assumed

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health care cost trend rates would have an immaterial impact on the total service and interest cost components of the net periodic benefit cost and the postretirement benefit obligation.

Benefits paid in the table above include only those amounts paid directly from plan assets.

The decline in Qualified Pension Plan asset performance in 2000 to 2002, combined with historically low interest rates (which are the key assumption in estimating plan liabilities) caused the Company to record a $24.0 million increase in its accrued Qualified Pension Plan liability and to take a $15.6 million non-cash charge to equity in the fourth quarter of 2003. In 2004, the Company increased its Qualified Pension Plan liability by an additional $1.2 million and recorded a non-cash charge to equity of $806,000. These charges did not impact earnings or cash flow, and could reverse in future periods if either interest rates increase or market performance and plan asset returns improve.

The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for the Qualified Pension Plan were $78.2 million, $73.2 million and $65.0 million, respectively, at December 31, 2004 and $70.5 million, $65.3 million and $62.4 million, respectively, at December 31, 2003.

The asset allocation for the Company’s Qualified Pension Plan at the end of 2004 and 2003, and the target allocation for 2005, by asset category, are as follows:

		Percentage of plan assets
	Target allocation	As of December 31,
Asset Category	2005		2004	2003
Equity Securities	50-70%		69%	66%
Debt Securities	30-50%		31%	34%
Total	100%		100%	100%

The Company’s Qualified Pension Plan assets are managed by outside investment managers and are rebalanced periodically. The Company’s investment strategy with respect to Qualified Pension Plan assets includes guidelines for asset quality standards, asset allocations among investment types and issuers, and other relevant criteria for the portfolio.

Following are expected cash flows for the Company's pension plans:

	Qualified		Non-Qualified
(dollar amounts in thousands)	Pension Benefits		Pension Benefits
Expected Employer Contributions:
2005	$	-	$	-
Expected Benefit Payments:
2005	$	2,583	$	310
2006		2,687		322
2007		2,794		348
2008		2,893		416
2009		3,084		438
2010-2014		20,882		2,820

Qualified Pension Plan benefits will be paid from the pension trust assets which have a fair value of $65.0 million at December 31, 2004. Non-qualified Pension Plan benefits will be paid from the general assets of the Company.

B. Defined Contribution Savings Plan — The Company also maintains a voluntary defined contribution savings plan covering substantially all employees. The Company matches employee contributions up to 5% of compensation. Contributions under such plans expensed in 2004, 2003 and 2002 were $2.6 million, $3.3 million and $3.4 million, respectively.

C. Postemployment Benefits — The Company may provide certain benefits to employees subsequent to their employment, but prior to retirement including severance, long-term and short-term disability payments, and other related benefits. Postemployment benefits attributable to prior service and/or that relate to benefits that vest or accumulate are

30

accrued presently if the payments are probable and reasonably estimable. Postemployment benefits that do not meet such criteria are accrued when payments are probable and reasonably estimable. See Note 14 for additional information regarding severance.

Note 14. Run-Off Operations

In November 2003, the Company announced its decision to withdraw from the reinsurance business previously served by the PMA Re operating segment. As a result of this decision, the results of PMA Re are now reported as Run-off Operations. Run-off Operations also includes the results of the Company’s former excess and surplus lines business.

As a result of the decision to exit from and run off the reinsurance business, results for the Run-off Operations for 2003 included a charge of $2.6 million pre-tax, mainly for employee termination benefits. Approximately 80 employees at PMA Re have been terminated in accordance with the Company’s exit plan. Approximately 60 positions, primarily claims and financial, remain. The Company has established an employee retention arrangement for the remaining employees. Under this arrangement, the Run-off Operations recorded expenses of $1.7 million, which include retention bonuses and severance, for 2004, and expects to record expenses of approximately $1.3 million for 2005. Employee termination benefits and retention bonuses of $3.3 million have been paid in accordance with this plan, including $450,000 in 2003. Additionally, in 2004 the Run-off Operations paid a $1 million fee to shorten the term of its Philadelphia office lease from fifteen years to seven and reduce the leased space by approximately 75% effective October 1, 2004.

In May 2002, the Company announced its decision to withdraw from the excess and surplus lines marketplace previously served by the Caliber One operating segment. In January 2003, the Company closed on the sale of the capital stock of Caliber One Indemnity Company. Pursuant to the agreement of sale, the Company has retained all assets and liabilities related to the in-force policies and outstanding claim obligations relating to Caliber One’s business written prior to closing on the sale. As a result of the Company’s decision to exit from and run off this business, its results are reported in Run-off Operations. The sale generated gross proceeds of approximately $31 million and resulted in a pre-tax gain of $2.5 million, which is included in other revenues in the Statement of Operations for 2003.

As a result of the decision to exit from and run off this business, 2002 results for the Run-off Operations include a charge of $43 million pre-tax. Components of the charge include approximately $16 million to write-down assets to their estimated net realizable value, including non-cash charges of approximately $6 million for leasehold improvements and other fixed assets and $1.3 million for goodwill. During 2003, the Company recognized an additional $2.5 million write-down of assets, including approximately $2 million for reinsurance receivables and $500,000 for premiums receivable, reflecting an updated assessment of their estimated net realizable value. The write-down is included in operating expenses in the Statement of Operations for 2003.

In addition, the $43 million pre-tax charge includes expenses associated with the recognition of liabilities of approximately $27 million, including reinsurance costs of approximately $19 million, long-term lease costs of approximately $4 million and involuntary employee termination benefits of approximately $3 million. The charge was included in operating expenses (approximately $24 million) and net premiums earned (approximately $19 million) in the Statement of Operations in 2002. At December 31, 2004, the Company had a remaining balance of approximately $410,000 for net lease costs and approximately $114,000 for severance.

During 2002, approximately 80 Caliber One employees, primarily in the underwriting area, were terminated in accordance with the Company’s exit plan. Approximately 6 positions, primarily claims staff, remain as of December 31, 2004. Involuntary employee termination benefits of $38,000, $730,000 and $1.9 million were paid during 2004, 2003 and 2002, respectively.

Note 15. Business Segments

In November 2003, the Company announced its decision to withdraw from the reinsurance business previously served by the PMA Re operating segment. As a result of this decision, the results of PMA Re are now reported as Run-off Operations. Run-off Operations also includes the results of the Company’s former excess and surplus lines business.

The Company's total revenues, substantially all of which are generated within the U.S., and pre-tax operating income (loss) by principal business segment are presented in the table below.

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Operating income (loss), which is GAAP net income (loss) excluding net realized investment gains and losses, is the financial performance measure used by the Company’s management and Board of Directors to evaluate and assess the results of the Company’s insurance businesses. Accordingly, the Company reports operating income by segment in this footnote as required by SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” The Company’s management and Board of Directors use operating income as the measure of financial performance for the Company’s business segments because (i) net realized investment gains and losses are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments and (ii) in many instances, decisions to buy and sell securities are made at the holding company level, and such decisions result in net realized gains and losses that do not relate to the operations of the individual segments. Operating income (loss) does not replace net income (loss) as the GAAP measure of our consolidated results of operations.

(dollar amounts in thousands)	2004			2003			2002
Revenues:
The PMA Insurance Group	$	492,335		$	620,432		$	460,573
Run-off Operations		101,722			665,783			631,377
Corporate and Other		7,414			1,252			(728	)
Net realized investment gains (losses)		6,493			13,780			(16,085	)
Total revenues	$	607,964		$	1,301,247		$	1,075,137
Components of net income (loss):
Pre-tax operating income (loss):
The PMA Insurance Group	$	13,166		$	21,541		$	25,346
Run-off Operations		5,509			(80,376	)		(74,204	)
Corporate and Other		(21,223	)		(22,691	)		(14,214	)
Net realized investment gains (losses)		6,493			13,780			(16,085	)
Income (loss) before income taxes		3,945			(67,746	)		(79,157	)
Income tax expense (benefit)		2,115			25,823			(31,133	)
Net income (loss)	$	1,830		$	(93,569	)	$	(48,024	)

Net premiums earned by principal business segment are as follows:

(dollar amounts in thousands)	2004			2003			2002
The PMA Insurance Group:
Workers' compensation and integrated disability	$	389,844		$	477,402		$	333,956
Commercial automobile		30,602			53,541			43,384
Commercial multi-peril		16,973			28,700			25,390
Other		4,924			10,389			7,536
Total premiums earned		442,343			570,032			410,266
Run-off Operations:
Reinsurance:
Traditional - Treaty		23,661			278,971			263,757
Finite Risk and Financial Products		15,501			221,093			207,531
Specialty - Treaty		36,348			83,008			58,348
Facultative		2,450			27,237			18,619
Accident Reinsurance		(873	)		13,940			3,258
Total reinsurance premiums earned		77,087			624,249			551,513
Excess and surplus lines		(20	)		4,672			30,113
Total premiums earned - Run-off Operations		77,067			628,921			581,626
Corporate and Other		(825	)		(788	)		(881	)
Consolidated net premiums earned	$	518,585		$	1,198,165		$	991,011

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The Company’s amortization and depreciation expense by principal business segment were as follows:

(dollar amounts in thousands)	2004		2003		2002
The PMA Insurance Group	$	7,648	$	7,117	$	3,598
Run-off Operations		12,015		14,035		5,472
Corporate and Other		4		77		129
Total depreciation and amortization expense	$	19,667	$	21,229	$	9,199

The Company's total assets⁽¹⁾ by principal business segment were as follows:

(dollar amounts in thousands)	2004		2003
The PMA Insurance Group	$	1,889,449	$	2,008,509
Run-off Operations		1,300,655		2,128,461
Corporate and Other(2)		63,881		50,988
Total assets	$	3,253,985	$	4,187,958

(1)	Equity investments in subsidiaries, which eliminate in consolidation, are excluded from total assets for each segment.
(2)	Corporate and Other includes the effects of eliminating transactions between the various insurance segments.

The PMA Insurance Group’s operations are concentrated in ten contiguous states in the eastern part of the U.S. As such, economic trends in individual states may not be independent of one another. Also, The PMA Insurance Group’s products are highly regulated by each of these states. For many of The PMA Insurance Group’s products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers’ compensation benefits are determined by statutes and regulations in each of these states. While The PMA Insurance Group considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have an adverse impact on the Company’s financial condition and results of operations. The PMA Insurance Group is the Company’s sole remaining ongoing insurance segment. In 2004, workers’ compensation net premiums written represented 85% of The PMA Insurance Group’s net premiums written. In 2003 and 2002, workers’ compensation net premiums written by The PMA Insurance Group represented 41% and 32%, respectively, of the Company’s net premiums written.

The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe-prone regions. The PMA Insurance Group maintains catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0 million.

Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes, or terrorist event, could exceed the Company’s reinsurance and/or retrocessional protection and may have a material adverse impact on the Company’s financial condition, results of operations and liquidity. In 2004, 2003 and 2002, the Company’s loss and LAE ratios were not significantly impacted by catastrophes.

Note 16. Transactions with Related Parties

In 2003 and 2002, the Company and certain of its subsidiaries provided certain administrative services to the PMA Foundation (the “Foundation”), for which the Company and its subsidiaries received reimbursement. The Foundation, a not-for-profit corporation qualified under Section 501(c)(6) of the Internal Revenue Code, whose purposes include the promotion of the common business interests of its members and the economic prosperity of the Commonwealth of Pennsylvania, owned 5,242,150 shares, or 16.7%, of the Company’s Class A Common stock as of December 31, 2003. As of December 31, 2004, the Foundation owns less than 5% of the Company’s Class A Common Stock. Total reimbursements amounted to $13,000 for both 2003 and 2002. The Foundation also leased its Harrisburg, Pennsylvania headquarters facility from a subsidiary of the Company under an operating lease which required rent payments of $25,000 per month, and reimbursed a subsidiary of the Company for its use of office space. Rent and related reimbursements paid to the Company’s affiliates by the Foundation was $304,000 in both 2003 and 2002. In 2004, the Company sold this building to the Foundation for gross proceeds of $1.6 million, resulting in a gain of $458,000, which is included in other revenues in the Statement of Operations.

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The Company incurred legal and consulting expenses aggregating approximately $4.4 million, $3.7 million and $3.9 million in 2004, 2003 and 2002, respectively, from firms in which directors of the Company are partners or principals.

At December 31, 2003 and 2002, the Company had notes receivable from officers totaling $65,000 and $62,000, respectively, that are accounted for as a reduction of shareholders’ equity. These loans were repaid in 2004.

Note 17. Statutory Financial Information

These consolidated financial statements vary in certain respects from financial statements prepared using statutory accounting practices that are prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department (collectively, "SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of NAIC publications. Permitted SAP encompasses all accounting practices that are not prescribed. The Codification of Statutory Accounting Principles ("Codification") guidance is the NAIC’s primary guidance on statutory accounting. The principal differences between GAAP and SAP are in the treatment of acquisition expenses, reinsurance, deferred income taxes, fixed assets and investments.

SAP net income (loss) and capital and surplus for PMA Capital’s domestic insurance subsidiaries are as follows:

(dollar amounts in thousands)	2004		2003			2002
SAP net income (loss):
The PMA Insurance Group	$	19,000	$	7,169		$	4,984
PMA Capital Insurance Company		40,803		(84,413	)		(8,039	)
Caliber One Indemnity Company(1)		-		409			(27,874	)
Total	$	59,803	$	(76,835	)	$	(30,929	)
SAP capital and surplus:
The PMA Insurance Group	$	300,034	$	296,777		$	305,533
PMA Capital Insurance Company		224,510		500,617			580,151
Caliber One Indemnity Company(1)		-		-			26,844
Eliminations(2)		-		(296,777	)		(332,377	)
Total	$	524,544	$	500,617		$	580,151

(1)

In January 2003, the Company sold the capital stock of Caliber One Indemnity Company.

(2)

The surplus of The PMA Insurance Group’s domestic insurance subsidiaries (for 2003 and 2002) and Caliber One Indemnity Company (2002 only) are eliminated as they are included in the statutory surplus of PMA Capital Insurance Company, then the parent company of these insurance companies. In June 2004, The PMA Insurance Group was transferred from PMA Capital Insurance Company to PMA Capital Corporation.

The Company’s statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Pennsylvania Insurance Department (for PMA Capital Insurance Company and The PMA Insurance Group) and the Delaware Insurance Department (for Caliber One Indemnity Company). Pennsylvania and Delaware have adopted Codification as the basis of their statutory accounting practices. However, Pennsylvania has retained the prescribed practice of non-tabular discounting of unpaid losses and LAE for workers’ compensation, which was not permitted under Codification. This prescribed accounting practice increased statutory capital and surplus by $101,000, $435,000 and $13.0 million at December 31, 2004, 2003 and 2002, respectively, over what it would have been had the prescribed practice not been allowed.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

PMA Capital Corporation

We have audited the accompanying balance sheets of PMA Capital Corporation and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, cash flows, shareholders’ equity, and comprehensive income for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, such 2004 and 2003 consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

March 16, 2005

35

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

PMA Capital Corporation

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that PMA Capital Corporation and subsidiaries (the “Company”) 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. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

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

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

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

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

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 2004 of the Company and our report dated March 16, 2005, expressed an unqualified opinion on those financial statements and financial statement schedules.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

March 16, 2005

36

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

PMA Capital Corporation:

In our opinion, the accompanying consolidated statements of operations, of cash flows, of shareholders’ equity and of comprehensive income (loss) for the year ended December 31, 2002 present fairly, in all material respects, the results of operations and cash flows of PMA Capital Corporation and its subsidiaries for the year ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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.

/s/ Pricewaterhouse Coopers LLP

Philadelphia, PA

February 5, 2003

37

Table of Contents

PENNSYLVANIA MANUFACTURERS’ ASSOCIATION INSURANCE COMPANY

BALANCE SHEETS

(in thousands, except share data)	2004		2003
Assets:
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
2004 - $327,183; 2003 - $367,322)	$	337,522	$	381,462
Preferred stock - affiliated		2		6,002
Short-term investments		24,802		33,094
Cash		24,961		11,307
Total investments and cash		387,287		431,865
Accrued investment income		3,657		4,054
Premiums receivable (net of valuation allowance: 2004 - $3,509; 2003 - $4,192)		107,219		148,325
Prepaid reinsurance premiums		63,716		95,766
Reinsurance receivables (net of valuation allowance: 2004 - $7,741; 2003 - $5,508)		997,067		1,010,738
Deferred income taxes, net		17,703		18,900
Deferred acquisition costs		18,590		23,181
Other assets		68,061		56,867
Total assets	$	1,663,300	$	1,789,696
Liabilities:
Unpaid losses and loss adjustment expenses	$	1,200,545	$	1,233,523
Unearned premiums		156,484		227,262
Payable to affiliates		6,572		7,741
Accounts payable, accrued expenses and other liabilities		68,844		84,537
Funds held under reinsurance treaties		8,525		3,051
Dividends to policyholders		3,586		5,087
Total liabilities		1,444,556		1,561,201
Commitments and contingencies (Note 6)
Shareholder's Equity:
Common stock, $10 par value
(2004 and 2003 - 2,000,000 shares authorized; 611,630 shares issued and outstanding)		6,116		6,116
Additional paid-in capital		48,803		48,803
Retained earnings		157,104		164,383
Accumulated other comprehensive income		6,721		9,193
Total shareholder's equity		218,744		228,495
Total liabilities and shareholder's equity	$	1,663,300	$	1,789,696

See accompanying notes to financial statements.

38

PENNSYLVANIA MANUFACTURERS’ ASSOCIATION INSURANCE COMPANY

STATEMENTS OF OPERATIONS

(in thousands)	2004		2003			2002
Revenues:
Net premiums written	$	205,305	$	333,259		$	238,770
Change in net unearned premiums		38,729		(20,137	)		(25,206	)
Net premiums earned		244,034		313,122			213,564
Net investment income		14,786		22,937			21,523
Net realized investment gains (losses)		2,660		2,223			(4,450	)
Other revenues		1,691		1,382			1,453
Total revenues		263,171		339,664			232,090
Losses and Expenses:
Losses and loss adjustment expenses		183,657		243,826			160,281
Acquisition expenses		50,728		53,333			42,222
Operating expenses		21,297		24,830			16,803
Dividends to policyholders		1,712		120			4,331
Total losses and expenses		257,394		322,109			223,637
Income before income taxes		5,777		17,555			8,453
Income tax expense (benefit)		2,920		5,348			(196	)
Net income	$	2,857	$	12,207		$	8,649

See accompanying notes to financial statements.

