AMERICAN PHYSICIANS CAPITAL INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Form 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 000-32057

AMERICAN PHYSICIANS CAPITAL, INC.
(Exact name of registrant as specified in its charter)

MICHIGAN 38-3543910
(State or other jurisdiction of (IRS employer
incorporation or organization) identification number)

1301 NORTH HAGADORN ROAD, EAST LANSING, MICHIGAN 48823
(Address of principal executive offices)(Zip Code)
Registrant's telephone number, including area code: (517) 351-1150
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
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in a definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant as of March 1, 2002, based on $17.65 per share (the last sale price
for the Common Stock on such date as reported on the Nasdaq Stock Market's
National Market), was approximately $172.3 million. For purposes of this
computation only, all executive officers, directors and 10% beneficial owners of
the Registrant are assumed to be affiliates.
As of March 1, 2002 the Registrant had 10,100,442 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement pertaining to the 2002
Annual Meeting of Shareholders (the "Proxy Statement") to be filed pursuant to
Regulation 14A are incorporated by reference into Part III.
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ITEM 1. BUSINESS

GENERAL

American Physicians Capital, Inc., or APCapital, is an insurance holding
company which writes primarily medical professional liability insurance through
its subsidiaries American Physicians Assurance Corporation, or APAssurance
(formerly Mutual Insurance Corporation Of America, or MICOA), Insurance
Corporation of America and APSpecialty Insurance Corporation (formerly RML
Insurance Company). It also provides workers' compensation insurance and, on a
limited basis, health coverage. APCapital also owns several financial services
companies. APCapital and its consolidated subsidiaries are sometimes referred to
in this report as "we" or the "Company". At December 31, 2001, we insured
approximately 12,500 physicians in 14 states throughout the United States, with
a concentration in the Midwest.

APCapital was incorporated in Michigan in July 2000 to facilitate the
conversion of APAssurance from a mutual insurance company to a publicly owned
stock insurance company. In connection with this conversion, APCapital offered
its common stock to policyholders of APAssurance, to various other groups having
specified relationships to APAssurance and to the general public. APCapital
stock began trading on the Nasdaq Stock Market's National Market on December 8,
2000. The conversion became effective, the offerings were closed and APAssurance
and its subsidiaries became subsidiaries of APCapital on December 13, 2000.

APAssurance, which is APCapital's primary subsidiary, was formed in June
1975 under the sponsorship of the Michigan State Medical Society in response to
a medical professional liability insurance crisis in Michigan. By 1981,
APAssurance was the largest writer of medical professional liability insurance
in Michigan, a distinction it maintains today.

PRODUCTS AND SERVICES

MEDICAL PROFESSIONAL LIABILITY. We underwrite medical professional and
hospital professional liability policy coverages for physicians and physician
medical groups, clinics and other providers in the health care industry. Medical
professional liability insurance insures physicians and other health care
providers against liabilities arising from the rendering of, or failure to
render, professional medical services. We offer both claims made and occurrence
policies, and include legal defense against asserted medical professional
liability claims. Claims-made policies provide coverage to the policyholder for
claims reported during the period of coverage. Policyholders are insured
continuously while their claims-made policy is in force. Occurrence policies
provide coverage to the policyholders for all losses incurred during the policy
coverage year regardless of when the claims are reported. Although we generate a
majority of our premiums from individual and small group practices, we also
insure several major physician groups as well as several hospitals.

We offer separate policy forms for physicians who are sole practitioners
and for those who practice as part of a medical group or clinic. The policy
issued to sole practitioners includes coverage for professional liability that
arises in the medical practice. The medical professional insurance for sole
practitioners and for medical groups provides protection against the legal
liability of the insureds for injury caused by or as a result of the performance
of patient treatment, failure to treat, failure to diagnose and related types of
malpractice.

WORKERS' COMPENSATION. We currently focus our efforts on eight workers'
compensation business niches: health care, light to medium manufacturing,
restaurants, educational services, non-profit organizations, specialty trade
contractors, wholesalers, and auto related sales and services. These niches were
determined after analyzing the current book of business, available premium, size
of market and profit potential. Within these eight niches, we only write 40
classes out of 660 workers' compensation classes. In some instances, we also
looked at the classes of business our agents specialize in writing. The areas on
which we focus our efforts tend to be under-serviced geographic markets and
under-served classes, and we make a special effort toward the health care
sector.

HEALTH INSURANCE. We currently write small business employee health
insurance through a single preferred provider organization located in western
Michigan. This coverage is provided as part of our long-term strategic
relationship with the physician organization which sponsors this plan. We also
provide medical

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professional liability coverage to a majority of the physician members of this
organization. All other programs have been discontinued.

OTHER INSURANCE. We previously sold personal and commercial insurance. We
are no longer accepting new business in this line of business and have not
renewed business previously written by us in this line.

OTHER FINANCIAL SUBSIDIARIES. We have developed and acquired a variety of
other organizations to offer financial services and consulting to its customers.
These services include captive insurance company arrangements, loss control
consulting, risk management and investment management. Revenues from these
sources are not yet material.

SUMMARY PREMIUM VOLUME BY LINE

The following table sets forth, for the years ended December 31, 2001, 2000
and 1999, the amount of direct premiums written and net premiums earned for each
of our lines of insurance.

MARKETING

Our marketing philosophy is to sell profitable business in our core lines
of insurance through a broad, multi-channeled, cost-effective distribution
system. In addition to our agency force, we have built our sales and marketing
efforts around several strategic business alliances. These alliances include
medical society endorsements, purchasing group programs, marketing alliances,
sales agreements with other insurance companies and exclusive agency agreements.

We currently market our products through approximately 300 independent
agents in 14 states. Our medical professional liability product line is marketed
through approximately 40 agents in 13 states, with one strategic partner, SCW
Agency Group, Inc. and its subsidiaries accounting for approximately 45% of
medical professional liability premiums written during 2001. In Florida, we have
six medical professional liability agents who cover the state through exclusive
regional contracts. The other agents who write our medical professional
liability insurance are independent agents. Due to the highly specialized nature
of medical professional liability, financially sound agencies that focus on this
line are selected to represent us in targeted geographic areas. The 40 medical
professional liability agencies are reviewed based upon premium volume,
retention and profitability goals. Of the 40 agencies that write medical
professional liability, 16 wrote over $1 million in premiums with us in 2001.

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We have reduced efforts to write business through our APDirect internet
sales channel, choosing to focus on improving customer and agent communication
via the internet. We continue to offer alternative risk transfer arrangements
through our ART group.

The Michigan State Medical Society, or MSMS, has endorsed APAssurance as
its exclusive professional liability carrier of choice for 26 years and
currently endorses APAssurance in accordance with an agreement pursuant to which
we compensate the MSMS for marketing our professional medical liability products
to MSMS members. APAssurance has also received a similar marketing endorsement
agreement from the Michigan Osteopathic Association, the Kentucky Medical
Association, and the New Mexico Medical Association.

Other independent agencies write workers' compensation for us. The premium
volume for these agencies is normally minor in relation to the total premiums.
Only 19 workers' compensation agencies exceeded $500,000 in premium volume in
2001, and only six of these exceeded $1 million in premium volume. In Minnesota,
we have terminated our endorsement for commission relationship with the
Minnesota Independent Insurance Agents Association, and are now dealing directly
with the insurance agents who write the coverage for us. This change will help
to reduce our costs in this market and to enhance our interaction with these
agents.

UNDERWRITING AND PRICING

Most of our underwriting work and customer contact is performed through our
local offices under the supervision of the home office. The home office
Underwriting department is responsible for the issuance, establishment and
implementation of underwriting standards for all of our underwritten coverages.
The local office underwriting staff have the authority to evaluate, approve and
issue medical professional liability coverage for individual providers and
medical groups with annual premiums that do not exceed present threshold amounts
or guidelines imposed by the home office.

Through our management and actuarial staff, we regularly establish rates
and rating classifications for our physician and medical group insureds based on
the loss and loss adjustment expense, or LAE, experience we have developed over
the past 25 years, and the loss and LAE experience for the entire medical
professional liability market. We have various rating classifications based on
practice location, medical specialty and other liability factors. We also
utilize various discounts, such as claim-free credits, to encourage low risk,
high profit physicians to insure with APAssurance.

The nature of our business requires that we remain sensitive to the
marketplace and the pricing strategies of our competitors. Using the market
information as our background, we normally set our prices based on our estimated
future costs. From time to time, we may reduce our discounts or apply a premium
surcharge to achieve an appropriate return. Pricing flexibility allows us to
provide a fair rate commensurate with the assumed liability. If our pricing
strategy cannot yield sufficient premium to cover our costs on a particular type
of risk, we may determine not to underwrite that risk. It is our philosophy not
to sacrifice profitability for premium growth.

CLAIMS MANAGEMENT

MEDICAL PROFESSIONAL LIABILITY. Our strategy for handling medical
professional liability claims combines a basic philosophy of vigorously
defending against non-meritorious claims with an overall commitment to providing
outstanding service to our insured physicians and hospitals. Our Claims
department is responsible for claims investigation, establishment of appropriate
case reserves for loss and loss adjustment expense, defense planning and
coordination, working closely with attorneys engaged by us to defend a claim and
negotiation of the settlement or other disposition of a claim. Our policies
require us to provide a defense for our insureds in any suit involving a medical
incident covered by the policy. The defense costs we incur are in addition to
the limit of liability under the policy. Medical professional liability claims
often involve the evaluation of highly technical medical issues, severe injuries
and conflicting expert opinions.

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We emphasize early evaluation and aggressive management of claims. When a
claim is reported, a Claims department professional completes an initial
evaluation and sets the initial reserve. As the discovery process continues, the
reserve may be adjusted. We have established different levels of authority
within the Claims department for settlement of claims.

WORKERS' COMPENSATION. Our claims professionals are committed to
exceptional service, aggressive claims management and timely claims settlement.
We perform on-site reviews of customers who need special attention in claims
reporting, internal accident investigation and job analysis/definition. We apply
numerous techniques to reduce medical and indemnity costs and, as allowed by
statute, we provide medical direction for injured workers. We encourage
development of limited/light duty work for workers who can re-enter the
workforce on a limited basis. All of this activity helps us reduce the cost of
workers' compensation claims.

We apply an aggressive defense for all non-compensable claims. We encourage
participation from the insured and maintain open communications with the
policyholder and defense counsel throughout the life of the case. In defense of
contested workers' compensation claims, our claims representatives work with
pre-approved counsel who specialize in workers' compensation defense practice.

Our claims representatives are responsible for the outcome of each claim.
Therefore, legal direction comes from the claim representative at all times.
Most workers' compensation claims are handled outside formal trial proceedings.
Of the small number of claims that do become contested, many are resolved prior
to hearing.

REINSURANCE

In accordance with industry practice, we cede to other insurance companies
some of the potential liability under insurance policies we have underwritten.
This practice, called reinsurance, helps us reduce our net liability on
individual risks, stabilize our underwriting results and increase our
underwriting capacity. As payment for sharing a portion of our risk, we are also
required to share a part of the premium we receive on the related policies. We
determine the amount and scope of reinsurance coverage to purchase each year
based upon an evaluation of the risks accepted, consultations with reinsurance
brokers and a review of market conditions, including the availability and
pricing of reinsurance. Our reinsurance arrangements are generally renegotiated
annually.

Under our primary professional liability reinsurance contract, the portion
of the policyholder premium ceded to the reinsurers is "swing-rated," or
experience rated on a retrospective basis. This swing-rated cession program is
subject to a minimum and maximum premium range to be paid to the reinsurers in
the future, depending upon the extent of losses actually paid by the reinsurers.
We pay a deposit premium during the initial policy year. An additional
liability, "retrospective premiums accrued under reinsurance treaties," is
recorded to represent an estimate of net additional payments to be made to the
reinsurers under the program, based on the level of loss and LAE reserves
recorded. Our largest net insured amount on any medical professional liability
risk is $500,000.

Our net retention in workers' compensation is also now $500,000, in states
other than Minnesota. In Minnesota, insurers are required to obtain reinsurance
from a state facility called the Workers' Compensation Reinsurance Association,
or WCRA. Our current net retention on any one claim with respect to the WCRA is
$660,000. To take advantage of emerging markets, we have also utilized quota
share reinsurance in the recent past, where we share the premium and losses with
the reinsurer.

