MERCER INSURANCE GROUP INC - 10-K Annual Report

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K


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

		for the fiscal year ended December 31, 2004

or

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

		transition period from to .

Commission file number 000-25425

Mercer Insurance Group, Inc.

(Exact name of registrant as specified in its charter)


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

10 North Highway 31

P.O. Box 278

Pennington, NJ 08534

(Address of principal executive offices)

Registrant’s telephone number, including area code:

(609) 737-0426

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

None

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

Common Stock (no par value)

Title of Each Class:

Common Stock, no par value

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

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

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

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

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

Documents Incorporated by Reference

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

FORM 10-K

For the year Ended December 31, 2004

Table of Contents


			Page

PART I				3
	ITEM 1.	Business		3
	ITEM 2.	Properties		27
	ITEM 3.	Legal Proceedings		27
	ITEM 4.	Submission of Matters to a Vote of Security Holders		27
PART II				27
	ITEM 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		27
	ITEM 6.	Selected Consolidated Financial Data		29
	ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		30
	ITEM 7A.	Quantitative and Qualitative Disclosures about Market Risk		45
	ITEM 8.	Financial Statements and Supplementary Data.		48
	ITEM 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.		72
	ITEM 9A.	Controls and Procedures.		72
PART III				74
	ITEM 10.	Directors and Executive Officers of the Registrant.		74
	ITEM 11.	Executive Compensation.		74
	ITEM 12.	Security Ownership of Certain Beneficial Owners and Management.		74
	ITEM 13.	Certain Relationships and Related Transactions.		74
	ITEM 14.	Principal Accounting Fees and Services.		74
PART IV				74
	ITEM 15.	Exhibits, Financial Statement Schedules.		74
EMPLOYMENT AGREEMENT, DATED AS OF OCTOBER 31, 2004
STOCK INCENTIVE PLAN
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
CERTIFICATION OF CHIEF FINANCIAL OFFICER
CERTIFICATION OF CEO IN ACCORDANCE WITH SECTION 906
CERTIFICATION OF CFO IN ACCORDANCE WITH SECTION 906

PART I


ITEM 1.	*BUSINESS*

THE CONVERSION TRANSACTION AND THE HOLDING COMPANY

Mercer Insurance Group, Inc. (the “Company” or the “Holding Company”) is a holding company owning all of the outstanding shares of Mercer Insurance Company, the company resulting from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of organization on December 15, 2003 (the “Conversion”). Prior to the Conversion, and since 1844, Mercer Mutual Insurance Company was engaged in the business of selling property and casualty insurance. Mercer Mutual Insurance Company, a Pennsylvania domiciled company, changed its name to Mercer Insurance Company immediately after the Conversion, and became a subsidiary of the Company.

The Company had no activity prior to the Conversion, and was formed for the purpose of owning all of the stock of Mercer Mutual Insurance Company after the Conversion. At the time of the Conversion, 6,845,733 shares of Mercer Insurance Group, Inc. were issued (including 502,525 shares issued immediately after the Conversion to acquire the remaining 51% of the common stock as well as all of the manditorily redeemable preferred stock of Franklin Holding Company, Inc., of which Mercer Mutual Insurance Company had acquired 49% for cash in 2001) with net cash proceeds of approximately $53 million received by the Company in exchange for the shares (approximately $27 million of this amount was contributed to the capital of Mercer Insurance Company after the Conversion). Also included in the total shares are 626,111 shares issued in the Conversion to the Mercer Insurance Group, Inc. Employee Stock Ownership Plan, (the “ESOP”) as to which no cash proceeds were received because the ESOP funded the purchase of these shares with a loan from the Company. The shares held by the ESOP will be allocated to participant accounts evenly over a ten-year period. The first and second annual allocations occurred in each of December, 2003 and 2004, in the amount of 62,611 shares each.

The Holding Company is subject to regulation by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance because it is the holding company for Mercer Insurance Company (Pennsylvania-domiciled), and for, indirectly through Queenstown Holding Company, Inc., Mercer Insurance Company of New Jersey, Inc. (New Jersey-domiciled), and for Franklin Holding Company, Inc. and its subsidiary, Franklin Insurance Company (Pennsylvania-domiciled).

OVERVIEW OF THE BUSINESS

Mercer Insurance Group, Inc., through its property and casualty insurance subsidiaries, provides a wide array of property and casualty insurance products designed to meet the insurance needs of consumers and small and medium-sized businesses throughout New Jersey and Pennsylvania. We report our operating results in three segments: commercial lines insurance, personal lines insurance and the investment function. However, assets are not allocated to segments and are reviewed in the aggregate for decision-making purposes. Our insurance products include commercial multi-peril, other liability, commercial automobile, workers compensation, homeowners, fire and inland marine and personal automobile coverages. We market our products through a network of over 300 independent producers in New Jersey and Pennsylvania. The majority of our producers market both commercial and personal lines products. Our insurance companies have been assigned an “A” (Excellent) rating by A.M. Best for 4 years. An “A” rating is the third highest rating out of A.M. Best’s 16 possible rating categories.

Prior to 1997, our business was primarily focused on providing personal lines for New Jersey customers. However, over the past seven years we have moved aggressively to expand our commercial and casualty premium volume and geographically diversify our writings into Pennsylvania. In order to attract and retain commercial and casualty business, we have developed insurance programs specifically tailored to meet the needs of particular types of businesses. In 2004, homeowners insurance represented 22% of our direct premiums written compared to 43% in 1998 and commercial writings represented 62%, up from 45% in 1998. This significant shift in the mix of our writings occurred despite our acquisition in 2001 of a 49% interest in Franklin Insurance Company whose business consists entirely of personal lines policies (as noted above, the

remaining 51% was acquired by the Company immediately after the completion of the Conversion to a publicly-traded company in December, 2003). Direct premiums written in 2004 in the state of Pennsylvania amounted to 22% of our business, with the remaining 78% being written in New Jersey.

OUR INSURANCE COMPANIES

Mercer Insurance Company is a Pennsylvania insurance company that was originally incorporated under a special act of the legislature of the State of New Jersey in 1844 as a mutual insurance company. It commenced operations under the name Mercer County Mutual Fire Insurance Company, subsequently changed its name to Mercer Mutual Insurance Company in 1958, and then to Mercer Insurance Company after the Conversion in 2003. On October 16, 1997, it filed Articles of Domestication with Pennsylvania thereby changing its state of domicile from New Jersey to Pennsylvania. Mercer Insurance Company owns all of the issued and outstanding capital stock of Queenstown Holding Company, Inc., which owns all of the issued and outstanding capital stock of Mercer Insurance Company of New Jersey, Inc. Mercer Insurance Company also owns 49% of the issued and outstanding stock of Franklin Holding Company, Inc., which owns all of the issued and outstanding capital stock of Franklin Insurance Company. The remaining 51% of Franklin Holding Company, Inc. is owned by the Mercer Insurance Group, Inc., which acquired the 51%, as well as all manditorily redeemable preferred stock held by third parties, in exchange for 502,525 of its shares immediately after the Conversion.

Mercer Insurance Company is a property and casualty insurer of small and medium-sized businesses and property owners located in New Jersey and Pennsylvania. It markets commercial multi-peril and homeowners policies, as well as other liability, workers’ compensation, fire, allied, inland marine and commercial automobile insurance through over 300 independent producers. Mercer Insurance Company does not market private passenger automobile insurance in New Jersey. Mercer Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business — Regulation.”

Mercer Insurance Company of New Jersey, Inc. is a stock property and casualty insurance company that was incorporated in 1981. It writes the same lines of business as Mercer Insurance Company, with its book of business intended to be predominantly located in New Jersey. Mercer Insurance Company of New Jersey, Inc. is subject to examination and comprehensive regulation by the New Jersey Department of Banking and Insurance. See “Business — Regulation.”

Franklin Insurance Company is a stock property and casualty insurance company that was incorporated in 1997. Mercer Insurance Company acquired 49% of the common stock of Franklin Holding Company, Inc. (“Franklin Holding”), on June 1, 2001. Franklin Holding owns 100% of Franklin Insurance Company. The Company acquired the remaining 51% of Franklin Holding in exchange for its shares immediately after the Conversion. Currently, Franklin Insurance Company offers private passenger automobile and homeowners insurance to individuals located in Pennsylvania. Franklin Insurance Company is represented by approximately 50 independent producers. All transactions conducted between Franklin Insurance Company and its producers are performed electronically. Franklin Insurance Company is subject to examination and comprehensive regulation by the Pennsylvania Insurance Department. See “Business — Regulation.”

OUR BUSINESS STRATEGIES

We continually strive to improve our profitability and reduce the impact of losses on our business. One of our principal objectives for the future is to become a more geographically diverse property and casualty insurer with at least 75% of our direct written premiums consisting of commercial and casualty business that meets our disciplined underwriting standards. By doing so, we believe that our results of operations will improve and we will lessen the impact of personal property insurance losses. The following discussion describes the strategies we will use to achieve our goals.

Increase our commercial and casualty writings

Over the last seven years we have taken, and will continue to take, steps to increase commercial and casualty premium volume. Growth in commercial and casualty lines reduces our personal lines exposure as a

percentage of direct written premiums. This reduces the relative adverse impact that weather-related property losses can have on us. Increased commercial lines business also benefits us because we have greater flexibility in establishing rates for these lines.

In order to attract and retain commercial and casualty insurance business, we have developed insurance programs specifically tailored to meet the needs of particular types of businesses. These programs are continually refined and, if successful, expanded based on input from our producers and our marketing personnel.

We have a program that is available for churches, synagogues and other religious institutions. This program includes many preferred coverages and special pricing, and we have policy forms tailored for these institutions. We use this program to attract producers that have substantial books of business with religious institutions.

At December 31, 2004, we had approximately 1,400 insured religious institutions with direct written premiums of $7.6 million. The performance of this book of business compares favorably to our commercial segment generally.

In order to complement our existing commercial accounts, a two-tiered pricing approach for commercial automobile insurance covering light to medium weight trucks and business-owned private passenger-type vehicles used for commercial purposes is available. In addition to a standard rate, a preferred rate for risks meeting specified underwriting standards can be used.

We believe that there is an opportunity to increase our volume of casualty business by: (1) marketing casualty products to existing producers who have supported the establishment and growth of our commercial lines, and (2) forming and developing relationships with new producers that focus on commercial and casualty business. We believe an increasing share of this market is desirable and attainable given our existing relationships with our producers and our insureds, as well as the extensive experience and producer relationships of our commercial business management personnel.

Capital raised in the Conversion is available to supply additional surplus to our insurance companies to support an increase in premium volume resulting from this continued diversification of our business lines.

Diversify our business geographically

For the year ended December 31, 2004, 78% of our business was written in New Jersey. We intend to geographically diversify our risk by increasing our business outside New Jersey. We intend to explore opportunities that may arise in states adjacent to our current operating territories, as well as in most parts of the United States and where we believe commercial lines insurers generally are permitted to manage risk selection and pricing without undue regulatory interference. We also will evaluate potential business opportunities in other jurisdictions to determine whether they would be a good fit with our businesses. If so, we may explore those opportunities as well.

We expect to accomplish our geographic diversification through the expansion of our existing producer relationships in Pennsylvania, exploration of additional state insurance licenses and through selective strategic acquisitions. We have no current definitive plans for any such acquisitions.

Attract and retain high-quality producers with diverse customer bases

We believe our insurance companies have a strong reputation for personal attention and prompt, efficient service with producers and insureds. This reputation has allowed us to grow and foster our relationships with many high volume producers. Several of these producers focus primarily on commercial business and are located in areas we have targeted as growth opportunities within Pennsylvania and New Jersey. We intend to focus our marketing efforts on maintaining and improving our relationships with these producers, as well as on attracting new high-quality producers in areas with a substantial potential for growth, particularly in Pennsylvania. We also intend to continue to develop and tailor our commercial programs to enable our

products to meet the needs of the customers served by our producers. Our religious institutions, “main street” business, and commercial automobile programs are successful examples of this effort.

Reduce our ratio of expenses to net premiums earned

We are committed to improving our profitability by reducing expenses through the use of enhanced technology and by increasing our premium writings through the strategic deployment of our capital. Currently, we are in the process of converting our information systems from an outside service bureau to an internally staffed system. Our target date for completion of this project is June 30, 2006. When completed, we will be able to eliminate the cost of the outside service bureau. In addition, the additional capital raised in the Conversion has and will continue to allow us to expand our premium writings while maintaining appropriate premium to surplus ratios. We anticipate that this increase in writings can be achieved without a commensurate increase in expenses, and will therefore help to reduce our expense ratio.

As a company that recently became publicly traded, and met the standards to be considered an accelerated filer under SEC rules, the Group was required to quickly implement the requirements of the Sarbanes — Oxley Act of 2002, which required an extensive and costly effort to document and test the Company’s system of internal controls. This effort resulted in the Company absorbing a substantial cost for Sarbanes — Oxley compliance during its first year as a public company, a cost which should decline substantially once the year of initial implementation passes.

Reduce our reliance on reinsurance

We have reduced our reliance on reinsurance by increasing the maximum exposure retained by our insurance companies on individual property and casualty risks. The capital raised in the Conversion and contributed to our insurance subsidiaries has allowed us to increase our retentions, as we did in 2004.

We will determine the appropriate increase in our maximum exposure based on a number of factors, which include:


	•	the amount of capital the Company is prepared to dedicate to support its underwriting activities;

	•	our evaluation of our ability to absorb multiple losses; and

	•	the revised terms and limits that we can obtain from our reinsurers.

A decrease in reinsurance would result in a decrease in ceded premiums and a corresponding increase in net premium income, but would increase our potential losses from underwriting. See “Business — Reinsurance” for a description of changes to our reinsurance program as of January 1, 2005.

COMMERCIAL LINES PRODUCTS

The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our commercial lines products on a consolidated basis for the periods indicated:


			Year Ended December 31,

			2004			2003			2002

Direct Premiums Written:
	Commercial multi-peril		$	22,249		$	18,588		$	13,485
	Other liability			9,771			8,944			6,641
	Workers’ compensation			4,381			3,971			3,665
	Commercial automobile			3,089			3,099			2,787
	Fire, allied, inland marine			1,393			1,201			911

		Total	$	40,883		$	35,803		$	27,489

Net Premiums Earned:
	Commercial multi-peril		$	16,522		$	12,673		$	9,631
	Other liability			7,184			6,295			4,810
	Workers’ compensation			4,691			3,700			2,735
	Commercial automobile			3,185			2,781			2,478
	Fire, allied, inland marine			788			515			434

		Total	$	32,370		$	25,964		$	20,088

Net Loss Ratios:
	Commercial multi-peril			32.6	%		30.9	%		40.7	%
	Other liability			41.0			46.6			21.5
	Workers’ compensation			28.8			41.3			38.4
	Commercial automobile			4.4			52.8			49.9
	Fire, allied, inland marine			63.2			58.6			9.3

		Total		31.9	%		39.1	%		36.3	%

Expense Ratio
	Commercial multi-peril			57.3	%		55.8	%		54.3	%
	Other liability			53.7			47.5			47.7
	Workers’ compensation			29.7			31.2			38.4
	Commercial automobile			38.8			41.5			42.0
	Fire, allied, inland marine			64.8			67.6			68.9

		Total		50.9	%		49.0	%		49.3	%

Combined Ratios(1):
	Commercial multi-peril			89.9	%		86.7	%		95.0	%
	Other liability			94.7			94.1			69.2
	Workers’ compensation			58.5			72.5			76.8
	Commercial automobile			43.2			94.3			91.9
	Fire, allied, inland marine			128.0			126.2			78.2

		Total		82.8	%		88.1	%		85.6	%


(1)	A combined ratio over 100% means that an insurer’s underwriting operations are not profitable.

Commercial Multi-Peril

We write a number of multi-peril policies in New Jersey and Pennsylvania providing property and liability coverage. These policies include larger apartment risks, condominium associations and 3-4 family dwelling policies. Various other risk classes also are written on this policy. As of December 31, 2004, approximately 1,050 multi-peril policies were in force.

We are working to increase market penetration for this product because it includes commercial risks that have more flexible and profitable rate structures. One of these marketing initiatives relates to certain habitational classes of business. Due to recent market conditions, we have targeted our business generation efforts toward condominium associations and certain types of garden style apartment complexes. Although pricing in this sector has become more competitive, we continue to view this market segment favorably, and are active in this market.

Many national insurance carriers have decided not to underwrite condominium associations and garden style apartment complexes because of a perceived inability to underwrite such business profitably. This practice of avoiding a class of business due to such an underwriting perception is known as “class underwriting.” Condominium associations and garden style apartment complexes, as a class, have been determined to be unprofitable by many national carriers because the pricing of this business was driven to inefficient levels during the soft market cycle. Therefore, they are avoiding this class of business entirely, and ignoring any individual risks within the class that can be underwritten profitably. This approach by national carriers has provided us greater opportunity to underwrite and price these risks at appropriate levels.

We also have a business owners policy that provides property and liability coverages to small businesses. This product is marketed to several distinct groups: (i) apartment building owners with 75 or fewer units; (ii) condominium associations up to 75 units; (iii) business owners who lease their buildings to tenants; (iv) mercantile business owners, such as florists, delicatessens, and beauty parlors; and (v) offices with owner or tenant occupancies. As of December 31, 2004, approximately 3,700 business owners policies were in force.

We also offer a specialized multi-peril policy specifically designed for religious institutions. This enhanced product includes directors and officers coverage, religious counseling coverage and systems breakdown coverage (through a reinsurance arrangement). Coverage for child care centers and schools also is available. As of December 31, 2004, approximately 1,400 religious sector insureds were covered under commercial multi-peril policies.

Other Liability

We write liability coverage for insureds who do not have property exposure or whose property exposure is insured elsewhere. The majority of these policies are written for small contractors such as carpenters, painters or electricians, who choose to self-insure small property exposures. Coverage for both premises and products liability exposures are regularly provided. Coverage is provided for other exposures such as vacant land and habitational risks. Approximately 600 commercial general liability and monoline umbrella policies were in force as of December 31, 2004.