39

PENNSYLVANIA MANUFACTURERS’ ASSOCIATION INSURANCE COMPANY

STATEMENTS OF CASH FLOWS

(in thousands)	2004			2003			2002
Cash flows from operating activities:
Net income	$	2,857		$	12,207		$	8,649
Adjustments to reconcile net income to net cash flows
provided by (used in) operating activities:
Deferred income tax expense (benefit)		2,525			(466	)		(2,855	)
Net realized investment (gains) losses		(2,660	)		(2,223	)		4,450
Depreciation and amortization		5,985			5,795			3,447
Change in:
Premiums receivable and unearned premiums, net		(29,672	)		(10,759	)		47,197
Prepaid reinsurance premiums		32,050			(17,171	)		(4,762	)
Reinsurance receivables		13,671			(47,168	)		(102,751	)
Unpaid losses and loss adjustment expenses		(32,978	)		67,376			59,482
Funds held under reinsurance treaties		5,474			1,348			1,191
Deferred acquisition costs		4,591			(3,822	)		(4,400	)
Accounts payable, accrued expenses and other liabilities		(19,696	)		15,115			7,420
Dividends to policyholders		(1,501	)		(3,912	)		(1,280	)
Accrued investment income		397			(241	)		221
Other, net		(14,450	)		(6,536	)		7,137
Net cash flows provided by (used in) operating activities		(33,407	)		9,543			23,146
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases		(96,614	)		(216,884	)		(144,473	)
Maturities and calls		47,770			81,620			51,948
Sales		93,103			104,388			111,716
Net sales of short-term investments		8,448			24,567			(52,092	)
Net redemption of affiliated preferred stock		6,000			3,000			2,998
Proceeds from other assets sold		1,600			-			-
Other, net		(3,080	)		(4,067	)		(3,581	)
Net cash flows provided by (used in) investing activities		57,227			(7,376	)		(33,484	)
Cash flows from financing activities:
Capital contribution received		-			-			25,000
Dividends paid to shareholders		(8,997	)		(10,483	)		(13,200	)
Advances from (to) affiliates		(1,169	)		7,741			-
Net cash flows provided by (used in) financing activities		(10,166	)		(2,742	)		11,800
Net increase (decrease) in cash		13,654			(575	)		1,462
Cash - beginning of year		11,307			11,882			10,420
Cash - end of year	$	24,961		$	11,307		$	11,882
Supplementary cash flow information:
Income tax paid	$	2,915		$	6,292		$	852

See accompanying notes to financial statements.

40

PENNSYLVANIA MANUFACTURERS’ ASSOCIATION INSURANCE COMPANY

STATEMENTS OF SHAREHOLDER’S EQUITY

(in thousands)	2004			2003			2002
Common Stock	$	6,116		$	6,116		$	6,116
Additional paid-in capital - Common stock
Balance at beginning of year		48,803			48,803			23,803
Capital contribution from parent		-			-			25,000
Balance at end of year		48,803			48,803			48,803
Retained earnings:
Balance at beginning of year		164,383			162,659			167,210
Net income		2,857			12,207			8,649
Dividends declared		(10,136	)		(10,483	)		(13,200	)
Balance at end of year		157,104			164,383			162,659
Accumulated other comprehensive income:
Balance at beginning of year		9,193			10,054			916
Other comprehensive income (loss), net of tax expense (benefit):
2004 - ($1,331); 2003 - ($464); 2002 - $4,920		(2,472	)		(861	)		9,138
Balance at end of year		6,721			9,193			10,054
Total shareholder's equity:
Balance at beginning of year		228,495			227,632			198,045
Net income		2,857			12,207			8,649
Captial contribution from parent		-			-			25,000
Dividends declared		(10,136	)		(10,483	)		(13,200	)
Other comprehensive income (loss)		(2,472	)		(861	)		9,138
Balance at end of year	$	218,744		$	228,495		$	227,632

See accompanying notes to financial statements.

41

PENNSYLVANIA MANUFACTURERS’ ASSOCIATION INSURANCE COMPANY

STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)	2004			2003			2002
Net income	$	2,857		$	12,207		$	8,649
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities
Holding gains (losses) arising during the period		(743	)		584			6,246
Less: reclassification adjustment for (gains) losses included
in net income, net of tax expense (benefit): 2004 - $931;
2003- $778; 2002 - ($1,558)		(1,729	)		(1,445	)		2,892
Other comprehensive income (loss), net of tax		(2,472	)		(861	)		9,138
Comprehensive income	$	385		$	11,346		$	17,787

See accompanying notes to financial statements.

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Notes to Financial Statements

Note 1. Business Description

The accompanying financial statements include the accounts of Pennsylvania Manufacturers’ Association Insurance Company (“PMAIC” or the “Company”), a wholly-owned subsidiary of PMA Capital Corporation (“PMA Capital”). The Company is the lead company in an intercompany pooling arrangement (the “Pooling Agreement”) covering business written by the Company and its affiliates Manufacturers Alliance Insurance Company (“MAICO”) and Pennsylvania Manufacturers Indemnity Company (“PMIC”) (collectively, the “Pooled Companies”). The Pooled Companies also operate under The PMA Insurance Group trade name. The Pooled Companies have an intercompany pooling agreement, under which PMAIC, MAICO and PMIC combine 100% of their written premium on all direct business and business assumed on policies written by other insurers, less reinsurance ceded, to form a pool. The pooled business, net of reinsurance, is then redistributed in accordance with the share percentages set forth in the Pooling Agreement. The Pooled Companies combine their ultimate net liability for losses and loss adjustment expenses ("LAE") incurred and other expenses incurred, except for Federal income taxes and investment expenses, and then redistribute the pooled losses and expenses according to the following share percentages: PMAIC 60%, MAICO 20%, and PMIC 20%.

In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly-owned subsidiaries of PMA Capital. Prior to June 2004, the Pooled Companies were wholly-owned subsidiaries of PMA Capital Insurance Company (“PMACIC"), a wholly-owned insurance subsidiary of PMA Capital.

The Company’s operations are concentrated in its principal marketing territory in the eastern part of the United States. Economic trends in individual states may not be independent of one another. Also, the Company’s products are highly regulated by each state. The Company writes workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance. Approximately 87% of the Company’s business for 2004 was produced through independent agents and brokers. For many of the Company’s products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers’ compensation benefits are determined by statutes and regulations in each state. While the Company considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have a material adverse impact on the Company’s financial condition and results of operations. In 2004, 2003 and 2002, workers’ compensation net premiums written represented 85%, 81% and 78%, respectively, of the Company’s total net premiums written.

Note 2. Summary of Significant Accounting Policies

See Note 2 to the PMA Capital Consolidated Financial Statements.

Note 3. Investments

The Company’s investment portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, the Company does not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 13% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers.

43

The amortized cost and fair value of the Company’s investment portfolio are as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(dollar amounts in thousands)	Cost		Gains		Losses		Value
December 31, 2004
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	74,194	$	1,363	$	1,405	$	74,152
States, political subdivisions and foreign government securities		5,819		348		17		6,150
Corporate debt securities		113,299		8,954		314		121,939
Mortgage-backed and other asset-backed securities		133,871		2,049		639		135,281
Total fixed maturities available for sale		327,183		12,714		2,375		337,522
Short-term investments		24,802		-		-		24,802
Preferred stock - affiliated		2		-		-		2
Total investments	$	351,987	$	12,714	$	2,375	$	362,326
December 31, 2003
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	60,333	$	1,109	$	107	$	61,335
States, political subdivisions and foreign government securities		4,273		184		22		4,435
Corporate debt securities		144,719		10,720		309		155,130
Mortgage-backed and other asset-backed securities		157,997		3,305		740		160,562
Total fixed maturities available for sale		367,322		15,318		1,178		381,462
Short-term investments		33,094		-		-		33,094
Preferred stock - affiliated		6,002		-		-		6,002
Total investments	$	406,418	$	15,318	$	1,178	$	420,558

As of December 31, 2004, the Company’s investment asset portfolio had gross unrealized losses of $2.4 million. For securities that were in an unrealized loss position at December 31, 2004, the length of time that such securities have been in an unrealized loss position, as measured by their month-end fair values, is as follows:

										Percentage
	Number of		Fair		Amortized		Unrealized			Fair Value to
(dollar amounts in thousands)	Securities		Value		Cost		Loss			Amortized Cost
Less than 1 year		27	$	22,767	$	22,966	$	(199	)		99	%
Greater than 1 year		13		12,159		12,560		(401	)		97	%
U.S. Treasury and Agency securities		53		83,550		85,325		(1,775	)		98	%
Total		93	$	118,476	$	120,851	$	(2,375	)		98	%

The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are as follows:

	Amortized		Fair
(dollar amounts in thousands)	Cost		Value
2005	$	14,472	$	14,464
2006-2009		58,570		57,751
2010-2014		51,763		53,684
2015 and thereafter		68,507		76,342
Mortgage-backed and other asset-backed securities		133,871		135,281
	$	327,183	$	337,522

Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.

44

Net investment income consists of the following:

(dollar amounts in thousands)	2004			2003			2002
Fixed maturities	$	17,342		$	19,421		$	21,327
Short-term investments		396			343			237
Preferred dividends from affiliates		360			5,340			720
Other		450			433			741
Total investment income		18,548			25,537			23,025
Investment expenses		(3,762	)		(2,600	)		(1,502	)
Net investment income	$	14,786		$	22,937		$	21,523

Net realized investment gains (losses) consist of the following:

(dollar amounts in thousands)	2004			2003			2002
Realized gains	$	2,893		$	2,811		$	3,832
Realized losses		(233	)		(588	)		(8,282	)
Total net realized investment gains (losses)	$	2,660		$	2,223		$	(4,450	)

Realized losses in 2004 reflected sales reducing the Company’s per issuer exposure and general duration management trades and realized losses of $112,000 on sales of securities where the Company reduced and/or eliminated its positions in certain issuers due to credit concerns. Realized losses in 2003 reflected sales reducing the Company’s per issuer exposure and general duration management trades.

Included in realized losses for 2002 were impairment losses of $5.5 million. The impairment losses for 2002 are primarily related to corporate bonds issued by telecommunications and energy companies, including $3.5 million for WorldCom. The write-downs were measured based on public market prices and the Company's expectation of the future realizable value for the security at the time when the Company determined the decline in value was other than temporary.

On December 31, 2004, the Company had securities with a total amortized cost of $25.9 million and fair value of $25.8 million on deposit with various governmental authorities, as required by law. The securities on deposit are included in fixed maturities on the Balance Sheet.

Note 4. Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and LAE is summarized as follows:

(dollar amounts in thousands)	2004			2003			2002
Balance at January 1	$	1,233,523		$	1,166,147		$	1,106,665
Less: reinsurance recoverable on unpaid losses and LAE		987,579			950,346			844,186
Net balance at January 1		245,944			215,801			262,479
Losses and LAE incurred, net:
Current year, net of discount		178,990			212,635			157,561
Prior years		-			30,000			680
Accretion of prior years' discount		4,667			1,191			2,040
Total losses and LAE incurred, net		183,657			243,826			160,281
Losses and LAE paid, net:
Current year		(51,064	)		(60,843	)		(51,891	)
Prior years		(133,840	)		(152,840	)		(155,068	)
Total losses and LAE paid, net		184,904			213,683			206,959
Net balance at December 31		244,697			245,944			215,801
Reinsurance recoverable on unpaid losses and LAE		955,848			987,579			950,346
Balance at December 31	$	1,200,545		$	1,233,523		$	1,166,147

45

Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. Due to the “long-tail” nature of a significant portion of the Company’s business, in many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. The Company defines long-tail business as those lines of business in which a majority of coverage involves average loss payment lags of several years beyond the expiration of the policy. The Company’s workers’ compensation business is long-tail business. As part of the process for determining the Company’s unpaid losses and LAE, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments, changes in social attitudes and economic conditions.

As part of the year end closing process, in the fourth quarter of 2003, the Company’s actuaries completed a comprehensive year-end actuarial analysis of The PMA Insurance Group’s loss reserves. Based on the actuarial work performed, the Company’s actuaries noticed higher than expected claims severity in workers' compensation business written for accident years 2001 and 2002, primarily from loss-sensitive and participating workers' compensation business. As a result, the Pooled Companies’ increased loss reserves for prior years by $50 million. An independent actuarial firm also conducted a comprehensive review of the Pooled Companies’ loss reserves as of December 31, 2003 and concluded that such carried loss reserves were reasonable as of December 31, 2003. Under the Pooled Companies’ loss-sensitive rating plans, the amount of the insured's premiums is adjusted after the policy period expires based, to a large extent, upon the insured's actual losses incurred during the policy period. Under policies that are subject to dividend plans, the ultimate amount of the dividend that the insured may receive is also based, to a large extent, upon loss experience during the policy period. Accordingly, offsetting the effects of this unfavorable prior year loss development were premium adjustments of $35 million under loss-sensitive plans and reduced policyholder dividends of $8 million, resulting in a net fourth quarter pre-tax charge of $7 million. The Company’s share of the unfavorable prior year loss development of reserves for losses and LAE for prior accident years, excluding accretion of discount, was $30 million in 2003, determined in accordance with the intercompany pooling arrangement. The Company’s share of the 2003 premium adjustments and reduced policyholder dividends were $21 million and $4.8 million, respectively, also determined in accordance with the intercompany pooling arrangement, resulting in a net pre-tax charge of $4.2 million.

Unpaid losses and LAE for the Company’s workers’ compensation claims, net of reinsurance, at December 31, 2004 and 2003 were $173.8 million and $162.6 million, net of discount of $7.6 million and $10.7 million, respectively. The discount rate used was approximately 5% at both December 31, 2004 and 2003.

The Company’s loss reserves were stated net of salvage and subrogation of $16.6 million and $16.8 million at December 31, 2004 and 2003, respectively.

Management believes that its unpaid losses and LAE are fairly stated at December 31, 2004. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates, assumptions and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2004, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

At December 31, 2004, 2003 and 2002, gross reserves for asbestos-related losses were $23.4 million, $33.8 million and $39.0 million, respectively ($7.8 million, $10.1 million and $15.0 million, net of reinsurance, respectively). Of the net asbestos reserves, approximately $6.2 million, $8.9 million and $13.7 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively.

At December 31, 2004, 2003 and 2002, gross reserves for environmental-related losses were $14.9 million, $12.8 million, and $17.4 million, respectively ($3.3 million, $4.6 million and $8.2 million, net of reinsurance, respectively). Of the net environmental reserves, approximately $1.6 million, $2.0 million and $4.7 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties

46

with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, the Company’s ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company’s financial condition, results of operations and liquidity.

Note 5. Reinsurance

The components of net premiums written and earned, and losses and LAE incurred are as follows:

(dollar amounts in thousands)	2004			2003			2002
Written premiums:
Direct	$	249,553		$	448,754		$	337,574
Assumed		173,820			230,984			178,279
Ceded		(218,068	)		(346,479	)		(277,083	)
Net	$	205,305		$	333,259		$	238,770
Earned premiums:
Direct	$	303,493		$	426,775		$	305,698
Assumed		190,658			215,501			167,013
Ceded		(250,117	)		(329,154	)		(259,147	)
Net	$	244,034		$	313,122		$	213,564
Losses and LAE:
Direct	$	233,554		$	341,277		$	230,401
Assumed		172,398			178,581			152,289
Ceded		(222,295	)		(276,032	)		(222,409	)
Net	$	183,657		$	243,826		$	160,281

The Company actively manages its exposure to catastrophes through its underwriting process, where the Company generally monitors the accumulation of insurable values in catastrophe-prone regions. The Company maintains property catastrophe reinsurance protection of 95% of $18.0 million excess of $2.0 million per occurrence, and workers’ compensation reinsurance protection of $104.8 million excess of $250,000. The Company’s maximum limit, after retention, for any one claimant is $4.8 million (increased to $5.8 million effective January 1, 2005).

Although the Company believes that it has adequate reinsurance to protect against the estimated probable maximum gross loss from a catastrophe, an especially severe catastrophe or series of catastrophes, or terrorist event, could exceed the Company’s reinsurance protection and could have a material adverse impact on the Company’s financial condition, results of operations and liquidity. In 2004, 2003 and 2002, the Company’s loss and LAE ratios were not significantly impacted by catastrophes.

47

At December 31, 2004, the Company had reinsurance receivables due from the following unaffiliated reinsurers in excess of 5% of shareholder's equity:

	Reinsurance
(dollar amounts in thousands)	Receivables		Collateral
Trabaja Reinsurance Company (1)	$	199,984	$	199,984
PXRE Reinsurance Company		106,531		67,813
Houston Casualty Company		68,101		-
Partner Reinsurance Company		24,489		-
American Re-Insurance Company		20,537		-
Hannover Ruckversicherungs AG		19,287		-
GE Reinsurance		18,304		-
Imagine International Reinsurance, Ltd.		18,212		18,212
Folksamerica Reinsurance Company		14,050		-
Berkley Insurance Company		12,903		-
Odyssey Reinsurance		11,092		-

⁽¹⁾ A member of the London Reinsurance Group.

The Company performs credit reviews of its reinsurers focusing on, among other things, financial capacity, stability, trends and apparent commitment to the reinsurance business. Reinsurers failing to meet the Company’s standards are excluded from the Company’s reinsurance programs. In addition, the Company requires collateral, typically assets in trust, letters of credit or funds withheld, to support balances due from certain reinsurers, generally those not authorized to transact business in the Commonwealth of Pennsylvania, the Company’s state of domicile. At December 31, 2004 and 2003, the Company’s reinsurance receivables of $997.1 million and $1,010.7 million, which were supported by $317.2 million and $306.0 million of collateral. Of the uncollateralized reinsurance receivables as of December 31, 2004, approximately 94% were recoverable from reinsurers rated “A-” or better by A.M. Best.

The Company has recorded reinsurance receivables of $13.9 million at December 31, 2004, related to certain umbrella policies covering years prior to 1977. The reinsurer has disputed the extent of coverage under the policies. The ultimate resolution of this dispute cannot be determined at this time. An unfavorable resolution of the dispute could have a material adverse effect on the Company’s financial condition and results of operations.

The Company’s largest reinsurer is Trabaja Reinsurance Company (“Trabaja”). See Note 5 to PMA Capital’s Consolidated Financial Statements for additional information regarding Trabaja.

Pursuant to the Pooling Agreement, PMAIC assumes 100% of the direct written premium from MAICO and PMIC and cessions to unaffiliated reinsurers are made subsequent to the assumption of pooled business by PMAIC. PMAIC returns 60% of the combined net premium of the Pooled Companies. At December 31, 2004, insurance receivables under the Pooling Agreement, were approximately $163.1 million.

Note 6. Commitments and Contingencies

Total rent expense was $1.9 million, $1.7 million and $1.5 million for 2004, 2003 and 2002, respectively. The Company leases certain office space and office equipment such as computers under noncancelable operating leases. Future minimum net operating lease obligations as of December 31, 2004 are as follows:

			Office		Total
			equipment		operating
(dollar amounts in thousands)	Office space		and autos		leases
2005	$	3,093	$	2,893	$	5,986
2006		3,008		2,061		5,069
2007		2,915		866		3,781
2008		2,405		102		2,507
2009		1,887		13		1,900
2010 and thereafter		3,525		-		3,525
	$	16,833	$	5,935	$	22,768

48

In the event a property and casualty insurer operating in a jurisdiction where the Company also operates becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. As of December 31, 2004 and 2003, the Company had recorded liabilities of $3.9 million and $4.4 million for these assessments, which are included in accounts payable, accrued expenses and other liabilities on the Balance Sheet.

At December 31, 2004, the Company is guarantor of $2.2 million principal amount on certain premium finance loans made by unaffiliated premium finance companies to insureds.

The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded receivables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.

See Note 5 for information regarding disputed reinsurance receivables.

Note 7. Shareholder’s Equity

The Company has 2,000,000 shares of Common stock, $10 par value per share authorized, of which 611,630 shares were issued and outstanding as of December 31, 2004 and 2003. The Company also has 5,000 shares of undesignated Preferred stock, $1,000 par value per share authorized. There were no shares of Preferred stock issued or outstanding as of December 31, 2004 or 2003.

The Company’s ability to pay dividends to PMA Capital is limited by the insurance laws and regulations of the Commonwealth of Pennsylvania. Prior to June 2004, the Company was wholly-owned by PMACIC. In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly-owned subsidiaries of PMA Capital.