The following table identifies our principal reinsurers, their percentage
participation in our aggregate reinsured risk based upon amounts recoverable and
their respective A.M. Best ratings as of December 31, 2001. A.M. Best classifies
"A" and "A-" ratings as "Excellent" and "A++" and "A+" ratings as "Superior."

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Other than the entities listed below, no single reinsurer's percentage
participation in 2001 exceeded 5% of total amounts recoverable from reinsurers.

We annually review the financial stability of all of our reinsurers. This
review includes a ratings analysis of each reinsurer participating in a
reinsurance contract. On the basis of this review, as of December 31, 2001, we
concluded that there was no material risk of not being paid by our reinsurers.
We have not experienced any difficulties in collecting amounts due from
reinsurers. We believe that our reinsurance is maintained with financially
stable reinsurers and that any reinsurance security we have is adequate to
protect our interests. However, our inability to collect on our reinsurance, or
the inability of our reinsurers to make payments under the terms of reinsurance,
due to insolvency or otherwise, could have a material adverse effect on our
future results of operations and financial condition.

LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES

Our insurance subsidiaries are required by applicable insurance laws and
regulations to maintain reserves for payment of losses and loss adjustment
expenses for reported claims and for claims incurred but not reported, arising
from policies that have been issued. Generally, these laws and regulations
require that we provide for the ultimate cost of those claims without regard to
how long it takes to settle them or the time value of money. We are also
required to maintain reserves on a physician's death, disability and retirement,
or DD&R reserves, which are included in our loss reserves. The determination of
reserves involves actuarial and statistical projections of what we expect to be
the cost of the ultimate settlement and administration of such claims 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.

When a claim is reported to us, claims personnel establish a "case reserve"
for the estimated amount of the ultimate payment. This estimate reflects an
informed judgment based upon insurance reserving practices appropriate for the
relevant line of business and on the experience and knowledge of the estimator
regarding 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 periodically adjusted by the claims staff, as more information becomes
available. The estimation of ultimate liability for losses and loss adjustment
expenses is an inherently uncertain process and does not represent an exact
calculation of that liability. We do not discount our reserves to recognize the
time value of money. We maintain reserves for claims incurred but not reported
to provide for future reporting of already incurred claims and developments on
reported claims. The reserve for claims incurred but not reported is determined
based on historical loss trends.

We compute our estimated liability using principles and procedures
applicable to the lines of business written. There can be no assurance that
losses will not exceed our loss reserves. Adjustments in aggregate reserves, if
any, are reflected in the operating results of the period during which such
adjustments are made. As required by insurance regulatory authorities, we
receive a statement of opinion by an independent consulting actuary concerning
the adequacy of statutory reserves. The results of these actuarial studies have
consistently indicated that our reserves are adequate.

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The following table provides a reconciliation, prepared in accordance with
generally accepted accounting principles, of beginning and ending loss and loss
adjustment expenses reserve balances for the years ended December 31, 2001, 2000
and 1999.

During 2001, we encountered adverse development on our prior year loss
reserves. This was the result of a significant increase in reported losses in
the second half of 2001. Losses on prior accident years were up in our Ohio,
Florida and Kentucky medical professional liability markets and were caused
primarily by a dramatic increase in loss severity. In addition, current accident
year losses in some of our newer medical professional liability markets (Ohio
and Florida) and workers compensation markets (Iowa, Illinois, and Kentucky)
developed much higher than originally estimated.

The following table shows the development of the net liability for unpaid
loss and loss adjustment expenses from 1992 through 2001. The top line of the
table shows the original estimated liabilities at the balance sheet date,
including losses incurred but not yet reported. The upper portion of the table
shows the cumulative amounts subsequently paid as of successive years with
respect to the liability. The lower portion of the table shows the re-estimated
amount of the previously recorded liability based on experience as of the end of
each succeeding year. The estimates change as claims settle and more information
becomes known about the ultimate frequency and severity of claims for individual
years. The redundancy (or deficiency) exists when the re-estimated liability at
each December 31 is less (or greater) than the prior liability estimate. The
"cumulative redundancy" (or deficiency) depicted in the table, for any
particular calendar year, represents the aggregate change in the initial
estimates over all subsequent calendar years.

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The volatility of professional liability claim frequency and severity makes
the prediction of the ultimate loss very difficult. Likewise, the long time
frame for professional liability claims to develop and be paid further
complicates the reserving process.

In evaluating the information in the table above, it should be noted that
each column includes the effects of changes in amounts for prior periods. The
table does not present accident year or policy year development data. Conditions
and trends that have affected the development of liabilities in the past may not
necessarily occur in the future. Accordingly, it may not be appropriate to
extrapolate future redundancies or deficiencies based on this table.

Statutory accounting principles require reserves to be reported on a net
basis, i.e., after reinsurance. Generally accepted accounting principles require
reserves to be reported on a gross basis, i.e., before reinsurance, with a
corresponding asset established for the reinsurance recoverable. When compared
on either a gross or net basis, our statutory and GAAP reserves are identical.

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INVESTMENTS

An important component of our operating results has been the total return
on invested assets. Our investment objectives are primarily to maximize current
returns, in addition to generating long-term capital appreciation that can
ultimately be converted to current income. We are pursuing these objectives
while maintaining safety of capital together with adequate liquidity for our
insurance operations. All of our investment securities are classified as
available for sale in accordance with Statement of Financial Accounting
Standards No. 115. As of December 31, 2001, 98% of our investment portfolio,
which consisted of fixed income securities, investment real estate, mortgage
loans and short-term investments, was investment grade. The fixed income
portfolio is managed by one of our subsidiaries. For additional information
regarding our investment results, see Note 5 of the Notes to Consolidated
Financial Statements contained elsewhere in this report.

COMPETITION

The insurance industry is highly competitive. We compete with numerous
insurance companies and various self-insurance mechanisms. Many of our
competitors have considerably greater financial resources and higher A. M. Best
Company ratings than we have, particularly our competitors in workers'
compensation lines. We believe that the principal competitive factors in all of
our lines are service quality, name recognition, breadth and flexibility of
coverages, financial stability and, to a lesser degree, price. We believe we
compare favorably to many of our competitors based on our excellent service to
customers, our close relationship with the medical community, primarily through
various medical societies which affords us a high degree of name recognition,
our ability to customize product features and programs to fit the needs of our
customers and our long history of financial stability.

SEGMENT INFORMATION

See Note 20 of the Notes to Consolidated Financial Statements contained
elsewhere in this report for information regarding our business segments. Such
information is incorporated herein by reference.

INSURANCE REGULATORY MATTERS

GENERAL. Insurance companies are subject to supervision and regulation
relating to numerous aspects of their business and financial condition in the
states in which they transact business. The nature and extent of such regulation
vary from jurisdiction to jurisdiction. Our Michigan insurance companies, for
example, are subject to supervision and regulation by the Office of Financial
and Insurance Services for the State of Michigan, or OFIS, which establishes
standards of solvency, licenses insurers and agents, establishes guidelines for
investments by insurers, reviews premium rates, reviews the provisions which
insurers must make for current losses and future liabilities, reviews
transactions involving a change in control and requires the filing of periodic
reports relating to financial condition. In addition, state regulatory
examiners, including the OFIS, perform periodic examinations of insurance
companies. Such regulation is generally intended for the protection of
policyholders rather than shareholders.

Our insurance subsidiaries together write insurance in 18 states and are
licensed to write insurance in a total of 33 states. Our current focus of
operations is on our existing states. However, we continue to expand our
geographic capabilities beyond the states where we currently write coverage, by
adding licenses when appropriate to allow for future growth.

HOLDING COMPANY REGULATION. Most states, including Michigan, have enacted
legislation that regulates insurance holding company systems such as ours. Each
insurance company in a holding company system is required to register with the
insurance supervisory agency of its state of domicile and furnish 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. These laws permit the OFIS or any other relevant
insurance departments to examine APCapital and its insurance subsidiaries at any
time, to require disclosure of material transactions between APCapital and its
insurance subsidiaries, and to require prior approval of sales or purchases of a
material amount of assets and the payment of extraordinary dividends.
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Holding company laws also limit the amount of dividends payable by
insurance subsidiaries to the parent company. Under Michigan law, the maximum
dividend that may be paid to APCapital from its insurance subsidiaries during
any twelve-month period without prior approval of the OFIS is the greater of 10%
of APAssurance's statutory surplus, as reported on the most recent annual
statement filed with the OFIS, and the net income of APAssurance for the period
covered by such annual statement. At December 31, 2001, the amount available for
payment of dividends without the prior approval of the OFIS was approximately
$12.3 million.

CHANGE OF CONTROL. The Michigan Insurance Code requires that the OFIS
receive prior notice of and approve a change of control for either APAssurance
or APCapital. The Michigan Insurance Code contains a complete definition of
"control." In simplified terms, a person, corporation, or other entity would
obtain "control" of APAssurance or APCapital if they possessed, had a right to
acquire possession, or had the power to direct any other person acquiring
possession, directly or indirectly, of 10% or more of the voting securities of
either company. In addition, our plan of conversion provides that no one may
acquire more than 5% of the common shares outstanding of APCapital before
December 13, 2005 without OFIS approval. To obtain approval for a change of
control, the proposed acquiror must file an application with the OFIS containing
detailed information such as the identity and background of the acquiror and its
affiliates, the sources of and amount of funds to be used to effect the
acquisition, and financial information regarding the proposed acquiror.
Insurance laws of other states applicable to our insurance subsidiaries have
similar requirements.

RISK-BASED CAPITAL REQUIREMENTS. In addition to state-imposed insurance
laws and regulations, the OFIS administers the requirements adopted by the
National Association of Insurance Commissioners, or NAIC, that require insurance
companies to calculate and report information under a risk-based formula that
attempts to measure capital and surplus needs based on the risks in a company's
mix of products and investment portfolio. Under the formula, we first determine
our risk-based capital base level by taking into account risks with respect to
our assets and underwriting risks relating to our liabilities and obligations.
We then compare our "total adjusted capital" to the base level. Our "total
adjusted capital" is determined by subtracting our liabilities from our assets
in accordance with rules established by the OFIS. A ratio of total adjusted
capital to risk-based capital of less than 2.0 may give rise to enhanced
regulatory scrutiny or even a regulatory takeover of the insurer, depending on
the extent to which the ratio is less than 2.0.

The ratio for our primary insurance subsidiary, APAssurance, has always
exceeded 2.0 in the past, but there can be no assurance that the requirements
applicable to APAssurance will not increase in the future. As of December 31,
2001, APAssurance's risk-based capital base level was $43.3 million and its
total adjusted capital was $176.8 million, for a ratio of 4.1.

IRIS REQUIREMENTS. The NAIC has also developed a set of financial ratios,
referred to as the Insurance Regulatory Information System, or IRIS, for use by
state insurance regulators in monitoring the financial condition of insurance
companies. The NAIC has established an acceptable range of values for each of
the IRIS financial ratios. Generally, an insurance company will become the
subject of increased scrutiny when four or more of its IRIS ratio results fall
outside the range deemed acceptable by the NAIC. The nature of increased
regulatory scrutiny resulting from IRIS ratio results outside the acceptable
range is subject to the judgment of the applicable state insurance department,
but generally will result in accelerated review of annual and quarterly filings.
For 2001, our results on a consolidated basis were within the acceptable range
for all IRIS tests. The NAIC does not compute IRIS ratios on a consolidated
basis. However, none of our insurance subsidiaries had more than two ratios
outside the acceptable range for 2001.

GUARANTY FUND. We participate in various guaranty associations in the
states in which we write business, which protects policyholders and claimants
against losses due to insolvency of insurers. When an insolvency occurs, the
associations are authorized to assess member companies up to the amount of the
shortfall of funds, including expenses. Member companies are assessed based on
the type and amount of insurance written during the previous calendar year.

We make accruals for our portion of assessments when we become aware of any
possible assessments by the associations.

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EMPLOYEES

As of December 31, 2001, we had 226 employees. None of the employees are
covered by a collective bargaining unit and we believe that employee relations
are good.