Commercial umbrella coverage is available for insureds who insure their primary general liability exposures with us through a business owners, commercial multi-peril, religious institution or commercial general liability policy. This coverage typically has limits of $1,000,000 to $5,000,000, but higher limits are available if needed. To improve processing efficiencies and maintain underwriting standards, we prefer to offer this coverage as an endorsement to the underlying liability policy rather than as a separate stand-alone policy, but both versions are available.

Workers’ Compensation

We typically write workers’ compensation policies in conjunction with an otherwise eligible business owners, commercial multi-peril, religious institution, commercial property or general liability policy. As of December 31, 2004, most of our workers’ compensation insureds have other policies with us. There were approximately 2,500 workers’ compensation policies in effect as of December 31, 2004.

Commercial Automobile

This product is designed to cover light and medium weight trucks used in business, as well as company-owned private passenger type vehicles. Other specialty classes such as church vans and funeral director vehicles also can be covered. The policy is marketed as a companion offering to our business owners, commercial multi-peril, religious institution, commercial property or general liability policies. Approximately 1,000 commercial automobile policies were in force as of December 31, 2004.

Fire, Allied Lines and Inland Marine

Fire and allied lines insurance generally covers fire, lightning, and removal and extended coverage. Inland marine coverage insures merchandise or cargo in transit and business and personal property. We offer these coverages for property exposures in cases where we are not insuring the companion liability exposures. Generally, the rates charged on these policies are higher than those for the same property exposures written on a multi-peril or business owners policy.

PERSONAL LINES PRODUCTS

The following tables set forth the direct premiums written, net premiums earned, net loss ratios, expense ratios and combined ratios of our personal lines products on a consolidated basis for the periods indicated:


			Year Ended December 31,

			2004			2003			2002

Direct Premiums Written:
	Homeowners		$	14,666		$	14,695		$	13,698
	Personal automobile			7,654			7,881			6,865
	Fire, allied, inland marine			2,050			2,183			2,227
	Other liability			493			544			528
	Workers’ compensation			43			46			51

		Total	$	24,906		$	25,349		$	23,369

Net Premiums Earned:
	Homeowners		$	13,477		$	12,552		$	11,874
	Personal automobile			7,197			6,894			5,948
	Fire, allied, inland marine			2,194			2,103			2,162
	Other liability			505			307			322
	Workers’ compensation			41			44			60

		Total	$	23,414		$	21,900		$	20,366

Net Loss Ratios:
	Homeowners			82.8	%		74.3	%		68.1	%
	Personal automobile			77.0			94.5			67.8
	Fire, allied, inland marine			28.1			53.6			14.8
	Other liability			104.1			200.3			102.7
	Workers’ compensation			0.0			11.1			29.3

		Total		76.1	%		80.3	%		62.8	%

Expense Ratio
	Homeowners			48.1	%		44.8	%		46.5	%
	Personal automobile			38.9			37.8			39.6
	Fire, allied, inland marine			47.7			43.7			45.6
	Other liability			32.6			33.5			41.4
	Workers’ compensation			25.8			26.5			24.7

		Total		44.9	%		42.3	%		44.2	%

Combined Ratios(1):
	Homeowners			130.9	%		119.1	%		114.6	%
	Personal automobile			115.9			132.3			107.4
	Fire, allied, inland marine			75.8			97.3			60.4
	Other liability			136.7			233.8			144.1
	Workers’ compensation			25.8			37.6			54.0

		Total		121.0	%		122.6	%		107.0	%


(1)	A combined ratio over 100% means that an insurer’s underwriting operations are not profitable.

Homeowners

Our homeowners policy is a multi-peril policy providing property and liability coverages and optional inland marine coverage. The homeowners policy is sold to provide coverage for an insured’s residence. We market both a standard and a preferred homeowner product. The preferred product is offered at a discount to our standard rates to our customers who have a lower risk of loss. As of December 31, 2004, we had approximately 26,000 homeowners policies in force, with 36% of those being the preferred product.

Personal Automobile

We write comprehensive personal automobile coverage including liability, property damage and all state required insurance minimums for individuals domiciled in Pennsylvania. This product is multi-tiered with an emphasis placed on individuals with lower than average risk profiles. As of December 31, 2004, we had approximately 7,500 personal automobile policies in force. We do not write any private passenger automobile products in New Jersey.

Combination Dwelling Policy

Our combination dwelling product is a flexible, multi-line package of insurance coverage. It is targeted to be written on an owner or tenant occupied dwelling of no more than two families. The dwelling policy combines property and liability insurance but also may be written on a monoline basis. The property portion is considered a fire, allied lines and inland marine policy, and the liability portion is considered an other liability policy. Approximately 3,100 combination dwelling policies were in force as of December 31, 2004.

Other Liability

We write personal line excess liability, or “umbrella,” policies covering personal liabilities in excess of amounts covered under our homeowners policies. These policies are available generally with limits of $1 million to $5 million. We do not market excess liability policies to individuals unless we also write an underlying primary liability policy.

Workers’ Compensation

A small portion of our workers’ compensation premiums are considered personal lines insurance because our New Jersey homeowners policy is required to include workers’ compensation coverage for domestic employees.

MARKETING

We market our insurance products in New Jersey and Pennsylvania exclusively through independent producers. All of these producers represent multiple carriers and are established businesses in the communities in which they operate. They generally market and write the full range of our insurance companies’ products. We consider our relationships with our producers to be good.

Our insurance companies manage their producers through quarterly business reviews (with underwriter participation) and establishment of benchmarks/goals for premium volume and profitability. Our insurance companies in recent years have eliminated a number of low volume or unprofitable producers.

For the years ended December 31, 2004 and 2003, our two largest producers accounted for approximately 24% and 24% of our direct premiums written, respectively. One of these agencies is the Davis Insurance Agency which is owned by H. Thomas Davis, Jr., a director and employee of the Company and the founder of Franklin Insurance Company. Pursuant to an Agency Business Agreement dated June 1, 2001, the Davis Insurance Agency has granted to Mercer Insurance Company a right of first refusal to acquire the Davis Insurance Agency upon any proposed sale by Mr. Davis. Under the Agency Business Agreement, the Davis Insurance Agency also has granted to Franklin Insurance Company a right of first refusal on all personal

automobile and homeowners insurance produced by the agency. However, the agency may terminate this right if:


	(i) Franklin Insurance Company does not remain reasonably competitive in rates, coverage, service and commissions with the majority of the carriers in its market;

	(ii) Mr. Davis ceases to beneficially own shares of the Company stock in an amount equal to the shares of Company stock exchanged for his shares of voting common stock of Franklin Holding Company, Inc. as a result of the Conversion; or

	(iii) Mercer Insurance Company fails to exercise its right of first refusal within the time period required by the agreement.

The other top producer is Brown & Brown, Inc., which is not affiliated with us. No other producer accounted for more than 5% of our direct premiums written. For the years ended December 31, 2004 and 2003, our top 10 producers accounted for 44% and 40%, respectively, of direct premiums written, with the largest producer generating approximately $8.0 million and $7.8 million of our premium revenue, respectively.

We emphasize personal contact between our producers and the policyholders. We believe that our producers’ fast and efficient service and name recognition, as well as our policyholders’ loyalty to and satisfaction with producer relationships are the principal sources of new customer referrals, cross-selling of additional insurance products and policyholder retention.

Our insurance companies depend upon their producer force to produce new business, to provide customer service, and to be selective underwriters in their screening of risks for our insurance companies to consider underwriting. The network of independent producers also serves as an important source of information about the needs of the communities served by our insurance companies. We use this information to develop new products and new product features.

Producers are compensated through a fixed base commission with an opportunity for profit sharing depending on the producer’s aggregate premiums earned and loss experience. Profit sharing opportunities are for a producer’s entire book of business with the Company and not specifically for any individual policy. The Company does not have any marketing services agreements, placement services agreements, or similar arrangements. By contract, our producers represent the Company. They are monitored and supported by our marketing representatives, who are employees of BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company. These representatives also have principal responsibility for recruiting and training new producers.

Our marketing efforts are further supported by our claims philosophy, which is designed to provide prompt and efficient service, resulting in a positive experience for producers and policyholders. We believe that these positive experiences are then conveyed by producers and policyholders to many potential customers.

UNDERWRITING

Our insurance companies write their personal and commercial lines by evaluating each risk with consistently applied standards. We maintain information on all aspects of our business that is regularly reviewed to determine product line profitability. We also employ numerous underwriters, who generally specialize in either personal or commercial lines, and have many years of experience as underwriters. Specific information is monitored with regard to individual insureds to assist us in making decisions about policy renewals or modifications. New risks are frequently inspected to insure they are as desirable as suggested by the application process.

We rely on information provided by our independent producers. Subject to certain guidelines, producers also pre-screen policy applicants. The producers have the authority to sell and bind insurance coverages in accordance with pre-established guidelines. Producers’ results are continuously monitored. On occasion, producers with historically poor loss ratios have had their binding authority removed until more profitable underwriting results were achieved. Continued poor loss ratios often result in agency termination.

CLAIMS

Claims on insurance policies are received directly from the insured or through our independent producers. Claims are then assigned to either an in-house adjuster or an independent adjuster, depending upon the size and complexity of the claim. The adjuster investigates and settles the claim. As of December 31, 2004, we had thirteen in-house adjusters and worked with numerous independent adjusters. The Company also has a contingency plan for adjusting and processing claims resulting from a natural catastrophe.

Claims settlement authority levels are established for each claims adjuster based upon his or her level of experience. Multi-line teams exist to handle all claims. The claims department is responsible for reviewing all claims, obtaining necessary documentation, estimating the loss reserves and resolving the claims.

We attempt to minimize claims costs by encouraging the use of alternative dispute resolution procedures. Approximately 25% of all open claims under our policies are in litigation. Litigated claims are assigned to outside counsel.

TECHNOLOGY

When Mercer Mutual was evaluating its acquisition of Franklin Holding and its subsidiary, Franklin Insurance Company, one of Franklin’s attractive features was its information technology system. Franklin Insurance was formed in 1997 with the idea that, by building an efficient information system, it could reduce expenses for both the producer and the company. Because homeowners’ and private passenger automobile insurance are largely commodity businesses, low cost product delivery is crucial, especially for small companies that do not otherwise enjoy economies of scale. Franklin Insurance licensed a flexible insurance software package and internally built a front-end Internet based interface to the system. All business generated by Franklin Insurance’s producers is processed and maintained in this system through the Internet, and these producers have access to their books of business through the Internet. This system provides efficiency because information for all users is entered only one time.

The Company has undertaken a project to convert all of its business on to a platform which is a modified version of the system Franklin built for its business. The reasons for this decision include efficiencies to be achieved and a modernized system that will provide greater flexibility and cost savings while bringing our data-processing needs in-house where they can be better managed. Completion of the project should result in cost reduction, because we are currently operating two systems as we gradually move the business from the external system to our internal system.

Because of the experience and knowledge of the Franklin Insurance staff with the software package, all internal programming is conducted at our branch office in Lock Haven, Pennsylvania. In addition to the expert knowledge of this staff, we are able to hire and maintain staff at a more efficient cost than the cost at the home office location in Pennington, New Jersey due to differences in the cost of living in the respective areas.

The focus of our ongoing information technology effort is:


	•	to continue to re-engineer our internal processes to allow for more efficient operations;

	•	to improve our producers’ ability to transact business with us; and

	•	to enable our producers to efficiently provide their clients with a high level of service.

	•	to enhance agency access to online inquiry capabilities

	•	to provide agencies with on-line monthly reporting

We believe that our technology initiative will increase revenues by making it easier for our insurance companies and producers to exchange information and do business with us. Increased ease of use also should lower expenses. However, our short-term expenses have increased because of costs associated with the implementation of the new system and the need to maintain two systems during the transition.

The Company also has an initiative underway to convert from a paper-based filing and policy production/mailing system to a digital imaging and workflow system enabling automatic transfer of policy output to an electronic repository, supporting on-line inquiry and automated mailing.

We have not taken any steps to legally protect our intellectual property under any statutory scheme. We believe our intellectual property is a trade secret that is protected under common law and provides us with some competitive advantage in the near term, but we believe Internet-based producer/company interfaces will become commonplace and commercially available interfaces will dominate the market. Therefore, we do not believe that taking the costly steps to protect our intellectual property is justified.

REINSURANCE

Reinsurance Ceded

In accordance with insurance industry practice, our insurance companies reinsure a portion of their exposure and pay to the reinsurers a portion of the premiums received on all policies reinsured. Insurance policies written by our companies are reinsured with other insurance companies principally to:


	•	reduce net liability on individual risks;

	•	mitigate the effect of individual loss occurrences (including catastrophic losses);

	•	stabilize underwriting results;

	•	decrease leverage; and

	•	increase our insurance companies’ underwriting capacity.

Reinsurance can be facultative reinsurance or treaty reinsurance. Under facultative reinsurance, each policy or portion of a risk is reinsured individually. Under treaty reinsurance, an agreed-upon portion of a class of business is automatically reinsured. Reinsurance also can be classified as quota share reinsurance, pro-rata insurance or excess of loss reinsurance. Under quota share reinsurance and pro-rata insurance, the ceding company cedes a percentage of its insurance liability to the reinsurer in exchange for a like percentage of premiums less a ceding commission. The ceding company in turn recovers from the reinsurer the reinsurer’s share of all losses and loss adjustment expenses incurred on those risks. Under excess reinsurance, an insurer limits its liability to all or a particular portion of the amount in excess of a predetermined deductible or retention. Regardless of type, reinsurance does not legally discharge the ceding insurer from primary liability for the full amount due under the reinsured policies. However, the assuming reinsurer is obligated to reimburse the ceding company to the extent of the coverage ceded.

We determine the amount and scope of reinsurance coverage to purchase each year based on a number of factors. These factors include the evaluation of the risks accepted, consultations with reinsurance representatives and a review of market conditions, including the availability and pricing of reinsurance. Our reinsurance arrangements are placed with non-affiliated reinsurers, and are generally renegotiated annually. For the year ended December 31, 2004, our insurance companies ceded to reinsurers $8.4 million of written premiums, compared to $10.0 million of written premiums for the year ended December 31, 2003, and $7.2 million for the year ended December 31, 2002.

The largest exposure that we retained in 2004 on any one individual property risk was $500,000. For 2005, that retention will remain at $500,000. Individual property risks in excess of these amounts are covered on an excess of loss basis pursuant to various reinsurance treaties. All property lines of business, including commercial automobile physical damage, are reinsured under the same treaties.

Except for umbrella liability, individual casualty risks that are in excess of $500,000 commencing January 1, 2004 ($300,000 in 2003) are covered on an excess of loss basis up to $1.0 million per occurrence, pursuant to various reinsurance treaties. Casualty losses in excess of $1.0 million arising from workers’ compensation claims are reinsured up to $10.0 million on a per occurrence and per person treaty basis by various reinsurers. Umbrella liability losses are reinsured on a 90% quota share basis up to $1.0 million and a 100% quota share basis in excess of $1.0 million up to $5.0 million. Beginning in 2005, umbrella liability losses

are reinsured on a 75% quota share basis up to $1.0 million, with the same 100% quota share basis in excess of $1.0 million up to $5.0 million. We also purchase casualty contingency loss excess reinsurance providing $3.0 million of coverage in excess of $1.0 million.

Catastrophic reinsurance protects the ceding insurer from significant aggregate loss exposure. Catastrophic events include windstorms, hail, tornadoes, hurricanes, earthquakes, riots, blizzards, terrorist activities and freezing temperatures. We purchase layers of excess treaty reinsurance for catastrophic property losses. We reinsure 97.5% (100% beginning in 2005) of losses per occurrence in excess of $2.0 million, up to a maximum of $32.0 million per occurrence. In 2003 we also reinsured 100% of any catastrophic losses per occurrence in an amount between $1.0 million and up to $2.0 million, but this coverage was discontinued for 2004 in view of our greater ability to absorb losses as a consequence of the new capital received in the Conversion.

The insolvency or inability of any reinsurer to meet its obligations to us could have a material adverse effect on our results of operations or financial condition. As of December 31, 2004, our five largest reinsurers based on percentage of ceded premiums are set forth in the following table:


	Percentage
	of Ceded			A.M. Best
Name	Premiums			Rating

1. American Re-Insurance Co		23.6	%		A
2. GE Reinsurance Corporation		17.3	%		A u
3. Motors Insurance Corporation		12.8	%		A
4. Endurance Reinsurance Corp of America		7.6	%		A
5. Arch Reinsurance Company		6.8	%		A	-

The following table sets forth the five largest amounts of loss and loss expenses recoverable from reinsurers on unpaid claims as of December 31, 2004.


	Loss and
	Loss Expenses
	Recoverable on		A.M. Best
Name	Unpaid Claims		Rating

	(In thousands)
1. Motors Insurance Corporation	$	991		A
2. SCOR Reinsurance Company		545		B	++
3. GE Reinsurance Corporation		302		A u
4. American Re-Insurance Co		281		A
5. Endurance Reinsurance Corp of America		154		A

The A and A- ratings are the third and fourth highest of A.M. Best’s 16 ratings. According to A.M. Best, companies with a rating of “A” or “A-” are rated “Excellent”, with “...an excellent ability to meet their ongoing obligations to policyholders.” Companies rated “B++” or “B+” have “...a good ability to meet their ongoing obligations to policyholders.” The subscript “u” after the rating means “under review”. We monitor the solvency of our reinsurers through regular review of their financial statements and their A.M. Best ratings. We have experienced no significant difficulties collecting amounts due from reinsurers.

Reinsurance Assumed

We generally do not assume risks from other insurance companies. However, we are required by statute to participate in certain residual market pools. This participation requires us to assume business for workers’ compensation and for property exposures that are not insured in the voluntary marketplace. We participate in these residual markets pro rata on a market share basis, and as of December 31, 2004, our participation is not material.