The Company paid $10.1 million in dividends to PMA Capital in 2004 and $10.5 million and $13.2 million in dividends to PMACIC in 2003 and 2002, respectively. As of December 31, 2004, the Company can pay a maximum of $18.3 million in dividends to PMA Capital during 2005 without the prior approval of the Pennsylvania Insurance Department.

During 2002 the Company received a $25 million capital contribution from its then parent, PMACIC.

Note 8. Fair Value of Financial Instruments

As of December 31, 2004 and 2003, the carrying amounts for the Company’s financial instruments approximated their estimated fair value. Certain financial instruments, specifically amounts relating to insurance contracts, are excluded from this disclosure.

Note 9. Income Taxes

The components of the Federal income tax expense (benefit) are:

(dollar amounts in thousands)	2004		2003			2002
Current	$	395	$	5,814		$	2,659
Deferred		2,525		(466	)		(2,855	)
Income tax expense (benefit)	$	2,920	$	5,348		$	(196	)

49

A reconciliation between the total income tax expense and the amounts computed at the statutory Federal income tax rate of 35% is as follows:

(dollar amounts in thousands)	2004			2003			2002
Federal income tax rate at the statutory rate	$	2,022		$	6,144		$	2,959
Increase/(decrease) in taxes resulting from:
Reversal of income tax accruals		(56	)		(836	)		(2,005	)
Affiliate intercompany dividends		(126	)		(1,869	)		(252	)
Affiliate reinsurance		993			1,828			-
Other		87			81			(898	)
Income tax expense (benefit)	$	2,920		$	5,348		$	(196	)

The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows:

(dollar amounts in thousands)	2004			2003
Unearned premiums	$	6,493		$	9,204
Discounting of unpaid losses and LAE		6,192			7,888
Postretirement benefit obligation		5,193			4,254
Allowance for uncollectible accounts		4,261			3,715
Affiliate reinsurance		3,966			4,388
Guaranty funds and other assessments		2,059			1,538
Deferred compensation		683			1,526
Net capital loss		-			737
Other		1,234			999
Gross deferred tax assets		30,081			34,249
Deferred acquisition costs		(6,507	)		(8,113	)
Unrealized appreciation of investments		(3,618	)		(4,947	)
Capitalized software		(1,144	)		(1,144	)
Other		(1,109	)		(1,145	)
Gross deferred tax liabilities		(12,378	)		(15,349	)
Net deferred tax assets	$	17,703		$	18,900

Management believes that it is more likely than not that the benefit of its net deferred tax asset will be fully realized.

The Company and its affiliates have a written Federal income tax agreement approved by the Board of Directors. Under this agreement, income tax expense is allocated to each entity, including the Company, on a separate return basis. For tax years beginning on or after January 1, 2002, the agreement was amended to give loss companies (entities, that on a separate return basis, reflect a net operating loss (“NOL”)) credit for current NOLs at the time and to the extent that the loss company would have been able to utilize such NOL on a stand-alone basis against post-2001 taxable income. Intercompany tax balances are settled on a quarterly basis.

The Company’s Federal income tax returns are subject to audit by the Internal Revenue Service (“IRS”). No tax years are currently under audit by the IRS. In 2002, the Company reversed $2.1 million of certain tax contingency reserves recorded in prior years, due primarily to closed examination years.

50

Note 10. Employee Retirement, Postretirement and Postemployment Benefits

See Note 13 to the PMA Capital Consolidated Financial Statements for a description of employee retirement, postretirement and postemployment benefits sponsored by PMA Capital. The Company has no legal obligation for benefits under these plans. The Company had net expenses for the qualified and non-qualified defined benefit pension plans of $2.3 million, $2.0 million and $1.2 million for 2004, 2003 and 2002, respectively. The Company had expenses for other postretirement benefit plans of $359,000, $334,000 and $226,000 for 2004, 2003 and 2002, respectively.

The Company also participates in a voluntary defined contribution savings plan, covering substantially all employees, sponsored by PMA Capital. The Company matches employee contributions, up to 5% of compensation. Contributions under the plan expensed in 2004, 2003 and 2002 were $1.3 million, $1.4 million and $1.3 million, respectively.

Note 11. Transactions with Related Parties

In 2004, the Company declared and paid cash dividends to PMA Capital of $9.0 million and dividends in the form of a partnership interest of $1.1 million. In 2003 and 2002, the Company paid cash dividends to PMACIC, its then parent, of $10.5 million and $13.2 million, respectively.

During 2004, 2003 and 2002, the Company purchased $500,000, $1.0 million and $2.0 million respectively, in notes from Mid-Atlantic States Investment Company, an affiliate. These amounts are included in other assets on the balance sheet as of December 31, 2004, 2003 and 2002, respectively. The notes outstanding at December 31, 2004 are due on December 19, 2005, and have an interest rate of 3.0%. The $1.0 million of notes outstanding at December 31, 2003 and $2.0 million outstanding at December 31,2002 were repaid in full during 2004 and 2003, respectively.

During 2004, 2003 and 2002, the Company purchased $872,000, $2.5 million and $2.5 million, respectively, in notes from PMA Re Management Company, an affiliate. These amounts are included in other assets on the Balance Sheet as of December 31, 2004, 2003 and 2002, respectively. The notes outstanding at December 31, 2004 are due on March 31, 2005, with interest payable in arrears for each calendar quarter beginning March 31, 2005, at an annual rate of 2.5%. The $2.5 million of notes outstanding at December 31, 2003 and December 31, 2002 were repaid in full during 2004 and 2003, respectively.

During 2003 and 2002, the Company sold $6 million and $9 million, respectively of net uncollected premiums without recourse to PMA Holdings, Cayman, Ltd., an affiliate of PMA Capital. The Company incurred an annual fee of $750,000 in both 2003 and 2002 as a result of the sale. In 2004, the Company terminated the arrangement with PMA Holdings, Cayman, Ltd.

In 2004, 2003 and 2002, The PMA Pool also ceded workers’ compensation business to Pennsylvania Manufacturers International Insurance Limited (“PMII”), a Bermuda affiliated engaged in reinsuring alternative market products offered by The PMA Pool. Premiums ceded to PMII were $5.8 million, $6.1 million and $5.5 million in 2004, 2003 and 2002, respectively.

The PMA Pool also ceded workers’ compensation and other business to PMA Insurance SPC, Cayman (“SPC Cayman”), a holding company affiliated in the Cayman Islands. Premiums ceded to SPC Cayman were $29.9 million, $42.0 million and $48.8 million in 2004, 2003 and 2002, respectively. Losses ceded to SPC Cayman were $21.6 million, $31.8 million and $36.1 million in 2004, 2003 and 2002, respectively.

The Company provides management and administrative services for various affiliates. The Company also participates in an expense sharing agreement with affiliates. The Company reimburses its affiliates for actual expenses incurred on the Company’s behalf, and is reimbursed for actual expenses incurred on behalf of affiliates.

Note 12. Statutory Financial Information

These financial statements vary in certain respects from financial statements prepared using statutory accounting practices that are prescribed or permitted by the Pennsylvania Insurance Department (“SAP”). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners (“NAIC”) publications. Permitted SAP encompasses all accounting practices that are not prescribed. The Codification of Statutory Accounting Principles (“Codification”) guidance is the NAIC’s primary guidance on statutory accounting. The

51

principal differences between GAAP and SAP are in the treatment of acquisition expenses, reinsurance, deferred income taxes, fixed assets and investments.

SAP net income for the Company was $11.0 million, $6.6 million and $4.0 million for 2004, 2003, and 2002, respectively. SAP capital and surplus for the Company as of December 31, 2004 and 2003 was $183.8 million and $184.7 million, respectively.

The Company’s statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Pennsylvania Insurance Department, which has adopted Codification as the basis of their statutory accounting practices. However, Pennsylvania has retained the prescribed practice of non-tabular discounting of unpaid losses and LAE for workers’ compensation, which was not permitted under Codification. This prescribed accounting practice increased statutory capital and surplus by $156,000, $669,000 and $5.3 million at December 31, 2004, 2003 and 2002, respectively, over what it would have been had the prescribed practice not been allowed.

52

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholder of

Pennsylvania Manufacturers’ Association Insurance Company:

We have audited the accompanying balance sheets of Pennsylvania Manufacturers’ Association Insurance Company (the “Company”) as of December 31, 2004 and 2003, and the related statements of operations, cash flows, shareholder’s equity, and comprehensive income for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

June 10, 2005

53

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholder of

Pennsylvania Manufacturers’ Association Insurance Company

In our opinion, the accompanying statements of operations, of cash flows, of shareholder’s equity and of comprehensive income for the year ended December 31, 2002 present fairly, in all material respects, the results of operations and cash flows of Pennsylvania Manufacturers’ Association Insurance Company for the year ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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.

/s/ Pricewaterhouse Coopers LLP

Philadelphia, PA

February 5, 2003

54

MANUFACTURERS ALLIANCE INSURANCE COMPANY

BALANCE SHEETS

(in thousands, except share data)	2004		2003
Assets:
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
2004 - $132,028; 2003 - $135,410)	$	135,786	$	139,526
Short-term investments		6,914		6,348
Cash		2,135		903
Total investments and cash		144,835		146,777
Accrued investment income		1,390		1,383
Premiums receivable (net of valuation allowance: 2004 - $1,170; 2003 - $1,397)		35,745		49,448
Prepaid reinsurance premiums		46,998		66,144
Reinsurance receivables		233,977		218,345
Deferred income taxes, net		5,563		6,097
Deferred acquisition costs		6,197		7,727
Other assets		2,264		2,712
Total assets	$	476,969	$	498,633
Liabilities:
Unpaid losses and loss adjustment expenses	$	315,543	$	300,326
Unearned premiums		77,920		109,977
Accounts payable, accrued expenses and other liabilities		16,495		20,224
Dividends to policyholders		1,195		1,696
Total liabilities		411,153		432,223
Commitments and contingencies (Note 6)
Shareholder's Equity:
Common stock, $20 par value
(2004 and 2003 - 2,000,000 shares authorized; 298,500 shares issued and outstanding)		5,970		5,970
Additional paid-in capital		43,693		43,693
Retained earnings		13,710		14,071
Accumulated other comprehensive income		2,443		2,676
Total shareholder's equity		65,816		66,410
Total liabilities and shareholder's equity	$	476,969	$	498,633

See accompanying notes to financial statements.

55

MANUFACTURERS ALLIANCE INSURANCE COMPANY

STATEMENTS OF OPERATIONS

(in thousands)	2004		2003			2002
Revenues:
Net premiums written	$	68,435	$	111,086		$	79,590
Change in net unearned premiums		12,910		(6,712	)		(8,402	)
Net premiums earned		81,345		104,374			71,188
Net investment income		5,972		5,628			6,428
Net realized investment gains (losses)		711		419			(832	)
Total revenues		88,028		110,421			76,784
Losses and Expenses:
Losses and loss adjustment expenses		61,219		81,275			53,427
Acquisition expenses		16,909		17,778			14,074
Operating expenses		5,660		7,558			4,493
Dividends to policyholders		571		40			1,444
Other expenses		512		519			513
Total losses and expenses		84,871		107,170			73,951
Income before income taxes		3,157		3,251			2,833
Income tax expense		1,518		1,404			416
Net income	$	1,639	$	1,847		$	2,417

See accompanying notes to financial statements.

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MANUFACTURERS ALLIANCE INSURANCE COMPANY

STATEMENTS OF CASH FLOWS

(in thousands)	2004			2003			2002
Cash flows from operating activities:
Net income	$	1,639		$	1,847		$	2,417
Adjustments to reconcile net income to net cash flows
provided by (used in) operating activities:
Deferred income tax expense (benefit)		660			(445	)		(624	)
Net realized investment (gains) losses		(711	)		(419	)		832
Amortization		662			346			175
Change in:
Premiums receivable and unearned premiums, net		(18,354	)		6,883			33,994
Prepaid reinsurance premiums		19,146			(11,813	)		(21,229	)
Reinsurance receivables		(15,632	)		(19,573	)		(11,025	)
Unpaid losses and loss adjustment expenses		15,217			29,620			(4,534	)
Deferred acquisition costs		1,530			(1,274	)		(1,467	)
Accounts payable, accrued expenses and other liabilities		(4,731	)		5,572			3,728
Dividends to policyholders		(501	)		(1,303	)		(427	)
Accrued investment income		(7	)		(332	)		157
Other, net		448			8,504			(11,094	)
Net cash flows provided by (used in) operating activities		(634	)		17,613			(9,097	)
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases		(27,885	)		(82,802	)		(26,531	)
Maturities and calls		12,581			20,596			17,609
Sales		19,673			12,256			30,548
Net sales of short-term investments		(503	)		27,596			(11,104	)
Net cash flows provided by (used in) investing activities		3,866			(22,354	)		10,522
Cash flows from financing activities:
Capital contribution received		-			-			10,000
Dividends paid to shareholders		(2,000	)		-			(2,000	)
Other		-			-			(3,891	)
Net cash flows provided by (used in) financing activities		(2,000	)		-			4,109
Net increase (decrease) in cash		1,232			(4,741	)		5,534
Cash - beginning of year		903			5,644			110
Cash - end of year	$	2,135		$	903		$	5,644
Supplementary cash flow information:
Income tax paid	$	1,329		$	1,774		$	573

See accompanying notes to financial statements.

57

MANUFACTURERS ALLIANCE INSURANCE COMPANY

STATEMENTS OF SHAREHOLDER’S EQUITY

(in thousands)	2004			2003			2002
Common Stock	$	5,970		$	5,970		$	5,970
Additional paid-in capital - Common stock
Balance at beginning of year		43,693			43,693			33,693
Capital contribution from parent		-			-			10,000
Balance at end of year		43,693			43,693			43,693
Retained earnings:
Balance at beginning of year		14,071			12,224			11,807
Net income		1,639			1,847			2,417
Dividends declared		(2,000	)		-			(2,000	)
Balance at end of year		13,710			14,071			12,224
Accumulated other comprehensive income:
Balance at beginning of year		2,676			2,974			849
Other comprehensive income (loss), net of tax expense (benefit):
2004 - ($125); 2003 - ($160); 2002 - $1,144		(233	)		(298	)		2,125
Balance at end of year		2,443			2,676			2,974
Total shareholder's equity:
Balance at beginning of year		66,410			64,861			52,319
Net income		1,639			1,847			2,417
Capital contribution from parent		-			-			10,000
Dividends declared		(2,000	)		-			(2,000	)
Other comprehensive income (loss)		(233	)		(298	)		2,125
Balance at end of year	$	65,816		$	66,410		$	64,861

See accompanying notes to financial statements.

58

MANUFACTURERS ALLIANCE INSURANCE COMPANY

STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)	2004			2003			2002
Net income	$	1,639		$	1,847		$	2,417
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities
Holding gains (losses) arising during the period		229			(26	)		1,584
Less: reclassification adjustment for (gains) losses included
in net income, net of tax expense (benefit): 2004 - $249;
2003 - $147; 2002 - ($291)		(462	)		(272	)		541
Other comprehensive income (loss), net of tax		(233	)		(298	)		2,125
Comprehensive income	$	1,406		$	1,549		$	4,542

See accompanying notes to financial statements.

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Notes to Financial Statements

Note 1. Business Description

The accompanying financial statements include the accounts of Manufacturers Alliance Insurance Company (“MAICO” or the “Company”), a wholly-owned subsidiary of PMA Capital Corporation (“PMA Capital”). The Company participates in an intercompany pooling arrangement (the “Pooling Agreement”) covering business written by the Company and its affiliates Pennsylvania Manufacturers Association Insurance Company (“PMAIC”), the lead company, and Pennsylvania Manufacturers Indemnity Company (“PMIC”) (collectively, the “Pooled Companies”). The Pooled Companies also operate under The PMA Insurance Group trade name. The Pooled Companies have an intercompany pooling agreement, under which PMAIC, MAICO and PMIC combine 100% of their written premium on all direct business and business assumed on policies written by other insurers, less reinsurance ceded, to form a pool. The pooled business, net of reinsurance, is then redistributed in accordance with the share percentages set forth in the Pooling Agreement. The Pooled Companies combine their ultimate net liability for losses and loss adjustment expenses ("LAE") incurred and other expenses incurred, except for Federal income taxes and investment expenses, and then redistribute the pooled losses and expenses according to the following share percentages: PMAIC 60%, MAICO 20%, and PMIC 20%.

In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly-owned subsidiaries of PMA Capital. Prior to June 2004, the Pooled Companies were wholly-owned subsidiaries of PMA Capital Insurance Company (“PMACIC"), a wholly-owned insurance subsidiary of PMA Capital.

The Company’s operations are concentrated in its principal marketing territory in the eastern part of the United States. Economic trends in individual states may not be independent of one another. Also, the Company’s products are highly regulated by each state. The Company writes workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance. Approximately 87% of the Company’s business for 2004 was produced through independent agents and brokers. For many of the Company’s products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers’ compensation benefits are determined by statutes and regulations in each state. While the Company considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have a material adverse impact on the Company’s financial condition and results of operations. In 2004, 2003 and 2002, workers’ compensation net premiums written represented 85%, 81% and 78%, respectively, of the Company’s total net premiums written.

Note 2. Summary of Significant Accounting Policies

See Note 2 to the PMA Capital Consolidated Financial Statements.

Note 3. Investments

The Company’s investment portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, the Company does not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 12% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers.

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The amortized cost and fair value of the Company’s investment portfolio are as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(dollar amounts in thousands)	Cost		Gains		Losses		Value
December 31, 2004
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	28,745	$	460	$	375	$	28,830
States, political subdivisions and foreign government securities		2,136		106		10		2,232
Corporate debt securities		49,738		3,423		183		52,978
Mortgage-backed and other asset-backed securities		51,409		574		237		51,746
Total fixed maturities available for sale		132,028		4,563		805		135,786
Short-term investments		6,914		-		-		6,914
Total investments	$	138,942	$	4,563	$	805	$	142,700
December 31, 2003
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	29,927	$	596	$	90	$	30,433
States, political subdivisions and foreign government securities		1,335		62		7		1,390
Corporate debt securities		49,719		3,066		132		52,653
Mortgage-backed and other asset-backed securities		54,429		884		263		55,050
Total fixed maturities available for sale		135,410		4,608		492		139,526
Short-term investments		6,348		-		-		6,348
Total investments	$	141,758	$	4,608	$	492	$	145,874

As of December 31, 2004, the Company’s investment asset portfolio had gross unrealized losses of $805,000. For securities that were in an unrealized loss position at December 31, 2004, the length of time that such securities have been in an unrealized loss position, as measured by their month-end fair values, is as follows:

										Percentage
	Number of		Fair		Amortized		Unrealized			Fair Value to
(dollar amounts in thousands)	Securities		Value		Cost		Loss			Amortized Cost
Less than 1 year		42	$	17,581	$	17,733	$	(152	)		99	%
Greater than 1 year		14		4,731		4,834		(103	)		98	%
U.S. Treasury and Agency securities		27		29,064		29,614		(550	)		98	%
Total		83	$	51,376	$	52,181	$	(805	)		98	%

The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are as follows:

	Amortized		Fair
(dollar amounts in thousands)	Cost		Value
2005	$	7,671	$	7,657
2006-2009		23,680		23,565
2010-2014		21,517		22,109
2015 and there after		27,751		30,709
Mortgage-backed and other asset-backed securities		51,409		51,746
	$	132,028	$	135,786

Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.