UNCERTAINTIES RELATING TO FORWARD-LOOKING STATEMENTS

We make forward-looking statements in this report and may make such
statements in future filings with the Securities and Exchange Commission. We may
also make forward-looking statements in our press releases or other public or
shareholder communications. Our forward-looking statements are subject to risks
and uncertainties and include information about our expectations and possible or
assumed future results of our operations. When we use any of the words
"believes," "expects," "anticipates," "estimates" or similar expressions, we are
making forward-looking statements.

We claim the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995 for all of our
forward-looking statements. While we believe that our forward-looking statements
are reasonable, you should not place undue reliance on any such forward-looking
statements, which speak only as of the date made. Because these forward-looking
statements are based on estimates and assumptions that are subject to
significant business, economic and competitive uncertainties, many of which are
beyond our control or are subject to change, actual results could be materially
different. Factors that might cause such a difference include the following:

- If we establish inadequate loss and loss adjustment expense reserves, or
if they develop less favorably than in the past, our profitability may
decline.

- Substantial jury awards against our insureds could impose liability on us
exceeding our policy limits or the funds we have reserved for the payment
of claims.

- If the marketplace puts pressure on pricing increases, we may not be able
to obtain expected rate increases.

- If competitive or other conditions change, our revenues may decrease or
our expenses may increase so that our business is no longer profitable.

- If we experience substantial change in claims frequency or severity
patterns, our profitability may decline.

- Changes in the health care industry could reduce the size of our premiums
and the number of customers buying our insurance.

- We may be unable to obtain adequate and affordable reinsurance coverage
from creditworthy reinsurers, which would increase our risk and restrict
our ability to offer insurance at competitive rates and coverage limits.

- The concentration of our business in Michigan leaves us vulnerable to
various factors specific to that state.

- If actions relating to the conversion are legally challenged, we may not
be able to implement our business plan.

- Although our strategy for growth includes expansion and diversification
of our insurance products, there is no assurance that this strategy will
be successful.

- If our current relationship with medical associations and physicians does
not continue, our ability to market our products and compete successfully
may be harmed.

- An interruption or change in our relationship with an insurance sales
agency which is principally owned by our President and Chief Executive
Officer could reduce our insurance premiums and net income. This agency
accounts for substantially more of our medical professional liability
premiums written than

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any other agency. However, the commission rates we pay to this agency are
somewhat less than we pay to other agents.

- If any of the member companies in the various guaranty associations in
which we participate were to become insolvent, we could be assessed by
the relevant association in an amount which could materially affect the
financial condition of the Company.

- We may not be able to implement our strategy of successfully completing
future acquisitions, and completed acquisitions may lead to unexpected
liabilities.

- If our president and chief executive officer does not continue in that
role, our financial performance may decline.

- If we fail to comply with insurance industry regulations, or if those
regulations become more burdensome to us, we may not be able to operate
profitably.

- A reduction in our A.M. Best Company rating could make it more difficult
for us to sell our products.

- We may be unable to obtain anticipated processing efficiencies, which may
negatively affect our profitability.

- Changes in prevailing interest rates and other negative changes in
financial market conditions may reduce our revenues, cash flows or
assets.

- A downturn in general economic conditions or significant increase in
inflation in the markets in which we compete could negatively affect our
profitability.

Other factors not currently anticipated by management may also materially
and adversely affect our results of operations. Except as required by applicable
law, we do not undertake any obligation to publicly update or alter any
forward-looking statements whether as a result of new information, events or
circumstances occurring after the date of this report or otherwise.

ITEM 2. PROPERTIES

We own our home office in East Lansing, Michigan which comprises
approximately 89,000 square feet. In addition, we lease office space as needed
in our major markets to provide a local presence. Our leases tend to be
approximately five years in length. We currently lease a total of approximately
88,000 square feet of space in East Lansing, Michigan; Chicago, Illinois;
Louisville, Kentucky; Boca Raton, Florida; Eden Prairie, Minnesota; Las Vegas,
Nevada; and Albuquerque, New Mexico. We also own various real estate investment
properties as part of our investment portfolio.

ITEM 3. LEGAL PROCEEDINGS

We are not currently subject to any material litigation. Though we have
many routine litigation matters in the ordinary course of our insurance
business, we do not expect these cases to have a material adverse effect on our
financial condition and results of operations.

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

No matters were submitted to a vote of shareholders during the fourth
quarter of 2001.

12

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

Our common stock has traded on the Nasdaq Stock Market's National Market
under the symbol ACAP since December 8, 2000. Prior to that time, there was no
public market for our stock. The following table sets forth the high and low
sales price per share of the common stock as reported on the Nasdaq Stock Market
for the periods indicated.

We have never paid a cash dividend and currently do not intend to pay cash
dividends in the future. Our ability to pay dividends may be contingent on the
receipt of cash dividends from our subsidiaries. The payment of any dividends
from our insurance subsidiaries to APCapital is subject to a number of
regulatory conditions described above under "Item 1. Business -- Insurance
Regulatory Matters."

As of March 1, 2002, there were approximately 300 shareholders of record of
our common stock, based on the records of our transfer agent.

13

ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data, other than the selected statutory
data, are derived from our consolidated financial statements which were prepared
in accordance with generally accepted accounting principles. The data should be
read in conjunction with the consolidated financial statements, related notes
and other financial information included elsewhere in this report. The selected
statutory data are derived from our annual statements which were prepared in
accordance with statutory accounting practices as required by insurance
regulatory authorities. See Note 19 of the consolidated financial statements
included under Item 8 for a discussion of the principal differences between GAAP
and statutory accounting practices.

- ---------------

(a) Operating results for the year ended December 31, 1999 include the effects
of a one-time settlement with the Internal Revenue Service. Without this
settlement, net income for the year ended December 31, 1999 would have been
approximately $4.6 million.

(b) APAssurance's mergers with New Mexico Physicians Mutual Insurance Company
and State Mutual Insurance Company in 1997 were accounted for under the
pooling method of accounting.

(c) The weighted average shares outstanding for the period from December 13,
2000, the date of the closing of the conversion, through December 31, 2000
were 11,134,981 basic common shares and 11,260,797 common shares assuming
dilution. The weighted average shares outstanding for the year ended
December 31, 2001, were 11,071,529 basic common shares. As the Company was
in a net loss position for the year ended December 31, 2001, no effect of
awards or options were calculated as the impact would be anti-dilutive.
There were no cash dividends declared during the periods presented.

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

The following discussion and analysis should be read in conjunction with
the consolidated financial statements and the notes thereto included elsewhere
in this report. The following discussion contains certain forward-looking
statements relating to our anticipated future financial condition and operating
results and our current business plans. These forward-looking statements
represent our outlook only as of the date of this report. While we believe any
forward-looking statements we have made are reasonable, actual results could
differ materially since the statements are based on our current expectations and
are subject to risks and uncertainties. These risks and uncertainties are
detailed elsewhere in this report and from time to time in other reports filed
by the Company with the Securities and Exchange Commission. See the disclosures
under "Item 1 -- Business -- Uncertainties Relating to Forward-Looking
Statements."

OVERVIEW

We are a leading provider of medical professional liability insurance
coverage, writing this coverage in 14 states throughout the country. This
insurance coverage protects physicians and other health providers from claims
filed against them for alleged acts of medical malpractice. Medical professional
liability insurance represented 64.7% of our direct premiums written in 2001. In
addition, we write workers' compensation insurance in 13 states, insuring a
variety of business classes. During 2001, we also provided a limited amount of
general personal and commercial coverage and participated in a health insurance
program.

Our policy liability limits vary by line and state. In workers'
compensation insurance, state statutes dictate the coverage we offer our
policyholders. For medical professional liability insurance, most states allow
physicians to choose their own coverage limits. The limits of liability
purchased by our medical professional liability policyholders differ by state.
In Michigan and New Mexico, the most common limits purchased by our
policyholders are $200,000 per claim, with a $600,000 annual aggregate
($200,000/$600,000). In Florida, the most common limits purchased is
$250,000/$750,000. In all other states, the most common limit purchased is
$11,000,000 per claim, with an $11,000,000 annual aggregate. Higher limits and
excess coverage may be written in conjunction with special reinsurance
arrangements.

15

We purchase reinsurance to limit risk on our individual exposures,
stabilize underwriting results and increase our capacity to write insurance. By
purchasing reinsurance, we transfer a portion of our loss exposure to a
reinsurer. Purchasing reinsurance does not discharge us from our obligation to
our insureds. If the reinsurer fails to meet its obligations, we remain liable
to pay the insured. We have various reinsurance agreements in place. In general,
we retain the first $500,000 of a claim; reinsurers pay amounts in excess of
$500,000 per claim.

We annually review the financial stability of all of our reinsurers. This
review includes a ratings analysis of each reinsurer participating in a
reinsurance contract. On the basis of this review, as of December 31, 2001, we
concluded that there was no material risk of not being paid by our reinsurers.
We have not experienced any material difficulties in collecting amounts due from
reinsurers. We believe that our reinsurance is maintained with financially
stable reinsurers and that any reinsurance security we have is adequate to
protect our interests. However, our inability to collect on our reinsurance, or
the inability of our reinsurers to make payments under the terms of reinsurance,
due to insolvency or otherwise, could have a material adverse effect on our
future results of operations and financial condition.

SIGNIFICANT ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect amounts reported in the accompanying consolidated
financial statements and related footnotes. These estimates and assumptions are
evaluated on an on-going basis based on historical developments, market
conditions, industry trends and other information 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
operations 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. The following policies are those we believe to be the most
sensitive to estimates and judgments. Our significant accounting policies are
more fully described in Note 1 to our consolidated financial statements.

UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES. The reserves for unpaid losses
and loss adjustment expenses are actuarially estimated using the Company's claim
experience. These estimates are subject to the effects of trends in loss
severity and frequency. When a claim is reported to us, claims personnel
establish a "case reserve" for the estimated amount of the ultimate payment.
This estimate reflects an informed judgment based upon insurance reserving
practices appropriate for the relevant line of business, and on the experience
and knowledge of the estimator regarding 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 periodically adjusted by the claims staff,
as more information becomes available.

The estimation of ultimate liability for losses and loss adjustment
expenses is an inherently uncertain process and does not represent an exact
calculation of that liability. We do not discount our reserves to recognize the
time value of money. We maintain reserves for claims incurred but not reported
to provide for future reporting of already incurred claims and developments on
reported claims. The reserve for claims incurred but not reported is determined
based on historical loss trends. Although considerable variability is inherent
in such estimates, we believe that the reserve for unpaid losses and loss
adjustment expenses is adequate. The methodology for making such estimates and
establishing the resulting liabilities is continually reviewed, and any
adjustments are reflected as an expense in the period in which the adjustment is
made.

INVESTMENTS. Investments represent our largest asset and are the primary
source of funds to pay insurance claims. All of our fixed maturity securities
are classified as available-for-sale, which are those securities that would be
available to be sold in the future in response to our liquidity needs, changes
in market interest rates and asset-liability management strategies.
Available-for-sale securities are reported at their estimated fair value, with
unrealized gains and losses excluded from earnings and reported as a separate
component of other comprehensive income, net of deferred taxes. Investment
income includes amortization of premium and accrual of discount on the
yield-to-maturity method relating to investments acquired at other than par
value.

16

Equity securities are carried at quoted market values. Fair values of fixed
maturities and equity securities are determined on the basis of dealer or market
quotations or comparable securities on which quotations are available. Mortgage
loans are carried at the unpaid principal balance which approximates the fair
market value as they bear current market interest rates. Real estate is carried
at historical cost, less accumulated depreciation. We periodically review the
investment portfolio for any potential credit quality or collection issues and
for any securities with respect to which we consider any decline in market value
to be other than temporary. Investments which are considered impaired are
written down to their estimated net realizable value. Realized gains or losses
on sales or maturities of investments are determined on a specific
identification basis and are credited or charged to income.