Changes on Renewal in Reinsurance Ceded

Effective January 1, 2004, we dropped the first layer of our catastrophe program (as described above, the first layer previously covered 100% of any catastrophic losses per occurrence in an amount between $1.0 million and up to $2.0 million), increased our underlying retention from $300,000 to $500,000, and replaced SCOR Reinsurance Company and PMA Capital Insurance Co. with two new reinsurers: Endurance Reinsurance Corp. of America (rated by A.M. Best at “A”) and GE Reinsurance Corporation. (rated by A. M. Best at “A u”).

INTERCOMPANY AGREEMENTS

Effective January 1, 2002, our insurance companies are parties to a Reinsurance Pooling Agreement and related Loss Portfolio Transfer Reinsurance Agreements. Under these agreements, all premiums, losses and underwriting expenses of our insurance companies are combined and subsequently shared based on each individual company’s statutory surplus from the most recently filed statutory annual statement. The Reinsurance Pooling Agreement has no impact on our consolidated results.

The Company’s insurance subsidiaries are parties to a Services Allocation Agreement, effective as of July 1, 2001. Pursuant to this agreement, any and all employees of Mercer Insurance Company and each of its subsidiaries (other than BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company) were transferred to, and became employees of, BICUS. BICUS has agreed to perform all necessary functions and services required by Mercer Insurance Company and each of its subsidiaries in conducting their respective operations. In turn, Mercer Insurance Company and each of its subsidiaries has agreed to reimburse BICUS for its costs and expenses incurred in rendering such functions and services in an amount determined by the parties.

The Company and its subsidiaries are parties to a consolidated tax allocation agreement that allocates each company a pro rata share of the consolidated income tax expense based upon its contribution of taxable income to the consolidated group.

LOSS AND LAE RESERVES

Our insurance companies are required by applicable insurance laws and regulations to maintain reserves for payment of losses and loss adjustment expenses (LAE). These reserves are established for both reported claims and for claims incurred but not reported (IBNR), arising from the policies they have issued. The laws and regulations require that provision be made for the ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what our insurance companies expect to be the cost of the ultimate settlement and administration of such claims. The reserves are set based on facts and circumstances then known, estimates of future trends in claims severity, and other variable factors such as inflation and changing judicial theories of liability.

Estimating the ultimate liability for losses and LAE is an inherently uncertain process. Therefore, the reserve for losses and LAE does not represent an exact calculation of that liability. Our reserve policy recognizes this uncertainty by maintaining reserves at a level providing for the possibility of adverse development relative to the estimation process. We do not discount our reserves to recognize the time value of money.

When a claim is reported to us, our claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator. The individual estimating the reserve considers the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. Case reserves are adjusted by our claims staff as more information becomes available. It is our policy to settle each claim as expeditiously as possible.

We maintain IBNR reserves to provide for already incurred claims that have not yet been reported and developments on reported claims. The IBNR reserve is determined by estimating our insurance companies’

ultimate net liability for both reported and IBNR claims and then subtracting the case reserves for reported claims.

Each quarter, we compute our estimated ultimate liability using principles and procedures applicable to the lines of business written. However, because the establishment of loss reserves is an inherently uncertain process, we cannot be certain that ultimate losses will not exceed the established loss reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. We do not believe our insurance companies are subject to any material potential asbestos or environmental liability claims.

The following table provides a reconciliation of beginning and ending consolidated loss and LAE reserve balances of the Company and its subsidiaries for the years ended December 31, 2004, 2003 and 2002, prepared in accordance with accounting principles generally accepted in the United States of America.

RECONCILIATION OF RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSES


		Year Ended December 31,

		2004			2003			2002

		(In thousands)
Reserves for losses and loss adjustment expenses at the beginning of period		$	37,261		$	31,348		$	31,059
Less: Reinsurance recoverable and receivables			(5,036	)		(4,150	)		(5,425	)

Net reserves for losses and loss adjustment expenses at beginning of period			32,225			27,198			25,634

Add: Provision for losses and loss adjustment expenses for claims occurring in:
	The current year		29,024			28,329			22,211
	Prior years		(886	)		(596	)		(2,144	)

Total incurred losses and loss adjustment expenses			28,138			27,733			20,067

Less: Loss and loss adjustment expenses payments for claims occurring in:
	The current year		14,626			13,866			11,128
	Prior years		12,772			8,840			7,375

Total losses and loss adjustment expenses paid			27,398			22,706			18,503

Net reserves for losses and loss adjustment expenses at end of period			32,965			32,225			27,198
Add: Reinsurance recoverables and receivables			3,063			5,036			4,150

Reserves for losses and loss adjustment expenses at end of period		$	36,028		$	37,261		$	31,348

The following tables show the development of our consolidated reserves for unpaid losses and LAE from 1994 through 2004 determined under U.S. generally accepted accounting principles (GAAP). The top line of each table shows the liabilities at the balance sheet date, including losses incurred but not yet reported. The upper portion of each table shows the cumulative amounts subsequently paid as of successive years with respect to the liability. The lower portion of each table shows the reestimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimates change as more information becomes known about the frequency and severity of claims for individual years. The redundancy exists when the re-estimated liability at each December 31 is less than the prior liability estimate. The “cumulative redundancy” depicted in the tables, for any particular calendar year, represents the aggregate change in the initial estimates over all subsequent calendar years.


		Year Ended December 31,

		1994		1995		1996		1997		1998		1999

		(In thousands)
Liability for unpaid losses and LAE net of reinsurance recoverable		$	18,298	$	19,357	$	20,074	$	19,851	$	22,565	$	23,643
Cumulative amount of liability paid through:
	One year later		6,935		6,368		6,042		4,536		5,525		5,842
	Two years later		10,272		9,554		8,829		7,537		8,655		8,627
	Three years later		12,336		11,539		11,143		9,738		10,605		11,237
	Four years later		13,228		12,819		12,472		10,975		11,893		12,726
	Five years later		13,749		13,690		13,422		11,550		12,554		13,613
	Six years later		14,079		14,196		13,826		11,816		13,034
	Seven years later		14,373		14,450		14,043		12,118
	Eight years later		14,605		14,621		14,236
	Nine years later		14,732		14,785
	Ten years later		14,795
Liability estimated as of:
	One year later		17,344		17,712		19,018		17,874		19,909		19,689
	Two years later		16,860		17,247		17,634		16,440		17,478		18,506
	Three years later		16,495		16,568		16,987		14,711		16,625		17,484
	Four years later		15,810		16,208		15,905		14,204		15,826		16,167
	Five years later		15,641		15,680		15,769		13,913		14,762		16,200
	Six years later		15,376		15,584		15,483		13,273		14,955
	Seven years later		15,358		15,573		14,986		13,462
	Eight years later		15,424		15,349		15,191
	Nine years later		15,281		15,493
	Ten years later		15,397

Cumulative total redundancy		$	2,901	$	3,863	$	4,883	$	6,389	$	7,611	$	7,443

Gross liability — end of year			35,531		36,176		35,221		31,872		30,948		29,471
Reinsurance recoverables			17,233		16,819		15,147		12,021		8,383		5,828

Net liability — end of year		$	18,298	$	19,357	$	20,074	$	19,851	$	22,565	$	23,643

Gross reestimated liability — latest			27,964		27,238		24,845		21,662		20,341		20,972
Reestimated reinsurance recoverables — latest			12,567		11,745		9,654		8,200		5,386		4,772

Net reestimated liability — latest		$	15,397	$	15,493	$	15,191	$	13,462	$	14,955	$	16,200

Gross cumulative redundancy		$	7,567	$	8,938	$	10,376	$	10,210	$	10,607	$	8,499


		Year Ended December 31,

		2000		2001		2002		2003		2004

		(In thousands)
Liability for unpaid losses and LAE net of reinsurance recoverable		$	24,091	$	25,634	$	27,198	$	32,225	$	32,965
Cumulative amount of liability paid through:
	One year later		5,726		7,376		8,840		12,772		—
	Two years later		9,428		11,850		15,442
	Three years later		12,142		15,610
	Four years later		14,139
	Five years later Six years later Seven years later Eight years later Nine years later Ten years later Liability estimated as of:
	One year later		20,810		23,490		26,601		31,339		—
	Two years later		19,539		22,084		26,924
	Three years later		17,745		22,522
	Four years later		18,050
	Five years later
	Six years later
	Seven years later
	Eight years later
	Nine years later
	Ten years later

Cumulative total redundancy		$	6,041	$	3,111	$	274	$	886		—

Gross liability — end of year			28,766		31,059		31,348		37,261		36,028
Reinsurance recoverables			4,675		5,425		4,150		5,036		3,063

Net liability — end of year		$	24,091	$	25,634	$	27,198	$	32,225	$	32,965

Gross reestimated liability — latest			22,600		27,842		31,214		36,042
Reestimated reinsurance recoverables — latest			4,550		5,320		4,290		4,703

Net reestimated liability — latest		$	18,050	$	22,522	$	26,924	$	31,339

Gross cumulative redundancy		$	6,166	$	3,216	$	134	$	1,219

INVESTMENTS

On a consolidated basis, all of our investment fixed income and equity securities are classified as available for sale and are carried at fair value.

An important component of our consolidated operating results has been the return on invested assets. Our investment objectives are to: (i) maximize current yield, (ii) maintain safety of capital through a balance of high quality, diversified investments that minimize risk, (iii) maintain adequate liquidity for our insurance operations, (iv) meet regulatory requirements, and (v) increase surplus through appreciation. However, in order to enhance the yield on our fixed income securities, our investments generally have a longer duration than the life of our liabilities. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the subsection entitled “Quantitative and Qualitative Information about Market Risk.”

Our investment policy requires that investments be made in a portfolio consisting of bonds, equity securities, and short-term money market instruments. Our equity investments are concentrated in companies with larger capitalizations. However, the Company’s second largest equity holding, valued at $1.1 million, is

our investment in the common stock of Excess Reinsurance Company, which is a privately held, illiquid security (which, in 2004, paid a special dividend to the Group of $274,000). The investment policy does not permit investment in unincorporated businesses, private placements or direct mortgages, foreign denominated securities, financial guarantees or commodities. The Board of Directors of the Company has developed this investment policy and reviews it periodically.

The following table sets forth consolidated information concerning our investments. The changes in the distribution of the fixed income securities portfolio among the categories in the table below from December 31, 2003 to December 31, 2004 reflects our decision, effective January 1, 2004, to move the management of our fixed income securities to a new management firm, and the reallocation undertaken by that firm to achieve an overall increase in returns while maintaining an investment-grade portfolio.


			At December 31, 2004				At December 31, 2003				At December 31, 2002

			Cost(2)		Fair Value		Cost(2)		Fair Value		Cost(2)		Fair Value

			(In thousands)
Fixed income securities(1):
	United States government and government agencies		$	17,870	$	17,700	$	38,974	$	38,826	$	38,802	$	39,499
	Obligations of states and political subdivisions			35,801		35,745		5,083		5,235		5,976		6,149
	Industrial and miscellaneous			16,896		16,781		2,157		2,147		3,216		3,259
	Mortgage-backed securities			30,535		30,431		68		69		336		340

		Total fixed income securities		101,102		100,657		46,282		46,277		48,330		49,247
Equity securities				16,145		24,447		15,866		22,656		16,697		20,332
Short-term investments				—		—		54,396		54,396		—		—

		Total	$	117,247	$	125,104	$	116,544	$	123,329	$	65,027	$	69,579


(1)	In our consolidated financial statements, investments are carried at fair value.

(2)	Original cost of equity securities; original cost of fixed income securities adjusted for amortization of premium and accretion of discount.

The table below contains consolidated information concerning the investment ratings of our fixed maturity investments at December 31, 2004.


		Amortized
Type/Ratings of Investment(1)		Cost		Fair Value		Percentages(2)

		(Dollars in thousands)
U.S. Government and agencies		$	17,870	$	17,700		17.6	%
AAA			49,106		48,899		48.5	%
AA			14,412		14,404		14.3	%
A			14,772		14,757		14.7	%
BBB			4,942		4,897		4.9	%

	Total	$	101,102	$	100,657		100.0	%


(1)	The ratings set forth in this table are based on the ratings assigned by Standard & Poor’s Corporation (S&P). If S&P’s ratings were unavailable, the equivalent ratings supplied by Moody’s Investors Services, Inc., Fitch Investors Service, Inc. or the NAIC were used where available.

(2)	Represents the fair value of the classification as a percentage of the total fair value of the portfolio.

The table below sets forth the maturity profile of our consolidated fixed maturity investments as of December 31, 2004:


		Amortized
Maturity		Cost(1)		Fair Value		Percentages(2)

		(Dollars in thousands)
1 year or less		$	65	$	65		0.1	%
More than 1 year through 5 years			18,772		18,661		18.5	%
More than 5 years through 10 years			39,864		39,708		39.5	%
More than 10 years			11,866		11,792		11.7	%
Mortgage-backed securities			30,535		30,431		30.2	%

	Total	$	101,102	$	100,657		100.0	%


(1)	Fixed maturities are carried at fair value in our consolidated financial statements.

(2)	Represents the fair value of the classification as a percentage of the total fair value of the portfolio.

The average duration of our fixed maturity investments, excluding mortgage-backed securities that are subject to prepayment, was approximately 3.7 years as of December 31, 2004. As a result, the market value of our investments may fluctuate in response to changes in interest rates. In addition, we may experience investment losses to the extent our liquidity needs require the disposition of fixed maturity securities in unfavorable interest rate environments.

Our consolidated average cash and invested assets, net investment income and return on average cash and invested assets for the years ended December 31, 2004, 2003 and 2002 were as follows:


	Year Ended December 31,

	2004			2003			2002

	(Dollars in thousands)
Average cash and invested assets	$	139,015		$	84,572		$	74,973
Net investment income		2,841			1,707			2,061
Return on average cash and invested assets		2.0	%		2.0	%		2.7	%

A.M. BEST RATING

A.M. Best rates insurance companies based on factors of concern to policyholders. A.M. Best currently assigns an “A” (Excellent) rating to our insurance companies as a group. This rating is the third highest out of 16 rating classifications. According to the A.M. Best guidelines, A.M. Best assigns “A” ratings to companies that have, on balance, excellent balance sheet strength, operating performance and business profiles. Companies rated “A” are considered by A.M. Best to have “an excellent ability to meet their ongoing obligations to policyholders.” In evaluating a company’s financial and operating performance, A.M. Best reviews:


	•	the company’s profitability, leverage and liquidity;

	•	its book of business;

	•	the adequacy and soundness of its reinsurance;

	•	the quality and estimated market value of its assets;

	•	the adequacy of its reserves and surplus;

	•	its capital structure;

	•	the experience and competence of its management; and

	•	its marketing presence.

COMPETITION

The property and casualty insurance market is highly competitive. Our insurance companies compete with stock insurance companies, mutual companies, local cooperatives and other underwriting organizations. Some of these competitors have substantially greater financial, technical and operating resources than our insurance companies. Within our producer’s offices we compete to be a preferred market for desirable business, as well as competing with other carriers to attract and retain the best producers. Our ability to compete successfully in our principal markets is dependent upon a number of factors, many of which are outside our control. These factors include market and competitive conditions. Many of our lines of insurance are subject to significant price competition. Some companies may offer insurance at lower premium rates through the use of salaried personnel or other distribution methods, rather than through independent producers paid on a commission basis (as our insurance companies do). In addition to price, competition in our lines of insurance is based on quality of the products, quality and speed of service, financial strength, ratings, distribution systems and technical expertise.

REGULATION

General

Insurance companies are subject to supervision and regulation in the states in which they do business. State insurance authorities have broad administrative powers to administer statutes and regulations with respect to all aspects of our insurance business including:


	•	approval of policy forms and premium rates;

	•	standards of solvency, including establishing statutory and risk-based capital requirements for statutory surplus;

	•	classifying assets as admissible for purposes of determining statutory surplus;

	•	licensing of insurers and their producers;

	•	advertising and marketing practices;

	•	restrictions on the nature, quality and concentration of investments;

	•	assessments by guaranty associations;

	•	restrictions on the ability of our insurance company subsidiaries to pay dividends to us;

	•	restrictions on transactions between our insurance company subsidiaries and their affiliates;

	•	restrictions on the size of risks insurable under a single policy;

	•	requiring deposits for the benefit of policyholders;

	•	requiring certain methods of accounting;

	•	periodic examinations of our operations and finances;

	•	claims practices;

	•	prescribing the form and content of records of financial condition required to be filed; and

	•	requiring reserves for unearned premium, losses and other purposes.

State insurance laws and regulations require our insurance companies to file financial statements with insurance departments everywhere they do business, and the operations of our insurance companies and accounts are subject to examination by those departments at any time. Our insurance companies prepare statutory financial statements in accordance with accounting practices and procedures prescribed or permitted by these departments.

Examinations

Examinations are conducted by the Pennsylvania Insurance Department and the New Jersey Department of Banking and Insurance every three to five years. The Pennsylvania Insurance Department’s last examination of Mercer Insurance Company was as of December 31, 1999. Their last examination of Franklin Insurance Company was as of December 31, 2001. The New Jersey Department of Banking and Insurance’s last completed examination of Mercer Insurance Company was as of December 31, 1995. Their last examination of Mercer Insurance Company of New Jersey, Inc. was as of December 31, 2000. These examinations did not result in any adjustments to the financial position of any of our insurance companies. In addition, there were no substantive qualitative matters indicated in the examination reports that had a material adverse impact on the operations of our insurance companies. The Group has been notified that normal tri-ennial financial examinations by both the Pennsylvania and New Jersey regulators will commence in 2005.

NAIC Risk-Based Capital Requirements

In 1990, the National Association of Insurance Commissioners (the “NAIC”) began an accreditation program to ensure that states have adequate procedures in place for effective insurance regulation, especially with respect to financial solvency. The accreditation program requires that a state meet specific minimum standards in over five regulatory areas to be considered for accreditation. The accreditation program is an ongoing process and once accredited, a state must enact any new or modified standards approved by the NAIC within two years following adoption. As of December 31, 2004, Pennsylvania and New Jersey, the states in which our insurance company subsidiaries are domiciled, were accredited.