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Net investment income consists of the following:

(dollar amounts in thousands)	2004			2003			2002
Fixed maturities	$	6,407		$	5,688		$	6,308
Short-term investments		64			257			241
Other		25			43			114
Total investment income		6,496			5,988			6,663
Investment expenses		(524	)		(360	)		(235	)
Net investment income	$	5,972		$	5,628		$	6,428

Net realized investment gains (losses) consist of the following:

(dollar amounts in thousands)	2004			2003			2002
Realized gains	$	739		$	580		$	1,379
Realized losses		(28	)		(161	)		(2,211	)
Total net realized investment gains (losses)	$	711		$	419		$	(832	)

Included in realized losses for 2002 were impairment losses of $1.6 million, primarily related to corporate bonds issued by telecommunications and energy companies, including $1.2 million for WorldCom. The write-downs were measured based on public market prices and the Company's expectation of the future realizable value for the security at the time when the company determined the decline in value was other than temporary. Also included in realized losses for 2002 were $168,000 on sales of securities where the Company reduced and/or eliminated the Company's positions in certain issuers due to credit concerns.

On December 31, 2004, the Company had securities with a total amortized cost and fair value of $6.0 million on deposit with various governmental authorities, as required by law. The securities on deposit are included in fixed maturities on the Balance Sheet.

Note 4. Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and LAE is summarized as follows:

(dollar amounts in thousands)	2004			2003			2002
Balance at January 1	$	300,326		$	270,706		$	275,240
Less: reinsurance recoverable on unpaid losses and LAE		218,345			198,772			187,747
Net balance at January 1		81,981			71,934			87,493
Losses and LAE incurred, net:
Current year, net of discount		59,663			70,878			52,520
Prior years		-			10,000			227
Accretion of prior years' discount		1,556			397			680
Total losses and LAE incurred, net		61,219			81,275			53,427
Losses and LAE paid, net:
Current year		(17,021	)		(20,281	)		(17,297	)
Prior years		(44,613	)		(50,947	)		(51,689	)
Total losses and LAE paid, net		(61,634	)		(71,228	)		(68,986	)
Net balance at December 31		81,566			81,981			71,934
Reinsurance recoverable on unpaid losses and LAE		233,977			218,345			198,772
Balance at December 31	$	315,543		$	300,326		$	270,706

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Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. Due to the “long-tail” nature of a significant portion of the Company’s business, in many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. The Company defines long-tail business as those lines of business in which a majority of coverage involves average loss payment lags of several years beyond the expiration of the policy. The Company’s workers’ compensation business is long-tail business. As part of the process for determining the Company’s unpaid losses and LAE, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments changes in social attitudes and economic conditions.

As part of the year end closing process, in the fourth quarter of 2003, the Company’s actuaries completed a comprehensive year-end actuarial analysis of The PMA Insurance Group’s loss reserves. Based on the actuarial work performed, the Company’s actuaries noticed higher than expected claims severity in workers' compensation business written for accident years 2001 and 2002, primarily from loss-sensitive and participating workers' compensation business. As a result, The Pooled Companies increased loss reserves for prior years by $50 million. An independent actuarial firm also conducted a comprehensive review of The PMA Insurance Group’s loss reserves as of December 31, 2003 and concluded that such carried loss reserves were reasonable as of December 31, 2003. Under The Pooled Company’s loss-sensitive rating plans, the amount of the insured's premiums is adjusted after the policy period expires based, to a large extent, upon the insured's actual losses incurred during the policy period. Under policies that are subject to dividend plans, the ultimate amount of the dividend that the insured may receive is also based, to a large extent, upon loss experience during the policy period. Accordingly, offsetting the effects of this unfavorable prior year loss development were premium adjustments of $35 million under loss-sensitive plans and reduced policyholder dividends of $8 million, resulting in a net fourth quarter pre-tax charge of $7 million. The Company’s share of the unfavorable prior year loss development of reserves for losses and LAE for prior accident years, excluding accretion of discount, was $10 million in 2003, determined in accordance with the intercompany pooling arrangement. The Company’s share of the 2003 premium adjustments and reduced policyholder dividends were $7 million and $1.6 million, respectively, also determined in accordance with the intercompany pooling arrangement, resulting in a net pre-tax charge of $1.4 million.

Unpaid losses and LAE for the Company’s workers’ compensation claims, net of reinsurance, at December 31, 2004 and 2003 were $57.9 million and $54.2 million, net of discount of $2.5 million and $3.6 million, respectively. The discount rate used was approximately 5% at both December 31, 2004 and 2003.

The Company’s loss reserves were stated net of salvage and subrogation of $5.5 million and $5.6 million at December 31, 2004 and 2003, respectively.

Management believes that its unpaid losses and LAE are fairly stated at December 31, 2004. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates, assumptions and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2004, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

At December 31, 2004, 2003 and 2002, gross and net reserves for asbestos-related losses were $2.6 million, $3.4 million and $5.0 million, respectively. Of the net asbestos reserves, approximately $2.1 million, $3.0 million and $4.6 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively.

At December 31, 2004, 2003 and 2002, gross and net reserves for environmental-related losses were $1.1 million, $1.5 million, and $2.7 million, respectively. Of the net environmental reserves, approximately $520,000, $655,000 and $1.6 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v)

63

changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, the Company’s ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company’s financial condition, results of operations and liquidity.

Note 5. Reinsurance

The components of net premiums written and earned, and losses and LAE incurred are as follows:

(dollar amounts in thousands)	2004			2003			2002
Written premiums:
Direct	$	117,241		$	170,089		$	136,271
Assumed		68,435			111,086			79,590
Ceded		(117,241	)		(170,089	)		(136,271	)
Net	$	68,435		$	111,086		$	79,590
Earned premiums:
Direct	$	136,388		$	158,275		$	113,195
Assumed		81,345			104,374			71,188
Ceded		(136,388	)		(158,275	)		(113,195	)
Net	$	81,345		$	104,374		$	71,188
Losses and LAE:
Direct	$	106,573		$	98,992		$	78,635
Assumed		61,392			81,488			53,626
Ceded		(106,746	)		(99,205	)		(78,834	)
Net	$	61,219		$	81,275		$	53,427

Pursuant to the Pooling Agreement, the Company cedes 100% of its direct written premium to PMAIC, the lead company in the pool. PMAIC purchases reinsurance from unaffiliated reinsurers. Cessions to unaffiliated reinsurers are made subsequent to the assumption of pooled business by PMAIC. All pool members are parties to the pool’s ceded reinsurance treaties. PMAIC cedes, and the Company assumes, 20% of the combined net written premium of the Pooled Companies.

Note 6. Commitments and Contingencies

Total rent expense was $630,000, $577,000 and $485,000 for 2004, 2003 and 2002, respectively.

In the event a property and casualty insurer operating in a jurisdiction where the Company also operates becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. As of December 31, 2004 and 2003, the Company had recorded liabilities of $1.3 million and $1.5 million for these assessments, which are included in accounts payable, accrued expenses and other liabilities on the Balance Sheet.

The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from

64

recorded receivables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.

Note 7. Shareholder’s Equity

The Company has 2,000,000 shares of Common stock, $20 par value per share authorized, of which 298,500 shares were issued and outstanding as of December 31, 2004 and 2003.

The Company’s ability to pay dividends to PMA Capital is limited by the insurance laws and regulations of the Commonwealth of Pennsylvania. Prior to June 2004, the Company was wholly-owned by PMACIC. In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly-owned subsidiaries of PMA Capital.

The Company paid dividends of $2.0 million to PMA Capital in 2004 and $2.0 million to PMACIC in 2002. As of December 31, 2004, the Company can pay a maximum of $5.2 million in dividends to PMA Capital during 2005 without the prior approval of the Pennsylvania Insurance Department.

During 2002 the Company received a $10 million capital contribution from its then parent, PMACIC.

Note 8. Fair Value of Financial Instruments

As of December 31, 2004 and 2003, the carrying amounts for the Company’s financial instruments approximated their estimated fair value. Certain financial instruments, specifically amounts relating to insurance contracts, are excluded from this disclosure.

Note 9. Income Taxes

The components of the Federal income tax expense are:

(dollar amounts in thousands)	2004		2003			2002
Current	$	858	$	1,849		$	1,040
Deferred		660		(445	)		(624	)
Income tax expense	$	1,518	$	1,404		$	416

A reconciliation between the total income tax expense and the amounts computed at the statutory Federal income tax rate of 35% is as follows:

(dollar amounts in thousands)	2004			2003			2002
Federal income tax at the statutory rate	$	1,105		$	1,138		$	992
Increase/(decrease) in taxes resulting from:
Affiliate reinsurance		446			525			-
Reversal of income tax accruals		(19	)		(279	)		(668	)
Other		(14	)		20			92
Income tax expense	$	1,518		$	1,404		$	416

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The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows:

(dollar amounts in thousands)	2004			2003
Unearned premiums	$	2,164		$	3,068
Discounting of unpaid losses and LAE		2,064			2,630
Postretirement benefit obligation		1,731			1,418
Affiliate reinsurance		1,322			1,463
Allowance for uncollectible accounts		1,007			1,086
Guaranty funds and other assessments		686			513
Other		521			646
Gross deferred tax assets		9,495			10,824
Deferred acquisition costs		(2,170	)		(2,704	)
Unrealized appreciation of investments		(1,315	)		(1,441	)
Other		(447	)		(582	)
Gross deferred tax liabilities		(3,932	)		(4,727	)
Net deferred tax assets	$	5,563		$	6,097

Management believes that it is more likely than not that the benefit of its net deferred tax asset will be fully realized.

The Company and its affiliates have a written Federal income tax agreement approved by the Board of Directors. Under this agreement, income tax expense is allocated to each entity, including the Company, on a separate return basis. For tax years beginning on or after January 1, 2002, the agreement was amended to give loss companies (entities, that on a separate return basis, reflect a net operating loss (“NOL”)) credit for current NOLs at the time and to the extent that the loss company would have been able to utilize such NOL on a stand-alone basis against post-2001 taxable income. Intercompany tax balances are settled on a quarterly basis.

At December 31, 2004 the Company had no net operating loss (“NOL”) carryforwards. At December 31, 2004, the Company had $9,000 of capital loss carryforwards, which will expire in 2007.

The Company’s Federal income tax returns are subject to audit by the Internal Revenue Service (“IRS”). No tax years are currently under audit by the IRS. In 2003 and 2002, the Company reversed $279,000 and $668,000, respectively, of certain tax contingency reserves recorded in prior years, due primarily to closed examination years.

Note 10. Employee Retirement, Postretirement and Postemployment Benefits

See Note 13 to the PMA Capital Consolidated Financial Statements for a description of employee retirement, postretirement and postemployment benefits sponsored by PMA Capital. The Company has no legal obligation for benefits under these plans. The Company had net expenses for the qualified and non-qualified defined benefit pension plans of $775,000, $655,000 and $398,000 for 2004, 2003 and 2002, respectively. The Company had expenses for other postretirement benefit plans of $120,000, $111,000 and $75,000 for 2004, 2003 and 2002, respectively.

The Company also participates in a voluntary defined contribution savings plan, covering substantially all employees, sponsored by PMA Capital. The Company matches employee contributions, up to 5% of compensation. Contributions under the plan expensed in 2004, 2003 and 2002 were $435,000, $470,000 and $450,000, respectively.

Note 11. Transactions with Related Parties

In 2004, the Company declared and paid dividends to PMA Capital of $2.0 million. In 2002, the Company declared and paid dividends to PMACIC, its then parent, of $2.0 million.

During 2003 and 2002, the Company purchased $250,000 and $500,000 respectively, in notes from Mid-Atlantic States Investment Company, an affiliate. These amounts are included in other assets on the balance sheets as of December 31, 2003 and 2002, respectively. The notes outstanding at December 31, 2003 and 2002 were repaid in full during 2004 and 2003, respectively.

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During 2003 and 2002, the Company purchased $800,000 each year in notes from PMA Re Management Company, an affiliate. These amounts are included in other assets on the balance sheets as of December 31, 2003 and 2002, respectively. The notes outstanding at December 31, 2003 and 2002 were repaid in full during 2004 and 2003, respectively.

The Company provides management and administrative services for various affiliates. The Company also participates in an expense sharing agreement with affiliates. The Company reimburses its affiliates for actual expenses incurred on the Company’s behalf, and is reimbursed for actual expenses incurred on behalf of affiliates.

Note 12. Statutory Financial Information

These financial statements vary in certain respects from financial statements prepared using statutory accounting practices that are prescribed or permitted by the Pennsylvania Insurance Department (“SAP”). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners (“NAIC”) publications. Permitted SAP encompasses all accounting practices that are not prescribed. The Codification of Statutory Accounting Principles (“Codification”) guidance is the NAIC’s primary guidance on statutory accounting. The principal differences between GAAP and SAP are in the treatment of acquisition expenses, reinsurance, deferred income taxes, fixed assets and investments.

SAP net income (loss) for the Company was $3.4 million, ($198,000) and $1.2 million for 2004, 2003, and 2002, respectively. SAP capital and surplus for the Company as of December 31, 2004 and 2003 was $54.8 million and $54.4 million, respectively.

The Company’s statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Pennsylvania Insurance Department, which has adopted Codification as the basis of their statutory accounting practices.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholder of

Manufacturers Alliance Insurance Company:

We have audited the accompanying balance sheets of Manufacturers Alliance Insurance Company (the “Company”) as of December 31, 2004 and 2003, and the related statements of operations, cash flows, shareholder’s equity, and comprehensive income for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

June 10, 2005

68

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholder of

Manufacturers Alliance Insurance Company

In our opinion, the accompanying statements of operations, of cash flows, of shareholder’s equity and of comprehensive income for the year ended December 31, 2002 present fairly, in all material respects, the results of operations and cash flows of Manufacturers Alliance Insurance Company for the year ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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.

/s/ Pricewaterhouse Coopers LLP

Philadelphia, PA

February 5, 2003

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PENNSYLVANIA MANUFACTURERS INDEMNITY COMPANY

BALANCE SHEETS

(in thousands, except share data)	2004		2003
Assets:
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
2004 - $127,772; 2003 - $137,066)	$	131,290	$	142,502
Short-term investments		14,426		1,601
Cash		707		541
Total investments and cash		146,423		144,644
Accrued investment income		1,378		1,659
Premiums receivable (net of valuation allowance: 2004 - $1,170; 2003 - $1,397)		35,745		49,447
Prepaid reinsurance premiums		8,153		10,102
Reinsurance receivables		126,923		145,705
Deferred income taxes, net		5,800		6,058
Deferred acquisition costs		6,197		7,727
Other assets		2,104		4,551
Total assets	$	332,723	$	369,893
Liabilities:
Unpaid losses and loss adjustment expenses	$	208,489	$	227,686
Unearned premiums		39,076		53,934
Accounts payable, accrued expenses and other liabilities		11,549		15,392
Dividends to policyholders		1,195		1,696
Total liabilities		260,309		298,708
Commitments and contingencies (Note 6)
Shareholder's Equity:
Common stock, $10 par value
(2004 and 2003 - 2,000,000 shares authorized; 460,000 shares issued and outstanding)		4,600		4,600
Additional paid-in capital		60,103		60,103
Retained earnings		5,424		2,948
Accumulated other comprehensive income		2,287		3,534
Total shareholder's equity		72,414		71,185
Total liabilities and shareholder's equity	$	332,723	$	369,893

See accompanying notes to financial statements.

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PENNSYLVANIA MANUFACTURERS INDEMNITY COMPANY

STATEMENTS OF OPERATIONS

(in thousands)	2004		2003			2002
Revenues:
Net premiums written	$	68,435	$	111,086		$	79,590
Change in net unearned premiums		12,910		(6,712	)		(8,402	)
Net premiums earned		81,345		104,374			71,188
Net investment income		6,064		6,624			7,257
Net realized investment gains (losses)		1,907		816			(2,483	)
Total revenues		89,316		111,814			75,962
Losses and Expenses:
Losses and loss adjustment expenses		61,219		81,275			53,427
Acquisition expenses		16,909		17,778			14,074
Operating expenses		5,660		7,557			4,493
Dividends to policyholders		571		40			1,444
Other expenses		512		519			513
Total losses and expenses		84,871		107,169			73,951
Income before income taxes		4,445		4,645			2,011
Income tax expense		1,969		1,891			128
Net income	$	2,476	$	2,754		$	1,883

See accompanying notes to financial statements.

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PENNSYLVANIA MANUFACTURERS INDEMNITY COMPANY

STATEMENTS OF CASH FLOWS

(in thousands)	2004			2003			2002
Cash flows from operating activities:
Net income	$	2,476		$	2,754		$	1,883
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Deferred income tax expense (benefit)		930			(320	)		(1,535	)
Net realized investment (gains) losses		(1,907	)		(816	)		2,483
Amortization		676			791			166
Change in:
Premiums receivable and unearned premiums, net		(1,156	)		(4,547	)		(2,507	)
Prepaid reinsurance premiums		1,949			(383	)		15,125
Reinsurance receivables		18,782			6,786			33,221
Unpaid losses and loss adjustment expenses		(19,197	)		3,261			(48,780	)
Deferred acquisition costs		1,530			(1,274	)		(1,467	)
Accounts payable, accrued expenses and other liabilities		(3,843	)		3,031			833
Dividends to policyholders		(501	)		(1,303	)		(427	)
Accrued investment income		281			(55	)		(112	)
Other, net		2,445			(3,792	)		3,939
Net cash flows provided by operating activities		2,465			4,133			2,822
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases		(24,525	)		(75,656	)		(80,088	)
Maturities and calls		8,453			20,057			15,646
Sales		26,507			43,809			47,224
Net sales of short-term investments		(12,734	)		7,922			14,629
Net cash flows used in investing activities		(2,299	)		(3,868	)		(2,589	)
Net increase in cash		166			265			233
Cash - beginning of year		541			276			43
Cash - end of year	$	707		$	541		$	276
Supplementary cash flow information:
Income tax paid	$	1,393		$	2,215		$	1,221

See accompanying notes to financial statements.

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PENNSYLVANIAMANUFACTURERS INDEMNITY COMPANY

STATEMENTS OF SHAREHOLDER’S EQUITY

(in thousands)	2004			2003		2002
Common Stock	$	4,600		$	4,600	$	4,600
Additional paid-in capital - Common stock		60,103			60,103		60,103
Retained earnings:
Balance at beginning of year		2,948			194		(1,689	)
Net income		2,476			2,754		1,883
Balance at end of year		5,424			2,948		194
Accumulated other comprehensive income:
Balance at beginning of year		3,534			3,500		(137	)
Other comprehensive income (loss), net of tax expense (benefit):
2004 - ($671); 2003 - $18; 2002 - $1,958		(1,247	)		34		3,637
Balance at end of year		2,287			3,534		3,500
Total shareholder's equity:
Balance at beginning of year		71,185			68,397		62,877
Net income		2,476			2,754		1,883
Other comprehensive income (loss)		(1,247	)		34		3,637
Balance at end of year	$	72,414		$	71,185	$	68,397

See accompanying notes to financial statements.

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PENNSYLVANIAMANUFACTURERS INDEMNITY COMPANY

STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)	2004			2003			2002
Net income	$	2,476		$	2,754		$	1,883
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on securities
Holding gains (losses) arising during the period		(7	)		564			2,023
Less: reclassification adjustment for (gains) losses included
in net income, net of tax expense (benefit): 2004 - $667;
2003 - $286; 2002 - ($869)		(1,240	)		(530	)		1,614
Other comprehensive income (loss), net of tax		(1,247	)		34			3,637
Comprehensive income	$	1,229		$	2,788		$	5,520

See accompanying notes to financial statements.