RESERVE FOR EXTENDED REPORTING PERIOD CLAIMS. The reserve for extended
reporting period claims coverage is recorded during the term of the original
claims-made policy, utilizing the pure-premium approach, in amounts believed to
be adequate to pay for estimated future claims reported subsequent to a current
policyholder's death, disability or retirement. Amounts are estimated on a basis
similar to the estimates made in respect of the reserve for unpaid losses and
loss adjustment expenses. Changes in this reserve are reflected as an expense in
the period in which the adjustment is made.

REINSURANCE. In accordance with industry practice, we cede to other
insurance companies some of the potential liability under insurance policies we
have underwritten. This practice, called reinsurance, helps us reduce our net
liability on individual risks, stabilize our underwriting results and increase
our underwriting capacity. As payment for sharing a portion of our risk, we are
also required to share a part of the premium we receive on the related policies.
We determine the amount and scope of reinsurance coverage to purchase each year
based upon an evaluation of the risks accepted, consultations with reinsurance
brokers and a review of market conditions, including the availability and
pricing of reinsurance. Our reinsurance arrangements are generally renegotiated
annually.

Reinsurance premiums and losses related to reinsured business are accounted
for on bases consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. Premiums ceded to other
companies are reported as a reduction of premium income. Reinsured losses
incurred are reported as a reduction of gross losses incurred.

KEY RATIOS BY PRODUCT

Set forth below are our GAAP ratios by product line for each of the last
three years. The loss ratio compares our losses and loss adjustment expenses to
our net premiums earned and indicates how much we expect to pay to policyholders
for claims and related settlement expenses compared to the amount of premiums we
earn. The lower the percentage, the more profitable our insurance business. The
underwriting expense ratio compares our expenses to obtain new business and
renew existing business plus normal operating expenses to our net premiums
earned and is used to measure how efficient we are at obtaining business and
operating the company. The lower the percentage, the more efficient we are.
Sometimes, however, a higher underwriting expense can result in better business
and improve our loss ratio and overall profitability. The

17

combined ratio compares the sum of our underwriting expense ratio and our loss
ratio. The lower the percentage, the more profitable our insurance business is.
This ratio excludes the effects of investment income.

RESULTS OF OPERATIONS -- 2001 COMPARED TO 2000

MEDICAL PROFESSIONAL LIABILITY INSURANCE OPERATIONS. Medical professional
liability net premiums earned were $119.7 million for the year ended December
31, 2001, an increase of $10.2 million, or 9.3%, compared to 2000. The increase
in net premiums earned was mainly due to price increases and reduced discounts
we instituted in all states. Also, we experienced greater penetration of the
Florida and Illinois markets. However, these factors were offset by the
reduction in the number of insured physicians in Ohio and Kentucky due to
re-underwriting efforts. We are currently seeking regulatory approval of
significant additional rate increases.

Medical professional liability incurred loss and loss adjustment expenses
totaled $168.6 million for the year ended December 31, 2001, an increase of
$72.6 million, or 75.6%, compared to 2000. The incurred loss and loss adjustment
expense ratio increased to 140.9% for the year ended December 31, 2001 from
87.6% for 2000. The increase in loss ratio was due primarily to reserve
adjustments taken in the third and fourth quarters, which related to prior
accident years and revisions made to current year expected losses. Due to the
unexpected significant increase in reported losses and claim severity primarily
in our newer markets in the third quarter of 2001, including an unusually high
frequency of large claims, we undertook and completed a comprehensive internal
actuarial study. As a result of this study, we revised the actuarial assumptions
upon which loss reserves are based and adjusted loss reserves accordingly.

The reserve adjustments included a total of approximately $22.7 million
increase on prior accident years, primarily the 1999 and 2000 years. In
addition, the current accident year loss estimates were increased to
approximately $145.9 million to reflect our revised assumptions regarding loss
development patterns. The adjustments were made primarily as a result of losses
in our Ohio, Florida and Kentucky medical professional liability markets. Ohio
and Florida are relatively new markets for us and have higher policy limits.
Thus, actual loss development can be volatile and difficult to predict. With
these revised loss assumptions, the 2001 accident year net loss and loss
adjustment expense ratio is 121.9%. We discontinued offering higher policy
limits in Ohio and Florida in the third quarter of 2001.

18

Medical professional liability underwriting expenses were $23.3 million for
the year ended December 31, 2001, an increase of $2.7 million, or 13.1%,
compared to 2000. The underwriting expense ratio was 19.5% for the year ended
December 31, 2001, compared to 18.8% for 2000. This increase was due primarily
to the growth of premiums in states where we pay higher commissions than we pay
in Michigan, where we have an arrangement with SCW Agency Group, Inc. where we
pay commissions at rates that are lower than market. Our President and Chief
Executive Officer is the principal owner of SCW Agency Group, Inc. In addition,
we recorded the maximum ceded premium on all affected swing-rated reinsurance
treaties due to the higher losses, which amounted to a $6.3 million increase in
ceded premiums.

WORKERS' COMPENSATION INSURANCE OPERATIONS. Workers' compensation net
premiums earned were $58.4 million for the year ended December 31, 2001, an
increase of $11.4 million, or 24.3%, compared to 2000. The increase in net
premiums earned was due primarily to retroactive premium adjustments and reduced
credits following audits, as well as growth in the number of policies written in
the states of Minnesota, Illinois and Indiana. We are seeking regulatory
approval of significant additional rate increases.

Workers' compensation incurred loss and loss adjustment expenses totaled
$62.7 million for the year ended December 31, 2001, an increase of $25.0
million, or 66.3%, compared to 2000. The incurred loss and loss adjustment
expense ratio increased to 107.4% for the year ended December 31, 2001 from
80.3% for 2000. The increasing loss ratio was due to an overall pattern of
increasing losses, especially in our newer states, Illinois, Iowa and Kentucky,
where we have less historical data on which to base our estimates. As a result
of these high loss patterns, we increased our prior year reserves in almost all
markets by a total of $5.6 million. The current accident year loss estimates
were increased to $57.1 million, primarily in the markets noted above. After
these adjustments, the 2001 accident year net loss and loss adjustment expense
ratio is 97.8%.

Workers' compensation underwriting expenses were $16.4 million for the year
ended December 31, 2001, an increase of $3.1 million, or 23.3%, compared to
2000. The underwriting expense ratio decreased to 28.1% for the year ended
December 31, 2001, from 28.3% for 2000. The decrease resulted primarily from our
expense reduction initiatives, lower assessments and fees, and premium
increases.

HEALTH INSURANCE OPERATIONS. Health net premiums earned were $18.7 million
for the year ended December 31, 2001, an increase of $7.6 million, or 68.5%,
compared to 2000. The increase was due to one health insurance program through a
preferred provider organization in western Michigan. We discontinued all of our
other health insurance programs during 2001.

Health incurred loss and loss adjustment expenses totaled $18.4 million for
the year ended December 31, 2001, an increase of $8.4 million or 84.0%, compared
to 2000. The incurred loss and loss adjustment expense ratio increased to 98.7%
for the year ended December 31, 2001, from 90.6% for 2000. The increase in loss
ratio was due to overall increases in health care costs, primarily in the state
of Michigan. We are increasing health insurance premium rates to offset these
higher health loss costs.

Health underwriting expenses were $4.2 million for the year ended December
31, 2001, an increase of $500,000, or 13.5%, compared to 2000. The underwriting
expense ratio decreased to 22.5% for the year ended December 31, 2001 from 33.2%
for 2000. The reduction was directly related to our expense reduction
initiatives and premium increases.

PERSONAL AND COMMERCIAL LINES INSURANCE OPERATIONS. Personal and
commercial net premiums earned were $5.7 million for the year ended December 31,
2001, a decrease of $7.1 million, or 55.5%, compared to 2000. The decrease was
due to our exiting this line of business. There will be no premiums in future
periods.

Personal and commercial incurred loss and loss adjustment expenses totaled
$8.1 million for the year ended December 31, 2001, a decrease of $1.7 million or
17.3%, compared to 2000. The incurred loss and loss adjustment expense ratio
increased to 143.2% for the year ended December 31, 2001, from 76.7% for 2000.
The increasing loss ratio was due primarily to a higher amount of winter
storm-related losses in 2001 and the adverse effects of discontinuing this line
of business.

19

Personal and commercial underwriting expenses were $1.2 million for the
year ended December 31, 2001, a decrease of $3.4 million, or 73.9%, compared to
2000. The underwriting expense ratio decreased to 21.8% for the year ended
December 31, 2001 from 35.8% for 2000. The reduction was directly related to our
exit from this line of business beginning in the fourth quarter of 2000.

CORPORATE, INVESTMENTS AND OTHER. Net investment income, excluding
realized investment gains and losses, was $47.9 million for the year ended
December 31, 2001, an increase of $11.1 million, or 30.2%, compared to 2000.
Approximately $7.8 million of the annual increase is attributable to investment
of the proceeds of our initial public offering received in December 2000. In
addition, in 2000 we liquidated approximately $35.0 million in equity
securities, invested the proceeds in interest income producing government and
corporate bonds and shifted some of our portfolio from tax-exempt securities to
higher yielding taxable corporate securities. Net realized losses and gains were
($5.6 million) and $1.2 million during the year ended December 31, 2001 and
2000, respectively. Approximately $6.0 million of the 2001 loss was attributable
to a security whose decline in market value in 2001 we considered to be other
than temporary. We maintain a portfolio of cash and short-term investments to
meet operating cash needs, fund the share repurchase programs and fund potential
acquisitions. Recent reductions in short-term interest rates have reduced the
yields generated by this portfolio.

Our general and administrative expenses increased $1.4 million to $2.2
million during the year ended December 31, 2001 compared to the prior year. The
increase was primarily due to new costs incurred by the holding company becoming
publicly traded in December 2000. These costs include stock market listing fees,
investor relations fees, shareholder meeting costs and securities reporting
expenses. We expect the general and administrative expenses for 2001 to be more
representative of continuing operations.

We incurred an additional restructuring charge of $2.5 million in 2001. The
elimination of nine staff members located in our now closed Michigan personal
and commercial branch office resulted in $567,000 of this charge. The remainder
of the charge was related to severance costs incurred in the elimination of 11
staff members at our East Lansing home office in the Information Systems
department and Senior Management. These actions were taken as part of an overall
corporate restructuring. The expected annual savings for the entire
restructuring is $1.4 million. At December 31, 2001, there was $1,130,000
accrued for restructuring charges that was paid in January 2001.

We recorded $23.5 million in federal income tax benefit for the year ended
December 31, 2001, compared to a $4.8 million expense during 2000, due to the
loss for 2001. The effective tax rate was 34.9% for the year ended December 31,
2001, compared to 28.7% for 2000. The 2000 effective tax rate was lower due to
the greater impact of tax exempt interest.

On March 9, 2002, new tax laws extended the net operating loss carryback
period from two years to five years. As a result, approximately $12.4 million of
the Company's net operating loss carryforward at December 31, 2001 will be
utilized to recover taxes previously paid in tax years 1996, 1997, and 1998.
This additional loss carryback will result in an increase to the reported
federal income taxes recoverable with a corresponding decrease in deferred
federal income taxes in the first quarter of 2002.

RESULTS OF OPERATIONS -- 2000 COMPARED TO 1999

MEDICAL PROFESSIONAL LIABILITY INSURANCE OPERATIONS. Net premiums earned
increased by $13.2 million, or 13.7%, to $109.5 million in 2000. This increase
reflects the increase in direct premiums written and changes in our reinsurance
program, primarily eliminating the 50% quota share arrangement in Florida.

Losses and loss adjustment expenses increased $12.7 million, or 15.2%, to
$96.0 million in 2000. The 2000 reported loss ratio was 87.6% compared to 86.5%
in 1999. The accident year loss ratio, which excludes the effects of prior year
developments of loss reserves, was 95.6% in 2000 compared to 107.0% in 1999. The
medical professional liability loss ratio increase was due to higher losses in
some of our newer markets, particularly Ohio and Florida.

Medical professional liability policy acquisition and underwriting expenses
were $20.6 million in 2000 compared to $22.2 million in 1999. As a percentage of
premiums earned, the medical professional liability
20

underwriting expense ratio decreased to 18.8% in 2000 from 23.0% in 1999. This
decrease was due primarily to expense reduction measures that we began
implementing in the fourth quarter of 1999 and the acquisition of the management
company in 1999.