Pennsylvania and New Jersey both impose the NAIC’s risk-based capital requirements that require insurance companies to calculate and report information under a risk-based formula. These risk-based capital requirements attempt to measure statutory capital and surplus needs based on the risks in a company’s mix of products and investment portfolio. Under the formula, a company first determines its “authorized control level” risk-based capital. This authorized control level takes into account (i) the risk with respect to the insurer’s assets; (ii) the risk of adverse insurance experience with respect to the insurer’s liabilities and obligations, (iii) the interest rate risk with respect to the insurer’s business; and (iv) all other business risks and such other relevant risks as are set forth in the RBC instructions. A company’s “total adjusted capital” is the sum of statutory capital and surplus and such other items as the risk-based capital instructions may provide. The formula is designed to allow state insurance regulators to identify weakly capitalized companies.

The requirements provide for four different levels of regulatory attention. The “company action level” is triggered if a company’s total adjusted capital is less than 2.0 times its authorized control level but greater than or equal to 1.5 times its authorized control level. At the company action level, the company must submit a comprehensive plan to the regulatory authority that discusses proposed corrective actions to improve the capital position. The “regulatory action level” is triggered if a company’s total adjusted capital is less than 1.5 times but greater than or equal to 1.0 times its authorized control level. At the regulatory action level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The “authorized control level” is triggered if a company’s total adjusted capital is less than 1.0 times but greater than or equal to 0.7 times its authorized control level; at this level the regulatory authority may take action it deems necessary, including placing the company under regulatory control. The “mandatory control level” is triggered if a company’s total adjusted capital is less than 0.7 times its authorized control level; at this level the regulatory authority is mandated to place the company under its control. The capital levels of our insurance companies have never triggered any of these regulatory capital levels. We cannot assure you, however, that the capital requirements applicable to the business of our insurance companies will not increase in the future.

NAIC Ratios

The NAIC also has developed a set of 11 financial ratios referred to as the Insurance Regulatory Information System or (IRIS). On the basis of statutory financial statements filed with state insurance regulators, the NAIC annually calculates these IRIS ratios to assist state insurance regulators in monitoring

the financial condition of insurance companies. The NAIC has established an acceptable range for each of the IRIS financial ratios. If four or more of its IRIS ratios fall outside the range deemed acceptable by the NAIC, an insurance company may receive inquiries from individual state insurance departments. During each of the years ended December 31, 2003 and 2002, Mercer Insurance Company, Mercer Insurance Company of New Jersey, Inc., and Franklin Insurance Company did not produce results outside the acceptable range for four or more IRIS tests. The results for 2004 are not yet available.

Market Conduct Regulation

State insurance laws and regulations include numerous provisions governing trade practices and the marketplace activities of insurers, including provisions governing the form and content of disclosure to consumers, illustrations, advertising, sales practices and complaint handling. State regulatory authorities generally enforce these provisions through periodic market conduct examinations, which the Company is subject to from time to time. A market conduct examination of Franklin Insurance Company was recently completed by the Pennsylvania Insurance Department without any material issues. A market conduct examination of our New Jersey Homeowners and Combination Dwelling lines of business was also recently completed, and we are waiting for the report. To our knowledge, we are currently in substantial compliance with the related provisions.

Property and Casualty Regulation

Our property and casualty operations are subject to rate and policy form approval. All of the rates and policy forms that we use that require regulatory approval have been filed with and approved by the appropriate insurance regulator. Our operations are also subject to laws and regulations covering a range of trade and claim settlement practices. To our knowledge, we are currently in compliance with these laws and regulations. State insurance regulatory authorities have broad discretion in approving an insurer’s proposed rates. The extent to which a state restricts underwriting and pricing of a line of business may adversely affect an insurer’s ability to operate that business profitably in that state on a consistent basis.

State insurance laws and regulations require us to participate in mandatory property-liability “shared market,” “pooling” or similar arrangements that provide certain types of insurance coverage to individuals or others who otherwise are unable to purchase coverage voluntarily provided by private insurers. Shared market mechanisms include assigned risk plans; fair access to insurance requirements or “FAIR” plans; and reinsurance facilities, such as the New Jersey Unsatisfied Claim and Judgment Fund. In addition, some states require insurers to participate in reinsurance pools for claims that exceed specified amounts. Our participation in these mandatory shared market or pooling mechanisms generally is related to the amounts of our direct writings for the type of coverage written by the specific arrangement in the applicable state. For the three years ended December 31, 2004, 2003 and 2002, we received earned premium from these arrangements in the amounts of $1,829,000, $1,312,000, and $666,000, respectively, and incurred losses and loss expenses from these arrangements in the amounts of $1,565,000, $582,000, and $415,000, respectively. Because we do not have a significant amount of direct writings in the coverages written under these arrangements, we do not anticipate that these arrangements will have a material effect on us in the future. However, we cannot predict the financial impact of our participation in any shared market or pooling mechanisms that may be implemented in the future by the states in which we do business.

Guaranty Fund Laws

Many states have guaranty fund laws under which insurers doing business in the state can be assessed to fund policyholder liabilities of insolvent insurance companies. New Jersey and Pennsylvania, the states in which our insurance companies do business, have such laws. Under these laws, an insurer is subject to assessment depending upon its market share in the state of a given line of business. For the years ended December 31, 2004, 2003 and 2002, we incurred approximately ($28,000), $101,000, and $99,000, respectively, in assessments pursuant to state insurance guaranty association laws. The negative assessment incurred in 2004 reflects the settlement of guaranty fund assessments for 2002 and 2001 at more favorable rates than anticipated. We establish reserves relating to insurance companies that are subject to insolvency proceedings

when we are notified of assessments by the guaranty associations. We cannot predict the amount and timing of any future assessments on our insurance companies under these laws.

Sarbanes-Oxley Act of 2002

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, or the SOA. The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission, or the SEC, under the Securities Exchange Act of 1934, or the Exchange Act.

The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of specified issues by the SEC and the Comptroller General.

The SOA addresses, among other matters:


	•	audit committees;

	•	certification of financial statements by the chief executive officer and the chief financial officer;

	•	the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

	•	a prohibition on insider trading during pension plan black out periods;

	•	disclosure of off-balance sheet transactions;

	•	a prohibition on personal loans to directors and officers;

	•	expedited filing requirements for Form 4 statements of changes of beneficial ownership of securities required to be filed by officers, directors and 10% shareholders;

	•	disclosure of whether or not a company has adopted a code of ethics;

	•	“real time” filing of periodic reports;

	•	auditor independence; and

	•	various increased criminal penalties for violations of securities laws.

The SEC has been delegated the task of enacting rules to implement various provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act. To date, the SEC has implemented most of the provisions of the SOA. However, the SEC continues to issue final rules, reports, and press releases. As the SEC provides new requirements, we will review those rules and comply as required. In addition, the common stock trades on the Nasdaq National Market. NASDAQ also has adopted corporate governance rules that require additional compliance and supplement the SEC requirements under the SOA. We believe we are in compliance with all NASDAQ rules.

Terrorism Risk Insurance Act of 2002

On November 26, 2002, President Bush signed the Terrorism Risk Insurance Act of 2002 (TRIA). Under this law, coverage provided by an insurer for losses caused by certified acts of terrorism is partially reimbursed by the United States under a formula under which the government pays 90% of covered terrorism losses, exceeding a prescribed deductible. Therefore, the act limits an insurer’s exposure to certified terrorist acts (as defined by the act) to the deductible formula. The deductible is based upon a percentage of direct earned premium for commercial property and casualty policies. Coverage under the act must be offered to all property, casualty and surety insureds.

The immediate effect was to nullify terrorism exclusions previously permitted by state regulators to the extent they exclude losses that would otherwise be covered under the act. The act further states that until December 31, 2003, rates and forms for terrorism risk insurance covered by the act are not subject to prior approval or a waiting period under any applicable state law. Rates and forms of terrorism exclusions and endorsements are subject to subsequent review.

We are currently charging a premium for certified terrorism coverage on our Businessowners, Commercial Automobile and commercial Workers’ Compensation policies. In 2005, we expect to start charging a premium for certified terrorism coverage for tenant-occupied dwelling policies and for all policies issued under a Special Contractors policy. Insureds who are charged a terrorism premium have the option (except Workers’ Compensation) of deleting certified terrorism coverage to reduce their premium costs, however most do not do so. Insureds under commercial Workers’ Compensation policies do not have the option to delete the certified terrorism coverage. Most other policies include certified terrorism coverage at no additional cost. Where allowed, we exclude coverage for losses that are from events not certified as terrorism events, with no buyback option available to the policyholder.

The legislation that created the Terrorism Risk Insurance Act of 2002 expires on December 31, 2005. If this legislation is not extended beyond that date, all potential reimbursement for certified terrorism losses will end on that date. In order to limit our exposure for certified terrorism losses, we have received approval from our state regulators to use a contingent certified terrorism exclusion that will exclude coverage for certified terrorism losses that occur after December 31, 2005 in the event that TRIA is not extended.

We are unable to predict the extent to which this legislation may affect the demand for our products or the risks that will be available for us to consider underwriting. We do not know the extent to which insureds will elect to purchase this coverage when available.

Financial Services Modernized

The Gramm-Leach-Bliley Act was signed into law by President Clinton on November 12, 1999. The principal focus of the act is to facilitate affiliations among banks, securities firms and insurance companies. The ability of banks and securities firms to affiliate with insurers may increase the number, size and financial strength of our potential competitors.

Privacy

As mandated by the Gramm-Leach-Bliley Act, states continue to promulgate and refine laws and regulations that require financial institutions, including insurance companies, to take steps to protect the privacy of certain consumer and customer information relating to products or services primarily for personal, family or household purposes. A recent NAIC initiative that affected the insurance industry was the adoption in 2000 of the Privacy of Consumer Financial and Health Information Model Regulation, which assisted states in promulgating regulations to comply with the Gramm-Leach-Bliley Act. In 2002, to further facilitate the implementation of the Gramm-Leach-Bliley Act, the NAIC adopted the Standards for Safeguarding Customer Information Model Regulation. Several states have now adopted similar provisions regarding the safeguarding of customer information. Our insurance subsidiaries have implemented procedures to comply with the Gramm-Leach-Bliley Act’s privacy requirements.

OFAC

The Treasury Department’s Office of Foreign Asset Control (OFAC) maintains a list of “Specifically Designated Nationals and Blocked Persons” (the SDN List). The SDN List identifies persons and entities that the government believes are associated with terrorists, rogue nations or drug traffickers. OFAC’s regulations prohibit insurers, among others, from doing business with persons or entities on the SDN List. If the insurer finds and confirms a match, the insurer must take steps to block or reject the transaction, notify the affected person and file a report with OFAC. The focus on insurers’ responsibilities with respect to the SDN List has increased significantly since September 11, 2001.

New and Proposed Legislation and Regulations

The property and casualty insurance industry has recently received a considerable amount of publicity because of rising insurance costs, the lack of availability of insurance, and the issue of paying profit-sharing commissions to agents. New regulations and legislation are being proposed to limit damage awards, to control plaintiffs’ counsel fees, to bring the industry under regulation by the federal government and to control premiums, policy terminations and other policy terms. We are unable to predict whether, in what form, or in what jurisdictions, any regulatory proposals might be adopted or their effect, if any, on our insurance companies.

Dividends

Our insurance companies are restricted by the insurance laws of their respective states of domicile regarding the amount of dividends or other distributions they may pay without notice to or the prior approval of the state regulatory authority. The Pennsylvania Insurance Department’s approval of Mercer Insurance Company’s Conversion to stock form was given subject to, among other things, the condition that for a period of three years following the Conversion, Mercer Insurance Company may not declare or pay a dividend to the Holding Company without the approval of the Pennsylvania Insurance Department. After this three-year period has expired, Mercer Insurance Company’s ability to declare and pay dividends to the Holding Company will be subject to Pennsylvania law.

Pennsylvania law sets the maximum amount of dividends that may be paid by Mercer Insurance Company and Franklin Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. With respect to each insurance company, this amount cannot exceed the greater of 10% of the company’s statutory surplus as reported on the most recent annual statement filed with the Pennsylvania Insurance Department, or the company’s net income for the period covered by the annual statement. If the dividend restrictions contained in the Pennsylvania Insurance Department’s approval of the Conversion were not in effect, then as of December 31, 2004, the amount available for payment of dividends by Mercer Insurance Company to the Company in 2005 without the prior approval of the Pennsylvania Insurance Department would be approximately $6.2 million.

New Jersey law sets the maximum amount of dividends that may be paid by Mercer Insurance Company of New Jersey, Inc. during any twelve-month period after notice to, but without prior approval of, the New Jersey Department of Banking and Insurance. This amount cannot exceed the greater of 10% of Mercer Insurance Company of New Jersey, Inc.’s statutory surplus as reported on the most recent annual statement filed with New Jersey, or the net income, not including realized capital gains, of Mercer Insurance Company of New Jersey, Inc. for the period covered by the annual statement. As of December 31, 2004, the amount available for payment of dividends by Mercer Insurance Company of New Jersey, Inc. to Mercer Insurance Company in 2005 (through Queenstown Holding Company, an intermediary holding company) without the prior approval of New Jersey Department of Banking and Insurance would be approximately $1.6 million.

Holding Company Laws

Most states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish certain information. This includes information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine our insurance companies and their holding companies at any time, require disclosure of material transactions by our insurance companies and their holding companies and require prior notice of approval of certain transactions, such as “extraordinary dividends” distributed by our insurance companies.

All transactions within the holding company system affecting our insurance companies and their holding companies must be fair and equitable. Notice of certain material transactions between our insurance companies and any person or entity in our holding company system will be required to be given to the

applicable insurance commissioner. In some states, certain transactions cannot be completed without the prior approval of the insurance commissioner.

Approval of the state insurance commissioner is required prior to any transaction affecting the control of an insurer domiciled in that state. In New Jersey and Pennsylvania, the acquisition of 10% or more of the outstanding capital stock of an insurer or its holding company is presumed to be a change in control. Pennsylvania law also prohibits any person from (i) making a tender offer for, or a request or invitation for tenders of, or seeking to acquire or acquiring any voting security of a Pennsylvania insurer if, after the acquisition, the person would be in control of the insurer, or (ii) effecting or attempting to effect an acquisition of control of or merger with a Pennsylvania insurer, unless the offer, request, invitation, acquisition, effectuation or attempt has received the prior approval of the Pennsylvania Insurance Department.

EMPLOYEES

All of our employees are employed directly by BICUS Services Corporation, a wholly owned subsidiary of Mercer Insurance Company. Our insurance companies do not have any employees. BICUS provides management services to all of our insurance companies. As of December 31, 2004, the total number of full-time equivalent employees of BICUS was 97. None of these employees are covered by a collective bargaining agreement and BICUS believes that its employee relations are good.


ITEM 2.	*PROPERTIES*

Our main office is located at 10 North Highway 31, Pennington, New Jersey in a 25,000 square foot facility owned by Mercer Insurance Company. Mercer Insurance Company completed in 2004 an addition of 11,000 square feet to this structure at a cost of $2.9 million. We also own a tract of land adjacent to our main office property.

Mercer Insurance Company also owns a 32,000 square foot office facility in Lock Haven, Pennsylvania. Mercer Insurance Company sub-leases a portion of this facility. Recent renovations to this facility were completed in December 2002 at a cost of $2.1 million.


ITEM 3.	*LEGAL PROCEEDINGS*

Our insurance companies are parties to litigation in the normal course of business. Based upon information presently available to us, we do not consider any litigation to be material. However, given the uncertainties attendant to litigation, we cannot be sure that our results of operations and financial condition will not be materially adversely affected by any litigation.


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

None.

PART II


ITEM 5.	*MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.*

The common stock trades on the Nasdaq National Market under the symbol “MIGP”. As of March 2, 2005, the Company had 370 shareholders of record holding approximately 1.3 million shares, with the balance of the outstanding shares held in street name.

The Company does not currently pay a dividend. Any payment of dividends in the future on the common stock is subject to determination and declaration by the Company’s Board of Directors, who will take into consideration the Company’s financial condition, results of operations and future prospects. Additionally, the Company is prohibited from declaring or paying any dividends during the three years following the

Conversion, unless such dividends are approved by the Pennsylvania Insurance Department. At present, the Company has no plans to pay a dividend to our shareholders.

Information regarding restrictions and limitations on the payment of cash dividends can be found in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the “Financial Condition, Liquidity and Capital Resources” section.

The range of closing prices of the Company’s stock, traded on the NASDAQ National Market, during 2004 fell between $11.55 and $13.93 per share. The range of closing prices during each of the quarters in 2004 is shown below:


		4^thQuarter				3^rdQuarter				2^ndQuarter				1^stQuarter

		2004		2003		2004		2003		2004		2003		2004		2003

Share price range:
	High	$	13.48	$	12.61	$	12.18		N/A	$	12.82		N/A	$	13.93		N/A
	Low	$	11.65	$	12.15	$	11.55		N/A	$	11.58		N/A	$	12.40		N/A

Information relating to the Company’s stock repurchase programs and activity in the most recent quarter is presented below:

Total Number of

Maximum Number

Shares Purchased as

of Shares that May

Part of Publicly

Yet be Purchased

Announced Plans or

Under the Plans or

Total Number of

Average Price Paid

Programs

Period

Shares Purchased

per Share

(Notes 1 and 2)

October 1-31, 2004

None

N/A

None

250,000

November 1-30, 2004

6,500

12.19

6,500

243,500

December 1-31, 2004

None

N/A

None

243,500

Total

6,500

12.19

6,500

243,500

Note 1 — On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. As of September 30, 2004, 250,000 shares had been repurchased under this authorization for a total consideration of $2,975,000, or $11.90 per share.