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Notes to Financial Statements

Note 1. Business Description

The accompanying financial statements include the accounts of Pennsylvania Manufacturers Indemnity Company (“PMIC” or the “Company”), a wholly-owned subsidiary of PMA Capital Corporation (“PMA Capital”). The Company participates in an intercompany pooling arrangement (the “Pooling Agreement”) covering business written by the Company and its affiliates Pennsylvania Manufacturers’ Association Insurance Company (“PMAIC”), the lead company and Manufacturers Alliance Insurance Company (“MAICO”) (collectively, the “Pooled Companies”). The Pooled Companies also operate under The PMA Insurance Group trade name. The Pooled Companies have an intercompany pooling agreement, under which PMAIC, MAICO and PMIC combine 100% of their written premium on all direct business and business assumed on policies written by other insurers, less reinsurance ceded, to form a pool. The pooled business, net of reinsurance, is then redistributed in accordance with the share percentages set forth in the Pooling Agreement. The Pooled Companies combine their ultimate net liability for losses and loss adjustment expenses ("LAE") incurred and other expenses incurred, except for Federal income taxes and investment expenses, and then redistribute the pooled losses and expenses according to the following share percentages: PMAIC 60%, MAICO 20%, and PMIC 20%.

In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly-owned subsidiaries of PMA Capital. Prior to June 2004, the Pooled Companies were wholly-owned subsidiaries of PMA Capital Insurance Company (“PMACIC"), a wholly-owned insurance subsidiary of PMA Capital.

The Company’s operations are concentrated in its principal marketing territory in the eastern part of the United States. Economic trends in individual states may not be independent of one another. Also, the Company’s products are highly regulated by each state. The Company writes workers’ compensation, integrated disability and, to a lesser extent, other standard lines of commercial insurance. Approximately 87% of the Company’s business for 2004 was produced through independent agents and brokers. For many of the Company’s products, the insurance departments of the states in which it conducts business must approve rates and policy forms. In addition, workers’ compensation benefits are determined by statutes and regulations in each state. While the Company considers factors such as rate adequacy, regulatory climate and economic factors in its underwriting process, unfavorable developments in these factors could have a material adverse impact on the Company’s financial condition and results of operations. In 2004, 2003 and 2002, workers’ compensation net premiums written represented 85%, 81% and 78%, respectively, of the Company’s total net premiums written.

Note 2. Summary of Significant Accounting Policies

See Note 2 to the PMA Capital Consolidated Financial Statements.

Note 3. Investments

The Company’s investment portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, the Company does not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 13% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers.

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The amortized cost and fair value of the Company’s investment portfolio are as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(dollar amounts in thousands)	Cost		Gains		Losses		Value
December 31, 2004
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	31,508	$	616	$	474	$	31,650
States, political subdivisions and foreign government securities		1,504		101		8		1,597
Corporate debt securities		49,828		3,152		170		52,810
Mortgage-backed and other asset-backed securities		44,932		564		263		45,233
Total fixed maturities available for sale		127,772		4,433		915		131,290
Short-term investments		14,426		-		-		14,426
Total investments	$	142,198	$	4,433	$	915	$	145,716
December 31, 2003
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	25,996	$	434	$	189	$	26,241
States, political subdivisions and foreign government securities		1,085		63		5		1,143
Corporate debt securities		61,769		4,653		140		66,282
Mortgage-backed and other asset-backed securities		48,216		904		284		48,836
Total fixed maturities available for sale		137,066		6,054		618		142,502
Short-term investments		1,601		-		-		1,601
Total investments	$	138,667	$	6,054	$	618	$	144,103

As of December 31, 2004, the Company’s investment asset portfolio had gross unrealized losses of $915,000. For securities that were in an unrealized loss position at December 31, 2004, the length of time that such securities have been in an unrealized loss position, as measured by their month-end fair values, is as follows:

										Percentage
	Number of		Fair		Amortized		Unrealized			Fair Value to
(dollar amounts in thousands)	Securities		Value		Cost		Loss			Amortized Cost
Less than 1 year		41	$	16,415	$	16,553	$	(138	)		99	%
Greater than 1 year		13		5,185		5,285		(100	)		98	%
U.S. Treasury and Agency securities		27		32,494		33,171		(677	)		98	%
Total		81	$	54,094	$	55,009	$	(915	)		98	%

The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are as follows:

	Amortized		Fair
(dollar amounts in thousands)	Cost		Value
2005	$	5,625	$	5,611
2006-2009		32,192		32,305
2010-2014		17,867		18,366
2015 and there after		27,156		29,775
Mortgage-backed and other asset-backed securities		44,932		45,233
	$	127,772	$	131,290

Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.

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Net investment income consists of the following:

(dollar amounts in thousands)	2004			2003			2002
Fixed maturities	$	6,471		$	6,907		$	7,038
Short-term investments		91			32			341
Other		26			45			112
		6,588			6,984			7,491
Investment expenses		(524	)		(360	)		(234	)
	$	6,064		$	6,624		$	7,257

Net realized investment gains (losses) consist of the following:

(dollar amounts in thousands)	2004			2003			2002
Realized gains	$	1,946		$	867		$	979
Realized losses		(39	)		(51	)		(3,462	)
Total net realized investment gains (losses)	$	1,907		$	816		$	(2,483	)

Included in realized losses for 2002 were impairment losses of $2.4 million, primarily related to corporate bonds issued by telecommunications and energy companies, including $900,000 for WorldCom. The write-downs were measured based on public market prices and the Company's expectation of the future realizable value for the security at the time when the company determined the decline in value was other than temporary. Also included in realized losses for 2002 were $504,000 on sales of securities where the Company reduced and/or eliminated the Company’s positions in certain issuers due to credit concerns.

On December 31, 2004, the Company had securities with a total amortized cost of $6.1 million and fair value of $6.2 million on deposit with various governmental authorities, as required by law. The securities on deposit are included in fixed maturities on the Balance Sheet.

Note 4. Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and LAE is summarized as follows:

(dollar amounts in thousands)	2004			2003			2002
Balance at January 1	$	227,686		$	224,425		$	273,205
Less: reinsurance recoverable on unpaid losses and LAE		145,705			152,491			185,712
Net balance at January 1		81,981			71,934			87,493
Losses and LAE incurred, net:
Current year, net of discount		59,663			70,878			52,520
Prior years		-			10,000			227
Accretion of prior years' discount		1,556			397			680
Total losses and LAE incurred, net		61,219			81,275			53,427
Losses and LAE paid, net:
Current year		(17,021	)		(20,281	)		(17,297	)
Prior years		(44,613	)		(50,947	)		(51,689	)
Total losses and LAE paid, net		(61,634	)		(71,228	)		(68,986	)
Net balance at December 31		81,566			81,981			71,934
Reinsurance recoverable on unpaid losses and LAE		126,923			145,705			152,491
Balance at December 31	$	208,489		$	227,686		$	224,425

77

Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. Due to the “long-tail” nature of a significant portion of the Company’s business, in many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. The Company defines long-tail business as those lines of business in which a majority of coverage involves average loss payment lags of several years beyond the expiration of the policy. The Company’s workers’ compensation business is long-tail business. As part of the process for determining the Company’s unpaid losses and LAE, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments changes in social attitudes and economic conditions.

As part of the year end closing process, in the fourth quarter of 2003, the Company’s actuaries completed a comprehensive year-end actuarial analysis of The PMA Insurance Group’s loss reserves. Based on the actuarial work performed, the Company’s actuaries noticed higher than expected claims severity in workers' compensation business written for accident years 2001 and 2002, primarily from loss-sensitive and participating workers' compensation business. As a result, The Pooled Companies increased loss reserves for prior years by $50 million. An independent actuarial firm also conducted a comprehensive review of The PMA Insurance Group’s loss reserves as of December 31, 2003 and concluded that such carried loss reserves were reasonable as of December 31, 2003. Under The Pooled Companies’ loss-sensitive rating plans, the amount of the insured's premiums is adjusted after the policy period expires based, to a large extent, upon the insured's actual losses incurred during the policy period. Under policies that are subject to dividend plans, the ultimate amount of the dividend that the insured may receive is also based, to a large extent, upon loss experience during the policy period. Accordingly, offsetting the effects of this unfavorable prior year loss development were premium adjustments of $35 million under loss-sensitive plans and reduced policyholder dividends of $8 million, resulting in a net fourth quarter pre-tax charge of $7 million. The Company’s share of the unfavorable prior year loss development of reserves for losses and LAE for prior accident years, excluding accretion of discount, was $10 million in 2003, determined in accordance with the intercompany pooling arrangement. The Company’s share of the 2003 premium adjustments and reduced policyholder dividends were $7 million and $1.6 million, respectively, also determined in accordance with the intercompany pooling arrangement, resulting in a net pre-tax charge of $1.4 million.

Unpaid losses and LAE for the Company’s workers’ compensation claims, net of reinsurance, at December 31, 2004 and 2003 were $57.9 million and $54.2 million, net of discount of $2.5 million and $3.6 million, respectively. The discount rate used was approximately 5% at both December 31, 2004 and 2003.

The Company’s loss reserves were stated net of salvage and subrogation of $5.5 million and $5.6 million at December 31, 2004 and 2003, respectively.

Management believes that its unpaid losses and LAE are fairly stated at December 31, 2004. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates, assumptions and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2004, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

At December 31, 2004, 2003 and 2002, gross and net reserves for asbestos-related losses were $2.6 million, $3.4 million and $5.0 million, respectively. Of the net asbestos reserves, approximately $2.1 million, $3.0 million and $4.6 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively.

At December 31, 2004, 2003 and 2002, gross and net reserves for environmental-related losses were $1.1 million, $1.5 million, and $2.7 million, respectively. Of the net environmental reserves, approximately $520,000, $655,000 and $1.6 million related to IBNR losses at December 31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v)

78

changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among participating insurers, and proof of coverage, the Company’s ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company’s financial condition, results of operations and liquidity.

Note 5. Reinsurance

The components of net premiums written and earned, and losses and LAE incurred are as follows:

(dollar amounts in thousands)	2004			2003			2002
Written premiums:
Direct	$	20,248		$	33,615		$	26,713
Assumed		68,435			111,086			79,590
Ceded		(20,248	)		(33,615	)		(26,713	)
Net	$	68,435		$	111,086		$	79,590
Earned premiums:
Direct	$	22,197		$	33,232		$	40,138
Assumed		81,345			104,374			71,188
Ceded		(22,197	)		(33,232	)		(40,138	)
Net	$	81,345		$	104,374		$	71,188
Losses and LAE:
Direct	$	30,024		$	56,937		$	55,676
Assumed		61,392			81,488			53,626
Ceded		(30,197	)		(57,150	)		(55,875	)
Net	$	61,219		$	81,275		$	53,427

Pursuant to the Pooling Agreement, the Company cedes 100% of its direct written premium to PMAIC, the lead company in the pool. PMAIC purchases reinsurance from unaffiliated reinsurers. Cessions to unaffiliated reinsurers are made subsequent to the assumption of pooled business by PMAIC. All pool members are parties to the pool’s ceded reinsurance treaties. PMAIC cedes, and the Company assumes, 20% of the combined net written premium of the Pooled Companies.

Note 6. Commitments and Contingencies

Total rent expense was $630,000, $577,000 and $485,000 for 2004, 2003 and 2002, respectively.

In the event a property and casualty insurer operating in a jurisdiction where the Company also operates becomes or is declared insolvent, state insurance regulations provide for the assessment of other insurers to fund any capital deficiency of the insolvent insurer. Generally, this assessment is based upon the ratio of an insurer’s voluntary premiums written to the total premiums written for all insurers in that particular jurisdiction. As of December 31, 2004 and 2003, the Company had recorded liabilities of $1.3 million and $1.5 million for these assessments, which are included in accounts payable, accrued expenses and other liabilities on the Balance Sheet.

The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from

79

recorded receivables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.

Note 7. Shareholder’s Equity

The Company has 2,000,000 shares of Common stock, $10 par value per share authorized, of which 460,000 shares were issued and outstanding as of December 31, 2004 and 2003. The Company’s ability to pay dividends to PMA Capital is limited by the insurance laws and regulations of the Commonwealth of Pennsylvania. Prior to June 2004, the Company was wholly-owned by PMACIC. In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly-owned subsidiaries of PMA Capital.

The Company did not pay any dividends in 2004, 2003 or 2002. The Company may not pay dividends during 2005 without the prior approval of the Pennsylvania Insurance Department.

Note 8. Fair Value of Financial Instruments

As of December 31, 2004 and 2003, the carrying amounts for the Company’s financial instruments approximated their estimated fair value. Certain financial instruments, specifically amounts relating to insurance contracts, are excluded from this disclosure.

Note 9. Income Taxes

The components of the Federal income tax expense are:

(dollar amounts in thousands)	2004		2003			2002
Current	$	1,039	$	2,211		$	1,663
Deferred		930		(320	)		(1,535	)
Income tax expense	$	1,969	$	1,891		$	128

A reconciliation between the total income tax expense and the amounts computed at the statutory Federal income tax rate of 35% is as follows:

(dollar amounts in thousands)	2004			2003			2002
Federal income tax at the statutory rate	$	1,556		$	1,625		$	704
Increase/(decrease) in taxes resulting from:
Affiliate reinsurance		446			525			-
Reversal of income tax accruals		(19	)		(279	)		(668	)
Other		(14	)		20			92
Income tax expense	$	1,969		$	1,891		$	128

80

The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows:

(dollar amounts in thousands)	2004			2003
Unearned premiums	$	2,164		$	3,068
Discounting of unpaid losses and LAE		2,064			2,630
Postretirement benefit obligation		1,731			1,418
Affiliate reinsurance		1,322			1,463
Allowance for uncollectible accounts		1,008			1,086
Guaranty funds and other assessments		686			513
Other		515			897
Gross deferred tax assets		9,490			11,075
Deferred acquisition costs		(2,170	)		(2,704	)
Unrealized appreciation of investments		(1,231	)		(1,903	)
Other		(289	)		(410	)
Gross deferred tax liabilities		(3,690	)		(5,017	)
Net deferred tax assets	$	5,800		$	6,058

Management believes that it is more likely than not that the benefit of its net deferred tax asset will be fully realized.

The Company and its affiliates have a written Federal income tax agreement approved by the Board of Directors. Under this agreement, income tax expense is allocated to each entity, including the Company, on a separate return basis. For tax years beginning on or after January 1, 2002, the agreement was amended to give loss companies (entities, that on a separate return basis, reflect a net operating loss (“NOL”) credit for current NOLs at the time and to the extent that the loss company would have been able to utilize such NOL on a stand-alone basis against post-2001 taxable income. Intercompany tax balances are settled on a quarterly basis.

The Company’s Federal income tax returns are subject to audit by the Internal Revenue Service (“IRS”). No tax years are currently under audit by the IRS. In 2003 and 2002, the Company reversed $279,000 and $668,000, respectively, of certain tax contingency reserves recorded in prior years, due primarily to closed examination years.

Note 10. Employee Retirement, Postretirement and Postemployment Benefits

See Note 13 to the PMA Capital Consolidated Financial Statements for a description of employee retirement, postretirement and postemployment benefits sponsored by PMA Capital. The Company has no legal obligation for benefits under these plans. The Company had net expenses for the qualified and non-qualified defined benefit pension plans of $775,000, $655,000 and $398,000 for 2004, 2003 and 2002, respectively. The Company had expenses for other postretirement benefit plans of $120,000, $111,000 and $75,000 for 2004, 2003 and 2002, respectively.

The Company also participates in a voluntary defined contribution savings plan, covering substantially all employees, sponsored by PMA Capital. The Company matches employee contributions, up to 5% of compensation. Contributions under the plan expensed in 2004, 2003 and 2002 were $435,000, $470,000 and $450,000, respectively.

Note 11. Transactions with Related Parties

During 2003 and 2002, the Company purchased $250,000 and $500,000 respectively, in notes from Mid-Atlantic States Investment Company, an affiliate. These amounts are included in other assets on the balance sheets as of December 31, 2003 and 2002, respectively. The notes outstanding at December 31, 2003 and 2002 were repaid in full during 2004 and 2003, respectively.

During 2003 and 2002, the Company purchased $800,000 each year in notes from PMA Re Management Company, an affiliate. These amounts are included in other assets on the balance sheets as of December 31, 2003 and 2002, respectively. The notes outstanding at December 31, 2003 and 2002 were repaid in full during 2004 and 2003, respectively.

81

The Company provides management and administrative services for various affiliates. The Company also participates in an expense sharing agreement with affiliates. The Company reimburses its affiliates for actual expenses incurred on the Company’s behalf, and is reimbursed for actual expenses incurred on behalf of affiliates.

Note 12. Statutory Financial Information

These financial statements vary in certain respects from financial statements prepared using statutory accounting practices that are prescribed or permitted by the Pennsylvania Insurance Department ("SAP"). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners ("NAIC") publications. Permitted SAP encompasses all accounting practices that are not prescribed. The Codification of Statutory Accounting Principles ("Codification") guidance is the NAIC’s primary guidance on statutory accounting. The principal differences between GAAP and SAP are in the treatment of acquisition expenses, reinsurance, deferred income taxes, fixed assets and investments.

SAP net income (loss) for the Company was $4.6 million, $741,000 and ($251,000) for 2004, 2003, and 2002, respectively. SAP capital and surplus for the Company as of December 31, 2004 and 2003 was $61.4 million and $57.7 million, respectively.

The Company’s statutory financial statements are presented on the basis of accounting practices prescribed or permitted by the Pennsylvania Insurance Department, which has adopted Codification as the basis of their statutory accounting practices.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholder of

Pennsylvania Manufacturers Indemnity Company:

We have audited the accompanying balance sheets of Pennsylvania Manufacturers Indemnity Company (the “Company”) as of December 31, 2004 and 2003, and the related statements of operations, cash flows, shareholder’s equity, and comprehensive income for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

June 10, 2005

83

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholder of

Pennsylvania Manufacturers Indemnity Company

In our opinion, the accompanying statements of operations, of cash flows, of shareholder’s equity and of comprehensive income for the year ended December 31, 2002 present fairly, in all material respects, the results of operations and cash flows of Pennsylvania Manufacturers Indemnity Company for the year ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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.

/s/ Pricewaterhouse Coopers LLP

Philadelphia, PA

February 5, 2003

84

PMACAPITAL INSURANCE COMPANY

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)	2004		2003
Assets:
Investments:
Fixed maturities available for sale, at fair value (amortized cost:
2004 - $605,230; 2003 - $1,040,556)	$	604,900	$	1,059,946
Affiliated preferred stock		-		8,000
Short-term investments		45,983		90,993
Short-term investments, loaned securities collateral		-		6,293
Cash		5,980		12,301
Total investments and cash		656,863		1,177,533
Accrued investment income		8,050		12,390
Premiums receivable (net of valuation allowance: 2004 - $200; 2003 - $200)		20,219		111,100
Reinsurance receivables (net of valuation allowance: 2004 - $1,261; 2003 - $1,261)		505,570		627,689
Deferred income taxes, net		16,239		37,945
Deferred acquisition costs		442		45,340
Funds held by reinsureds		113,601		115,481
Receivables from affiliates		23,276		39,286
Other assets		40,931		151,664
Assets of discontinued operations		-		1,966,299
Total assets	$	1,385,191	$	4,284,727
Liabilities:
Unpaid losses and loss adjustment expenses	$	941,376	$	1,369,381
Unearned premiums		2,005		176,446
Accounts payable, accrued expenses and other liabilities		19,687		104,653
Funds held under reinsurance treaties		192,821		375,351
Payable under securities loan agreements		22		6,284
Liabilities of discontinued operations		-		1,600,209
Total liabilities		1,155,911		3,632,324
Commitments and contingencies (Note 6)
Shareholder's Equity:
Common stock, $10 par value, 2,000,000 shares authorized and 500,000 shares issued and outstanding		5,000		5,000
Additional paid-in capital		193,625		540,240
Retained earnings		29,898		75,355
Accumulated other comprehensive income		757		31,808
Total shareholder's equity		229,280		652,403
Total liabilities and shareholder's equity	$	1,385,191	$	4,284,727

See accompanying notes to the consolidated financial statements.