WORKERS' COMPENSATION INSURANCE OPERATIONS. Net premiums earned increased
by $10.2 million, or 27.7%, to $47.0 million in 2000. The majority of this
increase was in the Minnesota market.

Losses and loss adjustment expense increased $8.5 million, or 29.1% to
$37.7 million in 2000. The loss ratio was 80.3% in 2000 compared to 79.5% in
1999. The increase in loss ratio was the result of increased losses, partially
offset by rate increases.

Workers' compensation underwriting expenses were $13.3 million in 2000
compared to $12.3 million in 1999. As a percentage of premiums earned, the
underwriting expense ratio decreased to 28.3% in 2000, from 33.5% in 1999. This
decrease was also due to the expense reduction measures that we began
implementing in the fourth quarter of 1999, including the closing of our
Indianapolis workers' compensation service office.

HEALTH INSURANCE OPERATIONS. Health net premiums earned were $11.1 million
for the year ended December 31, 2000, a increase of $6.3 million, or 131.3%. The
increase was primarily due to expansion of a preferred provider organization in
western Michigan.

Health incurred loss and loss adjustment expenses totaled $10.0 million for
the year ended December 31, 2000, an increase of $400,000 or 4.2%. The incurred
loss and loss adjustment expense ratio decreased to 90.6% for the year ended
December 31, 2000, from 199.3% for 1999. The decrease in loss ratio was due to a
one-time reserve establishment incurred in 1999.

Health underwriting expenses were $3.7 million for the year ended December
31, 2000, an increase of $2.6 million, or 236.4%. The underwriting expense ratio
increased to 33.2% for the year ended December 31, 2000 from 23.1% for 1999. The
increase was the result of the expansion of our health insurance premiums and
coverage.

PERSONAL AND COMMERCIAL LINES INSURANCE OPERATIONS. Personal and
commercial lines net premiums earned increased $2.1 million, or 19.6%, to $12.8
million in 2000 primarily due to rate increases. However, with the conclusion of
2000, we began the process of winding down the personal and commercial segment.

The personal and commercial loss ratio was 76.7% in 2000 and 81.9% in 1999.
The 1999 personal and commercial loss ratio reflected higher winter storm
losses.

Personal and commercial underwriting expenses increased $150,000, or 3.4%,
to $4.6 million in 2000. As a percentage of premiums earned, the underwriting
expense ratio decreased to 35.8% in 2000 from 41.3% in 1999. This decrease was
due to specific expense reduction efforts for this line of business.

CORPORATE, INVESTMENTS AND OTHER. Investment income, excluding realized
investment gains, increased $6.2 million, or 20.2%, to $36.8 million in 2000.
The increase reflects a shift of some of our portfolio from tax exempt
securities to higher yield taxable corporate securities in the first quarter of
2000 and a higher amount of invested assets. Net realized investment gains were
$1.2 million and $1.8 million during 2000 and 1999, respectively.

Additional restructuring charges of $919,000 were incurred in 2000. This
includes approximately $802,000 in severance charges related to the elimination
of 14 staff members located in our New Mexico and Lapeer branch offices and our
health insurance operation at our East Lansing, Michigan home office. These
events are expected to generate annual savings of approximately $2.0 million in
salaries and rent. At December 31, 2000 there was $454,000 accrued for
restructuring charges that were paid in 2001.

We have incurred $501,000 of conversion expenses in 2000. The increase in
amortization expense is a result of the acquisition of a management company in
October 1999 which previously had performed all of the managerial functions for
APAssurance and its subsidiaries.

We recorded $4.8 million in federal income tax expense in 2000, compared to
a refund of $23.8 million in federal income taxes during the same period in
1999. The effective tax rate was 28.7% in 2000, compared to

21

(238.3%) in 1999. In 1999, we received a significant settlement with the IRS
regarding the tax treatment of reserves.

LIQUIDITY AND CAPITAL RESOURCES

The primary sources of our liquidity, on both a short- and long-term basis,
are funds provided by insurance premiums collected, net investment income,
recoveries from reinsurance and proceeds from the maturity or sale of invested
assets. The primary uses of cash, on both a short- and long-term basis, are
losses, loss adjustment expenses, operating expenses, reinsurance premiums and
taxes. In addition, we are indebted to a related party in the amount of $9
million in connection with the purchase of Stratton-Cheeseman Management
Company. The indebtedness is due in annual installments, without interest, over
the next eight years. At December 31, 2001, we had no material commitments for
capital expenditures.

Our net cash flow from operating activities was approximately $13.0 million
for 2001, compared to $70.0 million for 2000. The decrease was primarily due to
the large net loss in 2001 and a federal income tax recovery and related
interest totaling $39.3 million in 2000. We invest our positive cash flow from
operations in both fixed maturity securities and equity securities. Our
investment strategy seeks to maximize after-tax income through a high quality,
diversified, duration sensitive, taxable bond and tax-preferenced municipal bond
portfolio, while maintaining an adequate level of liquidity. Should we
experience a dramatic decrease in premiums and operating cash flow, funds to
operate the Company and to pay claims would come from investment earnings and
liquidation of the investment portfolio.

In 2001, on a consolidated basis, we had $106.4 million of cash available
and an investment portfolio of $646.1 million. The large cash position at
December 31, 2001 reflects the residual of the net proceeds of $142.5 million
from our stock offerings in December 2000. The portfolio includes $16.9 million
of bonds maturing in the next year to meet short-term cash flow needs. On a
long-term basis, fixed income securities are purchased on a basis intended to
provide adequate cash flows from future maturities. At December 31, 2001, $281.6
million of bonds mature in the next one to five years and $264.8 million mature
in the next five to ten years.

Total assets increased $60.9 million to $1.04 billion at December 31, 2001,
compared to $978.0 million at December 31, 2000. The increase was due primarily
to increases in reinsurance recoverables, federal income tax recoverable, and
accrued investment income.

Loss and loss adjustment expense reserves increased $113.7 million to
$597.0 million at December 31, 2001, from $483.3 million at December 31, 2000.
This increase was due to increased writings in both the workers' compensation
and medical professional liability lines and the reserve enhancements incurred
in the third and fourth quarters of 2001.

The unearned premium reserve increased $12.0 million, or 13.6%, to $100.1
million at December 31, 2001, from $88.0 million at December 31, 2000. The
increase was due primarily to the higher seasonal writing in medical
professional liability in the third quarter of 2001.

In March 2001, our board of directors authorized the purchase of up to 5%
of its then outstanding common stock, representing approximately 581,000 shares.
The Company's purchase of any of its shares is subject to limitations that may
be imposed by applicable securities laws and regulations and the rules of the
Nasdaq Stock Market. The timing of the purchases and the number of shares to be
bought at any one time depend on market conditions and our capital requirements.
In July and November of 2001, our board of directors authorized the repurchase
of a total of 1.1 million additional shares. As of December 31, 2001, the
Company has purchased a total of 1,369,170 shares under the three authorized
programs, at a cost of $25.2 million. The Company intends to continue
repurchasing its shares, in the market and otherwise, when appropriate using
available cash resources.

Based on historical trends, market conditions and its business plans, we
believe that our existing resources and sources of funds will be sufficient to
meet our short- and long-term liquidity needs over the next 18 months and
beyond. However, because economic, market and regulatory conditions may change,
there can be no assurance that our funds will be sufficient to meet these
liquidity needs.
22

APCapital itself is a holding company whose only material assets are the
capital stock of APAssurance and its other subsidiaries and a portion of the net
proceeds from the stock offerings completed in December 2000. APCapital is using
these funds to finance its long- and short-term liquidity needs, which include
operating expenses, financing future acquisitions, additional share repurchases,
and additional contributions to its subsidiaries. APCapital's ongoing cash flow
will consist primarily of dividends and other permissible payments from its
subsidiaries and investment earnings on funds held. The payment of dividends to
APCapital by its insurance subsidiaries is subject to limitations imposed by
applicable law. APAssurance's ability to pay dividends to APCapital is
influenced by a variety of factors, including cyclical changes in the medical
professional liability insurance market, APAssurance's financial results,
insurance regulatory changes, including changes in the limitations imposed by
the Michigan Holding Company Systems Act on the payment of dividends by
APAssurance and changes in general economic conditions.

EFFECTS OF INFLATION

We consider the effects of inflation on our business in estimating our
reserves for unpaid losses and loss adjustment expenses, and in the premium
rate-making process. The actual effects of inflation on our operations cannot be
accurately known until the ultimate settlement of claims. However, based upon
the actual results reported to date, it is our opinion that our loss reserves,
including reserves for losses that have been incurred but not yet reported,
adequately provide for the effects of inflation.

EFFECTS OF NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which is effective for fiscal years beginning after June 15, 2000
(as amended by SFAS Nos. 137 and 138). SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction, and if it is, the type of hedge transaction. Because we
currently do not use derivative instruments, the adoption of SFAS No. 133 did
not affect our results of operations or financial position.

In July 2001, the FASB issued SFAS No. 141 "Business Combinations" and SFAS
No. 142 "Goodwill and Intangible Assets." These standards provide guidance on
the accounting for acquired businesses. In addition, these standards eliminate
the "pooling of interest" method for transactions initiated after June 30, 2001,
and effective January 1, 2002, eliminate the amortization of goodwill and
intangible assets with an indefinite life. The standards require annual
impairment testing and potential loss recognization for goodwill and intangible
assets. The change regarding the elimination of goodwill and other intangible
amortization will be made prospectively with the adoption of the new standard as
of January 1, 2002. Prior period financial results will not be restated.
Management is currently evaluating implementation of this standard, however,
anticipates that we have no finite lived intangibles, and as a result, will no
longer incur amortization expense on our recorded goodwill beginning January 1,
2002.

The FASB issued SFAS No. 144 "Accounting for Impairment or Disposal of
Long-lived Assets." This Standard will be effective for the Company on a
prospective basis, beginning January 1, 2002. SFAS No. 144 clarifies and revises
existing guidance on accounting for impairment of property, plant, and
equipment, amortized intangibles, and other long-lived assets not specifically
addressed in other accounting literature. Management does not expect the
adoption of this Standard to have a significant impact on our 2002 financial
results.

23

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

GENERAL

Market risk is the risk of loss due to adverse changes in market rates and
prices. We invest primarily in fixed maturity securities, which are
interest-sensitive assets. Accordingly, our primary market risk is exposure to
changes in interest rates.

As of December 31, 2001, the majority of our investment portfolio was
invested in fixed maturity securities and short-term investments. The fixed
maturity securities primarily consisted of U.S. government and agency bonds,
high-quality corporate bonds, mortgage-backed securities and tax-exempt U.S.
municipal bonds.

QUALITATIVE INFORMATION ABOUT MARKET RISK

Investments in our portfolio have varying degrees of risk. The primary
market risk exposure to the fixed maturity portfolio is interest rate risk,
which is limited somewhat by our management of duration. The distribution of
maturities and sector concentrations are monitored on a regular basis.

We regularly examine the quality distribution of our investment portfolio
for evidence of impairment. When a security in our investment portfolio has a
decline in market value which is other than temporary, we are required by GAAP
to reduce the carrying value of such security to its net realizable value. All
declines in market values of our investment securities at December 31, 2001 were
deemed to be temporary with the exception of an investment in Frontier Bonds,
which were written down $5.92 million during 2001.

QUANTITATIVE INFORMATION ABOUT MARKET RISK

At December 31, 2001, our fixed income security portfolio was valued at
$605.9 million and had an average modified duration of 3.65 years, compared to a
portfolio valued at $464.8 million with an average modified duration of 4.35
years at December 31, 2000. The following tables show the effects of a change in
interest rates on the fair value and duration of our portfolio at December 31,
2001 and 2000. We have assumed an immediate increase or decrease of 1% or 2% in
interest rate for illustrative purposes. You should not consider this assumption
or the values shown in the table to be a prediction of actual future results.

24

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Shareholders of
American Physicians Capital, Inc.