Note 2 — On October 20, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, in addition to the June 16, 2004 authorization, and under the same terms and conditions. The program was intended to continue until October 20, 2005, or until 250,000 shares were repurchased, whichever occurs first, unless the program was extended or expanded. The repurchased shares will be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. From January 1, 2005 through March 2, 2005, 243,500 shares were repurchased under this authorization , thereby completing all purchases currently authorized. The 2005 repurchases of 243,500 shares were completed for $3,210,000, or $13.18 per share. The total cost of repurchases under this authorization (250,000 shares) was $3,290,000, or $13.16 per share.


ITEM 6.	*SELECTED FINANCIAL DATA*

The following table sets forth selected consolidated financial data for Mercer Insurance Group, Inc. at and for each of the years in the five year period ended December 31, 2004. You should read this data in conjunction with the Company’s consolidated financial statements and accompanying notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial information included elsewhere in this report.


				Years Ended December 31,

				2004			2003			2002			2001			2000

				(Shares and dollars in thousands, except per share amounts)
Revenue Data:
	Direct premiums written			$	65,790		$	61,152		$	50,858		$	41,497		$	31,782
	Net premiums written				59,504			52,802			44,471			34,710			28,049
Statement of Earnings Data:
	Net premiums earned				55,784			47,864			40,454			30,728			27,635
	Investment income, net of expenses				2,841			1,707			2,061			2,425			2,517
	Net realized investment gains (losses)				484			703			(220	)		42			(288	)
	Total revenue				59,467			50,660			42,624			33,445			30,031
	Conversion expense(1)				—			66			95			—			—
	Minority interest in (income) of subsidiary(2)				—			(131	)		(138	)		(100	)		—
	Net income				3,264			583			2,242			3,300			3,068
	Comprehensive income(3)				3,972			2,073			1,620			2,485			4,983
Balance Sheet Data (End of Period):
	Total assets				180,427			175,875			105,848			97,119			84,857
	Total investments and cash				141,393			138,679			76,780			73,166			69,055
	Minority interest in subsidiary(2)				—			—			3,112			1,926			—
	Stockholders equity				100,408			98,326			37,017			35,397			32,912
Ratios:
	GAAP combined ratio(4)				98.8	%		103.8	%		96.4	%		93.6	%		93.2	%
	Statutory combined ratio(5)				95.4	%		102.2	%		94.7	%		93.4	%		92.9	%
	Statutory premiums to-surplus ratio(6)				0.96	x		1.72	x		1.54	x		1.10	x		0.97	x
Per-share data:(7)
		Net income (loss):
			Basic		0.52			(0.08	)		N/A			N/A			N/A
			Diluted		0.51			(0.08	)		N/A			N/A			N/A
		Stockholders’ equity			16.49			15.65			N/A			N/A			N/A
Weighted average shares:(8)
			Basic		6,236			6,253			N/A			N/A			N/A
			Diluted		6,354			6,253			N/A			N/A			N/A

(1)

Costs and expenses related to the stock conversion incurred in the years ended December 31, 2003 and 2002. These costs and expenses are reported separately in our consolidated income statements within income from continuing operations before income taxes. Stock conversion expenses consist primarily of the costs of engaging independent accounting, valuation, legal and other consultants to advise us and our insurance regulators as to the stock conversion process and related matters, as well as printing and postage costs relating to our communications with our policyholders. These costs and expenses are reported in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 00-3, “Accounting by Insurance Enterprises for Demutualizations and Formations of

Mutual Insurance Holding Companies and for Certain Long-Duration Participating Contracts.” SOP 00-3 addresses financial statement presentation and accounting for stock conversion expenses and accounting for retained earnings and other comprehensive income at the date of the stock conversion.

(2) Income of the Company attributable to the minority interest in Franklin Holding Company, which interest was acquired immediately after the Conversion for shares of the Company.

(3) Includes Net Income and the change in Unrealized Gains and Losses of the investment portfolio.

(4) The sum of losses, loss adjustment expenses, underwriting expenses and dividends to policyholders divided by net premiums earned. A combined ratio of less than 100% means a company is making an underwriting profit.

(5) The sum of the ratio of underwriting expenses divided by net premiums written, and the ratio of losses, loss adjustment expenses, and dividends to policyholders divided by net premiums earned.

(6) The ratio of net premiums written divided by ending statutory surplus, except for 2003, where a weighted average of statutory surplus is used.

(7) Earnings per share data reflects only net loss for the period from December 16, 2003, the date of the Conversion, through December 31, 2003. Net loss during this period was ($477,000).

(8) Unallocated ESOP shares at December 31, 2004 and 2003, are not reflected in weighted average shares.


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

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

OVERVIEW

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


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

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

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

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

Our income is principally derived from insurance premiums received from insureds in the commercial lines (businesses insured) and personal lines (individuals insured) segments, less the costs of underwriting the insurance policies, the costs of settling and paying claims reported on the policies, and from investment income reduced by investment expenses, and from gains or losses on holdings in our investment portfolio. Variability in our income is caused by a variety of circumstances, some within the control of our companies

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

CRITICAL ACCOUNTING POLICIES

General

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

Liabilities for Loss and Loss Adjustment Expenses

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

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

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

The table below summarizes the effect on net loss reserves and surplus in the event of reasonably likely changes in the variables considered in establishing loss and loss adjustment expense reserves. The range of reasonably likely changes was established based on a review of changes in accident year development by line of business and applied to loss reserves as a whole. The selected range of changes does not indicate what could be the potential best or worst case or likely scenarios:


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

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


(1)	Net of Tax

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

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

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


		December 31,

		2004		2003		2002

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

			21,679		22,883		18,636

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

			14,349		14,378		12,712

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

Investments

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

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

In evaluating the potential impairment of equity securities, the Investment Committee will evaluate certain factors, including but not limited to the following: the relationship of market price per share versus

carrying value per share at the date of acquisition and the date of evaluation, the price-to-earnings ratio at the date of acquisition and the date of evaluation, any rating agency announcements, the issuer’s financial condition and near-term prospects, including any specific events that may influence the issuer’s operations, the independent auditor’s report on the issuer’s financial statements; and any buy/sell/hold recommendations or price projections by outside investment advisors.

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

Policy Acquisition Costs

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

Reinsurance

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

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

We continually monitor the financial condition of our reinsurers.

Income Taxes

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

RESULTS OF OPERATIONS

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

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


				December 31,

				2004			2003			2002

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

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

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

			Total Revenues		59,467			50,660			42,624

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

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

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

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

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

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

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


2004 vs. 2003 Income		2004			2003			Change			% Change

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

(N/ M means “not meaningful”)

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

A strong performance in our commercial lines underwriting results, coupled with a modest improvement in our personal lines underwriting results, resulted in a return to underwriting profitability in 2004 from 2003, with an overall underwriting profit of $673,000, as compared to an underwriting loss of $1.8 million in 2003. Our GAAP combined ratio improved to 98.8% in 2004 from 103.8%, and our statutory combined ratio improved in 2004 to 95.4% from 102.2%. Our net investment income increased 66.4% to $2.8 million, primarily as a result of the increased investment portfolio resulting from the receipt of $53 million in Conversion proceeds on December 16, 2003. Realized investment gains, primarily from the sale of equity securities in both 2004 and 2003, added to the Company’s income as the equities portfolio value continued to grow in 2004. Our other income, primarily service charges recorded on insurance premiums paid over the term of the policy instead of when the policy is issued, declined modestly in 2004. In 2004 there was no minority interest in the income of our subsidiary, as there was in 2003, because all of the minority interest was acquired immediately after the Conversion in the acquisition of the remaining 51% of Franklin Holding Company. Also impacting the Company’s income in 2004 was the cost of being a public company, which adversely impacted both net income and the GAAP underwriting expense ratio, and, to a lesser extent, the statutory underwriting expense ratio.

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

tornados, and windstorms, all of which resulted in a higher than usual frequency of claims throughout most of 2003.

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


2004 vs. 2003 Revenue		2004		2003		Change			% Change

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

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

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

Growth in Net Investment Income is discussed below.


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

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

(N/ M means “not meaningful”)

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

Effective January 1, 2004, the Company engaged a new management firm for its fixed income securities portfolio. One of its assignments was to invest the proceeds of the Conversion, which, given a difficult interest rate environment and fixed income securities market, was not largely completed until the second quarter of 2004. Consequently, a significant portion of the Conversion proceeds earned a cash-equivalent yield during

this period. In addition, investment expenses increased in 2004 by approximately $210,000 for the cost of such management, compared to the prior commission-based fixed income securities management which existed while the Company was a mutual insurance company prior to the Conversion.

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

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


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

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

Total	$	1,301	$	296

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

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


					Length of Unrealized Loss

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

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

Results of our Commercial Lines segment were as follows:


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

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

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

2004, compared to $18.6 million for 2003, and commercial multi-peril net premiums earned increased by 30.4% to $16.5 million in 2004, compared to $12.7 million for 2003. Our largest increase in policy count was within our Religious Institutions sector, where our increasing market presence is helping us add new premium, and in our Special Contractors sector. We expect this trend of increasing commercial writings to continue by targeting selected types of risks with selected producers.

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

Results of our Personal Lines segment were as follows:


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

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

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

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

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

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

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


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

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

(N/ M means “not meaningful”)

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

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

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


2004 vs. 2003 Income Taxes		2004			2003			Change			% Change

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

(N/ M means “not meaningful”)

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

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

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

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

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

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

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

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

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


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

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

Total	$	1,080	$	204

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


						Length of Unrealized Loss

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

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

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

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

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

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

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

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

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

IMPACT OF INFLATION

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

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

OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS

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

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


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

	(Dollars in thousands)
Property and Casualty Insurance Reserves, Net of Reinsurance	$	12,602		12,399		4,706		3,258	$	32,965

Total Contractual Obligations	$	12,602		12,399		4,706		3,258	$	32,965

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

General. Market risk is the risk that we will incur losses due to adverse changes in market rates and prices. We have exposure to three principal types of market risk through our investment activities: interest rate risk, credit risk and equity risk. Our primary market risk exposure is to changes in interest rates. We have not entered, and do not plan to enter, into any derivative financial instruments for hedging, trading or speculative purposes.

Interest Rate Risk. Interest rate risk is the risk that we will incur economic losses due to adverse changes in interest rates. Our exposure to interest rate changes primarily results from our significant holdings of fixed rate investments. Fluctuations in interest rates have a direct impact on the market valuation of these securities.

As of December 31, 2004, the average maturity of our fixed income investment portfolio (excluding mortgage-backed securities) was 3.7 years. Our fixed maturity investments include U.S. government bonds, securities issued by government agencies, obligations of state and local governments and governmental authorities, corporate bonds and mortgage-backed securities, most of which are exposed to changes in prevailing interest rates. We carry these investments as available for sale. This allows us to manage our exposure to risks associated with interest rate fluctuations through active review of our investment portfolio by our management and board of directors and consultation with our financial advisor.

Fluctuations in near-term interest rates could have an impact on the results of operations and cash flows. Certain of these fixed income securities have call features. In a declining interest rate environment, these securities may be called by their issuer and replaced with securities bearing lower interest rates. In a rising interest rate environment, we may sell these securities (rather than holding to maturity) and receive less than we paid for them.

As a general matter, we do not attempt to match the durations of our assets with the durations of our liabilities. Our goal is to maximize the total return on all of our investments. An important strategy that we employ to achieve this goal is to try to hold enough in cash and short-term investments in order to avoid liquidating longer-term investments to pay claims.

The table below shows the interest rate sensitivity of our fixed income financial instruments measured in terms of market value (which is equal to the carrying value for all our securities).


	As of December 31, 2004
	Market Value

	-100 Basis		No Rate		+100 Basis
	Point Change		Change		Point Change

	(In thousands)
Bonds and preferred stocks	$	106,933	$	103,580	$	98,860
Cash and cash equivalents		16,289		16,289		16,289

Total	$	123,222	$	119,869	$	115,149

Credit Risk

The quality of our interest-bearing investments is generally good. 100% of our fixed maturity securities are rated investment grade.

Equity Risk

Equity price risk is the risk that we will incur economic losses due to adverse changes in equity prices. Our exposure to changes in equity prices primarily results from our holdings of common stocks, mutual funds and other equities. Our portfolio of equity securities is carried on the balance sheet at fair value. Therefore, an adverse change in market prices of these securities would result in losses. Portfolio characteristics are analyzed regularly and market risk is actively managed through a variety of techniques. In accordance with accounting principles generally accepted in the United States of America, when an equity security becomes other than temporarily impaired, we record this impairment as a charge against earnings. For the year ended December 31, 2004, we recorded pre-tax charges of $15,000 for an individual equity security that we concluded was other than temporarily impaired, and sold in early 2005.

Company and industry concentrations are monitored by the Board of Directors. At December 31, 2004, Mercer Insurance Company’s equity portfolio made up 19.5% of the Company’s total investment portfolio, and was relatively concentrated in terms of the number of issuers and industries. At December 31, 2004, Mercer Insurance Company’s top ten equity holdings represented $8.2 million or 33.5% of the equity portfolio.

Investments in the financial sector represented 30.4% while investments in pharmaceutical companies, conglomerates and information technology companies represented 4.0%, 7.8% and 7.9%, respectively, of the equity portfolio at December 31, 2004. Such concentration can lead to higher levels of short-term price volatility. Due to our long-term investment focus, we are not as concerned with short-term volatility as long as our insurance subsidiaries’ ability to write business is not impaired. The table below summarizes the Company’s equity price risk and shows the effect of a hypothetical 20% increase and a 20% decrease in market prices as of December 31, 2004. The selected hypothetical changes do not indicate what could be the potential best or worst case scenarios.

Estimated Fair

Hypothetical

Estimated Fair

Value After

Percentage Increase

Value of Equity

Hypothetical

(Decrease) in

Securities at

Hypothetical

Change in

Stockholders’

12/31/04

Price Change

Prices

Equity(1)

(In thousands)

24,447

20% increase

29,336

3.2

24,447

20% decrease

19,558

(3.2


(1)	Net of tax


ITEM 8.	*FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.*

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2004. 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, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

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

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2004 and 2003


				2004			2003

				(Dollars in thousands,
				except share amounts)
ASSETS
Investments, at fair value:
	Fixed-income securities, available for sale, at fair value (cost $101,102 and $46,282, respectively)			$	100,657		$	46,277
	Equity securities, at fair value (cost $16,145 and $15,866 respectively)				24,447			22,656
	Short-term investments, at cost, which approximates fair value				—			54,396

			Total investments		125,104			123,329
Cash and cash equivalents					16,289			15,350
Premiums receivable					11,217			9,096
Reinsurance receivables					1,683			4,159
Prepaid reinsurance premiums					1,573			1,614
Deferred policy acquisition costs					8,014			7,387
Accrued investment income					1,044			596
Property and equipment, net					9,718			6,944
Goodwill					4,673			4,673
Other assets					1,112			2,727

Total assets				$	180,427			175,875


LIABILITIES AND EQUITY
Liabilities:
	Losses and loss adjustment expenses			$	36,028		$	37,261
	Unearned premiums				34,007			30,329
	Accounts payable and accrued expenses				7,739			7,937
	Other reinsurance balances				10			81
	Other liabilities				1,089			1,228
	Deferred income taxes				1,146			713

			Total liabilities		80,019			77,549

Stockholders’ Equity:
	Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding				—			—
	Common stock, no par value, authorized 15,000,000 shares, issued 7,060,733 shares, outstanding 6,344,844 and 6,282,233 shares				—			—
	Additional paid-in capital				67,651			64,871
	Accumulated other comprehensive income:
		Unrealized gains in investments, net of deferred income taxes			5,186			4,478
	Retained Earnings				37,876			34,612
	Unearned restricted stock compensation				(2,242	)		—
	Unearned ESOP shares				(5,009	)		(5,635	)
	Treasury stock, 256,500 and -0- shares				(3,054	)		—

			Total stockholders’ equity		100,408			98,326

Total liabilities and stockholders’ equity				$	180,427		$	175,875

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Earnings

Years ended December 31, 2004, 2003, and 2002


			2004		2003			2002

			(Dollars in thousands, except
			per share data)
Revenue:
	Net premiums earned		$	55,784	$	47,864		$	40,454
	Investment income, net of expenses			2,841		1,707			2,061
	Net realized investment gains (losses)			484		703			(220	)
	Other revenue			358		386			329

		Total revenue		59,467		50,660			42,624

Expenses:
	Losses and loss adjustment expenses			28,138		27,733			20,067
	Amortization of deferred policy acquisition costs (related party amounts of $1,775, $1,198 and $955, respectively)			15,075		13,413			10,953
	Other expenses			11,898		8,560			7,974
	Stock conversion expenses			—		66			95

		Total expenses		55,111		49,772			39,089

		Income before income taxes and minority interest in income of subsidiary		4,356		888			3,535
Income taxes				1,092		174			1,155

		Income before minority interest in income of subsidiary		3,264		714			2,380
Minority interest in income of subsidiary				—		(131	)		(138	)

Net income			$	3,264	$	583		$	2,242


				For the Period
				December 16
				through
				December 31,
				2003

Net loss after conversion				$	(477	)
Net income per common share:
	Basic	$	0.52	$	(0.08	)	N/A
	Diluted	$	0.51	$	(0.08	)	N/A

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

Years ended December 31, 2004, 2003, and 2002


								Accumulated					Unearned
						Additional		other					Restricted			Uearned
		Preferred		Common		Paid-in		Comprehensive			Retained		Stock			ESOP			Treasury
		Stock		Stock		Capital		Income			Earnings		Compensation			Shares			Stock			Total

								(Dollars in thousands)
Balance, December 31, 2001		$	—		—	$	—	$	3,610		$	31,787	$	—			—			—		$	35,397
Net income												2,242											2,242
Unrealized (losses) on securities:
	Unrealized holding (losses) arising during period, net of related income tax (benefit) of $(395)								(767	)													(767	)
	Less reclassification adjustment for losses included in net income, net of related income tax benefit of $75								145														145

	Other comprehensive loss																						(622	)

