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UNITED STATES

Form 10-Q

American Physicians Capital, Inc.

1301 North Hagadorn Road, East Lansing, Michigan 48823

Registrant’s telephone number, including area code: (517) 351-1150

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  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

YES  x       NO  o

The number of shares outstanding of the registrant’s common stock, no par value per share, as of April 30, 2004 was 8,501,647.

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PART I. FINANCIAL INFORMATION

AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

ITEM 1. Financial Statements

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

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

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

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

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

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

Supplemental disclosures of cash flow information

      The Company purchased 49% of the outstanding common stock of Physicians Insurance Company in March 2003 for $2,450,000. Cash acquired in connection with the purchase was $5,000,000.

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

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AMERICAN PHYSICIANS CAPITAL, INC. AND SUBSIDIARIES

1.     Basis of Presentation

      The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of American Physicians Capital, Inc. (“APCapital”), its wholly owned subsidiaries, Insurance Corporation of America (“ICA”), APSpecialty Insurance Corporation (“APS”), APConsulting LLC, APDirect Sales, LLC, Alpha Advisors, Inc., APIndemnity (Bermuda) Ltd., APManagement Ltd. and American Physicians Assurance Corporation (“American Physicians”). In accordance with the guidance given in Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (“FIN No. 46”), the accounts of two wholly owned subsidiary trusts used to issue mandatorily redeemable trust preferred securities have been included on the equity method in the accompanying unaudited Condensed Consolidated Financial Statements, and the accounts of Physicians Insurance Company (“PIC”) have been included in the accompanying unaudited Condensed Consolidated Financial Statements. See Note 2 for further discussion regarding the impact of FIN No. 46. All significant intercompany accounts and transactions are eliminated in consolidation.

      Certain 2003 amounts have been restated for the inclusion of PIC, which was not initially consolidated until the fourth quarter of 2003.

      The Company is principally engaged in the business of providing medical professional liability insurance throughout the United States with a concentration of writings in the Midwest, as well as workers’ compensation and health insurance on a limited basis.

      The accompanying unaudited Condensed Consolidated Financial Statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X as they apply to interim financial information. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.

      In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The operating results for the three-month period ended March 31, 2004 are not necessarily indicative of the results to be expected for the year ending December 31, 2004. The accompanying unaudited Condensed Consolidated Financial Statements should be read with the annual consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

      The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

      The most significant estimates that are susceptible to significant change in the near-term relate to the determination of the losses and loss adjustment expense reserves, investments, income taxes, reinsurance, the reserve for extended reporting period claims, earned but unbilled premiums and deferred policy acquisition costs. Although considerable variability is inherent in these estimates, management believes that the current estimates are reasonable in all material respects. The estimates are reviewed regularly and adjusted as necessary. Such adjustments are reflected in current operations.

Stock-based Compensation

      The Company uses the intrinsic value-based method to account for all stock-based employee compensation plans and has adopted the disclosure alternative of Statement of Financial Accounting Standard (“SFAS”) No. 123 “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” In accordance with SFAS No. 123, as amended by SFAS No. 148, the Company is required to disclose the pro forma effects on operating results as

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

if the Company had elected the fair value approach to account for its stock-based employee compensation plans.

      If compensation had been determined based on the fair value at the grant date, consistent with the provisions of SFAS No. 123, our net income (loss) and net income (loss) per share would have been as follows for the three months ended March 31, 2004 and 2003:

      Such pro forma disclosures may not be representative of future compensation costs as options may vest over several years and additional grants may be made.

      During the three months ended March 31, 2004, there were 100,000 options granted with an exercise price of $21.54. At March 31, 2004, there were 903,180 options outstanding with a weighted average exercise price of $18.61. In addition, on January 14, 2004, the Company issued 30,000 shares of restricted stock to certain employees with a fair market value at the date of grant of $17.20 per share.

Derivative Financial Instruments

      During the second quarter of 2003, the Company purchased interest-only certificates that may not allow for the recovery of substantially all of its investment. These certificates pay a variable rate of interest that is inversely related to the London Interbank Offered Rate (“LIBOR”). The Company has determined that these certificates contain an embedded derivative instrument as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.”

      All interest-only certificates with an inverse floating rate of interest are carried on the balance sheet at fair value as a fixed maturity security. These certificates are not linked to specific assets or liabilities on the balance sheet or to a forecasted transaction and, therefore, do not qualify for hedge accounting. In addition, the Company does not feel that it can reliably identify and separately measure the embedded derivative instrument. Accordingly, any changes in the fair value of the entire interest-only certificates, based on quoted market prices, are recorded in current period earnings as a component of investment income.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      At March 31, 2004, the Company had such certificates with a fair value of approximately $7.0 million. The fair value of these certificates increased approximately $208,000 during the three months ended March 31, 2004.