In our opinion, the consolidated financial statements listed in the index
appearing under Item 14, present fairly, in all material respects, the financial
position of American Physicians Capital, Inc. and its subsidiaries at December
31, 2001 and 2000 and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2001 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedules listed in the index
appearing under Item 14 present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedules are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedules based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America which require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP
Grand Rapids, Michigan
March 9, 2002

25

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000

The accompanying notes are an integral part of the consolidated financial
statements.
26

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

The accompanying notes are an integral part of the consolidated financial
statements.
27

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

The accompanying notes are an integral part of the consolidated financial
statements.
28

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Federal income taxes of $8,481, $(28,104) and $(152) were paid (received),
net in 2001, 2000, and 1999 respectively.

SUPPLEMENTAL DISCLOSURES OF NON-CASH ITEMS

The Company purchased Stratton-Cheeseman Management Company during 1999. In
conjunction with the acquisition, a liability of $955,000 was assumed and a note
payable of $7.3 million was issued (Note 4).

The accompanying notes are an integral part of the consolidated financial
statements.
29

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SIGNIFICANT ACCOUNTING POLICIES

BASIS OF CONSOLIDATION AND REPORTING

The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America and include the accounts of American Physicians Capital, Inc.
("APCapital") and its wholly-owned subsidiaries, Insurance Corporation of
America ("ICA"), APSpecialty Insurance Company (formerly RML Insurance Company),
("APS"), APConsulting LLC, APDirect Sales, LLC, Alpha Advisors, Inc. and
American Physicians Assurance Corporation ("APA"), formerly known as Mutual
Insurance Corporation Of America ("MICOA"), together referred to as the
"Company". All significant intercompany accounts and transactions are eliminated
in consolidation.

On December 13, 2000, the conversion of APA from a mutual company to a
stock corporation was consummated according to a Plan of Conversion adopted by
the Board of Directors of MICOA on June 28, 2000, with subsequent amendment on
October 2, 2000. This plan was approved by MICOA policyholders at a special
meeting held on November 29, 2000 and by the State of Michigan Office of
Financial and Insurance Services. The Plan of Conversion included several key
components, including: formation of APCapital to be the ultimate parent holding
company; the conversion of APA from a mutual insurance company to a stock
company and wholly-owned by APCapital; the transfer of ICA, APS, APConsulting,
APDirect Sales, and Alpha Advisors, Inc. from APA to wholly-owned subsidiaries
of APCapital.

In connection with the conversion, 331,638 shares of common stock of
APCapital were sold at $13.50 per share under a subscription rights and best
efforts offering to MICOA policyholders, officers, directors, employees, and
others. APCapital then sold 9,668,362 shares of its common stock in an
underwritten public offering ("the Offering") that closed December 13, 2000. On
December 13, 2000, an additional 1,450,254 shares were sold to underwriters of
the Offering pursuant to an over-allotment option contained in the underwriting
agreement. The net proceeds of the Offering were approximately $142.6 million,
consisting of gross proceeds of $154.6 million less conversion and offering
expenses of $12.0 million.

In March, July and November 2001, APCapital's board of directors authorized
three separate 5% programs to purchase outstanding common stock, representing
approximately 1,689,000 shares. APCapital repurchased 1,369,170 shares during
2001 at a total cost of $25.2 million.

NATURE OF BUSINESS

The Company is principally engaged in the business of providing medical
professional liability, workers' compensation and health insurance throughout
the United States with a concentration of writings in the Midwest. During the
year, the Company ceased writing personal and commercial insurance.

INVESTMENTS

All of the Company's fixed maturities are classified as available-for-sale,
which are those securities that would be available to be sold in the future in
response to the Company's liquidity needs, changes in market interest rates and
asset-liability management strategies. Available-for-sale securities are
reported at estimated fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of other comprehensive income, net
of deferred taxes.

Investment income includes amortization of premium and accrual of discount
on the yield-to-maturity method relating to investments acquired at other than
par value. Realized gains or losses on sales or maturities of investments are
determined on a specific identification basis and are credited or charged to
income.

Equity securities are carried at quoted market values. Fair values of fixed
maturities and equity securities are determined on the basis of dealer or market
quotations or comparable securities on which quotations are available. Mortgage
loans are carried at the unpaid principal balance, which approximates the fair
market
30

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED

value as they bear current market interest rates. Real estate is carried at
historical cost, less accumulated depreciation. Real estate of $33,411,000 and
$33,953,000 in 2001 and 2000, respectively and mortgage loans of $4,474,000 in
2001 and $4,605,000 in 2000 and are included in other investments on the balance
sheet.

CASH AND CASH EQUIVALENTS

Cash equivalents consist principally of commercial paper and money market
funds, are stated at cost, which approximates fair value, and have original
maturities of three months or less.

PREMIUMS WRITTEN AND RECEIVABLE

Premiums written are earned primarily using pro rata methods over the
period of risk. Premiums receivable include $56,679,000 at December 31, 2001 and
$38,564,000 at December 31, 2000 of premium installments. Receivable balances
consist principally of written premiums from physicians in the states of
Michigan, Ohio, Illinois, Florida, and Minnesota. Receivables are generally
collateralized by unearned premiums.

DEFERRED POLICY ACQUISITION COSTS

Deferred policy acquisition costs ("DAC") include commissions, premium
taxes and other costs incurred in connection with writing business. These costs
are deferred and amortized over the period in which the related premiums are
earned. Future investment income has been considered in determining the
recoverability of deferred costs.

PROPERTY, EQUIPMENT AND DEPRECIATION

Property and equipment are recorded at cost. Depreciation is computed for
assets using straight-line and accelerated methods over the following periods:
building -- 40 years, furniture -- 10 years, and computer equipment and
software -- 5 years. Upon the sale or retirement of property and equipment,
balances are removed from the respective accounts and any gain or loss is
included in income.

UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

The provision for unpaid losses and loss adjustment expenses is estimated
actuarially using the Company's claim experience. These estimates are subject to
the effects of trends in loss severity and frequency. Although considerable
variability is inherent in such estimates, management believes that the
liability for unpaid losses and loss adjustment expenses is adequate. The method
for making such estimates and for establishing the resulting liabilities are
continually reviewed, and any adjustments are reflected in current earnings.

RESERVE FOR EXTENDED REPORTING PERIOD CLAIMS

The reserve for extended reporting period claims coverage is recorded
during the term of the original claims-made policy, utilizing the pure-premium
approach, in amounts believed to be adequate to pay for estimated future claims
reported subsequent to a current policyholder's death, disability or retirement.
The amount of this reserve is $15,000,000 and $21,000,000 at December 31, 2001
and 2000 respectively and is included in unpaid losses on the balance sheet.
Changes in this reserve are charged or credited to income.

31

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED

REVENUE RECOGNITION

Insurance premium income is recognized on a daily pro rata basis over the
respective terms of the policies in-force and unearned premiums represent the
portion of premiums written which are applicable to the unexpired terms of
policies in-force.

REINSURANCE

Reinsurance premiums and losses related to reinsured business are accounted
for on basis consistent with those used in accounting for the original policies
issued and the terms of the reinsurance contracts. Reinsurance recoverables and
prepaid reinsurance premiums are accounted for in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 113, "Accounting and Reporting for
Reinsurance." Premiums ceded to other companies have been reported as a
reduction of premium income. Reinsured losses incurred are reported as a
reduction of gross losses incurred.

INCOME TAXES

Deferred income taxes are recognized at prevailing income tax rates for
temporary differences between financial statement and income tax bases of assets
and liabilities and net operating loss carryforwards for which income tax
benefits will be realized in future years.

GOODWILL

Goodwill consists of the excess of cost over fair market value of net
assets of acquired businesses. Goodwill is amortized on a straight-line basis
over a period of ten years. Accumulated amortization was $3,863,000 and
$4,408,000 at December 31, 2001 and 2000, respectively.

The carrying value of goodwill is reviewed annually to determine if any
impairment has occurred. The Company measures the potential impairment of
recorded goodwill based on the estimated undiscounted cash flows of the entity
acquired over the remaining amortization period. During 2001, it was determined
that the goodwill associated with the purchase of Alpha Advisors, Inc. and ICA
was impaired based on changes in organizational structure and ongoing operating
losses. This resulted in additional amortization expense of $380,000.

STOCK-BASED COMPENSATION

In accordance with APB Opinion No. 25, the Company records compensation
expense for stock options only if the market price of the Company's stock, on
the date of grant, exceeds the amount an individual must pay to acquire the
stock.

NET INCOME (LOSS) PER SHARE

Net income (loss) per share is computed by dividing net income (loss) by
the weighted average number of shares of common stock and common stock
equivalents (stock options and stock grants) outstanding during each year (See
Note 17).

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principals ("GAAP") requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements

32

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SIGNIFICANT ACCOUNTING POLICIES -- CONTINUED

and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

2. EFFECTS OF NEW ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board has issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", which is
effective for fiscal quarters of all fiscal years beginning after June 30, 2000
(as amended by SFAS Nos. 137 and 138). SFAS No. 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is part of a hedge
transaction, and if it is, the type of hedge transaction. Because the Company
does not use derivative instruments, the adoption of SFAS No. 133 did not affect
the Company's results of operations or financial position.

In July 2001, the FASB issued SFAS No. 141 "Business Combinations" and SFAS
No. 142 "Goodwill and Intangible Assets." These standards provide guidance on
the accounting for acquired businesses. In addition, these standards eliminate
the "pooling of interest" method for transactions initiated after June 30, 2001,
and effective January 1, 2002, eliminate the amortization of goodwill and
intangible assets with an indefinite life. The standards require annual
impairment testing and potential loss recognization for goodwill and intangible
assets. The change regarding the elimination of goodwill and other intangible
amortization will be made prospectively with the adoption of the new standard as
of January 1, 2002. Prior period financial results will not be restated.
Management is currently evaluating implementation of this standard, however,
anticipates that the Company has no finite lived intangibles, and as a result,
will no longer incur amortization expense on its recorded goodwill beginning
January 1, 2002.

The FASB issued SFAS No. 144 "Accounting for Impairment or Disposal of
Long-lived Assets." This Standard will be effective for the Company on a
prospective basis, beginning January 1, 2002. SFAS No. 144 clarifies and revises
existing guidance on accounting for impairment of property, plant, and
equipment, amortized intangibles, and other long-lived assets not specifically
addressed in other accounting literature. Management does not expect the
adoption of this Standard to have a significant impact on the Company's 2002
financial results.

3. COMPREHENSIVE INCOME

SFAS No. 130, "Reporting Comprehensive Income", requires unrealized gains
or losses on the Company's available-for-sale securities to be included in other
comprehensive income. Realized investment (losses) gains on securities held as
of the beginning of the year totaling ($4,103,000) in 2001, $3,686,000 in 2000,
and $1,348,000 in 1999, and had unrealized appreciation of $100,000 at the
beginning of 2001, $4,139,000 at the beginning of 2000 and $412,000 at the
beginning of 1999.

4. MERGER AND ACQUISITION ACTIVITY

Effective October 31, 1999, APA purchased 100% of the outstanding stock of
Stratton-Cheeseman Management Company ("SCMC") which was substantially owned by
the president of the Company, for $19.5 million, consisting of $9.5 million in
cash and a commitment to pay $10 million in installments over the next nine
years without interest. Installments began April 30, 2001 and are to be made
annually thereafter. The Company discounted the non-interest bearing obligation,
using a discount rate of approximately 6%, recording a note payable of $7.3
million. The acquisition was accounted for using purchase accounting and
resulted in the recognition of $16.6 million in goodwill. The remaining purchase
price was allocated to the fair value of the asset acquired, consisting of a
$150,000 investment in an unaffiliated entity. The purchase

33

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

4. MERGER AND ACQUISITION ACTIVITY -- CONTINUED

agreement contains certain provisions, including change of control provisions,
for the acceleration or cancellation of the $10 million commitment. If the
commitment is accelerated or cancelled, any remaining discount or amounts
forfeited will be recorded as an adjustment to goodwill. Annual payments will
increase or decrease by $200,000 for each corresponding half-grade level
increase or decrease in the Company's A.M. Best Company, Inc. rating during the
term of the payments. Any amounts paid for changes in the industry rating will
be recorded as compensation expense in the period earned. If the Company
terminates the president or if he dies or is disabled, payments will accelerate.
Unaudited pro forma revenues and net income, as if this transaction had occurred
as of January 1, 1999, do not differ significantly, from revenues and net income
presented in the accompanying statement of income.