Comprehensive income																							1,620

Balance, December 31, 2002		$	—		—	$	—	$	2,988		$	34,029	$	—			—			—		$	37,017
Net income												583											583
Unrealized gains on securities:
	Unrealized holding gains arising during period, net of related income tax expense of $1,006								1,954														1,954
	Less reclassification adjustment for (gains) included in net income, net of related income tax (expense) of $(239)								(464	)													(464	)

	Other comprehensive income																						1,490

Comprehensive income																							2,073

Issuance of common stock							64,871																64,871
Unearned ESOP shares																	(6,261	)					(6,261	)
ESOP shares committed																	626						626

Balance, December 31, 2003		$	—		—	$	64,871	$	4,478		$	34,612	$	—			(5,635	)		—		$	98,326
Net income												3,264											3,264
Unrealized gains on securities:
	Unrealized holding gains arising during period, net of related income tax expense of $529								1,028														1,028
	Less reclassification adjustment for (gains) included in net income, net of related income tax (expense) of $(164)								(320	)													(320	)

	Other comprehensive income																						708

Comprehensive income																							3,972

Unearned restricted stock compensation							2,625							(2,625	)
Amortization of restricted stock compensation														383									383
ESOP shares committed							155										626						781
Treasury stock purchased																				(3,054	)		(3,054	)

Balance, December 31, 2004		$	—		—	$	67,651	$	5,186		$	37,876	$	(2,242	)		(5,009	)		(3,054	)	$	100,408

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended December 31, 2004, 2003, and 2002


					2004			2003			2002

					(Dollars in thousands)
Cash flows from operating activities:
	Net income				$	3,264		$	583		$	2,242
	Adjustments to reconcile net income to net cash provided by operating activities:
			Depreciation and amortization of fixed assets			1,472			1,301			819
			Net amortization of premium or (accretion of discount)			346			(61	)		(208	)
			Amortization of restricted stock compensation			383			—			—
			ESOP share commitment			781			778			—
			Net realized investment (gains) losses			(484	)		(703	)		220
			Deferred income tax			68			1,364			(58	)
			Change in assets and liabilities:
				Premiums receivable		(2,121	)		(1,975	)		(1,890	)
				Reinsurance receivables		2,476			(670	)		1,804
				Prepaid reinsurance premiums		41			(468	)		(357	)
				Deferred policy acquisition costs		(627	)		(1,604	)		(821	)
				Other assets		1,167			(1,797	)		(650	)
				Losses and loss expenses		(1,233	)		5,913			289
				Unearned premiums		3,678			5,406			4,375
				Other		(409	)		(68	)		1,396

				Net cash provided by operating activities		8,802			7,999			7,161

Cash flows from investing activities:
	Purchase of fixed income securities, available for sale					(82,036	)		(24,325	)		(35,444	)
	Purchase of equity securities					(3,464	)		(6,951	)		(6,240	)
	Sale (Purchase) of short-term investments, net					54,396			(54,396	)		—
	Sale and maturity of fixed income securities, available for sale					26,773			26,621			32,371
	Sale of equity securities					3,775			8,298			3,528
	Purchase of property and equipment, net					(4,253	)		(2,531	)		(3,299	)

				Net cash used in investing activities		(4,809	)		(53,284	)		(9,084	)

Cash flows from financing activities:
	Purchase of treasury stock					(3,054	)		—			—
	Proceeds from issuance of capital stock					—			53,434			—
	Proceeds from sale of securities in subsidiary to minority interest shareholder					—			—			689

				Net cash (used in) provided by financing activities		(3,054	)		53,434			689

				Net increase (decrease) in cash and cash equivalents		939			8,149			(1,234	)
	Cash and cash equivalents at beginning of period					15,350			7,201			8,435

	Cash and cash equivalents at end of period				$	16,289		$	15,350		$	7,201

	Cash paid (received) during the year for:
		Interest			$	52		$	39		$	33
		Income taxes				(922	)		150			1,605

See accompanying notes to consolidated financial statements.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollars in thousands)


(1)	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


*(a)*	*Description of Business*

Mercer Insurance Group, Inc. and Subsidiaries (collectively, the Group) includes Mercer Insurance Company (MIC), its subsidiaries Queenstown Holding Company, Inc. (QHC) and BICUS Services Corporation (BICUS), QHC’s subsidiary Mercer Insurance Company of New Jersey, Inc. (MICNJ), and Franklin Holding Company, Inc. (FHC). Mercer Insurance Group, Inc. (MIG) is a holding company owning all the outstanding shares of MIC, the company resulting from the conversion of Mercer Mutual Insurance Company from the mutual to the stock form of ownership on December 15, 2003 (“the Conversion”). On June 1, 2002, FHC was added to the Group when MIC purchased a 49% controlling interest in FHC and its wholly owned insurance subsidiary, Franklin Insurance Company (FIC) (note 12). The remaining 51% of FHC was purchased by MIG in conjunction with the Conversion. The companies in the Group are operated under common management. The Group provides property and casualty insurance to both individual and commercial customers in New Jersey and Pennsylvania. The Group’s business activities can be separated into three operating segments, which include commercial lines of insurance, personal lines of insurance and the investment function. The commercial lines of business consist primarily of multi-peril and general liability coverage. These two commercial lines represented 32% and 14%, respectively, of the Group’s net premiums written in 2004. The personal lines of business consist primarily of homeowners and private passenger automobile insurance. These two personal lines represented 23% and 12%, respectively, of net written premiums in 2004.


*(b)*	*Consolidation Policy and Basis of Presentation*

The consolidated financial statements include the accounts of each member of the Group since the date of acquisition. The insurer affiliates within the Group participate in a reinsurance pooling arrangement (the Pool) whereby each insurer affiliate’s underwriting results are combined and distributed proportionately to each participant. Each insurer’s share in the Pool is based on their respective statutory surplus as of the beginning of each year. The effects of the Pool as well as all other significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles, which differ in some respects from those followed in reports to insurance regulatory authorities.


*(c)*	*Use of Estimates*

The preparation of the accompanying financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates include liabilities for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance, deferred income tax assets and other than temporary impairment of investments. Actual results could differ from those estimates.


*(d)*	*Concentration of Risk*

Mercer’s business is subject to concentration risk with respect to both gross revenue and geographic concentration. Approximately 24%, 24% and 22% of the Company’s direct premiums written were produced in 2004, 2003 and 2002, respectively, by two agents, including one who is a related party (see Note 16 for information about related party transactions). In addition, the Company’s operating territory is limited to New Jersey and Pennsylvania, with 78%, 77%, and 77% of direct premiums written attributable to New Jersey for 2004, 2003, and 2002, respectively, and the balance attributable to Pennsylvania. Consequently, changes in

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

production by these two agents or in the New Jersey or Pennsylvania legal, regulatory or economic environment could adversely affect the Company.


*(e)*	*Investments*

Due to periodic shifts in the portfolio arising from income tax and asset-liability matching, as well as securities markets and economic factors, management considers the entire portfolio of fixed-income securities as available for sale. Fixed-income securities available for sale and equity securities are stated at fair value with changes in fair value, net of deferred income tax, reflected in stockholders’ equity as accumulated other comprehensive income. Realized gains and losses are determined on the specific identification basis. A decline in the market value of an investment below its cost that is deemed other than temporary is charged to earnings. The model used to determine anticipated prepayment assumptions for mortgage-backed securities uses separate home sale, refinancing, curtailment, and full pay-off components, derived from a variety of industry sources and created by the Company’s fixed income securities manager.

Interest on fixed maturities is credited to income as it accrues on the principal amounts outstanding, adjusted for amortization of premiums and accretion of discounts computed utilizing the effective interest rate method. Premiums and discounts on mortgage-backed securities are amortized using anticipated prepayments with significant changes in anticipated prepayments accounted for prospectively.


*(f)*	*Cash, Cash Equivalents and Short-term Investments*

Cash, cash equivalents, and short-term investments are carried at cost which approximates fair value. The Group considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.


*(g)*	*Fair Values of Financial Instruments*

The Group has used the following methods and assumptions in estimating its fair values:

Investments — The fair values for fixed-income securities available for sale are based on quoted market prices, when available. If not available, fair values are based on values obtained from investment brokers. Fair values for marketable equity securities are based on quoted market prices and on statutory equity for the security indicated below.

The fair value of an equity security in a reinsurance company is estimated based on statutory book value because the security is not traded and because of restrictions placed on the investors. After receipt of a bona fide offer to purchase this security, the stock must first be offered to the investee or its other shareholders at the lower of statutory book value or the offered price. The investee also has the ability to determine that the potential purchaser is not appropriate and void such an offer. The carrying value of this investment was $1,116 and $1,203 at December 31, 2004 and 2003, respectively.

Cash, cash equivalents, and short-term investments — The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

Premium and reinsurance receivables — The carrying amounts reported in the balance sheet for these instruments approximate their fair values.


*(h)*	*Reinsurance*

The Group cedes insurance to, and assumes insurance from, unrelated insurers to limit its maximum loss exposure through risk diversification. Ceded reinsurance receivables and unearned premiums are reported as assets; loss and loss adjustment expense reserves are reported gross of ceded reinsurance credits. Premiums receivable is recorded gross of ceded premiums payable.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)


*(i)*	*Deferred Policy Acquisition Costs*

Acquisition costs such as commissions, premium taxes, and certain other expenses which vary with and are directly related to the production of business, are deferred and amortized over the effective period of the related insurance policies. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to premiums to be earned, anticipated investment income, loss and loss adjustment expenses, and certain other maintenance costs expected to be incurred as the premiums are earned. To the extent that deferred policy acquisition costs are not realizable, the deficiency is charged to income currently.


*(j)*	*Property and Equipment*

Property and equipment are carried at cost less accumulated depreciation calculated on the straight-line basis. Property is depreciated over useful lives generally ranging from five to forty years. Equipment is depreciated over three to ten years.


*(k)*	*Premium Revenue*

Premiums include direct writings plus reinsurance assumed less reinsurance ceded to other insurers and are recognized as revenue over the period that coverage is provided using the monthly pro-rata method. Unearned premiums represent that portion of premiums written that are applicable to the unexpired terms of policies in force.


*(l)*	*Losses and Loss Adjustment Expenses*

The liability for losses includes the amount of claims which have been reported to the Group and are unpaid at the statement date as well as provision for claims incurred but not reported, after deducting anticipated salvage and subrogation. The liability for loss adjustment expenses is determined as a percentage of the liability for losses based on the historical ratio of paid adjustment expenses to paid losses by line of business.

Management believes that the liabilities for losses and loss adjustment expenses at December 31, 2004 are adequate to cover the ultimate net cost of losses and claims to date, but these liabilities are necessarily based on estimates, and the amount of losses and loss adjustment expenses ultimately paid may be more or less than such estimates. Changes in the estimates for losses and loss adjustment expenses are recognized in the period in which they are determined.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)


*(m)*	*Stock-Based Compensation*

Stock-based compensation plans are accounted for under the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense is recognized for fixed stock option grants. Compensation expense would be recorded on the date of a stock option grant only if the current market price of the underlying stock exceeded the exercise price. The following table illustrates the effect on net income and earnings per share as if the provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), “Accounting for Stock-Based Compensation,” had been applied to all periods presented.


		Years Ended December 31,

		2004			2003(1)			2002

		(In thousands, except
		per share data)
Net income, as reported		$	3,264			(477	)		N/A
Plus: Stock-based employee compensation expense included in reported net income, net of related tax effects			253			—			N/A
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(538	)		—			N/A
Pro forma net income		$	2,979			(477	)		N/A
Basic earnings per share:
	As reported	$	0.52			(0.08	)		N/A
	Pro forma	$	0.48			N/A			N/A
Diluted earnings per share:
	As reported	$	0.51			(0.08	)		N/A
	Pro forma	$	0.47			N/A			N/A


(1)	For 2003, earnings and earnings per share are presented for the post-conversion period of December 16 to December 31, 2003. See footnote (13), Earnings Per Share, for further information.

See Note 1(p) below, “New Accounting Pronouncements” for further information about the Group’s adoption of Financial Accounting Standards No. 123(R), “Share-Based Payment.”


*(n)*	*Income Taxes*

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


*(o)*	*Goodwill*

Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Group determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

unit in a manner similar to a purchase price allocation, in accordance with Statement No. 141, “Business Combinations”. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The Group has only one reporting unit with goodwill. The Group performed the annual impairment tests as of December 31, 2004 and 2003, and the results indicated that the fair value of the reporting unit exceeded its carrying amount.


*(p)*	*New Accounting Pronouncements*

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123(R), “Share-Based Payments,” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The compensation cost will be measured based on the fair value of the equity or liability instruments issued. The Statement is effective as of the beginning of the first interim or annual period beginning after June 15, 2005. The impact of adopting SFAS No. 123(R) on net income and earnings per share is not currently expected to be materially different from the pro forma amounts included in note 1(m) above, which includes all share-based payment transactions through December 31, 2004. The impact that any future share-based payment transactions will have on our financial position or results of operations is not yet known.


(2)	INVESTMENTS

Net investment income, net realized investment gains (losses), and change in unrealized gains (losses) on investment securities are as follows.

Net investment income and net realized investment gains (losses):


			2004			2003		2002

Investment income:
	Fixed income securities		$	3,284			2,120		2,346
	Equity securities			673			466		470
	Cash and cash equivalents			294			100		170
	Other			104			105		24

		Gross investment income		4,355			2,791		3,010
	Less investment expenses			1,514			1,084		949

		Net investment income		2,841			1,707		2,061

Realized gains (losses):
	Fixed income securities			(97	)		186		281
	Equity securities			590			517		(501	)
	Other			(9	)		—		—

		Net realized gains (losses)		484			703		(220	)

Net investment income and net realized investment gains			$	3,325			2,410		1,841

Investment expenses include salaries, counseling fees, and other miscellaneous expenses attributable to the maintenance of investment activities.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

The changes in unrealized (losses) gains of securities are as follows:


	2004			2003			2002

Fixed-income securities	$	(440	)		(922	)		1,614
Equity securities		1,512			3,155			(2,532	)

	$	1,072			2,233			(918	)

The cost and estimated fair value of available-for-sale investment securities at December 31, 2004 and 2003 are shown below.


							Gross		Gross		Estimated
							Unrealized		Unrealized		Fair
					Cost(1)		Gains		Losses		Value

2004
	Fixed-income securities, available for sale:
			U.S. government and government agencies		$	17,870		33		203		17,700
			Obligations of states and political subdivisions			35,801		165		221		35,745
			Industrial and miscellaneous			16,896		28		143		16,781
			Mortgage-backed securities			30,535		71		175		30,431

				Total fixed maturities		101,102		297		742		100,657

	Equity securities:
		At market value				16,051		7,293		13		23,331
		At estimated value				94		1,022		—		1,116

				Total equity securities		16,145		8,315		13		24,447

Total available for sale					$	117,247		8,612		755		125,104


							Gross		Gross		Estimated
							Unrealized		Unrealized		Fair
					Cost(1)		Gains		Losses		Value

2003
	Fixed-income securities, available for sale:
			U.S. government and government agencies		$	38,974		290		438		38,826
			Obligations of states and political subdivisions			5,083		168		16		5,235
			Industrial and miscellaneous			2,157		7		17		2,147
			Mortgage-backed securities			68		1		—		69

				Total fixed maturities		46,282		466		471		46,277

	Equity securities:
		At market value				15,772		5,759		78		21,453
		At estimated value				94		1,109		—		1,203

				Total equity securities		15,866		6,868		78		22,656

Total available for sale					$	62,148		7,334		549		68,933


(1)	Original cost of equity securities; original cost of fixed-income securities adjusted for amortization of premium and accretion of discount.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2004 are as follows:


	Less than 12 Months				12 Months or Longer				Total

	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	6,707	$	55	$	5,610	$	148	$	12,317	$	203
Obligations of states and political subdivisions		6,290		210		1,095		11		7,385		221
Corporate securities		11,868		135		1,371		8		13,239		143
Mortgage-backed securities		17,441		175		—		—		17,441		175

Total fixed maturities		42,306		575		8,076		167		50,382		742

Total equity securities		498		13		—		—		498		13

Total securities in a temporary unrealized loss position	$	42,804	$	588	$	8,076	$	167	$	50,880	$	755

The unrealized losses on fixed maturity investments with unrealized losses for less than twelve months were primarily due to changes in the interest rate environment. At December 31, 2004, the Group has sixteen fixed maturity securities with unrealized losses for more than twelve months. Of the sixteen securities with unrealized losses for more than twelve months, thirteen of them have fair values of no less than 96% of cost, and the other three securities have a fair value greater than 94% of cost. The Group believes these declines are temporary.

There are three equity securities that are in an unrealized loss position at December 31, 2004. All three securities have been in an unrealized loss position for less than six months. The Group believes these declines are temporary.

The estimated fair value and unrealized loss for securities in a temporary unrealized loss position as of December 31, 2003 are as follows:


	Less than 12 Months				12 Months or Longer				Total

	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses

U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	16,715	$	399	$	4,431	$	39	$	21,146	$	438
Obligations of states and political subdivisions		481		16		—		—		481		16
Corporate securities		1,033		17		—		—		1,033		17
Mortgage-backed securities		5		—		8		—		13		—

Total fixed maturities		18,234		432		4,439		39		22,673		471

Total equity securities		1677		78		—		—		1,677		78

Total securities in a temporary unrealized loss position	$	19,911	$	510	$	4,439	$	39	$	24,350	$	549

The unrealized losses on fixed maturity investments with unrealized losses for less than twelve months were primarily due to changes in the interest rate environment. The Group has twelve fixed maturity securities

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

with unrealized losses for more than twelve months. Of the twelve securities with unrealized losses for more than twelve months, eleven of them have fair values of 98% or more of cost, and the other security has a fair value greater than 96% of cost. The Group believes these declines are temporary.