85

PMACAPITAL INSURANCE COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)	2004			2003			2002
Revenues:
Net premiums written	$	(67,737	)	$	495,116		$	652,728
Change in net unearned premiums		152,427			39,472			(71,975	)
Net premiums earned		84,690			534,588			580,753
Net investment income		16,570			31,656			52,273
Net realized investment gains		4,381			6,572			1,932
Other revenues		-			2,500			-
Total revenues		105,641			575,316			634,958
Losses and Expenses:
Losses and loss adjustment expenses		70,383			467,409			495,410
Acquisition expenses		27,858			157,446			149,600
Operating expenses		17,665			21,091			28,133
Dividends to policyholders		994			343			369
Total losses and expenses		116,900			646,289			673,512
Loss before income taxes and income of discontinued operations		(11,259	)		(70,973	)		(38,554	)
Income tax expense (benefit)		30,126			418			(15,657	)
Loss before income of discontinued operations		(41,385	)		(71,391	)		(22,897	)
Income from discontinued operations, net of tax expense:
2004- $4,800; 2003- $8,643; 2002- $348		5,654			16,808			12,947
Net loss	$	(35,731	)	$	(54,583	)	$	(9,950	)

See accompanying notes to the consolidated financial statements.

86

PMACAPITAL INSURANCE COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)	2004			2003			2002
Cash flows from operating activities:
Net loss	$	(35,731	)	$	(54,583	)	$	(9,950	)
Less: Income from discontinued operations		5,654			16,808			12,947
Loss before income from discontinued operations		(41,385	)		(71,391	)		(22,897	)
Adjustments to reconcile loss before income from discontinued operations
to net cash flows provided by operating activities:
Deferred income tax expense (benefit)		30,126			418			(15,657	)
Net realized investment gains		(4,381	)		(6,572	)		(1,932	)
Change in:
Premiums receivable and unearned premiums, net		(83,560	)		18,230			(21,498	)
Reinsurance receivables		122,119			(22,986	)		65,226
Unpaid losses and loss adjustment expenses		(428,005	)		52,566			174,499
Funds held by reinsureds		1,880			35,907			(12,332	)
Funds held under reinsurance treaties		(182,530	)		89,970			(17,949	)
Accrued investment income		4,340			(2,171	)		2,022
Deferred acquisition costs		44,898			11,616			(17,538	)
Other assets		31,485			34,075			(96,695	)
Accounts payable, accrued expenses and other liabilities		(84,193	)		10,239			11,386
Depreciation and amortization		11,994			13,607			5,199
Discontinued operations		-			31,289			16,871
Net cash flows provided by (used in) operating activities		(577,212	)		194,797			68,705
Cash flows from investing activities:
Fixed maturities available for sale:
Purchases		(296,867	)		(649,909	)		(674,947	)
Maturities or calls		153,161			190,419			169,507
Sales		616,649			200,388			447,256
Net sale of short-term investments		42,600			95,153			31,862
Sales (purchases) of other assets		31,818			-			(13,786	)
Redemption of affiliated preferred stock		8,000			-			-
Other, net		(478	)		6,994			(21,925	)
Discontinued operations		-			(33,598	)		(25,551	)
Net cash flows provided by (used in) investing activities		554,883			(190,553	)		(87,584	)
Cash flows from financing activities:
Dividends paid to shareholder		-			(24,000	)		(28,000	)
Capital contribution received		-			-			10,000
Change in receivables from affiliates		16,008			5,805			43,141
Discontinued operations		(12,751	)		(2,742	)		15,909
Net cash flows provided by (used in) financing activities		3,257			(20,937	)		41,050
Net increase (decrease) in cash		(19,072	)		(16,693	)		22,171
Cash - beginning of year		25,052			41,745			19,574
Cash - end of year (a)	$	5,980		$	25,052		$	41,745
Supplementary cash flow information:
Income tax refunded (paid)	$	-		$	4,700		$	(7,020	)
(a) Included cash from discontinued operations of $12.8 million and $17.8 million at December 31, 2003 and 2002, respectively

See accompanying notes to the consolidated financial statements.

87

PMACAPITAL INSURANCE COMPANY

CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY

(in thousands)	2004			2003			2002
Common Stock	$	5,000		$	5,000		$	5,000
Additional paid in capital:
Balance at beginning of year		540,240			540,240			530,240
Dividend of discontinued operations		(346,615	)		-			-
Capital contribution		-			-			10,000
Balance at end of year		193,625			540,240			540,240
Retained earnings:
Balance at beginning of year		75,355			153,938			191,888
Net loss		(35,731	)		(54,583	)		(9,950	)
Dividends declared		-			(24,000	)		(28,000	)
Dividend of discontinued operations		(9,726	)		-			-
Balance at end of year		29,898			75,355			153,938
Accumulated other comprehensive income:
Balance at beginning of year		31,808			26,536			5,657
Other comprehensive income (loss), net of tax expense (benefit):
2004 - ($14,996); 2003 - $2,839; 2002 - $11,243		(27,849	)		5,272			20,879
Dividend of discontinued operations		(3,202	)		-			-
Balance at end of year		757			31,808			26,536
Total shareholder's equity:
Balance at beginning of year		652,403			725,714			732,785
Net loss		(35,731	)		(54,583	)		(9,950	)
Dividends declared		-			(24,000	)		(28,000	)
Dividend of discontinued operations		(359,543	)		-			-
Capital contribution		-			-			10,000
Other comprehensive income (loss)		(27,849	)		5,272			20,879
Balance at end of year	$	229,280		$	652,403		$	725,714

See accompanying notes to the consolidated financial statements.

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PMACAPITAL INSURANCE COMPANY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)	2004			2003			2002
Net loss	$	(35,731	)	$	(54,583	)	$	(9,950	)
Other comprehensive income (loss), net of tax
Unrealized gains (losses) on securities
Holding gains (losses) arising during the period		(21,986	)		6,985			20,768
Less: reclassification adjustment for gains included in net
loss, net of tax expense: 2004 - $1,533; 2003 - $2,300; 2002 - $676		(2,848	)		(4,272	)		(1,256	)
Total unrealized gains (losses) on securities		(24,834	)		2,713			19,512
Foreign currency translation gains (losses), net of tax expense (benefit):
2004 - ($1,623); 2003 - $1,378; 2002 - $736		(3,015	)		2,559			1,367
Other comprehensive income (loss), net of tax		(27,849	)		5,272			20,879
Comprehensive income (loss)	$	(63,580	)	$	(49,311	)	$	10,929

See accompanying notes to the consolidated financial statements.

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Notes to Consolidated Financial Statements

Note 1. Business Description and Basis of Presentation

The accompanying consolidated financial statements include the accounts of PMA Capital Insurance Company and its subsidiaries (collectively referred to as “PMA Capital Insurance Company” or the “Company”). The subsidiaries include the accounts of Caliber One Indemnity Company (“Caliber One”), PMA Holdings Ltd. (“PMAH Bermuda”) and Pennsylvania Manufacturers’ International Insurance Ltd. (“PMII”), a wholly owned subsidiary of PMAH Bermuda. The Company is a wholly-owned subsidiary of PMA Capital Corporation (“PMA Capital”).

Prior to June 2004, the Company also owned Pennsylvania Manufacturers’ Association Insurance Company (“PMAIC”), Manufacturers Alliance Insurance Company (“MAICO”) and Pennsylvania Manufacturers Indemnity Company (“PMIC”), which comprise The PMA Insurance Group, or the "Pooled Companies". In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies to become direct, wholly owned subsidiaries of PMA Capital. As a result of this change in ownership, the financial information for the Pooled Companies is presented in the financial statements as Discontinued Operations. See the Financial Statements of each of the Pooled Companies for disclosure of the significant classes of assets and liabilities. In its Order approving the transfer of all of the common stock of the Pooled Companies from the Company to PMA Capital, the Pennsylvania Insurance Department prohibited the Company from any declaration or payment of dividends, return of capital or any other types of distributions in 2004 and 2005 to PMA Capital and restricted such payments in 2006. See Note 7 for additional information.

The Company formerly offered excess of loss and pro rata property and casualty reinsurance protection mainly through reinsurance brokers. In November 2003, the Company decided to withdraw from the reinsurance business. In May 2002, the Company withdrew from its former excess and surplus lines business served by Caliber One. In January 2003, in connection with the Company’s decision to exit the excess and surplus lines marketplace, the Company sold the capital stock of Caliber One for gross proceeds of approximately $31 million, resulting in a pre-tax gain of $2.5 million, which is included in other revenues in the Statement of Operations.

PMAH Bermuda, a holding company which conducts business through its subsidiary PMII, offers alternative risk funding programs to various insureds.

Note 2. Summary of Significant Accounting Policies

See Note 2 to the PMA Capital Consolidated Financial Statements.

Note 3. Investments

The Company’s investment portfolio is diversified and does not contain any significant concentrations in single issuers other than U.S. Treasury and agency obligations. In addition, the Company does not have a significant concentration of investments in any single industry segment other than finance companies, which comprise 9% of invested assets at December 31, 2004. Included in this industry segment are diverse financial institutions, including the financing subsidiaries of automotive manufacturers.

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The amortized cost and fair value of the Company’s investment portfolio are as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
(dollar amounts in thousands)	Cost		Gains		Losses		Value
December 31, 2004
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	151,778	$	795	$	1,224	$	151,349
States, political subdivisions and foreign government securities		8,547		21		52		8,516
Corporate debt securities		197,551		3,903		1,168		200,286
Mortgage-backed and other asset-backed securities		247,354		2,741		5,346		244,749
Total fixed maturities available for sale		605,230		7,460		7,790		604,900
Short-term investments		45,983		-		-		45,983
Total investments	$	651,213	$	7,460	$	7,790	$	650,883
December 31, 2003
Fixed maturities available for sale:
U.S. Treasury securities and obligations of U.S. Government agencies	$	198,460	$	2,123	$	669	$	199,914
States, political subdivisions and foreign government securities		4,566		44		57		4,553
Corporate debt securities		467,573		13,824		1,471		479,926
Mortgage-backed and other asset-backed securities		369,957		12,385		6,789		375,553
Total fixed maturities available for sale		1,040,556		28,376		8,986		1,059,946
Affiliated preferred stock		8,000		-		-		8,000
Short-term investments		97,286		-		-		97,286
Total investments	$	1,145,842	$	28,376	$	8,986	$	1,165,232

As of December 31, 2004, the Company’s investment asset portfolio had gross unrealized losses of $7.8 million. For securities that were in an unrealized loss position at December 31, 2004, the length of time that such securities have been in an unrealized loss position, as measured by their month-end fair values, is as follows:

										Percentage
	Number of		Fair		Amortized		Unrealized			Fair Value to
(dollars amounts in millions)	Securities		Value		Cost		Loss			Amortized Cost
Less than 1 year		143	$	155.8	$	157.1	$	(1.3	)		99	%
Greater than 1 year		52		64.9		70.1		(5.2	)		93	%
U.S. Treasury and Agency securities		43		114.6		115.9		(1.3	)		99	%
Total		238	$	335.3	$	343.1	$	(7.8	)		98	%

The amortized cost and fair value of fixed maturities at December 31, 2004, by contractual maturity, are as follows:

	Amortized		Fair
(dollar amounts in thousands)	Cost		Value
2005	$	65,754	$	65,658
2006-2009		162,110		161,389
2010-2014		107,745		109,119
2015 and thereafter		22,267		23,985
Mortgage-backed and other asset-backed securities		247,354		244,749
	$	605,230	$	604,900

Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.

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Net investment income consists of the following:

(dollars amounts in thousands)	2004			2003			2002
Fixed maturities	$	31,555		$	40,170		$	47,910
Short-term investments		1,637			1,933			3,864
Other		925			1,228			2,363
Total investment income		34,117			43,331			54,137
Investment expenses		(1,443	)		(1,523	)		(1,339	)
Interest on funds held for retrocessional agreements		(15,836	)		(17,958	)		(16,706	)
Interest on deposit accounting		(2,294	)		3,810			1,309
Other interest on funds held, net		2,026			3,996			14,872
Net investment income	$	16,570		$	31,656		$	52,273

Net realized investment gains consist of the following:

(dollar amounts in thousands)	2004			2003			2002
Realized gains	$	13,712		$	11,321		$	23,036
Realized losses		(4,434	)		(4,749	)		(21,104	)
Foreign exchange loss		(4,897	)		-			-
Total net realized investment gains	$	4,381		$	6,572		$	1,932

Included in realized losses for 2004, 2003 and 2002 were impairment losses of $333,000, $2.6 million and $13.7 million, respectively. The impairment loss for 2004 related to one asset-backed security. The impairment losses for 2003 primarily related to securities issued by airline companies and an asset-backed security. In 2002, the impairment losses are primarily related to corporate bonds issued by telecommunications and energy companies, including $8.7 million for WorldCom. The write-downs were measured based on public market prices and the Company’s expectation of the future realizable value for the security at the time when the Company determined the decline in value was other than temporary.

At December 31, 2003, the Company had $6.3 million of collateral related to securities on loan, substantially all of which was cash received and subsequently reinvested in short-term investments.

On December 31, 2004, the Company had securities with a total amortized cost of $10.0 million and fair value of $10.5 million on deposit with various governmental authorities, as required by law. In addition, the Company had securities with a total amortized cost of $27.8 million and fair value of $28.2 million held in trust for the benefit of certain ceding companies on reinsurance balances assumed by the Company. Securities with a total amortized cost and fair value of $7.0 million were held in trust to support the Company’s participation in the underwriting capacity of a Lloyd’s of London syndicate. There were also securities with a total amortized cost and fair value of $4.0 million pledged as collateral for letters of credit issued on behalf of the Company. The securities held in trust, on deposit or pledged as collateral are included in fixed maturities and short-term investments on the Balance Sheet.

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Note 4. Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and LAE is summarized as follows:

(dollar amounts in thousands)	2004			2003			2002
Balance at January 1	$	1,369,381		$	1,316,815		$	1,261,589
Less: reinsurance recoverable on unpaid losses and LAE		624,204			587,081			655,824
Net balance at January 1		745,177			729,734			605,765
Losses and LAE incurred, net:
Current year, net of discount		82,877			299,168			341,377
Prior years		(12,809	)		168,028			153,204
Accretion of prior years' discount		315			213			829
Total losses and LAE incurred, net		70,383			467,409			495,410
Losses and LAE paid, net:
Current year		(36,827	)		(83,899	)		(50,946	)
Prior years		(353,024	)		(368,067	)		(295,495	)
Total losses and LAE paid, net		(389,851	)		(451,966	)		(346,441	)
Reserves transferred		-			-			(25,000	)
Net balance at December 31		425,709			745,177			729,734
Reinsurance recoverable on unpaid losses and LAE		515,667			624,204			587,081
Balance at December 31	$	941,376		$	1,369,381		$	1,316,815

Unpaid losses and LAE reflect management’s best estimate of future amounts needed to pay claims and related settlement costs with respect to insured events which have occurred, including events that have not been reported to the Company. Due to the “long-tail” nature of a significant portion of the Company’s business, in many cases, significant periods of time, ranging up to several years or more, may elapse between the occurrence of an insured loss, the reporting of the loss to the Company and the Company’s payment of that loss. The Company defines long-tail business as those lines of business in which a majority of coverage involves average loss payment lags of several years beyond the expiration of the policy. The Company’s major long-tail lines include its workers’ compensation and casualty reinsurance business. In addition, because reinsurers rely on their ceding companies to provide them with information regarding incurred losses, reported claims for reinsurers become known more slowly than for primary insurers and are subject to more unforeseen development and uncertainty. As part of the process for determining the Company’s unpaid losses and LAE, various actuarial models are used that analyze historical data and consider the impact of current developments and trends, such as trends in claims severity and frequency and claims settlement trends. Also considered are legal developments, regulatory trends, legislative developments, changes in social attitudes and economic conditions.

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The following table summarizes the effect on the Company’s underwriting assets and liabilities of the commutation and novation of certain reinsurance and retrocessional contracts occurring in 2004. The commutations and novations did not have a material effect on the Company’s results of operations for 2004.

(dollar amounts in thousands)	2004
Assets:
Reinsurance receivables	$	(63,662	)
Funds held by reinsureds		(31,330	)
Other assets		(70,537	)
Liabilities:
Unpaid losses and loss adjustment expenses	$	(202,667	)
Unearned premiums		(26,596	)
Other liabilities		(70,228	)
Funds held under reinsurance treaties		(82,095	)

During 2004, the favorable prior year loss development related primarily to reinsurance contracts that were novated or commuted. This favorable prior year loss development was substantially offset by net premiums earned and acquisition expenses.

During 2003, the Company increased its net loss reserves for prior accident years by $168.0 million, including $150 million during the third quarter. The third quarter 2003 reserve charge related to higher than expected underwriting losses, primarily from casualty business written in accident years 1997 through 2000. Approximately 75% of the charge was related to general liability business written from 1997 to 2000 with substantially all of the remainder of the charge from the commercial automobile line written during those same years. During the third quarter, the Company’s actuaries conducted their periodic comprehensive reserve review. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of reinsurance business written. The information derived during this review indicated that a large portion of the change in expected loss development was due to increasing loss trends emerging in calendar year 2003 for prior accident years. This increase in 2003 loss trends caused management to determine that the reserve levels, primarily for accident years 1997 to 2000, needed to be increased by $150 million. An independent actuarial firm also conducted a comprehensive review of the Company’s Traditional-Treaty, Specialty-Treaty and Facultative reinsurance loss reserves, and concluded that those carried loss reserves were reasonable at September 30, 2003.

The Company’s analysis was enhanced by an extensive review of specific accounts, comprising about 40% of the carried reserves of the reinsurance business for accident years 1997 to 2000. The Company’s actuaries visited a number of former ceding company clients, which collectively comprised about 25% of the reinsurance business total gross loss and LAE reserves from accident years 1997 to 2000, to discuss reserving and reporting experience with these ceding companies. The Company’s actuaries separately evaluated an additional number of other ceding companies, representing approximately 15% of the reinsurance business total gross loss and LAE reserves from accident years 1997 to 2000, to understand and examine data trends.

During 2002, the Company recorded net unfavorable prior year loss development of $153 million ($101 million for reinsurance and $52 million for excess and surplus lines). During 2002, company actuaries conducted reserve reviews to determine the impact of any emerging data on anticipated loss development trends and recorded unpaid losses and LAE reserves. Based on the actuarial work performed, which included analyzing recent trends in the levels of the reported and paid claims, an updated selection of actuarially determined loss reserve estimates was developed by accident year for each major line of business. Management’s selection of the ultimate losses resulting from their reviews indicated that net loss reserves for the excess and surplus lines business for prior accident years, mainly 1999 and 2000, needed to be increased by $52 million. This unfavorable prior year development reflects the impact of higher than expected claim severity and, to a lesser extent, frequency, that emerged in 2002 on casualty lines of business, primarily professional liability policies for the nursing homes class of business; general liability, including policies covering contractors’ liability for construction defects; and commercial automobile, mainly for accident years 1999 and 2000.