      The Company uses these certificates as a part of its overall interest rate risk-management strategy related to its investment portfolio.

2.     Effects of New Accounting Pronouncements

      In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” With the adoption of SFAS No. 146, effective for exit or disposal activities initiated after December 31, 2002, a liability for a cost associated with an exit or disposal activity should be recognized and measured initially at fair value only when the liability is incurred. Under the previous restructuring accounting guidance, companies were permitted to record a liability for costs associated with exit or disposal activities at the date that management had formally committed to the activity and announced its plan. As a result of this change in accounting practices, approximately $350,000 of estimated future employee separation costs associated with the exit of our workers’ compensation line of business were not recorded as a liability at March 31, 2004, but rather will be accrued prospectively over the remaining future minimum service period required of the employees affected.

      In January 2003, the FASB issued FIN No. 46, which was revised in December 2003 by FASB FIN No. 46R. These interpretations address consolidation by business enterprises of variable interest entities and are effective during the first interim or annual period ending after December 15, 2003. The Company has evaluated certain investments, as required by FIN No. 46, and has determined that its investments in subsidiary trusts used to issue mandatorily redeemable trust preferred securities should not be consolidated. Accordingly, the Company has not consolidated the trusts in the accompanying unaudited Condensed Consolidated Financial Statements. Also, during 2003, the Company invested $2,450,000 for 49% of the outstanding common stock of a start-up insurance company in the state of Florida, PIC. The Company has evaluated its investment in PIC, and based on the guidance given in FIN No. 46, has determined that PIC should be consolidated because, among other factors, the Company financed a portion of the other investor’s capital contribution at PIC’s inception. The amount financed was repaid in full prior to December 31, 2003. Minority interest in the accompanying Unaudited Condensed Consolidated Statements of Income and Condensed Consolidated Balance Sheets represents the remaining 51% of the net loss and shareholders’ equity of PIC, respectively.

      PIC was formed in March of 2003 with the intent of writing as much medical professional liability insurance as PIC’s capital and surplus levels could reasonably support. At March 31, 2004, PIC’s total assets were approximately $9.1 million and direct premiums written by PIC were approximately $1.3 million and $0 for the three months ended March 31, 2004 and 2003, respectively. The Company has no future obligations with respect to its investment in PIC, nor do creditors of PIC have any recourse to the general credit of the Company. Accordingly, the maximum exposure to loss as a result of the Company’s involvement with PIC, is approximately $2.7 million, which represents the initial pro-rata equity contribution of $2,450,000 plus the remaining unamortized balance of an intangible asset of $217,000 related to a covenant not to compete.

3.     Income (Loss) Per Share

      Net income (loss) per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock and common stock equivalents (e.g., stock options and stock awards) outstanding, calculated on a daily basis. Basic weighted average shares outstanding for the three months ended March 31, 2004 and 2003 were 8,411,234 and 8,594,572, respectively. Diluted weighted average shares outstanding for the three months ended March 31, 2004 were 8,526,870. As the Company was in a net loss

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

position for the three months ended March 31, 2003, no effect of options or other stock awards was calculated as the impact would have been anti-dilutive.

      The following table sets forth the computation of basic and diluted net income (loss) per common share:

      The Company is organized and operates principally in the property and casualty insurance industry and has three reportable segments — medical professional liability, other insurance lines, and corporate and other in 2004. Prior to 2004, the Company had five reportable segments — medical professional liability, workers’ compensation, health, and personal and commercial insurance lines, as well as a corporate and other segment. As the Company has begun to implement its exit from the workers’ compensation and health insurance lines, and exited the personal and commercial lines in 2001, management’s emphasis on these lines, as well as their financial significance has decreased. Accordingly, these three previously separately reported segments have been aggregated into the other insurance lines segment reported in 2004. Reported 2003 amounts have been reclassified to conform to the current year presentation.

      The accounting policies of the segments are consistent with those described in the Notes to the Consolidated Financial Statements included in the Company’s most recent Annual Report on Form 10-K. Expense allocations are based primarily on loss and loss adjustment expenses by line of business and certain other estimates for underwriting expenses. Investment income, investment expense, amortization expense and interest expense are allocated to the segments based on that segment’s “ownership” percentage of the assets or liabilities underlying the income or expense. General and administrative expenses are all attributed to the holding company and are included in corporate and other.