5. INVESTMENTS

The composition of the investment portfolio at December 31 was:

34

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. INVESTMENTS -- CONTINUED

The components of pretax investment income at December 31 were:

During 2001, the Company recorded a $5.92 million loss on a security whose
decline in market value was considered other than temporary.

Changes in unrealized gains (losses) on fixed maturities and equity
securities were:

35

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. INVESTMENTS -- CONTINUED

The composition of fixed maturities by maturity at December 31, 2001 was:

The amortized cost and estimated fair value of debt securities at December
31, 2001, by contractual maturity, are shown above. Expected maturities will
differ from contractual maturities because borrowers may have the right to call
or prepay obligations with or without call or prepayment penalties.

Bonds with amortized costs of $8,297,000 and $8,764,000 were on deposit
with various states as of December 31, 2001 and 2000, respectively. Proceeds on
the sales of investments in bonds totaled $27,400,000 in 2001, $212,701,000 in
2000, and $15,243,000 in 1999.

6. DEFERRED ACQUISITION COSTS

Changes in deferred policy acquisition costs for the years ended December
31, 2001, 2000 and 1999 are summarized as follows:

7. PROPERTY AND EQUIPMENT, NET

At December 31, 2001 and 2000, property and equipment consisted of the
following:

36

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in unpaid losses and loss adjustment expenses during 2001, 2000,
and 1999 is as follows:

Incurred loss and loss adjustment expenses for prior years increased during
2001 due to unfavorable development, and declined during 2000 and 1999 as a
result of favorable development. The unfavorable development in 2001 was
primarily the result of higher medical professional liability loss severities
which occurred in the Company's Ohio, Florida and Kentucky markets. In addition,
losses in certain new markets developed much higher than originally estimated.
Management believes the estimate of the ultimate liability for losses and loss
adjustment expenses at December 31, 2001 is reasonable and reflective of
anticipated ultimate experience. However, it is possible that the Company's
actual incurred loss and loss adjustment expenses will not conform to the
assumptions inherent in the determination of the liability. Accordingly, it is
reasonably possible that the ultimate settlement of losses and the related loss
adjustment expenses may vary significantly from the estimated amounts included
in the accompanying financial statements.

9. REINSURANCE

Reinsurance arises from the Company seeking to reduce its loss exposure on
its higher limit policies related primarily to medical malpractice. The Company
has mainly entered into excess of loss contracts for medical malpractice and
workers' compensation. A reconciliation of direct-to-net premiums, on both a
written and earned basis, for 2001, 2000, and 1999 is as follows:

37

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

9. REINSURANCE -- CONTINUED

Losses and loss adjustment expenses incurred are net of ceded losses of
$44,385,000 for 2001, $30,417,000 for 2000, and $43,132,000 for 1999.

The Company's policy is to enter into reinsurance contracts only with
highly rated reinsurers and periodically reviews these reinsurers for financial
impairment. Reinsurance contracts do not relieve the Company from its
obligations to policyholders. If the reinsurance company is unable to meet its
obligations under existing reinsurance agreements, the Company remains liable
for ceded reserves for unpaid losses and loss adjustment expense and unearned
premiums.

The Company had reinsurance recoverables from the following reinsurers at
December 31, 2001 and 2000:

Amounts due from reinsurers on the accompanying balance sheet consisted of
the following:

10. INCOME TAXES

The provision for income taxes consists of:

38

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. INCOME TAXES -- CONTINUED

Income taxes incurred do not bear the usual relationship to income before
income taxes due to the following:

At December 31, 2001 and 2000, the components of the net deferred tax asset
were as follows:

At December 31, 2001, the Company has approximately $37.2 million of net
operating loss carryforwards of which $28.6 million expire in 2021 and are not
limited to their use and $8.6 million of which expire in 2012 and are limited to
approximately $900,000 annually.

On March 9, 2002, new tax laws extended the net operating loss carryback
period from two years to five years. As a result, approximately $12.4 million of
the Company's net operating loss carryforward at December 31, 2001 will be
utilized to recover taxes previously paid in tax years 1996, 1997, and 1998, and
will be reflected in the first quarter of 2002.

On November 17, 1999, the Company received notice from the Internal Revenue
Service acknowledging their approval of an outstanding claim for refund totaling
$25,267,000 and interest thereon of approximately $9.8 million. The refund was
the result of a settlement with the IRS regarding the tax treatment of loss
reserves. The interest component, net of fees, is included in other income in
1999 operations. The taxes refunded have been reported as a federal income tax
credit in 1999 operations. On February 17, 2000, the Company received the first
installment of the refund which totaled $27.6 million of tax and interest. On
June 16, 2000, the Company received the second and final installment of $8.5
million, which included interest earned in 2000.

39

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. SHAREHOLDERS' EQUITY

Approximately $992.1 million of consolidated assets represents assets of
the Company's insurance operations that are subject to regulation and may not be
transferred to APCapital in the form of dividends, loans or advances. The amount
of dividends that the Company's insurance subsidiaries can pay to APCapital in
any 12-month period is limited to the greater of statutory net income for the
preceding year, excluding realized gains (losses) on sales of investments, or
10% of surplus as of the preceding year end. As of January 1, 2002,
approximately $12.3 million could be paid by the Company's insurance
subsidiaries without prior regulatory approval.

12. FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, "Disclosures About Fair Value of Financial Instruments",
requires disclosures of fair-value information about financial instruments,
whether or not recognized in the balance sheet, for which it is practicable to
estimate the value. In situations where quoted market prices are not available,
fair values are to be based on estimates using present value or other valuation
techniques. SFAS No. 107 excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements.

Under SFAS No. 107, the Company's investment securities, cash and cash
equivalents, premiums receivable, reinsurance recoverable on paid losses, and
note payable constitute financial instruments. The carrying amounts of all
financial instruments, other than investment securities, which are presented in
Note 5 approximated their fair values at December 31, 2001 and 2000.

13. RESTRUCTURING CHARGES

In November 1999, the Company closed two offices in Indiana and Ohio and
restructured the home office staff. A total of 35 people, primarily clerical
staff, were terminated at the time of the office closure and restructuring.
These events resulted in a charge of approximately $955,000, including $802,000
of severance costs and $74,000 of out-placement services.

In April 2000, the Company began to phase out its health lines and
restructure its New Mexico operations. A total of six people were terminated at
the time, resulting in charges of $408,000 of severance costs and $105,000 of
other charges. In October 2000, the Company began to phase out its personal and
commercial lines in Lapeer, Michigan. A total of 14 people were terminated,
resulting in a charge of $406,000.

In November, 2001, the Company reduced personnel in its Information Systems
department and its management team. A total of eleven people were terminated
resulting in $1,891,000 of severance costs and $26,000 of other costs. In
December 2001, the Company completed its phase out of the personal and
commercial lines and all policies have been non-renewed. A total of nine people
were terminated resulting in a charge of $567,000.

At December 31, 2001, substantially all activities related to the office
closings were complete.

40

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

13. RESTRUCTURING CHARGES -- CONTINUED

The remaining amounts to be paid for restructuring charges are as follows:

14. RELATED PARTY TRANSACTIONS

Prior to the acquisition of SCMC, the Company had no employees and
contracted with SCMC to provide management services to the Company through
October 31, 1999. The aggregate amount paid to SCMC during 1999 approximated
$29,533,000, including management fees of $3,209,000. The remaining amounts paid
related to pass-through costs, primarily for compensation costs and related
employee benefit expense.

The note payable to an officer of the Company represents the remaining
installment payments due to the former owner of SCMC discounted at 6%. This note
aggregated $7,194,000 and $7,817,000, at December 31, 2001 and 2000,
respectively (see Note 4).

The president of the Company is a majority owner of SCW Agency Group, Inc.,
formerly Stratton Cheeseman & Walsh, Inc., an agency that sells the Company's
medical professional liability insurance in Michigan, Illinois, Kentucky,
Florida and Nevada. Direct premiums written by the agency during 2001, 2000 and
1999 totaled $68,896,000, $67,758,000, and $71,902,000, respectively,
representing, 29.9%, 33.4% and 37.9% of direct premiums written during such
years. Commission expense incurred related to SCW Agency Group, Inc.
approximated $4,660,000, $4,633,000, and $4,811,000 in 2001, 2000 and 1999,
respectively.

The agency leases approximately 10,000 sq. feet of office space from the
Company and the Company received $216,000, $192,000 and $175,000 in rental
income in 2001, 2000 and 1999 respectively.

In 2001, a representative from a law firm providing legal services to the
Company was appointed an officer of the Company. Legal services provided by this
firm to the Company during 2001 was $370,000.

15. EMPLOYEE BENEFIT PLANS

The Company offers benefits under certain defined contribution plans. In
2001, the defined contribution plans provide for Company contributions of 5% of
employee compensation, as defined in the plan and a 100% match of employee
contributions on the first 3% of contributions and 50% match on the next 2% of
contributions (10% of employee compensation and a 25% match of employee
contributions on the first 4% of contributions for the years 2000 and 1999).
Employer contributions to the plans were approximately $1,654,000, $1,401,000,
and $1,405,000 for 2001, 2000 and 1999, respectively.

41

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. STOCK BASED COMPENSATION

In connection with the conversion, the Board of Directors adopted the
American Physicians Capital, Inc. Stock Compensation Plan (The "Plan"). The plan
provides for the award of stock options and stock awards for officers, directors
and employees of the Company. These awards must be approved by the compensation
committee of the board of directors. The total number of shares of the Company's
common stock which shall be available for options and stock awards is 1,200,000
shares.

Certain executive officers, board members and employees have been granted
options to purchase shares of APCapital common stock. Options granted during
2000 vest in annual installments of 10%, 15%, 20%, 25% and 30% on the first
through the fifth anniversaries, respectively, of the date of grant. Options
granted during 2001 vest in annual installments of 33%, 33%, and 34% on the
first through the third anniversaries, respectively, of the date of grant. All
options expire on the tenth anniversary of the grant date.

A summary of the Company's stock option activity is as follows:

In December 2000, the Company granted 135,200 restricted shares of
APCapital common stock, having a per share market value of $13.50 to certain
officers, board members and employees. The restricted shares vest in annual
installments of 10%, 15%, 20%, 25% and 30% on the first through fifth
anniversaries, respectively, of the date of grant.

In connection with the offering, the Company also granted 200 shares of
restricted stock to each employee for a total grant of 39,600 shares at $13.50
per share. These shares vest at a rate of 20%, 35% and 45%, respectively, over
the next three years. Upon issuance of the stock award, unearned compensation is
charged to shareholders' equity and amortized over the vesting periods. During
2001, a total of 18,110 shares vested under terms of these stock award programs.
A total of 21,700 shares were forfeited as a result of employee terminations
prior to vesting. The vesting of stock awarded to officers, directors and
employees resulted in a total compensation expense of $435,000 and $83,000 in
2001 and 2000, respectively.

The Company accounts for its stock-based compensation in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. The Company's policy regarding stock options is to issue
options with an exercise price equal to the market price on the date of grant.
Accordingly, no compensation expense has been recognized for options granted in
2001 and 2000. Had

42

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. STOCK BASED COMPENSATION -- CONTINUED

compensation expense for the options been recognized based on the fair value at
the grant date consistent with SFAS No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and net income per common share-assuming
dilution would have been reduced to the pro forma amounts below:

For pro forma disclosure purposes, the fair value of stock options was
estimated at the date of grant using a Black-Scholes option pricing model using
the following assumptions:

In management's opinion, existing stock option valuation models do not
provide an entirely reliable measure of the fair value of non-transferable
employee stock options with vesting restrictions.

17. EARNINGS PER SHARE

Basic and diluted earnings per share are calculated in accordance with SFAS
Statement No. 128, "Earnings per Share."

The following table sets forth the computation of basic and diluted
earnings per share for the year ended December 31, 2001 and the period ended
December 31, 2000:

43

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

17. EARNINGS PER SHARE -- CONTINUED

As the Company was in a net loss position for the year ended December 31,
2001, no effect of awards or options were calculated as the impact would be
anti-dilutive.