During 2002, the Company also recorded unfavorable prior year development of $101 million for the reinsurance business. During the fourth quarter, the Company’s actuaries observed a higher than expected increase in the frequency

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and, to a lesser extent, severity of reported claims by ceding companies. Management’s selection of the ultimate losses indicated that net loss and LAE reserves for prior accident years needed to be increased by approximately $58 million in the fourth quarter of 2002, primarily for excess of loss and pro rata general liability occurrence contracts and, to a lesser extent, excess of loss general liability claims-made contracts, from accident years 1998, 1999 and 2000.

The remaining $43 million of unfavorable prior year development on reinsurance business in 2002 primarily reflects the recording of losses and LAE on additional earned premiums recorded during 2002 as a result of a change in the Company’s estimate of ultimate premiums written from prior years. Because premiums from ceding companies are typically reported on a delayed basis, the Company monitors and updates as appropriate the estimated ultimate premiums written. The Company’s periodic reviews of estimated ultimate premiums written, which compared actual reported premiums and originally estimated premiums based on ceding company estimates, indicated that premiums written in recent years, primarily in the Traditional- and Specialty-Treaty units for 2001 and 2000, were higher than originally estimated. As a result, the Company recorded additional net premiums earned during 2002, including $39.9 million in the second quarter, which were completely offset by losses and LAE and acquisition expenses.

Reserves transferred in 2002 reflect the assumption of losses by a third party through an affiliated reinsurer. Cash and short-term investments of $25 million were transferred to support the payment of the transferred reserves.

Unpaid losses for the Company’s workers’ compensation claims, net of reinsurance, at December 31, 2004 and 2003 were $7.5 million and $36.5 million, respectively.

The Company’s loss reserves were stated net of salvage and subrogation of $3.1 million and $5.2 million at December 31, 2004 and 2003, respectively.

On December 6, 2004, the New York jury in the trial regarding the insurance coverage for the World Trade Center rendered a verdict that the September 11, 2001 attack on the World Trade Center constituted two occurrences under the policies issued by certain insurers. The Company considers the jury's verdict to be contrary to the terms of the insurance coverage in force and to the intent of the parties involved. Because the litigation is ongoing and the appraisal and valuation process is pending, the ultimate resolution of this issue cannot be determined at this time. The Company estimates that it could be required to incur a charge of up to $5 million pre-tax if it is ultimately determined that the September 11, 2001 attack on the World Trade Center constituted two occurrences under the policies issued by certain of its ceding companies and if as a result of this determination, additional losses are incurred by its ceding companies.

Management believes that its unpaid losses and LAE are fairly stated at December 31, 2004. However, estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates, assumptions and judgments using data currently available. As additional experience and data become available regarding claims payment and reporting patterns, legal and legislative developments, judicial theories of liability, the impact of regulatory trends on benefit levels for both medical and indemnity payments, changes in social attitudes and economic conditions, the estimates are revised accordingly. If the Company’s ultimate losses, net of reinsurance, prove to differ substantially from the amounts recorded at December 31, 2004, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations and liquidity.

At December 31, 2004, 2003 and 2002, gross reserves for asbestos-related losses were $4.5 million, $4.0 million and $3.9 million, respectively ($900,000, net of reinsurance). Of the net asbestos reserves, approximately $38,000 related to IBNR losses at December 31, 2004, 2003 and 2002.

At December 31, 2004, 2003 and 2002, gross reserves for environmental-related losses were $1.3 million, $1.4 million and $1.1 million, respectively ($900,000, $1.2 million and $600,000, net of reinsurance, respectively). Of the net environmental reserves, approximately $373,000, $373,000, and $47,500 related to IBNR losses at December 31, 2004, 2003 and 2002, respectively. All incurred asbestos and environmental losses were for accident years 1986 and prior.

Estimating reserves for asbestos and environmental exposures continues to be difficult because of several factors, including: (i) evolving methodologies for the estimation of the liabilities; (ii) lack of reliable historical claim data; (iii) uncertainties with respect to insurance and reinsurance coverage related to these obligations; (iv) changing judicial interpretations; and (v) changing government standards. Management believes that its reserves for asbestos and environmental claims are appropriately established based upon known facts, existing case law and generally accepted actuarial methodologies. However, due to changing interpretations by courts involving coverage issues, the potential for changes in Federal and state standards for clean-up and liability, as well as issues involving policy provisions, allocation of liability and damages among

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participating insurers, and proof of coverage, the Company’s ultimate exposure for these claims may vary significantly from the amounts currently recorded, resulting in a potential future adjustment that could be material to the Company’s financial condition, results of operations and liquidity.

Note 5. Reinsurance

The components of net premiums written and earned, and losses and LAE incurred are as follows:

(dollar amounts in thousands)	2004			2003			2002
Written premiums:
Direct	$	43		$	1,125		$	105,308
Assumed		(64,244	)		756,984			782,283
Ceded		(3,536	)		(262,993	)		(234,863	)
Net	$	(67,737	)	$	495,116		$	652,728
Earned premiums:
Direct	$	113		$	21,223		$	141,677
Assumed		110,144			771,448			694,075
Ceded		(25,567	)		(258,083	)		(254,999	)
Net	$	84,690		$	534,588		$	580,753
Losses and LAE:
Direct	$	1,034		$	(21,742	)	$	138,149
Assumed		57,851			651,116			519,856
Ceded		11,498			(161,965	)		(162,595	)
Net	$	70,383		$	467,409		$	495,410

The Company maintains reinsurance agreements with High Mountain Reinsurance, Ltd. (“High Mountain”), a wholly owned subsidiary of Mid-Atlantic States Investment Company (“MASIC”), which is a wholly owned subsidiary of PMA Capital. See Note 12 for income statement impacts of these agreements.

In 2004, the Company purchased reinsurance covering potential adverse loss development of its loss and LAE reserves. Under the agreement, the Company ceded $100 million in carried loss and LAE reserves and paid $146.5 million in cash. During 2004, the Company incurred $6.0 million in ceded premiums for this agreement. In addition, the contract requires additional premiums of $2.5 million if it is not commuted by December 2007. At December 31, 2004, the Company has $105 million of available coverage under this agreement for future adverse loss development.

Any future cession of losses may require the Company to cede additional premiums of up to $35 million on a pro rata basis, at the following contractually determined levels:

Losses ceded	Additional premiums
$0 - $20 million	No additional premiums
$20 - $50 million	Up to $20 million
$50 - $80 million	Up to $15 million
$80 - $105 million	No additional premiums

The additional premiums have been prepaid and are included in other assets on the Balance Sheet. Because the coverage is retroactive, the Company will not record the benefit of this reinsurance in its Statement of Operations until it receives the related recoveries.

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At December 31, 2004, the Company had reinsurance receivables due from the following unaffiliated reinsurers in excess of 5% of shareholder’s equity:

(dollar amounts in thousands)	Reinsurance Recievables		Collateral
Swiss Reinsurance America Corporation	$	139,284	$	27,087
St. Paul and Affiliates(1)		98,177		79,709
London Life and General Reinsurance Company		24,693		24,693
Federal Insurance Company		19,804		222
Essex Insurance Company		14,597		-

(1) Includes United States Fidelity & Guaranty Insurance Company ($68.5 million) and Mountain Ridge Insurance Company ($24.6 million), other affiliated entities ($5.1 million).

The Company performs credit reviews of its reinsurers focusing on, among other things, financial capacity, stability, trends and commitment to the reinsurance business. Reinsurers failing to meet the Company’s standards are excluded from the Company’s reinsurance programs. In addition, the Company requires collateral, typically assets in trust, letters of credit or funds withheld, to support balances due from certain reinsurers, generally those not authorized to transact business in the applicable jurisdictions. At December 31, 2004 and 2003, the Company’s reinsurance receivables of $505.6 million and $627.7 million were supported by $263.6 million and $470.8 million of collateral. Of the uncollateralized reinsurance receivables as of December 31, 2004, approximately 96% were recoverable from reinsurers rated “A-” or better by A.M. Best.

In January 2002, the Company supplemented its in-force reinsurance programs by entering into a retroactive reinsurance contract with PMA Insurance SPC, Cayman (“SPC Cayman”), a wholly owned subsidiary of MASIC, which is a wholly owned subsidiary of PMA Capital. This contract provides coverage for adverse loss development on certain lines of business for accident years prior to 1995, and provides coverage of up to $50 million in losses in return for $25 million of funding. Under the terms of the contract, the Company’s losses and LAE ceded to Trabaja for accident years 1996 through 2001 are recoverable as they are incurred. In 2002, the Company recognized a benefit of $25 million for losses ceded to this reinsurance contract. Any future cession of losses under this contract may require the Company to cede additional premiums of 40% of ceded losses depending on the level of such losses.

Note 6. Commitments and Contingencies

The Company leases certain office space and office equipment such as computers under noncancelable operating leases. Future minimum operating lease obligations as of December 31, 2004 are as follows:

(dollar amounts in thousands)	Office space (1)		Office equipment		Total operating leases
2005	$	631	$	125	$	756
2006		461		110		571
2007		603		98		701
2008		587		66		653
2009		556		-		556
2010 and thereafter		1,396		-		1,396
	$	4,234	$	399	$	4,633

  (1)   Net of sublease rentals of $1.5 million in 2005 and 2006, $1.6 million in 2007, 2008 and 2009, and $7.8 million in 2010 and thereafter, respectively.

Total rent expense incurred under operating leases was $1.3 million, $1.1 million and $1.7 million for 2004, 2003 and 2002, respectively.

Until December 31, 2003, PMA Capital had an executive loan program, through which a financial institution provided personal demand loans to PMA Capital’s officers. The Company had provided collateral and agreed to

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purchase any loan in default. In November 2003, the financial institution sold the Company’s collateral partially securing the loans of two former officers of the Company in satisfaction of their loans in the aggregate amount of $2.0 million. The Company received $1.7 million in repayment for the loans of one former officer in 2004, and in consideration of the Company forgiving $159,000 of indebtedness, the former officer executed an agreement, which, among other things, includes a release of the Company and its officers, employees and affiliates from any and all claims as of the date of that agreement. The loan of the other former officer in the outstanding principal amount of $185,000 is fully secured and is due on April 30, 2005. The Company is accruing interest on this loan, which is included in other assets on the Balance Sheet, at a rate of 4.5% as of December 31, 2004.

See Note 4 for information regarding losses related to the September 11, 2001 attack on the World Trade Center.

The Company is continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of business, either as a liability insurer defending third-party claims brought against its insureds, or as an insurer defending coverage claims brought against it by its policyholders or other insurers. While the outcome of all litigation involving the Company, including insurance-related litigation, cannot be determined, litigation is not expected to result in losses that differ from recorded reserves by amounts that would be material to the Company’s financial condition, results of operations or liquidity. In addition, reinsurance recoveries related to claims in litigation, net of the allowance for uncollectible reinsurance, are not expected to result in recoveries that differ from recorded receivables by amounts that would be material to the Company’s financial condition, results of operations or liquidity.

Note 7. Shareholder’s Equity

The Company had 500,000 shares of common stock outstanding as of December 31, 2004, 2003 and 2002.

In June 2004, the Pennsylvania Insurance Department approved the application for the Pooled Companies, previously subsidiaries of the Company, to become direct, wholly owned subsidiaries of PMA Capital. However, in its Order approving the transfer of the Pooled Companies from the Company to PMA Capital, the Pennsylvania Insurance Department prohibited the Company from any declaration or payment of dividends, return of capital or any other types of distributions in 2004 and 2005 to PMA Capital. In 2006, the Company may declare and pay ordinary dividends or returns of capital without the prior approval of the Pennsylvania Insurance Department if, immediately after giving effect to the dividend or returns of capital, the Company’s risk-based capital equals or exceeds 225% of Authorized Control Level Capital as defined by the National Association of Insurance Commissioners. In 2007 and beyond, the Company may make dividend payments, as long as such dividends are not considered “extraordinary” under Pennsylvania insurance law.

In 2003 and 2002, respectively, the Company declared and paid cash dividends of $24.0 million and $28.0 million to PMA Capital.

In October 2002, PMA Capital made a $10 million capital contribution to the Company in the form of cash.

Note 8. Fair Value of Financial Instruments

As of December 31, 2004 and 2003, the carrying amounts for the Company’s financial instruments approximated their estimated fair value. The Company measures the fair value of fixed maturities based upon quoted market prices or by obtaining quotes from dealers. For other financial instruments, the carrying values approximate their fair values. Certain financial instruments, specifically amounts relating to insurance and reinsurance contracts, are excluded from this disclosure.

Note 9. Income Taxes

The components of the Federal income tax expense (benefit) are:

(dollar amounts in thousands)	2004		2003		2002
Current	$	-	$	-	$	-
Deferred		30,126		418		(15,657	)
Income tax expense (benefit)	$	30,126	$	418	$	(15,657	)

98

A reconciliation between the total income tax expense (benefit) and the amounts computed at the statutory Federal income tax rate of 35% is as follows:

(dollar amounts in thousands)	2004			2003			2002
Federal income tax at the statutory rate	$	(3,941	)	$	(24,841	)	$	(13,494	)
Affiliate reinsurance		6,538			1,149			(6,043	)
Affiliate dividends		(183	)		(194	)		(190	)
Change in valuation allowance		29,000			25,000			-
Change in income tax accruals		(1,815	)		(305	)		1,691
Other		527			(391	)		2,379
Income tax expense (benefit)	$	30,126		$	418		$	(15,657	)

The tax effects of significant temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that represent the net deferred tax asset are as follows:

(dollar amounts in thousands)	2004			2003
Net operating loss	$	45,376		$	38,765
Discounting of unpaid losses and LAE		31,017			48,472
Unearned premiums		127			10,796
Postretirement benefit obligation		1,231			994
Allowance for uncollectible accounts		597			597
Reinsurance recoverables		1,569			1,726
Depreciation		925			758
Other		458			323
Gross deferred tax assets		81,300			102,431
Valuation allowance		(54,000	)		(25,000	)
Deferred tax assets, net of valuation allowance		27,300			77,431
Deferred acquisition costs		(155	)		(15,868	)
Losses of foreign reinsurance affiliates		-			(1,815	)
Unrealized appreciation of investments		-			(6,786	)
Affiliate reinsurance		(7,797	)		(8,427	)
Deposit accounting		-			(1,324	)
Foreign exchange translation		(449	)		(1,973	)
Other		(2,660	)		(3,293	)
Gross deferred tax liabilities		(11,061	)		(39,486	)
Net deferred tax assets	$	16,239		$	37,945

At December 31, 2004, the Company had a net operating loss ("NOL") carryforward of $129.6 million, which will expire in years 2022 through 2024. The NOL carryforward, which produces a gross deferred tax asset of $45.4 million, will be applied to reduce future taxable income of the Company.

In 2003, the Company established a valuation allowance in the amount of $25 million. This was based upon management’s assessment that it was more likely than not that the gross deferred tax asset related to the NOL carryforward and a portion of deductible temporary differences would not be realized. In the fourth quarter of 2004, the Company reassessed the valuation allowance previously established against its net deferred tax assets. Factors considered by management in this reassessment included recent losses, scheduled reversal of deferred tax liabilities and revised projections of future earnings. Based upon management’s consideration of these factors in conjunction with the current level of valuation allowance recorded, the Company determined it was necessary to increase the valuation allowance by $29 million.

99

The valuation allowance of $54 million reserves against the gross deferred tax asset related to the NOL carryforward and a portion of deductible temporary differences for which it is more likely than not that the corresponding tax benefit will not be realized. The Company will continue to periodically assess the realizability of its net deferred tax asset.

The Company and its affiliates have a written federal income tax allocation agreement approved by the Board of Directors. Under this agreement, income tax expense is allocated to each entity on a separate return basis. For tax years beginning on or after January 1, 2002, the agreement was amended to give loss companies (entities, that on a separate return basis, reflect a NOL) credit for NOL's current at the time and to the extent that the loss company would have been able to utilize such NOL on a stand-alone basis, against post-2001 taxable income. Intercompany tax balances are generally settled on a quarterly basis.

The Company's Federal income tax returns are subject to audit by the Internal Revenue Service ("IRS"). No tax years are currently under audit by the IRS. In 2004, the Company reversed $1.8 million of certain tax contingency reserves recorded in prior years, due in part to closed examination years.

Note 10. Employee Retirement, Postretirement and Postemployment Benefits

See Note 13 to the PMA Capital Consolidated Financial Statements for a description of employee retirement, postretirement and postemployment benefits sponsored by PMA Capital.

The Company has no legal obligation for benefits under these plans. The Company had expenses for the qualified and non-qualified pension plans of $728,000, $926,000 and $853,000 for 2004, 2003 and 2002, respectively. The Company had expenses for other postretirement benefit plans of $112,000, $152,000 and $161,000 for 2004, 2003 and 2002, respectively.

The Company also participates in a voluntary defined contribution savings plan, covering substantially all employees, sponsored and administered by PMA Capital. The Company matches employee contributions, up to 5% of compensation. Contributions under the plan expensed in 2004, 2003 and 2002 were $296,000, $749,000 and $971,000, respectively.

Note 11. Exit Costs

In November 2003, the Company announced its decision to withdraw from the reinsurance business previously served by PMA Capital Insurance Company.

As a result of this decision, results for 2003 included a charge of $2.6 million pre-tax, mainly for employee termination benefits. Approximately 80 employees have been terminated in accordance with the Company’s exit plan. Approximately 60 positions, primarily claims and financial, remain. The Company has established an employee retention arrangement for the remaining employees. Under this arrangement, the Company recorded expenses of $1.7 million, which include retention bonuses and severance, for 2004, and expects to record expenses of approximately $1.3 million for 2005. Employee termination benefits and retention bonuses of $3.3 million have been paid in accordance with this plan, including $450,000 in 2003. Additionally, in 2004 the Company paid a $1 million fee to shorten the term of its Philadelphia office lease from fifteen years to seven and reduce the leased space by approximately 75% effective October 1, 2004.

In May of 2002, the Company announced its decision to exit the excess and surplus insurance lines marketplace served by Caliber One. To service the run-off of policies that had been written by Caliber One, the Company entered into various insurance arrangements to ensure all obligations to policyholders would be met. These arrangements were reviewed and approved by both the Pennsylvania and Delaware Departments of Insurance. Accordingly, the Company commuted previous reinsurance agreements that had been in place with Caliber One and then entered into an Assumption Reinsurance and Assignment Agreement with Caliber One, whereby the Company assumed all assets and liabilities of Caliber One. The Company then entered into reinsurance agreements with Yardley Settlement Insurance Company (Cayman), Ltd. (“Yardley”) and Newtown Settlement Insurance Company (Cayman), Ltd. (“Newtown”), Cayman Islands based unconsolidated affiliates of the Company. Under these reinsurance agreements, Yardley and Newtown assumed 100% of the net losses not ceded under any of Caliber One’s previously negotiated reinsurance coverages that the Company assumed from Caliber One. Under the terms of the reinsurance agreements, the Company did not transfer significant underwriting risk. Accordingly, the Company accounted for the reinsurance agreements using deposit accounting. On November 1, 2004 the Company

100

commuted the reinsurance agreements with Yardley and Newtown. As a result of the commutation, the Company increased net liabilities by $39.1 million and received $33.9 million in assets, including $32.2 million in fixed maturities and cash.