There are eleven equity securities that are in an unrealized loss position at December 31, 2003. Ten of these securities have been in an unrealized loss position for less than six months. The other equity security has been in an unrealized loss position for less than twelve months. The Group believes these declines are temporary.

The amortized cost and estimated fair value of fixed-income securities at December 31, 2004, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


			Estimated
	Amortized		Fair
	Cost		Value

Due in one year or less	$	65		65
Due after one year through five years		18,772		18,661
Due after five years through ten years		39,864		39,708
Due after ten years		11,866		11,792

		70,567		70,226
Mortgage-backed securities		30,535		30,431

	$	101,102		100,657

The gross realized gains and losses on investment securities are as follows:


	2004			2003			2002

Gross realized gains	$	1,037			1,396			703
Gross realized losses		(553	)		(693	)		(923	)

	$	484			703			(220	)

The gross realized investment losses included write-downs for the other than temporary impairment of securities totaling $15, $454, and $647 for the years ended 2004, 2003 and 2002, respectively.

Proceeds from the sales of available-for-sale securities were $30,548, $34,919, and $35,594 in 2004, 2003, and 2002, respectively.

Accumulated other comprehensive income included deferred income taxes of $2,671 and $2,306 applicable to net unrealized investment gains at December 31, 2004 and 2003, respectively.

The amortized cost of invested securities on deposit with regulatory authorities at December 31, 2004 and 2003 was $201 and $202, respectively.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)


(3)	DEFERRED POLICY ACQUISITION COSTS

Changes in deferred policy acquisition costs are as follows:


	2004			2003			2002

Balance, January 1	$	7,387			5,783			4,962
Acquisition costs deferred		15,702			15,017			11,774
Amortization charged to earnings		(15,075	)		(13,413	)		(10,953	)

Balance, December 31	$	8,014			7,387			5,783


(4)	PROPERTY AND EQUIPMENT

Property and equipment was as follows:


		2004			2003

Home office:
	Land	$	423			423
	Buildings and improvements		7,145			4,691
	Furniture, fixtures, and equipment		8,816			7,050

			16,384			12,164
	Accumulated depreciation		(6,666	)		(5,220	)

		$	9,718			6,944


(5)	LIABILITIES FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liabilities for losses and loss adjustment expenses is summarized as follows:


			2004			2003			2002

Balance, January 1			$	37,261			31,348			31,059
	Less reinsurance recoverable on unpaid losses and loss expenses			(5,036	)		(4,150	)		(5,425	)

		Net balance at January 1		32,225			27,198			25,634

Incurred related to:
	Current year			29,024			28,329			22,211
	Prior years			(886	)		(596	)		(2,144	)

		Total incurred		28,138			27,733			20,067

Paid related to:
	Current year			14,626			13,866			11,128
	Prior years			12,772			8,840			7,375

		Total paid		27,398			22,706			18,503

		Net balance, December 31		32,965			32,225			27,198
	Plus reinsurance recoverable on unpaid losses and loss expenses			3,063			5,036			4,150

Balance at December 31			$	36,028			37,261			31,348

As a result of changes in estimates of insured events in prior years, the liabilities for losses and loss adjustment expense decreased by $886, $596, and $2,144, in 2004, 2003, and 2002, respectively. These

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

redundancies are primarily concentrated in the commercial automobile, commercial multi-peril, and other liability lines in 2004, the commercial multi-peril and workers’ compensation lines in 2003, and the commercial multi-peril and other liability lines in 2002.


(6)	REINSURANCE

The Group has geographic exposure to catastrophe losses in its operating region. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosion, severe weather, and fire. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas. However, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Group generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance.

In the ordinary course of business, the Group seeks to limit its exposure to loss on individual claims and from the effects of catastrophes by entering into reinsurance contracts with other insurance companies. Reinsurance is ceded on excess of loss and pro-rata bases with the Group’s retention in 2004 not exceeding $500, and in 2003 and 2002 not exceeding $300 per occurrence. Insurance ceded by the Group does not relieve its primary liability as the originating insurer. The Group also assumes reinsurance from other companies on a pro-rata basis.

The effect of reinsurance with unrelated insurers on premiums written and earned is as follows:


		2004			2003			2002

Premiums written:
	Direct	$	65,790			61,152			50,858
	Assumed		2,133			1,613			808
	Ceded		(8,419	)		(9,963	)		(7,195	)

Net		$	59,504			52,802			44,471

Premiums earned:
	Direct	$	62,415			56,047			46,625
	Assumed		1,829			1,312			666
	Ceded		(8,460	)		(9,495	)		(6,837	)

Net		$	55,784			47,864			40,454

The effect of reinsurance on unearned premiums as of December 31, 2004 and 2003 is as follows:


	2004		2003

Direct	$	33,060		29,685
Assumed		947		644

	$	34,007		30,329

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

The effect of reinsurance on the liability for losses and loss adjustment expenses, and on losses and loss adjustment expenses incurred is as follows:


		2004		2003

Liabilities:
	Direct	$	33,433		35,361
	Assumed		2,595		1,900

		$	36,028		37,261


		2004		2003			2002

Losses and loss expenses incurred:
	Direct	$	26,464		29,861			20,388
	Assumed		1,565		582			415
	Ceded		109		(2,710	)		(736	)

Net		$	28,138		27,733			20,067

The Group performs credit reviews of its reinsurers, focusing on financial stability. To the extent that a reinsurer may be unable to pay losses for which it is liable under the terms of a reinsurance agreement, the Group is exposed to the risk of continued liability for such losses. At December 31, 2004, one independent reinsurer accounted for approximately $1,000 of amounts recoverable for paid and unpaid losses and loss adjustment expenses.


(7)	RETIREMENT PLANS AND DEFERRED COMPENSATION PLAN

The Group maintains a 401(k) qualified retirement savings plan covering substantially all employees. Benefits are based on an employee’s annual compensation, with new employees participating after a one-year waiting period. The Group matches a percentage of each employees’ pre-tax contribution and also contributes an amount equal to 2% of each employee’s annual compensation. Deferral amounts in excess of the qualified plan limitations, as well as Company contributions on such compensation, are funded into a nonqualified plan benefiting affected individuals. The cost for these benefits was $134, $135, and $119 for 2004, 2003, and 2002, respectively. In addition, the Company makes a discretionary contribution of up to 5% each year , based on Company profitability, to both the qualified 401(k) plan, and, where applicable, to the nonqualified plan. The cost for this portion of the retirement plan was $255, $223, and $181 for 2004, 2003, and 2002, respectively.

The Group also maintains a nonqualified unfunded retirement plan for its directors. The plan provides for monthly payments for life upon retirement, with a minimum payment period of ten years. The expense for this plan amounted to $111, $102, and $93, for 2004, 2003, and 2002 respectively. Costs accrued under this plan amounted to $704 and $627 at December 31, 2004 and 2003, respectively.

The Group also maintains a deferred compensation plan for its directors and officers. Under the plan, participants may elect to defer receipt of all or a portion of their fees or salary amounts. Amounts deferred, together with accumulated earnings, are distributed either as a lump sum or in installments over a period of not greater than ten years. Deferred compensation, including accumulated earnings, amounted to $888 and $749 at December 31, 2004 and 2003, respectively.

The Group has purchased Company-owned life insurance covering key individuals. The Group’s cost, net of increases in cash surrender value, for the Company-owned life insurance was $5, $32, and $133 for the years ended December 31, 2004, 2003, and 2002, respectively. The cash surrender value of the Company-owned life insurance totaled $767 and $597 at December 31, 2004 and 2003, respectively, and is included in other assets.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

In conjunction with the Conversion described in note 1, the Group established an Employee Stock Ownership Plan (ESOP) and issued 626,111 shares to the ESOP at the Conversion offering price. The ESOP signed a promissory note in the amount of $6,261 to purchase the shares, which is due in 10 equal annual installments including interest at 4%. Shares purchased are held in a suspense account for allocation among participating employees as the loan is repaid, and are allocated to participants based on compensation as described in the plan. During 2004, 62,611 shares were allocated to employee participants, with an equal number of shares allocated to employee participants in the period December 16, 2003 to December 31, 2003. Compensation expense equal to the fair value of the shares allocated is recognized ratably over the period that the shares are committed to be allocated to the employees. In 2004 and 2003 the Group recognized compensation expense of $874 and $568, respectively, related to the ESOP. As of December 31, 2004, the cost of the 500,889 shares issued to the ESOP but not yet allocated to its employee participants is classified within equity as unearned ESOP shares.


(8)	FEDERAL INCOME TAXES

The tax effect of significant temporary differences that give rise to the Group’s net deferred tax asset (liability) as of December 31, is as follows:


		2004			2003

Net unearned premiums		$	2,241			1,978
Net loss reserve discounting			1,505			1,499
Compensation and benefits			702			478
Net operating loss carryforwards			227			362
Impairment of investments			77			130
Other			37			69

	Deferred tax assets		4,789			4,516

Deferred policy acquisition costs			2,725			2,512
Unrealized gain on investments			2,671			2,306
Depreciation			401			323
Other			138			88

	Deferred tax liabilities		5,935			5,229

Net deferred liability		$	(1,146	)		(713	)

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes it is more likely than not the Group will realize the benefits of the deferred tax assets at December 31, 2004 and 2003.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Actual income tax expense differed from expected tax expense, computed by applying the United States federal corporate income tax rate of 34% to income before income taxes, as follows:


	2004			2003			2002

Expected tax expense	$	1,481			302			1,202
Tax-exempt interest		(294	)		(64	)		(135	)
Dividends received deduction		(135	)		(93	)		(94	)
Non-deductible ESOP expense		52			—			—
Company-owned life insurance		2			11			45
Other		(14	)		18			137

Income tax expense	$	1,092			174			1,155

The components of the provision for income taxes are as follows:


	2004		2003			2002

Current	$	1,024		(1,190	)		1,213
Deferred		68		1,364			(58	)

Income tax expense	$	1,092		174			1,155

At December 31, 2004, the Group’s subsidiary FHC has net operating loss carryforwards available to offset future federal taxable income as follows:


Expires
	2020	$	537
	2021		131

		$	668

The utilization of the above net operating losses is subject to an annual limitation of approximately $379 per year.


(9)	SEGMENT INFORMATION

The Group markets its products through independent insurance agents, which sell commercial lines of insurance to small to medium-sized businesses and personal lines of insurance to individuals.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Financial data by segment is as follows:


				2004			2003			2002

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

			Total net premiums earned		55,784			47,864			40,454
	Net investment income				2,841			1,707			2,061
	Realized investment gains (losses)				484			703			(220	)
	Other				358			386			329

			Total revenues	$	59,467		$	50,660		$	42,624

Income before income taxes:
	Underwriting income (loss):
		Commercial lines		$	5,582		$	3,109		$	2,892
		Personal lines			(4,909	)		(4,951	)		(1,432	)

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

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

Assets are not allocated to the commercial and personal lines, and are reviewed in total by management for purposes of decision making.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)


(10)	RECONCILIATION OF STATUTORY FILINGS TO AMOUNTS REPORTED HEREIN

A reconciliation of the Group’s statutory net income and surplus to the Group’s net income and stockholder’s equity, under U.S. generally accepted accounting principles (GAAP), is as follows:


		2004			2003			2002

Net income:
	Statutory net income	$	2,898			632			1,292
	Deferred policy acquisition costs		627			1,604			821
	Deferred federal income taxes		(68	)		(1,364	)		58
	Minority interest in income of subsidiary		—			(131	)		(138	)
	Parent holding company loss		(238	)		(20	)		—
	Other		45			(138	)		209

GAAP net income		$	3,264			583			2,242

Surplus:
	Statutory surplus	$	61,990			58,338
	Deferred policy acquisition costs		8,014			7,387
	Deferred federal income taxes		(4,223	)		(3,504	)
	Nonadmitted assets		3,043			2,493
	Unrealized loss on fixed-income securities		(444	)		(5	)
	Parent company		31,366			33,557
	Other		662			60

GAAP stockholders’ equity		$	100,408			98,326

The Group’s insurance companies are required to file statutory financial statements with various state insurance regulatory authorities. Statutory financial statements are prepared in accordance with accounting principles and practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). Furthermore, the NAIC adopted the Codification of Statutory Accounting Principles effective January 1, 2001. The codified principles are intended to provide a comprehensive basis of accounting recognized and adhered to in the absence of conflict with, or silence of, state statutes and regulations. The effects of such do not affect financial statements prepared under U.S. generally accepted accounting principles.

The Group’s insurance companies are required by law to maintain a certain minimum surplus on a statutory basis, and are subject to risk-based capital requirements and to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. A condition imposed in connection with the approval by the Pennsylvania Department of Insurance of the Conversion is that for a period of three years after the Conversion, Mercer Insurance Company may not declare or pay any dividend to Mercer Insurance Group without the approval of the Pennsylvania Insurance Department. After this three-year period, Mercer Insurance Company will be restricted by the insurance laws of Pennsylvania as to the amount of dividends or other distributions it may pay to its holding company. Under Pennsylvania law, there is a maximum amount that may be paid by Mercer Insurance Company during any twelve-month period after notice to, but without prior approval of, the Pennsylvania Insurance Department. This limit is the greater of 10% of Mercer Insurance Company’s statutory surplus as reported on its most recent annual statement filed with the Pennsylvania Insurance Department, or the net income of Mercer Insurance Company for the period covered by such annual statement. If the dividend restrictions imposed on

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

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


(11)	CONVERSION COSTS

On December 15, 2003, MIC converted from a mutual form of ownership to a stock form of ownership. The Group incurred expenses of $66 and $95 in 2003 and 2002, respectively, in the mutual to stock conversion.


(12)	PURCHASE OF FHC, GOODWILL, AND MINORITY INTEREST

On June 1, 2001, MIC purchased certain holdings in FHC and its wholly owned insurance subsidiary, FIC (note 1). For an investment of $3,500, MIC acquired 49% of all outstanding voting common stock; 50% of all common stock options; 50% of convertible, redeemable Series A preferred stock and certain rights to purchase the remaining voting common stock in the future. The transaction resulted in goodwill totaling $3,310. In 2002, MIC and a minority interest shareholder exercised options to purchase Series B, nonvoting common stock and paid $662 and $689, respectively, for such shares. These exercises did not change MIC’s ownership percentage in FHC.

Prior to the acquisition of the remaining 51% in FHC, the Group consolidated FHC as it had a controlling interest in the subsidiary as evidenced by the following: MIC had control of the Board of Directors of FHC (seven of nine board members of FHC were on the board of MIC), MIC had common management with FHC and the ability to direct the policies and management that guide the ongoing activities and all substantive decision making of FHC, and MIC had the option to purchase the remaining stock of FHC. In addition, FHC and MIC entered into a reinsurance pooling agreement in connection with the acquisition whereby 100% of the direct business of FHC is ceded to MIC. MIC then retrocedes a percentage of the combined business to FHC. The effect of this agreement subsequent to the acquisition was eliminated in consolidation. The Group’s investment in FHC including common stock, options to purchase common equity, and preferred stock was eliminated in consolidation.

On December 15, 2003, at the time of the Conversion, the Group acquired the remaining minority interest in FHC in exchange for 502,525 shares of Group. Additional goodwill of $1,797 was recorded at the time the minority interest was acquired.

The changes in the carrying amount of goodwill for the years ended December 31, 2004 and 2003 are as follows:


	2004		2003

Balance beginning of year	$	4,673	$	2,876
Goodwill on the purchase of the remaining minority interest in FHC		—		1,797

Balance end of year	$	4,673	$	4,673


(13)	EARNINGS PER SHARE

As described in Note 1, the Conversion resulted in the issuance of common shares of the Group on December 15, 2003. Earnings per share for 2003 are computed by dividing net income for the period subsequent to the Conversion (December 16, 2003 to December 31, 2003) by the weighted average number of common shares outstanding for the period. There were no dilutive potential common shares outstanding during this 2003 period.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

The computation of basic and diluted earnings per share is as follows:


	Year/ Period Ended December 31

	2004		2003			2002

	(Dollars in thousands, except
	per share data)
Numerator for basic and diluted earnings per share:
Net income	$	3,264		(477	)		N/A

Denominator for basic earnings per share – weighted-average shares outstanding		6,236,163		6,252,884			N/A
Effect of stock incentive plans		117,570		0			N/A

Denominator for diluted earnings per share		6,353,733		6,252,884			N/A

Basic earnings per share	$	0.52		(0.08	)		N/A

Diluted earnings per share	$	0.51		(0.08	)		N/A


(14)	STOCK-BASED COMPENSATION

Mercer has accounts for its stock based compensation plans under Accounting Principles Board (APB) opinion no. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under Statement of Financial Accounting Standards (SFAS) No. 123 (as amended by SFAS No. 148), Accounting for Stock Based Compensation,” the Company has adopted the pro forma footnote disclosure-only provisions. See Note 1(m) for the pro forma effect on net income and earnings per share as if the Company had adopted FAS 123. See Note 1(p), “New Accounting Pronouncements” for further information regarding adoption of SFAS 123(R), “Share-Based Payment”.

The Company adopted the Mercer Insurance Group, Inc. 2004 Stock Incentive Plan (the Plan) on June 16, 2004. Awards under the Plan may be made in the form of incentive stock options, nonqualified stock options, restricted stock or any combination to employees and non-employee Directors. The Plan limits to 250,000 the number of shares that may be awarded as restricted stock, and to 500,000 the number of shares for which incentive stock options may be granted. The total number of shares authorized in the plan is 876,555 shares, with an annual increase equal to 1% of the shares outstanding at the end of the previous year. The Plan provides that stock options and restricted stock awards may include vesting restrictions and performance criteria at the discretion of the Compensation Committee of the Board of Directors. The term of options may not exceed ten years for incentive stock options, and ten years and 1 month for nonqualified stock options, and the option price may not be less than fair market value on the date of grant. The 2004 grants have vesting periods of 3 or 5 years on restricted stock, incentive stock options, and nonqualified stock options.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Information regarding fixed stock option activity in Mercer Insurance Group’s plan is presented below:


				Weighted Average
		Number of		Exercise Price
		Shares		per Share

Outstanding at December 31, 2003			0	$	0.00
Granted — 2004			537,700		12.21
Exercised — 2004			0		0.00
Forfeited — 2004			0		0.00

Outstanding at December 31, 2004			537,700	$	12.21

Exercisable at:
	December 31, 2004		0	$	0.00
	Weighted-average remaining contractual life		9.5 years

In determining the pro-forma effect described in Note 1(m), the per share weighted-average fair value of options granted during 2004 was $4.19, estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2004: dividend yield of 0%; expected volatility of 20.91%; risk-free interest rate of 4.73%, and an expected life of 6.5 years.

Included in the 2004 stock option grants were grants of 173,000 Incentive Stock Options, and 364,700 non-qualified stock options.

Grants of 215,000 shares of restricted stock were awarded to employees and non-employee Directors in 2004. The weighted average price per share on the grant date was $12.21 per share.


(15)	CONTINGENCIES

The Group becomes involved with certain claims and legal actions arising in the ordinary course of business operations. Such legal actions involve disputes by policyholders relating to claims payments as well as other litigation. In addition, the Group’s business practices are regularly subject to review by various state insurance regulatory authorities. These reviews may result in changes or clarifications of the Group’s business practices, and may result in fines, penalties or other sanctions. In the opinion of management, while the ultimate outcome of these actions and these regulatory proceedings cannot be determined at this time, they are not expected to result in liability for amounts material to the financial condition, results of operations, or liquidity, of the Group.


(16)	RELATED-PARTY TRANSACTIONS

The Group produces a large percentage of its business through one insurance agent who is also an officer and board member of the companies within the Group, Davis Insurance Agency (Davis). In 2004, 2003, and 2002, premiums written through Davis totaled 12%, 13% and 14%, respectively, of the Group’s direct written premiums. Commissions paid to Davis were $1,336, $1,314 and $1,182 in 2004, 2003, and 2002, respectively.

Van Rensselaer, Ltd., which is owned by William V.R. Fogler, a director, has provided investment management services to the Group since the year 2000. Fees to Van Rensselaer, Ltd. amounted to $166 in 2004, $141 in 2003, and $139 in 2002.

MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)


(17)	QUARTERLY FINANCIAL DATA (unaudited)

The Group’s unaudited quarterly financial information is as follows:

Mercer Insurance Group, Inc. and Subsidiaries

Quarterly Financial Data


		First Quarter						Second Quarter						Third Quarter				Fourth Quarter

		2004			2003			2004			2003			2004		2003		2004		2003

		(Unaudited, in thousands, except per share data)
Net premiums written		$	12,919		$	11,259		$	15,854		$	14,922		$	13,420	$	13,052	$	17,310	$	13,569
Net premiums earned			13,862			11,056			13,723			11,327			14,032		12,379		14,167		13,102
Net investment income earned			668			427			626			394			639		400		908		486
Net realized gains (losses)			(97	)		149			196			(186	)		340		167		45		573
Net income			229			232			1,071			40			1,121		173		843		138
Other comprehensive income (loss)			771			(380	)		(1,974	)		1,081			962		312		949		477
Comprehensive income (loss)		$	1,000		$	(148	)	$	(903	)	$	1,121		$	2,083	$	485	$	1,792	$	615
Net income (loss) per share (Note 1 and 2):
	Basic	$	.04			N/A		$	0.17			N/A		$	0.18		N/A	$	0.14		(0.08	)
	Diluted	$	.04			N/A		$	0.17			N/A		$	0.17		N/A	$	0.13		(0.08	)

Note 1 — Earnings per share data for 2003 reflects only the net loss for the period from December 16, 2003, through December 31, 2003, the period subsequent to the Conversion. Net loss during this period was $477.

Note 2 — Earnings per share for the periods prior to December 16, 2003 are not applicable because the Group was then organized as a mutual insurance company.


(18)	SUBSEQUENT EVENT

Shareholders equity

On June 16, 2004, the Company’s Board of Directors authorized the repurchase of up to 250,000 shares of its common stock, to be made from time to time in the open market or in privately negotiated transactions as, in management’s sole opinion, market conditions warranted. The repurchased shares are to be held as treasury shares available for issuance in connection with Mercer Insurance Group’s 2004 Stock Incentive Plan. All shares under this authorization had been purchased as as of September 30, 2004, for a total consideration of $3.0 million, or $11.90 per share. On October 20, 2004, the Board of Directors authorized the repurchase of an additional 250,000 shares of its common stock, under the same terms and conditions. As of March 7, 2005, all 250,000 shares authorized under the second authorization have been purchased, with 243,500 of the shares purchased after December 31, 2004. The total cost of the 243,500 shares purchased in 2005 was $3.2 million, or $13.18 per share, bringing the total cost of the purchase of the 500,000 shares to $6.3 million, or $12.53 per share.


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

None.


ITEM 9A.	*CONTROLS AND PROCEDURES.*

Management’s Annual Report on Internal Control Over Financial Reporting

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

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


		Mercer Insurance Group, Inc.

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

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

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

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

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

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

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

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

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

/s/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

PART III


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

The information required by Item 10 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.


ITEM 11.	*EXECUTIVE COMPENSATION.*

The information required by Item 11 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.


ITEM 12.	*SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.*

The information required by Item 12 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.


ITEM 13.	*CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.*

The information required by Item 13 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.


ITEM 14.	*PRINCIPAL ACCOUNTING FEES AND SERVICES.*

The information required by Item 14 is incorporated by reference to Registrant’s definitive proxy statement to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, within 120 days after December 31, 2004.

PART IV


ITEM 15.	*EXHIBITS, FINANCIAL STATEMENT SCHEDULES.*

(a) (1) The following consolidated financial statements are filed as a part of this report in Item 8.


Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Earnings for Each of the Years in the Three-year Period Ended December 31, 2004
Consolidated Statements of Stockholders’ Equity for Each of the Years in the Three-year Period Ended December 31, 2004
Consolidated Statements of Cash Flows for Each of the Years in the Three-year Period Ended December 31, 2004
Notes to Consolidated Financial Statements

(2) The following consolidated financial statement schedules for the years 2004, 2003 and 2002 are submitted herewith:


Financial Statement Schedules:
Report of Independent Registered Public Accounting Firm
Schedule I.		Summary of Investments — Other Than Investments in Related Parties
Schedule II.		Condensed Financial Information of Parent Company
Schedule III.		Supplementary Insurance Information
Schedule IV.		Reinsurance
Schedule V.		Allowance for Uncollectible Premiums and other Receivables
Schedule VI.		Supplemental Insurance Information Concerning Property and Casualty Subsidiaries

All other schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.

(3) Exhibits:

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

EXHIBIT INDEX


Number			Title

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

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

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

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

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

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

	10	.2	Employment Agreement, dated as of October 31, 2004, among BICUS Services Corporation, Mercer Insurance Company and David Merclean (filed herewith)

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

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

	10	.5	Mercer Insurance Group, Inc. 2004 Stock Incentive Plan dated June 16, 2004, (filed herewith)

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

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

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

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

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

SIGNATURES

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


	Mercer Insurance Group, Inc.


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


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

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.



By:	/s/ Roland D. Boehm Roland D. Boehm	Vice Chairman of the Board of Directors	March 16, 2005

By:	/s/ H. Thomas Davis H. Thomas Davis	Senior Vice President and a Director	March 16, 2005

By:	/s/ William V. R. Fogler William V. R. Fogler	Director	March 16, 2005

By:	/s/ William C. Hart William C. Hart	Director	March 16, 2005

By:	/s/ George T. Hornyak, Jr. George T. Hornyak, Jr.	Director	March 16, 2005

By:	/s/ Samuel J. Malizia Samuel J. Malizia	Director	March 16, 2005



By:	/s/ Richard U. Niedt Richard U. Niedt	Director	March 16, 2005

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

By:	/s/ Richard G. Van Noy Richard G. Van Noy	Chairman of the Board of Directors	March 16, 2005

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Mercer Insurance Group, Inc. and Subsidiaries:

Under date of March 16, 2005, we reported on the consolidated balance sheets of Mercer Insurance Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, which are included in the annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules in the annual report on Form 10-K. These financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.

In our opinion, such 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/ KPMG LLP

Philadelphia, Pennsylvania

March 16, 2005

Mercer Insurance Group, Inc. and Subsidiaries

Schedule I — Summary of Investments — Other than

Investments in Related Parties as of December 31, 2004


Column A			Column B		Column C		Column D

					Market		Balance
Type of Investment			Cost		Value		Sheet

			(Dollars in thousands)
Fixed maturities:
Bonds:
	United States Government and government agencies and authorities		$	17,870		17,700		17,700
	States, municipalities and political subdivisions			35,801		35,745		35,745
	All other			47,431		47,212		47,212

		Total bonds		101,102		100,657		100,657
	Preferred stock			2,825		2,923		2,923

		Total fixed maturities		103,927		103,580		103,580

Equity securities:
Common stocks:
	Banks, trust and insurance companies			815		3,673		3,673
	Industrial, miscellaneous and all other			12,505		17,851		17,851

		Total equity securities		13,320		21,524		21,524

		Total investments	$	117,247		125,104		125,104

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Balance Sheet

December 31, 2004 and 2003


				2004			2003

				(Dollars in thousands)
ASSETS
Fixed income securities, available for sale, at fair value				$	22,798			0
Investment in common stock of subsidiaries (equity method)					71,137			66,864
Investment in preferred stock of subsidiaries (equity method)					2,475			2,475
Short-term investments, at cost, which approximates fair value					—			25,495
Cash and cash equivalents					829			1,547
Goodwill					1,797			1,797
Other assets					1,309			255
Deferred tax asset					123			0

Total assets				$	100,468			98,433


LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
	Accounts payable and accrued expenses			$	60			107

			Total liabilities		60			107

Stockholders’ Equity:
	Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding				—			—
	Common stock, no par value, authorized 15,000,000 shares, issued 7,060,733 shares, outstanding 6,344,844 and 6,282,233 shares				—			—
	Additional paid-in capital				67,651			64,871
	Accumulated other comprehensive income:
		Unrealized gains in investments, net of deferred income taxes			5,186			4,478
	Retained Earnings				37,876			34,612
	Unearned restricted stock compensation				(2,242	)		—
	Unearned ESOP shares				(5,009	)		(5,635	)
	Treasury stock, 256,500 and -0- shares				(3,054	)		—

			Total stockholders’ equity		100,408			98,326

Total liabilities and stockholders’ equity				$	100,468			98,433

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statement of Earnings

For the Year ended December 31, 2004 and the period December 16, 2003 to December 31, 2003


			2004			2003

			(Dollars in thousands)
Revenue:
	Investment income, net of expenses		$	574			5

		Total revenue		574			5

Expenses:
	Other expenses			972			36

		Total expenses		972			36

		Loss before tax benefit		(398	)		(31	)
Income tax benefit				(160	)		(11	)

Loss before equity in income (loss) of subsidiaries				(238	)		(20	)
Equity in income (loss) of subsidiaries				3,502			(457	)

Net income (loss)			$	3,264			(477	)

MERCER INSURANCE GROUP, INC.

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF PARENT COMPANY

Condensed Statements of Cash Flows

For the Year ended December 31, 2004 and the period December 16, 2003 to December 31, 2003


				2004			2003

				(Dollars in thousands)
Cash flows from operating activities:
	Net income (loss)			$	3,264			(477	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Equity in undistributed (income) loss of subsidiaries			(3,502	)		457
		Accretion of discount			178			—
		ESOP share allocation			780			35
		Amortization of restricted stock compensation			383			—
		Deferred income tax			(90	)		(11	)
		Other			(1,100	)		(139	)

			Net cash used in operating activities		(87	)		(135	)

Cash flows from investing activities:
	Purchase of fixed income securities				(23,508	)		—
	Sale and maturity of fixed income securities				436			—
	Sale of short-term investments				25,495			—
	Purchase of short-term investments				—			(25,495	)

			Net cash provided by (used in) investing activities		2,423			(25,495	)

Cash flows from financing activities:
	Proceeds from issuance of capital stock				—			54,177
	Capital contribution to subsidiary				—			(27,000	)
	Purchase of treasury stock				(3,054	)		—

			Net cash (used in) provided by financing activities		(3,054	)		27,177

			Net (decrease) increase in cash and cash equivalents		(718	)		1,547
Cash and cash equivalents at beginning of period					1,547			—

Cash and cash equivalents at end of period				$	829			1,547

Cash paid during the year for:
	Interest			$	—			—
	Income taxes				—			—

Mercer Insurance Group, Inc. and Subsidiaries

Schedule III — Supplementary Insurance Information


Column A			Column B		Column C		Column D		Column E		Column F

					Future Policy
			Deferred		Benefits,				Other Policy
			Policy		Losses, Claims,				Claims and
			Acquisition		and Loss		Unearned		Benefits		Premium
Segment			Costs		Expenses		Premiums		Payable		Revenue

			(Dollars in thousands)
December 31, 2004
	Commercial lines		$	5,327		21,679		22,822		0		32,370
	Personal lines			2,687		14,349		11,185		0		23,414

		Total	$	8,014		36,028		34,007		0		55,784

December 31, 2003
	Commercial lines		$	4,590		22,883		19,099		0		25,964
	Personal lines			2,797		14,378		11,230		0		21,900

		Total	$	7,387		37,261		30,329		0		47,864

December 31, 2002
	Commercial lines			XXXXX		XXXXX		XXXXX		XXXXX		20,088
	Personal lines			XXXXX		XXXXX		XXXXX		XXXXX		20,366

		Total		XXXXX		XXXXX		XXXXX		XXXXX		40,454


			Column G		Column H		Column I		Column J		Column K

					Benefits,
					Claims,
			Net		Losses and				Other
			Investment		Settlement		Amortization		Operating		Premiums
			Income		Expenses		of DPAC		Expenses		Written

			(Dollars in thousands)
December 31, 2004
	Commercial lines		$		$	10,325		9,202		7,261		36,492
	Personal lines					17,813		5,873		4,637		23,012

		Total	$	2,841		28,138		15,075		11,898		59,504

December 31, 2003
	Commercial lines		$		$	10,145		7,758		4,952		30,315
	Personal lines					17,588		5,655		3,608		22,487

		Total	$	1,707		27,733		13,413		8,560		52,802

December 31, 2002
	Commercial lines		$		$	7,283		5,737		4,176		23,591
	Personal lines					12,784		5,216		3,798		20,880

		Total	$	2,061		20,067		10,953		7,974		44,471

Mercer Insurance Group, Inc. and Subsidiaries

Schedule IV — Reinsurance

For the years ended December 31, 2004, 2003 and 2002


Column A	Column B		Column C		Column D		Column E		Column F

					Assumed				Percentage
			Cede to		from				of Amount
	Gross		Other		Other		Net		Assumed
Premiums Earned	Amount		Companies		Companies		Amount		to Net

			(Dollars in thousands)
For the year ended December 31, 2004	$	62,415		8,460		1,829		55,784		3.3	%
For the year ended December 31, 2003		56,047		9,495		1,312		47,864		2.7	%
For the year ended December 31, 2002		46,625		6,837		666		40,454		1.6	%

Mercer Insurance Group, Inc. and Subsidiaries

Schedule V — Allowance for Uncollectible Premiums and Other Receivables

For the years ended December 31, 2004, 2003 and 2002


Premiums Earned	2004			2003			2002

	(Dollars in thousands)
Balance, January 1	$	97		$	72		$	60
Additions		129			228			77
Deletions		(123	)		(203	)		(65	)

Balance, December 31	$	103		$	97		$	72

Mercer Insurance Group, Inc. and Subsidiaries

Schedule VI — Supplemental Information

For the years ended December 31, 2004, 2003 and 2002

Column A

Column B

Column C

Column D

Column E

Column F

Column G

Deferred

Reserve for

Discount if

Policy

Losses and

any

Net

Acquisition

Loss Adj.

Deducted in

Unearned

Earned

Investment

Affiliation with Registrant

Costs

Expenses

Column C

Premiums

Income

(Dollars in thousands)

Year ended December 31, 2004

8,014

36,028

34,007

55,784

2,841

Year ended December 31, 2003

7,387

37,261

30,329

47,864

1,707

Year ended December 31, 2002

5,783

31,348

24,923

40,454

2,061


	Column H					Column I		Column J		Column K

	Losses and							Paid
	Current		LAEor					Losses and		Net
	Incurre		dYear			Amortization		Adjustment		Written
						of DPAC		Expenses		Premiums

	Year

	(Dollars in thousands)
Year ended December 31, 2004		29,024		(886	)		15,075		27,398		59,504
Year ended December 31, 2003		28,329		(596	)		13,413		22,706		52,802
Year ended December 31, 2002		22,211		(2,144	)		10,953		18,503		44,471


	Mutual Insurance Holding Companies and for Certain Long-Duration Participating Contracts.” SOP 00-3 addresses financial statement presentation and accounting for stock conversion expenses and accounting for retained earnings and other comprehensive income at the date of the stock conversion.

(2)	Income of the Company attributable to the minority interest in Franklin Holding Company, which interest was acquired immediately after the Conversion for shares of the Company.

(3)	Includes Net Income and the change in Unrealized Gains and Losses of the investment portfolio.

(4)	The sum of losses, loss adjustment expenses, underwriting expenses and dividends to policyholders divided by net premiums earned. A combined ratio of less than 100% means a company is making an underwriting profit.

(5)	The sum of the ratio of underwriting expenses divided by net premiums written, and the ratio of losses, loss adjustment expenses, and dividends to policyholders divided by net premiums earned.

(6)	The ratio of net premiums written divided by ending statutory surplus, except for 2003, where a weighted average of statutory surplus is used.

(7)	Earnings per share data reflects only net loss for the period from December 16, 2003, the date of the Conversion, through December 31, 2003. Net loss during this period was ($477,000).

(8)	Unallocated ESOP shares at December 31, 2004 and 2003, are not reflected in weighted average shares.