18. COMMITMENTS AND CONTINGENCIES

The Company participates in various guaranty associations in the states in
which it writes business, which protect policyholders and claimants against
losses due to insolvency of insurers. When an insolvency occurs, the
associations are authorized to assess member companies up to the amount of the
shortfall of funds, including expenses. Member companies are assessed based on
the type and amount of insurance written during the previous calendar years. The
Company accrues for its portion of assessments in accordance with SOP 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments." Assessments to date are not significant; however, the ultimate
liability for future assessments is not known. Accordingly, the Company is
unable to predict whether such future assessments will materially affect the
financial condition of the Company.

The Company is obligated under operating leases, which have various
expiration dates through December 2006. Minimum future lease payments are as
follows: 2002 -- $1,624,000; 2003 -- $1,384,000; 2004 -- $688,000;
2005 -- $529,000 and 2006 -- $560,000. Rental expense was $2,177,000 in 2001,
$2,419,000 in 2000 and $2,665,000 in 1999.

19. GAAP AND STATUTORY REPORTING

APA, APSpecialty and ICA, domiciled in the State of Michigan, are included
in the accompanying consolidated financial statements in accordance with GAAP.
These organizations are subject to regulation by the State of Michigan Office of
Financial and Insurance Services and file financial statements using statutory
accounting practices prescribed or permitted by the state insurance regulators.
Prescribed statutory accounting practices include a variety of publications of
the National Association of Insurance Commissioners ("NAIC"), as well as state
laws, regulations and general administrative rules. Permitted statutory
accounting practices encompass all accounting practices not so prescribed. Such
practices vary in certain respects from GAAP. The principal variances are as
follows:

- Deferred policy acquisition costs are charged against operations as
incurred for statutory accounting purposes.

- Assets designated as "nonadmitted assets" are charged directly to
surplus for statutory accounting purposes.

- Bonds and U. S. government securities, which the Company does not
intend to hold to maturity, are generally carried at amortized cost
for statutory accounting purposes.

- Unpaid losses and loss adjustment expense and unearned premiums are
reported net of the impact of reinsurance for statutory accounting
purposes.

- Deferred federal income taxes are recognized for generally accepted
accounting principles and were not recorded for statutory purposes
prior to 2001.

- The settlement refund with the IRS was credited directly to surplus
for statutory purposes.

44

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

19. GAAP AND STATUTORY REPORTING -- CONTINUED

The following is statutory surplus at December 31, 2001, 2000, and 1999 and
net (loss) income for the years then ended.

On January 1, 2001, significant changes to the statutory basis of accounting
became effective in all states in which the Company is licensed. The cumulative
effect of these changes, known as the Codification guidance, was recorded as a
direct adjustment to statutory surplus. The effect of adoption resulted in an
increase in statutory surplus of $16.7 million.

20. SEGMENT INFORMATION

The Company is organized and operates principally in the property and
casualty insurance industry and has five reportable segments -- medical
professional liability, workers' compensation, personal and commercial, other
insurance, and corporate and investments. The accounting policies of the
segments are the same as those described in the basis of presentation. Expense
allocations are based primarily on loss and loss adjustment expenses by line of
business and certain other estimates for underwriting expenses; reported segment
results would change if different methods were applied. The Company does not
allocate assets, investment income and income taxes to operating segments.
Segment information, for which results are regularly reviewed by management in
making decisions about resources to be allocated to the segments and assess
their performance, is summarized as follows:

45

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

21. QUARTERLY FINANCIAL DATA (UNAUDITED)

The unaudited operating results by quarter for 2001, 2000, and 1999 are
summarized below:

- ---------------
* For periods subsequent to conversion; (for periods where the Company incurred
a loss, no effect of awards or options were calculated as the impact would be
anti-dilutive).

46

SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
AMERICAN PHYSICIANS CAPITAL, INC. (PARENT COMPANY)
CONDENSED BALANCE SHEET
DECEMBER 31, 2001 AND 2000

These condensed financial statements should be read in conjunction with the
accompanying consolidated financial statements and notes thereto of American
Physicians Capital, Inc. and subsidiaries.

See accompanying notes to the condensed financial information of registrant.
49

SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
AMERICAN PHYSICIANS CAPITAL, INC. (PARENT COMPANY)
NOTES TO CONDENSED FINANCIAL INFORMATION OF REGISTRANT
YEAR ENDED DECEMBER 31, 2000

(1) DESCRIPTION OF BUSINESS

American Physicians Capital, Inc. (APCapital) is an insurance holding
company incorporated under Michigan law on July 6, 2000.

APCapital owns all of the issued and outstanding common stock of the
following entities:

American Physicians Assurance Corporation -- a stock insurance company
incorporated under Michigan law (APA), formerly MICOA.

Insurance Corporation of America -- a stock insurance company incorporated
under Michigan law (ICA).

APSpecialty Insurance Company -- a stock insurance company incorporated
under Michigan law (APS), formerly RML Insurance Company.

APConsulting, LLC -- a Michigan consulting company.

APDirect Sales, LLC -- a Michigan corporation that serves as APCapital's
direct sales channel.

Alpha Advisors, Inc. -- an Illinois corporation that provides investment
management services.

APIndemnity (Bermuda) Ltd. -- A Bermuda company that provides a
rent-a-captive vehicle for clients and prospects.

APManagement Ltd. -- A Bermuda company that provides management and
compliance services to APIndemnity and to clients and prospects of the
financial group.

(2) FEDERAL INCOME TAXES

Income tax provisions for the individual companies are computed on a
separate company basis.

(3) CONVERSION AND INITIAL PUBLIC OFFERING

On December 13, 2000, the conversion of APA from a mutual company to a
stock corporation was consummated according to a Plan of Conversion adopted by
the board of directors of MICOA on June 28, 2000, with subsequent amendment on
October 2, 2000. This plan was approved by MICOA policyholders at a special
meeting held on November 29, 2000 and by the State of Michigan Office of
Financial and Insurance Services. The Plan of Conversion included several key
components, including: formation of APCapital to be the ultimate parent holding
company; the conversion of APA from a mutual insurance company to stock company
and wholly-owned by APCapital; the transfer of ICA, APS, APConsulting, APDirect
Sales, and Alpha Advisors, Inc. from APA to wholly-owned subsidiaries of
APCapital.

In connection with the conversion, 331,638 shares of common stock of
APCapital were sold at $13.50 per share under a subscription rights and best
efforts offering to MICOA policyholders, officers, directors, employees, and
others. APCapital then sold 9,668,362 shares of its common stock in an
underwritten public offering ("the offering") that closed December 13, 2000. On
December 13, 2000, an additional 1,450,254 shares were sold to underwriters of
the offering pursuant to an over-allotment option contained in the offering
agreement. The net proceeds of the offering were approximately $142.6 million,
consisting of gross proceeds of $154.6 million less conversion and offering
expenses of $12.0 million.

50

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

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The required information will be contained in the Proxy Statement under the
captions "Election of Directors" (excluding the Report of the Audit Committee)
and "Section 16(a) Beneficial Ownership Reporting Compliance" and is
incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The required information will be contained in the Proxy Statement under the
caption "Compensation of Executive Officers" (excluding the Report of the
Executive Compensation Committee and the stock performance graph) and "Election
of Directors -- Director Compensation" and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The required information will be contained in the Proxy Statement under the
caption "Common Stock Ownership of Certain Beneficial Owners and Management" and
is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The required information will be contained in the Proxy Statement under the
caption "Certain Relationships and Transactions" and is incorporated herein by
reference.

51

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) and (2)

Financial Statements:

Report of independent accountants

Consolidated balance sheets as of December 31, 2001 and 2000

Consolidated statements of income for each of the years ended December
31, 2001, 2000 and 1999

Consolidated statements of cash flows for each of the years ended
December 31, 2001, 2000 and 1999

Consolidated statements of shareholders' equity and comprehensive income
for each of the years ended December 31, 2001, 2000 and 1999

Notes to consolidated financial statements

Financial Statement Schedules:

II. Condensed financial information of registrant

All other schedules for which provision is made in Regulation S-X either
(i) are not required under the related instructions or are inapplicable
and, therefore, have been omitted, or (ii) the information required is
included in the consolidated financial statements or the notes thereto that
are a part hereof.

(a)(3) The exhibits included as part of this report are listed in the attached
Exhibit Index, which is incorporated herein by reference.

(b) Reports on Form 8-K

No reports on Form 8-K were filed during the three months ended December
31, 2001.

52

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, on March 25, 2002.

AMERICAN PHYSICIANS CAPITAL, INC.

By: /s/ WILLIAM B. CHEESEMAN
------------------------------------
William B. Cheeseman
Its: President and Chief Executive
Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on March 25, 2002 on behalf of
the registrant and in the capacities indicated.

53

EXHIBIT INDEX

The following documents are filed as part of this report. Those exhibits
previously filed and incorporated herein by reference are identified below.
Exhibits not required for this report have been omitted. APCapital's commission
file number is 000-32057.

- ---------------

* Current management contracts or compensatory plans or arrangements.

(1) Filed herewith.

(2) Filed as an exhibit to APCapital's Registration Statement on Form S-1 (no.
333-41136), as amended, and incorporated herein by reference.

54

(3) Filed as an exhibit to APCapital's Registration Statement on Form S-8 (no.
333-56428) and incorporated herein by reference.

(4) Filed as an exhibit to APCapital's 2000 Annual Report on Form 10-K and
incorporated herein by reference.

(5) Filed as an exhibit to APCapital's Current Report on Form 8-K dated February
21, 2002 and incorporated herein by reference.

55

ABOUT AMERICAN PHYSICIANS CAPITAL, INC.

BOARD OF DIRECTORS
- --------------------------------------------------------------------------------

THOMAS R. BERGLUND, M.D. APPARAO MUKKAMALA, M.D.
Chairman of the Board Radiologist
Family Practice Physician SPENCER L. SCHNEIDER, J.D.
WILLIAM B. CHEESEMAN Attorney
President and Chief Executive Officer LLOYD A. SCHWARTZ
of the Company Certified Public Accountant
BILLY B. BAUMANN, M.D.
Retired Pathologist
MYRON R. EMERICK, D.O.
General Practice Physician

CORPORATE SECRETARY
- --------------------------------------------------------------------------------

MONTE D. JAHNKE
Kerr, Russell and Weber, PLC

EXECUTIVE OFFICERS
- --------------------------------------------------------------------------------

WILLIAM B. CHEESEMAN ANNETTE E. FLOOD,
President and Chief Executive Officer Vice President, Professional Liability
FRANK H. FREUND Operations
Executive Vice President, Treasurer and LAURA A. KLINE
Chief Financial Officer Vice President, Marketing
R. KEVIN CLINTON MARGO C. RUNKLE
Executive Vice President and Vice President, Human Resources/Legal
Chief Operating Officer

SHAREHOLDER INFORMATION
- --------------------------------------------------------------------------------

CORPORATE HEADQUARTERS INVESTOR RELATIONS
1301 N. Hagadorn Road Investor relations information for security
P.O. Box 1471 analysts, investment professionals and
East Lansing, Michigan 48826-1471 shareholders can be found on the Internet at:
1-800-748-0465 www.acaponline.com/investor.
WEBSITE SHAREHOLDERS MEETING
www.acaponline.com The annual meeting of shareholders will be
held on Wednesday, May 8, 2002 at 10:00 a.m.
TRANSFER AGENCY AND REGISTRAR EDT at the corporate offices of APCapital,
Mellon Investor Services LLC 1301 North Hagadorn Road, East Lansing,
P.O. Box 3310 Michigan.
South Hackensack, NJ 07606
1-888-213-0965 Inquiries or requests for additional
www.melloninvestor.com information should be directed to:
AUDITORS American Physicians Capital, Inc.
PricewaterhouseCoopers LLP Investor Relations
Grand Rapids, Michigan 1301 North Hagadorn Road
TRADING OF COMMON STOCK East Lansing, Michigan 48826
The common stock of American Physicians Capital, Inc. began Or call: 1-866-561-8222
trading on December 8, 2000, and is listed on the Nasdaq
Stock Market under the symbol ACAP. At March 1, 2002,
APCapital had approximately 10.0 million shares of common
stock outstanding.