As a result of the decision to exit from and run off this business, 2002 results included a charge of $11 million pre-tax. Components of the charge include approximately $10 million to write-down assets to their estimated net realizable value, including a non-cash charge of approximately $1.3 million for goodwill. In addition, the $11 million pre-tax charge includes expenses associated with the recognition of liabilities of approximately $1 million. The charge was included in operating expenses in the Statement of Operations in 2002.

During 2003, in connection with the Company’s decision to exit the excess and surplus lines marketplace, an additional $2.5 million write-down of assets was recognized, including approximately $2 million for reinsurance receivables and $500,000 for premiums receivable, reflecting an updated assessment of their estimated net realizable value. The write-down is included in operating expenses in the Statement of Operations for 2003.

Note 12. Transactions with Related Parties

The Company participates in service agreements with PMA Re Management Company (“PMA Re Management”), and Caliber One Management Company Inc. (“Caliber One Management”), wholly owned subsidiaries of PMA Capital. Under the terms of these arrangements, PMA Re Management and Caliber One Management provide the Company with accounting, actuarial, administrative, claims-handling, legal, human resources and underwriting services. In return for these services, the Company agrees to reimburse PMA Re Management and Caliber One Management for all expenses attributable to the provision of such services, not to exceed actual expenses incurred. Under the terms of this agreement, the Company reimbursed PMA Re Management in the amount of $23.4 million, $35.7 million and $27.9 million during 2004, 2003 and 2002, respectively, and Caliber One Management in the amount of $2.4 million, $3.6 million and $13.5 million during 2004, 2003 and 2002, respectively. The Company owed PMA Re Management approximately $820,000, $544,000 and $651,000 as of December 31, 2004, 2003 and 2002, respectively.

During 2002, the Company entered into reinsurance agreements with Yardley and Newtown, Cayman Islands based affiliates of the Company. The Company accounted for these reinsurance agreements using deposit accounting. See Note 11 for further discussion of these agreements. As a result of these agreements, the Company had deposit assets of $42.6 million and $97.6 million as of December 31, 2003 and 2002, respectively, included within other assets on the balance sheet. The Company recorded interest expense (revenue) in the amount of $2.3 million, ($3.8) million and ($1.3) million as of December 31, 2004, 2003 and 2002, respectively, and incurred $1.5 million, $0 and $1.3 million in other expenses in 2004, 2003 and 2002, respectively.

The Company had notes receivable from affiliates in the amount of $15.8 million, $17.5 million and $19.7 million as of December 31, 2004, 2003 and 2002, respectively. These notes bear interest at a rate ranging between 2.50% and 2.96% per annum for December 31, 2004, 1.56% per annum for December 31, 2003 and 2.50% per annum for December 31, 2002. The current notes mature at various dates throughout 2005, with the final maturity date in December 2005.

The Company, PMA Capital, and certain other affiliates (the “Applicants”) were parties to a letter of credit facility. At December 31, 2003, the outstanding face amount of letters of credit issued on behalf of the Company was $12.3 million. There were no outstanding letters of credit at December 31, 2004. The letter of credit facility primarily secured reinsurance liabilities of the Company and other insurance affiliates.

The Company maintains various reinsurance agreements with High Mountain, a wholly owned subsidiary of MASIC, which is a wholly owned subsidiary of PMA Capital. Under these agreements, as of December 31, 2004, 2003 and 2002, respectively, the Company had reinsurance receivables of $91.5 million, $135.0 million, and $62.9 million, and funds held liabilities were due to High Mountain by the Company of $92.5 million, $116.3 million, and $37.4 million.

101

The following represents the income statement impacts during 2004, 2003 and 2002 as a result of the reinsurance agreements in place with High Mountain:

(dollars amounts in thousands)	2004			2003		2002
Ceded premium	$	(1,978	)	$	100,444	$	6,049
Ceded losses		(14,978	)		99,050		10,626
Commission expense		2,821			10,111		68
Interest on funds held		5,223			4,899		(611	)

The Company owned $4.0 million of preferred stock from High Mountain as of December 31, 2003 and 2002, respectively, earning interest at the rate of 6.25%. The Company recorded interest income of $250,000 for 2004, 2003 and 2002, respectively. The preferred stock was redeemed in 2004.

The Company owned $4.0 million of preferred stock from MASIC as of December 31, 2003 and 2002, respectively, earning interest at the rate of 6.8%. The Company recorded interest income of $272,000 for 2004, 2003 and 2002, respectively. The preferred stock was redeemed in 2004.

Note 13. Statutory Financial Information

These consolidated financial statements vary in certain respects from financial statements prepared using statutory accounting practices that are prescribed or permitted by the Pennsylvania Insurance Department and the Delaware Insurance Department (collectively, “SAP”). Prescribed SAP includes state laws, regulations and general administrative rules, as well as a variety of National Association of Insurance Commissioners (“NAIC”) publications. Permitted SAP encompasses all accounting practices that are not prescribed. The Codification of Statutory Accounting Principles (“Codification”) guidance is the NAIC’s primary guidance on statutory accounting. The principal differences between GAAP and SAP are in the treatment of reinsurance, acquisition expenses, deferred income taxes, fixed assets and investments.

SAP net income (loss) for the Company’s domestic insurance subsidiaries are $40.8 million, ($84.4) million and ($8.0) million for 2004, 2003 and 2002, respectively. SAP capital and surplus for the Company’s domestic insurance subsidiaries are $224.5 million, $500.6 million and $580.1 million as of December 31, 2004, 2003 and 2002, respectively. The Company’s 2003 and 2002 surplus included $296.8 million and $305.5 million, respectively, related to its investment in the Pooled Companies which were contributed to PMA Capital in June 2004.

102

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholder of

PMA Capital Insurance Company:

We have audited the accompanying consolidated balance sheets of PMA Capital Insurance Company and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, cash flows, shareholder’s equity, and comprehensive income (loss) for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2004 and 2003, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

June 10, 2005

103

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholder of

PMA Capital Insurance Company

In our opinion, the accompanying consolidated statements of operations, of cash flows, of shareholder’s equity and of comprehensive income (loss) for the year ended December 31, 2002 present fairly, in all material respects, the results of operations and cash flows of PMA Capital Insurance Company and its subsidiaries for the year ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.  We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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.

/s/ Pricewaterhouse Coopers LLP

Philadelphia, PA

February 5, 2003,

except for the matter described in paragraph 2 of Note 1,

as to which the date is September 13, 2005. 

104

Signatures

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

	PMA CAPITAL CORPORATION
Date: September 16, 2005	By:/s/ William E. Hitselberger
	William E. Hitselberger
	Executive Vice President and
	Chief Financial Officer

105

PMA Capital Corporation

Index to Financial Statement Schedules

Schedule No.	Description	Page
II	Condensed Financial Information of	FS-2
	Registrant as of December 31, 2004 and
	2003 and for the years ended December 31,
	2004, 2003 and 2002
III	Supplementary Insurance Information for the	FS-5
	years ended December 31, 2004, 2003 and 2002
IV	Reinsurance for the years ended December 31,	FS-6
	2004, 2003 and 2002
V	Valuation and Qualifying Accounts for the	FS-7
	years ended December 31, 2004, 2003 and 2002
VI	Supplemental Information Concerning	FS-8
	Property and Casualty Insurance Operations
	for the years ended December 31, 2004, 2003 and 2002
	Independent Auditors’ Reports on Financial Statement	FS-9
	Schedules

Certain financial statement schedules have been omitted because they are either not applicable or the required financial information is contained in the Company’s 2004 Consolidated Financial Statements and notes thereto.

FS-1

PMA Capital Corporation
Schedule II - Registrant Only Financial Statements
Balance Sheets
(Parent Company Only)
	December 31,
(dollar amounts in thousands)		2004			2003
Assets
Cash	$	434		$	500
Short-term investments		286			14,481
Investment in subsidiaries		642,466			659,149
Related party receivables		37,638			6,312
Deferred income taxes, net		29,602			21,989
Other assets		13,379			9,380
Total assets	$	723,805		$	711,811
Liabilities
Long-term debt	$	214,467		$	187,566
Other liabilities		63,887			60,578
Total liabilities		278,354			248,144
Shareholders' Equity
Class A Common stock, $5 par value
(2004 - 60,000,000 shares authorized; 34,217,945 shares issued and 31,676,851 outstanding;
2003 - 60,000,000 shares authorized; 34,217,945 shares issued and 31,334,403 outstanding)		171,090			171,090
Additional paid-in capital		109,331			109,331
Retained earnings		213,313			216,115
Accumulated other comprehensive income (loss)		(1,959	)		19,622
Notes receivable from officers		-			(65	)
Treasury stock, at cost (2004 - 2,541,094 shares; 2003 - 2,883,542 shares)		(45,573	)		(52,426	)
Unearned restricted stock compensation		(751	)		-
Total shareholders' equity		445,451			463,667
Total liabilities and shareholders' equity	$	723,805		$	711,811

These financial statements should be read in conjunction with the Consolidated Financial

Statements and the notes thereto.

FS-2

PMA Capital Corporation

Schedule II - Registrant Only Financial Statements

Statements of Operations

(Parent Company Only)

		Year Ended December 31,
(dollar amounts in thousands)		2004			2003			2002
Revenues:
Net investment income (expense)	$	118		$	(31	)	$	(18	)
Net realized investment loss		(3,846	)		-			-
Other revenues		6,680			30			8
Total revenues		2,952			(1	)		(10	)
Expenses:
General expenses		9,893			14,200			8,819
Interest expense		12,579			10,244			4,090
Loss on debt exchange		5,973			-			-
Total expenses		28,445			24,444			12,909
Loss before income taxes and equity in earnings
(loss) of subsidiaries		(25,493	)		(24,445	)		(12,919	)
Income tax expense (benefit)		(11,094	)		23,676			(32,548	)
Income (loss) before equity in earnings (loss)
of subsidiaries		(14,399	)		(48,121	)		19,629
Equity in earnings (loss) of subsidiaries		16,229			(45,448	)		(67,653	)
Net income (loss)	$	1,830		$	(93,569	)	$	(48,024	)

 These financial statements should be read in conjunction with the Consolidated Financial

Statements and the notes thereto.

FS-3

PMA Capital Corporation

Schedule II - Registrant Only Financial Statements

Statements of Cash Flows

(Parent Company Only)

		Year ended December 31,
(dollar amounts in thousands)		2004			2003			2002
Cash Flows From Operating Activities:
Net income (loss)	$	1,830		$	(93,569	)	$	(48,024	)
Adjustments to reconcile net income (loss) to net cash flows provided
by (used in) operating activities:
Equity in (earnings) loss of subsidiaries		(16,229	)		45,448			67,653
Dividends received from subsidiaries		10,998			24,000			28,000
Net tax sharing payments received from subsidiaries		4,851			5,637			11,989
Net realized investment losses		3,846			-			-
Loss on debt exchange		5,973			-			-
Deferred income tax expense (benefit)		(7,143	)		25,138			(16,954	)
Other, net		(8,889	)		3,003			(6,994	)
Net cash flows provided by (used in) operating activities		(4,763	)		9,657			35,670
Cash Flows From Investing Activities:
Net sales (purchases )of short-term investments		14,195			(14,481	)		-
Cash contributions to subsidiaries		-			(500	)		(25,175	)
Proceeds from other assets sold		7,729			-			-
Net cash flows provided by (used in) investing activities		21,924			(14,981	)		(25,175	)
Cash Flows From Financing Activities:
Dividends paid to shareholders		-			(9,870	)		(12,102	)
Issuance of long-term debt		15,825			100,000			151,250
Debt issue costs		(600	)		(3,662	)		(3,009	)
Repayment of debt		(1,185	)		(65,000	)		(62,500	)
Proceeds from exercise of stock options		-			2			2,866
Purchase of treasury stock		-			-			(1,726	)
Net repayments of notes receivable from officers		59			-			96
Change in related party receivables and payables		(31,326	)		(15,646	)		(85,371	)
Net cash flows provided by (used in) financing activities		(17,227	)		5,824			(10,496	)
Net increase (decrease) in cash		(66	)		500			(1	)
Cash - beginning of year		500			-			1
Cash - end of year	$	434		$	500		$	-
Supplementary cash flow information:
Income taxes paid (refunded)	$	(2,592	)	$	2,600		$	(10,649	)
Interest paid	$	11,832		$	8,723		$	2,924

 These financial statements should be read in conjunction with the Consolidated Financial

Statements and the notes thereto.

FS-4

PMA Capital Corporation

Schedule III

Supplementary Insurance Information

(dollar amounts in thousands)		Deferred acquisition costs		Unpaid losses and loss adjustment expenses			Unearned premiums		Net premiums earned			Net investment income(1)			Losses and loss adjustment expenses		Acquisition expenses		Operating expenses		Net premiums written
December 31, 2004:
The PMA Insurance Group	$	30,984	$	1,226,781		$	156,484	$	442,343		$	30,984		$	331,181	$	86,078	$	56,911	$	377,795
Run-off Operations		442		919,222			2,005		77,067			24,655			49,375		29,147		17,691		(75,360	)
Corporate and Other (2)		-		(34,405	)		-		(825	)		1,306			-		-		10,310		(825	)
Total	$	31,426	$	2,111,598		$	158,489	$	518,585		$	56,945		$	380,556	$	115,225	$	84,912	$	301,610
December 31, 2003:
The PMA Insurance Group	$	38,635	$	1,259,737		$	227,262	$	570,032		$	32,907		$	442,502	$	90,575	$	65,173	$	603,593
Run-off Operations		45,340		1,315,071			176,446		628,921			34,362			555,845		165,871		24,443		589,449
Corporate and Other (2)		-		(33,490	)		-		(788	)		1,654			-		-		14,056		(788	)
Total	$	83,975	$	2,541,318		$	403,708	$	1,198,165		$	68,923		$	998,347	$	256,446	$	103,672	$	1,192,254
December 31, 2002:
The PMA Insurance Group	$	32,266	$	1,192,069		$	189,799	$	410,266		$	35,613		$	307,734	$	71,874	$	48,032	$	452,276
Run-off Operations		56,956		1,304,746			215,580		581,626			49,751			515,924		145,110		44,547		653,602
Corporate and Other (2)		-		(46,925	)		-		(881	)		(483	)		-		-		10,229		(881	)
Total	$	89,222	$	2,449,890		$	405,379	$	991,011		$	84,881		$	823,658	$	216,984	$	102,808	$	1,104,997

(1) Net investment income is based on each segment's invested assets.

(2) Corporate and Other includes unallocated investment income and expenses, including debt service. Corporate and Other also inludes the effect of eliminating intercompany transactions.

FS-5

PMA Capital Corporation

Schedule IV

Reinsurance

(dollar amounts in thousands)		Direct amount		Ceded to other companies		Assumed from other companies		Net amount	Percentage of amount assumed to net
Year Ended December 31, 2004:
Property and liability insurance premiums	$	461,365	$	78,911	$	136,131	$	518,585	26%
Year Ended December 31, 2003:
Property and liability insurance premiums	$	638,716	$	228,576	$	788,025	$	1,198,165	66%
Year Ended December 31, 2002:
Property and liability insurance premiums	$	599,827	$	300,556	$	691,740	$	991,011	70%

FS-6

PMA Capital Corporation

Schedule V

Valuation and Qualifying Accounts

(dollar amounts in thousands)
Description		Balance at beginning of period		Charged (credited) to costs and expenses			Deductions - write-offs of uncollectible accounts			Balance at end of period
Year ended December 31, 2004:
Valuation allowance:
Premiums receivable	$	7,972	$	(923	)	$	-		$	7,049
Reinsurance receivable		6,769		2,233			-			9,002
Deferred income taxes, net		49,000		8,000			-			57,000
Year ended December 31, 2003:
Valuation allowance:
Premiums receivable	$	9,528	$	(544	)	$	(1,012	)	$	7,972
Reinsurance receivable		5,483		4,286			(3,000	)		6,769
Deferred income taxes, net		-		49,000			-			49,000
Year ended December 31, 2002:
Valuation allowance:
Premiums receivable	$	12,583	$	245		$	(3,300	)	$	9,528
Reinsurance receivable		4,562		4,371			(3,450	)		5,483
Deferred income taxes, net		-		-			-			-

FS-7

PMA Capital Corporation

Schedule VI

Supplemental Information Concerning Property and Casualty Insurance Operations

														Losses and loss adjustment expenses incurred related to
(dollars amounts in thousands)		Deferred acquisition		Unpaid losses and loss adjustment		Discount on unpaid losses and loss adjustment		Unearned		Net premiums		Net investment		Current		Prior			Acquisition		Paid losses and loss adjustment		Net premiums
Affiliation with registrant		costs		expenses		expenses(1)		premiums		earned		income		year		years (2)			expenses		expenses		written
Consolidated property-casualty
subsidiaries:
December 31, 2004	$	31,426	$	2,111,598	$	60,787	$	158,489	$	518,585	$	56,945	$	406,828	$	(40,363	)	$	115,225	$	728,011	$	301,610
December 31, 2003	$	83,975	$	2,541,318	$	67,012	$	403,708	$	1,198,165	$	68,923	$	768,114	$	218,774		$	256,446	$	836,383	$	1,192,254
December 31, 2002	$	89,222	$	2,449,890	$	97,849	$	405,379	$	991,011	$	84,881	$	655,395	$	159,748		$	216,984	$	732,469	$	1,104,997

(1) - Reserves discounted at approximately 5%.

(2) - Exlcudes accretion of loss reserve discount of $14,091, $11,459 and $8,515 in 2004, 2003 and 2002, respectively.

FS-8

Reportof Independent Registered Public Accounting Firm

Board of Directors and Shareholders

PMA Capital Corporation

We have audited the consolidated financial statements of PMA Capital Corporation and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and for the years then ended, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, and have issued our reports thereon dated March 16, 2005; such reports are included elsewhere in this From 10-K/A. Our audits also included the consolidated financial statement schedules of the Company listed in Item 15. These consolidated financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Philadelphia, PA

March 16, 2005

FS-9

Reportof Independent Registered Accounting Firm on

Financial Statement Schedules

To the Board of Directors and Shareholders

of PMA Capital Corporation:

Our audits of the consolidated financial statements referred to in our report dated February 5, 2003, appearing in the 2004 Annual Report to Shareholders of PMA Capital Corporation (which report and consolidated financial statements are included in this Annual Report on Form 10-K/A) also included an audit of the 2002 financial statement schedules incorporated by reference in this Form 10-K/A. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

/s/ PricewaterhouseCoopers LLP

Philadelphia, PA

February 5, 2003

FS-10

INDEX TO EXHIBITS

Exhibit No.		Description of Exhibit	Method of Filing
(23)		Consents of Independent Registered Public Accounting Firms:
	23.1	Consent of Deloitte & Touche LLP	Filed herewith.
	23.2	Consent of Pricewaterhouse Coopers LLP	Filed herewith.
(31)		Rule 13a-14(a) Certifications:
	31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934	Filed herewith.
	31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934	Filed herewith.
(32)		Section 1350 Certifications:
	32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.
	32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed herewith.

* The registrant will furnish to the Commission, upon request, a copy of any of the registrant’s agreements with respect to its long-term debt not otherwise filed with the Commission.

Shareholders may obtain copies of exhibits by writing to the Company at PMA Capital Corporation, 380 Sentry Parkway, Blue Bell, PA. 19422, Attn: Secretary

E-1