      The following tables show total assets and income (loss) before income taxes and minority interests for each of the Company’s reportable segments:

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In late 2003, management announced its intention to exit both the workers’ compensation and health insurance lines of business, both of which are included above in other insurance lines. In early 2004 the Company began non-renewing workers’ compensation policies and will begin non-renewing health policies effective July 1, 2004.

      The following table shows the Company’s fair value and gross unrealized investment losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2004.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Unrealized losses above are primarily related to mortgage-backed securities, which are typically slightly more sensitive to changes in prevailing interest rates than other fixed-maturity securities due to pre-payment options. The unrealized losses associated with mortgage-backed securities are considered by the Company to be interest rate related and temporary in nature.

      On both December 30, 2003 and February 20, 2004, separate putative shareholder class action complaints were filed in United States District Court for the Western District of Michigan against the Company, its former President and Chief Executive Officer, and its Chief Financial Officer. The complaints allege violations of federal securities laws for certain disclosures made by the Company between February 13, 2003 and November 6, 2003, regarding its operating results and the adequacy of its reserves, and each seeks monetary damages in an unspecified amount. The Company denies the allegations and intends to vigorously defend the lawsuits. On March 23, 2004, the Court dismissed the first case and entered an Order approving a lead plaintiff in the second case. A consolidated amended complaint was filed by the lead plaintiff on May 7, 2004. The Company and individual defendants intend to file a motion to have the complaint dismissed. While management believes that meritorious defenses to the allegations exist, the ultimate disposition of this litigation could have a material adverse impact on the Company’s financial position, liquidity and results of operations.

7.     Related Party Transactions

      On January 2, 2004, the $6.0 million obligation to the Company’s former President and Chief Executive Officer (“CEO”) was repaid in its entirety in connection his retirement.

      At December 31, 2003, the Company had a $286,000 non-interest bearing note receivable from SCW Agency Group, Inc. (“SCW”), an insurance agency that is principally owned by the Company’s former President and CEO. At December 31, 2003, the Company had established an allowance in the amount of $286,000 related to the note. As part of a new master agency agreement between American Physicians, a wholly owned subsidiary of APCapital, and SCW, which was effective January 1, 2004, this note was forgiven in exchange for certain more favorable contract terms. Accordingly, the note and the allowance were written off during 2004, which did not result in a charge to income.

8.     Restructuring Charges

      In the fourth quarter of 2003, the Company began to exit its workers’ compensation and health lines of business. In connection with the exit of these lines, the Company expects to incur a total of approximately $1.3 million of restructuring charges for one-time employee termination benefits and employee stay bonuses.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During the three months ended March 31, 2004, $121,000 of additional restructuring costs were incurred, bringing the total amount incurred through March 31, 2004, to $929,000. The costs are included on the accompanying unaudited Condensed Consolidated Statements of Income in the other expenses line item.

      The activity in the liability for restructuring charges for the three months ended March 31, 2004 was as follows:

      Payments related to this liability will primarily be made in the next six months; however, some payments will extend through 2005.

      Certain employees related to the workers’ compensation line of business have been retained to manage the run-off of this line through June 30, 2005. The employee separation costs related to these individuals will be recognized prospectively over the future service period. At March 31, 2004, total future employee separation costs are estimated to be approximately $350,000.

9.     Income Taxes

      The provision for income taxes for the three months ended March 31, 2004 and 2003 consists of:

      Income taxes incurred do not bear the usual relationship to income before federal income taxes for the three months ended March 31, 2004 and 2003 due to the following:

      Deferred federal income tax assets and liabilities are recognized for the estimated future tax consequences attributable to the differences between financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. The Company has reviewed its deferred federal income tax assets for recoverability based on the availability of future taxable income when the deductible temporary differences are

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expected to reverse, and has determined, based on its recent loss experience, that sufficient taxable income may not exist in the periods of reversal. Accordingly, the Company has recorded a deferred tax asset valuation allowance for the entire net deferred tax asset. As the Company’s deferred tax assets and liabilities change, the valuation allowance also changes. Any change in the valuation allowance is recorded as federal income tax expense (benefit) in the period of change. Once the Company has re-established a pattern of profitability, the deferred tax asset valuation allowance may be reduced upon evaluation of the availability of future taxable income.

      At March 31, 2004 and December 31, 2003, the components of the net deferred federal income tax asset were as follows: